Download Statement of Cash Flows Revisited

Statement of
Cash Flows
Revisited
21
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
21-2
Learning Objectives
Explain the usefulness of the statement of
cash flows.
21-3
CASH INFLOWS
Operating Activities
Cash received
from revenues
Investing Activities
Sale of operational assets
Sale of investments
Collections of loans
Financing Activities
Issuance of stock
Issuance of bonds
and notes
Business
Cash paid for
expenses
Purchase of operational
assets
Purchase of investments
Loans to others
CASH OUTFLOWS
Payment of dividends
Repurchase of stock
Repayment of debt
21-4
Role of the Statement of Cash Flows
The Statement helps users assess . . .




a firm’s ability to generate cash.
a firm’s ability to meet its obligations.
the reasons for differences between income
and associated cash flows.
the effect of cash and noncash investing and
financing activities on a firm’s financial
position.
21-5
Role of the Statement of Cash Flows
Lists inflows and outflows
of cash and cash
equivalents by category
Explains the change in cash
during the period
Required by SFAS No. 95
21-6
Evolution of the Statement of Cash Flows
Early efforts to instill the standard of accrual
accounting internationally suppressed the
widespread practice of cash flow reporting.
The statement of changes
in financial position was the
predecessor to the
statement of cash flows.
The increasingly widespread acceptance of cash flow
reporting in the 1980’s, coupled with a recommendation in
1984 of FASB Concept Statement 5 that a full set of financial
statements show cash flows during the period, virtually
assured the eventual requirement of a statement of cash
flows.
21-7
Learning Objectives
Define cash equivalents.
21-8
Cash and Cash Equivalents
Resources
immediately
available to
pay
obligations.



Short-term, highly liquid
investments.
Readily convertible into
known, fixed amounts of cash.
So near maturity that there is
insignificant risk of market
value fluctuation from interest
rate changes.
Primary Elements of the Statement of Cash
Flows (SCF)
21-9
Operating Activities
Investing Activities
Financing Activities
Reconciliation of the Net
Increase or Decrease in
Cash with the Change in the
Balance of the Cash
Account
Noncash Investing
and Financing
Activities
Primary Elements of the Statement of Cash
Flows (SCF)
Operating
Activities
Reports the cash effects of the
elements of net income.
Investing
Activities
Reports the cash effects of the
acquisition and disposition of assets
(other than inventory and cash
equivalents).
Financing
Activities
Reports the cash effects of the sale
or repurchase of shares, the
issuance or repayment of debt
securities, and the payment of cash
dividends.
21-10
21-11
Learning Objectives
Determine cash flows from operating activities
by the direct method.
Determine cash flows from operating activities
by the indirect method.
21-12
Cash Flows from Operating Activities
Inflows from:

Sales to customers.
 Interest and dividends
received.
+
Outflows to:




Purchase of inventory.
Salaries, wages, and other
operating expenses.
Interest on debt.
Income taxes.
_
Cash
Flows
from
Operating
Activities
Direct Method or Indirect Method of Reporting
Cash Flows from Operating Activities
21-13
Two Formats for Reporting Operating Activities
Direct Method
Indirect Method
Reports the cash
effects of each
operating activity
Starts with
accrual net
income and
converts to cash
basis
Note that no matter which format is used, the same
amount of net cash flows operating activities is generated.
Direct Method or Indirect Method of Reporting
Cash Flows from Operating Activities
Cash Flows from Operating Activities--Direct Method
Cash Inflows:
From customers
$
98
From investment revenue
3
Cash Outflows:
To suppliers of goods
(50)
To employees
(11)
To bondholders
(3)
For insurance expense
(4)
For income taxes
(11)
Net cash flows from operating activities
$
22
The net cash increase or
decrease from operating
activities is derived indirectly
by starting with reported net
income on an accrual basis
and working backwards to
convert that amount to a cash
basis.
21-14
The cash effect of each
operating activity is
reported directly on
the statement of cash
flows.
Cash Flows from Operating Activities--Indirect Method
Net Income
$
12
Adjustments for noncash effects:
Increase in accounts receivable
(2)
Gain on sale of land
(8)
Decrease in inventory
4
Increase in accounts payable
6
Increase in salaries payable
2
Depreciation expense
3
Discount on bonds payable
2
Decrease in prepaid insurance
3
Loss on sale of equipment
2
Decrease in income tax payable
(2)
Net cash flows from operating activities
$
22
21-15
Learning Objectives
Identify transactions that are classified as
investing activities.
21-16
Cash Flows from Investing Activities
Inflows from:



