Download vi presentation of the cash flow statement - lo 7

CHAPTER 13
REPORTING AND INTERPRETING CASH
FLOWS
CHAPTER OUTLINE
I
BUSINESS BACKGROUND
II
CLASSIFICATIONS OF THE CASH FLOWS (L.O. 1)
A. Cash Flows from Operating Activities
B. Cash Flows from Investing Activities
C. Cash Flows from Financing Activities
III
REPORTING AND INTERPRETING CASH FLOWS FROM
OPERATING ACTIVITIES (L.O. 2 & 3)
A. Noncurrent Accruals
B. Changes in Current Assets and Current Liabilities
C. A Comparison of the Direct and Indirect Methods
IV
REPORTING AND INTERPRETING CASH FLOWS FROM INVESTING
ACTIVITIES (L.O. 4 & 5)
V
REPORTING AND INTERPRETING CASH FLOWS FROM
FINANCING ACTIVITIES (L.O. 6)
VI
PRESENTATION OF THE CASH FLOW STATEMENT
A. Noncash Investing and Financing Activities
B. Supplemental Cash Flow Information
VII
EPILOGUE
VIII
CHAPTER SUPPLEMENTS
A. Adjustment for Gains and Losses
B. Spreadsheet Approach - - Cash flow statement: Indirect Method
© McGraw-Hill Ryerson Limited, 2003
13.1
CHAPTER LEARNING OBJECTIVES
1.
Classify cash flow statement items as part of net cash flows from operating, investing, and
financing activities.
2.
Report and interpret differences between net income and cash flows from operating
activities.
3.
Analyze and interpret the quality of income ratio.
4.
Report and interpret cash flows from investing activities.
5.
Analyze and interpret the capital acquisitions ratio.
6.
Report and interpret cash flows from financing activities.
7.
Explain the impact of noncash investing and financing activities.
CHAPTER SUMMARY
The text materials contain many useful exhibits for this chapter. In addition, other chapter
features useful in the teaching of this text are contained in this manual.
The cash flow statement is one of the required financial statements. Its primary purpose is to
provide cash flow information in a manner that maximizes its usefulness to investors, creditors, and
others in projecting future cash flows related to the enterprise.
The cash flow statement has three main sections: cash flows from operating activities which are
related to earning income from normal operations; cash flow from investing activities which are
related to the acquisition and sale of productive assets; and cash flows from financing activities
which are related to the sources of financing the enterprise. The net cash inflow or outflow for the
year is the same amount as the increase or decrease in cash and cash equivalents for the year.
Cash equivalents are highly liquid investments with original maturities of less than three months.
Two different methods for reporting cash flows from operating activities are permitted. They are
called the direct and indirect methods. Investing and financing activities are reported in exactly the
same manner under both methods. The direct method reports the gross cash flows for the main
classifications of revenues and expenses. In contrast, the indirect method reports operating
activities by showing a reconciliation of net income with net cash flows from operating activities.
The amount of net cash flow from operations reported is the same under both methods.
13.2
Cash Flow Statement
CHAPTER LECTURE NOTES
I
BUSINESS BACKGROUND
1. Net income on the income statement (IS) indicates that revenues exceeded costs and
expenses for the accounting period.
2. Net income does not pay bills. Cash pays bills. The cash flow statement (CFS) is an
indication of a company's ability to pay bills. It presents the sources of a company's cash
inflows and the uses of cash outflows. The statement highlights the internal generation
of cash. It also details investments and external financing. The CFS is an important
statement to use to predict the going concern ability (continuity) of a business. Both
managers and analysts are interested in the CFS for a business. It helps to assess the
"health" of a company in regard to expanding operations, replacing operational assets,
taking advantage of market opportunities, and paying dividends.
3. The CFS is designed to give managers and analysts information about operating,
investing, and financing activities.
II
CLASSIFICATIONS OF THE CASH FLOWS -L.O.1
A.
