1. Statement of Cash Flows and Articulation
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Intermediate Accounting,17E
Statement of Cash Flows and Articulation
PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine University
© 2010 Cengage Learning

2. What Good is a Cash Flow Statement?
It explains the change during the period in cash and cash equivalents.
Sometimes earnings fail.
Everything is on one page.
It is used as a forecasting tool.

3. Pro Forma Cash Flow Statement
A pro forma cash flow statement is a prediction of what the actual cash flow statement will look like in future years if the operating, investing, and financing plans are implemented.

4. Cash Equivalent
A cash equivalent is a short-term, highly liquid investment that can be converted easily into cash.
To qualify as a cash equivalent, an item must be:
Readily convertible into cash
So near to its maturity that there is insignificant risk of changes in value due to changes in interest rates

5. Cash Flow Activities
Operating activities include those transactions and events that enter into the determination of net income.
Investing activities include those transactions and events that involve the purchase and sale of financial instruments not intended for trading purposes; property, plant, equipment; and other assets not generally held for resale, as well as the making and collecting of loans. 6 5

6. Cash Flow Activities
Financing activities include those transactions and events whereby resources are obtained from or repaid to owners and creditors.

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10. Cash Flow Pattern
The normal pattern of positive inflows or negative outflows of cash reported are as follows:
Cash from operating activities, +
Cash from investing activities, −
Cash from financing activities, + or −

11. Noncash Investing and Financing Activities
Noncash investing and financing activities affect an entity’s financial position but not the entity’s cash flow. Examples include:
Equipment purchased with a note payable
Land acquired by issuing stock
Significant transactions should be disclosed separately.
These transactions do not appear in the statement of cash flows.

12. Cash Flow Categories Under IAS 7
The provisions of IAS 7, Statement of Cash Flows, are more flexible than the U.S. rules contained in SFAS No. 95. A summary of these differences are shown next.

13. Types of Cash Flow

15. Operating Activities Section
The direct method is essentially a reexamination of each income statement item with the objective of reporting how much cash was received or disbursed in association with the item.

16. Operating Activities Section
The indirect method begins with net income as reported on the income statement and adjusts this accrual amount for any items that do not affect cash flow.
Both methods produce identical results.

17. Indirect Method
The indirect method net income is adjusted for items that do not affect cash flow. There are three basic types.
Revenues and expenses that do not involve cash inflow or outflow.
Gains and losses associated with investing or financing activities.
Adjustments for changes in current operating assets and liabilities that indicate noncash sources of revenues and expenses.

18. Orchard Blossom Company

19. Sales and Cash Collected from Customers
Direct Method
Sales and Cash Collected from Customers
Beginning accounts receivable $ 40
+ Sales
= Cash available for collection $190
 Ending accounts receivable
= Cash collected from customers $130

20. Cost of Goods Sold and Cash Paid for Inventory
Direct Method
Cost of Goods Sold and Cash Paid for Inventory
Ending inventory $ 75
+ Cost of goods sold
= Required inventory $155
 Beginning inventory 100
= Inventory purchased this year $ 55

21. Wages Expense and Cash Paid for Wages
Direct Method
Wages Expense and Cash Paid for Wages
Beginning wages payable $ 7
+ Wages expense 25
= Total obligation to employees $32
– Ending wages payable 10
= Cash paid for wages $22

22. Direct Method
Operating Activities Section of the Statement of Cash Flows—Direct Method

23. Indirect Method
Sales
The $20 increase in accounts receivable means that cash collected is $20 less than the $150 the sales number indicates. So, the necessary adjustment is to subtract the $20 to show that $130 was collected on account.

24. Indirect Method
Cost of Goods Sold
The $25 decrease in inventory means that although cost of good sold of $80 is included in the income statement, less cash was used to purchase inventory than suggested—add $25 to net income.

25. Indirect Method
Wages Expense
The $3 increase in wages payable indicates that only $22 of the $25 expense was paid in cash. The $3 increase in wages payable is added to net income.

26. Indirect Method
Depreciation Expense
The $30 depreciation expense is a noncash expense. It must be added back to net income because it was deducted from net income to determine the accrual net income.

27. Indirect Method
Note the same net cash from operating activities as calculated using the direct method.

28. Important Point
Depreciation is not a source of cash. Because you added depreciation back to net income as an adjustment using the indirect method does not mean that there is an inflow of cash. However, depreciation does lower the amount of income taxes paid.

29. Step 1 Compute how much the cash balance changed during the year.
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30. Cash increased $10 during the year.
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31. Step 2
Convert the income statement from an accrual-basis to a cash-basis summary of operations. Start with depreciation.
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39. Step 3
Analyze the long-term assets to identify the cash flow effects of investing activities.
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40. Investing Activities Cash Inflow Sale of plant assets
Sale of securities, other than trading securities
Collection of principal on loans
Cash Outflow
Purchase of plant assets
Purchase of securities, other than trading securities
Making of loans with other entities

41. Land
Because there is no indication of a land sale, we conclude that land increased by $15 during the year.
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42. Building
The building account increased $40. We are told that a building was sold for $32 during the year.
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43. Building Cash proceeds (given) $32 Book value ($36  $14) 22
Gain on sale of building $10
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44. Building
Known
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45. Building
Building(s) costing $76 must have been purchased during the year.

46. Step 4
Analyze the long-term debt and stockholders’ equity accounts to determine the cash flow effects of any financing transactions.

47. Financing Activities Cash Inflow Cash Outflow Issuance of own stock
Borrowings
Cash Outflow
Dividend payments
Repaying principal on borrowing
Treasury stock purchase

48. Long-Term Debt
We can infer that Orchard Blossom repaid $21 in long-term loans during the year.

49. Retained Earnings
Retained earnings decreased by $9. We know there was a $15 net income, so we can use a T-account to determine the amount of the dividend.

50. Long-Term Debt
The $6 debit, or “squeeze” figure, has to be the dividends declared (and we will assume paid) during the year.

51. Step 5
Prepare a formal statement of cash flows.

53. Step 6 Prepare supplemental disclosures.
Cash paid for interest and income taxes
Noncash investing and financing activities

54. Cash-flow-to-net-income ratio
Cash Flow Ratios
Cash Flow to Net Income
Cash from operations
Net income
Cash-flow-to-net-income ratio =
Measure of earnings quality
Tends to be greater than 1
Should remain fairly stable for the years for a specific company

55. Cash Flow Ratios Cash Flow Adequacy Cash flow adequacy ratio
Cash from operations
Capital expenditures and acquisitions
Cash flow adequacy ratio =
Measures relationship between investment spending and cash generated by operations
Indicate a company’s attitude towards reinvestment in long-lived production assets
When ratio is small it indicates that cash flows from operations fall short of funding growth

56. Cash Times Interest Earned
Cash Flow Ratios
Cash Times Interest Earned
Cash from operations + Interest paid + Taxes paid
Interest expense
Cash times interest earned ratio =
Measures ability to service debt
Generally, a higher ratio indicates more solvency

57. Articulation
In an accounting context, articulation means that the three primary financial statements are not isolated lists of numbers but are an integrated set of reports on a company’s financial health.

58. Forecasted Statement of Cash Flows
Compute the change in cash.
Convert the income statement from an accrual basis to a cash basis.
Analyze the long-term asset accounts.
Analyze the long-term debt and stockholders’ equity accounts.
Prepare the statement of cash flows.
Disclose any significant noncash activities.