1. Statement of Cash Flows
Chapter 16
Statement of Cash Flows
Chapter 16: Reporting the Statement of Cash Flows

2. Purpose of the Statement of Cash Flows
Where does a company spend its cash?
How does a company obtain its cash?
The Statement of Cash Flows helps users determine how a company obtains its cash and where it spends its cash. By providing this information, this statement helps explain the change in the cash balance from the beginning of the period to the end of the period.
What explains the change in the cash balance?

3. Importance of Cash Flows
How did the business fund its operations?
Does the business have sufficient cash to pay its debts as they mature?
While it is important for users to know how much cash a company has, it is also important to know how a company funded its operations. Did it have to borrow money or sell shares to help pay the operating expenses of the company? If so, users need to be aware of this so they can fully assess the cash flow position of the company. Cash flow information is also useful to determine if the business has sufficient cash to pay its debts or if the business paid dividends during the period.
Did the business borrow any funds or repay any loans?
Did the business make any dividend payments?

4. Measurement of Cash Flows
Cash Equivalents
Currency
Cash includes currency and cash equivalents. Cash equivalents are short-term, highly liquid investments that are easily converted into cash and that have very little risk of loss. An example of a cash equivalent would be a short-term Treasury Bill that is government issued, is very close to maturity, and has very little risk associated with it.
Short-term, highly liquid investments.
Readily convertible into cash.
Sufficiently close to maturity so that market value is unaffected by interest rate changes.

5. Classification of Cash Flows
The Statement of Cash Flows includes the following three sections:
Operating Activities
Investing Activities
Financing Activities
There are three basic sections on the Statement of Cash Flows:
 Operating Activities
Investing Activities
Financing Activities

6. Operating Activities Examples of inflows are:
The principal revenue-producing activities of the entity and other activities that are not investing or financing activities. These generally include those transactions and events that determine net profit.
Examples of inflows are:
cash receipts from the sale of goods and the rendering of services.
cash receipts from royalties, fees, commissions, and other revenue.
Operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities. These generally include those transactions and events that determine net profit or net profit.
Examples of inflows are:
cash receipts from the sale of goods and the rendering of services.
cash receipts from royalties, fees, commissions, and other revenue.

7. Operating Activities Examples of outflows are:
The principal revenue-producing activities of the entity and other activities that are not investing or financing activities. These generally include those transactions and events that determine net profit or net profit.
Examples of outflows are:
cash payments to suppliers for goods and services.
cash payments to and on behalf of employees.
Operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities. These generally include those transactions and events that determine net profit or net profit.
Examples of outflows are:
cash payments to suppliers for goods and services.
cash payments to and on behalf of employees.

8. Investing Activities Examples of inflows are:
The acquisition and disposal of long-term assets and other investments not included in cash equivalents.
Examples of inflows are:
cash receipts from sales of PPE, intangibles and other long-term assets.
cash receipts from sales of equity or debt instruments of other entities.
cash receipts from the repayment of advances and loans made to other parties.
Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.
Examples of inflows are:
cash receipts from sales of PPE, intangibles and other long-term assets.
cash receipts from sales of equity or debt instruments of other entities.
cash receipts from the repayment of advances and loans made to other parties.

9. Investing Activities Examples of outflows are:
The acquisition and disposal of long-term assets and other investments not included in cash equivalents.
Examples of outflows are:
cash payments to acquire PPE, intangibles and other long-term assets.
cash payments to acquire equity or debt instruments of other entities.
cash advances and loans made to other parties.
Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.
Examples of outflows are:
cash payments to acquire PPE, intangibles and other long-term assets.
cash payments to acquire equity or debt instruments of other entities.
cash advances and loans made to other parties.

10. Financing Activities C1
Activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.
Examples of inflows are:
cash proceeds from issuing shares or other equity instruments.
cash proceeds from issuing debentures, loans, notes, bonds, mortgages, and other short-term or long-term borrowings.
Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.
Examples of inflows are:
cash proceeds from issuing shares or other equity instruments.
cash proceeds from issuing debentures, loans, notes, bonds, mortgages, and other short-term or long-term borrowings.

11. Financing Activities C1
Activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.
Examples of outflows are:
cash payments to owners to acquire or redeem the entity’s shares.
cash repayments of amounts borrowed.
Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.
Examples of outflows are:
cash payments to owners to acquire or redeem the entity’s shares.
cash repayments of amounts borrowed.

