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Chapter 14 (Statement of Cash Flows)
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Chapter 14 (Statement of Cash Flows)

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  • This chart explains how to treat a change in a noncash current asset or current liability in the operating section of the Statement of Cash Flows. Maybe a couple of examples will help you see how this table works. Let’s start with current assets. If Accounts Receivable, a current asset, decreased during the year, this decrease would be added to net income. A decrease in Accounts Receivable means that customer cash payments on account exceeded customer charges on account during the period. This excess of cash payments over charges is used to adjust the accrual based revenues reported on the income statement to report the total cash received from customers during the period. Similarly, if Accounts Receivable increased during the year, this increase would be subtracted from net income. An increase in Accounts Receivable means that customer charges on account exceeded customer cash payments on account during the period. This excess of charges over cash payments is used to adjust the accrual based revenues reported on the income statement to report the total cash received from customers during the period. Now, let’s look at how to treat changes in current liabilities. If Salaries Payable, a current liability, decreased during the year, this decrease would be subtracted from net income. A decrease in Salaries Payable means that the company paid off more in salaries than it charged during the period. This excess of cash payments over charges is used to adjust the accrual based expense reported on the income statement to report the total cash paid for salaries during the period. Similarly, if Salaries Payable increased during the year, this increase would be added to net income. An increase in Salaries Payable means the company charged more than it paid off during the period. This excess of charges over cash payments is used to adjust the accrual based expense reported on the income statement to report the total cash paid for salaries during the period.
  • Transcript

    • 1. Statement of Cash Flows 14 0 Revised by Judy Beebe, Western Oregon University
    • 2. The statement of cash flows reports a firm’s major cash inflows and outflows for a period. It provides useful information about a firm’s ability to generate cash from operations, maintain and expand its operating capacity, meet its financial obligations, and pay dividends. 14-1 0
    • 3. Reporting Cash Flows The statement of cash flows reports cash flows from three types of activities: 1. Cash flows from operating activities are cash flows from transactions that affect net income. 2 . Cash flows from investing activities are cash flows from transactions that affect the investments in noncurrent assets. 3. Cash flows from financing activities are cash flows from transactions that affect the equity and debt of the business. 14-1 0
    • 4. Sources (increases) of Cash Uses (decreases) of Cash Cash Flows 14-1 0 (payments for treasury stock, dividends, and redemption of debt securities) Financing (payments for expenses) Operating (receipts from sales of noncurrent assets) Investing (receipts from issuing equity and debt securities) Financing (payments for acquiring noncurrent assets) Investing (receipts from revenues) Operating
    • 5. Cash Flows from Operating Activities The direct method reports the sources of operating cash and the uses of operating cash. 14-1 0
    • 6. The indirect method reports the operating cash flows by beginning with net income and adjusting it for revenues and expenses that do not involve the receipt or payment of cash. 14-1 0
    • 7. A primary advantage of the direct method is that it reports the sources and uses of operating cash flows in the statement of cash flow. A primary disadvantage of the direct method is that the necessary data may not be readily available and may be costly to gather. 14-1 0
    • 8. A primary advantage of the indirect method is that it focuses on the differences between net income and cash flows from operations. Because the data are readily available, another advantage of the indirect method is that it is normally less costly to use than the direct method. 14-1 0
    • 9. Cash Flows from Operations: Direct and Indirect Methods— NetSolutions same amount 3 14-1 0
    • 10. Noncash Investing and Financing Activities Noncash investing and financing activities are transactions that do not involve cash. The effect of such transactions is recorded in a separate schedule that appears at the bottom of the statement of cash flows. 14-1 0
    • 11. 14-1
      • For each of the following, identify whether it would be disclosed as an operating, financing, or investing activity on the statement of cash flows under the indirect method.
