1. The Statement of Cash Flows C hapter 22 COPYRIGHT © 2010 South-Western/Cengage Learning Intermediate Accounting 11th edition Nikolai Bazley Jones An electronic presentation By Norman Sunderman and Kenneth Buchanan Angelo State University

2. 2 Cash Flow Statement Cash is the lifeblood of any company and is critical to its success. Cash flow information is used by both managers and analysts to understand a company’s operations, assess its liquidity, gain insight into its ability to invest in new assets, and evaluate its financing decisions.

3. 3 1.A company’s ability to generate positive future net cash flows 2.A company’s ability to meet its obligations and pay dividends 3.A company’s need for external financing 4.The reasons for differences between a company’s net income and related cash receipts and payments 5.Both the cash and noncash aspects of a company’s financing and investing transactions during the accounting period Purpose of a Cash Flow Statement Helps users assess:

4. 4 Operating Activities Operating activities include transactions involving acquiring (purchasing or manufacturing), selling, and delivering goods for sale, as well as providing services. Inflows Cash receipts from: The sale of goods or services Collection of accounts receivable Collection of interest on loans Receipts of dividends on investments in equity securities Outflows Cash payments to: Suppliers for inventory Employees The government for taxes Lenders for interest Other suppliers for various expenses

5. 5 Investing Activities Investing activities include transactions involving acquiring and selling investments (both current and noncurrent), and lending money and collecting on the loans. Outflows Cash payments for: Acquiring property, plant, and equipment Purchasing investments in other companies Making loans to borrowers Inflows Cash receipts from: Sales of property, plant, and equipment Sales of investments in other companies Principal repayments of loans by borrowers

6. 6 Financing Activities Financing activities include transactions involving obtaining resources from owners and providing them with a return on, and of, their investment, as well as obtaining money and other resources from creditors and repaying the amounts borrowed. Inflows Cash receipts from: Issuing equity securities Issuing bonds Issuing mortgages Issuing notes Other short- or long-term borrowings Outflows Cash payments for: Dividends Repurchase of the company’s equity securities Repayments of amounts borrowed

7. 7 Cash and Cash Equivalents  The cash flow statement is prepared using cash and cash equivalents.  Cash equivalents –Treasury bills –Commercial paper –Money market funds

8. 8 Inflows of Cash 1.Decreases in Assets Other than Cash. The sale or other disposal of assets (other than cash) causes an increase because cash is received in exchange for the assets. 2.Increases in Liabilities. The issuance or other incurrence of liabilities causes an increase in cash because cash is received in exchange for the liabilities. 3.Increases in Stockholders’ Equity. Net income and additional investments by owners result in an inflow of cash.

9. 9 Outflows of Cash 1.Increases in Assets Other than Cash. The acquisition of assets (other than cash) causes an decrease because cash is paid in exchange for the assets. 2.Decreases in Liabilities. The payment of liabilities causes an decrease in cash because cash is paid to satisfy the liabilities. 3.Decreases in Stockholders’ Equity. The payment of dividends and the acquisition of treasury stock are two common transactions that result in stockholders’ equity and also cash.

10. 10 Classifications of Cash Flows A.Inflows of Cash. Increases in stockholders’ equity because of revenues, adjusted for changes in current assets and current liabilities that are related to the operating cycle, as well as changes in certain noncurrent assets and liabilities. B.Outflows of Cash. Decreases in stockholders’ equity because of expenses, adjusted for changes in current assets and current liabilities that are related to the operating cycle, as well as changes in certain noncurrent assets and liabilities. Operating Cash Flows ContinuedContinued

11. 11 Classifications of Cash Flows A.Inflows of Cash. Decreases in noncurrent assets and certain current assets. B.Outflows of Cash. Increases in noncurrent assets and certain current assets. A.Inflows of Cash. Increases in noncurrent liabilities, stockholders’ equity, and certain current liabilities. B.Outflows of Cash. Decreases in noncurrent liabilities, stockholders’ equity, and certain current liabilities. Investing Cash Flows Financing Cash Flows

