CHAPTER 17 STATEMENT OF CASH FLOWS Slides Authored by  Brian Leventhal University of Illinois at Chicago FINANCIAL REPORTI...
I. General Format <ul><li>A. The  purpose  of this  SCF  is to  explain  the  sources  and  uses  of  cash  from three dis...
I. General Format <ul><ul><li>Investing cash flows  result from the  purchase  or  sale  of  productive assets  like : </l...
I. General Format <ul><ul><li>Financing cash flows   result  from a company:  </li></ul></ul><ul><ul><li>selling  its  own...
I. General Format <ul><li>SFAS No. 95  allows firms the  option  of choosing between two alternative formats for presentin...
II. The Direct Approach <ul><li>A. The  direct approach   requires  that firms report  major classes  of:  </li></ul><ul><...
 
 
 
27.747 35.035 32.061 Cash NI
Why and how these adjustment are made will be discussed later.
III.  The Indirect Approach <ul><li>A. The  indirect approach  begins with the  accrual basis   net income  (before extrao...
III.  The Indirect Approach <ul><ul><li>2. Items   excluded  from  accrual basis income  that  did affect   operating cash...
III.  The Indirect Approach <ul><li>B. The  indirect approach  for reporting CFOP Activities is used by  98.8 percent  of ...
III.  The Indirect Approach <ul><li>C. The  indirect approach   reconciles   accrual accounting NI  with  cash flows from ...
III.  The Indirect Approach This is in  effect   Converting   Accrual Basis Revenues  and  Expenses   back to   Cash Basis...
III.  The Indirect Approach <ul><li>D. Both the  direct  and  indirect  approaches for  computing   net cash provided by o...
III.  The Indirect Approach <ul><li>D. Both the  direct  and  indirect  approaches for  computing   net cash provided by o...
III.  The Indirect Approach <ul><ul><li>3. For  comparability purposes , the  FASB  requires firms  using the direct appro...
III.  The Indirect Approach <ul><ul><li>5. The  entire amount of cash taxes paid  is  included  in the  cash flows from op...
III.  The Indirect Approach <ul><ul><li>5. The  entire amount of cash taxes paid  is  included  in the  cash flows from op...
III.  The Indirect Approach <ul><li>D. Both the direct and indirect approaches for computing NCPOA will be the same amount...
III.  The Indirect Approach <ul><li>E. Other elements of the  cash flow statement : </li></ul><ul><ul><li>1. The  investin...
III.  The Indirect Approach <ul><ul><li>2. Investing and financing transactions  that  do not directly  and  immediately  ...
IV.  Preparing the Cash Flow Statement <ul><li>A. The following  three-step process  is used to build the components of th...
IV.  Preparing the Cash Flow Statement <ul><li>B. Comparative balance sheets  and an  income statement  will provide much ...
V. Cash Flows from Operations <ul><li>A. The  purpose  of this section is to  reconcile   net income  to  cash from operat...
<ul><li>Cash Flows from  Investing Activities </li></ul><ul><li>A. This section shows  component increases  and  decreases...
<ul><li>Cash Flows from  Investing Activities </li></ul><ul><ul><li>1. A  loss on sale   occurs  when  book value   is gre...
<ul><li>Cash Flows from  Investing Activities </li></ul><ul><ul><li>1. A  gain on sale   occurs  when  book value   is les...
<ul><li>Cash Flows from  Investing Activities </li></ul><ul><li>C. Purchases  of  long-term assets  with  debt issuances  ...
VII.  Cash Flows from  Financing Activities <ul><li>A. This section reports  cash flow effects  of transactions  affecting...
Statement of Cash Flows Example- Indirect <ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to t...
Statement of Cash Flows Example- Indirect <ul><li>DEPRECIATION </li></ul>ADDED BACK TO NET INCOME  – Depreciation does  no...
Statement of Cash Flows Example- Indirect <ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to t...
Statement of Cash Flows Example- Indirect <ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to t...
Statement of Cash Flows Example- Indirect <ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to t...
Statement of Cash Flows Example- Indirect <ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to t...
Statement of Cash Flows Example- Indirect <ul><li>Gain on Equipment Sale </li></ul><ul><li>Gain on Sale  $17,000  DEDUCTED...
Statement of Cash Flows Example- Indirect <ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to t...
Statement of Cash Flows Example- Indirect Cash from Operating Activities Interest Expense  ( 44,000) Accrual Basis NI  $  ...
Statement of Cash Flows Example- Indirect <ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to t...
Statement of Cash Flows Example- Indirect Cash from Operating Activities Income Tax Exp  (102,375) Accrual Basis NI  $  18...
Statement of Cash Flows Example- Indirect <ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to t...
