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Chapter 16

Statement of Cash Flows


Accounting, 21st Edition
Warren Reeve Fess

PowerPoint Presentation by Douglas Cloud


Professor Emeritus of Accounting Pepperdine University

Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.

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Objectives
1. Summarize the studying this flow After types of cash activities reportedyouthe statement of chapter, in should cash flows. be able to: 2. Prepare a statement of cash flows, using the indirect method. 3. Prepare a statement of cash flows, using the direct method. 4. Calculate and interpret the free cash flow.

Reporting Cash Flows


The statement of cash flows reports cash flows by three types of activities: 1. Cash flows from operating activities transactions that affect net income. 2. Cash flows from investing activities transactions that affect noncurrent assets. 3. Cash flows from financing activities transactions that affect equity and debt of the entity.

Reporting Cash Flows


Increases in Cash Decreases in Cash

Operating
(receipts from revenues)

Operating
(payments for expenses)

Investing
(receipts from sales of noncurrent assets)

Investing
(payments for acquiring noncurrent assets)

Financing
(receipts from issuing equity and debt securities)

Financing
(payments for treasury stock, dividends, and redemption of debt securities)

Cash Flows from Operating Activities


Typical cash inflows What are some of the typical cash inflows from operating activities?` Sales of goods and services Interest revenue Dividend revenue Typical cash outflows What are some of the typical cash outflows from operating activities? Merchandise purchases Payments of wages and other expenses Tax payments

Cash Flows from Investing Activities


Typical cash inflows What are some of the typical cash inflows from investing activities? Sales of fixed assets Sale of longlongterm investments Typical cash outflows What are some of the typical cash outflows from investing activities? Purchase of fixed assets Purchase of longlong-term investments

Cash Flows from Financing Activities


Typical cash inflows What are some of the typical cash inflows from financing activities? Issuing bonds and long-term longnotes payable Issuing preferred and common stock Typical cash outflows What are some of the typical cash outflows from financing activities? Paying cash dividends Repaying debt Acquiring treasury stock

Noncash Investing and Financing Activities


 Issuing bonds to acquire land  Issuing common stock for

convertible preferred stock


 Issuing a long-term note to

acquire equipment
 Issuing a stock dividend

No cash flow per share is reported in the financial statements because the user might incorrectly interpret this as the amount available for dividends.

The Indirect Method


Balance Sheet
Cash Liabilities Noncash Assets Stockholders Equity

Assets = Liabilities + Stockholders Equity Cash + Noncash Assets = Liabilities + Stockholders Equity Cash = Liabilities + Stockholders Equity Noncash Assets

The Indirect Method


Balance Sheet

Cash Liabilities Noncash Assets Stockholders Equity

Assets = Liabilities + Stockholders Equity Cash + Noncash Assets = Liabilities + Stockholders Equity Cash = Liabilities + Stockholders Equity Noncash Assets
1 2 3

The cash flows are determined by analyzing liabilities, stockholders equity, and noncash assets.

The Indirect Method

Start with the accrual basis net income (shown in the income statement, the Retained Earnings account, or the statement of stockholders equity).

The Indirect Method


Find the net income.
ACCOUNT Retained Earnings Date
2006

ACCOUNT NO. 32 Debit Credit Balance Debit Credit 202,300 310,300 282,300

Item

To statement
108,000

Jan. 1 Balance Dec. 31 Net income 31 Cash dividends

28,000

Operating Activities Indirect Method Cash flows from operating activities: Net income per income statement $108,000 Add: Depreciation $ 7,000 Decrease in inventories 8,000 Increase in accrued expenses 2,200 17,200 Deduct: $125,200 Inc. in accounts receivable $ 9,000 Dec. in accounts payable 3,200 Dec. in income taxes payable 500 Gain on sale of land 12,000 24,700 Net cash flow from operating activity $100,500

The Indirect Method

Next, we need to determine depreciation expense for the year. If it isnt given on the income statement, sometimes it can be found by analyzing the Accumulated Depreciation account.

The Indirect Method


Determine depreciation expense.
ACCOUNT Accumulated Depreciation--Building ACCOUNT NO. 17 Date
2006

Item

Debit

Credit

Balance Debit Credit 58,300 65,300

Jan. 1 Balance Dec. 31 Depreciation for year

7,000

to statement

Operating Activities Indirect Method Cash flows from operating activities: Net income per income statement $108,000 Add: Depreciation $ 7,000 Decrease in inventories 8,000 Increase in accrued expenses 2,200 17,200 Deduct: $125,200 Inc.Because Depreciation Expense in accounts receivable $ 9,000 Dec. in accounts payable but did not 3,200 reduced net income Dec. in income taxes payable 500 require an outflow of cash, it is Gain on sale of land 12,000 24,700 added back to net income. Net cash flow from operating activities $100,500

The Indirect Method

Select current assets and current liabilities that impact cash flow and determine the increases and decreases.

