Prepared by: Jan Hájek Accounting 2 Lecture no 1

PURPOSE OF THE CASH FLOW STATEMENT  The primary purpose of the cash flow statement is to provide information about the cash receipts and cash payments of an entity during a period.  A secondary objective is to provide information about its Operating activities Investing activities Financing activities

3 Related Standards  FAS 95 Statement of cash flows  FAS 102 Statement of cash flows—exemption of certain enterprises and classification of cash flows from certain securities acquired for resale  FAS 104 Statement of cash flows—net reporting of certain cash receipts and cash payments and classification of cash flows from hedging transactions

4 Related Standards  IAS 1 Presentation of financial statements

5 IAS 7 - Overview  Objective and scope  Cash flows  Reporting operating cash flows  Reporting investing cash flows  Reporting financing cash flows  Specific items  Disclosures

6 IAS 7 – Objective and Scope  IAS 7 objective: to provide a statement to help investors assess the prospects for future cash flows, and to confirm or change their past expectations  Statement provides historical information on the entity’s operating, investing and financing cash flows and how its cash balances have changed in the period as a result

7 IAS 7 – Cash Flows  Cash and cash equivalents: Cash on hand and on deposit and “short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value”  Can include bank overdrafts if part of cash management activities and balance fluctuates between positive and negative amounts

MEANING OF CASH FLOWS  The cash flow statement is usually prepared using cash and cash equivalents as its basis.  Cash equivalents are short-term, highly liquid investments that are both 1.readily convertible to known amounts of cash, and 2. so near to their maturity that their market value is relatively insensitive to changes in interest rates.

CLASSIFICATION OF CASH FLOWS  Operating activities  Investing activities  Financing activities

 Include Cash effects of transactions that create revenues and expenses and Enter into determination of net income (loss) OPERATING ACTIVITIES Balance Sheet: Noncash Current Assets and Current Liabilities; Income Statement Items

 Include Purchasing and disposing of investments and productive long-lived assets using cash and Lending money and collecting the loans Balance Sheet: Investment and Long-Term Asset Items INVESTING ACTIVITIES

 Include Obtaining cash from issuing debt and repaying the amounts borrowed and Obtaining cash from owners/shareholders and paying them drawings/dividends FINANCING ACTIVITIES Balance Sheet: Long-Term Liability and Equity Items

 If it does not affect cash, do NOT report in body of cash flow statement  Report in separate note to the financial statements SIGNIFICANT NONCASH ACTIVITIES

Operating, investing, and financing plus the significant noncash investing and financing activities constitute the general format of the cash flow statement, an example of which is shown on the right. FORMAT OF CASH FLOW STATEMENT COMPANY NAME Cash Flow Statement Period Covered Cash flows from operating activities (List of individual items)XX Net cash provided (used) by operating activitiesXXX Cash flows from investing activities (List of individual items) XX Net cash provided (used) by investing activitiesXXX Cash flows from financing activities (List of individual items) XX Net cash provided (used) by financing activitiesXXX Net increase (decrease) in cashXXX Cash at beginning of periodXXX Cash at end of period XXX Note x: Noncash investing and financing activities (List of significant noncash transactions)XXX

PREPARING THE CASH FLOW STATEMENT The cash flow statement is prepared differently from the three other basic financial statements. 1.It is not prepared from the adjusted trial balance. 2. The cash flow statement deals with cash receipts and payments, so the accrual concept is not used in the preparation of this statement. The information to prepare this statement usually comes from three sources: 1.Comparative balance sheet 2.Current income statement 3.Additional information

THREE MAJOR STEPS IN PREPARING THE CASH FLOW STATEMENT + or - The difference between the beginning and ending cash balances can be easily calculated from comparative balance sheets. This step involves analysing not only the current year’s income statement but also comparative balance sheets and selected additional data. XYZ Goods This step involves analysing comparative balance sheet data and selected additional information for their effects on cash. For Sale InvestingFinancing Step 1: Determine the net increase (decrease) in cash. Step 2: Determine net cash provided (used) by operating activities. Step 3: Determine net cash provided (used) by investing and financing activities.

STEP 1: DETERMINE NET INCOME (DECREASE) IN CASH

STEP 2: DETERMINE NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES  Net income must be converted from an accrual basis to a cash basis in the operating activities section  Conversion may be done by two methods: Indirect (used extensively in practice) Direct

INDIRECT AND DIRECT METHODS  Both methods arrive at the same total amount of cash provided (used) by operating activities  Methods differ in disclosing the items that make up the total amount  Choice of section; the investing and finamethods affects only the operating activities ncing activities sections are the same

OPERATING ACTIVITIES – INDIRECT METHOD Section 1

NET INCOME VS. NET CASH PROVIDED BY OPERATING ACTIVITIES The indirect method starts with net income and converts it to net cash provided by operating activities. In other words, it adjusts net income for items that affect reported net income but do not affect cash, as shown below. Earned Revenues Net Income Incurred Expenses Accrual Basis of AccountingCash Basis of Accounting Net Cash Provided (Used) by Operating Activities Eliminate noncash revenues Eliminate noncash expenses

NET INCOME TO NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES (B/S: Noncash Current Assets and Current Liabilities) Adjustments to Convert Net Income to Net Cash Provided (Used) by Operating Activities Add*Deduct* Change in Current Asset Account Balance Accounts receivable Decrease Increase Inventory Decrease Increase Prepaid expenses Decrease Increase Other current assets Decrease Increase Change in Current Liability Account Balance Accounts payable Increase Decrease Accrued expenses payable Increase Decrease Other current liabilities Increase Decrease * Add (deduct) change in account balance to net income