Statement of Cash Flows Example- Indirect Cash from Operating Activities Sales Revenue  $3,030,000 Accrual Basis NI  $  18...
Statement of Cash Flows Example- Indirect <ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to t...
Statement of Cash Flows Example- Indirect Cash from Operating Activities Sales Revenue  $3,030,000 Accrual Basis NI  $  18...
Statement of Cash Flows Example- Indirect <ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to t...
Statement of Cash Flows Example- Indirect <ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to t...
Statement of Cash Flows Example- Indirect <ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to t...
Statement of Cash Flows Example- Indirect <ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to t...
Statement of Cash Flows Example- Indirect Example:Indirect Method SCF Cash from Operating Activities Cost of Goods Sold  (...
SCF Example- INVESTING SECTION <ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to the  reporte...
Investing  Activities Equipment Sale  $57,000 Land Purchase  (86,000) CASH OUTFLOW   –  Investing Activities Section SCF E...
<ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to the  reported   net balance sheet change  i...
CASH OUTFLOW   –  Investing Activities Section <ul><li>Buildings and Equipment purchase </li></ul>SCF Example- INVESTING S...
SCF Example- FINANCING SECTION <ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to the  reporte...
Financing  Activities Common stock issued  $50,000 CASH INFLOW   –  Financing Activities Section SCF Example- FINANCING SE...
SCF Example- FINANCING SECTION <ul><li>Step 1 .  Identify  the  journal entry(s)  or  T-Accounts  that led to the  reporte...
Financing  Activities Dividends Paid  ($90,000) Common stock issued  $50,000 CASH OUTFLOW   –  Financing Activities Sectio...
 
VIII.   Reconciling Between Statements:  Some Complexities <ul><li>A. Users  of  financial statements  frequently  encount...
<ul><ul><li>1. Asset write-offs  due to  impairment ,  corporate restructuring  or  retirement . </li></ul></ul><ul><ul><l...
<ul><li>C. Footnote disclosures  and  information  in the  income statement  and  operating section  of the  cash flow sta...
IX.   Analytical Insights: Cash Burn Rates of Internet Stocks <ul><li>A. The  ability  to  generate positive operating cas...
IX.   Analytical Insights: Cash Burn Rates of Internet Stocks <ul><li>B. The  cash burn rate  is a popular  metric  for  a...
IX.   Analytical Insights: Cash Burn Rates of Internet Stocks <ul><li>C. A  related  measure is  months to burnout . </li>...
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  1. 1. CHAPTER 17 STATEMENT OF CASH FLOWS Slides Authored by Brian Leventhal University of Illinois at Chicago FINANCIAL REPORTING & ANALYSIS BY REVSINE – COLLINS – JOHNSON 2 nd Edition Copyright © Prentice Hall 2002
  2. 2. I. General Format <ul><li>A. The purpose of this SCF is to explain the sources and uses of cash from three distinct types of activities: </li></ul><ul><ul><li>1. Operating cash flows result from events or transactions that enter into the determination of net income. </li></ul></ul><ul><ul><ul><li>a. Operating cash flows result from transactions related to the production and delivery of goods and services to customers . </li></ul></ul></ul><ul><ul><ul><li>b. In effect, operating cash flows are the cash basis revenues and expenses of a company. </li></ul></ul></ul>
  3. 3. I. General Format <ul><ul><li>Investing cash flows result from the purchase or sale of productive assets like : </li></ul></ul><ul><ul><li>plant and equipment , </li></ul></ul><ul><ul><li>buying and selling marketable securities (government bonds or stocks and bonds issued by other companies), and </li></ul></ul><ul><ul><li>acquisitions and divestitures of other companies. </li></ul></ul>A. Statement of Cash Flows explain the sources and uses of cash from three distinct types of activities:
  4. 4. I. General Format <ul><ul><li>Financing cash flows result from a company: </li></ul></ul><ul><ul><li>selling its own stocks or bonds , </li></ul></ul><ul><ul><li>paying dividends , </li></ul></ul><ul><ul><li>treasury stock , </li></ul></ul><ul><ul><li>borrowing money and </li></ul></ul><ul><ul><li>repaying amounts borrowed . </li></ul></ul>A. Statement of Cash Flows explain the sources and uses of cash from three distinct types of activities:
  5. 5. I. General Format <ul><li>SFAS No. 95 allows firms the option of choosing between two alternative formats for presenting cash flows from operating activities : </li></ul><ul><li>the direct approach </li></ul><ul><li>(2) the indirect approach . </li></ul>
  6. 6. II. The Direct Approach <ul><li>A. The direct approach requires that firms report major classes of: </li></ul><ul><ul><li>gross cash receipts ( cash revenues ) and </li></ul></ul><ul><ul><li>gross cash payments ( cash expenses ).   </li></ul></ul>
  7. 10. 27.747 35.035 32.061 Cash NI
  8. 11. Why and how these adjustment are made will be discussed later.
