©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber The Statement of Cash Flows Chapter 17

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber The statement of cash flows reports the entity’s cash flows (cash receipts and cash payments) during the period. Purpose of The Statement of Cash Flows: Basic Concepts

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Identify the purposes of the statement of cash flows. Objective 1

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Purposes of the Statement of Cash Flows Statement of Retained Earnings 12/31/x1 For the Year Ended 12/31/x2 12/31/x2 (a point in time) (a period of time) (a point in time) Statement of Cash Flows Income Statement Balance Sheet Balance Sheet

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Purposes of the Statement of Cash Flows l The statement of cash flows is designed to fulfill the following: – predict future cash flows – evaluate management decisions – determine the ability to pay dividends plus interest and principal – show the relationship of net income to changes in the firm’s cash

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Cash Balance Includes... – cash on hand. – cash in the bank. – cash equivalents.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Cash Equivalents Are.... – short-term, highly liquid investments convertible into cash with little delay. – money market accounts. – U.S. Government Treasury bills.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Report cash flows from operating, investing, and financing activities. Objective 2

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Basic Organization of the Statement of Cash Flows l A business may be evaluated in terms of three types of business activities: 1 Operating activities 2 Investing activities 3 Financing activities

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Operating Activities Operating activities are related to the transactions that make up net income. Operating activities are related to the transactions that make up net income. Interest and dividends received are related to investing activities. Interest and dividends received are related to investing activities. However, the FASB has decided to classify the cash received from these items as operating activities. However, the FASB has decided to classify the cash received from these items as operating activities.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Investing activities increase and decrease the assets that are available to the business. Investing activities increase and decrease the assets that are available to the business. Investing Activities Investing activities are related to the Long-Term Asset accounts. Investing activities are related to the Long-Term Asset accounts.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber These are transactions involving obtaining resources from the owners or returning resources to them. These are transactions involving obtaining resources from the owners or returning resources to them. Financing Activities It also involves obtaining resources from creditors and repaying the amount borrowed. It also involves obtaining resources from creditors and repaying the amount borrowed.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Format of the Statement of Cash Flows l FASB Statement 95 approved two methods for reporting cash flows from operating activities. 1 Direct method 2 Indirect method

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Format of the Statement of Cash Flows l The direct method lists cash receipts from specific operating activities and cash payments for each major operating activity. l The indirect method is a short-cut method for accrual systems.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Prepare a statement of cash flows by the direct method. Objective 3

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Cash flows from operating activities: Receipts: Collections from customers$271 Interest received on notes receivable 10 Dividends received on investments in stock 9 Total receipts$290 Statement of Cash Flows (Direct Method) Year Ended December 31, 2002 (Thousands) The Direct Method

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Payments: To suppliers$133 To employees 58 For interest 16 For income tax 15 Total payments 222 Net cash inflows from operating activities$ 68 The Direct Method Statement of Cash Flows (Direct Method) Year Ended December 31, 2002 (Thousands)

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Cash flows from investing activities: Acquisition of plant assets$(306) Loan to another company (11) Proceeds from sale of plant assets 62 Net cash outflow from investing activities$(255) The Direct Method Statement of Cash Flows (Direct Method) Year Ended December 31, 2002 (Thousands)

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Cash flows from financing activities: Proceeds from issuance of common stock$101 Proceeds from issuance of long-term notes payable 94 Payment of long-term notes payable (11) Payment of dividends (17) Net cash inflow from financing activities$167 The Direct Method Statement of Cash Flows (Direct Method) Year Ended December 31, 2002 (Thousands)

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Net cash inflows from operating activities$ 68 Net Cash outflow from investing activities (255) Net Cash inflow from financing activities 167 Net (decrease in cash)$(20) Cash balance, December 31, Cash balance, December 31, 2002$ 22 The Direct Method Statement of Cash Flows (Direct Method) Year Ended December 31, 2002 (Thousands)

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Compute the cash effects of a wide variety of business transactions. Objective 4

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Revenues or expenses from the income statement +–+– Adjusted for the change in the related balance sheet account(s) Amount for the statement of cash flows = Computing Individual Amounts for the Statement of Cash Flows

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Revenues and gains: Sales revenue$284 Interest revenue 12 Dividend revenue 9 Gain on sale of plant assets 8 Total revenues and gains$313 Computing Individual Amounts for the Statement of Cash Flows Income Statement Year Ended December 31, 2002 (Thousands)

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Expenses: Cost of goods sold$150 Salary expense 56 Depreciation expense 18 Other operating expense 17 Interest expense 16 Income tax expense 15 Total expenses$272 Computing Individual Amounts for the Statement of Cash Flows

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Total revenues and gains$313 Total expenses 272 Net income$ 41 Computing Individual Amounts for the Statement of Cash Flows Income Statement Year Ended December 31, 2002 (Thousands)

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Assets20x220x1 Inc./(Dec.) Current: Cash$ 22$ 42$ (20) Accounts receivable Interest receivable Inventory (3) Prepaid expenses Long-term receivable 11 – 11 Plant assets, net Total assets$725$487$238 Comparative Balance Sheets