Sale of long-term assets used in
the business.
Sale of investment securities
(stocks and bonds).
Collection of nontrade
receivables.
+
Outflows to:

Purchase of long-term assets
used in the business.
 Purchase of investment
securities (stocks and bonds).
 Loans to other entities.
_
Cash
Flows
from
Investing
Activities
21-17
Learning Objectives
Identify transactions that are classified as
financing activities.
21-18
Cash Flows from Financing Activities
Inflows from:


Sale of shares to owners.
Borrowing from creditors
through notes, loans,
mortgages, and bonds.
+
Outflows to:



Owners in the form of dividends
or other distributions.
Owners for the reacquisition of
shares previously sold.
Creditors as repayment of the
principal amounts of debt.
_
Cash
Flows
from
Financing
Activities
21-19
Reconciliation with Change in Cash Balance
The net amount of cash inflows and
outflows reconciles the change in the
company’s beginning and ending cash
balances.
For example, assume the net increase in cash is $9
million and the Cash beginning balance is $20
million. The cash reconciliation would be as
follows:
Net increase in Cash
Cash balance, January 1
Cash balance, December 31
$ 9,000,000
20,000,000
$ 29,000,000
21-20
Learning Objectives
Identify transactions that represent noncash
investing and financing activities.
21-21
Noncash Investing and Financing Activities
Significant investing and financing
transactions not involving cash also are
reported in the Statement of Cash Flows.
1. Acquiring an asset by incurring a debt payable
to the seller.
2. Acquiring an asset by entering into a capital
lease.
3. Converting debt into common stock or other
equity securities.
4. Exchanging noncash assets or liabilities for
other noncash assets or liabilities.
21-22
Learning Objectives
Prepare a statement of cash flows with the aid
of a spreadsheet or T-accounts.
21-23
Using a Spreadsheet
Reconstructing the events and transactions that
occurred during the period helps identify the
operating, investing and financing activities to be
reported.
A spreadsheet can be used to ensure that
no reportable activities are inadvertently
overlooked.
Let’s see how to use a spreadsheet to prepare a
Statement of Cash Flows on the next few slides.
UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
Dec. 31,
2005
Debits
Credits
2006
Balance Sheet
Assets:
Cash
Accounts receivable
Short-term investments
Inventory
Prepaid insurance
Land
Buildings and equipment
Less: Accumulated depreciation
20
30
50
6
60
75
(20)
221
29
32
12
46
3
80
81
(16)
267
Liabilities:
Accounts payable
Salaries payable
Income tax payable
Notes payable
Bonds payable
Less: Discount on bonds payable
20
1
8
50
(3)
26
3
6
20
35
(1)
Shareholders' Equity:
Common stock
100
130
Paid-in capital
20
29
Retained earnings
25
221
19
267
21-24
We begin by
entering the
beginning and
ending balances
for each account
on the
comparative
balance sheet and
income statement.
The changes
columns will be
used later to
explain the
increase or
decrease in each
account balance.
Changes
Dec. 31,
2005
Debits
21-25
Dec. 31,
Credits
2006
Income Statement
Revenues:
Sales revenue
Investment revenue
Gain on sale of land
100
3
8
Expenses:
Cost of good sold
Salaries expense
Depreciation expense
Bond interest expense
Insurance expense
Loss on sale of equipment
Income tax expense
Net income
(60)
(13)
(3)
(5)
(7)
(2)
(9)
12
The beginning balances for income
statement accounts are always zero.
Changes
Dec. 31,
2005
Statement of Cash Flows
Operating Activities:
Debits
21-26
Dec. 31,
Credits
2006
Next we
allocate space
on the
spreadsheet
for the
statement of
cash flows.
Investing Activities:
Financing Activities:
