Chapter 13 Statement of Cash Flows ( 現金流量表 ) Instructor: Chih-Liang Julian Liu Department of Industrial and Business Management Chang Gung University

Learning Objectives 1.Indicate the usefulness of the statement of cash flows. 2.Distinguish among operating, investing, and financing activities. 3.Prepare a statement of cash flows using the indirect method. 4.Analyze the statement of cash flows.

Preview of Chapter 13

Income Statement Statement of Cash Flows Accrual BasisCash Basis Indirect Method Net Income=Cash + Accruals (A/R, A/P) Accrual versus Cash Basis

Provides information to help assess: 1.Entity’s ability to generate future cash flows. 2.Entity’s ability to pay dividends and meet obligations. 3.Reasons for difference between net income and net cash provided (used) by operating activities. 4.Cash investing and financing transactions during the period. Usefulness of the Statement of Cash Flows Usefulness and Format

Classification of Cash Flows Income Statement Items Operating Activities Changes in Investments and Non- Current Asset Investing Activities Changes in Non-Current Liabilities and Equity Financing Activities Usefulness and Format

Classification of Cash Flows Illustration 13-1 Typical receipt and payment classifications

Usefulness and Format Classification of Cash Flows

1.Direct issuance of ordinary shares to purchase assets. 2.Conversion of bonds into ordinary shares. 3.Direct issuance of debt to purchase assets. 4.Exchanges of plant assets. Companies report non-cash activities in either a  separate note ( 單獨附註 ) or  supplementary schedule to the financial statements ( 附表報導 ). Significant Non-Cash Activities ( 重大非現金活動 ) Usefulness and Format

Order of Presentation: 1.Operating activities. 2.Investing activities. 3.Financing activities. Direct Method Indirect Method Format of the Statement of Cash Flows Usefulness and Format The cash flows from operating activities section always appears first, followed by the investing and financing sections.

Illustration 13-3 Format of the Statement of Cash Flows

Illustration: Classify each of these transactions by type of cash flow activity. 1. Issued 100,000 shares of HK$50 par value ordinary shares for HK$800,000 cash. 2. Borrowed HK$2,000,000 from Castle Bank, signing a 5-year note bearing 8% interest. 3. Purchased two semi-trailer trucks for HK$1,700,000 cash. 4. Paid employees HK$120,000 for salaries and wages. 5. Collected HK$200,000 cash for services provided. Financing Investing Operating

Three Sources of Information: 1.Comparative statements of financial position 2.Current income statement 3.Additional information Preparing the Statement of Cash Flows Usefulness and Format

Three Major Steps: Illustration 13-4 Preparing the Statement of Cash Flows Usefulness and Format

Three Major Steps:

Indirect and Direct Methods Usefulness and Format Companies favor the indirect method for two reasons: 1.Easier and less costly to prepare, and 2.Focuses on the differences between net income and net cash flow from operating activities.

Illustration – Indirect Method Illustration 13-5 Preparing the Statement of Cash Flows

Illustration 13-6

Additional information for 2014: 1.Depreciation expense was comprised of €6,000 for building and €3,000 for equipment. 2.The company sold equipment with a book value of €7,000 (cost €8,000, less accumulated depreciation €1,000) for €4,000 cash. 3.Issued €110,000 of long-term bonds in direct exchange for land. 4.A building costing €120,000 was purchased for cash. Equipment costing €25,000 was also purchased for cash. 5.Issued ordinary shares for €20,000 cash. 6.The company declared and paid a €29,000 cash dividend. Preparing the Statement of Cash Flows Illustration 13-6

Income Statement Operating Cash Flows Indirect Method Cash = Net Income adjust Accruals Cash Net Income = Cash + Accruals Preparing the Statement of Cash Flows

Step 1: Operating Activities Determine net cash provided/used by operating activities by converting net income from accrual basis to cash basis. Common adjustments to Net Income (Loss):  Add back non-cash expenses (depreciation, amortization, or depletion expense).  Deduct gains and add losses.  Changes in non-cash current asset and current liability accounts. Preparing the Statement of Cash Flows

Which is an example of a cash flow from an operating activity? a.Payment of cash to lenders for interest. b.Receipt of cash from the sale of ordinary shares. c.Payment of cash dividends to the company’s shareholders. d.None of the above. Question Step 1: Operating Activities

Depreciation Expense Although depreciation expense reduces net income, it does not reduce cash. The company must add it back to net income. Depreciation Expense 9,000 (I/S) Accumulated Depreciation 9,000 (S/FP) Illustration 13-7 Step 1: Operating Activities

Income Statement Operating Cash Flows Indirect Method Cash = Net Income + Depreciation Expense Net Income = Rev. – Dep. Exp. = Rev. – 9,000 Operating Cash Flows = Cash Inflows – Cash Outflows = Cash Inflows – 0 Depreciation Expense

