Chapter 14 The Statement of Cash Flows

Chapter 14 The Statement of Cash Flows

Chapter 14 Learning Objectives
Identify the purposes of the statement of cash flows and distinguish among operating, investing, and financing cash flows Prepare the statement of cash flows by the indirect method © 2018 Pearson Education, Inc.

Chapter 14 Learning Objectives
Use free cash flow to evaluate business performance Prepare the statement of cash flows by the direct method (Appendix 14A) Prepare the statement of cash flows by the indirect method using a spreadsheet (Appendix 14B) © 2018 Pearson Education, Inc.

© 2018 Pearson Education, Inc.
Learning Objective 1 Identify the purposes of the statement of cash flows and distinguish among operating, investing, and financing cash flows © 2018 Pearson Education, Inc.

WHAT IS THE STATEMENT OF CASH FLOWS?
The statement of cash flows reports on a business’s cash receipts and cash payments for a specific period. This statement does the following: Reports on the cash flows of a business Reports why cash increased or decreased during the period Covers a span of time and is dated the same as the income statement Up to this point, you have learned about three financial statements: the income statement, the statement of retained earnings, and the balance sheet. Each of these financial statements reports specific items about a company. The statement of cash flows reports on a business’s cash receipts and cash payments for a specific period. This statement does the following: Reports on the cash flows of a business—where cash came from (receipts) and how cash was spent (payments) Reports why cash increased or decreased during the period Covers a span of time and is stated the same as the income statement—“Year Ended December 31, 2016,” for example © 2018 Pearson Education, Inc.

Purpose of the Statement of Cash Flows
The statement of cash flows explains why net income as reported on the income statement does not equal the change in the cash balance. The statement of cash flows helps: Predict future cash flows Evaluate management Predict ability to pay debts and dividends The statement of cash flows explains why net income as reported on the income statement does not equal the change in the cash balance. In essence, the statement of cash flows is the link between the accrual-based income statement and the cash reported on the balance sheet. The statement of cash flows helps do the following: Predicts future cash flows―Past cash receipts and payments help predict future cash flows. Evaluate management―Wise investment decisions help the business prosper, while unwise decisions cause the business to have problems. Investors and creditors use cash flow information to evaluate managers’ decisions. Predict ability to pay debts and dividends―Lenders want to know whether they will collect on their loans. Stockholders want dividends on their investments. The statement of cash flows helps make these predictions. © 2018 Pearson Education, Inc.

Classification of Cash Flows
There are three basic types of cash flows, and the statement of cash flows has a section for each: Operating activities Investing activities Financing activities There are three basic types of cash flows, and the statement of cash flows has a section for each: Operating activities Investing activities Financing activities Each section reports cash inflows (cash receipts coming into the company) and cash outflows (cash going out of the company) based on these three divisions. © 2018 Pearson Education, Inc.

Operating Activities Operating activities is the first section on the statement of cash flows. This section reports on activities that create revenue or expense in the entity’s business. This is often the most important category. Operating activities is the first section on the statement of cash flows and is often the most important category. The operating activities section reports on activities that create revenue or expense in the entity’s business. It reflects the day-to-day operations of the business, such as cash receipts (cash inflows) from customers for the sales of merchandise inventory and services and the cash outflow for purchases of merchandise inventory or payment of operating expenses. The operating activities section also includes cash receipts (cash inflows) for interest and dividend income and cash payments (cash outflows) for interest expense and income tax expense. © 2018 Pearson Education, Inc.

Investing Activities Investing activities is the second category listed on the statement of cash flows. This section reports cash receipts and cash payments that increase or decrease long-term assets. It includes the cash inflow from selling and the cash outflow from purchasing long-term assets. Investing activities is the second category listed on the statement of cash flows. This section reports cash receipts and cash payments that increase or decrease long-term assets, such as property, plant, equipment, notes receivable, and investments. It includes the cash inflow from selling and the cash outflow from purchasing these long-term assets. In addition, it includes the loaning (cash outflow) and collecting (cash inflow) of long-term notes receivable. © 2018 Pearson Education, Inc.

Financing Activities Financing activities is the last category listed on the statement of cash flows. Financing activities include cash inflows and outflows involved in long-term liabilities and equity. Financing activities include issuing stock, paying dividends, and buying and selling treasury stock. The last category on the statement of cash flows is financing activities. Financing activities include cash inflows and outflows involved in long-term liabilities and equity. This includes issuing stock, paying dividends, and buying and selling treasury stock. It also includes borrowing money and paying off long-term liabilities such as notes payable, bonds payable, and mortgages payable. © 2018 Pearson Education, Inc.

