11th Edition Chapter 16.

11th Edition Chapter 16

“How Well Am I Doing?” Statement of Cash Flows
Chapter Sixteen This chapter explains how to classify transactions as operating, investing, or financing activities, and it explains how to create a statement of cash flows. The indirect method of determining the net cash provided by operating activities is illustrated within the chapter and the direct method is demonstrated in the appendix.

Purpose of the Statement of Cash Flows
Can we meet our obligations to creditors? Are cash flows sufficient to support ongoing operations? Why is there a difference between net income and net cash flow? Will the company have to borrow money to make needed investments? The statement of cash flows can be used to answer crucial questions such as: Are cash flows sufficient to support ongoing operations? Will the company be able to repay its debts? Will the company be able to pay its usual dividend? Why do net income and net cash flow differ? Will the company have to borrow money to make needed investments? Can we pay dividends?

Currency and Bank Accounts
Cash The term cash on the statement of cash flows refers broadly to both currency and cash equivalents. Currency and Bank Accounts T-bills In a statement of cash flows, cash is broadly defined to include both cash and cash equivalents. Cash equivalents consist of short-term, highly liquid investments such as Treasury Bills, commercial paper, and money market funds. These short-term liquid assets are usually included in marketable securities on the balance sheet. Cash Commercial Paper Money Market Funds

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts
Net Income Dividends Paid to Stockholders Changes in Noncash Assets Changes in Liabilities Changes in Capital Stock Net Cash Flows for a Period The net cash flow for a period is a function of the following: Net income Changes in noncash assets Changes in liabilities Changes in capital stock accounts Dividends paid to stockholders

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts
Exh. 16-2 Changes in the accounts mentioned on the previous slide can be classified as either sources or uses of cash as shown on this slide. Net income is always a source of cash. Net loss is always a use of cash. Decreases in noncash asset accounts are always sources of cash and increases are uses of cash. Increases in liability accounts are always sources of cash and decreases are uses of cash. Contra-assets follow the rules for liabilities Increases in capital stock accounts are always sources of cash and decreases are uses of cash. Dividends paid to stockholders are always uses of cash.

Increases in noncash asset accounts imply uses of cash.
Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts Increases in noncash asset accounts imply uses of cash. Example: Inventory is purchased on credit from a supplier. Increases in noncash asset accounts imply uses of cash. For example: If inventory is purchased on credit from a supplier, it is implied that cash was used to acquire the inventory. It is implied that cash was used to acquire the inventory.

Example: Inventory is purchased on credit from a supplier.
Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts Increases in liability accounts imply sources of cash. Example: Inventory is purchased on credit from a supplier. Increases in liability accounts imply sources of cash. For example: If inventory is purchased on credit from a supplier, it is implied that an increase in a payable has the effect of increasing cash available for other uses. It is implied that an increase in a payable has the effect of increasing cash available for other uses.

Decreases in noncash assets accounts imply sources of cash.
Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts Decreases in noncash assets accounts imply sources of cash. Example: Accounts receivable decreases when customers pay their bill. Decreases in noncash asset accounts imply sources of cash. For example: If accounts receivable decrease when customers pay their bill, the company’s cash balance increases accordingly. When the customer pays his bill, the company’s cash increases.

When the company makes the payment, cash decreases.
Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts Decreases in liability accounts imply uses of cash. Example: The company made a payment on a note payable held by a creditor. I.O.U. Decreases in liability accounts imply uses of cash. For example: If a company makes a payment on a note payable, the company’s cash balance decreases accordingly. When the company makes the payment, cash decreases.

A Simplified Statement of Cash Flows: An Example
Assume that comparative balance sheet account balances for Ed’s Pizza Hut were as shown. The change in the cash balance is a decrease of nineteen thousand dollars.

Additional Information: There was a net loss for the year of $27,000. Depreciation charges for the year were $6,000. During the year, Ed sold land originally costing $32,000 for $32,000. During the year, Ed paid dividends of $3,000 to the stockholders. Ed issued $50,000 of common stock to settle the note due to Joe Doe. Assume the additional information as shown.

Here is a summary of the sources of cash for Ed’s Pizza Hut. A summary of the sources of cash is as shown. The total sources of cash are sixty six thousand dollars.