12. Classification of Cash Flow Items
Reporting entities have choices in classifying interest and dividends
Operating
Investing
Financing
Interest received
Yes
Dividends received
Interest paid
Dividends paid
IFRS allow alternative classifications of interest and dividends received, as well as interest and dividends paid. Interest and dividends received may be classified as operating cash flows because they enter into the determination of profit or loss. Alternatively, interest and dividends received may be classified as investing cash flows because they are returns on investments. Interest paid may be operating or financing because it enters into the determination of profit or loss and is also a cost of obtaining financial resources. Dividends paid may be classified as a financing cash flow because they are a cost of obtaining financial resources. Alternatively, dividends paid may be classified as cash flows from operating activities in order to assist users to determine the ability of an entity to pay dividends out of operating cash flows.

13. Noncash Investing and Financing
Items requiring separate disclosure include:
Retirement of debt by issuing equity securities.
Conversion of preference shares to ordinary shares.
Some transactions involve investing activities and or financing activities but no cash. An example would be purchasing equipment and paying for it by issuing company shares. In this transaction, the purchase of equipment is an investing activity and the issuance of shares is a financing activity. But, not a single dollar of cash was exchanged in the transaction. As a result, this transaction would NOT appear on the Statement of Cash Flows. Because of their significance and the full disclosure principle, these noncash investing and financing transactions must be disclosed in the financial statements or the notes.

14. Format of the Statement of Cash Flows
This is a summary of the components of a Statement of Cash Flows. You can see the operating, investing, and financing sections that we just discussed are on the statement. There is also a cash reconciliation at the bottom of the statement that reconciles the change in cash with the beginning and ending cash balances. The ending cash balance on the Statement of Cash Flows should always equal the cash balance on the Statement of Financial Position.

15. Preparing the Statement of Cash Flows
Preparing a statement of cash flows involves five steps:
Compute the net increase or decrease in cash;
Compute and report net cash from or used in operating activities;
Compute and report net cash from or used in investing activities;
Compute and report net cash from or used in financing activities;
Compute the net cash flow by combining net cash from or used in operating, investing, and financing activities and then prove it by adding it to the beginning cash balance to show that it equals the ending cash balance.
We will follow these steps in the preparation of our example statement of cash flows.

16. Analyzing the Cash AccountP1
The Cash account is a natural place to look for information about cash flows from operating, investing, and financing activities.
Cash
Balance, Dec. 31, 2014
12,000
Payments for merchandise
319,000
Receipts from customers  
570,000
Payments for wages and operating expenses  
218,000
Receipts from asset sales
Payments for interest  
8,000
Receipts from share issuance  
15,000
Payments for taxes  
5,000
Receipts from dividends  
16,000
Payments for assets  
10,000
Payments for notes retirement  
34,000
Payments for dividends
14,000
Balance, Dec. 31, 2015
33,000
A company’s cash receipts and cash payments are recorded in the Cash account in its general ledger. The Cash account is therefore a natural place to look for information about cash flows from operating, investing, and financing activities. To illustrate, review the summarized Cash T-account of Genesis, Inc., on this slide. Individual cash transactions are summarized in this Cash account according to the major types of cash receipts and cash payments. For instance, only the total of cash receipts from all customers is listed. Individual cash transactions underlying these totals can number in the thousands. Accounting software is available to provide summarized cash accounts.

17. Analyzing the Cash AccountP1
Analyzing the Cash Account
GENESIS
Statement of Cash Flows
For Year Ended December 31, 2015
Cash flows from operating activities
Cash received from customers
$570,000
Cash paid for merchandise
(319,000)
Cash paid for wages and other operating expenses
(218,000)
Cash paid for taxes
(5,000)
Cash received from dividends*……………………………………..
16,000
Cash paid for interest**
(8,000)
Net cash from operating activities
$36,000
Cash flows from investing activities
Cash received from sale of property, plant and equipment . . .
12,000
Cash paid for purchase of property, plant and equipment
(10,000)
Net cash from investing activities
2,000
Cash flows from financing activities
Cash received from issuing shares
15,000
Cash paid to retire notes
(34,000)
Cash paid for dividends***
(14,000)
Net cash used in financing activities
(33,000)
Net increase in cash
$5,000
Cash balance at prior year-end
Cash balance at current year-end
$17,000
Cash from Operating
Cash from Investing
Preparing a statement of cash flows from the cash account on the previous slide requires determining whether an individual cash inflow or outflow is an operating, investing, or financing activity, and then listing each by activity. This yields the statement shown on this slide. However, preparing the statement of cash flows from an analysis of the summarized Cash account has two limitations. First, most companies have many individual cash receipts and payments, making it difficult to review them all. Accounting software minimizes this burden, but it is still a task requiring professional judgment for many transactions. Second, the Cash account does not usually carry an adequate description of each cash transaction, making assignment of all cash transactions according to activity difficult.
Cash from Financing
Cash Proved
*Can also be classified as investing.
**Can also be classified as financing.
***Can also be classified as operating.

