1 Chapter 12 The Statement of Cash Flows Financial Accounting, Alternate 4e by Porter and Norton

2 Cash Flows and Net Income for Four Computer Companies in 2002 Dell Computer Corp. IBM Hewlitt-Packard Co. Gateway, Inc. Increase (Decrease) Net Income in Cash (Loss) $ 591 $2,122 (948) 3,579 6,995 (903) (265) (298) (in millions)

3 Purpose of the Statement of Cash Flows u Explains changes in cash over a period of time Operating Activities Financing Activities Investing Activities u Summarizes cash inflows and outflows from:

4 Cash Equivalents  Readily convertible to cash  Little risk of price change  Original maturity to investor of three months or less Examples: Commercial paper U.S. Treasury bills Certain money market funds

5 Statement of Cash Flows Format Classified by: Operating activities Investing activities Financing activities outflows inflows Cash Increase or decrease in cash Beginning Cash + = Ending Cash =

6 Statement of Cash Flows Format Cash flows from operating activities: Inflows$ xxx Outflows (xxx) Net cash provided (used) by operating activities $ xxx Cash flows from investing activities: Inflows$ xxx Outflows (xxx) Net cash provided (used) by investing activities xxx Cash flows from financing activities: Inflows$ xxx Outflows (xxx) Net cash provided (used) by financing activities xxx Net increase (decrease) in cash and cash equivalents $ xxx Cash and cash equivalents at beginning of year xxx Cash and cash equivalents at end of year $ xxx from balance sheets

7 Cash transactions concerned with acquiring and selling products and services Make inventory purchases Sell products and services Incur employee salaries and wages Incur utility and other operating costs Operating Activities

8 Cash transactions concerned with acquiring and disposing of long- term assets Purchase/Sell intangible assets (e.g., patents, trademarks) Buy/Sell property, plant & equipment Purchase/Sell long-term investments Investing Activities

9 Cash transactions concerned with internal and external financing of the business Issue/Retire bonds Borrow $/ repay loans Sell/Repurchase stocks Issue dividends Paycheck for Date Dept. of Treasurer Jane Doe Financing Activities

10 Categorizing Cash Flow Activities Current Assets and Current Liabilities Income Statement Transactions Operating Activities Long-Term Liabilities or Stockholders’ Equity Financing Activities Long-Term Assets Investing Activities

11 Methods to Report Cash from Operating Activities u Direct Method u Indirect Method both methods arrive at same cash from operating activities Ý reports major classes of cash receipts and payments Ý adjusts net income to remove effect of accruals and deferrals

12 Preparing the Statement of Cash Flows: Direct Method u Step 1 –Set up three schedules Cash Flows from Operating Activities Cash Flows from Investing Activities Cash Flows from Financing Activities u Step 2 – Determine the cash flows from operating activities by analyzing each item on the income statement, current assets and current liabilities

13 Direct Method - Operating Activities Determine cash collected from customers: Beginning accounts receivable$ 57,000 + Sales revenue 670,000 – Cash collections (x) = Ending accounts receivable$ 63,000 Solve for x. Cash collections = $664,000 From Balance Sheet From Income Statement

14 Schedule of Cash Flows from Operating Activities Cash receipts from: Sales on account 664,000

15 Direct Method - Operating Activities Interest Revenue: Since no Interest Receivable account exists on the balance sheet, the interest earned was received, not accrued. Gain on Sale of Machine: Not an operating cash flow

16 Schedule of Cash Flows from Operating Activities Cash receipts from: Sales on account 664,000 Interest 15,000

17 Direct Method - Operating Activities Calculate cash paid to suppliers by first finding purchases: Beginning inventory$ 92,000 + Purchases (x) – Cost of goods sold (390,000) = Ending inventory$ 84,000 Solve for x. Purchases = $382,000

18 Direct Method - Operating Activities Then examine Accounts Payable to determine cash paid to suppliers: Beginning accounts payable $ 31,000 + Purchases 382,000 – Cash payments (x) = Ending accounts payable $ 38,000 Solve for x. Cash paid to suppliers = $ 375,000