12. 12 Noncash Simultaneous Investing/Financing Transactions  Acquisitions of assets by issuing equity securities  Acquisitions of assets by assuming liabilities such as capital lease obligations  Exchanges of debt securities for equity securities such as the conversion of bonds to common stock  Exchanges of assets for assets  Exchanges of liabilities for liabilities  Exchanges of equity securities such as the conversion of preferred stock to common stock Examples of changes in assets, liabilities, and stockholders’ equity that may be the result of investing and financing activities not affecting cash include:

13. 13 Net Cash Flow From Operating Activities GAAP allows two ways for a company to calculate and report its net cash flow from operating activities on its statement of cash flows.

14. 14 Net Cash Flow From Operating Activities Even though GAAP recommends the direct method, most companies (99%) use the indirect method. The first is called the direct method and the second is the indirect method.

15. 15 Direct Method Under the direct method, a company deducts its operating cash outflows from its operating cash inflows to determine its net cash flow from operating activities.

16. Inflows Collections from customers Collections of interest and dividends Other operating receipts Outflows Payments to suppliers Payments to employees Other operating payments Payments for interest Payments for income taxes Operating Activities—Direct Method 16

17. 17 Steps in Visual Inspection Method

18. 18 Step 1:Prepare the column headings on a worksheet. Then enter the account title Cash on the first line of the account titles column and list the beginning balance, ending balance, and the change in cash in the respective columns. Step 2:Enter the titles of all the remaining accounts from the balance sheets on the worksheet and list each beginning and ending account balance, and the change in the account balance directly below the cash information. Steps in the Worksheet (Spreadsheet) Method Steps 1–3: Setting up the worksheet ContinuedContinued

19. 19 Step 3:Directly below these accounts, add the following headings: A. Net Cash Flow From Operating Activities B. Cash Flows From Investing Activities C. Cash Flows From Financing Activities D. Investing and Financing Activities Not Affecting Cash Leave sufficient room below each heading so that each type of cash flow may be listed. Steps in the Worksheet (Spreadsheet) Method Steps 1–3: Setting up the worksheet ContinuedContinued

20. 20 Account for all the changes in the noncash accounts. Reconstruct the journal entries that caused the changes in the noncash accounts directly on the worksheet. Use these general rules: A. Start with net income. B. Account for the changes in the current assets (except cash) and current liability accounts. C. Account for the changes in the noncurrent accounts. Steps in the Worksheet (Spreadsheet) Method Step 4: Completion of the worksheet ContinuedContinued

21. 21 Make a final worksheet entry to record the net change in cash. The difference between the total cash inflows and outflows must be equal to the change in the Cash account. Prepare the statement of cash flows and accompanying schedule from the information developed on the worksheet. Steps in the Worksheet (Spreadsheet) Method Step 5: Record the net change in cash Step 6: Prepare the final worksheet entry

22. 22 Jones Company: Condensed Financial Information

23. 23 Changes in Land First, let’s reconstruct the original entry. During the year, the company sold land for $3,900 that cost $2,200. Worksheet Entries for Investing and Financing Activities

24. 24 Cash Flow Worksheet for 2010 (Jones Company)

25. 25 During the year, an earthquake (extraordinary event) occurred that destroyed a building owned by the company with a cost of $10,000 and a book value of $5,200. The company received after-tax cash proceeds of $3,100 from its insurance company. Worksheet Entries for Investing and Financing Activities Changes in Buildings (and Extraordinary Loss)

26. 26 Cash Flows From Investing Activities: Proceeds From Building Destroyed by Earthquake3,100 Accumulated Depreciation: Building4,800 Net Cash Flow From Operating Activities: Extraordinary Loss2,100 Buildings10,000 Worksheet Entries for Investing and Financing Activities Changes in Buildings (and Extraordinary Loss)

27. 27 Cash Flow Worksheet for 2010 (Jones Company)