18. Analyzing Noncash AccountP1
A second approach to preparing the statement of cash flows is analyzing noncash accounts.
A second approach to preparing the statement of cash flows is analyzing noncash accounts. This approach uses the fact that when a company records cash inflows and outflows with debits and credits to the Cash account, it also records credits and debits in noncash accounts (reflecting double-entry accounting). Many of these noncash accounts are statement of financial position accounts—for instance, from the sale of land for cash. Others are revenue and expense accounts that are closed to equity. For instance, the sale of services for cash yields a credit to Services Revenue that is closed to Retained Earnings for a corporation. In sum, all cash transactions eventually affect noncash statement of financial position accounts. Thus, we can determine cash inflows and outflows by analyzing changes in noncash statement of financial position accounts.
This slide illustrates the accounting equation to show the relation between the Cash account and the noncash statement of financial position accounts. This illustration starts with the accounting equation at the top. It is then expanded in line (2) to separate cash from noncash asset accounts. Line (3) moves noncash asset accounts to the right-hand side of the equality where they are subtracted. This shows that cash equals the sum of the liability and equity accounts minus the noncash asset accounts. Line (4) points out that changes on one side of the accounting equation equal changes on the other side. It shows that we can explain changes in cash by analyzing changes in the noncash accounts consisting of liability accounts, equity accounts, and noncash asset accounts. By analyzing noncash statement of financial position accounts and any related income statement accounts, we can prepare a statement of cash flows.

19. Information to Prepare the Statement
Information to prepare the statement of cash flows usually comes from three sources:
Comparative
Statements of Financial Position
Current
Income Statement
Information to prepare the statement of cash flows usually comes from three sources:
comparative statements of financial position,
the current income statement, and
additional information.
Comparative statements of financial position are used to compute changes in noncash accounts from the beginning to the end of the period. The current income statement is used to help compute cash flows from operating activities. Additional information often includes details on transactions and events that help explain both the cash flows and noncash investing and financing activities.
Additional
Information

20. Application of the Indirect Method of Reporting
We will prepare the statement of cash flows for Genesis, Inc. using the indirect method. This slide shows the December 31, 2014 and 2015, statements of financial position of Genesis along with its 2015 income statement. We use this information to prepare a statement of cash flows that explains the $5,000 increase in cash for 2015 as reflected in its statements of financial position. This $5,000 is computed as Cash of $17,000 at the end of 2015 minus Cash of $12,000 at the end of 2014.

21. Application of the Indirect Method of Reporting
Additional information on Genesis Inc.’s 2015 transactions:
The accounts payable balances result from merchandise inventory purchases.
Purchased $70,000 in PPE by paying $10,000 cash and issuing $60,000 of notes payable.
Sold PPE with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss.
Received $15,000 cash from issuing 3,000 shares of no-par ordinary shares.
Paid $34,000 cash to retire notes with a $34,000 carrying amount.
Declared and paid cash dividends of $14,000.
Received all its dividend income on financial assets in cash of $16,000.
In addition to the financial statements, Genesis discloses the following additional information on its 2015 transactions:
The accounts payable balances result from merchandise inventory purchases.
Purchased $70,000 in property, plant and equipment by paying $10,000 cash and issuing $60,000 of notes payable.
Sold property, plant and equipment with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss.
Received $15,000 cash from issuing 3,000 shares of no-par ordinary shares.
Paid $34,000 cash to retire notes with a $34,000 carrying amount.
Declared and paid cash dividends of $14,000.
Received all its dividend income on financial assets in cash of $16,000.