Loss on Disposal of Plant Assets Companies should report cash received from the sale (disposal) of plant assets in the investing activities section. Because of this,  any loss on sale is added to net income in the operating section.  any gain on sale is deducted from net income in the operating section. Step 1: Operating Activities

Illustration 13-8 Step 1: Operating Activities Loss on Disposal of Plant Assets

Computer Services’ income statement reports a $3,000 loss on disposal of plant assets (book value $7,000, less $4,000 cash received from sale of plant assets). Cash 4,000 (S/C: Investing Cash) Accumulated Depreciation 1,000 Loss on Disposal of Plant Assets 3,000 (I/S: Net Income) Equipment 8,000 Loss on Disposal of Plant Assets

Income Statement Operating Cash Flows Indirect Method Cash = Net Income + Loss on Sale of Equipment Net Income = Sales – Loss = Sales – 3,000 Cash = Cash Inflows – Cash Outflows = Cash Inflows – 0 Loss on Disposal of Plant Assets

Changes to Non-Cash Current Asset Accounts When the Accounts Receivable balance decreases, cash receipts are higher than revenue earned under the accrual basis. Company adds to net income the amount of the decrease in accounts receivable. Accounts Receivable 1/1/014 Balance 30,000 Sales revenue 507,000 Receipts from customers 517,000 12/31/14 Balance 20,000 Illustration 13-9 Step 1: Operating Activities

Changes to Accountings Receivable When the Accounts Receivable balance decreases, cash receipts are higher than revenue earned under the accrual basis. Accounts Receivable 507,000 (S/F) Sales 507,000 (I/S: Net Income) Cash 517,000 (S/C: Operating Inflows) Accounts Receivable 517,000 (S/F)

Income Statement Operating Cash Flows Indirect Method Cash = Net Income + Decrease in A/R Net Income = Sales – COGS = 507,000 – COGS Cash = Cash Inflows – Cash Outflows = 517,000 – Cash Outflows Changes to Accountings Receivable

Illustration Step 1: Operating Activities Changes to Non-Cash Current Asset Accounts

When the Inventory balance increases, the cost of merchandise purchased exceeds the cost of goods sold. Changes to Non-Cash Current Asset Accounts Inventory 1/1/14 Balance 10,000 Purchases 155,000 Cost of goods sold 150,000 12/31/14 Balance 15,000 Cost of goods sold does not reflect cash payments made for merchandise. The company deducts from net income this inventory increase. Step 1: Operating Activities

When the Inventory balance increases, the cost of merchandise purchased exceeds the cost of goods sold. Merchandise Inventory 155,000 (S/F) Cash 155,000 (Operating Outflows) Cost of Goods Sold 150,000 (I/S: Net Income) Merchandise Inventory 150,000 (S/F) Merchandise Inventory 1/1/11 Balance 10,000 Purchases 155,000 Cost of goods sold 150,000 12/31/11 Balance 15,000 As a result, cost of goods sold does not reflect cash payments made for merchandise. The company deducts from net income this inventory increase.

Changes to Inventory When the Inventory balance increases, the cost of merchandise purchased exceeds the cost of goods sold. Merchandise Inventory 155,000 (S/F) Cash 155,000 (Operating Outflows) Cost of Goods Sold 150,000 (I/S: Net Income) Merchandise Inventory 150,000 (S/F)

Income Statement Operating Cash Flows Indirect Method Cash = Net Income – Increase of Inventory Net Income = Sales – COGS = Sales – 150,000 Cash = Cash Inflows – Cash Outflows = Cash Inflows – 155,000 Changes to Inventory

Step 1: Operating Activities Illustration Changes to Non-Cash Current Asset Accounts

When the Prepaid Expense balance increases, cash paid for expenses is higher than expenses reported on an accrual basis. The company deducts the decrease from net income to arrive at net cash provided by operating activities. If prepaid expenses decrease, reported expenses are higher than the expenses paid. Step 1: Operating Activities Changes to Non-Cash Current Asset Accounts

When the Prepaid Expense balance increases  Cash paid for expenses is higher than expenses reported on an accrual basis.  Prepaid Expense 5,000 (S/F) Cash 5,000 (S/F: Operating Outflows)  Expense 1,000 (I/S: Net Income) Prepaid Expense 1,000 (S/F)  Company deducts the increase from net income to arrive at net cash provided by operating activities. Prepaid Expense 1/1/11 Balance 1,000 5,000 1,000 12/31/11 Balance 5,000 Changes to Prepaid Expense

Income Statement Operating Cash Flows Indirect Method Cash = Net Income – Increase in Prepaid Exp. Net Income = Sales – Exp. = Sales – 1,000 Cash = Cash Inflows – Cash Outflows = Cash Inflows – 5,000 Changes to Prepaid Expense

