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Chapter 15:

Statement of Cash Flows

Cornerstones of Managerial Accounting, 4e

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1
Overview of the
Statement of Cash Flows
► All firms that are registered with the U.S. Securities and Exchange
Commission (SEC) must issue a statement of cash flows.
► The statement of cash flows provides information regarding the sources
and uses of a firm’s cash.
Activities that increase cash are sources of
cash and are referred to as cash inflows.
Activities that decrease cash are uses of
cash and referred to as cash outflows.

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license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1 Cash Defined
►Cash is defined as both currency and cash
equivalents.
►Cash equivalents are highly liquid investments such
as Treasury bills, money market funds, and
commercial paper.
►Many firms, as part of their cash management
programs, invest their excess cash in these short-
term securities.
►Because of their high liquidity, these short-term
investments are treated as cash for the statement of
cash flows.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1 Statement of Cash Flows Categories
► The statement provides additional information by classifying
cash flows into three categories:
► Operating activities are the ongoing, day-to-day, revenue-generating
activities of an organization. Typically, operating cash flows involve
increases or decreases in either current assets or current liabilities.
► Investing activities are those activities that involve the acquisition or
sale of long-term assets. Long-term assets may be productive assets
(e.g., acquiring new equipment) or long-term activities (e.g., acquiring
stock in another company).
► Financing activities are those activities that raise (provide) cash from
(to) creditors and owners. Although interest payments could be seen
as financing outflows, the statement includes these payments in the
operating section.
► This classification, called the activity format, is the format for
preparing the statement.
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license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1 Noncash Exchanges

► Occasionally, investing and financing activities take place


without affecting cash.
► These are referred to as noncash investing and financing
activities.
► A direct exchange of noncurrent balance sheet items may
occur, like land exchanged for common stock.
► These noncash transactions must also be disclosed in a
supplementary schedule attached to the statement.

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1 Methods for Calculating
Operating Cash Flows
►There are two approaches for calculating operating
cash flows.
►The indirect method computes operating cash flows by
adjusting net income for items that do not affect cash
flows.
►The direct method computes operating cash flows by
adjusting each line on the income statement to reflect
cash flows.

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1 Methods for Calculating
Operating Cash Flows (continued)
► If the direct method is used, companies must also provide a
supplementary schedule that shows how net income is
reconciled with operating cash flows.
► This requirement means that direct method users must also
provide the information associated with the indirect method.
► On the other hand, if the indirect method is used, there is no
need to provide a line-by-line adjustment as found in the
direct method.
► The indirect method is the most commonly used method.

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license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
2 Preparation of the Statement: Indirect Method
► Five basic steps are followed in preparing a statement of cash flows:
► 1. Compute the change in cash for the period. This figure is the difference
between the ending and beginning cash balances shown on the balance
sheets. It must equal the net cash inflow or outflow shown on the statement
of cash flows.
► 2. Compute the cash flows from operating activities. Use the period’s
beginning and ending balance sheets and information about other events
and transactions to adjust the period’s income statement to an operating
cash flow basis.
► 3. Identify the cash flows from investing activities. Use the period’s
beginning and ending balance sheets and information about other events
and transactions to identify the cash flows associated with the sale and
purchase of long-term assets.
► 4. Identify the cash flows from financing activities. Use the period’s
beginning and ending balance sheets to identify the cash flows associated
with long-term debt and capital stock.
► 5. Prepare the statement of cash flows based on the previous four steps.
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license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
2 Compute Operating Cash Flows
► The accrual income statement can be converted to an
operating cash flow basis by making four adjustments to net
income:
A. Add to net income any increases in current liabilities and
decreases in noncash current assets.
B. Deduct from net income any decreases in current
liabilities and increases in noncash current assets.
C. Add to or deduct from net income the remaining net
income items that do not affect cash flows (e.g., add back
noncash expenses).
D. Eliminate any income items that belong in either the
investing or financing section.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
3 The Direct Method:
An Alternative Approach
► Some individuals prefer to show operating cash flows as the
difference between cash receipts and cash payments.
► To do so, each item on the accrual income statement is
adjusted to reflect cash flows.
► However, if a company chooses to prepare the statement of
cash flows using this direct method, it must also present the
indirect method in a separate schedule.
► The same adjustments and the same reasoning are used to
produce the operating cash flows for both the direct and
indirect methods, but the presentation is different.

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Worksheet Approach to the
4
Statement of Cash Flows
► As transactions increase in number and complexity, a worksheet
becomes useful in preparing the statement of cash flows.
► The approach minimizes confusion and allows careful consideration
of all the details underlying an analysis of cash flows.
► One advantage of a worksheet is the fact that it uses a spreadsheet
format, allowing the preparer to use a computer and spreadsheet
software like Excel.
► Furthermore, a worksheet offers the user an efficient, logical
means to organize the data needed to prepare a statement of cash
flows.
► Although the worksheet itself is not the statement of cash flows,
the statement can be easily extracted from the worksheet.

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.