Classification of Cash Flows
Each section of the statement of cash flows affects a different part of the balance sheet. The operating activities section reports on how cash flows affect the current accounts—current assets and current liabilities. Investing activities affect the long-term assets. And the financing activities affect long-term liabilities and equity. Exhibit 14-1 shows the relationship between operating, investing, and financing cash flows and the various parts of the balance sheet. © 2018 Pearson Education, Inc.

Non-cash Investing and Financing Activities
Companies make investments that do not require cash. Such transactions are called non-cash investing and financing activities. These activities appear as a separate schedule at the bottom of the statement of cash flows or in the notes to the financial statements. The three sections of the statement of cash flows report only activities that involve cash. Companies also make investments that do not require cash. They also obtain financing other than cash. Such transactions are called non-cash investing and financing activities. Non-cash investing and financing activities are investing and financing activities that do not involve cash. Examples of these activities include the purchase of equipment financed by a long-term note payable or the contribution of equipment by a stockholder in exchange for common stock. These activities are not included in the statement of cash flows. Instead, they appear as a separate schedule at the bottom of the statement of cash flows or in the notes to the financial statements. © 2018 Pearson Education, Inc.

Two Formats for Operating Activities
Indirect method Starts with accrual income and adjusts to net cash Uses account relationships to determine changes in cash Direct method Restates the income in terms of cash Shows actual cash receipts and cash payments There are two ways to format the operating activities section of the statement of cash flows: The indirect method starts with net income and adjusts it to net cash provided by operating activities. The direct method restates the income statement in terms of cash. The direct method shows all the cash receipts and all the cash payments from operating activities. The indirect method and direct method use different computations but produce the same amount of net cash flow from operating activities. Both methods present investing activities and financing activities in exactly the same format. Only the operating activities section is presented differently between the two methods. © 2018 Pearson Education, Inc.

HOW IS THE STATEMENT OF CASH FLOWS PREPARED USING THE INDIRECT METHOD?
Items needed: Income statement for the current year Balance sheet from current year Balance sheet from prior year Additional information based on review of transactions To prepare the statement of cash flows, you need the income statement for the current year, as well as the balance sheets from the current and prior years. In addition, you need to review the transactions for some additional information. For illustrative purposes, we use ShopMart, Inc., a fictitious retail store that sells electronics, home furnishings, home supplies, and more. © 2018 Pearson Education, Inc.

Prepare in five steps: Complete the cash flows from operating activities. Complete the cash flows from investing activities section. Complete the cash flows from financing activities section. Compute the change in cash. Prepare a schedule for non-cash activities. To prepare the statement of cash flows by the indirect method, we follow steps 1–5: Step 1: Complete the cash flows from operating activities section using net income and adjusting for increases or decreases in current assets (other than cash) and current liabilities. Also adjust for gains and losses from long-term assets and non-cash expenses such as depreciation expense. Step 2: Complete the cash flows from investing activities section by reviewing the long-term assets section of the balance sheet. Step 3: Complete the cash flows from financing activities section by reviewing the long-term liabilities and equity sections of the balance sheet. Step 4: Compute the net increase or decrease in cash during the year. The change in cash is the key reconciling figure for the statement of cash flows and must match the change in cash reported on the comparative balance sheet. Step 5: Prepare a separate schedule reporting any non-cash investing and financing activities. © 2018 Pearson Education, Inc.

ShopMart’s comparative balance sheet is shown in Exhibit 14-3. © Pearson Education, Inc.

Let’s apply these steps to show the operating activities of ShopMart: Add back all non-cash expenses to the net income. Expenses such as Depreciation Expense, Amortization Expense, and Depletion Expense represent expenses that are not related to current cash flows. Subtract accounting gains from net income. These gains (such as Gain on Sale of Land) are not cash flows that are related to operating activities, so their effect should be eliminated from net income. Add accounting losses back to net income. These losses (such as Loss on Sale of Equipment) are not cash flows that are related to operating activities, so their effect should be eliminated from net income. When current assets increase, we treat that as a “use” of cash and subtract it from net income. When current assets decrease, we treat that as a “source” of cash and add it to net income. When current liabilities increase, we treat that as a “source” of cash and add the increase to net income. When current liabilities decrease, we treat that as a “use” of cash and subtract the decrease from net income. Exhibit 14-5 shows the completed statement of cash flows. © 2018 Pearson Education, Inc.

