©2009 The McGraw-Hill Companies, Inc. Chapter 11 Statement of Cash Flows

©2009 The McGraw-Hill Companies, Inc. Part A Formatting the Statement of Cash Flows

11-3 Statement of Cash Flows Provides a summary of cash inflows and cash outflows during the reporting period E-Games, Inc. Statement of Cash Flows For the Year Ended December 31, 2010 Cash Flows from Operating Activities Net income$42,000 Adjustments for noncash effects: Depreciation expense9,000 Loss on sale of land4,000 Increase in accounts receivable(7,000) Decrease in inventory10,000 Increase in prepaid rent(2,000) Decrease in accounts payable(5,000) Increase in interest payable1,000 Decrease in income tax payable(2,000) Net cash flows from operating activities$50,000

11-4 Statement of Cash Flows (continued) Cash Flows from Investing Activities Purchase of investment(35,000) Sale of land6,000 Net cash flows from investing activities(29,000) Cash Flows from Financing Activities Issuance of common stock5,000 Payment of cash dividends(12,000) Net cash flows from financing activities(7,000) Net increase (decrease) in cash14,000 Cash at the beginning of the period48,000 Cash at the end of the period$62,000 Note: Noncash Activities Purchased equipment by issuing a note payable$20,000

11-5 LO1 Classification of Cash Flows Categories of Cash Flows Operating activities Investing activities Financing activities Include cash receipts and cash payments for transactions relating to revenue and expense activities Include cash transactions involving the purchase and sale of long-term assets and current investments Inflows and outflows of cash resulting from the external financing of a business

11-6 Classification of Cash Flows Cash Flows from Operating Activities Cash Inflows: Sale of goods or services. Receipt of interest and dividends. Cash Outflows: Purchase of inventory. For operating expenses. For interest. For income taxes. Cash Flows from Investing Activities Cash Inflows: Sale of investments. Sale of PPE or intangibles. Collection of notes receivable. Cash Outflows: Purchase of investments. Purchase of PPE or intangibles. Acceptance of notes receivable. Cash Flows from Financing Activities Cash Inflows: Issuance of bonds or notes payable. Issuance of stock. Cash Outflows: Repayment of bonds or notes payable. Reacquisition of stock (treasury stock). Payment of dividends.

11-7 Sources of Information SourcesExplanation 1. Income statementThe income statement provides important information in the determination of cash flows from operating activities. 2. Balance sheetsWe look at the change in asset, liability, and stockholders’ equity accounts from the end of last period to the end of this period to find cash flows from operating, investing, and financing activities. 3. Additional information Sometimes we need additional information from the accounting records to determine specific cash inflows or cash outflows for the period.

11-8 Relationship between Financial Statements

11-9 Reporting Noncash Activities  Transactions that don’t increase or decrease cash  Excluded from the statement of cash flows  Reported in a separate note to the financial statements as noncash activities Purchase of long-term assets by issuing debt Purchase of long-term assets by issuing stock Conversion of bonds payable into common stock. Exchange of long-term assets Examples:

11-10 Operating Activities – Indirect and Direct Methods  Begin with net income and then list adjustments to net income in order to arrive at operating cash flows.  More popular method.  Easier and less costly.  Adjust the items on the income statement to directly show the cash inflows and outflows from operations.  Conceptually better method.  More difficult and more costly.  Differ only in the presentation format for operating activities.  We report investing, financing, and noncash activities identically under both methods. Indirect MethodDirect Method

©2009 The McGraw-Hill Companies, Inc. Part B Preparing the Statement of Cash Flows

11-12 Steps in Preparing the Statement of Cash Flows 1.Calculate net cash flows from operating activities using information from the income statement and changes in current assets (other than cash) and current liabilities from the comparative balance sheets. 2.Determine the net cash flows from investing activities by analyzing changes in long-term asset accounts from the comparative balance sheets. 3.Determine the net cash flows from financing activities by analyzing changes in long-term liabilities and stockholders’ equity accounts from the comparative balance sheets. 4.Combine the operating, investing, and financing activities and make sure the total agrees with the net increase (decrease) in cash.