  9. 12. III. The Indirect Approach <ul><li>A. The indirect approach begins with the accrual basis net income (before extraordinary items) and adjusts for: </li></ul><ul><ul><li>1. Items included in accrual basis net income that did not affect cash in the current period , such as: </li></ul></ul><ul><ul><ul><li>a. Non-cash revenues or gains (e.g., revenues earned but not received in cash , and gains on disposal of fixed assets ). </li></ul></ul></ul><ul><ul><ul><li>b. Non-cash expenses or losses (e.g., depreciation and amortization , provision for bad debt expense , and expenses accrued but not paid in cash ). </li></ul></ul></ul>
  10. 13. III. The Indirect Approach <ul><ul><li>2. Items excluded from accrual basis income that did affect operating cash flows in the current period , such as: </li></ul></ul><ul><ul><ul><li>a. Cash inflows ( revenues ) received but not recognized as earned in the current period (e.g., rent received in advance and collections on account ). </li></ul></ul></ul><ul><ul><ul><li>b. Cash outflows ( expenses ) paid but not recognized for accrual purposes in the current period (e.g., prepaid insurance and payments on account ). </li></ul></ul></ul>A. The indirect approach begins with the accrual basis net income (before extraordinary items) and adjusts for:
  11. 14. III. The Indirect Approach <ul><li>B. The indirect approach for reporting CFOP Activities is used by 98.8 percent of the 600 companies included in the AICPA's annual financial reporting survey. </li></ul><ul><ul><li>1. The indirect approach is easier for firms to implement because it relies exclusively on data already available in the accrual accounts . </li></ul></ul><ul><ul><li>2. The indirect approach is more familiar to many accountants because this format was widely used in the changes in working capital statement that preceded SFAS No. 95 . </li></ul></ul>
  12. 15. III. The Indirect Approach <ul><li>C. The indirect approach reconciles accrual accounting NI with cash flows from operations. </li></ul><ul><li>Noncash adjustments such as: </li></ul><ul><ul><li>depreciation and amortization, </li></ul></ul><ul><ul><li>equity in the net (income) loss of affiliated comp. </li></ul></ul><ul><ul><li>(gains) losses on disposals of fixed assets, and </li></ul></ul><ul><ul><li>deferred income tax provisions </li></ul></ul><ul><li>Must be added to ( subtracted from ) net income since they do not have a cash flow effect . </li></ul>
  13. 16. III. The Indirect Approach This is in effect Converting Accrual Basis Revenues and Expenses back to Cash Basis Revenue and Expenses . Cash Flow for Operating Activities Section Accrual Basis Net Income XXXX + Non Cash Expenses(Losses) - Non Cash Revenues(Gains) + Decrease in Current Assets X + Increase in Current Liabilities X - Increase in Current Assets X - Decrease in Current Liabilities X Cash Flows from Oper. Activities XXXX
  14. 17. III. The Indirect Approach <ul><li>D. Both the direct and indirect approaches for computing net cash provided by operating activities will report the same amount. </li></ul><ul><ul><li>1. Those who prefer the direct approach justify their preference because this method discloses operating cash flows by category —inflows from customers, outflows to suppliers, etc.—facilitating cash flow predictions. </li></ul></ul>
  15. 18. III. The Indirect Approach <ul><li>D. Both the direct and indirect approaches for computing net cash provided by operating activities will report the same amount. </li></ul><ul><ul><li>2. Analysts who prefer the indirect approach do so because the size and direction of the items reconciling income to operating cash flow provide a rough yardstick for evaluating the quality of earnings . </li></ul></ul>
  16. 19. III. The Indirect Approach <ul><ul><li>3. For comparability purposes , the FASB requires firms using the direct approach to reconcile accrual earnings and operating cash flows as would occur under the indirect approach . </li></ul></ul><ul><ul><li>4. Firms using the indirect approach are required to separately disclose the amount of interest paid and income taxes paid . </li></ul></ul>D. Both the direct and indirect approaches for computing net cash provided by operating activities will report the same amount.
  17. 20. III. The Indirect Approach <ul><ul><li>5. The entire amount of cash taxes paid is included in the cash flows from operating activities computation , even though some of the taxes relate, for example, to gains on sales of assets whose gross cash flows are included in the cash flows from investing activities section of the statement. </li></ul></ul><ul><ul><ul><li>a. On the income statement , items not included in the computation of income from continuing operations such as extraordinary items and cumulative effects of changes in accounting principles are reflected net of their associated income tax effects to facilitate predictions by statement users. </li></ul></ul></ul>D. Both the direct and indirect approaches for computing NCPOA will be the same amount .