22. Why start with profit before tax?
International Financial Reporting Standards (IFRS)
Cash flows arising from taxes on profit should be separately disclosed and should be classified as cash flows from operating activities.
IFRS stipulate that cash flows arising from taxes on profit should be separately disclosed and should be classified as cash flows from operating activities.
Cash Flows from Operating Activities
Profit before tax

23. Adjustments for Operating Items Not Providing or Using Cash
The income statement usually includes some expenses (e.g., depreciation, amortization, depletion, bad debts) or losses (e.g., impairment) that do not reflect cash outflows in the period. The indirect method for reporting operating cash flows requires that Expense or losses with no cash outflows are added back to profit. To see the logic of this adjustment, recall that items such as depreciation expense and impairment loss are debited to expense or loss accounts (reducing profit) and credited to noncash accounts. These entries have no cash effect, and we add them back to profit when computing net cash flows from operating activities. Adding them back cancels their deductions.
Depreciation expense is the only Genesis operating item that has no effect on cash flows in the period (the account depreciation expense was debited and the account accumulated depreciation was credited). We must add back the $24,000 depreciation expense to profit when computing cash from operating activities as shown in Exhibit 16.7.

24. Adjustments for Nonoperating Items
Genesis reports a $6,000 loss on sale of property, plant and equipment as part of profit. This loss is a proper deduction in computing profit, but it is not part of operating activities. Instead, a sale of property, plant and equipment is part of investing activities. Thus, the $6,000 nonoperating loss is added back to profit. Adding it back cancels the loss.

25. P2
Adjustments for Changes in NonCash Current Assets and Current Liabilities
From the comparative statements of financial position presented earlier, we can determine the change in the noncash current assets and current liabilities.
Accounts receivable increase $20,000, from a beginning balance of $40,000 to an ending balance of $60,000. This increase implies that Genesis collects less cash than is reported in sales. That is, some of these sales were in the form of accounts receivable and that amount increased during the period. This $20,000 — as reflected in the $20,000 increase in Accounts Receivable — is subtracted from profit when computing cash from operating activities.
Merchandise inventory increases by $14,000, from a $70,000 beginning balance to an $84,000 ending balance. This increase implies that Genesis had greater cash purchases than cost of goods sold. The amount by which purchases exceed cost of goods sold — as reflected in the $14,000 increase in inventory — is subtracted from profit when computing cash from operating activities.
Prepaid expenses increase $2,000, from a $4,000 beginning balance to a $6,000 ending balance, implying that Genesis’s cash payments exceed its recorded prepaid expenses. The amount by which cash payments exceed the recorded operating expenses — as reflected in the $2,000 increase in Prepaid Expenses — is subtracted from profit when computing cash from operating activities.
Accounts payable decrease $5,000, from a beginning balance of $40,000 to an ending balance of $35,000. This decrease implies that cash payments to suppliers exceed purchases by $5,000 for the period. The amount by which cash payments exceed purchases — as reflected in the $5,000 decrease in Accounts Payable — is subtracted from profit when computing cash from operating activities.

26. Adjustments for Changes in Noncash Current Assets and Current LiabilitiesP2
Change in Account Balance During Year
Increase
Decrease
Noncash Current Assets
Subtract from profit
Add to profit
Current
Liabilities
This chart explains how to treat a change in a noncash current asset or current liability in the operating section of the statement of cash flows. Maybe a couple of examples will help you see how this table works. Let’s start with current assets. If accounts receivable, a current asset, decreased during the year, this decrease would be added to profit. A decrease in accounts receivable means that customer cash payments on account exceeded customer charges on account during the period. This excess of cash payments over charges is used to adjust the accrual based revenues reported on the income statement to report the total cash received from customers during the period. Similarly, if accounts receivable increased during the year, this increase would be subtracted from profit. An increase in accounts receivable means that customer charges on account exceeded customer cash payments on account during the period. This excess of charges over cash payments is used to adjust the accrual based revenues reported on the income statement to report the total cash received from customers during the period. Now, let’s look at how to treat changes in current liabilities. If salaries payable, a current liability, decreased during the year, this decrease would be subtracted from profit. A decrease in salaries payable means that the company paid off more in salaries than it charged to expense during the period. This excess of cash payments over charges is used to adjust the accrual based expense reported on the income statement to report the total cash paid for salaries during the period. Similarly, if salaries payable increased during the year, this increase would be added to profit. An increase in salaries payable means the company charged more to expense than it paid off during the period. This excess of charges over cash payments is used to adjust the accrual based expense reported on the income statement to report the total cash paid for salaries during the period.
Use this table when adjusting profit before taxes to operating cash flows