1. The CFS demonstrates how the beginning of the year cash balance became the end of
the year cash balance. Cash balance, in this instance, includes cash and cash
equivalents.
2. Cash equivalents are short-term, highly liquid investments. They possess two
characteristics:
a. Readily convertible to known amounts of cash by the holder.
b. So near their maturity that the risk of change in value (because of interest rates) is
insignificant. The "so near" characteristic considers maturities of less than three
months from the investor’s acquisition date.
Examples of cash equivalents include Treasury bills, money market funds, and
commercial paper.
3. There are three classifications of cash inflows and outflows presented on the CFS:
operating activities, investing activities, and financing activities.
Cash Flows from Operating Activities
1. The operating activities (operations) section of the CFS reports cash inflows and
outflows directly associated with income and expenses from normal operations reported
on the IS. This classification includes:
Inflows
Receipts from customers
Receipts of interest
Receipts of dividends
.
Outflows
Purchases of goods/services
Payments of interest
Payments to employees
Payments of income taxes
Payments of operating expenses
2. There are two alternative approaches for preparing the operating activities section of the
CFS.
a. The direct method reports the components of cash flows from operating activities as
gross receipts and gross payments. This method is recommended by the AcSB, but
it is not widely used in practice because managers say it is more costly (cost/benefit
constraint) to use than the indirect method. Cash receipts and cash expenditures
are used to compute cash inflows and cash outflows from operations. The
difference is called net cash inflow (outflow) from operating activities.
b. The indirect method adjusts net income (net loss) to derive net cash flows from
operating activities. It is widely used in practice. Adjustments are made to net
© McGraw-Hill Ryerson Limited, 2003
13.3
B.
income (including noncash items) to compute the net cash inflow (outflow) from
operating activities.
3. The operating activities section of the CFS describes cash flows related to the profit
making activities of a business. The IS presents net income on an accrual basis without
regard to when the related cash flows occur. The CFS, on the other hand, provides
information on a cash basis. Depreciation and amortization expense is a common
difference in NI on the IS and net cash flows from operating activities on the CFS.
Depreciation and amortization expense is deducted from revenues on the IS to arrive at
NI. However, depreciation and amortization expense does not require a cash outlay so it
is added back under the indirect method.
4. A company can report NI even when the cash account has decreased over the year. It
can report a net loss even when the cash account has increased over the year.
Cash Flows from Investing Activities
1. Cash flows from investing activities report cash inflows and outflows associated with the
acquisition and disposal of operational and investment assets.
Inflows
Sales of plant, property, & equipment
Sales of investments
Sales of intangibles
Collections of loans (N/R), except interest
C.
Outflows
Purchases of plant, property, &
equipment
Purchases of investments
Purchases of intangibles
Loans to other parties (N/R)
2. For cash flows from investing activities, analysis for changes in long-term asset accounts
is performed (plant, property, and equipment, for example).
3. The difference between cash inflows and cash outflows from this category is the net
cash inflow (outflow) from investing activities.
Cash Flows from Financing Activities
1. Cash flows from financing activities report cash inflows and outflows associated with
owners and creditors. This category relates to the external financing sources of a
business.
Inflows
Owners:
Sales of stock
Creditors: Borrowing money
Outflows
Owners: Repurchases of stock
Payments of dividends
Creditors: Payments of debt principal
2. For cash flows from financing activities, analysis for changes in liabilities and owners'
equity accounts is performed (N/P, R/E, and capital stock, for example).
3. The difference between cash inflows and cash outflows from this category is the net
cash inflow (outflow) from financing activities.
III
REPORTING AND INTERPRETING CASH FLOWS FROM
OPERATING ACTIVITIES - L.O. 2
1. Many analysts believe that the operating activities section of the CFS is the most
important part of the statement. It focuses attention on a company’s ability to internally
generate cash through operations. A company with increasing NI on the IS but
decreasing cash flows from operations on the CFS should serve as a warning signal of a
going concern issue. Most companies rely on at least some external financing. If the
operating activities cash flows are of concern, creditors and investors may not lend
money or invest money in that company.
