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Copyright 2008, The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

Chapter Fifteen

How Well Am I Doing?Statement of Cash Flows

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15-2

Purpose of the Statement of Cash Flows

Are cash flowssufficient to

support ongoingoperations?

Can we meet

our obligationsto creditors?

Can we paydividends?

Why is there adifference

between netincome and net

cash flow?

Will the companyhave to borrowmoney to make

neededinvestments?

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15-3

Learning Objective 1

Classify changes in

noncash balancesheet accounts assources or uses of

cash.

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15-4

Cash

The term cashon the statement of cashflows refers broadly to both currency and

cash equivalents.

Cash

T-bills

Money MarketFunds

CommercialPaper

Currency andBank Accounts

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15-5

Net CashFlows for a

Period

Net Income

Dividends

Paid toStockholders

Changes in

NoncashAssets

Changes inLiabilities

Changes inCapital Stock

Constructing the Statement of Cash Flows Using Changesin Noncash Balance Sheet Accounts

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15-6


Sources

Net Income Always

Net Loss

Changes in noncash assets DecreasesChanges in liabilities* Increases

Changes in capital stock

accounts Increases

Dividends paid to stockholders

Total sources - Total uses = Net cash flow

* Contra asset accounts, such as the Accumulated Depreciation and

Amortization account, follow the rules for liabilities.

Decreases

Decreases

Always

Uses

Always

Increases

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Example: Inventory ispurchased on credit from

a supplier.

It is implied that cashwas used to acquire the

inventory.

Increases in noncash assetaccounts imply uses of cash.

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It is implied that an increasein a payable has the effect

of increasing cash availablefor other uses.

Increases in liabilityaccounts implysources of cash.

Example: Inventory ispurchased on credit from

a supplier.

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Decreases in noncash assetsaccounts imply sources of cash.

Example: Accounts receivabledecreases when a company

pays its bill.

When the customer pays thebill, the companys cash

increases.

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Decreases in liabilityaccountsimply uses of cash.

When the payment is made,cash decreases.

Example: A companypays a note payable held

by a creditor.

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15-11A Simplified Statement of Cash Flows: An

Example

Ed's Pizza HutComparative Balance Sheet Account Balances

3/31/2008 3/31/2007 Change

DR (CR) DR (CR) Incr. (Decr.)

Cash 71,000$ 90,000$ (19,000)$

Accounts Receivable 23,000 40,000 (17,000)Inventory 350,000 300,000 50,000

Land 68,000 100,000 (32,000)

Equipment 84,000 84,000 -

Accumulated Depr. (45,000) (39,000) 6,000

Accounts Payable (38,000) (27,000) 11,000

Salaries Payable (9,000) (14,000) (5,000)

Note Payable - Joe Doe - (50,000) (50,000)

Common Stock (500,000) (450,000) 50,000

Retained Earnings (4,000) (34,000) (30,000)

-$ -$

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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 thestockholders.

Ed issued $50,000 of common stock to settle thenote due to Joe Doe.

A Simplified Statement of Cash Flows: AnExample

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Example

Decrease in A/R 17,000$

Decrease in Land 32,000

Increase in A/P 11,000

Depreciation charges 6,000

Total sources of cash 66,000$

Ed's Pizza Hut

Sources of Cash

Here is a summary of the sourcesof cash for Eds Pizza Hut.

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Example

Here is a summary of the uses ofcash for Eds Pizza Hut.

Net loss 27,000$

Increase in Inventory 50,000

Increase in Salaries Payable 5,000

Dividends paid 3,000Total uses of cash 85,000$

Ed's Pizza Hut

Uses of Cash

The net cash flow for Eds Pizza Hut is ($19,000):

$66,000 in sources minus $85,000 in uses.

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A Simplified Statement of Cash Flows

Decrease in A/R 17,000$

Decrease in Land 32,000


Depreciation charges 6,000Total sources of cash 66,000$

Ed's Pizza HutSources of Cash

Net loss 27,000$Increase in Inventory 50,000

Increase in Salaries Payable 5,000

Dividends paid 3,000

Total uses of cash 85,000$

Ed's Pizza Hut

Uses of Cash

This simplifiedapproach does

not follow theformat requiredfor externalreporting

purposes. It isfor illustrativepurposes only.

