© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Reporting the Statement of Cash Flows(refer to HOU’s) Chapter 16

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin How does a company obtain its cash? Where does a company spend its cash? What explains the change in the cash balance? Purpose of the Statement of Cash Flows

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin How did the business fund its operations? Did the business borrow any funds or repay any loans? Does the business have sufficient cash to pay its debts as they mature? Did the business make any dividend payments? Importance of Cash Flows

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Cash Currency Cash Equivalents Short-term, highly liquid investments. Readily convertible into cash. So near maturity that market value is unaffected by interest rate changes. Short-term, highly liquid investments. Readily convertible into cash. So near maturity that market value is unaffected by interest rate changes. Measurement of Cash Flows

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin The Statement of Cash Flows includes the following three sections:  Operating Activities  Investing Activities  Financing Activities Classifying Cash Flows

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Outflows Salaries and wages. Payments to suppliers. Taxes and fines. Interest paid to lenders. Other. Outflows Salaries and wages. Payments to suppliers. Taxes and fines. Interest paid to lenders. Other. Inflows Receipts from customers. Cash dividends received. Interest from borrowers. Other. Inflows Receipts from customers. Cash dividends received. Interest from borrowers. Other. Operating Activities

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Outflows Purchasing long-term productive assets. Purchasing equity investments. Purchasing debt investments. Other. Outflows Purchasing long-term productive assets. Purchasing equity investments. Purchasing debt investments. Other. Inflows Selling long-term productive assets. Selling equity investments. Collecting principal on loans. Other. Inflows Selling long-term productive assets. Selling equity investments. Collecting principal on loans. Other. Investing Activities

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Outflows Pay dividends. Purchasing treasury stock Repaying cash loans. Paying owners’ withdrawals. Outflows Pay dividends. Purchasing treasury stock Repaying cash loans. Paying owners’ withdrawals. Inflows Issuing its own equity securities. Issuing bonds and notes. Issuing short- and long-term liabilities. Inflows Issuing its own equity securities. Issuing bonds and notes. Issuing short- and long-term liabilities. Financing Activities

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Items requiring separate disclosure include:  Retirement of debt by issuing equity securities.  Conversion of preferred stock to common stock.  Leasing of assets in a capital lease transaction. Items requiring separate disclosure include:  Retirement of debt by issuing equity securities.  Conversion of preferred stock to common stock.  Leasing of assets in a capital lease transaction. Noncash Investing and Financing

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin There are two acceptable methods to determine Cash Flows from Operating Activities: Direct Method Indirect Method

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Let’s look at the Direct Method for preparing the Cash Flows from Operating Activities section.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Analyzing the Cash Account Let’s use this Cash account to prepare B&G Company’s Statement of Cash Flows under the Direct Method.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Let’s look at the Indirect Method for preparing the Cash Flows from Operating Activities section.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Net Income Cash Flows from Operating Activities 97.5% of all companies use the indirect method. Changes in current assets and current liabilities. + Losses and - Gains + Noncash expenses such as depreciation and amortization. Indirect Method of Reporting Operating Cash Flows

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Use this table when adjusting Net Income to Operating Cash Flows. Indirect Method of Reporting Operating Cash Flows

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin East, Inc. reports $125,000 net income for the year ended December 31, Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000. During 2005, East reported $12,500 of Depreciation Expense. East, Inc. reports $125,000 net income for the year ended December 31, Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000. During 2005, East reported $12,500 of Depreciation Expense. What is East, Inc.’s Operating Cash Flow for 2005? Indirect Method Example

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Net income125,000$ Deduct: Increase in accounts receivable Cash provided by operating activities Net income125,000$ Deduct: Increase in accounts receivable Cash provided by operating activities For the indirect method, start with net income. Indirect Method Example

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable Cash provided by operating activities Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable Cash provided by operating activities Add noncash expenses such as depreciation, depletion, amortization, or bad debt expense. Indirect Method Example

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Cash provided by operating activities Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Cash provided by operating activities Indirect Method Example

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities Indirect Method Example

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities140,000$ Net income125,000$ Add: Depreciation expense12,500 Deduct: Increase in accounts receivable(7,500) Add: Increase in accounts payable10,000 Cash provided by operating activities140,000$ Indirect Method Example If we used the Direct Method, we would get the same $140,000 for Cash Provided by Operating Activities.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Let’s prepare a Statement of Cash Flows for B&G Company using the Indirect Method.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin  Additional Information for 2005: Net income was $105,000. Cash dividends declared and paid were $40,000. Bonds payable of $50,000 were redeemed for $50,000 cash. Common stock was issued for $35,000 cash.  Additional Information for 2005: Net income was $105,000. Cash dividends declared and paid were $40,000. Bonds payable of $50,000 were redeemed for $50,000 cash. Common stock was issued for $35,000 cash.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Add noncash expenses and losses. Subtract noncash revenues and gains. Add noncash expenses and losses. Subtract noncash revenues and gains. Start with accrual-basis net income. Then, analyze the changes in current assets and current liabilities.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Now, let’s complete the investing section.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Now, let’s complete the financing section.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin CASE TWO  Prepare a statement of cash flow using the indirect method

