1. Prepared by: Gabriela H. Schneider, CMA Northern Alberta Institute of Technology INTERMEDIATE ACCOUNTING Seventh Canadian Edition KIESO, WEYGANDT, WARFIELD, YOUNG, WIECEK

2. C H A P T E R 23 Statement of Cash Flows

3. 1. Describe the purpose and uses of the statement of cash flows. 2. Define cash and cash equivalents. 3. Identify the major classifications of cash flows and explain the significance of each. 4. Contrast the direct and indirect methods of calculating net cash flow from operating activities. Learning Objectives

4. 5. Differentiate between net income and cash flows from operating activities. 6. Prepare a statement of cash flows. 7. Read and interpret a statement of cash flows. 8. Identify the financial reporting and disclosure requirements for the statement of cash flows. 9. Use a work sheet to prepare a statement of cash flows. (Appendix 23A) Learning Objectives

5. Statement of Cash Flows Introduction to the Statement Usefulness What is cash? Classification of cash flows Format of the statement Appendix A - Use of a Worksheet Preparing the worksheet Analysis of transactions Completing the work sheet Preparing a Statement of Cash Flows Sources of information and steps First illustration Second illustration Third illustration Interpreting the statement Reporting and Disclosure Issues Cash flow statement Cash flow per share Free cash flow Financial reporting examples Perspectives

6. Usefulness of the Statement of Cash Flows The information may help users assess the following:The information may help users assess the following: –The entity’s ability to generate future cash flows –The entity’s ability to pay dividends and meet obligations, and increase capacity –The reasons why net income and net cash flow from operating activities differ

7. Cash and Cash Equivalents Cash Cash on handCash on hand Demand depositsDemand deposits Cash Equivalents Investments that areInvestments that are –Short term, –Highly liquid, and –Easily converted to a known amount of cash –Subject to an insignificant risk of change in value All references to Cash include Cash Equivalents when discussing the Statement of Cash Flows

8. The Cash Flow Statement The cash flow statement provides information about:The cash flow statement provides information about: the cash receipts (cash inflows), andthe cash receipts (cash inflows), and uses of cash (cash outflows) during the yearuses of cash (cash outflows) during the year Inflows and outflows are reported for:Inflows and outflows are reported for: operating activitiesoperating activities investing activities, andinvesting activities, and financing activities during the yearfinancing activities during the year

9. Cash Flow Classifications 1.Operating Activities The cash flows resulting from the primary revenue generating activities of the business, such asThe cash flows resulting from the primary revenue generating activities of the business, such as Collections from customersCollections from customers Payments to suppliersPayments to suppliers Payments to employeesPayments to employees Payments to CRA for taxPayments to CRA for tax Cash flow provided by operating activities necessary for long term sustainability of the businessCash flow provided by operating activities necessary for long term sustainability of the business

10. Cash Flow Classifications 2.Investing Activities The acquisition and disposal of long term assets and long-term investmentsThe acquisition and disposal of long term assets and long-term investments Examples include:Examples include: Purchase/disposal of capital assetsPurchase/disposal of capital assets Acquiring an interest in another corporationAcquiring an interest in another corporation Cash flow generated by investing activities shows if the business is investing in its futureCash flow generated by investing activities shows if the business is investing in its future

11. Cash Flow Classifications 3.Financing Activities Changes in long-term debt or equity capitalChanges in long-term debt or equity capital Examples include:Examples include: Issuing debt, or repayment of debtIssuing debt, or repayment of debt Issuing new shares, or repurchase of currently outstanding sharesIssuing new shares, or repurchase of currently outstanding shares Provides information to assess potential for future claims to entity’s cash, extent of debt and increased interest chargesProvides information to assess potential for future claims to entity’s cash, extent of debt and increased interest charges

12. Exercise E23-1: Identify Transactions Identify each of the transactions as eitherIdentify each of the transactions as either –Operating activity –Investing activity –Financing activity –Significant noncash investing or financing activity –None of the above