11-13 Illustration The income statement, balance sheets, and additional information for E-Games, Inc., are provided in the following Illustration. We will use this information in preparing the statement of cash flows following the four basic steps. E-Games, Inc. Income Statement For the Year Ended December 31, 2010 Revenues$ 1,012,000 Expenses: Cost of goods sold$ 650,000 Operating expenses (salaries, rent, utilities)286,000 Depreciation expense9,000 Loss on sale of land4,000 Interest expense5,000 Income tax expense16,000 Total expenses970,000 Net Income$ 42,000

11-14 Illustration (continued) E-Games, Inc. Balance Sheets December 31, 2009 and Increase (I) or Decrease (D) Assets Current Assets: Cash$ 62,000$ 48,000$14,000 (I) Accounts receivable27,00020,000 7,000 (I) Inventory35,00045,000 10,000 (D) Prepaid rent4,0002,000 2,000 (I) Long-Term Assets: Investment in stock35, ,000 (I) Land70,00080,000 10,000 (D) Equipment90,00070,000 20,000 (I) Accumulated depreciation(23,000)(14,000) 9,000 (I) Total Assets$ 300,000$ 251,000

11-15 Illustration (continued) Liabilities and Stockholders’ Equity Current Liabilities: Accounts payable$ 22,000$ 27,000$ 5,000 (D) Interest payable2,0001,000 1,000 (I) Income tax payable5,0007,000 2,000 (D) Long-Term Liabilities: Notes payable95,000 75,000 20,000 (I) Stockholders’ Equity: Common stock105,000100,000 5,000 (I) Retained earnings71,00041,000 30,000 (I) Total Liabilities and Equity$ 300,000$ 251,000 Additional Information for 2010: 1.Purchased stock in Intendo Corporation for $35, Sold land originally costing $10,000 for $6,000, resulting in a $4,000 loss on sale of land. 3.Purchased $20,000 in equipment by issuing a $20,000 note payable due in three years. No cash was exchanged in the transaction. 4.Issued common stock for $5,000 cash. 5.Declared and paid a cash dividend of $12,000.

11-16 Basic Format E-Games, Inc. Statement of Cash Flows For the Year Ended December 31, 2010 Cash Flows from Operating Activities: Cash Flows from Investing Activities: Cash Flows from Financing Activities: Net increase (decrease) in cash14,000 Cash at the beginning of the period48,000 Cash at the end of the period$62,000 Note: Noncash Activities List of noncash transactions

11-17 LO2 Operating Activities – Indirect Method  Both net income and cash flows from operating activities represent the same operating activities.  The income statement reports net income on an accrual basis. On the other hand, the statement of cash flows reports the very same activities on a cash basis.  We remove the noncash components from net income so that what’s left is cash flows from operating activities. We can classify the noncash components as: (a)revenues and expenses that don’t affect cash at all (adjustments for noncash components of net income). (b)revenues and expenses that do affect cash, but not by the amount reported as the revenue or expense (adjustments for changes in current assets and current liabilities).

11-18 Adjustments for noncash components of net income Depreciation Expense and Loss on Sale of Land Cash6,000 Loss on Sale of Land4,000 Land10,000 (To record loss on sale of land) Cash Flows from Operating Activities Net income$42,000 Adjustments for noncash effects: Depreciation expense9,000 Loss on sale of land4,000 Add back Depreciation Expense and Loss on Sale of Land which was earlier subtracted from the net income.