13.4
Cash Flow Statement
2. There are two basic considerations for adjusting net income to net cash flows from
operations:
a. Noncash expenses and revenues do not affect cash flows.
b. Changes in current assets (except for short-term investments and cash itself) and
changes in current liabilities (except for the principal of debt to financial institutions
and current portions of principal on long-term debt) reflect timing differences
between net income and cash flows.
3. For cash flows from operating activities, analysis is performed for earnings related
accounts. This will include all IS accounts and those BS accounts that are related to the
IS items. These relationships are summarized as follows:
IS Account
Sales
CGS
Operating expenses
Depreciation expense
Amortization expense
A.
B.
Related BS Account
A/R
Inventory and A/P
Prepaid expenses and
accrued liabilities
Accumulated Depreciation
Accumulated Amortization
(or Intangible asset)
CFS Impact
Customer collections
Payments to suppliers
Payments for operating
expenses
No Cash Effect
No Cash Effect
Noncurrent Accruals
Some expenses presented on the accrual basis IS (matching principle) do not require
cash outlays during the accounting period. Following are examples of noncash
expenses:
Depreciation expense (the cash outlay occurred with the acquisition of the tangible
asset being depreciated).
Amortization expense (the cash outlay occurred with the acquisition of the
intangible asset being amortized).
Bad debt expense (there is no cash outlay for bad debts and cash was not
collected from the customer).
Changes in Current Assets and Current Liabilities
Computing the adjustments to net income to derive cash flows from operating activities
requires several considerations of current balance sheet accounts.
1. Decreases in current assets are added to NI while increases in current assets are
subtracted from NI.
a. Change in Accounts Receivable
The accrual sales presented on the IS often includes sales that have not yet
generated cash from customers. These noncash amounts cause changes in the A/R
account. If less cash is collected from customers than the revenue account reflects,
A/R will increase. This increase must be subtracted from NI to derive cash flows.
Conversely, if more cash is collected from customers than the revenue account
reflects, A/R will decrease. This decrease must be added to NI to derive cash flows.
If A/R (rent receivable, interest receivable, etc.) did not change, the revenues on the
IS were equivalent to cash inflows and no adjustment is needed.
b. Change in Inventory
The cost of goods sold (CGS) amount presented on the IS considers the beginning
and ending inventories in its computation. CGS is an accrual amount. In order to
consider the cash purchases of inventory, adjustments must be made. If inventory
increased from the beginning to the end of the period, the increase must be
subtracted from NI to derive cash flows. Conversely, if inventory decreased, the
decrease must be added to NI to derive cash flows.
© McGraw-Hill Ryerson Limited, 2003
13.5
c.
Change in Prepaid Expenses
The accrual of expenses presented on the IS does not necessarily coincide with the
cash payment for expense items. In order to consider the cash payments for
expenses, adjustments must be made. If prepaid expenses increased from the
beginning to the end of the period, the increase must be subtracted from NI to derive
cash flows. Conversely, if prepaids decreased, the decrease must be added to NI to
derive cash flows.
d. Changes in Other Current Assets and Other Assets
Some other current assets require inclusion, such as interest receivable or long-term
accounts receivable as they result from short term or current operating activities.
2. Increases in current liabilities are added to NI while decreases in current liabilities
are subtracted from NI.
a. Change in Accounts Payable
If accounts payable (A/P) increased from the beginning to the end of the accounting
period, cash paid to suppliers was less than the purchases account. The amount of
this increase must be added to NI to derive cash flows. Conversely, if the A/P
account decreased, cash paid to suppliers was more than the purchases account.
The amount of this decrease must be subtracted from NI to derive cash flows.
b. Change in Accrued Expenses
The accrual of expenses presented on the IS does not necessarily coincide with the
cash payments for expense items. In order to consider the cash payments for
expenses, adjustments must be made. If accrued expenses payable increased from
the beginning to the end of the period, the increase must be added to NI to derive
cash flows. Conversely, if accrued payables decreased, the decrease must be
subtracted from NI to derive cash flows.