Spreadsheet entries duplicate the actual journal entries used
to record the transactions as they occurred during the year.
They are only entered on the spreadsheet and are not
recorded in the accounting records.
UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
Dec. 31,
2005
Debits
Credits
2006
Balance Sheet
Assets:
Cash
Accounts receivable
Short-term investments
Inventory
Prepaid insurance
Land
Buildings and equipment
Less: Accumulated depreciation
20
29
30
32
12
50
46
6
3
60
80
75
81
(20)
(16)
Changes
Dec. 221
31,
Dec. 267
31,
2005
Debits
Credits
2006
Liabilities:
Income
AccountsStatement
payable
20
26
Revenues:
Salaries payable
1
3
Sales
100
Incomerevenue
tax payable
8
6
Investment
revenue
3
Notes payable
20
Accounts
Receivable
Gain
sale of land
8
Bondsonpayable
50
35
Beg.
bal.
30
Less: Discount on bonds payable
(3)
(1)
Expenses:
Credit sales
100
?
Cash received
Cost
of good sold
(60)
Shareholders'
Equity:bal.
End.
32
Salaries
(13)
Commonexpense
stock
100
Depreciation expense
(3)
130
Bond
(5)
Paid-ininterest
capitalexpense
20
Insurance expense
(7)
29
Loss
on sale
of equipment
(2)
Retained
earnings
25
Income tax expense
(9)
19
Net income
12
221
267
21-27
Let’s start by
analyzing Sales
Revenue and its
related account
Accounts
Receivable by
looking at the
relationship in a Taccount format.
UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
Dec. 31,
2005
Debits
Credits
2006
Balance Sheet
Assets:
Cash
Accounts receivable
Short-term investments
Inventory
Prepaid insurance
Land
Buildings and equipment
Less: Accumulated depreciation
20
29
30
32
12
50
46
6
3
60
80
75
81
(20)
(16)
Changes
Dec. 221
31,
Dec. 267
31,
2005
Debits
Credits
2006
Liabilities:
Income
AccountsStatement
payable
20
26
Revenues:
Salaries payable
1
3
Sales
100
Incomerevenue
tax payable
8
6
Investment
revenue
3
Notes payable
20
Accounts
Receivable
Gain
sale of land
8
Bondsonpayable
50
35
Beg.
bal.
30
Less: Discount on bonds payable
(3)
(1)
Expenses:
Credit sales
100
98
Cash received
Cost
of good sold
(60)
Shareholders'
Equity:bal.
End.
32
Salaries
(13)
Commonexpense
stock
100
Depreciation expense
(3)
130
Bond
(5)
Paid-ininterest
capitalexpense
20
Insurance expense
(7)
29
Loss
on sale
of equipment
(2)
Retained
earnings
25
Income tax expense
(9)
19
Net income
12
221
267
21-28
We can see from
this analysis that
cash received from
customers must
have been $98
million.
Let’s see how to
post this entry to
the spreadsheet.
UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
Dec. 31,
2005
Debits
Credits
2006
Balance Sheet
Assets:
Cash
Accounts receivable
Short-term investments
Inventory
Prepaid insurance
Land
Buildings and equipment
Less: Accumulated depreciation
20
29
30 (1)
2
32
12
50
46
6
3
60
80
75
81
(20)
(16)
Changes
Dec. 221
31,
Dec. 267
31,
2005
Debits
Credits
2006
Liabilities:
Income
AccountsStatement
payable
20
26
Revenues:
Salaries payable
1
3
Sales
(1)
100
100
Incomerevenue
tax payable
8
6
Investment
revenue
3
Notes payable
20
Accounts
Receivable
Gain
sale of land
8
Bondsonpayable
50
35
Beg.
bal.
30
Less: Discount on bonds payable
(3)
(1)
Expenses:
Credit sales
100
98
Cash received
Cost
of good sold
(60)
Shareholders'
Equity:bal.
End.
32
Salaries
(13)
Commonexpense
stock
100
Depreciation expense
(3)
130
Bond
(5)
Paid-ininterest
capitalexpense
20
Insurance expense
(7)
29
Loss
on sale
of equipment
(2)
Retained
earnings
25
Income tax expense
(9)
19
Net income
12
221
267
21-29
First, $2 million is
debited to
Accounts
Receivable to
account for the
total change in the
account.
Then, $100 million
is credited to Sales
Revenue to
account for the
total change in the
account.
Changes
Dec. 31,
2005
Statement of Cash Flows
Operating Activities:
Cash Inflows:
From customers
Debits
(1)
21-30