Changes in Current Accounts


Accounts Accounts receivable (net) Inventories Accounts payable (mdse.) Accrued expenses payable Income taxes payable 2006 $74,000 172,000 43,500 26,500 7,900 2005 $65,000 180,000 46,700 24,300 8,400 Change Debit Credit 9,000 8,000 3,200 2,200 500

Determine the debit or credit change of each item above.

Changes in Current Accounts


Accounts Accounts receivable (net) Inventories Accounts payable (mdse.) Accrued expenses payable Income taxes payable 2006 $74,000 172,000 43,500 26,500 7,900 2005 $65,000 180,000 46,700 24,300 8,400 Change Debit Credit 9,000 8,000 3,200 2,200 500

These debit changes are subtracted from net income in the operating activities section of the statement of cash flows. Think of these debits as deductions from net income in arriving at net cash flow from operations.

Changes in Current Accounts


Accounts Accounts receivable (net) Inventories Accounts payable (mdse.) Accrued expenses payable Income taxes payable 2006 $74,000 172,000 43,500 26,500 7,900 2005 $65,000 180,000 46,700 24,300 8,400 Change Debit Credit 9,000 8,000 3,200 2,200 500

These credit changes are added to net income in the operating activities section of the statement of cash flows. Think of these credits as additions to net income in arriving at net cash flow from operations.

Operating ActivitiesIndirect Method Activities Cash flows from operating activities: Net income per income statement $108,000 Add: Depreciation $ 7,000 Decrease in inventories 8,000 Increase in accrued expenses 2,200 17,200 $125,200 Inc. in accounts receivable $ 9,000 Dec. in accounts payable 3,200 Dec. in income taxes payable 500 Gain on sale of land 12,000 24,700 Net cash flow from operating activities $100,500

The Indirect Method

Analyze the income statement to determine if there are any gains or losses from selling investments, equipment, etc.

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales Cost of merchandise sold Gross profit Operating expenses: Depreciation expense Other operating expenses Total operating expenses Income from operations Other income: Gain on sale of land Other expense: Interest expense Income before income tax Income tax Net income $1,180,000 790,000 $ 390,000 $ 7,000 196,000 203,000 $ 187,000 $12,000 8,000 4,0000 $ 191,000 83,000 $ 108,000

Operating ActivitiesIndirect Method Activities Cash flows from operating activities: Net income, per income statement $108,000 Add: Depreciation $ 7,000 ThisDecrease in included in net income, but did gain was inventories 8,000 Increase in accrued operating cash flow.17,200 not represent an expenses 2,200 $125,200 Inc. in accounts receivable $ 9,000 Dec. in accounts payable 3,200 Dec. in income taxes payable 500 Gain on sale of land 12,000 24,700 Net cash flow from operating activities $100,500

The Indirect Method


If there had been a loss on this sale, the loss would have been added to net income.

Cash Flows from Financing Activities


Dividends
ACCOUNT Dividends Payable Date
2006

ACCOUNT NO. 23 Debit Credit Balance Debit Credit 10,000 -14,000 -14,000

Item Balance Cash paid Dividends declared Cash paid Dividends declared

1 10 June 20 July 10 Dec. 20

Jan.

10,000 14,000 14,000 14,000

---

Total cash paid

$24,000

Cash Flows from Financing Activities


Because paying of dividends affects equity, it is a negative $24,000 cash flow from financing activities transaction.

Cash Flows from Financing Activities


Sale of Common Stock
ACCOUNT

Common Stock
Item Debit Credit

ACCOUNT NO. 33

Date
2006

Balance Debit Credit 16,000 24,000

Jan. Nov.

1 Balance 1 4,000 shares issued for cash

8,000

Cash Flows from Financing Activities


Sale of Common Stock
ACCOUNT

Paid-In Capital in Excess of Par--Common ACCT. NO. 34


Item Debit Credit Balance Debit Credit 80,000 120,000

Date
2006

Jan. Nov.

1 Balance 1 4,000 shares issued for cash

40,000

Cash Flows from Financing Activities


Issuing common stock affects equity; therefore, we have a total positive cash flow of $48,000 from this financing activities transaction.