  18. 21. III. The Indirect Approach <ul><ul><li>5. The entire amount of cash taxes paid is included in the cash flows from operating activities computation , even though some of the taxes relate, for example, to gains on sales of assets whose gross cash flows are included in the cash flows from investing activities section of the statement. </li></ul></ul>D. Both the direct and indirect approaches for computing NCPOA will be the same amount . <ul><li>b. Therefore, tax expense associated with the presumably recurring income from continuing operations is reported separately from the tax expense associated with items appearing below income from continuing operations . </li></ul>
  19. 22. III. The Indirect Approach <ul><li>D. Both the direct and indirect approaches for computing NCPOA will be the same amount. </li></ul><ul><ul><li>5. The entire amount of cash taxes paid is included in the CFOA …….. </li></ul></ul><ul><ul><ul><li>c. Regrettably, SFAS No. 95 does not treat cash outflows for income taxes in the same way . </li></ul></ul></ul><ul><ul><ul><li>d. This failure to differentiate tax cash flows by type (those pertaining to income from continuing operations versus other items) complicates forecasts of future cash flows. </li></ul></ul></ul>
  20. 23. III. The Indirect Approach <ul><li>E. Other elements of the cash flow statement : </li></ul><ul><ul><li>1. The investing activities and financing activities sections of the statement show items that are relatively straightforward and there should be little difficulty in interpreting these disclosures. </li></ul></ul>
  21. 24. III. The Indirect Approach <ul><ul><li>2. Investing and financing transactions that do not directly and immediately affect cash are not included in the statement of cash flows . </li></ul></ul><ul><ul><ul><li>a. Because cash is initially unaffected , SFAS No. 95 does not include either the increase in the investment or the increase in the financing within the statement of cash flows . </li></ul></ul></ul><ul><ul><ul><li>b. These transactions must be disclosed in a separate schedule or as a footnote to the statement of cash flows . </li></ul></ul></ul>E. Other elements of the cash flow statement :
  22. 25. IV.  Preparing the Cash Flow Statement <ul><li>A. The following three-step process is used to build the components of the statement: </li></ul><ul><ul><li>1. Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul></ul><ul><ul><li>2. Determine the net cash flow effect of the journal entry(s) or T-Accounts identified in Step 1 . </li></ul></ul><ul><ul><li>3. Compare the financial statement effect of the entry / T-Account (Step 1) with its cash flow effect (Step 2) to determine what cash flow statement treatment is necessary for each item . </li></ul></ul>
  23. 26. IV.  Preparing the Cash Flow Statement <ul><li>B. Comparative balance sheets and an income statement will provide much of the information necessary to use the three-step approach.   </li></ul>
  24. 27. V. Cash Flows from Operations <ul><li>A. The purpose of this section is to reconcile net income to cash from operations (Cash NI) . </li></ul><ul><li>B. Noncash items are added to ( subtracted from ) net income to reconcile to cash from operations (Cash NI) . </li></ul><ul><li>C. Noncash components of CA&CL are added to ( subtracted from ) net income to reconcile to cash from operations (Cash NI) . </li></ul>
  25. 28. <ul><li>Cash Flows from Investing Activities </li></ul><ul><li>A. This section shows component increases and decreases in long-term asset accounts. </li></ul>PP &E PP &E Investments
  26. 29. <ul><li>Cash Flows from Investing Activities </li></ul><ul><ul><li>1. A loss on sale occurs when book value is greater than the cash proceeds . </li></ul></ul><ul><ul><li>2. The loss is added back to cash flows from operations since it is a nonoperating loss . </li></ul></ul><ul><ul><li>3. The loss is then subtracted from the book value of the item(s) sold so that the cash proceeds are reported . </li></ul></ul>B. Sales of equipment are shown at the cash transaction price.
  27. 30. <ul><li>Cash Flows from Investing Activities </li></ul><ul><ul><li>1. A gain on sale occurs when book value is lesser than the cash proceeds . </li></ul></ul><ul><ul><li>2. The gain is deducted from cash flows from operations since it is a nonoperating gain . </li></ul></ul><ul><ul><li>3. The gain is then added to the book value of the item(s) sold so that the cash proceeds are reported . </li></ul></ul>B. Sales of equipment are shown at the cash transaction price.
