1 Click to edit Master title style Statement of Cash Flows 16

2 Click to edit Master title style The statement of cash flows reports a firm’s major cash inflows and outflows for a period. It provides useful information about a firm’s ability to generate cash from operations, maintain and expand its operating capacity, meet its financial obligations, and pay dividends.

3 Click to edit Master title style Reporting Cash Flows 16-1 The statement of cash flows reports cash flows from three types of activities: 1. Cash flows from operating activities are cash flows from transactions that affect net income. 2.Cash flows from investing activities are cash flows from transactions that affect the investments in noncurrent assets. 3.Cash flows from financing activities are cash flows from transactions that affect the equity and debt of the business.

4 Click to edit Master title style Statement of Cash Flows— NetSolutions

5 Click to edit Master title style (payments for treasury stock, dividends, and redemption of debt securities) Financing Financing (payments for expenses) Operating Operating Sources (increases) of Cash Uses (decreases) of Cash (receipts from sales of noncurrent assets) Investing Investing (receipts from issuing equity and debt securities) Financing Financing (payments for acquiring noncurrent assets) Investing Investing (receipts from revenues) Operating Operating Exhibit 2 Cash Flows 16-1

6 Click to edit Master title style Cash Flows from Operating Activities 16-1 The direct method reports the sources of operating cash and the uses of operating cash. 8

7 Click to edit Master title style The indirect method reports the operating cash flows by beginning with net income and adjusting it for revenues and expenses that do not involve the receipt or payment of cash. 9

8 Click to edit Master title style  Cash inflows from operating activities normally arise when cash is received from customers.  Cash outflows from operating activities normally arise when cash is paid to suppliers for merchandise, supplies, services and to employees for salaries and wages.

9 Click to edit Master title style A primary advantage of the direct method is that it reports the sources and uses of operating cash flows in the statement of cash flow. A primary disadvantage of the direct method is that the necessary data may not be readily available and may be costly to gather.

10 Click to edit Master title style A primary advantage of the indirect method is that it focuses on the differences between net income and cash flows from operations. Because the data are readily available, another advantage of the indirect method is that it is normally less costly to use than the direct method.

11 Click to edit Master title style Cash Flows from Operations: Direct and Indirect Methods— NetSolutions 16-1 same amount 3

12 Click to edit Master title style 12 Cash Flows from Investing Activities 16-1  Cash inflows from investing activities normally arise from selling fixed assets, investments, and intangible assets.  Cash outflows from investing activities normally include payments to acquire fixed assets, investments, and intangible assets.

13 Click to edit Master title style 13 Cash Flows from Financing Activities 16-1  Cash inflows from financing activities normally arise from issuing debt or equity securities.  Cash outflows from financing activities normally include paying cash dividends, repaying debt, and acquiring treasury stock.

14 Click to edit Master title style 14 Noncash Investing and Financing Activities 16-1 Noncash investing and financing activities are transactions that do not involve cash. The effect of such transactions is recorded in a separate schedule that appears at the bottom of the statement of cash flows.

15 Click to edit Master title style Example Exercise For each of the following, identify whether it would be disclosed as an operating, financing, or investing activity on the statement of cash flows under the indirect method. a.Purchase patent b.Pay cash dividend c.Disposal of equipment d.Net income e.Purchase treasury stock f.Depreciation expense

16 Click to edit Master title style An efficient approach to preparing the statement of cash flows is to analyze the changes in the noncash balance sheet accounts. The logic of this approach is that a change in any balance sheet account (including Cash) can be analyzed in terms of changes in the other balance sheet accounts.

17 Click to edit Master title style Comparative Balance Sheet (Continued)

18 Click to edit Master title style Comparative Balance Sheet (Concluded) 24

19 Click to edit Master title style Retained Earnings The Retained Earnings account for Rundell Inc. reveals that the balance increased $80,000 during the year. ACCOUNT Retained Earnings ACCOUNT NO. 32 Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance202, Dec.31Net income108, , Cash dividends28, ,300.00

20 Click to edit Master title style ACCOUNT Retained Earnings ACCOUNT NO. 32 Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance202, Dec.31Net income108, , Cash dividends28, , The net income of $108,000 is entered on the statement (or working papers). To statement

21 Click to edit Master title style Operating Activities— Rundell Inc. Cash flows from operating activities: Net income $108,000 Adjustments to reconcile net income to net cash flow from operating activities: This phrase is added to indicate that accrual basis net income is being adjusted to arrive at cash flows from operations. 16-2

22 Click to edit Master title style ACCOUNT Accumulated Depreciation—Building ACCT. NO. Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance58, Dec.31Depr. for year7, , to statement The comparative balance sheet (Exhibit 4: Slides 23 and 24) indicates that Accumulated Depreciation—Building increased by $7,000. By analyzing the account we can see that the increase is the result of the year-end adjusting entry.