13. Exercise E23-1: Identify Transactions a)Acquisition of raw materials Operating Activity (noncash) b)Declaration of dividends Financing Activity (noncash) c)Acquisition of a 4% interest in a company Investing Activity d)Contribution to employees’ pension plan Operating Activity e)Equipment leased through capital lease Significant noncash investing and financing activity f)Office space leased with an operating lease Operating Activity (noncash)

14. Exercise E23-1: Identify Transactions g)Paid interest on outstanding debt and amortized the discount Financing Activity h)Paid the supplier from transaction a) Operating Activity i)Paid for new fleet of vehicles Investing Activity j)Received dividend payment from c) Operating Activity k)Sold vehicles for an amount greater than book value Investing Activity l)Stock options granted to executives Noncash Operating and Financing Activity

15. Statement of Cash Flows: Concept Operatingactivities Investingactivities Financingactivities Inflows CashPool Operatingactivities Investingactivities Financingactivities Outflows

16. Significant Noncash Transactions Transactions that do not involve the direct receipt or disbursement of cash in the periodTransactions that do not involve the direct receipt or disbursement of cash in the period Examples:Examples: –Asset purchased, paid for by assuming debt, or issuance of shares –Conversion of debt to equity Noncash transactions are not reported on the Statement of Cash FlowsNoncash transactions are not reported on the Statement of Cash Flows

17. Preparing a Statement of Cash Flows Two methods of preparing the operating cash flow section of the Statement of Cash Flows:Two methods of preparing the operating cash flow section of the Statement of Cash Flows: –Indirect method –Direct method Indirect method derives operating cash flows from accrual basis income statementIndirect method derives operating cash flows from accrual basis income statement Direct method determines operating cash flows directly for each operating source or use of cashDirect method determines operating cash flows directly for each operating source or use of cash

18. Cash Flow from Operations: Indirect Method – Concept Net Income + - EarnedRevenues ExpensesIncurred Operating cash flow Eliminate non-cash revenues Eliminate non-cash charges

19. The Statement of Cash Flows: Indirect Method Accrual Basis Statements Cash Flow Statement Income Statement items and changes in Current Assets and Current Liabilities Operating activities: Adjust net income for accruals, non-cash charges and non- operating gains/losses Balance Sheet: Changes in Non-Current Assets Investing activities: Inflows from sale of assets and outflows for purchases of assets Balance Sheet: Changes in Non-Current Liabilities and Equity Financing activities: Inflows and outflows from loan and equity transactions

20. Cash Flows from Operations: Direct Method InflowsOutflows Received from customers for cash sales and on accountReceived from customers for cash sales and on account Cash dividends and interest receivedCash dividends and interest received To suppliers for cash purchases and payments on accountTo suppliers for cash purchases and payments on account To employees for salaries and wages paidTo employees for salaries and wages paid To government for taxes paidTo government for taxes paid To lenders for interest paidTo lenders for interest paid To others for expenses paidTo others for expenses paid

21. Format of the Statement of Cash Flows (Indirect Method) Cash flows from operating activities: Net Income (Loss) $ XXX Adjustments (List individual adjustments) $ XX Net cash flow from operating activities $ XXX Cash flows from investing activities: (List individual inflows and outflows) $ XX Net cash flow from investing activities $ XXX Cash flows from financing activities: (List individual inflows and outflows) $ XX Net cash flow from financing activities $ XXX Change in cash $ XXX

22. Format of the Statement of Cash Flows (Direct Method) Cash flows from operating activities: Cash receipts (individually): Inflows $ XXX Cash payments (separately): outflows ($ XXX) Net cash flow from operating activities $ XXX Cash flows from financing activities: (List individual inflows and outflows) $ XX Net cash flow from financing activities $ XXX Cash flows from investing activities: (List individual inflows and outflows) $ XX Net cash flow from investing activities $ XXX Change in cash $ XXX

23. Indirect Method: Example Tax Consultants Inc. began operations on January 1, 2005. The income statement and balance sheet for year 2005 follow. Income Statement Income Statement Revenues $ 125,000 Less: Operating expenses 85,000 Income before Tax 40,000 Less: Income Tax 6,000 Net Income $ 34,000 A dividend of $14,000 was declared during year.