3. In summary, current assets are the opposite of current liabilities. Therefore, their
treatment is opposite for making adjustments to NI on the IS to arrive at cash flows from
operating activities on the CFS.
1. Decreases in current assets are added to NI.
2. Decreases in current liabilities are subtracted from NI.
3. Increases in current assets are subtracted from NI.
4. Increases in current liabilities are added to NI.
5. Noncash expenses and losses are added to NI.
6. Noncash revenues and gains are subtracted from NI.
There are some additional issues to consider in terms of deferred taxes and consolidated
entities. These are usually covered in an advanced accounting course.
An income and an expense example applying the rules for the INDIRECT Method for cash flows
follows:
(Reconciliation approach to cash flows from operating activities). Start with net income
(an accrual amount) and make adjustments to end up with the cash flow amount.
Adjustments Needed to NI
Income:
Sales
Accounts Receivable
Unearned Fees (Deposits)
13.6
Income on IS
Current assets:
Increase
Decrease
Current liabilities:
Increase
Decrease
Already "in" NI
Less paid in
More paid in
+
More paid in
Less paid in
+
-
Cash Flow Statement
Expenses/Costs:
Rent Expense
Prepaid Rent
Expense on I/S
Already "out" of NI
Current assets:
Increase
More paid out
Decrease
Less paid out
+
Rent Payable
Current liabilities:
Increase
Less paid out
+
Decrease
More paid out
Other adjustments needed for the Indirect Method:
Depreciation expense (noncash)
+
Amortization expense (noncash)
+
* Loss on sale (take out the negative)
+
* Gain on sale (take out the positive)
* The entire sales proceeds will be presented in the investing activities
section of the CFS
C. Additional Issues in Interpreting Cash Flows from Operations
1. Gain or Loss on sale of property, plant and equipment need to be reversed to allow their
inclusion in the investment portion of the CFS
2. Future Income taxes are a result of different calculations for income tax using GAAP and
the tax laws. Any change must also be included to reflect the difference between the tax
liability recognized and the actual remittance to the government.
3. Equity in income or losses of unconsolidated affiliates affects the income reported when
using the equity method to account for investments but there are no cash affects and
hence these incomes or losses must be reversed to reflect the true cash flow.
The impact of currency fluctuations also are reported as profits or losses and may
require reversals if reported as such on the income statement.
D. A Comparison of the Direct and Indirect Methods
1. The only differences in presentations on the CFS are in the operating activities section of
the CFS.
a. The indirect method of presenting cash flows follows a reconciliation approach.
Adjustments are added to and subtracted from NI to derive "cash income".
b. The direct method presents gross cash inflows and gross cash outflows related to
operating activities. Unlike the indirect method, this method gives the statement
user a sense of the magnitude of dollars flowing in and out of the day-to-day
operations of the business.
2. The amount of "net" cash flow from operating activities is the same under either method.
It is just the presentation of the details that differs.
IV.
REPORTING AND INTERPRETING CASH FLOWS FROM
INVESTING ACTIVITIES - L.O. 4
1. The investing activities section of the CFS includes purchases (cash outflows) and sales
(cash inflows) of operational and investment assets.
2. Cash outflows relate to capital expenditures such as the purchase of plant, property, and
equipment. Purchases of intangibles and investments (assets not used in the operations
of the business) are also included in this category.
3. Cash inflows relate to the sales of these assets. Any gain or loss on the sale is removed
from the operating activities section so that the entire sales proceeds can be presented
in the Investing activities section.
4. Cash outflows for lending money with notes receivables (N/R) and cash inflows for
collecting principal payments or for sales of N/R are presented in this section. Any
interest receipts related to N/R are presented in the operating activities section of the
CFS.
© McGraw-Hill Ryerson Limited, 2003
13.7
V.