23 Click to edit Master title style Amortization is treated in the same manner as depreciation Cash flows from operating activities: Net income $108,000 Adjustments to reconcile net income to net cash flow from operating activities: Depreciation 7,000 Operating Activities—Rundell Inc.

24 Click to edit Master title style Operating Activities—Rundell Inc. Cash flows from operating activities: Net income $108,000 Adjustments to reconcile net income to net cash flow from operating activities: Depreciation 7,000 Gain on sale of land(12,000) 33

25 Click to edit Master title style Adjustments to Net Income (Loss) Using the Indirect Method

26 Click to edit Master title style Changes in Current Accounts Accounts Accounts receivable (net)$ 74,000$ 65,000 Inventories172,000180,000 Accounts payable (mdse.)43,50046,700 Accrued expenses payable26,50024,300 Income taxes payable7,9008,400 9,000 8,000* 3,200* 2, * December 31 Increase Decrease* 16-2 Note that Cash and Dividends Payable are not included in this analysis.

27 Click to edit Master title style 27 Cash flows from operating activities: Net income $108,000 Adjustments to reconcile net income to net cash flow from operating activities: Depreciation 7,000 Gain on sale of land(12,000) Changes in current operating assets and liabilities: Increase in accounts receivable(9,000) Decrease in inventory8,000 Decrease in accounts payable(3,200) Increase in accrued expenses2,200 Decrease in income taxes payable(500) 16-2 Operating Activities—Indirect Method 39 You will notice that increases actually decrease cash flows from operating activities, and decreases do just the opposite.

28 Click to edit Master title style Statement of Cash Flows— Indirect Method for Rundell Inc. (Operating Activities Section) Same information as Slide 39, only in final form.

29 Click to edit Master title style Building ACCOUNT Building ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance200,000 Dec.27Purchased for cash60,000260,000 By examining the Building account, we can determine that Rundell Inc. bought a building for $60,000 cash.

30 Click to edit Master title style Land ACCOUNT Land ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance125,000 June8Sold for $72,000 cash60,00065,000 Oct.12Purchased for $15,000 cash15,00080,000 The $45,000 decline in the Land account resulted from two separate transactions: a sale and a purchase. 54

31 Click to edit Master title style 31 The first transaction, the sale of land, is classified as a positive cash flows from investing activity because land is a noncash asset. 16-2

32 Click to edit Master title style 32 The $12,000 gain was recorded earlier on Slide 34 as an operating activity. The purchase of land also is an investing activity. Click the button to view Slide 34. To return to this slide, type “56” and press the “Enter” key. 16-2

33 Click to edit Master title style The second transaction is the purchase of land for cash of $15,000. This transaction is reported as an outflow of cash in the cash flows from investing activities section.

34 Click to edit Master title style Cash Flows Used for Payment of Dividends ACCOUNT Dividends Payable ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance10,000 10Cash paid10,000— June20Dividends declared14,00014,000 July 10Cash paid14,000— Dec. 20Dividends declared14,00014,000 Note that while $28,000 in dividends were declared, only $24,000 were paid during the year.

35 Click to edit Master title style 35 Because paying of dividends affects equity and is an outflow of cash, it is a negative $24,000 cash flows from financing activities transaction. 16-2

36 Click to edit Master title style Common Stock Common Stock increased by $8,000. ACCOUNT Common Stock ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance16,000 Nov. 14,000 shares issued/cash8,00024,000

37 Click to edit Master title style ACCOUNT Paid-in Capital in Excess of Par—Common Stock Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance80,000 Nov. 14,000 shares issued/cash40,000120,000 Analyzing the two accounts together, we can determine that the 4,000 shares were sold for $48,000.

38 Click to edit Master title style 38 Issuing common stock affects equity; therefore, we have a positive $48,000 cash flows from financing activities item. 16-2

39 Click to edit Master title style Bonds Payable Bonds Payable decreased by $50,000. ACCOUNT Bonds Payable ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan.1Balance150,000 June 30Retired by payment of cash at face amount50,000100,000

40 Click to edit Master title style 40 Retiring bonds is a cash outflow reported as a negative item under cash flows from financing activities. 16-2

41 Click to edit Master title style Statement of Cash Flows— Indirect Method for Rundell Inc. (Partial Statement) 16-2 The ending balance in the Cash account should match this amount.