  28. 31. <ul><li>Cash Flows from Investing Activities </li></ul><ul><li>C. Purchases of long-term assets with debt issuances are not shown in the statement of cash flows .   </li></ul>
  29. 32. VII.  Cash Flows from Financing Activities <ul><li>A. This section reports cash flow effects of transactions affecting long-term liability and owners’ equity accounts . </li></ul><ul><li>B. Net income , which is one component of the change in retained earnings , is reported in the operating section . </li></ul><ul><li>C. Component increases and decreases in these accounts are reported separately .   </li></ul>
  30. 33. Statement of Cash Flows Example- Indirect <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul>158,000 <ul><li>DEPRECIATION </li></ul>158,000 Beg bal . $1,430,000 End bal .$1,628,000 Asset retirements or Asset Sales Dr Deprecation Expense $158,000 Cr A/D $158,000 ADDED BACK TO NET INCOME – Operating Activities Section Depreciation does not involve a cash outflow so add it back . Step 3 . What Cash Flow Statement treatment is necessary ? Step 2 . What is the Cash Flow effect ? Dep. Exp Building & Equipment A/D Depreciation Expense $518,000 Beg bal . $653,000 End bal . Asset retirements or Asset Sales Dep. Exp
  31. 34. Statement of Cash Flows Example- Indirect <ul><li>DEPRECIATION </li></ul>ADDED BACK TO NET INCOME – Depreciation does not involve a cash outflow so add it back . Cash from Operating Activities Depreciation Expense $ ( 158,000) Accrual Basis NI $ 182,000 Add back Expenses not affecting Cash Flow +Depreciation 158,000 Notice the net effect is $0 since there is no cash effect !
  32. 35. Statement of Cash Flows Example- Indirect <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul><ul><li>Gain on Equipment Sale </li></ul>Equipment with a cost of $63,000 and a BV of $40,000 was sold for $57,000. BV = Cost – A/D $40,000 = $63,000 – ??? $40,000 = $63,000 – 23,000 Gain = Sales Price – Book Value $17,000 = $57,000 – $40,000
  33. 36. Statement of Cash Flows Example- Indirect <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul>$$ Sale of Equipment <ul><li>Gain on Equipment Sale </li></ul>Equipment with a cost of $63,000 and a BV of $40,000 was sold for $57,000. Dr A/D $23,000 Dr Cash 57,000 Cr Equipment $63,000 Cr Gain on Sale 17,000 23,000 63,000 17,000 57,000 A/D $518,000 Beg bal . $653,000 End bal . Asset retirements or Asset Sales 158,000 Dep Exp Gain on Sale Bldg & PPE Beg bal . $1,430,000 End bal .$1,628,000 Asset retirements or Asset Sales Equipment Purchases Cash
  34. 37. Statement of Cash Flows Example- Indirect <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul>Dr A/D $23,000 Dr Cash 57,000 Cr Equipment $63,000 Cr Gain on Sale 17,000 23,000 63,000 17,000 57,000 Step 2 . What is the Cash Flow effect ? <ul><li>Gain on Equipment Sale </li></ul>A/D $518,000 Beg bal . $653,000 End bal . Asset retirements or Asset Sales 158,000 Dep Exp Gain on Sale Bldg & PPE Beg bal . $1,430,000 End bal .$1,628,000 Asset retirements or Asset Sales Equipment Purchases Cash
  35. 38. Statement of Cash Flows Example- Indirect <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul>Dr A/D $23,000 Dr Cash 57,000 Cr Equipment $63,000 Cr Gain on Sale 17,000 17,000 Step 2 . What is the Cash Flow effect ? Step 3 . What Cash Flow Statement treatment is necessary ? <ul><li>Gain on Sale $17,000 DEDUCTED FROM NET INCOME - Operating Activities Section- Gain on sale does not involve a cash inflow . The cash inflow results from the sales price of the asset. </li></ul><ul><li>Investing Section- Inflow of Cash of $57,000 . </li></ul><ul><li>Gain on Equipment Sale </li></ul>Gain on Sale Cash 57,000
  36. 39. Statement of Cash Flows Example- Indirect <ul><li>Gain on Equipment Sale </li></ul><ul><li>Gain on Sale $17,000 DEDUCTED FROM NET INCOME - Operating Activities Section- </li></ul><ul><li>Investing Section- Inflow of Cash of $57,000 . </li></ul>Cash from Operating Activities Gain on Sale of Eq. 17,000 Accrual Basis NI $ 182,000 Subtract Gains not affecting Cash Flow - Gain on Sale of Equip (17,000) Investing Activities Sale of Equipment $57,000 Notice the net effect is $0 since there is no cash effect in the operating activities section !