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Liabilities 20x220x1 Inc./(Dec.) Current: Accounts payable $ 91$ 57$ 34 Salary payable 4 6 (2) Accrued liabilities 1 3 (2) Long-term notes payable Stockholders’ equity: Common stock Retained earnings Total liabilities and shareholders’ equity $725$487$238 Comparative Balance Sheets

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Computing Cash Collections from Customers l Collections can be computed by converting sales revenue to the cash basis. l Beginning Accounts Receivable balance + Sales on account – Collections = Ending Accounts Receivable balance

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Computing Cash Collections from Customers l $80,000 + $284,000 – 93,000 = $271,000 l Because Accounts Receivable increased by $13,000, the business received $13,000 less cash than its sales revenue for the period. l All collections of receivables are computed following the pattern illustrated for collections from customers.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Computing Payments to Suppliers l This computation includes two parts, payments for inventory and payments for expenses other than interest and income tax. l Payments for inventory are computed by converting cost of goods sold to the cash basis. l This is accomplished by analyzing the Inventory and Accounts Payable accounts.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Payments for Inventory Inventory Beg. inventory138,000 Purchasesx Cost of goods sold150,000 End. inventory135,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Payments for Inventory l How much were the purchases? l $138,000 + x – $150,000 = $135,000 l x = $135,000 – $138,000 + $150,000 l $147,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Payments for Inventory Accounts Payable Payments for inventoryx Beg. balance 57,000 End. balance 91,000 Purchases147,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Payments for Inventory l How much did the business pay for this inventory? l $57,000 + $147,000 – x = $91,000 l x = $57,000 + $147,000 – $91,000 l x = $113,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Payments for Operating Expenses l Increases in prepaid expenses require cash payments, and decreases indicate that payments were less than expenses. l Decreases in accrued liabilities can occur only from cash payments, and increases mean that cash was not paid.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Payments to Employees l Salary Payable was $6,000 at the beginning of the year and $4,000 at year end. l During the year Salary and Wages Expense was $56,000. l How much did the business pay? l $58,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Acquisition and Sales of Plant Assets l The business had plant assets net of depreciation of $219,000 at the beginning of the year and $453,000 at year end. l Further, the acquisition of plant assets amounted to $306,000 during the year.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Acquisition and Sales of Plant Assets l The income statement shows depreciation expense of $18,000 and a $8,000 gain on sale of plant assets. l What is the book value of the assets sold? l Beginning net balance + Acquisitions – Depreciation – Book value of assets sold = Ending balance

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Acquisition and Sales of Plant Assets l $219,000 + $306,000 – $18,000 – x = $453,000 l x = $219,000 + $306,000 – $18,000 – $453,000 l x = $54,000 (book value) l How much are the proceeds from the sale of plant assets?

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Acquisition and Sales of Plant Assets l Book value + Gain or – Loss = Proceeds l $54,000 + $8,000 = $62,000 l How do we determine acquisitions? l Beginning net balance + Acquisitions – Depreciation – Book value of assets sold = Ending balance

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Computing the Cash Amounts of Financing Activities l Financing activities affect liability and stockholders’ equity accounts. – Notes Payable – Bonds Payable – Long-Term Debt – Common Stock – Paid-in Capital – Retained Earnings

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Issuance and Payments of Long-Term Notes Payable l Beginning balance was $77,000. l New debt amounting to $94,000 was incurred during the year. l The ending balance for the Long-Term Notes Payable account was $160,000. l How much was the payment? l $11,000

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Computing Dividend Payments l Dividend payments are computed by analyzing the Dividends Payable account. l Beginning balance + Dividends declared – Dividend payments = Ending balance

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Noncash Investing and Financing Activities... – are not reported in the statement of cash flows. l The FASB requires that significant non- cash investing and financing activities be shown in a separate schedule at the bottom of the statement.

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Reconciling Net Income to Net Cash Flow l The FASB requires companies that format operating activities by the direct method to report a reconciliation from net income to net cash inflow (or outflow).

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Prepare a statement of cash flows by the indirect method. Objective 5

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Current Assets Add to Net Income if this account has decreased The Indirect Method Deduct from Net Income if this account has increased

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Current Liabilities Add to Net Income if this account has increased The Indirect Method Deduct from Net Income if this account has decreased

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Statement of Cash Flows (Indirect Method) Year Ended December 31, 2002 (Thousands) Cash flows from operating activities: Net Income$41 Add (deduct) items that affect net income and cash flows differently: Depreciation 18 Gain on sale of plant 8 Increase in accounts receivable (13) Increase in interest receivable (2) Decrease in inventory 3 The Indirect Method

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber Add (deduct) items that affect net income and cash flows differently: Increase in prepaid expenses (1) Increase in accounts payable 34 Decrease is salary payable (2) Decrease in accrued liabilities (2) Net cash inflow from operating activities$68 The Indirect Method Statement of Cash Flows (Indirect Method) Year Ended December 31, 2002 (Thousands)

©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber End of Chapter 17