Cash Flows from Operating Activities
When using the indirect method, the operating activities section begins with accrual-basis net income or loss, which needs to be adjusted to a cash number. For example: Sales on account generate revenues that increase net income, but the company has not yet collected cash from those sales. Accrued expenses decrease net income, but the company has not yet paid cash. When using the indirect method, the statement of cash flows operating activities section begins with net income (or net loss) because revenues and expenses, which affect net income, produce cash receipts and cash payments. Revenues bring in cash receipts, and expenses must be paid. But net income as shown on the income statement is accrual-based, and the cash flows (cash basis net income) do not always equal the accrual basis revenues and expenses. For example, sales on account generate revenues that increase net income, but the company has not yet collected cash from those sales. Accrued expenses decrease net income, but the company has not yet paid cash if the expenses are accrued. To go from net income to cash flow from operating activities, we must make some adjustments to net income on the statement of cash flows. These additions and subtractions follow net income and are labeled Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities. © 2018 Pearson Education, Inc.

Depreciation, Depletion, and Amortization Expenses
Depreciation, depletion, and amortization expenses are added back to net income to reconcile net income to net cash flow from operating activities. Depreciation is recorded as: Adjustments include adding back non-cash expenses such as depreciation, depletion, and amortization expenses. These expenses are added back to net income to reconcile net income to net cash flows from operating activities. © 2018 Pearson Education, Inc.

Depreciation, Depletion, and Amortization Expenses
Depreciation does not affect cash. To go from net income to net cash flows, we must remove depreciation by adding it back to net income. Depreciation does not affect cash as there is no Cash account in the journal entry (Depreciation Expense—Plant Assets, debit, Accumulated Depreciation—Plant Assets, credit). However, deprecation, like all the other expenses, decreases net income. Therefore, to go from net income to cash flows, we must remove depreciation by adding it back to net income. Suppose you had only two transactions during the period: • Cash sale of $60,000 • Depreciation expense of $20,000 Accrual basis net income is $40,000 ($60,000 – $20,000), but net cash flow from operations is $60,000. To reconcile from net income, depreciation of $20,000 must be added to net income, $40,000, to determine net cash flow from operations, $60,000. We would also add back any depletion and amortization expenses because they are non-cash expenses, similar to depreciation. © 2018 Pearson Education, Inc.

Gains and Losses on the Disposal of Long-term Assets
Disposals from long-term assets create a gain or loss that must be removed from net income, which is in the operating activities section. Disposals of long-term assets such as land and buildings are investing activities, and these disposals usually create a gain or a loss. The gain or loss is included in net income, which is already in the operating activities section of the statement of cash flows. The gain or loss must be removed from net income on the statement of cash flows, so the total cash receipts from the sale of the assets can be shown in the investing section. Exhibit 14-4, ShopMart’s income statement, includes a gain on disposal of plant assets. The gain increased net income, so it is subtracted in the operating activities section. On the other hand, a loss on the disposal of plant assets would decrease net income on the income statement, so the amount of the loss would be reversed to determine the net cash provided by operating activities on the statement of cash flows. © 2018 Pearson Education, Inc.

Changes in Current Assets and Current Liabilities
Most current assets and current liabilities result from operating activities. Most current assets and current liabilities result from operating activities. For example, accounts receivable result from sales, and merchandise inventory relates to cost of goods sold. Changes in the Current Assets and Current Liabilities accounts create adjustments to net income on the statement of cash flows, as follows: An increase in a current asset other than cash causes a decrease in Cash. A decrease in current assets other than cash causes an increase in Cash. An increase in a current liability causes an increase in Cash. A decrease in a current liability causes a decrease in Cash. © 2018 Pearson Education, Inc.

Evaluating Cash Flows from Operating Activities
The operating activities section starts with accrual net income, and then adjustments are made to reconcile net income to net cash. When all of the adjustments have been made to net income, you can compute net cash flow from operating activities. Exhibit 14-5 shows how the cash flows from operating activities section might appear on ShopMart’s statement of cash flows. © 2018 Pearson Education, Inc.

