Statement of Cash Flows June 2 Statement of Cash Flows Chapter 13: “How Well An I Doing?” Statement of Cash Flows. This chapter explains how to classify transactions as operating, investing, or financing activities, and it explains how to create a statement of cash flows. The indirect method of determining the net cash provided by operating activities is illustrated within the chapter and the direct method is demonstrated in Appendix 13A. Appendix 13B describes the T-account approach to preparing the statement of cash flows.

Today’s Agenda Cash Flow Statements What Cash Flow Statements show us Building a Cash Flow Statement

Cash Flow Statements Cash Flow Statements present a company’s Changes in cash over a period of time Sources and uses of its cash Cash position Is the company generating sufficient cash? To maintain operations? To re-pay its debts? Pay dividends Cash flows and net income differ

Four Areas of Cash Sources and Uses Profit & Loss Net income or loss Plus non-cash expenses - depreciation and amortization Changes in working capital Increases and decreases in current assets and current liabilities Investment activities Investments in and disposals of longer term assets Financing activities Issuance of or repayment/redemption of debt or equity Dividends

Constructing the Statement of Cash Flows Changes in these accounts can be classified as either sources or uses of cash as shown on this slide.   Net income is always a source of cash, while a net loss is always a use of cash. Decreases in noncash asset accounts are always sources of cash and increases are uses of cash. Increases in liability accounts are always sources of cash and decreases are uses of cash. Contra-assets follow the rules for liabilities. Increases in capital stock accounts are always sources of cash and decreases are uses of cash. Dividends paid to stockholders are always uses of cash.

Organization of the Full-Fledged Statement of Cash Flows Cash flows are divided into three categories. Part I Cash flows are divided into three categories – operating, investing, and financing activities. Part II Here is a summary which can be used to classify transactions as operating, investing, and financing activities. Generally, operating activities are those activities that enter into the determination of net income. Technically, the FASB defines operating activities as all transactions that are not classified as investing or financing activities. Investing activities include transactions that involve acquiring or disposing of noncurrent assets. Financing activities include transactions that involve borrowing from or repaying creditors, as well as transactions with the company's owners.

Operating Activities The general format for the operating activities section of the statement is as shown. It includes those activities that enter into the determination of net income. Includes those activities that enter into the determination of net income.

Investing Activities The general format for the investing activities section of the statement is as shown. It includes those transactions that involve the acquisition or disposal of noncurrent assets. Includes transactions that involve the acquisition or disposal of noncurrent assets.

Financing Activities The general format for the financing activities section of the statement is as shown. It includes those transactions that involve the receipts from or payments to creditors and owners. Includes transactions involving receipts from or payments to creditors and owners.

A Full-Fledged Statement of Cash Flows: Indirect Method

A Full-Fledged Statement of Cash Flows: Indirect Method Additional Information: There was a net loss for the year of $27,000. Depreciation charges for the year were $6,000. During the year, Ed sold land originally costing $32,000 for $32,000. During the year, Ed paid dividends of $3,000 to the stockholders. Ed issued $50,000 of common stock to settle the note due to Joe Doe. Additional information provided by Ed: There was a net loss for the year of $27,000. Depreciation charges for the year were $6,000. During the year, Ed sold land originally costing $32,000 for $32,000. During the year, Ed paid dividends of $3,000 to the stockholders. Ed issued $50,000 of common stock to settle the note due to Joe Doe.

Preparing the Statement of Cash Flows: Step 1 List each account appearing on the comparative balance sheets except for cash and cash equivalents and retained earnings. There are eight steps to preparing the statement of cash flows. The first step is to copy on to a worksheet the title of each account appearing on the comparative balance sheets, except for cash and cash equivalents and retained earnings. Contra-asset accounts, like accumulated depreciation, should be listed with the liabilities.

Preparing the Statement of Cash Flows: Step 2 Compute the change from the beginning balance to the ending balance for each account. The second step is to compute the change from the beginning balance to the ending balance in each balance sheet account. Separate the change in retained earnings into net income and dividends.

Preparing the Statement of Cash Flows: Step 3 Code each entry on the worksheet as a source or use of cash. The third step is to code each entry on the worksheet as a source or use of cash. The noncash assets are coded as shown. The liabilities and depreciation are coded as shown. The capital stock account is coded as shown. The net income/loss and dividends are coded as shown. Recall that the transaction involving the Note Payable and Common Stock was noncash. Recall that the transaction involving the Note Payable and Common Stock was noncash. {

Preparing the Statement of Cash Flows: Step 4 Code sources of cash as positive numbers and uses of cash as negative numbers. The fourth step is to code sources of cash as positive numbers and uses of cash as negative numbers as shown.

Preparing the Statement of Cash Flows: Step 5 Make any necessary adjustments, including adjustments for gains and losses. The net effect of these should equal zero. Part I The fifth step is to make any necessary adjustments – including adjustments for gains and losses. The net effect of these adjustments should equal zero. Part II Ed’s Pizza Hut’s only adjustment was for the noncash transaction relating to the exchange of a Note Payable and Common Stock. The net effect of these adjustments should equal zero. We need to make an adjustment for the noncash transaction. {

Preparing the Statement of Cash Flows: Step 6 The sixth step is to classify each entry on the worksheet as an operating, investing, or financing activity as shown.

Preparing the Statement of Cash Flows: Step 7 Copy the data from the worksheet into the Statement of Cash Flows section by section. The seventh step is to copy the data from the worksheet into the statement of cash flows section by section. The net cash flow from operations, investing and financing activities would appear as shown. Remember that the depreciation is added back to net income to cancel out the reduction in net income caused by including this noncash expense in the income statement.

Preparing the Statement of Cash Flows: Step 8 Prepare a cash reconciliation at the bottom of the statement. The eighth step is to prepare a cash reconciliation at the bottom of the statement as shown. The complete statement of cash flows with cash reconciliation would appear as shown.

Preparing the Statement of Cash Flows In addition, on the face of the statement or in a supplemental schedule, disclose the issuance of $50,000 of stock to a creditor, a noncash financing activity. As a supplement to this statement, Ed’s Pizza Hut would also disclose the issuance of $50,000 of stock to a creditor as a noncash financing activity. This amount was adjusted out of the worksheet in step 5.

Tutorial Assignment Complete Review Problems

Similarities and Differences in Handling Data Adjustments for accounts that affect revenue are the same in the direct method and indirect methods. In either case, increases in the accounts are deducted and decreases in the accounts are added. Adjustments for accounts that affect expenses are handled in opposite ways for the direct and indirect methods. In the indirect method, an increase in prepaid expenses is deducted from net income. However, in the direct method an increase in prepaid expenses is added to operating expenses. Part I The adjustments for accounts that affect revenue are the same in the direct and indirect methods. In either case, increases in the accounts are deducted and decreases in the accounts are added.   Part II The adjustments for accounts that affect expenses are handled in opposite ways for the direct and indirect methods. Under the indirect method, the adjustments are made to net income, whereas, under the direct method, the adjustments are made directly against the expense accounts. For example, in the indirect method, an increase in prepaid expenses is deducted from net income. However, in the direct method an increase in prepaid expenses is added to operating expenses.