28. 28 On January 1, the company issued bonds payable with a face value of $10,000, receiving proceeds of $9,000. The company amortized $100 of the discount during the year. Worksheet (Spreadsheet) Method Changes in Bonds Payable (and Related Discount)

29. 29 Cash Flow Worksheet for 2010 (Jones Company)

30. 30 Cash Flow Worksheet for 2010 (Jones Company) ContinuedContinued

31. 31 Cash Flow Worksheet for 2010 (Jones Company)

32. 32 Comprehensive Statement of Cash Flows

33. 33  IFRS require a company to include a cash flow statement as one of its basic financial statements.  Contrary to U.S. GAAP, IFRS do not require a company using the direct method to reconcile its net income to its operating cash flows.  IFRS require that the cash paid for any development costs that is capitalized as an intangible asset be reported as an investing cash outflow.  IFRS allow the reporting of dividends and interest paid as either an operating cash outflow or a financing cash outflow. IFRS vs. U.S. GAAP

34. 34  IFRS allow the reporting of dividends and interest received as either an operating cash inflow or an investing cash inflow.  IFRS allow the reporting of bank overdrafts as a financing cash flow.  IFRS allow the reporting of payments of income taxes identified with financing or investing transactions as financing or investing cash outflows.  IFRS allow the reporting of cash flow per share.  IFRS allow more freedom in netting cash receipts and payments. IFRS vs. U.S. GAAP

35. 35 Brandt Company sold equipment with a cost of $2,200 and accumulated depreciation of $700 for $2,100. Here is another situation that was not part of the chapter’s comprehensive problem. Sale of Depreciable Asset

36. 36 Sale of Depreciable Asset Cash Flows From Investing Activities: Proceeds From Sale of Equipment2,100 Accumulated Depreciation700 Equipment2,200 Net Cash Flow From Operating Activities: Gain on Sale of Equipment600

37. 37 Retirement of Bonds Assume Rosen Company paid $8,900 to retire bonds with a face value of $10,000 and a book value of $9,700.

38. 38 Bonds Payable10,000 Discount on Bonds Payable300 Cash8,900 Gain on Retirement of Bonds800 Retirement of Bonds  The cash paid of $8,900 is a cash payment for a financing activity.  The gain increased net income but there was no cash inflow from operating activities.  Therefore, the gain from net income is subtracted in the operating activities section.

39. 39 Interest Paid and Income Taxes Paid GAAP requires that a company using the indirect method of reporting its operating cash flows to also disclose its interest paid and income taxes paid.

40. 40 GAAP flexibility GAAP permits flexibility in reporting a company’s net cash from operating activities under the indirect method. That is, the company may show the reconciliation of net income to the net cash provided by (or used in) operating activities in a separate schedule accompanying its statement of cash flows. Flexibility in Reporting

41. 41 Partial Cash Investing and Financing Activities One method to disclose the effects of this transaction is to report the cash payment on its statement of cash flows and the noncash element on the accompanying schedule of investing and financing activities not affecting cash. Small Amount of Cash

42. 42 Partial Cash Investing and Financing Activities When the amount of cash is large in such an exchange, it may be more appropriate to report the items in the statement of cash flows. Several alternative disclosure formats are acceptable. Large Amount of Cash

43. 43 On November 28, 2010, the Dougherty Company purchased 1,000 shares of Bear Company common stock for $40,000 as a temporary investment in available-for-sale securities. On December 31, 2010, the fair value of the stock was $42 per share. 1.Reconstruct the two entries related to this investment. 2.Make the worksheet entry in journal format. 1.Reconstruct the two entries related to this investment. 2.Make the worksheet entry in journal format. Temporary and Long-Term Investments

44. 44 1.Temporary Investment in Available-for-Sale Securities40,000 Cash40,000 2.Temporary Investment in Available-for-Sale Securities40,000 Cash Flows From Investing Activities: Payment for Purchase of Temporary Investments40,000 Temporary and Long-Term Investments ContinuedContinued

45. 45 1.Allowance for Change in Value of Investment 2,000 Unrealized Increase in Value of Available- for-Sale Securities2,000 2.Allowance for Change in Value of Investment2,000 Unrealized Increase in Value of Available- for-Sale Securities2,000 Temporary and Long-Term Investments No change! The debit portion appears only in the upper part of the worksheet.

