©The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin Chapter Twelve Statement of Cash Flows

Reporting Format for the Statement of Cash Flows The Statement of Cash Flows must include the following three sections, as defined in FASB Statement 95: Operating Activities Investing Activities Financing Activities

Cash Flows from Operating Activities Inflows Receipts from sales. Commissions and fees. Interest and dividends received. Inflows Receipts from sales. Commissions and fees. Interest and dividends received. Outflows Payments for inventory. Salaries and wages. Operating expenses Interest on liabilities. Taxes. Outflows Payments for inventory. Salaries and wages. Operating expenses Interest on liabilities. Taxes.

Cash Flows from Investing Activities Inflows Selling property, plant, and equipment. Selling investment securities. Collecting loans. Inflows Selling property, plant, and equipment. Selling investment securities. Collecting loans. Outflows Purchasing property, plant, and equipment. Purchasing investment securities. Lending to others. Outflows Purchasing property, plant, and equipment. Purchasing investment securities. Lending to others.

Cash Flows from Financing Activities Inflows Borrowing. Issuing stock. Inflows Borrowing. Issuing stock. Outflows Repaying debt (excluding interest). Purchasing treasury stock. Paying dividends. Outflows Repaying debt (excluding interest). Purchasing treasury stock. Paying dividends.

Significant noncash investing and financing transactions must be reported separately. Example: issuing common stock in exchange for land. Significant noncash investing and financing transactions must be reported separately. Example: issuing common stock in exchange for land. Noncash Investing and Financing Transactions

Cash flows from operating activities can be prepared using either the direct method or the indirect method. Let’s look at the direct method first. Cash Flows from Operating Activities

Accrual basis revenue includes sales that did not result in cash inflows. Cash received from customers can be computed as follows: Cash received from customers Decrease in receivables Increase in receivables + – = = Net sales Converting from Accrual to Cash-Basis Accounting

We will use T-accounts to analyze changes in accounts. Let’s look at an example. We will use T-accounts to analyze changes in accounts. Let’s look at an example. The Accounts Receivable balance was $27,000 on 12/31/04 and $35,000 on 12/31/05. If accrual Sales Revenue for 2005 was $800,000, what were cash receipts from sales?

Converting from Accrual to Cash-Basis Accounting 12/31/04 Balance 12/31/05 Balance Accrual Sales Revenue Accounts Receivable Cash receipts = The Accounts Receivable balance was $27,000 on 12/31/04 and $35,000 on 12/31/05. If accrual Sales Revenue for 2005 was $800,000, what were cash receipts from sales? $792,000 $27,000 + $800,000 - $35,000

Converting from Accrual to Cash-Basis Accounting The Salaries Payable balance was $7,000 on 12/31/04 and $5,000 on 12/31/05. If accrued Salaries Expense for 2005 was $80,000, what amount of cash was paid for salaries? Now let’s use T-account analysis for a liability account with an accrued expense.

Converting from Accrual to Cash-Basis Accounting The Salaries Payable balance was $7,000 on 12/31/04 and $5,000 on 12/31/05. If accrual Salaries Expense for 2005 was $80,000, what amount of cash was paid for salaries? 12/31/04 Balance 12/31/05 Balance Accrued Salaries Expense Salaries Payable Cash payments =$82,000 $7,000 + $80,000 - $5,000

Direct Method Now that we have seen the T-account method of analysis, let’s use it to prepare a Direct Method Statement of Cash Flows for Batson Company. We will begin with by analyzing changes in balance sheet accounts.

Direct Method Additional Information Depreciation on buildings was $6,000 in Depreciation on equipment was $4,000 in A building addition in 2005 cost $31,000, paid in cash. Equipment with a book value of $40,000 was sold during the year for $43,000. Equipment with a book value of $30,000 was destroyed during a flood in There was no insurance. Batson had no noncash financing and investing activities. Additional Information Depreciation on buildings was $6,000 in Depreciation on equipment was $4,000 in A building addition in 2005 cost $31,000, paid in cash. Equipment with a book value of $40,000 was sold during the year for $43,000. Equipment with a book value of $30,000 was destroyed during a flood in There was no insurance. Batson had no noncash financing and investing activities.

