The Statement of Cash Flows C hapter 22

2 Cash Flow Statement Cash is the lifeblood of any company and is critical to its success. Cash flow information is used by both managers and analysts to understand a company’s operations, assess its liquidity, gain insight into its ability to invest in new assets, and evaluate its financing decisions.

3 1.A company’s ability to generate positive future net cash flows 2.A company’s ability to meet its obligations and pay dividends 3.A company’s need for external financing 4.The reasons for differences between a company’s net income and related cash receipts and payments 5.Both the cash and noncash aspects of a company’s financing and investing transactions during the accounting period Purpose of a Cash Flow Statement Helps users assess:

4 Operating Activities Operating activities include transactions involving acquiring (purchasing or manufacturing), selling, and delivering goods for sale, as well as providing services. Inflows Cash receipts from: The sale of goods or services Collection of accounts receivable Collection of interest on loans Receipts of dividends on investments in equity securities Outflows Cash payments to: Suppliers for inventory Employees The government for taxes Lenders for interest Other suppliers for various expenses

5 Investing Activities Investing activities include transactions involving acquiring and selling investments (both current and noncurrent), and lending money and collecting on the loans. Outflows Cash payments for: Acquiring property, plant, and equipment Purchasing investments in other companies Making loans to borrowers Inflows Cash receipts from: Sales of property, plant, and equipment Sales of investments in other companies Principal repayments of loans by borrowers

6 Financing Activities Financing activities include transactions involving obtaining resources from owners and providing them with a return on, and of, their investment, as well as obtaining money and other resources from creditors and repaying the amounts borrowed. Inflows Cash receipts from: Issuing equity securities Issuing bonds Issuing mortgages Issuing notes Other short- or long-term borrowings Outflows Cash payments for: Dividends Repurchase of the company’s equity securities Repayments of amounts borrowed

Context  Remember, the context of a transaction will determine the nature of the cash flow. It is not a obvious as it might seem. (Corner Lot Example). 7

8 Cash and Cash Equivalents  The cash flow statement is prepared using cash and cash equivalents.  Cash equivalents –Treasury bills –Commercial paper –Money market funds

Indirect Method Example  See textbook – page

10 Net Cash Flow From Operating Activities GAAP allows two ways for a company to calculate and report its net cash flow from operating activities on its statement of cash flows.

11 Net Cash Flow From Operating Activities Even though GAAP recommends the direct method, most companies (99%) use the indirect method. The first is called the direct method and the second is the indirect method.

12 Direct Method Under the direct method, a company deducts its operating cash outflows from its operating cash inflows to determine its net cash flow from operating activities.

Inflows Collections from customers Collections of interest and dividends Other operating receipts Outflows Payments to suppliers Payments to employees Other operating payments Payments for interest Payments for income taxes Operating Activities—Direct Method 13

14 Direct Method Example See page 1155

15 Steps in Visual Inspection Method See Page 1158

16 Steps in the Worksheet (Spreadsheet) Method See page 168

17 Jones Company: Condensed Financial Information See page 1164

18 Cash Flow Worksheet for 2010 (Jones Company)

19 Cash Flow Worksheet for 2010 (Jones Company)

20 Cash Flow Worksheet for 2010 (Jones Company)

21 Cash Flow Worksheet for 2010 (Jones Company) See Pages 1168 & 1169

22 Comprehensive Statement of Cash Flows See Page 1169

23  See pages 1171 IFRS vs. U.S. GAAP

Special Topics – Page 1171 to 1179  Sale of Depreciable Asset  Retirement of Bonds  Interest Paid and Income Taxes Paid  Flexibility in Reporting  Partial Cash Investing and Financing Activities  Temporary and Long-Term Investments  Financial Institutions  Cash Dividends Declared  Cash Flows for Compensatory Share Option Plans  Effects of Exchange Rates  Cash Flow Per Share  Additional IFRS Adjustments  Disclosures 24

Read as time permits Appendix: Operating Cash Flows 25

Homework This Week  For this week, complete and turn in: –Exercise E22-2, p. 1,196 –Exercise E22-4, p. 1,197 –Exercise E22-10, p. 1,199 –Problem P22-6, p. 1,205 26

Example Solution – P22-7 (Page 1 of 5) Balances Worksheet Entries Account Titles01/01/201012/31/2010Change Debit Credit Debits Cash Noncash Accounts: Accounts receivable Marketable securities Allow for change in value Inventories Prepaid items Investments (long-term) Land Buildings and equipment Discount on bonds payable Totals Credits Accumulated depreciation Accounts payable Income taxes payable Wages payable Interest payable Notes payable (long-term) 12% bonds payable Deferred income taxes Convertible preferred stock Common stock, $10 par Additional paid-in capital Unrealized increase in value of marketable securities of marketable securities Retained earnings Totals 1,400 2,800 1, ,100 1,300 7,000 15,000 32,000 – 69,800 16,000 3,800 2,400 1,100 – 3,500 – 800 9,000 14,000 8, ,000 69,800 2,400 2,690 3, ,910 1,710 5,400 15,000 46, ,400 16,400 4,150 2, – 10,000 1,196 – 21,500 13, ,100 85,400 1,000 (110) 1, (190) 410 (1,600) – 14, , (450) 400 (3,500) 10, (9,000) 7,500 5, ,100 15,600 (u) (d) (t) (f) (p) (q) (o) (i) (n-2) (l-2) (k) 1,000 1, , , ,500 9, ,860 (c) (e) (m) (o) (s) (b) (g) (h) (j) (q) (r) (l-1) (n-1) (l-1) (n-1) (t) (a) ,600 2, , , ,000 2,500 4,000 1, ,800 34, LAMBERSON COMPANY Worksheet for Statement of Cash Flows For Year Ended December 31, 2010 (Worksheet continued on next page)

Example Solution – P22-7 (Page 2 of 5) Worksheet Entries Debit Credit 28 Net Cash Flow From Operating Activities Net income Add:Depreciation expense Decrease in accounts receivable Decrease in inventories Increase in accounts payable Increase in income taxes payable Increase in interest payable Loss on sale of equipment Increase in deferred taxes payable Bond discount amortization Less:Increase in prepaid items Decrease in wages payable Gain on sale of investments Cash Flows From Investing Activities Payment for purchase of short-term marketable securities Proceeds from sale of long-term investments Proceeds from sale of equipment Payment for purchase of equipment Cash Flows From Financing Activities Payment of dividends Proceeds from issuance of 12% bonds Investing and Financing Activities Not Affecting Cash Issuance of common stock to convert preferred stock Conversion of preferred stock to common stock Issuance of common stock to pay long-term note Payment of long-term note by issuing common stock Net Increase in Cash Totals (a) (b) (c) (e) (g) (h) (j) (o) (r) (s) (m) (o) (q) (l-1) (n-1) 4,800 2, , ,700 9,000 3,500 33,260 (f) (i) (m) (d) (p) (k) (l-2) (n-2) (u) ,300 16, ,000 3,500 1,000 33,260

Example Solution – P22-7 (Page 3 of 5) 29

Example Solution – P22-7 (Page 4 of 5) 30

Example Solution – P22-7 (Page 5 of 5)  The difference in the results of the two ratios is due primarily to the $2,100 depreciation expense which was deducted to compute net income, but did not involve an operating cash outflow. 31

Q & A 32

33 C hapter 22 Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.