Evaluating Cash Flows from Operating Activities
The operating activities section (indirect method) always starts with accrual basis net income. Adjustments are then made to determine the cash basis net income. Exhibit 14-6 summarizes the adjustments made to reconcile net income to net cash provided by operating activities: Add back all non-cash expenses to the net income. Expenses such as Depreciation Expense, Amortization Expense, or Depletion Expense represent expenses that are not related to current cash flows. Subtract accounting gains from net income. These gains (such as Gain on Sale of Land) are not cash flows that are related to operating activities, so their effects should be eliminated from net income. Add accounting losses back to net income. These losses (such as Loss on Sale of Equipment) are not cash flows that are related to operating activities, so their effects should be eliminated from net income. When current assets increase, we treat that as a “use” of cash and subtract it from net income. When current assets decrease, we treat that as a “source” of cash and add it to net income. When current liabilities increase, we treat that as a “source” of cash and add the increase to net income. When current liabilities decrease, we treat that as a “use” of cash and subtract the decrease from net income. © 2018 Pearson Education, Inc.

Cash Flows from Investing Activities
Investing activities affect long-term assets, such as: Plant Assets Investments Notes Receivable It is helpful to evaluate the T-accounts for each long-term asset to determine if there was an acquisition or disposal. Investing activities affect long-term assets, such as Plant Assets, Investments, and Notes Receivable. When computing investing cash flows, it is helpful to evaluate the T-accounts for each long-term asset. A T-account will show if an acquisition or a disposal happened during the year. © 2018 Pearson Education, Inc.

Let’s look at the Plant Assets and Accumulated Depreciation accounts for ShopMart. The beginning and ending balances for each account are taken directly from the comparative balance sheet. Depreciation expense has been included in the Accumulated Depreciation account, and this was taken from the income statement. The acquisition and disposal information came from the additional information provided when we introduced the example: Purchased $310,000 in plant assets by paying cash. Sold plant assets with a cost of $55,000 and accumulated depreciation of $15,000, yielding a gain of $10,000. © 2018 Pearson Education, Inc.

Use the information available to determine the cash received from an asset disposal: We need to determine the amount of cash received for the disposal of plant assets. Using the information provided, we can re-create the journal entry for the disposal and solve for the missing cash amount. We compute the cash receipt from the disposal as follows: Cash received = Cost – Accumulated Depreciation + Gain – Loss. Using the figures from this example, the cash received is $50,000 ($55,000 – $15,000 + $10,000). © 2018 Pearson Education, Inc.

Cash Flows from Financing Activities
Financing activities affect the long-term liability and equity accounts: Long-term Notes Payable Bonds Payable Common Stock Retained Earnings Financing activities affect the long-term liability and equity accounts, such as Long-term Notes Payable, Bonds Payable, Common Stock, and Retained Earnings. To determine the cash flows from financing activities, we need to review each of these accounts. © 2018 Pearson Education, Inc.

Long-term Liabilities
The T-account for ShopMart’s Notes Payable is shown below. Additional information: Received $90,000 cash from issuance of notes payable. Paid $10,000 cash to retire notes payable. The beginning and ending balances of Notes Payable are taken from the comparative balance sheet. © 2018 Pearson Education, Inc.

A new issuance of notes payable is known to be a $90,000 cash receipt. In addition, ShopMart paid $10,000 cash to retire notes payable. A new issuance of notes payable is known to be a $90,000 cash receipt. Cash is debited and Notes Payable is credited. In addition, ShopMart paid $10,000 cash to retire notes payable. Notes Payable is debited and Cash is credited. © 2018 Pearson Education, Inc.

The cash inflow and cash outflow associated with these notes payable are listed first in the cash flows from financing activities section. The cash inflow and cash outflow associated with notes payable are listed first in the cash flows from financing activities section. © 2018 Pearson Education, Inc.

Common Stock and Treasury Stock
The amount of new issuances of stock is determined by analyzing the stock accounts and reviewing additional information: Received $120,000 cash from issuing shares of common stock. Paid $20,000 cash for purchase of shares of treasury stock. Cash flows for financing activities are also determined by analyzing the stock accounts. © 2018 Pearson Education, Inc.

The common stock account shows a new stock issuance of $120,000. Acquisition of treasury stock: The common stock account shows a new stock issuance of $120,000. The entry to record this debits Cash for $120,000 and credits Common Stock for $120,000. The entry to record the acquisition of treasury stock debits Treasury Stock and credits cash for the $20,000 cost of the stock. © 2018 Pearson Education, Inc.