      • a. Purchase Patent d. Net Income
      • Pay cash dividend e. Purchase treasury stock
      • Disposal of f. Depreciation expense
      • Equipment
      0 For Practice: PE 14-1A, PE 14-1B
      • Investing
      b. Financing c. Investing
      • Operating
      e. Financing f. Operating Example Exercise 14-1
    • 12. An efficient approach to preparing the statement of cash flows is to analyze the changes in the noncash balance sheet accounts. The logic of this approach is that a change in any balance sheet account (including Cash ) can be analyzed in terms of changes in the other balance sheet accounts. 14-2 0
    • 13. The analysis of Retained Earnings provides a good starting point for determining the cash flows from operating activities, which is the first section of the statement of cash flows. 14-2 0
    • 14. Comparative Balance Sheet (Continued) 14-2 0
    • 15. Comparative Balance Sheet (Concluded) 14-2 0
    • 16. Indirect Method Use this table when adjusting Net Income to Cash Flow form Operations.
    • 17. Retained Earnings The Retained Earnings account for Rundell Inc. reveals that the balance increased $80,000 during the year. 14-2 0 ACCOUNT Retained Earnings ACCOUNT NO. 32 Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 202,300.00 Dec. 31 Net income 108,000.00 310,300.00 31 Cash dividends 28,000.00 282,300.00
    • 18. The net income of $108,000 is entered on the statement (or working papers). To statement 14-2 0 ACCOUNT Retained Earnings ACCOUNT NO. 32 Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 202,300.00 Dec. 31 Net income 108,000.00 310,300.00 31 Cash dividends 28,000.00 282,300.00
    • 19. 18 Operating Activities— Rundell Inc. Cash flows from operating activities: Net income $108,000 Adjustments to reconcile net income to net cash flow from operating activities: This phrase is added to indicate that accrual basis net income is being adjusted to arrive at cash flows from operations. 14-2 0
    • 20. Next, we need to determine depreciation expense for the year. If it isn’t given in the income statement, sometimes it can be found by analyzing the various accumulated depreciation accounts. Depreciation 14-2 0
    • 21. to statement The comparative balance sheet (Exhibit 4: Slides 23 and 24 ) indicates that Accumulated Depreciation—Building increased by $7,000. By analyzing the account we can see that the increase is the result of the year-end adjusting entry. 14-2 0 ACCOUNT Accumulated Depreciation—Building ACCT . NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 58,300.00 Dec. 31 Depr. for year 7,000.00 65,300.00
    • 22. The offsetting $7,000 debit is to an expense for depreciation. The effect on the income statement was to reduced net income; however, this expense did not require an outflow of cash. Therefore, the $7,000 is added back to net income in determining cash flows from operating activities. 14-2 0
    • 23. Cash flows from operating activities: Net income $108,000 Adjustments to reconcile net income to net cash flow from operating activities: Depreciation 7,000 Operating Activities—Rundell Inc. 14-2 0 Amortization is treated in the same manner as depreciation.
    • 24. Gain on Sale of Land The ledger or income statement of Rundell Inc. indicates that the sale of land resulted in a gain of $12,000. This gain increased net income by $12,000, yet cash flows was provided by an investing activity (selling land) rather than an operating activity, so the gain is deducted from net income on the statement of cash flows. 14-2 0
    • 25. Operating Activities—Rundell Inc. Cash flows from operating activities: Net income $108,000 Adjustments to reconcile net income to net cash flow from operating activities: Depreciation 7,000 Gain on sale of land (12,000) 14-2 0
    • 26. 14-2 Omni Corporation’s accumulated depreciation increased by $12,000, while patents decreased by $3,400 between balance sheet dates. There were no purchases or sales of depreciable or intangible assets during the year. In addition, the income statement showed a gain of $4,100 from sale of land. Reconcile a net income of $50,000 to net cash flow from operating activities. 0 Example Exercise 14-2
    • 27. For Practice: PE 14-2A, PE 14-2B 14-2 Net income $50,000 Adjustments to reconcile net income from operating activities: Depreciation 12,000 Amortization 3,400 Gain on sale of land (4,100 ) Net cash flow from operating activities $61,300 0 Follow My Example 14-2