Cash Flows from Financing Activities


Retirement of Bonds Payable
ACCOUNT

Bonds Payable
Item Debit Credit

ACCOUNT. NO. 25

Date
2006

Balance Debit Credit 150,000

Jan. 1 Balance June 30 Retired by payment of cash at face amount

50,000

100,000

Cash Flows from Financing Activities


This transaction is a negative cash flows from financing activities item because longterm debt is involved.

Cash Flows from Investing Activities


Purchased a Building
ACCOUNT

Building
Item Debit

ACCOUNT NO. 18 Credit Balance Debit Credit 200,000 260,000

Date
2006

Jan. 1 Balance Dec. 27 Purchased for cash

60,000

Cash Flows from Investing Activities


Purchased a Building Purchasing a building involves a noncurrent asset, so this is a negative cash flows from investing activities item.

Cash Flows from Investing Activities


Land Transactions
ACCOUNT

Land
Item Debit

ACCOUNT NO. 16 Credit Balance Debit Credit

Date
2006

Jan. 1 Balance June 8 Sold for $72,000 cash Oct. 12 Purchased for $15,000 cash

125,000 60,000 65,000 15,000 80,000

Cash Flows from Investing Activities


Land Transactions The first transaction, the sale of land, results in a positive cash flow from investing activities because land is a noncash asset.

Cash Flows from Investing Activities


Land Transactions The $12,000 gain was recorded earlier on Slide 29 as an operating activity. The purchase of land also is an investing activity.
Click here to return to Slide 29. To return to this slide, type 43 and press the Enter key.

Refer to Exhibit 6 in your textbook to see the formal statement of cash flows using the indirect approach.

Rundell Inc. Statement of Cash Flows For the Year Ended December 31, 2006 Cash flows from operating activities: Net inco me Add: Depreciation $ 7,000 Decrease in inventor. 8,000 Increase in accrued exp. 2,200 Deduct: Increase in A/R $9,000 Decrease in accts. Pay. 3,200 Decrease in ITP 500 Gain on sale of land 12,000 Net cash flow fro m operating act. Cash flows from investing activities: Cash from sale of land Less: Cash paid to pur. land $15,000 Cash paid for bldg. 60,000 Cash flows from financing activities: Cash received fro m sale of c.s. Less: Cash paid to retire b. $50,000 Cash paid for divid. 24,000 Net cash flow for financing Increase in cash Cash at beginning of year Cash at end of year $108,000 17,200 $125,000

24,700 $100,500 $72,000 75,000 (3,000) $48,000 74,000 (26,000) $71,500 26,000 $97,500

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 This is an accrual basis income statement. Income tax 83,000 The direct Net income method of reporting cash flows will $ 108,000

Cash Basis

essentially convert this to a cash basis statement.

Rundell Inc. Income Statement For the Year Ended December 31, 2006

Cash Basis

Sales $1,180,000 Cost of merchandise sold 790,000 Cash collected Gross profit $ 390,000 Changes from Operating expenses: customers Debit Credit Depreciation expense $ 7,000 Sales 1,180,000 Other operating expenses 196,000 Receivables 9,000 203,000 Total operating expenses Income from operations $ 187,000 Other income: Note: The changes in$12,000 the current balance Gain on sale of land Other expense: sheet accounts are determined by Interest expense 8,000 4,000 comparing the beginning and ending Income before income tax $ 191,000 balances. Receivables increased by Income tax 83,000 Net income $ 108,000 $9,000 during the period.

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Cash collected Gross profit $390,000 Changes from Operating expenses: customers Debit Credit Depreciation expense $ 7,000 Sales 1,180,000 Other operating expenses 196,000 Receivables 9,000 203,000 Total operating expenses Cash 1,171,000 $187,000 Income from operations Other income: Gain on sale of land The increase $12,000 in receivables Other expense: represents a reduction in4,000 cash Interest expense 8,000 inflow relative to the $ 191,000 accrual Income before income tax Income tax revenue reported on the income 83,000 Net income $ 108,000

Cash Basis
$1,171,000

statement.

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $390,000 Cash payments for Operating expenses: Changes merchandise Depreciation expense $ 7,000 Credit Debit Other operating expenses 196,000 Cost of mdse. sold 790,000 Total operating expenses 203,000 Inventories 8,000 Income from operations $187,000 Accounts payable 3,200 Other income: Cash Gain on sale of land $12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000

Cash Basis
$1,171,000

Rundell Inc. Income Statement For the Year Ended December 31, 2006

Cash Basis

Sales $1,180,000 $1,171,000 Cost of merchandise sold 790,000 (785,200) Gross profit $390,000 Cash payments for Operating expenses: Changes merchandise Depreciation expense $ 7,000 Credit Debit Other operating expenses 196,000 Cost of mdse. sold 790,000 Total operating expenses minus 203,000 Inventories 8,000 Income from operations $187,000 Accounts payable 3,200 plus Other income: Cash Gain on sale of land $12,000 785,200 Other expense: A decrease in Inventories (credit Interest expense 8,000 4,000 change) Income before income taxand an decrease in Accounts $ 191,000 Income tax 83,000 Payable (debit change) have the Net income $ 108,000

opposite effects.