The $20,000 payment for treasury stock is shown as a cash outflow in the financing section of the statement of cash flows. The $20,000 payment for treasury stock is shown as a cash outflow in the financing section of the statement of cash flows. © 2018 Pearson Education, Inc.

Computing Dividend Payments
The amount of dividend payments can be computed by analyzing the Retained Earnings account. ShopMart earned net income of $40,000 The amount of dividend payments can be computed by analyzing the Retained Earnings account. First, we input the balances from the balance sheet. Retained Earnings increases when companies earn net income. Retained Earnings decreases when companies have a net loss and when they declare dividends. We know from the income statement in Exhibit 14-4 that ShopMart earned net income of $40,000. ShopMart can’t have both net income and net loss for the same period; therefore, the missing value must be the amount of dividends ShopMart declared. © 2018 Pearson Education, Inc.

Computing Dividend Payments
Only cash dividends paid are reported on the statement of cash flows. In order for the cash dividends to be reported on the statement of cash flows, the company must have paid the dividends. In this case, we know the cash dividends are paid because there are no dividends payable reported on ShopMart’s balance sheet. Companies can also distribute stock dividends. A stock dividend has no effect on Cash and is not reported in the financing activities section of the statement of cash flows. ShopMart had no stock dividends, only cash dividends, which are shown as an outflow in the financing activities section of the statement of cash flows. © 2018 Pearson Education, Inc.

Net Change in Cash and Cash Balances
To complete the statement of cash flows, the net change in cash and its effect on the beginning cash balance must be shown. This represents the total change in cash for the period and reconciles the statement of cash flows. First, the net increase or decrease in cash is computed by combining the cash provided by or used for operating, investing, and financing activities. © 2018 Pearson Education, Inc.

The last step is to prepare the non-cash investing and financing activities section. Let’s consider three non-cash transactions for The Outdoors, Inc.: Acquired $300,000 building by issuing common stock. Acquired $70,000 land by issuing notes payable. Retired $100,000 notes payable by issuing common stock. The last step in preparing the statement of cash flows is to prepare the non-cash investing and financing activities section. This section appears as a separate schedule of the statement of cash flows or in the notes to the financial statements. © 2018 Pearson Education, Inc.

The Outdoors issues common stock of $300,000 to acquire a building. The journal entry to record the purchase would be as follows: This transaction would not be reported on the statement of cash flows because no cash was paid or received. But the building and the common stock are important. The purchase of the building is an investing activity. The issuance of common stock is a financing activity. Taken together, this transaction is a non-cash investing and financing activity. © 2018 Pearson Education, Inc.

The second transaction listed indicates that The Outdoors acquired $70,000 of land by issuing a note. The journal entry to record the purchase would be as follows: This transaction would not be reported on the statement of cash flows because no cash was paid or received. But the land and the notes payable are important. The purchase of the land is an investing activity. The issuance of the note is a financing activity. Taken together, this transaction is a non-cash investing and financing activity. © 2018 Pearson Education, Inc.

The third transaction listed indicates that The Outdoors retired $100,000 of debt by issuing common stock. The journal entry to record the transaction would be as follows: This transaction would not be reported on the statement of cash flows because no cash was paid or received. But the notes payable and the stock issuance are important. The retirement of the note and the issuance of the common stock are both financing activities. Taken together, this transaction, even though it is two financing transactions, is reported in the non-cash investing and financing activities. © 2018 Pearson Education, Inc.

Non-cash investing and financing activities are reported in a separate part of the statement of cash flows. Exhibit 14-7 illustrates non-cash investing and financing activities for The Outdoors. This information is either reported as a separate schedule following the statement of cash flows or can be disclosed in a note. © 2018 Pearson Education, Inc.

HOW DO WE USE FREE CASH FLOW TO EVALUATE BUSINESS PERFORMANCE?
Investors want to know how much cash a company can “free up” for new opportunities. Free cash flow is the amount of cash available from operating activities after paying for planned investments in long-term assets and after paying dividends. Throughout this chapter, we have focused on cash flows from operating, investing, and financing activities. Some investors want to know how much cash a company can “free up” for new opportunities. Free cash flow is the amount of cash available from operating activities after paying for planned investments in long-term assets and after paying dividends to shareholders. Free cash flow = Net cash provided by operating activities – Cash payments planned for investments in long-term assets – Cash dividends. © 2018 Pearson Education, Inc.