27. Interest Revenues, Dividend Revenues, Interest Expenses and Income Taxes
Under IFRS, interest and dividends received, interest paid and income taxes must be separately shown.
Since interest and dividend revenues are added to
derive profit amount, adjustments involve
deducting these amounts from profit.
Interest expenses are added to profit to
cancel the earlier deduction.
IFRS state that cash flows arising from taxes on profit shall be separately disclosed and shall be classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities. cash flows from interest and dividends received and paid shall each be disclosed separately. For example, a company with interest revenue and interest expense reporting under the indirect method would have to start with profit before tax, make adjustments by subtracting interest revenue, and adding back interest expense. It would show tax paid under operating activities, and has the choice of putting interest received in operating or investing activities, as well as the choice of putting interest paid in operating or financing activities. Similar reasoning applies for dividends received and paid.

28. COMPLETING THE OPERATING SECTION
Cash flows arising from tax on profit shall be separately disclosed and shall be classified as cash flows from operating activities. Cash flows on interest paid shall each be disclosed separately. Therefore, Genesis must add back interest expense before showing the interest paid separately in either operating or financing section. In this example, Genesis showed the interest paid under operating section.

29. Summary of Adjustments for Indirect MethodP2
Common adjustments to profit when computing net cash from or used in operating activities under the indirect method:
This slide summarizes the most common adjustments to profit when computing net cash from or used in operating activities under the indirect method. The computations in determining cash from or used in operating activities are different for the indirect and direct methods, but the result is identical. As we illustrated earlier, both methods yield the same $20,000 figure for cash from operating activities for Genesis.

30. Cash Flows from InvestingP3
A three-stage process to determine cash from or used in investing activities:
Identify changes in investing-related accounts
Explain these changes using reconstruction analysis
The third major step in preparing the statement of cash flows is to compute and report cash flows from investing activities. We normally do this by identifying changes in (1) all noncurrent asset accounts and (2) the current accounts for both notes receivable and investments in securities (excluding trading securities). We then analyze changes in these accounts to determine their effect, if any, on cash and report the cash flow effects in the investing activities section of the statement of cash flows. Reporting of investing activities is identical under the direct method and indirect method.
Information to compute cash flows from investing activities is usually taken from beginning and ending statements of financial position and the income statement. We use a three-stage process to determine cash from or used in investing activities: (1) identify changes in investing-related accounts, (2) explain these changes using reconstruction analysis, and (3) report their cash flow effects.
Report their cash flow effects

31. Cash Flows from InvestingP3
This analysis reveals a $40,000 increase in property, plant and equipment from $210,000 to $250,000 and a $12,000 increase in accumulated depreciation from $48,000 to $60,000.
Information about the Genesis transactions provided earlier reveals that the company both purchased and sold property, plant and equipment during the period. Both transactions are investing activities and are analyzed for their cash flow effects.
The first stage in analyzing the Property, plant and equipment account and its related Accumulated Depreciation is to identify any changes in these accounts from comparative statements of financial position presented earlier. This analysis reveals a $40,000 increase in property, plant and equipment from $210,000 to $250,000 and a $12,000 increase in accumulated depreciation from $48,000 to $60,000.