Direct Method Additional Information Batson’s tax rate is 40%. Interest Expense on Notes Payable was $6,500. Interest Expense on Bonds Payable was $18,000. Issued Common Stock during 2005 for $50,000. Other Expenses of $71,000 were paid in cash. Additional Information Batson’s tax rate is 40%. Interest Expense on Notes Payable was $6,500. Interest Expense on Bonds Payable was $18,000. Issued Common Stock during 2005 for $50,000. Other Expenses of $71,000 were paid in cash. Let’s get started analyzing the accounts. First, we will review the T-account analysis that we completed earlier. Then we will analyze the remaining balance sheet accounts starting with the current accounts.

12/31/04 Balance 12/31/05 Balance Accrual sales revenue Accounts Receivable Cash receipts = $792,000 12/31/04 Balance 12/31/05 Balance Accrued salaries expense Salaries Payable Cash Payments = $82,000

12/31/04 Balance 12/31/05 Balance Cost of Goods Sold Inventory Purchases = 12/31/04 Balance 12/31/05 Balance Purchases Accounts Payable Cash Payments = $430,000 $433,000

12/31/04 Balance 12/31/05 Balance Interest Expense Interest Payable Cash payments = 12/31/04 Balance 12/31/05 Balance Income Tax Expense Income Taxes Payable Cash payment = $22,000 $54,000

Direct Method Now, that we have analyzed the current accounts and found the cash receipts and cash payments related to operations, we are ready to prepare the Cash Flows from Operating Activities portion of the Statement of Cash Flows.

Cash Flow from Operating Activities

Now, Let’s continue to use the T-account analysis for the remaining noncurrent balance sheet accounts. Direct Method

12/31/04 Balance 12/31/05 Balance Depreciation Buildings, Net Cash paid for addition = 12/31/04 Balance 12/31/05 Balance Depreciation Equipment, Net Flood loss Equipment sale $31,000

12/31/04 Balance 12/31/05 Balance Land Cash paid for land purchase = After completing the analysis of noncurrent assets, we are ready to prepare the Cash Flow from Investing portion of the Statement of Cash flows. $72,000

Cash Flow from Investing Activities Next, we will analyze noncurrent liabilities and equity so that we can prepare the Cash Flow from Financing portion of the Statement of Cash flows.

12/31/04 Balance 12/31/05 Balance Notes Payable Cash paid to retire notes = 12/31/04 Balance 12/31/05 Balance Bonds Payable Cash paid to retire bonds = $10,000 $100,000

12/31/04 Balance 12/31/05 Balance Common Stock Cash received from stock sale = After completing the analysis of noncurrent liabilities and equity, we are ready to prepare the Cash Flow from Financing portion of the Statement of Cash flows. $50,000

Cash Flow from Financing Activities Next, we will put the three sections together to complete the Statement of Cash Flows.

Notice that the Ending Cash Balance on the Statement of Cash Flows agrees with the 12/31/05 Cash balance on the Balance Sheet.

Now let’s look at the Indirect Method that is used by over 95% of all companies. Indirect Method

A Comparison of the Direct and Indirect Methods Net cash flow is the same for both methods. The Direct Method provides more detail about cash from operating activities. The investing and financing sections for the two methods are identical. Net cash flow is the same for both methods. The Direct Method provides more detail about cash from operating activities. The investing and financing sections for the two methods are identical.

Net Income Cash Flows from Operating Activities Indirect Method Changes in current assets and current liabilities as shown on the following table. + Losses and - Gains + Noncash expenses such as depreciation and amortization.

Use this table when adjusting Net Income to Cash Flow form Operations. Indirect Method

We will use the Indirect Method to prepare the Cash Flows from Operating Activities for the Batson Company. First, we will review the Balance Sheet and Income Statement for Batson Company. Indirect Method

The Indirect Method begins with Net Income, which is then adjusted for the non-cash items included in net income. For Batson, the only non-cash items are depreciation, and gains and losses. The Indirect Method begins with Net Income, which is then adjusted for the non-cash items included in net income. For Batson, the only non-cash items are depreciation, and gains and losses.

(Remember, we showed the balance sheets a few slides earlier.) To complete the Cash flows from operating activities section, we must examine comparative balance sheets to determine the changes in current assets and current liabilities from the beginning of the period to the end of the period.

Statement of Cash Flows Indirect Method Example

Remember that when we prepared the operating section using the Direct Method, we also arrived at Net Cash flows from Operating Activities of $130,000.

Because the investing and financing sections are identical with either method of preparation, we will not repeat those sections of the statement. Indirect Method

The Financial Analyst The statement focuses attention on: Ability to generate cash from its operations. Management of current assets and current liabilities. Expenditures for long-term assets. Amount received from external financing.

End of Chapter Twelve