HOW DO WE USE FREE CASH FLOW TO EVALUATE BUSINESS PERFORMANCE?
ShopMart expects net cash provided by operations of $200,000. It plans to spend $160,000 to modernize its retail facilities and pays $15,000 in cash dividends. ShopMart’s free cash flow is $25,000: ($200,000 ‒ $160,000 ‒ $15,000) Many companies use free cash flow to estimate the amount of cash would be available for unexpected opportunities. ShopMart’s free cash flow equals $25,000 ($200,000 ‒ $160,000 ‒ $15,000 ). If a good investment opportunity comes along, the company should have $25,000 cash available to invest. © 2018 Pearson Education, Inc.

HOW IS THE STATEMENT OF CASH FLOWS PREPARED USING THE DIRECT METHOD?
The Financial Accounting Standards Board (FASB) prefers the direct method of reporting cash flows from operating activities. This method provides clearer information about the sources and uses of cash than the indirect method. Only the operating section differs between the two methods. The Financial Accounting Standards Board (FASB) prefers the direct method of reporting cash flows from operating activities. The direct method provides clearer information about the sources and uses of cash than does the indirect method. Investing and financing cash flows are exactly the same presentation under both direct and indirect methods. © 2018 Pearson Education, Inc.

Cash Collections from Customers
Net Sales Revenue can be converted to cash receipts from customers as follows: When using the direct method, we take each line item of the income statement and convert it from accrual to cash basis. So, in essence, the operating activities section of the direct-method cash flow statement is really just a cash basis income statement. The first item on the income statement is Sales Revenue. Sales Revenue represents the total of all sales, whether for cash or on account. The balance sheet account related to Sales Revenue is Accounts Receivable. © 2018 Pearson Education, Inc.

Cash Collections from Customers
The cash ShopMart received from customers is the first item in the operating activities section of the direct-method statement of cash flows. The cash ShopMart received from customers is the first item in the operating activities section of the direct-method statement of cash flows. © 2018 Pearson Education, Inc.

Cash Receipts of Interest Revenue
The income statement reports interest revenue of $12,000. Because there is no Interest Receivable account on the balance sheet, the interest revenue must have all been received in cash. The income statement reports interest revenue of $12,000. The balance sheet account related to Interest Revenue is Interest Receivable. Because there is no Interest Receivable account on the balance sheet, the interest revenue must have all been received in cash. So, the statement of cash flows shows interest received of $12,000. © 2018 Pearson Education, Inc.

Cash Receipts of Dividend Revenue
The income statement reports dividend revenue of $9,000. No Dividends Receivable indicates that all dividend revenue was received in cash. The income statement reports dividend revenue of $9,000. The balance sheet account related to Dividend Revenue is Dividends Receivable. As with the interest, there is no Dividends Receivable account on the balance sheet. Therefore, the dividend revenue must have all been received in cash. So, the statement of cash flows shows cash received from dividends of $9,000. © 2018 Pearson Education, Inc.

Payments to Suppliers Payments to suppliers include all payments for the following: Merchandise inventory Operating expenses except employee compensation, interest, and income taxes Suppliers, also called vendors, are those entities that provide the business with its merchandise inventory and essential services. Payments to suppliers include all payments for the following: merchandise inventory, operating expenses except employee compensation, interest, and income taxes. Suppliers, also called vendors, are those entities that provide the business with its merchandise inventory and essential services. © 2018 Pearson Education, Inc.

Payments to Suppliers Cash paid for inventory is calculated as follows: The accounts related to supplier payments for merchandise inventory are Cost of Goods Sold, Merchandise Inventory, and Accounts Payable. Cost of Goods Sold on the income statement was $156,000. Merchandise Inventory decreased from $145,000 at December 31, 2017, to $143,000 at December 31, Accounts Payable increased from $50,000 at December 31, 2017, to $90,000 at December 31, 2018. © 2018 Pearson Education, Inc.

Payments to Suppliers Cash paid for operating expenses is calculated as follows: The accounts related to supplier payments for operating expenses are Other Operating Expense and Accrued Liabilities. Other operating expenses on the income statement were $16,000. Accrued Liabilities decreased from $10,000 at December 31, 2017, to $5,000 at December 31, 2018. © 2018 Pearson Education, Inc.