Here is a summary of the uses of cash for Ed’s Pizza Hut. A summary of the uses of cash and the net cash flow is as shown. The total uses of cash are eighty five thousand dollars. The net cash flow is negative nineteen thousand dollars. This amount agrees with the change in cash shown earlier when we looked at comparative balance sheet account balances. The net cash flow for Ed’s Pizza Hut is ($19,000): $66,000 in sources minus $85,000 in uses.

A Simplified Statement of Cash Flows
This simplified approach does not follow the format required for external reporting purposes. It is for illustrative purposes only. This simplified approach does not follow the format required for external reporting purposes. It is for illustrative purposes only.

The Full-Fledged Statement of Cash Flows: Operating Activities
Operating activities are those activities that enter into the determination of net income. Transactions affecting current assets Changes in noncurrent balance sheet accounts that directly affect net income Operating activities are those activities that enter into the determination of net income. Generally speaking, this includes: All transactions affecting current assets. All transactions affecting current liabilities (except for issuing and repaying a note payable). All changes in noncurrent balance sheet accounts that directly affect net income such as the Accumulated Depreciation and Amortization account. Transactions affecting current liabilities

The Full-Fledged Statement of Cash Flows: Investing Activities
Investing activities relate to transactions involving the acquiring or disposing of noncurrent assets. Acquiring or selling property, plant and equipment Lending money to another entity and subsequently collecting on the loan Investing activities relate to transactions involving the acquiring or disposing of noncurrent assets. These transactions include: Acquiring or selling property, plant and equipment. Acquiring or selling securities (such as bonds and stocks of other companies) held for long-term investment. Lending money to another entity and subsequently collecting on the loan. Acquiring or selling securities

The Full-Fledged Statement of Cash Flows: Financing Activities
Financing activities relate to transactions involving borrowing from creditors or repaying creditors and engaging in transactions with the company’s owners. Financing activities relate to transactions involving borrowing from creditors or repaying creditors and engaging in transactions with the company’s owners. Transactions with creditors that affect net income, such as interest on debt, are classified as operating activities. Interest on debt is classified as an operating activity

The Full-Fledged Statement of Cash Flows: An Overview
Cash flows are divided into three categories. Cash flows are divided into three categories – operating, investing, and financing activities.

The Full-Fledged Statement of Cash Flows: An Overview
A reconciliation of beginning cash to ending cash is also required. { The beginning cash balance is reconciled with the ending cash balance.

Operating Activities The general format for this section of the statement is as shown. It includes those activities that enter into the determination of net income. Includes those activities that enter into the determination of net income.

Operating Activities Sources of cash are added to net income and uses of cash are subtracted from net income. As a reminder, as shown in this table, sources of cash are added to net income and uses of cash are deducted from net income.

Operating Activities Decreases in current noncash assets would be added to net income. Increases in current liabilities would be added to net income.

Operating Activities Increases in current noncash assets would be subtracted from net income. Decreases in current liabilities would be subtracted from net income.

Operating Activities Depreciation charges are treated the same as current liabilities, thus they are added to net income. Remember that depreciation charges are non-cash transactions. Since depreciation was subtracted out to arrive at net income on the income statement, we need to add it back to cancel it out. Depreciation and Amortization charges are added back to net income because they are decreases in noncash assets.

Operating Activities Gains are subtracted from net income.
Gains are subtracted from net income and losses are added to net income. Gains are subtracted from net income. Losses are added back to net income.

Investing Activities The general format for this section of the statement is as shown. It includes those transactions that involve the acquisition or disposal of noncurrent assets. Includes transactions that involve the acquisition or disposal of noncurrent assets.

Financing Activities The general format for this section of the statement is as shown. It includes those transactions that involve the receipts from or payments to creditors and owners. Includes transactions involving receipts from or payments to creditors and owners.

Other Issues: Gross or Net?
Example: Assume Macy’s purchases $50 million in property during the year and sells other property for $30 million. Instead of showing the net change of $20 million, the company must report the gross amounts of both transactions. For investing and financing activities, items on the statement of cash flows should be presented in gross amounts rather than in net amounts. For both financing and investing activities, items on the statement of cash flows should be presented in gross amounts rather than in net amounts. For example: If Macy’s Department Stores purchases fifty million dollars in property during the year and sells other property for thirty million dollars, instead of showing the net change of twenty million dollars, the company must report the gross amounts of both transactions. The gross method of reporting does not extend to operating activities, where debits and credits to an account are netted against each other.