Step 1: Operating Activities Illustration Changes to Non-Cash Current Asset Accounts

Changes to Non-Cash Current Liability Accounts When Accounts Payable increases, the company received more in goods than it actually paid for. The increase is added to net income to determine net cash provided by operating activities. When Income Taxes Payable decreases, the income tax expense reported on the income statement was less than the amount of taxes paid during the period. The decrease is subtracted from net income to determine net cash provided by operating activities. Step 1: Operating Activities

When Accounts Payable increases  Company received more in goods than it actually paid for.  Increase is added to net income. Purchases 26,000 (I/S) Accounts Payable 16,000 (S/F) Cash 10,000 (S/C: Outflows)  Cost of Goods Sold = Beg. Inventory + Purchases -Ending inventory Changes to Non-Cash Current Liability Accounts

Income Statement Operating Cash Flows Indirect Method Cash = Net Income + Increase in A/P Net Income = Sales – COGS = Sales – 26,000 Cash = Cash Inflows – Cash Outflows = Cash Inflows – 10,000 Changes to Accounting Payable

When Income Tax Payable decreases Income tax expense was less than the amount of taxes paid during the period. Decrease is subtracted from net income. Accounting entry: Income Tax Expense 47,000 (I/S) Income Tax Payable 47,000 (S/F) Income Tax Payable 49,000 (S/F) Cash 49,000 (S/C: Outflow) Changes to Non-Cash Current Liability Accounts

Income Statement Operating Cash Flows Indirect Method Cash = Net Income - Decrease in IT/P Net Income = Sales – Tax Exp. = Sales – 47,000 Cash = Cash Inflows – Cash Outflows = Cash Inflows – 49,000 Changes to Income Tax Payable

Illustration Step 1: Operating Activities Changes to Non-Cash Current Liability Accounts

Illustration Summary of Conversion to Net Cash Provided by Operating Activities—Indirect Method Step 1: Operating Activities

Company purchased land of €110,000 by issuing long-term bonds. This is a significant non-cash investing and financing activity that merits disclosure in a separate schedule. Land 1/1/14 Balance 20,000 Issued bonds 110,000 12/31/14 Balance 130,000 Bonds Payable 1/1/14 Balance 20,000 For land 110,000 12/31/14 Balance 130,000 Step 2: Investing and Financing Activities

Illustration Partial statement Step 2: Investing and Financing Activities

From the additional information, the company acquired an office building for €120,000 cash. This is a cash outflow reported in the investing section. 1/1/14 Balance 40,000 Office building 120,000 12/31/14 Balance 160,000 Building Step 2: Investing Activities

Illustration Partial statement Step 2: Investing Activities

The additional information explains that the equipment increase resulted from two transactions: (1) a purchase of equipment of €25,000 (investing cash), and (2) the sale for €4,000 (investing cash), of equipment costing €8,000. 1/1/14 Balance 10,000 Purchase 25,000 12/31/14 Balance 27,000 Cost of equipment sold 8,000 Cash4,000 Accumulated depreciation1,000 Loss on disposal of plant assets3,000 Equipment8,000 Journal Entry Equipment Step 2: Investing Activities Illustration 13-12

Statement of Cash Flows Illustration Indirect Method

The increase in ordinary shares resulted from the issuance of new shares (Financing Cash Inflows). 1/1/14 Balance 50,000 Shares sold 20,000 12/31/14 Balance 70,000 Share Capital - Ordinary Step 2: Financing Activities

Illustration Partial statement Step 2: Financing Activities

Retained earnings increased €116,000 during the year. This increase can be explained by two factors: (1) Net income of €145,000 increased retained earnings, and (2) Dividends of €29,000 decreased retained earnings (Financing Cash outflow). 1/1/14 Balance 48,000 Net income 145,000 12/31/14 Balance 164,000 Dividends 29,000 Retained Earnings Step 2: Financing Activities

Which is an example of a cash flow from an investing activity? a.Receipt of cash from the issuance of bonds payable. b.Payment of cash to repurchase ordinary shares. c.Receipt of cash from the sale of equipment. d.Payment of cash to suppliers for inventory. Question Step 2: Investing and Financing Activities

Illustration Statement of Cash Flows Indirect Method

Illustration 13-5 Compare The Net Change In Cash On The Statement Of Cash Flows With The Change In The Cash Account Reported On The Statement Of Financial Positions To Make Sure The Amounts Agree. Step 3: Net Change in Cash

Free Cash Flow Free cash flow describes the cash remaining from operations after adjustment for capital expenditures and dividends. Illustration Using Cash Flows to Evaluate a Company

€4,189 Illustration Less: Expenditures on property and equipment 1,794 Dividends paid 2,088 €307 Illustration Required: Calculate free cash flow. Using Cash Flows to Evaluate a Company Cash provided by operating activities Free cash flow