©2008 Pearson Prentice Hall. All rights reserved The Statement of Cash Flows Chapter 12

©2008 Pearson Prentice Hall. All rights reserved Learning Objective 1 Identify the purpose the statement of cash flows

©2008 Pearson Prentice Hall. All rights reserved Cash Flow Statement Shows cash receipts and payments during a period Purposes:  Predicts future cash flows  Evaluates management decisions  Determines ability to pay dividends and interest  Shows relationship of net income to cash flows

©2008 Pearson Prentice Hall. All rights reserved Importance of Cash Flow A company needs both net income and strong cash flow to succeed

©2008 Pearson Prentice Hall. All rights reserved Learning Objective 2 Distinguish among operating, investing and financing cash flows

©2008 Pearson Prentice Hall. All rights reserved Cash Flow Categories Operating activities  Related to the transactions that result in net income  Most important as they reflect core of the business Investing activities  Related to long-term assets  How a company uses its resources in the long-term Financing activities  Related to long-term debt and equity  How a company obtains resources

©2008 Pearson Prentice Hall. All rights reserved Formats for Operating Cash Flows Indirect  Reconciles net income to cash provided by operating activities  Easier to prepare Direct  Shows cash inflows and outflows by type  Easier to interpret

©2008 Pearson Prentice Hall. All rights reserved Learning Objective 3 Prepare a statement of cash flows by the indirect method

©2008 Pearson Prentice Hall. All rights reserved The Indirect Method Net Income Reconciling adjustments: + Depreciation/depletion/amortization + Losses on sales of long-term assets - Gains on sales of long-term assets + or - changes in current assets & current liabilities Net cash provided by operating activities

©2008 Pearson Prentice Hall. All rights reserved Reconciling Items Goal: To convert accrual net income to operating cash flow Start with net income and adjust for noncash items  Add back noncash expenses  Subtract gains and add losses These amounts do not reflect cash flows  Add or subtract changes in current assets and current liabilities

©2008 Pearson Prentice Hall. All rights reserved Current Assets and Current Liabilities Each account relates to an income statement item  Accounts receivable Sales  Salaries payable Salaries expense The change in each account is computed  Change = Current year balance – prior year balance Current assets inverse relationship  Subtract increases from net income; add decreases Current liabilities direct relationship  Add increases to net income; subtract decreases

©2008 Pearson Prentice Hall. All rights reserved E12-15 ItemO I or F + or - a.Net IncomeO + b.Cash dividendF- c.Sale of LT investmentI+ d.Loss on sale of equip.O+ e.AmortizationO+ f.Issuance of LTNPF+ g.Depreciation expenseO+ h.Issuance of stock___+ What type of account is stock?

©2008 Pearson Prentice Hall. All rights reserved E12-15 ItemO I or F + or - j.Increase in accts payO + k. Purchase of equipment with note payable NIF l.Payment of long-term debt F- m.Purchase buildingI- n.Accrual of salary expenseN o.Purchase of long-term investment I-

©2008 Pearson Prentice Hall. All rights reserved E12-15 ItemO I or F + or - p.Decrease in inventoryO + q.Increase in prepaid expenses O- r.Sale of landI+ s.Decrease in accrued liabilities O-

©2008 Pearson Prentice Hall. All rights reserved Preparing the Operating Section – Indirect Method Use current year income statement for the following amounts  Net Income  Depreciation, depletion and amortization expense  Gains or losses on sales of assets Use comparative balance sheets to compute the changes in current assets and current liabilities

©2008 Pearson Prentice Hall. All rights reserved The Indirect Method Use as first line in operating section Add back to net income Subtract from net income

©2008 Pearson Prentice Hall. All rights reserved Added to net income Subtracted from net income Added to net income Subtracted from net income

©2008 Pearson Prentice Hall. All rights reserved E12-17 Net Income $ 35,000 Reconciling items: Depreciation 18,000 Loss on sale of land 5,000 Changes in current assets & current liabilities Increase in current assets _______ Decrease in current liabilities (20,000) Net cash provided by operating activities $ 11,000 Remember: inverse relationship

©2008 Pearson Prentice Hall. All rights reserved Investing Activities Affect long-term assets:  Plant assets  Investments  Notes receivable Purchases = outflows Sales = inflows Loans made = outflows Collections = inflows

©2008 Pearson Prentice Hall. All rights reserved Computing Purchases and Sales of Plant Assets Plant assets, net, beginning balance +Acquisitions -Depreciation -Book value of assets sold =Plant assets, net, ending balance From Balance Sheet From Income Statement

©2008 Pearson Prentice Hall. All rights reserved Proceeds from Sales of Plant Assets Compare book value of assets sold to gain or loss  Gain or loss located on income statement Book value + Gain on sale Book value – Loss on sale Cash Proceeds