Other Issues: Direct Method or Indirect Method?
The net cash provided by operating activities can be computed by either the direct or indirect method. The direct method reconstructs the income statement on a cash basis from top to bottom. For example: Cash collected from customers is used instead of revenue, and payments to suppliers is used instead of cost of sales. The indirect method (also known as the reconciliation method) constructs the operating activities section of the statement of cash flows by starting with net income and adjusting it to a cash basis. Items that do not affect cash flows are removed from net income thereby showing the reasons why net income differs from net cash provided by operating activities. The FASB encourages the use of the direct method. However, if the direct method is used it must be accompanied by a supplementary reconciliation of net income with operating cash flows. In other words, the indirect method must also be shown. If a company decides to use the indirect method for determining net cash flows from operating activities, there is no requirement that it also report the results using the direct method. Not surprisingly, only about one percent of companies use the direct method to construct the statement of cash flows for external reports.

Other Issues: Direct Exchange Transactions
Direct exchange transactions occur when noncurrent balance sheet items are swapped. Such exchanges are not included in the statement of cash flows, but must be disclosed separately. Example: Bobo, Inc. acquires a building in exchange for 2,000 shares of common stock. No cash has changed hands so this transaction would be reported in a separate supplemental schedule attached to the statement of cash flows. Direct exchange transactions occur when noncurrent balance sheet items are swapped. For example, a company might issue common stock in exchange for property. These types of transactions are not reported on the statement of cash flows. However, such direct exchanges are disclosed in a separate schedule that accompanies the statement.

A Full-Fledged Statement of Cash Flows: An Example
Let’s revisit the comparative balance sheet account balances for Ed’s Pizza Hut. Let’s revisit the comparative balance sheet account balances for Ed’s Pizza Hut as shown.

A Full-Fledged Statement of Cash Flows: An Example
Let’s also refresh our memory regarding the following additional information. Additional Information: There was a net loss for the year of $27,000. Depreciation charges for the year were $6,000. During the year, Ed sold land originally costing $32,000 for $32,000. During the year, Ed paid dividends of $3,000 to the stockholders. Ed issued $50,000 of common stock to settle the note due to Joe Doe. Let’s also refresh our memory regarding the following additional information as shown.

Preparing the Statement of Cash Flows: Step 1
List each account appearing on the comparative balance sheets except for cash and cash equivalents and retained earnings. There are eight steps to preparing the statement of cash flows. The first step is to copy on to a worksheet the title of each account appearing on the comparative balance sheets except for cash and cash equivalents and retained earnings. Contra asset accounts should be listed with the liabilities.

Compute the change from the beginning balance to the ending balance for each account. The second step is to compute the change from the beginning balance to the ending balance in each balance sheet account. Break down the change in retained earnings into net income and dividends.

Code each entry on the worksheet as a source or use of cash. The third step is to code each entry on the worksheet as a source or use of cash. The noncash assets are coded as shown. The liabilities and depreciation are coded as shown. The capital stock account is coded as shown. The net income/loss and dividends are coded as shown. Recall that the transaction involving the Notes Payable and Common Stock was noncash. Recall that the transaction involving the Notes Payable and Common Stock was noncash. {

Code sources of cash as positive numbers and uses of cash as negative numbers. The fourth step is to code sources of cash as positive numbers and uses of cash as negative numbers as shown.

Make any necessary adjustments, including adjustments for gains and losses. The net effect of these should equal zero. The fifth step is to make any necessary adjustments – including adjustments for gains and losses. The net effect of these adjustments should equal zero. Ed’s Pizza Hut’s only adjustment was for the noncash transaction relating to the exchange of a Notes Payable and Common Stock. We need to make an adjustment for the noncash transaction relating to Notes Payable and Common Stock. {

Classify each entry as operating, investing or financing activity. The sixth step is to classify each entry on the worksheet as an operating, investing, or financing activity as shown.

Copy the data from the worksheet into the Statement of Cash Flows section by section. The seventh step is to copy the data from the worksheet into the statement of cash flows section by section. The net cash flow from operations, investing and financing activities would appear as shown. Remember that the depreciation is added back to net income to cancel out the reduction in net income caused by including this noncash expense in the income statement.

Prepare a cash reconciliation at the bottom of the statement. The eighth step is to prepare a cash reconciliation at the bottom of the statement as shown. The complete statement of cash flows would appear as shown.

