McGraw-Hill /Irwin© 2009 The McGraw-Hill Companies, Inc. THE STATEMENT OF CASH FLOWS REVISITED Chapter 21

Slide Investing ActivitiesOperating ActivitiesFinancing Activities Sale of operational assets Sale of investments Collections of loans Cash received from revenues Issuance of stock Issuance of bonds and notes CASH INFLOWS Business CASH OUTFLOWS Purchase of operational assets Purchase of investments Loans to others Cash paid for expenses Payment of dividends Repurchase of stock Repayment of debt

Slide Role of the Statement of Cash Flows The Statement helps users assess...  a firm’s ability to generate cash.  a firm’s ability to meet its obligations.  the reasons for differences between income and associated cash flows.  the effect of cash and noncash investing and financing activities on a firm’s financial position. The Statement helps users assess...  a firm’s ability to generate cash.  a firm’s ability to meet its obligations.  the reasons for differences between income and associated cash flows.  the effect of cash and noncash investing and financing activities on a firm’s financial position.

Slide Role of the Statement of Cash Flows Lists inflows and outflows of cash and cash equivalents by category Explains the change in cash during the period Required by SFAS No. 95

Slide Cash and Cash Equivalents Resources immediately available to pay obligations. Short-term, highly liquid investments. Readily convertible into known, fixed amounts of cash. So near maturity that there is insignificant risk of market value fluctuation from interest rate changes.

Slide Primary Elements of the Statement of Cash Flows (SCF) Operating Activities Investing Activities Financing Activities Reconciliation of the Net Increase or Decrease in Cash with the Change in the Balance of the Cash Account Noncash Investing and Financing Activities

Slide Primary Elements of the Statement of Cash Flows (SCF) Operating Activities Reports the cash effects of the elements of net income. Investing Activities Reports the cash effects of the acquisition and disposition of assets (other than inventory and cash equivalents). Financing Activities Reports the cash effects of the sale or repurchase of shares, the issuance or repayment of debt securities, and the payment of cash dividends.

Slide Cash Flows from Operating Activities + Inflows from: Sales to customers. Interest and dividends received. _ Outflows to: Purchase of inventory. Salaries, wages, and other operating expenses. Interest on debt. Income taxes.

Slide Direct Method or Indirect Method of Reporting Cash Flows from Operating Activities Two Formats for Reporting Operating Activities Reports the cash effects of each operating activity Direct Method Starts with accrual net income and converts to cash basis Indirect Method Note that no matter which format is used, the same amount of net cash flows operating activities is generated.

Slide Direct Method or Indirect Method of Reporting Cash Flows from Operating Activities The cash effect of each operating activity is reported directly on the statement of cash flows. The net cash increase or decrease from operating activities is derived indirectly by starting with reported net income on an accrual basis and working backwards to convert that amount to a cash basis.

Slide Cash Flows from Investing Activities + Inflows from: Sale of long-term assets used in the business. Sale of investment securities (stocks and bonds). Collection of nontrade receivables. _ Outflows to: Purchase of long-term assets used in the business. Purchase of investment securities (stocks and bonds). Loans to other entities.

Slide Cash Flows from Financing Activities + _ Inflows from: Sale of shares to owners. Borrowing from creditors through notes, loans, mortgages, and bonds. Outflows to: Owners in the form of dividends or other distributions. Owners for the reacquisition of shares previously sold. Creditors as repayment of the principal amounts of debt.

Slide Reconciliation with Change in Cash Balance The net amount of cash inflows and outflows reconciles the change in the company’s beginning and ending cash balances. For example, assume the net increase in cash is $9 million and the Cash beginning balance is $20 million. The cash reconciliation would be as follows:

Slide Noncash Investing and Financing Activities Significant investing and financing transactions not involving cash also are reported (usually in a disclosure note). 1.Acquiring an asset by incurring a debt payable to the seller. 2.Acquiring an asset by entering into a capital lease. 3.Converting debt into common stock or other equity securities. 4.Exchanging noncash assets or liabilities for other noncash assets or liabilities.