Payments to Suppliers Total cash paid to suppliers = Cash paid for merchandise inventory + Cash paid for other operating expenses Adding the cash paid for merchandise inventory and the cash paid for other operating expenses together, we get total cash paid to suppliers of $135,000 ($114,000 + $21,000). © 2018 Pearson Education, Inc.

Payments to Employees This category includes payments for salaries, wages, and other forms of employee compensation. This category includes payments for salaries, wages, and other forms of employee compensation. Accrued amounts are not cash flows because they have not yet been paid. The accounts related to employee payments are Salaries and Wages Expense from the income statement and Salaries and Wages Payable from the balance sheet. Because there is not a Salaries and Wages Payable account on the balance sheet, the Salaries and Wages Expense account must represent all amounts paid in cash to employees. So, the statement of cash flows shows cash payments to employees of $56,000. © 2018 Pearson Education, Inc.

Payments for Interest Expense and Income Tax Expense
These cash payments are reported separately from the other expenses. The accounts related to interest payments are Interest Expense from the income statement and Interest Payable from the balance sheet. Because there is no Interest Payable account on the balance sheet, the Interest Expense account from the income statement must represent all amounts paid in cash for interest. So, the statement of cash flows shows cash payments for interest of $15,000. The accounts related to income tax payments are Income Tax Expense from the income statement and Income Tax Payable from the balance sheet. Because there is no Income Tax Payable account on the balance sheet, the Income Tax Expense account from the income statement must represent all amounts paid in cash for income tax. So, the statement of cash flows shows cash payments for income tax of $14,000. © 2018 Pearson Education, Inc.

Non-cash Expenses and Gains or Losses on Disposal of Long-term Assets
Non-cash expenses and gains or losses on disposal of long-term assets are reported on the income statement but are not included in the operating activities when using the direct method. The Indirect Method adjusts Net Income for these items. The Direct Method does not start with Net Income, so we can skip over these items that are not cash transactions from operating activities. The cash received from the disposal of long-term assets is reported in the investing activities section, not the operating activities section. © 2018 Pearson Education, Inc.

Net Cash Provided by Operating Activities
To calculate net cash provided by operating activities using the direct method, we add all the cash receipts and cash payments described previously and find the difference. To calculate net cash provided by operating activities using the direct method, we add all the cash receipts and cash payments described previously and find the difference. For ShopMart, total cash receipts were $290,000. Total cash payments were $220,000. So, net cash provided by operating activities is $70,000. If you refer back to the indirect method statement of cash flows shown in Exhibit 14-5, you will find that it showed the same $70,000 for net cash provided by operating activities. The amount is the same; only the method by which it was calculated is different. The remainder of ShopMart’s statement of cash flows is exactly the same as what we calculated using the indirect method. Exhibit 14A-1 shows the completed statement of cash flows using the direct method for operating activities. © 2018 Pearson Education, Inc.

HOW IS THE STATEMENT OF CASH FLOWS PREPARED USING THE INDIRECT METHOD AND A SPREADSHEET? Most companies use a spreadsheet to prepare the statement of cash flows. This statement starts with the beginning balance sheet and concludes with the ending balance sheet. Columns labeled “Transaction Analysis” hold the data for the statement of cash flows. This chapter discusses the uses of the statement of cash flows in decision making and shows how to prepare the statement using T-accounts. The T-account approach works well as a learning device. In practice, however, most companies face complex situations. In these cases, a spreadsheet can help in preparing the statement of cash flows. The spreadsheet starts with the beginning balance sheet and concludes with the ending balance sheet. Two middle columns—one for debit amounts and the other for credit amounts—complete the spreadsheet. These columns, labeled “Transaction Analysis,” hold the data for the statement of cash flows. Accountants can prepare the statement directly from the lower part of the spreadsheet. © 2018 Pearson Education, Inc.

HOW IS THE STATEMENT OF CASH FLOWS PREPARED USING THE INDIRECT METHOD AND A SPREADSHEET? The indirect method reconciles accrual basis net income to net cash provided by operating activities. Exhibit 14B-1 is the spreadsheet for preparing the statement of cash flows by the indirect method. Panel A shows the transaction analysis. © 2018 Pearson Education, Inc.

The indirect method reconciles accrual basis net income to net cash provided by operating activities. Exhibit 14B-1 is the spreadsheet for preparing the statement of cash flows by the indirect method. Panel B gives the information to prepare the statement of cash flows. © 2018 Pearson Education, Inc.

Chapter 14 The Statement of Cash Flows

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