24. Indirect Method: Example Balance Sheet Balance Sheet Dec 31, 2005 Jan 1, 2005 Assets: Cash$ 49,000$-0- Accounts Receivable 36,000 -0- Total $ 85,000$-0- Liabilities and Shareholders’ Equity: Accounts Payable$ 5,000$-0- Common Shares 60,000 -0- Retained Earnings 20,000 -0- Total $85,000$-0-

25. Operating Activities Net Income $34,000 Accounts Receivable +$ 36,000 Accounts Payable +$ 5,000 Accrual Basis Net Income $34,000 Less: Increase in A/R $ 36,000 Add: Increase in A/P $ 5,000 Cash Flow Changes between beginning and ending balances Operations: Net Inflow $3,000 See explanations next slide

26. Operating Activities Accounts Receivable Increased by $36,000 Cash collections are less than revenue recognized Reduce net income by $36,000 to derive cash flows from operations

27. Operating Activities Accounts Payable Increased by $5,000 Cash paid for purchases is less than expenses reported Increase net income by $5,000 to derive cash flows from Operations; net income for the year increases by $5,000

28. Investing and Financing Activities Accrual Basis Common Stock + $60,000 Retained Earnings + $20,000 Beg Bal:$ 0 Net Income: 34,000 less: Dividends (14,000) End Balance:$20,000 Cash Flow Financing Activities: Issue of Shares: $60,000 Dividends paid: ( 14,000) Inflow 46,000

29. Cash Flow Statement: (Indirect Method) - Summary Cash provided by operating activities: $ 3,000Cash provided by operating activities: $ 3,000 Cash used by investing activities: -0-Cash used by investing activities: -0- Cash provided by financing activities: 46,000Cash provided by financing activities: 46,000 Net inflow for the year $ 49,000Net inflow for the year $ 49,000 Beginning cash balance: $ -0-Beginning cash balance: $ -0- Cash, end of year $ 49,000Cash, end of year $ 49,000

30. Other Items Income statement gains and losses on disposal of long-term assets must be adjusted in determining cash from operations. Why?Income statement gains and losses on disposal of long-term assets must be adjusted in determining cash from operations. Why? These result from investing activities, not operating activities andThese result from investing activities, not operating activities and The amount of the cash flow is the proceeds on disposal, not the gain or lossThe amount of the cash flow is the proceeds on disposal, not the gain or loss

31. Other Items Income statement gains and losses on redemption of long-term debts must be adjusted in determining cash from operations. Why?Income statement gains and losses on redemption of long-term debts must be adjusted in determining cash from operations. Why? These result from financing activities, not operating activities andThese result from financing activities, not operating activities and The amount of the cash flow is the amount paid to redeem the debt, not the gain or lossThe amount of the cash flow is the amount paid to redeem the debt, not the gain or loss

32. Exercise E23-6: Cash Flows from Operating Activities - Indirect Method Using the Income Statement and Additional Information providedUsing the Income Statement and Additional Information provided Prepare the Operating Activities section of the Statement of Cash FlowsPrepare the Operating Activities section of the Statement of Cash Flows Year ended December 31, 2005Year ended December 31, 2005 Solution followsSolution follows

33. Exercise E23-6: Cash Flows from Operating Activities - Indirect Method Net Income $1,050,000 Non-Cash Items and Non-Cash Items and Changes in Working Capital: Changes in Working Capital: Increase in A/R Increase in A/R$(360,000) Decrease in Inventory Decrease in Inventory300,000 Increase in Prepaids Increase in Prepaids(170,000) Decrease in A/P Decrease in A/P(275,000) Increase in Accrued Increase in Accrued10,000 Amortization Expense Amortization Expense60,000(435,000) Cash Flow from Operating Activities Cash Flow from Operating Activities$615,000

34. Direct Method: Concept Cash Receipts Collections from customers From receipts of interest and dividends less Cash Payments To suppliers To employees For operating exp For interest For taxes equals Cashflowfromoperations

35. Cash From Operations: Direct Method Cash receipts from customers: = Revenue from credit sales – Increase in A/R balances = $125,000 – $36,000 = $89,000 Cash payments to suppliers: = cost of goods sold = $85,000 – $5,000 = $80,000 Refer to Tax Consultant Inc. the data for the indirect method.