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15-16


Classify transactions

as operating,investing, or

financing activities.

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15-17The Full-Fledged Statement of Cash Flows:

Operating Activities

Operating activities arethose activities that enterinto the determination of

net income.

Transactionsaffecting current

assets

Transactionsaffecting current

liabilities

Changes innoncurrent

balance sheet

accounts thatdirectly affect net

income

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15-18The Full-Fledged Statement of Cash Flows:

Investing Activities

Investing activities relate totransactions involving theacquiring or disposing of

noncurrent assets.

Acquiring orselling property,

plant andequipment

Acquiring orselling securities

Lending money toanother entity and

subsequentlycollecting on the

loan

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15-19The Full-Fledged Statement of Cash Flows:Financing Activities

Financing activities relate totransactions involving borrowing

from creditors or repayingcreditors and engaging in

transactions with thecompanys owners.

Issuing stock andpurchasing

treasury stock

Payment ofdividends (notethat interest on

debt is classifiedas an operating

activity)Issuing long-termdebt and

repayment of debt.

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15-20The Full-Fledged Statement of Cash Flows: An

Overview

O eratin Activities:

Net income

Changes in current assets

Changes in noncurrent assets that affect net income (e.g., depreciation)

Changes in current liabilities (except for debts to lenders and dividends

payable)Changes in noncurrent liabilities that affect net income

Investing Activities:

Changes in noncurrent assets that are not included in net income

Financing Activities:Changes in the current liabilities that are debts to lenders rather than

obligations to suppliers, employees, or the government

Changes in noncurrent liabilities that are not included in net income

Changes in capital stock accounts

Dividends

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15-21The Full-Fledged Statement of Cash Flows: An

Overview



Financing Activities

Reconciliation of thebeginning cash balance

with the ending cashbalance

Noncash Investingand Financing

Activities

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Net Income (Loss) $ XXX

Add: Decr. in Current Noncash Assets XXX

Incr. in Current Liabilities XXX

Depreciation Charges XXX

Losses XXX

Less: Incr. in Current Noncash Assets (XXX)

Decr. in Current Liabilities (XXX)

Gains (XXX)

Net Cash Flows from Operating Activities $ XXX

Includes those activities that enter into thedetermination of net income.

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Sources of cash are added to netincome and uses of cash are

subtracted from net income.Impact on Net Income

Sources Uses

Current

Noncash Assets

Current

Liabilities

Decreases

Increases

Increases

Decreases

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Net Income (Loss) $ XXXAdd: Decr. in Current Noncash Assets XXX



Losses XXXLess: Incr. in Current Noncash Assets (XXX)


Gains (XXX)



Impact on Net Income

Sources Uses

Current

Noncash Assets

Current

Liabilities

Decreases

Increases

Increases

Decreases

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15 25






Gains (XXX)



Impact on Net Income

Sources Uses

Current

Noncash Assets

Current

Liabilities

Decreases

Increases

Increases

Decreases

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Gains (XXX)


Depreciation and Amortization charges are added backto net income because they are decreases in noncash

assets.


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Gains (XXX)


Losses are addedback to net income.


Gains aresubtracted from net

income.

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Add: Proceeds from sale of land,buildings, equipment, or other

noncurrent assets $ XXX

Receipt of principal from

investments XXX

Less: Payments to acquire land,buildings, equipment, or other

noncurrent assets (XXX)

Payments to acquire

investments (XXX)Net Cash Flows from Investing Activities $ XXX

Includes transactions that involve theacquisition or disposal of noncurrent assets.


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Add: Proceeds from borrowings $ XXXProceeds from issuing capital

stock XXX

Proceeds from sale of bonds XXX

Less: Principal payments on

borrowed funds (XXX)Payments related to bond

maturities (XXX)

Dividend payments (XXX)

Net Cash Flows from Financing Activities $ XXX

Includes transactions involving receiptsfrom or payments to creditors and owners.

Financing Activities

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Other Issues: Gross or Net?