Rundell Inc. Income Statement For the Year Ended December 31, 2006

Cash Basis

Sales $1,180,000 $1,171,000 Cost of merchandise sold 790,000 (785,200) Gross profit $ 390,000 Operating expenses: 0 Depreciation expense $ 7,000 Other operating expenses 196,000 Changes Depreciation Total operating expenses 203,000 Debit $ Credit Income from operations 187,000 Depreciation expense 7,000 Other income: Accumulated 7,000 Gain on sale of land depreciation $12,000 Other expense: Interest expense There is no cash flow for 8,000 4,000 Income before income tax depreciation $ 191,000 expense. Income tax 83,000 Net income $ 108,000

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Cash payments for Changes Income from operations $ 187,000 operating expenses Changes Debit Credit Other income: 196,000 Gain onOperating expenses sale of land $12,000 Other expense: Accrued expenses 2,200 minus InterestCash expense 8,000 193,800 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000

Cash Basis
$1,171,000 (785,200)

0 (193,800)

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Changes Gain on Operating expenses: sale of investments Depreciation expense $Debit Credit 7,000 Cash 72,000 Other operating expenses 196,000 Investments 60,000 Total operating expenses 203,000 Gain on sale of Income from operations invest. $ 12,000 187,000 Other income: Gain on sale of land $12,000 Other expense: Interest expense inflow of $72,000 will 8,000 4,000 The cash Income before income tax $ 191,000 be shown in the investing section Income tax 83,000 of Net incomethe statement of cash flows 108,000 $ and

Cash Basis
$1,171,000 (785,200)

0 (193,800)

the gain is ignored.

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Cash expenses Changes Other operating paid for 196,000 interest expenses Debit Credit Total operatingexpense 203,000 Interest expense Income from operations 8,000 $ 187,000 Cash Other income: Gain on sale of land $12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 There is no interest payable Income tax 83,000 Net income $ year. account at the end of the108,000

Cash Basis
$1,171,000 (785,200)

0 (193,800)

0 (8,000)

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Cash paid for Changes Income from operations $ 187,000 income taxes Debit Credit Other income: Income tax expense 83,000 Gain on sale of land $12,000 Income 500 Other expense: tax payable plus InterestCash expense 8,000 (83,500) 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000

Cash Basis
$1,171,000 (785,200)

0 (193,800)

(8,000) (83,500)

Rundell Inc. Income Statement For the Year Ended December 31, 2006

Cash Basis

Sales $1,180,000 $1,171,000 Cost of merchandise sold 790,000 (785,200) Gross profit $ 390,000 Two different Operating expenses: Depreciation expense $ 7,000 viewpoints 0 Other operating expenses 196,000 (193,800) Total operating expenses 203,000 of income from Income from operations $ 187,000 operations Other income: Gain on sale of land $12,000 0 Accrual Cash Other expense: Basis Basis Interest expense 8,000 4,000 (8,000) Income before income tax $ 191,000 Income tax 83,000 (83,500) Net income $ 108,000 $ 100,500

Operating ActivitiesDirect Method Activities


Cash flows from operating activities:
Cash inflows: Cash received from customers $1,171,000 Cash outflows: Cash payments for merchandise $785,200 Cash payments for operating expenses 193,800 Cash payments for interest 8,000 Cash payments for income tax 83,500 1,070,500 Net cash flow from operating activities $ 100,500

Financial Analysis and Interpretation


Free Cash Flow Dell Corporation

Cash flow from operations $4,195,000 Less: Cash used to purchase fixed assets to maintain productive capacity used up in producing income during the period (482000) Less: Cash used for dividends Free cash flow $3,713,000 Free cash flow as a percent of cash flow from operating activities 89%

Financial Analysis and Interpretation


Free Cash Flow Dell Corporation

Cash flow from operations $4,195,000 Use: To measure the financial strength of a Less: Cash used toA company that has positive business. purchase fixed assets to maintain productive free cash flow is able to fund internal capacity used up in producing growth, retire debt, and income during the period enjoy (482000) financial flexibility. Less: Cash used for dividends () Free cash flow $3,713,000 Free cash flow as a percent of cash flow from operations 89%

Chapter 16 The End

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