11-19 Adjustments for Changes in Current Assets and Current Liabilities Increase in Accounts Receivable (Increase in a current asset) Cash (to balance)1,005,000 Accounts Receivable ($27,000 – $20,000)7,000 Revenues (from income statement)1,012,000 (To record increase in accounts receivable) Cash Flows from Operating Activities Net income$42,000 Adjustments for noncash effects: Depreciation expense9,000 Loss on sale of land4,000 Increase in accounts receivable(7,000) Subtract

11-20 Adjustments for Changes in Current Assets and Current Liabilities Decrease in Inventory (Decrease in a Current Asset) Cash Flows from Operating Activities Net income$42,000 Adjustments for noncash effects: Depreciation expense9,000 Loss on sale of land4,000 Increase in accounts receivable(7,000) Decrease in inventory10,000 Add Back

11-21 Adjustments for Changes in Current Assets and Current Liabilities Decrease in Accounts Payable (Decrease in a Current Liability) Subtract Cash Flows from Operating Activities Net income$42,000 Adjustments for noncash effects: Depreciation expense9,000 Loss on sale of land4,000 Increase in accounts receivable(7,000) Decrease in inventory10,000 Increase in prepaid rent(2,000) Decrease in accounts payable(5,000)

11-22 Adjustments for Changes in Current Assets and Current Liabilities Increase in Interest Payable (Increase in a Current Liability) Add Back Cash Flows from Operating Activities Net income$42,000 Adjustments for noncash effects: Depreciation expense9,000 Loss on sale of land4,000 Increase in accounts receivable(7,000) Decrease in inventory10,000 Increase in prepaid rent(2,000) Decrease in accounts payable(5,000) Increase in interest payable1,000

11-23 Cash Flows from Operating Activities Net income$42,000 Adjustments for noncash effects: Depreciation expense9,000 Loss on sale of land4,000 Increase in accounts receivable(7,000) Decrease in inventory10,000 Increase in prepaid rent(2,000) Decrease in accounts payable(5,000) Increase in interest payable1,000 Decrease in income tax payable(2,000) Net cash flows from operating activities$50,000

11-24 Summary of All Adjustments Cash Flows from Operating Activities Net income Adjustments for noncash effects: For noncash components of income + Depreciation expense + Loss on sale of assets – Gain on sale of assets For changes in current assets and current liabilities – Increase in a current asset + Decrease in a current asset + Increase in a current liability – Decrease in a current liability = Net cash flows from operating activities

11-25 LO3 Investing Activities Cash Flows from Investing Activities Purchase of investment(35,000) Sale of land6,000 Net cash flows from investing activities(29,000) Cash Flows from Financing Activities Net cash flows from financing activities Net increase (decrease) in cash14,000 Cash at the beginning of the period48,000 Cash at the end of the period$62,000 Note: Noncash Activities Purchased equipment by issuing a note payable$20,000 Cash Outflow Cash Inflow Noncash activity disclosed in the footnote

11-26 LO3 Financing Activities Cash Flows from Investing Activities Purchase of investment(35,000) Sale of land6,000 Net cash flows from investing activities(29,000) Cash Flows from Financing Activities Issuance of common stock5,000 Payment of cash dividends(12,000) Net cash flows from financing activities(7,000) Net increase (decrease) in cash14,000 Cash at the beginning of the period48,000 Cash at the end of the period$62,000 Note X: Noncash Activities Purchased equipment by issuing a note payable$20,000 Cash Inflow Cash Outflow Retained earnings, beg. Balance $41,000 + Net income 42,000 – Dividends (12,000) Retained earnings, ending balance $71,000

11-27 LO4 Cash Flow Analysis Analysis based on net cash flows from operating activities (CFFO) ($ in millions) Apple Net Sales$19,315$13,931 Net Income1,9891,335 Net Cash Flows from Operations (CFFO)2,2202,535 Total Assets17,20511,551 Dell Net Sales$55,908$49,205 Net Income3,5723,043 Net Cash Flows from Operations (CFFO)4,8395,310 Total Assets23,10923,215

11-28 Cash Return on Assets ($ in millions) CFFO÷ Average Total Assets =Cash Return on Assets Apple2,220÷(17, ,551)/2=15.4% Dell4,839÷(23, ,215)/2=20.9% ($ in millions)Net Income ÷Average Total Assets =Return on Assets Apple1,989÷(17, ,551)/2=13.8% Dell3,572÷(23, ,215)/2=15.4% Return on Assets Cash Return on Assets Cash Return on Assets is higher than the Return on Assets

