CORNERSTONES of Managerial Accounting, 5e

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. CHAPTER 15: STATEMENT OF CASH FLOWS Cornerstones of Managerial Accounting, 5e

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Overview of the Statement of Cash Flows  All firms that are registered with the U.S. Securities and Exchange Commission (SEC) must issue a statement of cash flows.  The statement of cash flows provides information regarding the sources and uses of a firm’s cash. LO-1

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Overview of the Statement of Cash Flows (cont.) LO-1 Activities that increase cash are sources of cash and are referred to as cash inflows. Activities that decrease cash are uses of cash and referred to as cash outflows.

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Cash Defined  Cash is defined as both currency and cash equivalents.  Cash equivalents are highly liquid investments such as Treasury bills, money market funds, and commercial paper.  Many firms invest their excess cash in these short-term securities. LO-1

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Cash Defined (cont.)  Because of their high liquidity, these short-term investments are treated as cash for the statement of cash flows. LO-1

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Statement of Cash Flows Categories  The statement provides additional information by classifying cash flows into three categories:  Operating activities are the ongoing, day-to-day, revenue-generating activities of an organization.  Operating cash flows involve increases or decreases in either current assets or current liabilities.  Investing activities are those activities that involve the acquisition or sale of long-term assets.  Long-term assets may be productive assets (e.g., acquiring new equipment) or long-term activities (e.g., acquiring stock in another company). LO-1

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Statement of Cash Flows Categories (cont.)  Financing activities are those activities that raise (provide) cash from (to) creditors and owners.  Interest payments could be seen as financing outflows, the statement includes these payments in the operating section.  This classification, called the activity format, is the format for preparing the statement. LO-1

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Noncash Exchanges  Investing and financing activities take place without affecting cash.  These are referred to as noncash investing and financing activities.  A direct exchange of noncurrent balance sheet items may occur, like land exchanged for common stock.  These noncash transactions must also be disclosed in a supplementary schedule attached to the statement. LO-1

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Methods for Calculating Operating Cash Flows  There are two approaches for calculating operating cash flows.  The indirect method computes operating cash flows by adjusting net income for items that do not affect cash flows.  The direct method computes operating cash flows by adjusting each line on the income statement to reflect cash flows. LO-1

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Methods for Calculating Operating Cash Flows (cont.)  If the direct method is used, companies must also provide a supplementary schedule that shows how net income is reconciled with operating cash flows.  This requirement means that direct method users must also provide the information associated with the indirect method. LO-1

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Methods for Calculating Operating Cash Flows (cont.)  If the indirect method is used, there is no need to provide a line-by-line adjustment as found in the direct method.  The indirect method is the most commonly used method. LO-1

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Preparation of the Statement: Indirect Method  Five basic steps are followed in preparing a statement of cash flows:  1. Compute the change in cash for the period. This figure is the difference between the ending and beginning cash balances shown on the balance sheets. It must equal the net cash inflow or outflow shown on the statement of cash flows.  2. Compute the cash flows from operating activities. Use the period’s beginning and ending balance sheets and information about other events and transactions to adjust the period’s income statement to an operating cash flow basis. LO-2

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Preparation of the Statement: Indirect Method (cont.)  3. Identify the cash flows from investing activities. Use the period’s beginning and ending balance sheets and information about other events and transactions to identify the cash flows associated with the sale and purchase of long-term assets.  4. Identify the cash flows from financing activities. Use the period’s beginning and ending balance sheets to identify the cash flows associated with long-term debt and capital stock.  5. Prepare the statement of cash flows based on the previous four steps. LO-2

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Compute Operating Cash Flows  The accrual income statement can be converted to an operating cash flow basis by making four adjustments to net income:  Add to net income any increases in current liabilities and decreases in noncash current assets.  Deduct from net income any decreases in current liabilities and increases in noncash current assets. LO-2

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Compute Operating Cash Flows (cont.)  Add to or deduct from net income the remaining net income items that do not affect cash flows (e.g., add back noncash expenses).  Eliminate any income items that belong in either the investing or financing section. LO-2

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Direct Method: An Alternative Approach  Some individuals prefer to show operating cash flows as the difference between cash receipts and cash payments.  Each item on the accrual income statement is adjusted to reflect cash flows. LO-3

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Direct Method: An Alternative Approach (cont.)  If a company prepares the statement of cash flows using this direct method, it must also present the indirect method in a separate schedule.  The same adjustments and the same reasoning are used to produce the operating cash flows for both the direct and indirect methods, but the presentation is different. LO-3

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Worksheet Approach to the Statement of Cash Flows  As transactions increase in number and complexity, a worksheet becomes useful in preparing the statement of cash flows.  The approach minimizes confusion and allows consideration of all the details underlying an analysis of cash flows.  One advantage of a worksheet is the fact that it uses a spreadsheet format, allowing the preparer to use a computer and spreadsheet software like Excel. LO-4

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Worksheet Approach to the Statement of Cash Flows (cont.)  A worksheet offers the user an efficient, logical means to organize the data needed to prepare a statement of cash flows.  Although the worksheet itself is not the statement of cash flows, the statement can be easily extracted from the worksheet. LO-4