Dec. 31,
Credits
2006
98
Investing Activities:
Accounts Receivable
Beg. bal.
30
Credit sales
100
98
Cash received
Financing Activities:
End. bal.
32
The final part
of this entry is
a $98 million
entry on the
Statement of
Cash Flows
under Cash
Inflows from
Customers.
Let’s skip
ahead and
look at the
analysis of
Short-term
Investments.
UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
Dec. 31,
2005
Debits
Credits
2006
Balance Sheet
Assets:
Cash
Accounts receivable
Short-term investments
Inventory
Prepaid insurance
Land
Buildings and equipment
Less: Accumulated depreciation
Liabilities:
Accounts payable
Salaries payable
Income tax payable
Notes payable
Bonds payable
Less: Discount on bonds payable
20
30 (1)
(12)
50
6
60
75
(20)
221
2
12
20
1
8
50
(3)
Short-term Investments
0100
Purchases
12
Paid-in capital
End. bal.
1220
29
32
12
46
3
80
81
(16)
267
26
3
6
20
35
(1)
21-31
The $12 million
increase in the
Short-term
Investments
account is due to
the purchase of
short-term
investments
during the year.
Shareholders' Equity:
Common stockBeg. bal.
Retained earnings
130
29
25
221
19
267
In the textbook, entry
number 12 illustrates the
analysis of the Shortterm Investment account.
Changes
Dec. 31,
2005
Statement of Cash Flows
Operating Activities:
Cash Inflows:
From customers
Dec. 31,
Credits
2006
Debits
(1)
21-32
The final part
of this entry is
a $12 million
entry on the
Statement of
Cash Flows
under
Investing
Activities.
98
Investing Activities:
Purchase of S-T investment
(12)
12
Financing Activities:
Short-term Investments
Beg. bal.
0
Purchases
12
End. bal.
12
Now, let’s look
at a noncash
transaction.
UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
Dec. 31,
2005
Debits
Credits
2006
Balance Sheet
Assets:
Cash
Accounts receivable
Short-term investments
Inventory
Prepaid insurance
Land
Buildings and equipment
Less: Accumulated depreciation
20
30 (1)
(12)
50
6
60
75 (14)
(20)
221
Liabilities:
Accounts payable
Salaries payable
Income tax payable
Notes payable
Bonds payable
Less: Discount on bonds payable
20
1
8
50
(3)
Shareholders' Equity:
Common stock
100
29
32
12
46
3
80
81
(16)
267
2
12
20 x
(14)
20 x
26
3
6
20
35
(1)
130
Paid-in capital
20
29
Retained earnings
25
221
x denotes a noncash transaction
19
267
21-33
In entry number
14, we find that a
note payable was
issued as payment
for a building.
Investing in a new
building is a
significant
investing activity
and financing the
acquisition with
long-term debt is a
significant
financing activity.
UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
Dec. 31,
2005
Debits
Credits
2006
Balance Sheet
Assets:
Cash
Accounts receivable
Short-term investments
Inventory
Prepaid insurance
Land
Buildings and equipment
Less: Accumulated depreciation
20
30
50
6
60
75
(20)
221
(19)
(1)
(12)
9
2
12
(13)
(14)
(9)
(4)
(8)
30 (3)
20 x (9)
7 (6)
4
3
10
14
3
(4)
(5)
6
2
(14)
20 x
(7)
2
(16)
(17)
(16)
(17)
10
20
3
6
13
5 (11)
12
Liabilities:
Accounts payable
Salaries payable
Income tax payable
Notes payable
Bonds payable
Less: Discount on bonds payable
20
1
8 (10)
50 (15)
(3)
Shareholders' Equity:
Common stock
100
Paid-in capital
Retained earnings
20
25 (16)
(18)
221
2
15
29
32
12
46
3
80
81
(16)
267
26
3
6
20
35
(1)
130
29
19
267
21-34
After entering all
the transactions,
this is what the
balance sheet
portion of the
spreadsheet looks
like.
Changes
Dec. 31,
2005
Expenses:
Cost of good sold
Salaries expense
Depreciation expense
Bond interest expense
Insurance expense
Loss on sale of equipment
Income tax expense
Net income
Dec. 31,
Credits
2006
Debits
Income Statement
Revenues:
Sales revenue
Investment revenue
Gain on sale of land
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
21-35
100