11-29 Components of Cash Return on Assets Cash Return on Assets = Cash Flow to Sales x Asset Turnover CFFO = x Net Sales Average Total Assets Net Sales Average Total Assets ($ in millions)CFFO÷Net Sales=Cash Flow to Sales Apple2,220÷19,315=11.5% Dell4,839÷55,908=8.7% Net Sales ÷Average Total Assets =Asset Turnover Apple19,315÷(17, ,551)/2=1.3 times Dell55,908÷(23, ,215)/2=2.4 times

©2009 The McGraw-Hill Companies, Inc. Appendix Operating Activities-Direct Method

11-31 LO5 Operating Activities-Direct Method  We report the cash inflows and cash outflows directly on the statement of cash flows. For instance, we report cash received from customers as the cash effect of sales activities, and cash paid to suppliers as the cash effect of cost of goods sold.  Income statement items that have no cash effect—such as depreciation expense or gains and losses on the sale of assets—are simply not reported under the direct method.

11-32 Operating Activities-Direct Method Cash Flows from Operating Activities Cash Inflows: Cash received from customers Cash received from interest Cash received from dividends Less Cash Outflows: Cash paid to suppliers Cash paid for operating expenses Cash paid for interest Cash paid for income taxes Net cash flows from operating activities $ xxx

11-33 Cash Received from Customers Operating Activities-Direct Method Cash (to balance)1,005,000 Accounts Receivable ($27,000 - $20,000)7,000 Revenues (from income statement)1,012,000 (To record increase in accounts receivable) Revenues$1,012,000 – Increase in accounts receivable(7,000) Cash received from customers$1,005,000

11-34 Cash Paid to Suppliers Operating Activities-Direct Method Beginning balance 45,000 Cost of goods purchased (increases inventory) ?650,000Cost of goods sold (decreases inventory) Ending balance 35,000 Inventory 27,000Beginning balance Cash paid to suppliers (decreases A/P) ?640,000Cost of goods purchased (increases A/P) 22,000Ending balance Accounts Payable Cost of Goods Sold (from income statement)650,000 Accounts Payable ($27,000 – 22,000)5,000 Inventory ($45,000 – 35,000)10,000 Cash (to balance)645,000 (Merchandise purchases and sales)

11-35 Cash Paid to Suppliers Operating Activities-Direct Method Cost of goods sold$650,000 – Decrease in inventory(10,000) = Purchases640,000 + Decrease in accounts payable5,000 = Cash paid to suppliers$645,000

11-36 Operating Activities-Direct Method Depreciation Expense and Loss on Sale of Land Cash (selling price: given)6,000 Loss on Sale of Land (difference)4,000 Land (cost: given)10,000 (Sale of land) Not reported on the statement of cash flows

11-37 Operating Activities-Direct Method Cash Paid for Interest Interest expense$5,000 – Increase in interest payable(1,000) = Cash paid for interest$4,000 Interest Expense (from the income statement) 5,000 Interest Payable ($2,000 – 1,000)1,000 Cash (to balance)4,000 (Payment for interest expense)

11-38 Operating Activities-Direct Method Cash Paid for Income Taxes Income tax expense$16,000 + Decrease in income tax payable2,000 = Cash paid for income taxes$18,000 Income Tax Expense (from the income statement) 16,000 Income Tax Payable ($7,000 – 5,000)2,000 Cash (to balance)18,000 (Payment for income taxes)

11-39 Operating Activities-Direct Method Cash Flows from Operating Activities Cash received from customers$1,005,000 Cash paid to suppliers(645,000) Cash paid for operating expenses(288,000) Cash paid for interest(4,000) Cash paid for income taxes(18,000) Net cash flows from operating activities$50,000

©2009 The McGraw-Hill Companies, Inc. End of chapter 11