Purpose of the Statement of Cash Flows Explains changes in cash over a period of time Summarizes cash inflows and outflows from: Financing Activities Operating Activities Investing Activities LO1

Cash Equivalents Readily convertible to cash Examples: Little risk of price change Original maturity to investor of three months or less Examples: Commercial paper U.S. Treasury bills Certain money market funds LO2

Statement of Cash Flows Format outflows Cash inflows Classified by: Operating activities Investing activities Financing activities = + Beginning Cash and Cash Equivalents = Ending Cash and Cash Equivalents Increase or decrease in cash and cash equivalents LO3

Statement of Cash Flows Format Cash flows from operating activities: Inflows $ xxx Outflows (xxx) Net cash provided (used) by operating activities $ xxx Cash flows from investing activities: Net cash provided (used) by investing activities xxx Cash flows from financing activities: Net cash provided (used) by financing activities xxx Net increase (decrease) in cash and cash equivalents $xxx Cash and cash equivalents at beginning of year xxx Cash and cash equivalents at end of year $xxx from balance sheets

Operating Activities Collection of customer accounts Cash transactions concerned with acquiring and selling products and services Payment to suppliers for inventory Payment of wages Payment of taxes

Investing Activities Cash transactions concerned with acquiring and disposing of long-term assets Capital expenditures Purchase/sale of another company Sale of property, plant, and equipment

Financing Activities Issuance/repayment of bank note Issuance/repurchase of stock Cash transactions concerned with the raising and repayment of funds in the form of debt and equity Issuance/retirement of bonds Payment of dividends

Categorizing Cash Flow Activities Current assets and current liabilities Operating Activities Long-term assets Investing Activities Long-term liabilities or stockholders’ equity Financing Activities

Noncash Investing and Financing Activities Disclose important financing and investing activities which do not require cash Exchange stock for assets Buy assets through debt financing from supplier

Methods to Report Cash from Operating Activities Direct Method Reports major classes of gross cash receipts and cash payments The amount of cash provided by operating activities is the same under both methods Indirect Method Adjusts net income to remove the effect of all accruals and deferrals LO4

Statement of Cash Flows Format Cash flows from operating activities: Inflows $ xxx Outflows (xxx) Net cash provided (used) by operating activities $xxx Cash flows from investing activities: Outflows (xxx) Net cash provided (used) by investing activities xxx Cash flows from financing activities: Net cash provided (used) by financing activities xxx Net increase (decrease) in cash and cash equivalents $xxx Cash and cash equivalents at beginning of year xxx Cash and cash equivalents at end of year $xxx Only section of statement that differs in form between direct and indirect method (net cash flow total is the same)

Preparing the Statement Cash Flows: Direct Method Step 1: Set up three master T accounts Cash Flows from Operating Activities Cash Flows from Investing Activities Cash Flows from Financing Activities Step 2: Determine the cash flows from operating activities LO5

Direct Method: Operating Activities Review journal entries recorded during period: Accounts Receivable 670,000 Sales Revenue* 670,000 To record sales on account. *from income statement Sales on account 670,000 Bal., Jan. 1 57,000 Bal., Dec. 31 63,000 From Balance Sheet Accounts Receivable 664,000 Cash collections

Direct Method: Operating Activities Review journal entries recorded during period: Cost of goods sold* 390,000 Inventory 390,000 To record cost of goods sold. *from income statement 390,000 Cost of goods sold Bal., Jan. 1 92,000 Bal., Dec. 31 84,000 From Balance Sheet Inventory Purchases on account 382,000

Direct Method: Operating Activities Review journal entries recorded during period: Accounts Payable 375,000 Cash 375,000 To record cash payments on account. Cash payments 375,000 31,000 Bal., Jan. 1 38,000 Bal., Dec. 31 From Balance Sheet Accounts Payable 382,000 Purchases

Direct Method: Operating Activities Review journal entries recorded during period: Salaries and Wages Payable 62,000 Cash 62,000 To record cash paid to employees. Cash payments 62,000 9,000 Bal., Jan. 1 7,000 Bal., Dec. 31 From Balance Sheet Salaries and Wages Payable 60,000 New unpaid wages

Direct Method: Operating Activities Review journal entries recorded during period: Depreciation Expense 40,000 Accumulated Depreciation 40,000 To record depreciation. There is no effect on cash flow from depreciation.

Direct Method: Operating Activities Review journal entries recorded during period: Prepaid Insurance 6,000 Cash 6,000 To record cash paid for insurance. Cash payments 6,000 Bal., Jan. 1 18,000 Bal., Dec. 31 12,000 From Balance Sheet Prepaid Insurance 12,000 Expense

Master T Account for Cash Flows from Operating Activities Cash receipts from: Cash payments for: 375,000 Inventory purchases 62,000 Salaries and wages 6,000 Insurance 15,000 Interest 47,000 Taxes Sales on account 664,000 Interest 15,000 Net cash inflows 174,000

Preparing the Statement of Cash Flows: Direct Method Step 3: Determine the cash flows from investing activities

Direct Method: Investing Activities Review journal entries recorded during period: Long-Term Investments 30,000 Cash 30,000 To record purchase of investments. Cash payments 30,000 Bal., Jan. 1 90,000 Bal., Dec. 31 120,000 From Balance Sheet Long-Term Investments

Direct Method: Investing Activities statement of cash flows. Review journal entries recorded during period: Land 50,000 Notes Payable 50,000 To record acquisition of land in exchange for note. No cash was involved in this transaction so it should be reported in a separate schedule instead of directly on the statement of cash flows.

