Gary A. Porter and Curtis L. Norton Using Financial Accounting Information: The Alternative to Debits and Credits Fifth Edition Gary A. Porter and Curtis L. Norton Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

Cash Flows and Net Income for Four Companies in 2004 Increase (Decrease) Net Income in Cash (Loss) $ 225 $ 984 (196.8) 337.2 33.9 (567.6) (439) (862) (in millions) Best Buy Radio Shack Gateway Northwest Airlines

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

Cash Equivalents Readily convertible to cash 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 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 Payment to suppliers for inventory Cash transactions concerned with acquiring and selling products and services Collection of customer accounts Payment of wages Payment of taxes

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

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

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: 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)

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

Preparing the Statement Cash Flows: Direct Method Step 1: Set up three schedules with the following headings: 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 Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: Accounts receivable, January 1 $ 57,000 + Sales revenue (from income statement) 670,000 - (X) = Accounts receivable, December 31 $ 63,000 ??? Cash collections From Balance Sheet

Direct Method – Operating Activities Accounts receivable, January 1 $ 57,000 + Sales revenue 670,000 - Accounts receivable, December 31 63,000 Cash collections 664,000

Direct Method – Operating Activities 15,000 Interest Revenue = Cash collected since there was no Interest Receivable account on Balance Sheet Direct Method – Operating Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet:

Direct Method – Operating Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: Inventory, Bal., Jan. 1 92,000 - Cost of Goods Sold (390,000) Inventory, Bal., Dec. 31 84,000 From Balance Sheet + Purchases on account ???

Direct Method – Operating Activities Inventory, January 1 $ 92,000 Less: Cost of Goods Sold (390,000) Inventory, December 31 84,000 Purchases $ 382,000

Direct Method – Operating Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: From Balance Sheet Accounts Payable, January 1 $ 31,000 + Purchases 382,000 - Cash payments ??? Accounts Payable, December 31 $ 38,000

Direct Method – Operating Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: From Balance Sheet Accounts Payable, January 1 $ 31,000 + Purchases 382,000 - Accounts Payable, December 31 (38,000) Cash collections $ 375,000

Direct Method – Operating Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: From Balance Sheet Salaries and Wages Payable, January 1 $ 9,000 + Salaries and Wages Expense 60,000 - Cash payments ??? Salaries and Wages Payable, December 31 $ 7,000

Direct Method – Operating Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: From Balance Sheet Salaries and Wages Payable, January 1 $ 9,000 + Salaries and Wages Expense 60,000 - Salaries and Wages Payable, December 31 7,000 Cash payments for Salaries and Wages $ 62,000

Direct Method – Operating Activities Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Accumulated Depreciation Expense Depreciation (40,000) (40,000) There is no effect on cash flow from depreciation.

Direct Method – Operating Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: From Balance Sheet Prepaid Insurance, January 1 $ 18,000 + Cash payments for insurance ??? Insurance expense (12,000) Prepaid Insurance, December 31 $ 12,000

Direct Method – Operating Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: From Balance Sheet Prepaid Insurance, January 1 $ 18,000 Insurance expense 12,000 - Prepaid Insurance, December 31 12,000 Cash paid for Insurance $ 6,000

Direct Method – Operating Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: From Balance Sheet Income Taxes Payable, January 1 $ 5,000 + Income Tax Expense 50,000 - Cash payments for Income Taxes ??? Income Taxes Payable, December 31 $ 8,000

Direct Method – Operating Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: From Balance Sheet From Balance Sheet Income Taxes Payable, January 1 $ 5,000 + Income Tax Expense 50,000 - Income Taxes Payable, December 31 8,000 Cash paid for Income Taxes $ 47,000

Direct Method – Operating Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: From Balance Sheet Income Taxes Payable, January 1 $ 5,000 + Income Taxes Expense 50,000 - Income Taxes Payable, December 31 8,000 Cash paid for Income Taxes $47,000

Schedule for Cash Flows from Operating Activities Cash receipts from: Less: 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 from Operating Activities $174,000

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

Direct Method – Investing Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: From Balance Sheet Property and Equipment, January 1 $ 280,000 + Acquisitions 75,000 - Disposals ??? Property and Equipment, December 31 $ 320,000

Direct Method – Investing Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: From Balance Sheet Property and equipment, January 1 $ 280,000 + Acquisitions 75,000 - Property and equipment, December 31 (320,000) Disposals $ 35,000

Direct Method – Investing Activities Book value of equipment sold was $20,000. Original cost of equipment was $35,000. From Balance Sheet Accumulated Depreciation, January 1 $ 75,000 + Depreciation Expense 40,000 - Accumulated Depreciation on assets sold ( ???) Accumulated Depreciation, December 31 $100,000

Direct Method – Investing Activities From Balance Sheet Accumulated Depreciation, January 1 $ 75,000 + Depreciation Expense 40,000 - Accumulated Depreciation, December 31 (100,000) Accumulated Depreciation on assets sold $ 15,000

Direct Method – Investing Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: Balance Sheet Income Statement Assets = Liabilities + Stockholders’+ Revenues - Expenses Equity Land = Notes Payable 50,000 50,000 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.

Schedule 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 Net cash outflows from Investing Activities $80,000

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

Direct Method – Financing Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ + Revenues - Expenses Equity Land = Notes Payable 50,000 50,000 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 Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: Bonds Payable From Balance Sheet $ 260,000 January 1 balance ??? Retirements $ 200,000 December 31 balance Retirements for the year were $60,000

Direct Method – Financing Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: Capital Stock $ 75,000 January 1 balance From Balance Sheet ??? Stock issued $ 100,000 December 31 balance Stock issued during the year was $25,000

Direct Method – Financing Activities Consider each of the items on the income statement and any related current assets or liabilities from the balance sheet: Retained Earnings From Balance Sheet $ 193,000 January 1 balance + 120,000 Net income 2007 (???) Cash dividends $ 246,000 December 31 balance Cash dividends paid during the year was $67,000

Schedule 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 Net cash outflows from Financing Activities $105,000

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 Net decrease 8,000

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 Increase $7,000 Accounts Payable 31,000 Bal. Jan. 1 7,000 Net Increase 38,000 Bal. Dec. 31

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) Increase $2,000 Salaries and Wages Payable 9,000 Bal. Jan. 1 7,000 Bal. Dec. 31 2,000 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 Decrease $6,000 Prepaid Insurance Bal. Jan. 1 18,000 Bal. Dec. 31 12,000 Net decrease 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 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 Enter account balances LO8

Indirect Method: Using a Work Sheet Record investing and financing activities

Indirect Method: Using a Work Sheet Enter net income

Indirect Method: Using a Work Sheet Enter noncash revenues or expenses

Indirect Method: Using a Work Sheet Extend current assets and current liabilities

Indirect Method: Using a Work Sheet Total columns

Indirect Method: Using a Work Sheet Determine net cash inflow (outflow)

End of Chapter 12