  37. 40. Statement of Cash Flows Example- Indirect <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul>Cash Interest Paid Accrual Interest Exp <ul><li>Amortization of Bond Discount-Getting Cash Interest Expense </li></ul>Discount on Bonds Payable Beg bal . $70,000 End bal . $66,000 Amortization Dr Interest Expense $44,000 Cr Discount of B/P $4,000 Cr Cash 40,000 $4,000 $44,000 $40,000 Step 2 . What is the Cash Flow effect ? Step 3 . What Cash Flow Statement treatment is necessary ? ADDED BACK TO NET INCOME – Operating Activities Section Bond Discount does not involve a cash outflow so add it back . Cash Interest Expense 44,000 End bal
  38. 41. Statement of Cash Flows Example- Indirect Cash from Operating Activities Interest Expense ( 44,000) Accrual Basis NI $ 182,000 Adjustments to reconcile NI to Cash +Bond Discount 4,000 ADDED BACK TO NET INCOME – Operating Activities Section Bond Discount does not involve a cash outflow so add it back . <ul><li>Amortization of Bond Discount-Getting Cash Interest Expense </li></ul>Notice the net effect is ( $40,000 ) cash effect in the operating activities section !
  39. 42. Statement of Cash Flows Example- Indirect <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul>Cash Taxes Paid Accrual Income Tax Exp <ul><li>Deferred Income Taxes- Getting Cash Taxes Paid </li></ul>Deferred Tax Liability $94,000 Beg bal $100,000 End bal Increase in Deferred Tax Dr Income Tax Expense $102,375 Cr Deferred Income Taxes $4,000 Cr Cash 96,375 $6,000 $102,375 $96,375 Step 2 . What is the Cash Flow effect ? Step 3 . What Cash Flow Statement treatment is necessary ? ADDED BACK TO NET INCOME – Operating Activities Section Deferred Tax does not involve a cash outflow so add it back . Cash Income Tax Exp 102,375 End bal
  40. 43. Statement of Cash Flows Example- Indirect Cash from Operating Activities Income Tax Exp (102,375) Accrual Basis NI $ 182,000 Adjustments to reconcile NI to Cash +Increase in Deferred Tax 6,000 ADDED BACK TO NET INCOME – Operating Activities Section Operating Activities Section Cash Revenues are higher than Accrual Basis Revenues. <ul><li>Deferred Income Taxes- Getting Cash Taxes Paid </li></ul>Notice the net effect is ( $96,375) cash effect in the operating activities section !
  41. 44. Statement of Cash Flows Example- Indirect <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul><ul><li>Accounts Receivable- Getting Cash Revenues Received </li></ul>End bal $171,000 Dr Accounts Receivable $3,030,000 Cr Sales Revenue $3,030,000 Dr Cash $3,039,000 Cr Accounts Receivable $3,039,000 $3,039,000 Step 2 . What is the Cash Flow effect ? Step 3 . What Cash Flow Statement treatment is necessary ? ADDED BACK TO NET INCOME – Operating Activities Section Cash Revenues are higher than Accrual Basis Revenues Credit Sales Cash Collections $3,030,000 $3,030,000 $3,039,000 Cash Collections Accounts Receivable Beg bal $180,000 Credit Sales Cash Sales Revenue End bal $3,030,000
  42. 45. Statement of Cash Flows Example- Indirect Cash from Operating Activities Sales Revenue $3,030,000 Accrual Basis NI $ 182,000 Adjustments to reconcile NI to Cash +Decrease in A/R 9,000 ADDED BACK TO NET INCOME – Operating Activities Section Cash Revenues are higher than Accrual Basis Revenues. <ul><li>Accounts Receivable- Getting Cash Revenues Received </li></ul>Assuming all Revenues come from Credit Sales Notice the net effect is $3,039,000 cash effect in the operating activities section !
  43. 46. Statement of Cash Flows Example- Indirect <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul><ul><li>Customer Advance Deposits- Getting Cash Revenues Received </li></ul>Cash Deposit Service Performed Dr Customer Advance Deposits $11,000 Cr Sales Revenue $11,000 Step 2 . What is the Cash Flow effect ? Step 3 . What Cash Flow Statement treatment is necessary ? SUBTRACT FROM TO NET INCOME – Operating Activities Section Decrease in deposits, Cash Revenues are adjusted for decrease in deposits . $11,000 Decrease In Deposits Service Performed From deposit Services Performed Credit Sales $3,019,000 $11,000 Assumed Cash Collections Of Total Sales $3,039,000 Total Cash Collections Of Revenues $3,028,000 $11,000 $99,000 End bal Customer Adv. Deposits $110,000 Beg bal Sales Revenue End bal $3,030,000 Cash
  44. 47. Statement of Cash Flows Example- Indirect Cash from Operating Activities Sales Revenue $3,030,000 Accrual Basis NI $ 182,000 Adjustments to reconcile NI to Cash +Decrease in A/R 9,000 - Decrease in Adv Deposits (11,000) SUBTRACT FROM TO NET INCOME – Operating Activities Section Cash Revenues are adjusted for decrease in deposits . <ul><li>Customer Advance Deposits- Getting Cash Revenues Received </li></ul>Notice the net effect is $3,028,000 Revenues cash effect in the operating activities section !