For investing andfinancing

activities, items on

the statement ofcash flows shouldbe presented in

gross amountsrather than in net

amounts.

Example:Assume Macys

purchases $50million in propertyduring the year and

sells other propertyfor $30 million.

Instead of showingthe net change of$20 million, thecompany mustreport the grossamounts of bothtransactions.

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Other Issues: Direct Method or Indirect Method?

Two Formats for Reporting Operating Activities

Reports thecash effects ofeach operating

activity

Starts withaccrual netincome and

converts tocash basis

Direct Method Indirect Method

No matter which format is used, the same amount of net

cash flows from operating activities is generated.

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Prepare a statementof cash flows using

the indirect method todetermine the net

cash provided byoperating activities.

15-33A Full-Fledged Statement of Cash Flows:

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A Full-Fledged Statement of Cash Flows:An Example

Lets revisit thecomparative

balance sheetaccount balancesfor Eds Pizza Hut.

Ed's Pizza Hut

Comparative Balance Sheet Account Balances

3/31/2008 3/31/2007 Change


Cash 71,000$ 90,000$ (19,000)$

Accounts Receivable 23,000 40,000 (17,000)

Inventory 350,000 300,000 50,000

Land 68,000 100,000 (32,000)

Equipment 84,000 84,000 -



Salaries Payable (9,000) (14,000) (5,000)Note Payable - Joe Doe - (50,000) (50,000)

Common Stock (500,000) (450,000) 50,000


-$ -$

15-34A Full-Fledged Statement of Cash Flows:

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A Full-Fledged Statement of Cash Flows:An Example

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 tothe stockholders.

Ed issued $50,000 of common stock to settle thenote due to Joe Doe.

Lets also refresh our memory regarding thefollowing additional information.

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ChangeSourceor Use?

Cash FlowEffect

Adjust-ments

AdjustedEffect

Classifi-cation

Accounts receivable

Inventory

Land

Equipment

Accumulated depreciation

Accounts payable

Salaries payable

Notes payable

Common stock

Net loss

Dividends

Total (net cash flow)

Retained earnings

Ed's Pizza Hut

Statement of Cash Flows Worksheet

Noncurrent liabilities

Stockholders' equity

Current liabilities

Assets (except cash and

Current assets

Noncurrent assets

Contra Assets, Liabilities,

Contra assets

Preparing the Statement of Cash Flows: Step 1

List each accountappearing on thecomparative balance

sheets except for cashand cash equivalents

and retained earnings.

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ChangeSourceor Use?

Cash FlowEffect

Adjust-ments

AdjustedEffect

Classifi-cation

Accounts receivable (17,000)$

Inventory 50,000

Land (32,000)

Equipment -

Accumulated depreciation 6,000

Accounts payable 11,000

Salaries payable (5,000)

Notes payable (50,000)

Common stock 50,000

Net loss (27,000)

Dividends 3,000

Ed's Pizza Hut




Current liabilities


Current assets

Noncurrent assets


Contra assets


Retained earnings


Compute the changefrom the beginning

balance to the endingbalance for each

account.

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ChangeSourceor Use?

Cash FlowEffect

Adjust-ments

AdjustedEffect

Classifi-cation

Accounts receivable (17,000)$ Source

Inventory 50,000 Use

Land (32,000) Source

Equipment -

Accumulated depreciation 6,000 Source

Accounts payable 11,000 Source

Salaries payable (5,000) Use

Notes payable (50,000) Use

Common stock 50,000 Source

Net loss (27,000) Use

Dividends 3,000 Use


Contra assets


Retained earnings

Ed's Pizza Hut




Current liabilities


Current assets

Noncurrent assets


Code each entry on

the worksheet as asource or use of

cash.

Recall that the transactioninvolving the Notes Payable and

Common Stock was noncash.{

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ChangeSourceor Use?