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin  Additional Information for 2005: Net income was $38,000. a. The accounts payable balances result from merchandise inventory purchases. b. Purchased plant assets costing $70,000 by paying $10,000 cash and issuing $60,000 of bonds payable. c. Sold plant assets with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss. d. Received cash of $15,000 from issuing 3,000 shares of common stock. e. Paid $18,000 cash to retire bonds with a $34000 book value, yielding a $16000 gain. f. Cash dividends declared and paid were $14,000.  Additional Information for 2005: Net income was $38,000. a. The accounts payable balances result from merchandise inventory purchases. b. Purchased plant assets costing $70,000 by paying $10,000 cash and issuing $60,000 of bonds payable. c. Sold plant assets with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss. d. Received cash of $15,000 from issuing 3,000 shares of common stock. e. Paid $18,000 cash to retire bonds with a $34000 book value, yielding a $16000 gain. f. Cash dividends declared and paid were $14,000.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Add noncash expenses and losses. Subtract noncash revenues and gains. Add noncash expenses and losses. Subtract noncash revenues and gains. Start with accrual-basis net income. Then, analyze the changes in current assets and current liabilities.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Adjustments for changes in current assets and current liabilities  Decreases in noncash current assets are added to net income  Increases in noncash assets are subtracted from net income

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Accounts receivable Accounts Receivable Beg Bal: 40,000 End Bal: 60,000 Sales 590,000Cash receipts 570,000 Increase in A/R balance from 40,000 to 60,000 indicates that the company collects less cash than is reported in sales. The 20,000 is subtracted from net income.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Merchandise Inventory Merchandise inventory Beg Bal: 70,000 End Bal: 84,000 Purchases 314,000 Cost of goods sold 300,000 Increase in merchandise inventory balance from 70,000 to 84,000 indicates that the company has a larger amount of cash purchase than cost of goods sold. The 14,000 increase is subtracted from net income.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Prepaid expense Beg Bal 4,000 Prepaid expense End Bal 6,000 Cash payment 218,000 Wages and other operating exp 216,000 Increase in prepaid expense balance from 4,000 to 6,000 indicates the company’s cash payments exceed its recorded prepaid expense. The 2,000 increase is subtracted from net income.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Adjustments for changes in current liabilities  Increases in current liabilities are added to net income  Decreases in current liabilities are subtracted from net income

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Accounts payable  The decrease in A/P balance from 40,000 to 35,000 indicates that cash payments to suppliers exceed purchases by $5,000 for the period. The 5,000 is subtracted from net income. Accounts payable Cash payment 319,000 Beg Bal 40,000 Purchases 314,000 End Bal 35,000

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Interest payable  The decrease in interest payable balance from 4,000 to 3,000 indicates that cash paid for interest exceeds interest expense. The 1,000 is subtracted from net income. Interest payable Cash paid for interest 8,000 Beg Bal 4,000 Interest expense 7,000 End Bal 3,000

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Income tax payable  The increase in income tax payable balance from 12,000 to 15,000 indicates that reported income tax taxes exceed the cash paid for tax. The 10,000 is added to net income. Income tax payable Beg Bal 12,000 Income tax expense 15,000 Cash paid for taxes 5,000 End Bal 22,000

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Adjustments for operating items not providing or using cash  Expenses with no cash outflows are added back to net income  Revenues with no cash inflows are subtracted from net income  Depreciation expense is the only operating item that has no effect on cash flows in the period. The 24,000 is added to net income.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Adjustments for nonoperating items  Nonoperating losses are added back to net income  Nonoperating gains are subtracted from net income

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Loss on sale of plant assets c.Sold plant assets with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss.  The loss is not part of operating activities. The sale of plant assets is part of investing activities. Thus, the 6,000 loss is added back to net income.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin  e. Paid $18,000 cash to retire bonds with a $34000 book value, yielding a $16000 gain.  A gain on retirement of debt is not part of operating activities, but financing activities. Thus, the 16,000 nonoperating gain is subtracted from net income.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Cash Flow from Investing  (1) Identify changes in investing related accounts.  (2) Report their cash flow effects.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Cash Flow from Investing  b. Purchased plant assets costing $70,000 by paying $10,000 cash and issuing $60,000 of bonds payable.  Dr. Plant assets 70,000 Cr. Bonds payable 60,000 Cr. Cash 10,000 Cash outflow for purchase of plant assets = 10,000

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Cash Flow from Investing  C. Sold plant assets with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss.  Dr. Cash 12,000 Dr. Accumulated Dep. 12,000 Dr. Loss on sale of plant assets 6,000 Cr. Plant assets 30,000 Cash inflow from sale of plant assets = 12,000

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Now, let’s complete the financing section.

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Cash Flow from Financing  (1) Identify changes in financing related accounts.  (2) Report their cash flow effects

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Cash Flow from Financing  Analysis of noncurrent liabilities  e. Paid $18,000 cash to retire bonds with a $34000 book value, yielding a $16,000 gain.  Dr. Bonds payable 34,000 Cr. Gain on retirement of debt 16,000 Cr. Cash 18,000 Cash paid to retire bonds = 18,000

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Cash Flow from Financing  Analysis of equity  d. Received cash of $15,000 from issuing 3,000 shares of common stock.  Dr. Cash 15,000 Cr. Common Stock 15,000 Cash received from issuing stock = 15,000

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Cash Flow from Financing f. Cash dividends declared and paid were $14,000.  Dr. Retained earnings 14,000 Cr. Cash 14,000 Cash paid for dividends = 14,000

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Analyzing Cash Sources and Uses

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin Homework for Chap 16  Ex 16-1, 16-2  Problem 16-4A

© The McGraw-Hill Companies, Inc., 2006 McGraw-Hill/Irwin End of Chapter 16