  45. 48. Statement of Cash Flows Example- Indirect <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul>COGS COGS <ul><li>Changes in Inventory & A/P- Getting Cash Purchases of Inventory </li></ul>Cash Payments $ ?? COGS BI $295,000 $163,000 EB $2,526,625 $2,526,625 EI $307,000 $160,000 BB Purchases Purchases 2,538,625 Cash Cash Payments $ ?? COGS Cash Payments $ 2,535,625 Cash Payments $ 2,535,625 Cost of Goods Sold Inventory A/P
  46. 49. Statement of Cash Flows Example- Indirect <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul>COGS COGS <ul><li>Changes in Inventory & A/P- Getting Cash Purchases of Inventory </li></ul>Cash Payments $ ?? COGS BI $295,000 $163,000 EB $2,526,625 $2,526,625 EI $307,000 $160,000 BB Purchases Purchases Pur $ 2,538,625 2,538,625 Cash Cash Payments $ ?? COGS Cash Payments $ 2,535,625 Cash Payments $ 2,535,625 DR COGS $2,526,625 CR Inventory $2,526,625 DR Purchases $2,538,625 CR A/P $2,538,625 Cost of Goods Sold Inventory A/P
  47. 50. Statement of Cash Flows Example- Indirect <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul>COGS COGS <ul><li>Changes in Inventory & A/P- Getting Cash Purchases of Inventory </li></ul>Cash Payments $ ?? COGS BI $295,000 $163,000 EB $2,526,625 $2,526,625 EI $307,000 $160,000 BB Purchases Purchases Pur $ 2,538,625 2,538,625 Cash Cash Payments $ ?? COGS Cash Payments $ 2,535,625 Cash Payments $ 2,535,625 DR A/P $2,535,625 CR Cash $2,535,625 Step 2 . What is the Cash Flow effect ? Cost of Goods Sold Inventory A/P
  48. 51. Statement of Cash Flows Example- Indirect <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul>COGS COGS <ul><li>Changes in Inventory & A/P- Getting Cash Purchases of Inventory </li></ul>Cash Payments $ ?? COGS BI $295,000 $163,000 EB $2,526,625 $2,526,625 EI $307,000 $160,000 BB Purchases Purchases Pur $ 2,538,625 2,538,625 Cash Cash Payments $ ?? COGS Cash Payments $ 2,535,625 Cash Payments $ 2,535,625 DR A/P $2,535,625 CR Cash $2,535,625 Step 3 . What Cash Flow Statement treatment is necessary ? ADJUST NET INCOME – Operating Activities Section Subtract Increase in Inventory & Add increase in A/P Cost of Goods Sold Inventory A/P
  49. 52. Statement of Cash Flows Example- Indirect Example:Indirect Method SCF Cash from Operating Activities Cost of Goods Sold ( 2,526,625) Accrual Basis NI $ 182,000 Adjustments to reconcile NI to Cash - Increase in Inv (12,000) + Increase in A/P 3,000 ADJUST NET INCOME – Operating Activities Section SUBTRACT Increase in Inventory & ADD increase in A/P <ul><li>Changes in Inventory & A/P- Getting Cash Purchases of Inventory </li></ul>Notice the net effect is ( $2,535,625 ) cash effect in the operating activities section !