32. Cash Flows from InvestingP3
Item b: Genesis purchased property, plant and equipment of $70,000 by issuing $60,000 in notes payable to the seller and paying $10,000 in cash.
Item c: Genesis sold property, plant and equipment costing $30,000 (with $12,000 of accumulated depreciation) for $12,000 cash, resulting in a $6,000 loss.
The second stage is to explain these changes. Items b and c of the additional information for Genesis provided earlier are relevant in this case. Recall that the Property, plant and equipment account is affected by both asset purchases and sales, while its Accumulated Depreciation account is normally increased from depreciation and decreased from the removal of accumulated depreciation in asset sales. To explain changes in these accounts and to identify their cash flow effects, we prepare reconstructed entries from prior transactions; they are not the actual entries by the preparer.
Item b reports that Genesis purchased property, plant and equipment of $70,000 by issuing $60,000 in notes payable to the seller and paying $10,000 in cash. The reconstructed entry for analysis of item b would be a debit to Property, plant and equipment for $70,000 , a credit to Notes Payable for $60,000, and a credit to Cash for $10,000. This entry reveals a $10,000 cash outflow for property, plant and equipment and a $60,000 noncash investing and financing transaction involving notes exchanged for property, plant and equipment.
Next, item c reports that Genesis sold property, plant and equipment costing $30,000 (with $12,000 of accumulated depreciation) for $12,000 cash, resulting in a $6,000 loss. The reconstructed entry for analysis of item c is a debit to Cash for $12,000, a debit to Accumulated Depreciation for $12,000, a debit to Loss on Sale of Property, plant and equipment for $6,000, and a credit to Property, plant and equipment for $30,000. This entry reveals a $12,000 cash inflow from assets sold. The $6,000 loss is computed by comparing the asset carrying amount to the cash received and does not reflect any cash inflow or outflow.
We also reconstruct the entry for Depreciation Expense using information from the income statement: debit Depreciation Expense for $24,000 and credit Accumulated Depreciation for $24,000. This entry shows that Depreciation Expense results in no cash flow effect.
This reconstruction analysis is complete in that the change in property, plant and equipment from $210,000 to $250,000 is fully explained by the $70,000 purchase and the $30,000 sale. Also, the change in accumulated depreciation from $48,000 to $60,000 is fully explained by depreciation expense of $24,000 and the removal of $12,000 in accumulated depreciation from an asset sale.
We also reconstruct the entry for Depreciation Expense using information from the income statement.

33. Cash Flows from InvestingP3
The third stage looks at the reconstructed entries for identification of cash flows. The two identified cash flow effects reported in the investing section of the statement are cash received from sale of property, plant and equipment for $12,000 and cash paid for purchase of property, plant and equipment for $10,000.
The $60,000 portion of the purchase described in item b and financed by issuing notes is a noncash investing and financing activity. It is reported in a note or in a separate schedule to the statement.

34. Cash Flows from FinancingP3
A three-stage process to determine cash from or used in financing activities:
Identify changes in financing-related accounts
Explain these changes using reconstruction analysis
The fourth major step in preparing the statement of cash flows is to compute and report cash flows from financing activities. We normally do this by identifying changes in all noncurrent liability accounts (including the current portion of any notes and bonds) and the equity accounts. These accounts include long-term debt, notes payable, bonds payable, share capital, and retained earnings. Changes in these accounts are then analyzed using available information to determine their effect, if any, on cash. Results are reported in the financing activities section of the statement. Reporting of financing activities is identical under the direct method and indirect method.
We again use a three-stage process to determine cash from or used in financing activities: (1) identify changes in financing-related accounts, (2) explain these changes using reconstruction analysis, and (3) report their cash flow effects.
Report their cash flow effects

35. Cash Flows from FinancingP3
This analysis reveals:
an increase in notes payable from $64,000 to $90,000,
an increase in share capital from $80,000 to $95,000, and
an increase in retained earnings from $88,000 to $112,000.
Information about Genesis provided earlier reveals two transactions involving noncurrent liabilities. We analyzed one of those, the $60,000 issuance of notes payable to purchase property, plant and equipment. This transaction is reported as a significant noncash investing and financing activity in a footnote or a separate schedule to the statement of cash flows. The other remaining transaction involving noncurrent liabilities is the cash retirement of notes payable.
The first stage in analysis of notes is to review the comparative statements of financial position which reveals an increase in notes payable from $64,000 to $90,000, a $26,000 increase. We also note that analyzing share capital on the comparative statements of financial position reveals an increase in share capital from $80,000 to $95,000, a $15,000 increase. Finally, the retained earnings account reveals an increase from $88,000 to $112,000, a $24,000 increase.

36. Cash Flows from FinancingP3
Item b: Genesis purchased property, plant and equipment of $70,000 by issuing $60,000 in notes payable to the seller and paying $10,000 in cash.
Item b of the additional information reports that Genesis purchased property, plant and equipment costing $70,000 by issuing $60,000 in notes payable to the seller and paying $10,000 in cash. We reconstructed this entry when analyzing investing activities: It showed a $60,000 increase to notes payable that is reported as a noncash investing and financing transaction. The increase of $26,000 in the Notes Payable account is fully explained by these reconstructed entries.