Direct Method: Investing Activities Review journal entries recorded during period: Property and equipment 75,000 Cash 75,000 To record acquisition of equipment for cash. Acquisitions 75,000 Bal., Jan. 1 280,000 Bal., Dec. 31 320,000 From Balance Sheet Property and Equipment Disposals 35,000

Direct Method: Investing Activities Book value of equipment sold was $20,000. Original cost of equipment was $35,000. 75,000 Bal., Jan. 1 100,000 Bal., Dec. 31 From Balance Sheet Accumulated Depreciation Disposals 15,000 40,000 Depreciation Exp.

Master T Account for Cash Flows from Investing Activities Cash receipts from: Cash payments for: Sale of machine 25,000 30,000 Purchase of investments 75,000 Purchase of property and equipment 80,000 Net cash outflows

Preparing the Statement of Cash Flows: Direct Method Step 4: Determine the cash flows from financing activities

Direct Method: Financing Activities statement of cash flows. Review journal entries recorded during period: Land 50,000 Notes Payable 50,000 To record acquisition of land in exchange for note. No cash was involved in this transaction so it should be reported in a separate schedule instead of directly on the statement of cash flows.

Direct Method: Financing Activities Review journal entries recorded during period: Loss on Retirement of Bonds (Retained Earnings) 3,000 Bonds Payable 60,000 Cash 63,000 To record retirement of bonds. Retirement 60,000 260,000 Bal., Jan. 1 200,000 Bal., Dec. 31 From Balance Sheet Bonds Payable

Direct Method: Financing Activities Review journal entries recorded during period: Cash 25,000 Capital Stock 25,000 To record issuance of stock in exchange for cash. 25,000 Stock issued 75,000 Bal., Jan. 1 100,000 Bal., Dec. 31 From Balance Sheet Capital Stock

Direct Method: Financing Activities Review journal entries recorded during period: Retained Earnings 67,000 Cash 67,000 To record cash dividends paid. Cash dividends 67,000 193,000 Bal., Jan. 1 246,000 Bal., Dec. 31 From Balance Sheet Retained Earnings 120,000 Net income 2012

Master T Account for Cash Flows from Financing Activities Cash receipts from: Cash payments for: 63,000 Retirement of bonds 67,000 Payment of cash dividends Issuance of stock 25,000 105,000 Net cash outflows

Indirect Method: Operating Activities Income Statement Conversion of accrual to cash basis Cash Flows from Operating Activities LO6

Indirect Method: Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease $6,000 Accounts Receivable Bal. Jan. 1 57,000 Bal. Dec. 31 63,000 Net increase 6,000

Indirect Method: Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase $8,000 Inventory Bal. Jan. 1 92,000 Bal. Dec. 31 84,000 8,000 Net decrease

Indirect Method: Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 Increase $7,000 Accounts Payable 31,000 Bal. Jan. 1 38,000 Bal. Dec. 31 7,000 Net increase

Indirect Method: Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries and wages payable (2,000) Salaries and Wages Payable Increase $2,000 9,000 Bal. Jan. 1 7,000 Bal. Dec. 31 Net decrease 2,000

Indirect Method: Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries and wages payable (2,000) Decrease in prepaid insurance 6,000 Decrease $6,000 Prepaid Insurance Bal. Jan. 1 18,000 Bal. Dec. 31 12,000 6,000 Net decrease

Indirect Method: Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries and wages payable (2,000) Decrease in prepaid insurance 6,000 Increase in income taxes payable 3,000 Increase $3,000 Income Taxes Payable 5,000 Bal. Jan. 1 8,000 Bal. Dec. 31 3,000 Net increase

Indirect Method: Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries and wages payable (2,000) Decrease in prepaid insurance 6,000 Increase in income taxes payable 3,000 Gain on sale of machine (5,000) Depreciation expense 40,000 Loss on retirement of bonds 3,000 Gain is not part of operating activities Add back noncash expense Report entire outflow as a financing activity

Cash Flow Adequacy Measures company’s ability to meet principal and interest obligations Creditors concerned with cash available to repay debts after company has replaced and updated its existing base of long-term assets Cash Flow from Operating Activities – Capital Expenditures Average Amount of Debt Maturing over Next Five Years LO7

Accounting Tools: A Work-Sheet Approach to the Statement of Cash Flows Appendix Accounting Tools: A Work-Sheet Approach to the Statement of Cash Flows

Indirect Method: Using a Work Sheet 12/31/12 12/31/11 Enter account balances LO8

Indirect Method: Using a Work Sheet Record investing and financing activities 12/31/12 12/31/11

Indirect Method: Using a Work Sheet 12/31/12 12/31/11 Enter net income

Indirect Method: Using a Work Sheet 12/31/12 12/31/11 Enter noncash revenues or expenses

Indirect Method: Using a Work Sheet 12/31/12 12/31/11 Extend current assets and current liabilities

Indirect Method: Using a Work Sheet 12/31/12 12/31/11 Total columns

Indirect Method: Using a Work Sheet 12/31/12 12/31/11 Determine net cash inflow (outflow)

End of Chapter 12