Cash FlowEffect

Adjust-ments

AdjustedEffect

Classifi-cation

Accounts receivable (17,000)$ Source 17,000$

Inventory 50,000 Use (50,000)

Land (32,000) Source 32,000

Equipment - -

Accumulated depreciation 6,000 Source 6,000

Accounts payable 11,000 Source 11,000

Salaries payable (5,000) Use (5,000)

Notes payable (50,000) Use (50,000)

Common stock 50,000 Source 50,000

Net loss (27,000) Use (27,000)

Dividends 3,000 Use (3,000)

(19,000)$Total (net cash flow)

Retained earnings

Ed's Pizza Hut




Current liabilities


Current assets

Noncurrent assets


Contra assets


Code sourcesof cash aspositive

numbers anduses of cashas negativenumbers.

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Change Sourceor Use? Cash FlowEffect Adjust-ments AdjustedEffect Classifi-cation

Accounts receivable (17,000)$ Source 17,000$ - 17,000$

Inventory 50,000 Use (50,000) - (50,000)

Land (32,000) Source 32,000 - 32,000

Equipment - - - -

Accumulated depreciation 6,000 Source 6,000 - 6,000

Accounts payable 11,000 Source 11,000 - 11,000

Salaries payable (5,000) Use (5,000) - (5,000)

Notes payable (50,000) Use (50,000) 50,000 -

Common stock 50,000 Source 50,000 (50,000) -

Net loss (27,000) Use (27,000) - (27,000)

Dividends 3,000 Use (3,000) - (3,000)

(19,000)$ -$ (19,000)$

Ed's Pizza Hut




Current liabilities


Current assets

Noncurrent assets


Contra assets


Retained earnings


Make anynecessary

adjustments,including

adjustments

for gains andlosses. Thenet effect ofthese should

equal zero.We need to make an adjustmentfor the noncash transaction

relating to Notes Payable andCommon Stock.

{

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Change Sourceor Use? Cash FlowEffect Adjust-ments AdjustedEffect Classifi-cation

Accounts receivable (17,000)$ Source 17,000$ - 17,000$ Operating

Inventory 50,000 Use (50,000) - (50,000) Operating

Land (32,000) Source 32,000 - 32,000 Investing

Equipment - - - -

Accumulated depreciation 6,000 Source 6,000 - 6,000 Operating

Accounts payable 11,000 Source 11,000 - 11,000 Operating

Salaries payable (5,000) Use (5,000) - (5,000) Operating

Notes payable (50,000) Use (50,000) 50,000 -

Common stock 50,000 Source 50,000 (50,000) -

Net loss (27,000) Use (27,000) - (27,000) Operating

Dividends 3,000 Use (3,000) - (3,000) Financing

(19,000)$ -$ (19,000)$


Contra assets


Retained earnings

Ed's Pizza Hut




Current liabilities


Current assets

Noncurrent assets Classify

eachentry as

operating,investing

orfinancingactivity.

15-41Preparing the Statement of Cash Flows:

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Preparing the Statement of Cash Flows:Step 7


Net Loss (27,000)$

Add: Decrease in A/R 17,000


Increase in Depr. Charges 6,000

Less: Increase in Inventory (50,000)

Decrease in Salaries Payable (5,000)

Net Cash Flow from Operations (48,000)


Proceeds from sale of Land 32,000Financing Activities

Dividends paid (3,000)

Net change in cash (19,000)

Ed's Pizza Hut

Statement of Cash FlowsFor the Period Ending 3/31/2008

Copy the data fromthe worksheet intothe Statement of

Cash Flows sectionby section.

15-42Preparing the Statement of Cash Flows:

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Preparing the Statement of Cash Flows:Step 8


Net Loss (27,000)$











Cash, beginning 90,000

Cash, ending 71,000$

Ed's Pizza Hut


Prepare a cashreconciliation at the

bottom of thestatement.

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E l I di M h d

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In addition, on the

face of the statementor in a supplementalschedule, disclose

the issuance of

$50,000 of stock to acreditor, a noncashfinancing activity.

Example Indirect Method


Net Loss (27,000)$













Ed's Pizza Hut


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I t t ti f th St t t f C h Fl

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Interpretation of the Statement of Cash Flows

Examine the operating activitiessection carefully.

Eds Pizza Hut generated a negative

cash flow from operations of $48,000.This is usually a sign of fundamentaldifficulties.