19 Schedule of Cash Flows from Operating Activities Cash receipts from: Sales on account 664,000 Interest 15,000 Cash payments for: Inventory purchases(375,000)

20 Salaries and wages: Beginning salaries & wages pay. $ 9,000 + Salaries & wages expense 60,000 – Cash paymentsto employees (x) = Ending salaries & wages pay. $ 7,000 Direct Method - Operating Activities Solve for x. Cash paid for salaries & wages = $ 62,000

21 Schedule of Cash Flows from Operating Activities Cash receipts from: Sales on account 664,000 Interest 15,000 Cash payments for: Inventory purchases(375,000) Salaries and wages (62,000)

22 Direct Method - Operating Activities Depreciation expense is not a cash flow Insurance Expense and Prepaid Insurance: Beginning prepaid insurance $ 18,000 + Cash payments for insurance (x) – Insurance expense (12,000) = Ending prepaid insurance $ 12,000 Solve for x. Cash paid for insurance = $6,000

23 Schedule of Cash Flows from Operating Activities Cash receipts from: Sales on account 664,000 Interest 15,000 Cash payments for: Inventory purchases(375,000) Salaries and wages (62,000) Insurance (6,000)

24 Direct Method - Operating Activities Interest Expense: Since no Interest Payable account exists on the balance sheet, the interest expensed was paid, not deferred. Income Tax Expense and Income Taxes Payable: Beginning income taxes payable $ 5,000 + Income tax expense 50,000 – Cash payments for taxes(x) = Ending income taxes payable $ 8,000 Solve for x. Cash paid for taxes = $47,000

25 Schedule of Cash Flows from Operating Activities Cash receipts from: Sales on account $ 664,000 Interest 15,000 Cash payments for: Inventory purchases (375,000) Salaries and wages (62,000) Insurance (6,000) Interest (15,000) Taxes (47,000) Net cash provided by operating activities$ 174,000

26 Preparing the Statement of Cash Flows: Direct Method u Step 3 – Determine the cash flows from investing activities by examining the long-term asset accounts and any additional info

27 Direct Method – Investing Activities Long-Term Investments: The net increase of $30,000 matches the additional info given on the balance sheet and required the use of cash. Land: The additional balance sheet info reveals that a note payable was issued. No cash was involved in the land transaction so it should be reported in a separate schedule instead of on the Statement of Cash Flows

28 Direct Method – Investing Activities Property and Equipment: The additional balance sheet info reveals that equipment was purchased for $75,000 and a machine was sold for $25,000. Beginning property and equip.$280,000 + Acquisitions 75,000 – Disposals (x) = Ending property and equip.$320,000 Solve for x. The cost of fixed assets sold = $35,000

29 Direct Method – Investing Activities Accumulated Depreciation: Beginning accum. depreciation$ 75,000 + Depreciation expense 40,000 – Accum. depreciation on assets sold (x) = Ending accum. depreciation$100,000 Solve for x. The accumulated depreciation on the assets disposed of during the year = $15,000

30 Cash inflows from: Sale of machine$ 25,000 Cash outflows from: Purchase of investment (30,000) Purchase of property and equip. (75,000) Net cash used by investing activities$(80,000) Schedule of Cash Flows from Investing Activities

31 Preparing the Statement of Cash Flows: Direct Method u Step 4 – Determine the cash flows from financing activities Paycheck for Date Dept. of Treasurer Jane Doe

32 Direct Method – Financing Activities Notes payable: This increase is already shown on a supplemental schedule of noncash activities. Bonds payable: Bonds with a face value of $60,000 are retired by paying $63,000.