©2008 Pearson Prentice Hall. All rights reserved Computing Purchases and Sales of Investments Investments, beginning balance +Purchases -Cost of investments sold =Investments, ending balance Cost + Gain on sale Cost – Loss on sale Cash Proceeds To compute cash proceeds of investments sold:

©2008 Pearson Prentice Hall. All rights reserved Computing Loans Made and Collections on Notes Notes receivable, beginning balance +Loans made -Collections =Notes receivable, ending balance

©2008 Pearson Prentice Hall. All rights reserved Financing Activities Affect long-term liabilities & equity:  Long-term Debt Notes payable Bonds payable  Common stock and Paid-in Capital  Retained earnings Payments = outflows Borrowings = inflows Cash dividends = outflows Issuance of new shares = inflows

©2008 Pearson Prentice Hall. All rights reserved Computing Issuance and Payments of Long-Term Debt Long-term debt, beginning balance +Issuance of new debt -Payments of debt =Long-term debt, ending balance

©2008 Pearson Prentice Hall. All rights reserved Computing Issuance of Stock and Purchases of Treasury Stock Common stock, beginning balance +Issuance of new stock =Common stock, ending balance Treasury stock, beginning balance +Purchase of treasury stock =Treasury stock, ending balance Inflow of cash Outflow of cash

©2008 Pearson Prentice Hall. All rights reserved Computing Dividend Payments Retained earnings, beginning balance +Net Income -Dividends declared =Retained earnings, ending balance From income statement

©2008 Pearson Prentice Hall. All rights reserved Noncash Investing and Financing Activities Transactions that involve long-term assets, long-term debt and/or equity  But do not increase or decrease cash Examples:  Purchasing plant assets by signing a note payable  Issuing stock for land  Stock dividends

©2008 Pearson Prentice Hall. All rights reserved Proves that cash flow statement “works”

©2008 Pearson Prentice Hall. All rights reserved Learning Objective 4 Prepare a cash flow statement by the direct method

©2008 Pearson Prentice Hall. All rights reserved Direct Method FASB prefers as it provides clearer information  Rarely used as it requires more calculations Refers to how operating section is prepared  Investing and Financing activities always prepared using the direct method Goal: Convert each income statement item into a cash amount  Or exclude if a noncash item

©2008 Pearson Prentice Hall. All rights reserved Direct Method Collections from customers Sales Cost of goods sold Payments to suppliers Salaries expense Payments to employees Interest expense Interest payments Income StatementCash Flow Statement Income tax expense Income tax paid

©2008 Pearson Prentice Hall. All rights reserved Direct Method Formulas RECEIPTS Income Statement Balance Sheet Change From customers Sales +Decrease in accounts receivable -Increase in accounts receivable Of interestInterest revenue +Decrease in interest receivable -Increase in interest receivable

©2008 Pearson Prentice Hall. All rights reserved Direct Method Formulas PAYMENTS Income Statement Balance Sheet Change To suppliersCost of goods sold +Increase in inventory -Decrease in inventory AND +Decrease in accounts Payable -Increase in accounts payable

©2008 Pearson Prentice Hall. All rights reserved Direct Method Formulas PAYMENTS Income Statement Balance Sheet Change For expenses Operating expenses +Increase in prepaid -Decrease in prepaids OR +Decrease in accrued liabilities -Increase in accrued liabilities

©2008 Pearson Prentice Hall. All rights reserved Direct Method Formulas PAYMENTS Income Statement Balance Sheet Change To employees Salaries expense +Decrease in salaries payable -Increase in salaries payable For interestInterest expense +Decrease in interest payable -Increase in interest payable

©2008 Pearson Prentice Hall. All rights reserved Direct Method Formulas PAYMENTS Income Statement Balance Sheet Change For income taxes Income tax expense +Decrease in income tax payable -Increase in income tax payable

©2008 Pearson Prentice Hall. All rights reserved E12-27 Credit sales$60,000 Ending accounts receivable 32,000 Beginning accounts receivable 22,000 Increase in accounts receivable 10,000 Collections from customers If more customers buy on account, how would that affect cash flow? Add or subtract?

©2008 Pearson Prentice Hall. All rights reserved E12-27 Cost of goods sold$111,000 Ending inventory 21,000 Beginning inventory 24,000 Decrease in inventory (3,000) Ending accounts payable 8,000 Beginning accounts payable 14,000 Decrease in accounts payable 6,000 Payments to suppliers$114,000

©2008 Pearson Prentice Hall. All rights reserved Direct Method Noncash expenses not listed  Depreciation, depletion and amortization Gains and losses not included  Gain or loss does not equal cash received  Cash proceeds included as an investing inflow Investing and financing activities reported as explained previously

©2008 Pearson Prentice Hall. All rights reserved End of Chapter 12