NET INCOME TO NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES (I/S: Noncash Items) Adjustments to Convert Net Income to Net Cash Provided (Used) by Operating Activities Noncash Items on Income Statement Amortization (of capital assets) expenseAdd Amortization of bond discount to interest expenseAdd Amortization of bond premium to interest expense Deduct Loss on sale of assetAdd Gain on sale of asset Deduct Income from long-term equity investment Deduct

NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES Indirect Method – Sample Format Indirect Method – Sample Format

OPERATING ACTIVITIES – DIRECT METHOD Section 2

CASH RECEIPTS AND CASH PAYMENTS (Direct Method)

CASH RECEIPTS FROM CUSTOMERS  The relationships among cash receipts from customers, revenues from sales, and changes in accounts receivable is: Cash receipts from customers = Revenues from sales { + Decrease in accounts receivable or – Increase in accounts receivable

Cash payments to suppliers = Cost of goods sold { + Increase in inventory or – Decrease in inventory { + Decrease in accounts payable or – Increase in accounts payable CASH PAYMENTS TO SUPPLIERS  The relationship among cash payments to suppliers, cost of goods sold, changes in inventory, and changes in accounts payable is:

Cash payments for services + Increase in prepaid expenses or – Decrease in prepaid expenses + Decrease in accrued expenses payable or – Increase in accrued expenses payable { Operating expenses { = CASH PAYMENTS FOR OPERATING EXPENSES  The relationship among cash payments for operating expenses, changes in prepaid expenses, and changes in accrued expenses payable is:

Cash payments for income tax { = Income tax expense + Decrease in income tax payable or – Increase in income tax payable CASH PAYMENTS FOR INCOME TAX  The relationships among cash payments for income tax, income tax expense, and changes in income tax payable is:

Cash flows from operating activities Cash receipts from customers$120,000 Cash payments: To suppliers($75,000) For operating expenses (36,000) For income tax (10,000)(121,000) Net cash used by operating activities (1,000) COMPUTER SERVICES CORPORATION Cash Flow Statement – Direct Method For the Year Ended December 31, 2002 NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES Direct Method – Sample Format Direct Method – Sample Format

STEP 3: DETERMINE NET CASH PROVIDED (USED) BY INVESTING AND FINANCING ACTIVITIES

 Study the balance sheet to determine changes in investments and long-term assets  Changes in each short-term investment (unless incorporated as part of cash definition) and long-term account are analysed using selected transaction data to determine the effect, if any, the changes had on cash NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES

NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES  Study the balance sheet to determine changes in noncurrent liabilities and owner’s/shareholders’ equity  Changes in each noncurrent account are analysed using selected transaction data to determine the effect, if any, the changes had on cash

Operating activities used $1,000 cash and investing activities used $10,000 cash, while financing activities provided $45,000 cash. CASH FLOW STATEMENT INDIRECT METHOD COMPUTER SERVICES COMPANY Cash Flow Statement — Indirect Method For the Year Ended December 31, 2002

CASH FLOW STATEMENT DIRECT METHOD Cash flows from operating activities Cash receipts from customers$120,000 Cash payments: To suppliers$(75,000) For operating expenses (36,000) For income tax (10,000) (121,000) Net cash provided by operating activities (1,000) Cash flows from investing activities Purchase of equipment $(10,000) Net cash used by investing activities (10,000) Cash flows from financing activities Issue of common shares $ 60,000 Payment of cash dividends (15,000) Net cash provided by financing activities 45,000 Net increase in cash 34,000 Cash, January 1 0 Cash, December 31$ 34,000 COMPUTER SERVICES CORPORATION Cash Flow Statement For the Year Ended December 31, 2002 The cash flow statement shows that operating activities used $1,000 cash and investing activities used $10,000 cash, while financing activities provided $45,000 cash.

37 IAS 7 – Specific Items  No netting of inflows and outflows  Interest and dividends received and interest and dividends paid – choice of operating, investing or financing flows as appropriate  Income tax cash flows – generally operating flows  Non-cash transactions – not included in statement; disclosed instead  Cash flows between an entity and its subsidiaries, associates and joint ventures reported only if accounted for by the cost or equity method  Acquisition/loss of control of subsidiary – investing cash flow  Exchange rate changes on foreign cash balances – reconciling item at bottom of statement

Purpose of Statement of Owner Equity  To reconcile the owner equity amount stated at the beginning of the time period, with the owner equity amount determined at the end of the time period.

Statement of Owner Equity  Components should include: 1. Beginning owner equity 2. Plus net income amount 3. Minus owner withdrawals 4. Plus contributions received by business 5. Minus contributions distributed to others 6. Equals Change in Retained Earnings/Contributed Capital 7. Ending Owner Equity (Cost Value Basis)

Statement of Owner Equity  Components should include: 7. Ending Owner Equity (Cost Value Basis) 8. Adjustment for change in Asset Values (Ending market value - cost value) - (Beginning market value - cost value) from beginning to end of time period and adjustment for change in Deferred Debt (+Beginning - Ending Deferred Liabilities) 9. Equals change in market valuation equity 10. Ending Owner Equity (Market Value Basis)

Statement of Owner Equity

Statement of Owner Equity 8. Change in Excess of Market Value over Cost Basis of Marketable Securities and Farm Capital Assets

Statement of Owner Equity (net worth) Cash Grain Farm -- Jan. to Dec. 2000

Statement of Owner Equity

Statement of Owner Equity -- Summary  Can determine CHANGE in Owner Equity from beginning to end of time period  Components of change are: 1 Retained earnings from profit 2 Contributed capital from sources outside the business 3 Inflation/Deflation -- Change in Market Values