36. Direct Method: Operating Activities Operating Activities: Cash receipts from customers $ 89000 Cash receipts from customers $ 89000 Cash paid to suppliers (80,000) Cash paid to suppliers (80,000) Cash paid for income taxes (6,000) Cash paid for income taxes (6,000) Net cash inflow $ 3,000 Net cash inflow $ 3,000

37. Exercise E23-5: Cash Flows from Operating Activities - Direct Method Using the Income Statement and Additional Information providedUsing the Income Statement and Additional Information provided Prepare the Operating Activities section of the Statement of Cash FlowsPrepare the Operating Activities section of the Statement of Cash Flows Year ended December 31, 2005Year ended December 31, 2005 Solution followsSolution follows

38. Exercise E23-6: Cash Flows from Operating Activities - Direct Method Cash Flow from Operating Activities: Cash receipts from customers (1)$6,540,000 Cash payments to suppliers for goods and services (2)(5,130,000) for goods and services (2)(5,130,000) Cash payments to and on behalf of employees (3) (795,000) of employees (3) (795,000) Cash provided by Operating Activities $ 615,000

39. Calculations (1) 6,900,000 – 360,000 = 6,540,000 (2) 4,700,000 + 450,000 + 700,000 - 300,000 (inv.) + 170,000 (ppd.) + 275,000 (A/P) – 60,000 (amort.) - (280,000 + 525,000) (salaries) = 5,130,000 (3) 280,000 + 525,000 – 10,000 = 795,000

40. Special Items: Amortization Given: 2005 2004 2005 2004 Property, plant, and equipment $277,000 $247,000 Accumulated amortization (178,000) ( 167,000) Other information: Amortization expense$ 33,000 Gain on sale of equipment$ 14,500 During 2005, equipment costing $45,000 was sold for cash Present relevant T- accounts and cash flow information.

41. Special Items: Amortization - Steps Prepare the T-Account for accumulated amortization and determine the accumulated amortization on asset soldPrepare the T-Account for accumulated amortization and determine the accumulated amortization on asset sold Determine cash from sale of equipmentDetermine cash from sale of equipment Determine any purchases of plant and equipment (at cost)Determine any purchases of plant and equipment (at cost) Identify the inflows and outflows affecting the operating and investing sectionsIdentify the inflows and outflows affecting the operating and investing sections

42. Special Items: Amortization Accum. amort. (beg): $167,000 Plus: amortization expense $ 33,000 less: amortization on equipment sold (?) $ 22,000 Accum. amort. (ending):$178,000 Accumulated Amortization 1 Equipment sold (cost): $45,000 Less: Accum. amort. on equipment 22,000 Book value of equipment sold 23,000 Add: Gain on sale 14,500 Cash from sale of equipment $37,500 Equipment Sold 2 Beginning balance:$247,000 Add: Purchases (?)$ 75,000 Less: Equipment Sold$ 45,000 Ending balance: $277,000 Prop., Plant, & Equipment 3 Operating Activities: Amortization – Adjust. $ 33,000 Gain on sale ($14,500) Investing Activities: Sale of equipment - inflow $37,500 Asset purchases - outflow ($75,000) Cash Flow Statement 4

43. Reporting Significant Non-Cash Transactions Transactions not involving cash inflows or cash outflows are non-cash transactionsTransactions not involving cash inflows or cash outflows are non-cash transactions They are not reported in the body of the cash flow statementThey are not reported in the body of the cash flow statement If material, they are reported as notes to the statement or in a supplementary schedule to the financial statementsIf material, they are reported as notes to the statement or in a supplementary schedule to the financial statements Example: issue of bonds (payable) for the purchase of landExample: issue of bonds (payable) for the purchase of land

44. Reporting and Disclosure Issues CICA Handbook, Section 1540 requires the following disclosure: 1.Pre-tax cash flows from extraordinary items 2.Cash flow for interest and dividend payments 3.Income tax cash flows 4.Business combination and business unit/segment disposal cash flows 5.Policy for determining cash and cash equivalents, and its components

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