37. Cash Flows from FinancingP3
Item d: Issued 3,000 no-par ordinary shares for $5 per share.
Item f: Cash dividends of $14,000 are paid.
The second stage to explain the $15,000 change in share capital requires review of item d in the additional information provided earlier. Item d of the additional information reports that 3,000 no-par ordinary shares are issued at $5 per share. The reconstructed entry for analysis of item d is a debit to Cash for $15,000 and a credit to Share Capital for $15,000. This entry reveals a $15,000 cash inflow from share issuance.
The second stage to explain the change in retained earnings requires review of item f in the additional information provided earlier. Item f of the additional information reports that cash dividends of $14,000 are paid. The reconstructed entry for analysis of item f is a debit to Retained Earnings for $14,000 and a credit to Cash for $14,000. This entry reveals a $14,000 cash outflow for cash dividends.

38. P3
In the third stage, the cash flow effects from the analysis of the notes payable, share capital, and retained earnings accounts are reported in the financing section of the statement as illustrated on this slide.

39. P3
The fifth and final step in preparing the statement is to report the beginning and ending cash balances and prove that the net change in cash is explained by operating, investing, and financing cash flows. The net increase of $5,000 reported on this statement is also the same increase in the Cash account reported on the comparative statements of financial position.

40. Analyzing Cash Sources and Uses
Most managers stress the importance of understanding and predicting cash flows for business decisions.
Most managers stress the importance of understanding and predicting cash flows for business decisions. Creditors evaluate a company’s ability to generate cash before deciding whether to lend money. Investors also assess cash inflows and outflows before buying and selling shares. Information in the statement of cash flows helps address these and other questions such as (1) How much cash is generated from or used in operations? (2) What expenditures are made with cash from operations? (3) What is the source of cash for debt payments? (4) What is the source of cash for distributions to owners? (5) How is the increase in investing activities financed? (6) What is the source of cash for new property, plant and equipment ? (7) Why is cash flow from operations different from profit? (8) How is cash from financing used? To effectively answer these questions, it is important to separately analyze investing, financing, and operating activities.
To illustrate, consider data from three different companies as presented on this slide. These companies operate in the same industry and have been in business for several years. Each company generates an identical $15,000 net increase in cash, but its sources and uses of cash flows are very different. BMX’s operating activities provide net cash flows of $90,000, allowing it to purchase property, plant and equipment of $48,000 and repay $27,000 of its debt. ATV’s operating activities provide $40,000 of cash flows, limiting its purchase of property, plant and equipment to $25,000. Trex’s $15,000 net cash increase is due to selling property, plant and equipment and incurring additional debt. Its operating activities yield a net cash outflow of $24,000. Overall, analysis of these cash flows reveals that BMX is more capable of generating future cash flows than is ATV or Trex.

41. Cash Flow on Total Assets
Used, along with profit-based ratios, to assess company performance.
Cash flow on
total assets =
Net cash flow from operating activities
Average total assets
The Cash Flow on Total Assets ratio is used with profit-based ratios to help assess a company’s performance. It is calculated as Net cash flow from operating activities divided by Average total assets. This ratio reflects actual cash flows and is not affected by accounting profit recognition and measurement. It can help business decision makers estimate the amount and timing of cash flows when planning and analyzing operating activities.

42. Appendix 16A: Direct Method of Reporting Operating Cash Flows
Adjust income statement accounts related to operating activities for changes in their related statement of financial position accounts:
Appendix 16A: Direct Method of Reporting Operating Cash Flows
We compute cash flows from operating activities under the direct method by adjusting accrual-based income statement items to the cash basis. The usual approach is to adjust income statement accounts related to operating activities for changes in their related statement of financial position accounts as illustrated in the first graphic on this slide.
The framework for reporting cash receipts and cash payments for the operating section of the cash flow statement under the direct method is shown in the second graphic on this slide.

43. Appendix 16A: Direct Method of Reporting Operating Cash Flows
The graphic on this slide summarizes common adjustments for profit to yield net cash from (used in) operating activities under the direct method.

44. End of Chapter 16
End of Chapter 16.