Ultimately, a positive cash flow is

necessary to avoid liquidating assets orborrowing money to pay for day-to-dayactivities.

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The Direct Method of

Determining the Net CashProvided by Operating

Activities

Appendix 15A

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L i Obj ti 4

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Use the direct method

to determine the netcash provided by

operating activities.

(Appendix 15A)

15-47 Computing Net Cash Provided by Operating

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Co put g et Cas o ded by Ope at gActivities

The direct method computesnet cash provided by operatingactivities by reconstructing the

income statement on a cashbasis from top to bottom.

Cash provided by operating activitiesunder the direct method will always

agree with the amount computed usingthe indirect method.

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Si il iti d Diff i H dli D t

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Similarities and Differences in Handling DataAdd (+) or

Deduct (-) to

Adjust to a

Cash Basis

Sales revenue (as reported)

Increases in accounts receivable -

Decreases in accounts receivable +

Cost of goods sold (as reported)

Increase in merchandise inventory +

Decrease in merchandise inventory -

Increase in accounts payable -Decrease in accounts payable +

Operating expenses (as reported)

Increase in prepaid expenses +

Decrease in prepaid expenses -Increase in accrued liabilities -

Decrease in accrued liabilities +Period's depreciation, depletion and

amortization charges

-

Income tax expense (as reported)

Increase in accrued taxes payable -

Decrease in accrued taxes payable +Increase in deferred income taxes -

Decrease in deferred income taxes +

Adjustments to a cash basis:

Revenue or Expense Item




Adjustments for accountsthat affect revenue are the

same in the direct and

indirect methods.

Adjustments for accountsthat affect expenses are

handled in opposite waysfor the direct and indirect

methods.

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Direct Method Gains and Losses

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Direct Method: Gains and Losses

Under the direct method,no adjustments for gainsand losses on the sale of

assets are needed.

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The Direct Method: An Example

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Lets revisit the

comparativebalance sheet

account balancesfor Eds Pizza Hut.

Ed's Pizza Hut

Comparative Balance Sheet Account Balances

3/31/2008 3/31/2007 Change


Cash 71,000$ 90,000$ (19,000)$

Accounts Receivable 23,000 40,000 (17,000)

Inventory 350,000 300,000 50,000Land 68,000 100,000 (32,000)

Equipment 84,000 84,000 -



Salaries Payable (9,000) (14,000) (5,000)Note Payable - Joe Doe - (50,000) (50,000)

Common Stock (500,000) (450,000) 50,000


-$ -$

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Sales 1,000,000$

Cost of goods sold 750,000

Gross margin 250,000

Operating expenses 277,000

Net loss (27,000)$

Ed's Pizza Hut

Income Statement

For the Year Ended 3/31/2008

Lets assume that Eds Pizza Hutprepared this income statement.

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Step 1: Translate sales revenue into cashcollected from customers.

Sales (as reported) 1,000,000$Add: Decrease in accounts receivable 17,000

Cash collected from customers 1,017,000$

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Step 2: Translate cost of goods sold intocash disbursements for purchases.

Cost of goods sold (as reported) 750,000$Add: Increase in inventory 50,000

Less: Increase in accounts payable (11,000)

Cash paid for purchases 789,000$

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Step 3: Translate operating expenses intocash paid for operating expenses.

Operating expenses (as reported) 277,000$Add: Decrease in salaries payable 5,000

Less: Increase in depreciation (6,000)

Cash paid for operating expenses 276,000$

No adjustment for income taxes isrequired because Eds Pizza Hut has a net

loss of $27,000.

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Cash received from customers 1,017,000$

Cash paid for purchases (789,000)Cash paid for operating expenses (276,000)



Proceeds from sale of land 32,000

Financing ActivitiesDividends paid (3,000)




Ed's Pizza HutStatement of Cash Flows

For the Period Ending 3/31/2008 Notice that thenet cash

provided byoperating

activities agreeswith that

computed usingthe indirect

method.

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End of Chapter 15

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End of Chapter 15

GNB_15_12e

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Transcript of GNB_15_12e