33 Direct Method – Financing Activities Capital stock was issued for cash Retained earnings: Beginning retained earnings $ 193,000 + Net income 120,000 – Cash dividends (x) = Ending retained earnings $ 246,000 Solve for x. Cash paid for dividends = $67,000

34 Cash inflows from: Issuance of stock$ 25,000 Cash outflows from: Retirement of bonds (63,000) Payment of cash dividends (67,000) Net cash used by financing activities$(105,000) Schedule of Cash Flows from Financing Activities

35 Noncash Investing and Financing Activities u Disclose important financing and investing activities which do not require cash Buy Assets through Debt Financing from Supplier Exchange Stock for Assets Certificate of Stock u Examples:

36 Statement of Cash Flows Format Cash flows from operating activities: Inflows$ xxx Outflows (xxx) Net cash provided (used) by operating activities $ xxx Cash flows from investing activities: Inflows$ xxx Outflows (xxx) Net cash provided (used) by investing activities xxx Cash flows from financing activities: Inflows$ xxx Outflows (xxx) Net cash provided (used) by financing activities xxx Net increase (decrease) in cash and cash equivalents $ xxx Cash and cash equivalents at beginning of year xxx Cash and cash equivalents at end of year $ xxx Only section of statement that differs in form between direct and indirect method (net cash flow total is the same)

37 Indirect Method - Operating Activities Income Statement Cash Flows from Operating Activities Conversion of accrual to cash basis

38 Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable (6,000) Decrease $6,000 From balance sheet: Accts. receivable, 2004 $63,000 Accts. receivable, ,000 $ 6,000

39 Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable (6,000) Gain on sale of machine 5,000 Increase $5,000 Selling price of machine $25,000 Book value of machine 20,000 Gain on sale $ 5,000

40 Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable ( 6,000) Gain on sale of machine 5,000 Decrease in inventory 8,000 Decrease $8,000 From balance sheet: Inventory, 2003 $92,000 Inventory, ,000 $ 8,000

41 Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable ( 6,000) Gain on sale of machine 5,000 Decrease in inventory 8,000 Increase in accounts payable 7,000 Increase $7,000 From balance sheet: Accts. payable, 2004 $38,000 Accts. payable, ,000 $ 7,000

42 Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable ( 6,000) Gain on sale of machine 5,000 Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries & wages payable ( 2,000) Decrease $2,000 Salaries & wages payable, 2003$9,000 Salaries & wages payable, ,000 $2,000

43 Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable ( 6,000) Gain on sale of machine 5,000 Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries & wages payable ( 2,000) Decrease in prepaid insurance 6,000 Decrease $6,000 Prepaid insurance, 2003 $18,000 Prepaid insurance, ,000 $ 6,000

44 Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable ( 6,000) Gain on sale of machine 5,000 Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries & wages payable ( 2,000) Decrease in prepaid insurance 6,000 Depreciation expense 40,000 Add back noncash expense

45 Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable ( 6,000) Gain on sale of machine 5,000 Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries & wages payable ( 2,000) Decrease in prepaid insurance 6,000 Depreciation expense 40,000 Increase in income taxes payable 3,000 Increase $3,000 Inc. taxes payable, 2004 $8,000 Inc. taxes payable, ,000 $3,000

46 Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable ( 6,000) Gain on sale of machine ( 5,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries & wages payable ( 2,000) Decrease in prepaid insurance 6,000 Increase in income taxes payable 3,000 Depreciation expense 40,000 Loss on retirement of bonds 3,000 Report entire outflow as a financing activity

47 Cash Flow Adequacy u Measures company’s ability to meet principal and interest obligations u Creditors concerned with cash available to repay debts after company has replaced its long-term assets Cash Flow from Operating Activities - Capital Expenditures. Avg. Debt Maturing over Next Five Years

48 Appendix Accounting Tools: A Work-Sheet Approach to the Statement of Cash Flows

49 Indirect Method: Using a Work Sheet Enter account balances

50 Indirect Method: Using a Work Sheet Record investing & financing activities

51 Indirect Method: Using a Work Sheet Enter net income

52 Indirect Method: Using a Work Sheet Enter noncash revenues or expenses

53 Indirect Method: Using a Work Sheet Extend current assets & current liabilities

54 Indirect Method: Using a Work Sheet Total columns

55 Indirect Method: Using a Work Sheet Determine net cash inflow (outflow)

56 End of Chapter 12