46. 46 1.Reconstruct the two entries related to this investment. 2.Make the worksheet entry in journal format. 1.Reconstruct the two entries related to this investment. 2.Make the worksheet entry in journal format. Temporary and Long-Term Investments On January 16, 2011, the Dougherty Company sold its investment in Bear Company stock for $45,000.

47. 47 1.Cash45,000 Temporary Investment in Available-for- Sale Securities40,000 Gain on Sale of Temporary Investment5,000 Temporary and Long-Term Investments 2.Cash Flows From Investing Activities: Proceeds From Sale of Temporary Investment45,000 Temporary Investment in Available-for- Sale Securities40,000 Net Cash Flow From Operating Activities: Gain on Sale of Temporary Investment5,000 ContinuedContinued

48. 48 1.Unrealized Increase in Value of Available-for- Sale Securities 2,000 Allowance for Change in Value of Investment2,000 Temporary and Long-Term Investments No change! 2.Unrealized Increase in Value of Available-for- Sale Securities 2,000 Allowance for Change in Value of Investment2,000

49. 49 Financial Institutions  GAAP is different for banks, brokers and dealers in securities, and other similar companies that hold loans for resale on a short- term basis or carry securities in a “trading account.”  The FASB requires that the cash flows from the purchases or sales of these trading accounts be reported in the operating activities section of the statement of cash flows.

50. 50 Financial Institutions Banks and other financial institutions are allowed to report the net cash flows for: 1.Deposits and withdrawals with other financial institutions 2.Time deposits accepted and repaid 3.Loans made to customers and principal collections of these loans

51. 51 Cash Dividends Declared  In some instances, a company will declare a cash dividend in the current year and pay the cash dividend in the next year. –In this case, the cash dividend is handled differently in preparing the worksheet for the statement of cash flows.  When a company follows a policy of declaring a dividend in one year and paying the dividend in the next year, its Dividends Payable account balance will change during each year.  A comparison of the change in the account balance to the dividends reported on the retained earnings statement will determine the worksheet entry necessary to account for the cash dividends.

52. 52 Cash Flows for Compensatory Share Option Plans  If compensation expense for compensatory share option plans is reported for financial purposes but not for income tax purposes, the result is a deferred tax asset for the future deductible amount.  Therefore, on the corporation's statement of cash flows, under the indirect method the increase in compensation expense must be added back to net income and the increase in the deferred tax asset must be subtracted from net income to help determine the net cash flow from operating activities.

53. Inflows Collections from customers Interest and dividends collected Other operating receipts Outflows Payments to suppliers Payments to employees Other operating payments Payments of interest Payments of income taxes Appendix: Operating Cash Flows 53

54. 54 Appendix: Major Adjustments to Convert Income Statement Amounts to Operating Cash Flows

55. 55 Appendix: Procedures for Statement Preparation Normally, under the direct method, a company obtains the information for its statement of cash flows from the following working papers:  Post-closing trial balance (or balance sheet) from previous period  Adjusted trial balance of current period

56. 56 Appendix: Visual Inspection Method  Make adjustments to the applicable revenues for the period to determine the amounts of collections from customers, interest and dividends collected, and other operating receipts.  Make adjustments to the applicable expenses for the period to determine the amounts of payments to suppliers, payments to employees, other operating payments, payments of interest, and payments of income taxes. Under the visual inspection method, the steps to complete the statement of cash flows using the direct method for operation activities are similar to those for the indirect method, except that the information for the cash flows from operating activities section is computed as follows:

57. 57 Appendix: Steps in Worksheet Approach for Direct Method

58. 58 Appendix: Steps in Worksheet Approach for Direct Method

59. 59 Appendix: Steps in Worksheet Approach for Direct Method

60. 60 Appendix: Steps in Worksheet Approach for Direct Method

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