Example – Indirect Method
In addition, on the face of the statement or in a supplemental schedule, disclose the issuance of $50,000 of stock to a creditor, a noncash financing activity. As a supplement to this statement, Ed’s Pizza Hut would also disclose the issuance of fifty thousand dollars of stock to a creditor as a noncash financing activity. This amount was adjusted out of the worksheet in step 5.

Interpretation of the Statement of Cash Flows
Examine the operating activities section carefully. Ed’s Pizza Hut generated a negative cash flow from operations of $48,000. This is usually a sign of fundamental difficulties. Ultimately, a positive cash flow is necessary to avoid liquidating assets or borrowing money to pay for day-to-day activities. Ed’s Pizza Hut generated a net cash flow from operations of negative forty eight thousand dollars. This suggests that the company may not be generating sufficient cash flows on a continuing basis to sustain the business without liquidating assets or borrowing money.

The Direct Method of Determining the Net Cash Provided by Operating Activities
Appendix 16A Now, let’s look at the direct method of determining the net cash provided by operating activities.

Computing Net Cash Provided by Operating Activities
The direct method computes net cash provided by operating activities by reconstructing the income statement on a cash basis from top to bottom. The direct method computes net cash provided by operating activities by reconstructing the income statement on a cash basis from top to bottom. The amount of net cash provided by operating activities under the direct method will always agree with the amount computed using the indirect method. Cash provided by operating activities under the direct method will always agree with the amount computed using the indirect method.

Similarities and Differences in Handling Data
Adjustments for accounts that affect revenue are the same in the direct method and indirect methods. Adjustments for accounts that affect expenses are handled in opposite ways for the direct and indirect methods. The adjustments for accounts that affect revenue are the same in the direct and indirect methods. In either case, increases in the accounts are deducted and decreases in the accounts are added. The adjustments for accounts that affect expenses are handled in opposite ways for the direct and indirect methods. Under the indirect method, the adjustments are made to net income, whereas under the direct method the adjustments are made to the expense accounts themselves. For example: In the indirect method, an increase in prepaid expenses is deducted from net income. However, in the direct method an increase in prepaid expenses is added to operating expenses.

Direct Method: Gains and Losses
Regarding gains and losses on sale of assets, no adjustments are needed at all under the direct method. Regarding gains and losses on sale of assets, no adjustments are needed at all under the direct method. These gains and losses are ignored since they are not part of sales, cost of goods sold, operating expenses, or income taxes.

The Direct Method: An Example
Let’s revisit the comparative balance sheet account balances for Ed’s Pizza Hut. Let’s revisit the comparative balance sheet account balances for Ed’s Pizza Hut as shown.

Let’s assume that Ed’s Pizza Hut prepared this income statement. Let’s also assume that Ed’s Pizza Hut prepared the income statement as shown.

Step 1: Translate sales revenue into cash collected from customers. The first step is to translate sales revenue into cash collections from customers. This is accomplished as shown.

Step 2: Translate cost of goods sold into cash disbursements for purchases. The second step is to translate cost of goods sold into cash disbursements for purchases. This is accomplished as shown.

Step 3: Translate operating expenses into cash paid for operating expenses. The third step is to translate operating expenses into cash paid for operating expenses. There is no adjustment for income taxes because Ed’s Pizza Hut has a net loss of twenty seven thousand dollars. There is not an adjustment needed for income taxes because Ed’s Pizza Hut has a net loss of $27,000.

Notice that the net cash provided by operating activities agrees with that computed using the indirect method. The net cash provided by operating activities is negative forty eight thousand dollars. Notice that this agrees with the net cash provided by operating activities that was computed using the indirect method.

Now, this is what I call CA$H FLOW!
End of Chapter 16 Now, this is what I call CA$H FLOW! In this chapter we explained how to classify transactions as operating, investing, or financing activities and how to create a statement of cash flows. Both the indirect method and the direct method were demonstrated in this chapter.

11th Edition Chapter 16.

Similar presentations

Presentation on theme: "11th Edition Chapter 16."— Presentation transcript:

Similar presentations

About project

Feedback

Log in

Auth with social network:

11th Edition Chapter 16.

Similar presentations

Presentation on theme: "11th Edition Chapter 16."— Presentation transcript:

Similar presentations

About project

Feedback