    • 28. Next, select current assets and current liabilities that impact cash flows and determine their increases and decreases. Exhibit 5 in ( Slide 28 ) may prove to be helpful in determining how to treat increases and decreases in noncash current operating assets and current operating liabilities. Changes in Current Operating Assets and Liabilities 14-2 0
    • 29. Adjustments to Net Income (Loss) Using the Indirect Method 14-2 0
    • 30. Changes in Current Accounts Accounts Accounts receivable (net) $ 74,000 $ 65,000 Inventories 172,000 180,000 Accounts payable (mdse.) 43,500 46,700 Accrued expenses payable 26,500 24,300 Income taxes payable 7,900 8,400 9,000 8,000* 3,200* 2,200 500* 2008 2007 December 31 Increase Decrease* Note that Cash and Dividends Payable are not included in this analysis. 14-2 0
    • 31. Cash flows from operating activities: Net income $108,000 Adjustments to reconcile net income to net cash flow from operating activities: Depreciation 7,000 Gain on sale of land (12,000) Changes in current operating assets and liabilities: Increase in accounts receivable (9,000) Decrease in inventory 8,000 Decrease in accounts payable (3,200) Increase in accrued expenses 2,200 Decrease in income taxes payable (500) Operating Activities—Indirect Method You will notice that increases actually decrease cash flows from operating activities, and decreases do just the opposite. 14-2 0
    • 32. Statement of Cash Flows—Indirect Method for Rundell Inc. (Operating Activities Section) Same information as Slide 30, only in final form. 14-2 0
    • 33. 14-2 Victor Corporation’s comparative balance sheet for current assets and current liabilities was as follows: Dec. 31, 2009 Dec. 31, 2008 Accounts receivable $ 6,500 $ 4,900 Inventory 12,300 15,000 Accounts payable 4,800 5,200 Dividends payable 5,000 4,000 Adjust net income of $70,000 for changes in operating assets and liabilities. 0 Example Exercise 14-3
    • 34. For Practice: PE 14-3A, PE 14-3B 14-2 Net income $70,000 Adjustments to reconcile net income to net cash from from operating activities: Increase in accounts receivable (1,600) Decrease in inventory 2,700 Decrease in accounts payable (400 ) Net cash flow from operating activities $70,700 0 Follow My Example 14-3
    • 35. 14-2 Omicron, Inc. reported the following data: Prepare the cash flow for operating activities section of the statement of cash flows using the indirect method. Net income $120,000 Depreciation expense 12,000 Loss on disposal of equipment 15,000 Increase in Accounts receivable 5,000 Decrease in Accounts payable (2,000) 0 Example Exercise 14-4
    • 36. For Practice: PE 14-4A, PE 14-4B 14-2 Cash flows from operating activities: Net income $120,000 Adjustments to reconcile net income to net cash flow from operating activities: Depreciation 12,000 Loss from disposal of equipment 15,000 Changes in current operating assets and liabilities: Increase in accounts receivable (5,000) Decrease in accounts payable (2,000 ) Net cash flow from operating activities $140,000 0 Follow My Example 14-4
    • 37. 14-2 Cash Flows Used for Payment of Dividends ACCOUNT Dividends Payable ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 10,000 10 Cash paid 10,000 — June 20 Dividends declared 14,000 14,000 July 10 Cash paid 14,000 — Dec. 20 Dividends declared 14,000 14,000 Note that while $28,000 in dividends were declared, only $24,000 were paid during the year. 0
    • 38. Because paying of dividends affects equity and is an outflow of cash, it is a negative $24,000 cash flows from financing activities transaction. 14-2 0
    • 39. Common Stock Common Stock increased by $8,000. ACCOUNT Common Stock ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 16,000 Nov. 1 4,000 shares issued/cash 8,000 24,000 14-2 0
    • 40. ACCOUNT Paid-in Capital in Excess of Par—Common Stock Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 80,000 Nov. 1 4,000 shares issued/cash 40,000 120,000 Analyzing the two accounts together, we can determine that the 4,000 shares were sold for $48,000. 14-2 0
    • 41. Issuing common stock affects equity; therefore, we have a positive $48,000 cash flows from financing activities item. 14-2 0
    • 42. Bonds Payable Bonds Payable decreased by $50,000. ACCOUNT Bonds Payable ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 150,000 June 30 Retired by payment of cash at face amount 50,000 100,000 14-2 0
