PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. R EPORTING THE S TATEMENT OF C ASH F LOWS Chapter 16

How does a company obtain its cash? Where does a company spend its cash? What explains the change in the cash balance? P URPOSE OF THE S TATEMENT OF C ASH F LOWS

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? I MPORTANCE OF C ASH F LOWS

Cash Currency Cash Equivalents  Short-term, highly liquid investments.  Readily convertible into cash.  Sufficiently close to maturity so that market value is unaffected by interest rate changes. M EASUREMENT OF C ASH F LOWS SHORT TERM TREASURY BILLS, bank accounts, money market and marketable securities

C LASSIFICATION OF C ASH F LOWS The Statement of Cash Flows includes the following three sections:  Operating Activities  Investing Activities  Financing Activities  NON CASH ACTIVITIES REQUIRE DISCLOSURE in the notes C1

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 O PERATING A CTIVITIES C1

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 I NVESTING A CTIVITIES C1

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  Contributions by owners Inflows  Issuing its own equity securities  Issuing bonds and notes  Issuing short- and long-term liabilities  Contributions by owners F INANCING A CTIVITIES C1

N ONCASH I NVESTING AND F INANCING 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.  Purchase of equipment by issuing stock 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.  Purchase of equipment by issuing stock C1

F ORMAT OF THE S TATEMENT OF C ASH F LOWS

P REPARING THE S TATEMENT OF C ASH F LOWS P1

A NALYZING THE C ASH A CCOUNT P1 The Cash account is a natural place to look for information about cash flows from operating, investing, and financing activities. Cash summarized data

A NALYZING THE C ASH A CCOUNT P1 Cash from Operating Cash from Investing Cash from Financing Cash Provided

A NALYZING N ONCASH A CCOUNT P1 A second approach to preparing the statement of cash flows is analyzing noncash accounts. we can explain changes in cash by analyzing changes in the noncash accounts consisting of liability accounts, equity accounts, and noncash asset account And any related income statement accounts

I NFORMATION TO P REPARE THE S TATEMENT P1 Comparative Balance Sheets Current Income Statement Additional Information Information to prepare the statement of cash flows usually comes from three sources:

C ASH F LOWS FROM O PERATING I NDIRECT AND D IRECT M ETHODS OF R EPORTING The net cash amount provided by operating activities is identical under both the direct and indirect methods. Direct Method Indirect Method

A PPLICATION OF THE I NDIRECT M ETHOD OF R EPORTING P2

A PPLICATION OF THE I NDIRECT M ETHOD OF R EPORTING P2 Additional information on Genesis Inc.’s 2011 transactions: a) The accounts payable balances result from merchandise inventory purchases. b) Purchased $70,000 in plant assets by paying $10,000 cash and issuing $60,000 of notes 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 $15,000 cash from issuing 3,000 shares of common stock. e) Paid $18,000 cash to retire notes with a $34,000 book value, yielding a $16,000 gain. f) Declared and paid cash dividends of $14,000.

Net Income Cash Flows from Operating Activities Changes in noncash current assets and current liabilities + Losses and - Gains + Noncash expenses such as depreciation and amortization A PPLICATION OF THE I NDIRECT M ETHOD OF R EPORTING P2 1 23

Use this table when adjusting Net Income to Operating Cash Flows. A DJUSTMENTS FOR C HANGES IN C URRENT A SSETS AND C URRENT L IABILITIES P2

P2 A DJUSTMENTS FOR C HANGES IN C URRENT A SSETS AND C URRENT L IABILITIES

P2 A DJUSTMENTS FOR O PERATING I TEMS N OT P ROVIDING OR U SING C ASH

P2 A DJUSTMENTS FOR N ONOPERATING I TEMS

P2 S UMMARY OF A DJUSTMENTS FOR I NDIRECT M ETHOD Common adjustments to net income when computing net cash provided or used by operating activities under the indirect method:

P3 C ASH F LOWS FROM I NVESTING Identify changes in investing-related accounts Explain these changes using reconstruction analysis Report their cash flow effects A three-stage process to determine cash provided or used by investing activities:

P3 C ASH F LOWS FROM I NVESTING This analysis reveals a $40,000 increase in plant assets from $210,000 to $250,000 and a $12,000 increase in accumulated depreciation from $48,000 to $60,000.

P3 C ASH F LOWS FROM I NVESTING Item b: Genesis purchased plant assets of $70,000 by issuing $60,000 in notes payable to the seller and paying $10,000 in cash. Item c: Genesis sold plant assets costing $30,000 (with $12,000 of accumulated depreciation) for $12,000 cash, resulting in a $6,000 loss. We also reconstruct the entry for Depreciation Expense using information from the income statement.

P3 C ASH F LOWS FROM I NVESTING

P3 C ASH F LOWS FROM F INANCING Identify changes in financing-related accounts Explain these changes using reconstruction analysis Report their cash flow effects A three-stage process to determine cash provided or used by financing activities:

P3 C ASH F LOWS FROM F INANCING This analysis reveals: 1.an increase in notes payable from $64,000 to $90,000, 2.an increase in common stock from $80,000 to $95,000, and 3.an increase in retained earnings from $88,000 to $112,000.

P3 C ASH F LOWS FROM F INANCING Item e: Notes with a carrying value of $34,000 are retired for $18,000 cash, resulting in a $16,000 gain. Item b: Genesis purchased plant assets of $70,000 by issuing $60,000 in notes payable to the seller and paying $10,000 in cash.

P3 C ASH F LOWS FROM F INANCING Item d: Issued 3,000 shares of common stock at par for $5 per share. Item f: Cash dividends of $14,000 are paid.

P3

P3

G LOBAL V IEW Reporting Cash Flows from Operating Both U.S. GAAP and IFRS permit the reporting of cash flows from operating activities using either the direct or indirect method. However, two notable differences include: 1.U.S. GAAP requires cash inflows from interest revenue and dividend revenue be classified as operating, whereas IFRS permits classification under operating or investing provided that this classification is consistently applied across periods. 2.U.S. GAAP requires cash outflows for interest expense be classified as operating, whereas IFRS again permits classification under operating or financing provided that it is consistently applied across periods. Reporting Cash Flows from Investing and Financing U.S. GAAP and IFRS are broadly similar in computing and classifying cash flows from investing and financing activities. One notable exception is that U.S. GAAP requires cash outflows for income tax be classified as operating, whereas IFRS permits the splitting of those cash flows among operating, investing, and financing depending on the sources of that tax.

A NALYZING C ASH S OURCES AND U SES A1 Most managers stress the importance of understanding and predicting cash flows for business decisions.

Used, along with income-based ratios, to assess company performance. Cash flow on total assets = Operating cash flows Average total assets C ASH F LOW ON T OTAL A SSETS A1

P4 A spreadsheet, also called work sheet or working paper, can help us organize the information needed to prepare a statement of cash flows. Appendix 16A: Spreadsheet Preparation of the Statement of Cash Flows

A PPENDIX 16B: D IRECT M ETHOD OF R EPORTING O PERATING C ASH F LOWS P5 Adjust income statement accounts related to operating activities for changes in their related balance sheet accounts: Framework for reporting cash receipts and cash payments

A PPENDIX 16B: D IRECT M ETHOD OF R EPORTING O PERATING C ASH F LOWS P5

E ND OF C HAPTER 16