  50. 53. SCF Example- INVESTING SECTION <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul>Land Purchase <ul><li>Long-Term Assets- Getting Land Cash effect </li></ul>Dr Land $86,000 Cr Cash 86,000 336,000 EB Step 2 . What is the Cash Flow effect ? Step 3 . What Cash Flow Statement treatment is necessary ? CASH OUTFLOW – Investing Activities Section 250,000 BB Land Purchase Cash $86,000 $86,000 Land
  51. 54. Investing Activities Equipment Sale $57,000 Land Purchase (86,000) CASH OUTFLOW – Investing Activities Section SCF Example- INVESTING SECTION <ul><li>Long-Term Assets- Getting Land Cash effect </li></ul>
  52. 55. <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul><ul><li>Buildings and Equipment purchase </li></ul>Equipment with a cost of $63,000 and a BV of $40,000 was sold for $57,000. Dr A/D $23,000 Dr Cash 57,000 Cr Equipment $63,000 Cr Gain on Sale 17,000 23,000 63,000 17,000 57,000 SCF Example- INVESTING SECTION Bldg. & Eq. Purchases 261,000 261,000 Dr Bldg. & Eq. 261,000 Cr Cash $261,000 Step 2 . What is the Cash Flow effect ? Step 3 . What Cash Flow Statement treatment is necessary ? CASH OUTFLOW – Investing Activities Section A/D $518,000 Beg bal . $653,000 End bal . Asset retirements or Asset Sales 158,000 Dep Exp Gain on Sale Bldg & PPE Beg bal . $1,430,000 End bal .$1,628,000 Asset retirements or Asset Sales Bldg. & Eq. Purchases Cash
  53. 56. CASH OUTFLOW – Investing Activities Section <ul><li>Buildings and Equipment purchase </li></ul>SCF Example- INVESTING SECTION Investing Activities Equipment Sale $57,000 Land Purchase (86,000) Bldg. & Eq. Purchase (261,000)
  54. 57. SCF Example- FINANCING SECTION <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul><ul><li>Long-Term Liabilities & SE- Getting Financing Cash effect </li></ul>Dr Cash $50,000 Cr Common Stock $50,000 Step 2 . What is the Cash Flow effect ? Step 3 . What Cash Flow Statement treatment is necessary ? CASH INFLOW – Financing Activities Section Sale of Stock Common Stock $50,000 Sale of Stock $50,000 Cash
  55. 58. Financing Activities Common stock issued $50,000 CASH INFLOW – Financing Activities Section SCF Example- FINANCING SECTION <ul><li>Long-Term Liabilities & SE- Getting Financing Cash effect </li></ul>
  56. 59. SCF Example- FINANCING SECTION <ul><li>Step 1 . Identify the journal entry(s) or T-Accounts that led to the reported net balance sheet change in each account . </li></ul><ul><li>Long-Term Liabilities & SE- Getting Financing Cash effect </li></ul>Dr Retained Earnings $90,000 Cr Cash $90,000 Step 2 . What is the Cash Flow effect ? Step 3 . What Cash Flow Statement treatment is necessary ? CASH OUTFLOW – Financing Activities Section Dividends Paid Retained Earnings Net Income $76,000 BB $168,000 EB Dividends 182,000 90,000 90,000 Cash
  57. 60. Financing Activities Dividends Paid ($90,000) Common stock issued $50,000 CASH OUTFLOW – Financing Activities Section SCF Example- FINANCING SECTION <ul><li>Long-Term Liabilities & SE- Getting Financing Cash effect </li></ul>
  58. 62. VIII.   Reconciling Between Statements:  Some Complexities <ul><li>A. Users of financial statements frequently encounter situations where changes in balance sheet accounts over the year do not reconcile to the corresponding account change included in the statement of cash flows . </li></ul>
  59. 63. <ul><ul><li>1. Asset write-offs due to impairment , corporate restructuring or retirement . </li></ul></ul><ul><ul><li>2. Translation adjustments on assets held by foreign subsidiaries . </li></ul></ul><ul><ul><li>3. Acquisitions and divestitures of other companies. </li></ul></ul>VIII.   Reconciling Between Statements:  Some Complexities B. These differences arise for at least three reasons:
  60. 64. <ul><li>C. Footnote disclosures and information in the income statement and operating section of the cash flow statement may be helpful in reconciling some of these differences.   </li></ul>VIII.   Reconciling Between Statements:  Some Complexities
  61. 65. IX.   Analytical Insights: Cash Burn Rates of Internet Stocks <ul><li>A. The ability to generate positive operating cash flows is critical to the survival and success of any company. </li></ul>
  62. 66. IX.   Analytical Insights: Cash Burn Rates of Internet Stocks <ul><li>B. The cash burn rate is a popular metric for assessing how quickly internet firms are using up their cash reserves . </li></ul><ul><ul><li>1. May be calculated as cash used for operations plus cash used for capital expenditures and purchases of on-going businesses divided by the number of months covered by the cash flow statement. </li></ul></ul><ul><ul><li>2. Alternatively , this may be calculated as earnings before interest, taxes, depreciation and amortization (EBITDA) adjusted for non-recurring gains and losses divided by number of months covered by the income statement . </li></ul></ul>
  63. 67. IX.   Analytical Insights: Cash Burn Rates of Internet Stocks <ul><li>C. A related measure is months to burnout . </li></ul><ul><ul><li>1. This measure provides an estimate of how much longer a company can survive without an infusion of external capital. </li></ul></ul><ul><ul><li>2. Calculated as cash, cash equivalents, and short-term marketable securities divided by the cash burn rate . </li></ul></ul>

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