    • 43. Retiring bonds is a cash outflow reported as a negative item under cash flows from financing activities . 14-2 0
    • 44. Building ACCOUNT Building ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 200,000 Dec. 27 Purchased for cash 60,000 260,000 By examining the Building account, we can determine that Rundell Inc. bought a building for $60,000 cash. 14-2 0
    • 45. Purchasing a building involves a noncurrent asset, so this is a negative cash flows from investing activity . 14-2 0
    • 46. Land ACCOUNT Land ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 125,000 June 8 Sold for $72,000 cash 60,000 65,000 Oct. 12 Purchased for $15,000 cash 15,000 80,000 The $45,000 decline in the Land account resulted from two separate transactions: a sale and a purchase. 14-2 0
    • 47. The first transaction, the sale of land, is classified as a positive cash flows from investing activity because land is a noncash asset. 14-2 0
    • 48. The $12,000 gain was recorded earlier on Slide 24 as an operating activity. The purchase of land also is an investing activity. Click the button to view Slide 24. To return to this slide, type “47” and press the “Enter” key. 14-2 0
    • 49. The second transaction is the purchase of land for cash of $15,000. This transaction is reported as an outflow of cash in the cash flows from investing activities section. 14-2 0
    • 50. Statement of Cash Flows—Indirect Method for Rundell Inc. (Partial Statement) 14-2 0
    • 51. Statement of Cash Flows—Indirect Method for Rundell Inc. (Partial Statement) The ending balance in the Cash account should match this amount. 14-2 0
    • 52. 14-2 Alpha Corporation purchased land for $125,000. Later in the year the company sold land with a book value of $165,000 for $200,000. How are the effects of these transactions are reported on the statement of cash flows? 0 Example Exercise 14-5
    • 53. For Practice: PE 14-5A, PE 14-5B 14-2 0 Follow My Example 14-5 The gain on sale of land is deducted from net income as shown below: Gain on sale of land $(35,000) Cash received for sale of land $200,000 Cash paid for purchase of land (125,000) The purchase and sale of land is reported as part of cash inflow form investing activities as shown below:
    • 54. The final amount for cash flows from operating activities will be the same whether the direct or indirect approach is used. The methods differ in how the data are obtained, analyzed, and reported. The Direct Method 14-3 0
    • 55. Statement of Cash Flows—Direct Method (Operating Activities Section) 14-3 (Continued) 0
    • 56. Statement of Cash Flows—Direct Method (Reconciliation) A reconciliation is required when the direct method is used. 14-3 0
    • 57. Financial Analysis and Interpretation Free cash flow is a measure of operating cash flow available for corporate purposes after providing sufficient fixed asset additions to maintain current productive capacity and dividends. 14-3 0
    • 58. Cash flow from operations Less: Investments in fixed assets to maintain current production Free cash flow Free Cash Flow Positive free cash flow is considered favorable. A company that has free cash flow is able to fund internal growth, retire debt, pay dividends, and enjoy financial flexibility. 14-3 0
    • 59. Cash Flow Patterns and the Financial Health of a Company Operating Cash Flows are Positive Investing Cash Flows are Negative Financing Cash Flows are Positive The company is prosperous and growing. Financing cash flow is used to take advantage of growth opportunities.
    • 60. Cash Flow Patterns and the Financial Health of a Company Operating Cash Flows are Negative Investing Cash Flows are Positive Financing Cash Flows are Positive The company faces serious financial problems. It is selling assets and using financing activities to meet current cash needs.
    • 61. Cash Flow Patterns and the Financial Health of a Company Operating Cash Flows are Positive Investing Cash Flows are Positive or Negative Financing Cash Flows are Negative The company is prosperous but may not have a lot of good growth opportunities. It is using operating cash to pay off debt and pay stockholders.
    • 62. Cash Flow Patterns and the Financial Health of a Company Operating Cash Flows are Positive or Negative Investing Cash Flows are Positive Financing Cash Flows are Negative The company may be facing a current cash flow problem. It is selling assets to supplement current cash flows to cover its financing needs.