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Transcript of CashFlow With Solutions

The Statement of Cash Flows (complete with solutions)

Acct 592 Spring 2005

The Statement of Cash Flows

Purpose of a statement of cash flows:To provide information about the cash inflows and outflows of an entity during a period.

To summarize the operating, investing, and financing activities of the business.

The cash flow statement helps users to assess a companys liquidity, financial flexibility, operating capabilities, and risk.

The statement of cash flows is useful because it provides answers to the following important questions:

Where did cash come from?

What was cash used for?

What was the change in the cash balance?

Specifically, the information in a statement of cash flows, if used with information in the other financial statements, helps external users to assess:

1.A companys ability to generate positive future net cash flows,

2.A companys ability to meet its obligations and pay dividends,

3.A companys need for external financing,

4.The reasons for differences between a companys net income and associated cash receipts and payments, and

5.Both the cash and noncash aspects of a companys financing and investing transactions.

What can we learn from SCF that is not already available in the other financial statements?

It provides answers to important questions like:

Where did cash come from?

What was cash used for?

What was the change in the cash balance?Couldnt we just look the balance sheet?

The change in cash could be determined, but the statement of cash flows provides detailed information about a companys cash receipts and cash payments during the period.

Many things you want to know about a company is summarized in this one statement

Operating, financing and investing cash flows

Net income does not always tell the whole story about operating performance.

A statement of cash flows is an excellent forecasting tool.Review of terms

Cash and cash equivalents

It is a short-term, highly liquid investment.It must be readily convertible to cash and it must be so near to maturity that there is insignificant risks of changes in value due to changes in interest rate.Noncash revenues and expenses

Net income includes items that were neither cash inflow nor cash outflows:

Depreciation expense

Accretion expense on asset retirement obligation

Amortization of intangibles

Impairment loss on goodwill and intangibles

Earnings of affiliated companies accounted for using the equity method

Impairment losses on other noncurrent assets

Compensation expense related to stock options

Net income also includes gains and losses from investing and financing activitiesGain cash received (unless carrying value was zero)Even when there is a loss, cash might have been receivedNet income must be adjusted for these items to get the cash provided by operations part of the reconciling schedule or indirect method

For other items, there are revenues/expenses as well as cash flows but the amounts are different:

Bond interest expense bond interest paid (if bonds were sold at premium or discount)

Sales were not all collected in cash (bad debts, other changes in Accounts Receivable)Purchases were not necessarily paid for during period (change in Accounts Payable)

Income tax expense income taxes paid due to deferred tax assets/liabilities as well as income taxes refunds receivable or unpaid taxes owed

Company, Inc.Statement of Cash Flows

For the year ended December 31, 199X

Cash Flows from Operating Activities

Cash received from customers(Cash received as interest income *

(Cash received as dividend income

(Cash paid for cost of goods sold *

(Cash paid for selling expenses

(Cash paid for general & administrative expenses

Cash paid for interest (including interest on capital leases)

Cash paid for income taxes

Cash that would have been paid for taxes except for excess tax deduction related to stock based compensation

Net cash provided by (or used by) operating activities

Cash Flows from Investing Activities

Cash received from sale of property, plant, & equipment

Cash received from sale of investments

Cash received from repayment of note receivables

Cash paid to acquire property, plant, and equipment

Cash paid to acquire investments

Cash paid out as a loan

Net cash provided by (or used by) investing activities

Cash Flows from Financing Activities

Cash received as proceeds from issuance of debt

Cash received as proceeds from issuance of stock

Cash received as proceeds from reissuance of treasury stock

Cash paid to repay debt (principal payment)

Cash paid on principal related to capital leases

Cash paid to reacquire stock (purchase treasury stock)

Cash paid as dividends

Cash retained due to excess tax deduction related to stock options

Net cash provided by (or used by) financing activities

Net increase (decrease) in cash

Beginning cash and cash equivalents balance

=Ending cash and cash equivalents balance

Schedule of Noncash Investing and Financing ActivitiesAssets for Liabilities &/or EquityLiabilities &/or Equity for AssetsLiabilities for Equity and Equity for LiabilitiesCapital lease (acquisition of asset and obligation for lessee)

A reconciliation of net income to cash provided by operations

*Brackets indicate items that are normally combined

Operating Activities

(Usually associated with working capital accounts like Accounts receivable, inventory, salaries payable, etc.)

Inflows:

From sale of goods and services

From receiving dividends investments

From receiving interest from investments or loans

From sale of trading securities

From reduced income taxes due to excess tax deduction related to stock options

Outflows:

To suppliers for inventory and other materials

To employees for services

To other entities for services (insurance, etc.)

To government for taxes

To lenders for interest

To purchase trading securities

Interest expense is an operating item! Investment earnings (dividends & interest) is an operating item! Buying and selling trading securities are operating activities! These things may not make sense to you so memorize.

Investing Activities

(Usually associated with long-term assets)

Inflows:

From sale of property, plant and equipment

From sale of debt or equity investments of other entities*

From collections of principal on loans to other entities

Outflows:

To purchase property, plant and equipment

To purchase debt or equity securities of other entities

To make loans to other entities

*except investments classified as trading securities which are included in operating activities

Financing Activities

(Usually associated with long-term liability and equity items)

Inflows:

From issuance of debt (bonds and notes)

From issuance of equity securities

Common stockPreferred stockRe-issuance of treasury stock

Outflows:

To stockholders as dividends

To repay or retire long-term debt, including capital leases for lessee (interest on leases is classified as operating)

To reacquire capital stock (treasury stock)

An anomaly on SCF

Dividends are paid to stockholders and interest is paid to bondholders.

Dividends paid are shown as outflows under financing activities

However, FASB defined interest expense to be an operating activity

Interest & dividend revenue are defined to be operating activities, too.

Direct versus Indirect PresentationsFASB Statement No. 95 allows two ways to calculate and report a companys net cash flow from operating activities on its statement of cash flows.

The Direct Method

Under the direct method, operating cash outflows are deducted from operating cash inflows to determine the net cash flow from operating activities.

If you choose the direct method, a reconciliation of cash provided by operations to net income is a required disclosure.

This is the same schedule that appears in a statement prepared using the indirect method

The required information items on a direct method statement of cash flow (per FASB)

Operating Inflows

Cash collected from customers (including lessees, tenants, licensees, and the like)

Interest and dividends received

Other operating cash receipts, if any

Operating outflows

Cash paid to employees and other suppliers of goods or services (including insurance, advertising and the like)

Interest paid

Income taxes paid

Other operating cash payments, if any

The Indirect Method

Under the indirect method, net income is adjusted for noncash items related to operations to compute the net cash flow from operating activities.

If you choose to use the indirect method, you must also disclose interest paid and income taxes paid during the year.

Other disclosures

Under both methods (direct & indirect), you must disclose noncash financing and investing activities

This can be on face of the statement or in the notes to the financial statements.

Examples:

Trade common stock for land

Convertible bonds converted to common stock

Noncash Items

Some financi