Slide Preparation of the Statement of Cash Flows A spreadsheet can be used to ensure that no reportable activities are inadvertently overlooked. Reconstructing the events and transactions that occurred during the period helps identify the operating, investing and financing activities to be reported. Let’s see how to use a spreadsheet to prepare a Statement of Cash Flows on the next few slides.

Slide We begin by entering the beginning and ending balances for each account on the comparative balance sheet and income statement. The changes columns will be used later to explain the increase or decrease in each account balance.

Slide The beginning balances for income statement accounts are always zero.

Slide Next we allocate space on the spreadsheet for the statement of cash flows. Spreadsheet entries duplicate the actual journal entries used to record the transactions as they occurred during the year. They are only entered on the spreadsheet and are not recorded in the accounting records.

Slide Let’s start by analyzing Sales Revenue and its related account Accounts Receivable by looking at the relationship in a T- account format.

Slide We can see from this analysis that cash received from customers must have been $98 million. Let’s see how to post this entry to the spreadsheet.

Slide First, $2 million is debited to Accounts Receivable to account for the total change in the account. Then, $100 million is credited to Sales Revenue to account for the total change in the account.

Slide The final part of this entry is a $98 million entry on the Statement of Cash Flows under Cash Inflows from Customers. Let’s skip ahead and look at the analysis of Short-term Investments.

Slide In the textbook, entry number 12 illustrates the analysis of the Short- term Investment account. The $12 million increase in the Short-term Investments account is due to the purchase of short-term investments during the year.

Slide The final part of this entry is a $12 million entry on the Statement of Cash Flows under Investing Activities. Now, let’s look at a noncash transaction.

Slide In entry number 14, we find that a note payable was issued as payment for a building. Investing in a new building is a significant investing activity and financing the acquisition with long-term debt is a significant financing activity. x denotes a noncash transaction x x

Slide x x After entering all the transactions, this is what the balance sheet portion of the spreadsheet looks like.

Slide After entering all the transactions, this is what the income statement portion of the spreadsheet looks like.

Slide After entering all the transactions, this is what the statement of cash flows portion of the spreadsheet looks like.

Slide Here is the Statement of Cash Flows prepared using the direct method.

Slide Preparing an SCF: The Indirect Method The indirect method derives the net cash increases or decreases from operating activities indirectly by starting with reported net income and “working backwards” to convert that amount to a cash basis.

Slide Components of Net Income that Do Not Increase or Decrease Cash Depreciation Expense Loss on Sale of Equipment Adding these items back to net income restores net income to what it would have been had depreciation and the loss not been subtracted at all. Subtracting the gain reverses the effect of the gain having been added to net income. Gain on Sale of Land

Slide Components of Net Income that Do Increase or Decrease Cash Note: Cash and cash equivalents, short-term investments in securities available for sale, dividends payable, and short-term payables to financial institutions are excluded from this category. For components of net income that increase or decrease cash, but by an amount different from that reported on the income statement, net income is adjusted for changes in the balances of related balance sheet accounts to convert the effects of those items to a cash basis.

Slide Comparison with the Direct Method

Slide Appendix 21A: Spreadsheet for the Indirect Method A spreadsheet is equally useful in preparing a statement of cash flows whether we use the direct or the indirect method of determining cash flows from operating activities.

Slide Appendix 21B: The T-Account Method of Preparing the Statement of Cash Flows The T-Account method serves the same purpose as a spreadsheet in assisting in the preparation of a statement of Cash Flows.

Slide Appendix 21B: The T-Account Method of Preparing the Statement of Cash Flows 1.Draw a T-account for each income statement and balance sheet account. 2.The T-account for cash should be drawn considerably larger. 3.Enter each account’s net change on the appropriate side (debit or credit) of the uppermost portion of each T- account. 4.Reconstruct the transactions that caused changes in each account balance during the year and record the entries for those transactions directly in the T-accounts. 5.After all account balances have been explained by T- account entries, prepare the statement of cash flows from the cash T-account, being careful also to report noncash investing and financing activities.

McGraw-Hill /Irwin© 2009 The McGraw-Hill Companies, Inc. End of Chapter 21