3
8
60
13
3
5
7
2
9
12
After entering all the transactions, this is
what the income statement portion of the
spreadsheet looks like.
100
3
8
(60)
(13)
(3)
(5)
(7)
(2)
(9)
12
Changes
Dec. 31,
2005
Statement of Cash Flows
Operating Activities:
Cash Inflows:
From customers
From investment revenue
Cash Outflows:
To suppliers of goods
To employees
To bondholders
For insurance expense
For income taxes
Net cash flows
Investing Activities:
Sale of land
Sale of equipment
Purchase of S-T investment
Purchase of land
Net cash flows
Financing Activities:
Retirement of bonds payable
Sale of common stock
Payment of cash dividends
Net cash flows
Net increase in cash
Totals
Dec. 31,
Credits
2006
Debits
(1)
(2)
21-36
98
3
(4)
(5)
(7)
(8)
(10)
50
11
3
4
11
22
(3)
(9)
18
5
(12)
(13)
12
30
(19)
(17)
(15)
15
(18)
5
26
(19)
376
9
376
6
9
After entering
all the
transactions,
this is what
the statement
of cash flows
portion of the
spreadsheet
looks like.
Here is the
Statement of
Cash Flows
prepared using
the direct
method.
UNITED BRANDS CORPORATION
Statement of Cash Flows
For the Year Ended December 31, 2006
($ in millions)
Cash Flows from Operating Activities:
Cash Inflows:
From customers
$
98
From investment revenue
3
Cash Outflows:
To suppliers of goods
(50)
To employees
(11)
To bondholders
(3)
For insurance expense
(4)
For income taxes
(11)
Net cash flows from operating activities
$
Cash Flows from Investing Activities:
Sale of land
(30)
Sale of equipment
(12)
Purchase of S-T investment
18
Purchase of land
5
Net cash flows from investing activities
Cash Flows from Financing Activities:
Retirement of bonds payable
26
Sale of common stock
(15)
Payment of cash dividends
(5)
Net cash flows from financing activities
Net increase in cash
Cash balance, January 1
Cash balance, December 31
$
21-37
22
(19)
6
9
20
29
21-38
Preparing an SCF: The Indirect Method
Cash Flows from Operating Activities--Indirect Method
and
Reconciliation of Net Income to
Net Cash Flows from Operating Activities
Net Income
$
12
Adjustments for noncash effects:
Increase in accounts receivable
(2)
Gain on sale of land
(8)
Decrease in inventory
4
Increase in accounts payable
6
Increase in salaries payable
2
Depreciation expense
3
Discount on bonds payable
2
Decrease in prepaid insurance
3
Loss on sale of equipment
2
Decrease in income tax payable
(2)
Net cash flows from operating activities
$
22
The indirect method
derives the net cash
increases or decreases
from operating activities
indirectly by starting with
reported net income and
“working backwards” to
convert that amount to a
cash basis.
Components of Net Income that Do Not
Increase or Decrease Cash
Depreciation
Expense
Loss on Sale
of Equipment
Gain on Sale
of Land
Adding these items back to net
income restores net income to
what it would have been had
depreciation and the loss not been
subtracted at all.
Subtracting the gain reverses the
effect of the gain having been
added to net income.
21-39
Components of Net Income that Do Increase
or Decrease Cash
21-40
For components of net income that increase or decrease
cash, but by an amount different from that reported on the
income statement, net income is adjusted for changes in
the balances of related balance sheet accounts to convert
the effects of those items to a cash basis.
Account
Type
Current
Assets
Current
Liabilities
Change in Account Balance During Year
Increase
Decrease
Subtract from net
Add to net income.
income.
Add to net income.
Subtract from net
income.
Note: Cash and cash equivalents, short-term investments in securities
available for sale, dividends payable, and short-term payables to financial
institutions are excluded from this category.
21-41
End of Chapter 21