REPORTING AND INTERPRETING CASH FLOWS FROM
FINANCING ACTIVITIES - L.O. 6
1. The financing activities section of the CFS is associated with generating funds from
creditors and owners.
2. Cash outlays include repayments of debt principal to creditors (any interest paid is
presented under operating activities). Outlays of cash associated with owners include
dividend payments, purchases of treasury shares, and purchases of shares for
retirement.
3. Cash inflows include the proceeds of borrowing and the sale of stock (including the
resale of treasury shares).
VI
A.
B.
VII
PRESENTATION OF THE CASH FLOW STATEMENT - L.O. 7
1. Once the amounts of cash flows have been determined, the proper category for
reporting must be determined. After the amount and category are determined, the
preparation of the CFS is basically a formatting issue.
2. The heading should include the date "for the year ended ____." That is, the amounts
presented under operating, investing, and financing activities are inflows and outflows of
cash during the accounting period.
3. When the overall net increase (or decrease) in cash is determined, it should be added to
(or subtracted from) the beginning cash balance. The ending cash balance derived
should agree with the cash balance on the current BS.
Noncash Investing and Financing Activities
1. Certain transactions are important investing and financing activities, but they do not
affect cash flows during the accounting period. Often these events involve significant
amounts.
2. Noncash disclosure of investing and financing activities is required on a schedule or in
the notes to the financial statements. This disclosure helps statement users forecast the
impacts of future cash flows.
3. Examples of noncash items include the purchase of a building in exchange for common
stock, the retirement of bonds payable by issuing stock, and the purchase of equipment
by signing a N/P.
Supplemental Cash Flow Information
When the indirect method of presenting cash flows from operations is used, two figures
must be derived for presentation about the operating activities of a company. They are
interest PAID and income taxes PAID. If they are not included on the face of the CFS,
these amounts should be disclosed in the notes.
EPILOGUE
It should be noted that seasonal variations in many businesses and industries can cause
concerns in interim statements of cash flows. Seasonality needs to be factored in for
those companies when considering quarterly financial statement analysis.
VIII
A.
13.8
CHAPTER SUPPLEMENTS
Adjustment for Gains and Losses
Gains and losses from the sale of operational assets and investments are derived by
comparing the sales proceeds and the book value. If the sales proceeds exceed the
book value, a gain is reported on the IS. If the book value exceeds the sales proceeds,
a loss is reported on the IS. These gains and losses must be removed from the
operating activities section of the CFS because the gross sales proceeds are presented
Cash Flow Statement
B.
in the investing activities section of the CFS. This procedure avoids double counting on
the CFS. Gains are subtracted from NI as an adjustment while losses are added to NI
under the indirect method. These gains and losses are ignored in the operating
activities section when using the direct method.
Spreadsheet Approach - - Cash flow statement: Indirect Method
1. The preparation of the CFS can become complex for companies with extensive charts of
accounts. The spreadsheet approach utilizes a worksheet for a systematic way to
analyze, organize, and summarize data. Comparative balance sheet amounts are
needed.
2. The four money column worksheet is organized as follows:
a. On the far left at the top, each balance sheet account title is listed.
b. The first money column lists balance sheet account balances at the beginning of the
year.
c. The next two money columns are for the debit/credit analysis of changes in the
balance sheet accounts during the year.
d. The fourth (last) money column lists balance sheet account balances at the end of
the year.
e. On the far left at the bottom, each item that will be reported on the CFS is entered.
These items should be listed by category (operating, investing, and financing).
3. As the debit/credit entries for the BS accounts are made at the top of the worksheet,
offsetting debit/credit entries are made for CFS items at the bottom of the worksheet.
When all of the balance sheet items have been analyzed and footed across (reconciled),
the information at the bottom of the worksheet is accumulated for the CFS preparation.
4. The worksheet is an efficient tool for analysis of both cash and noncash events. It
provides assurance to the CFS preparer that all items (cash and noncash) have been
properly considered.
5. The IS and BS can be prepared directly from general ledger account balances. The CFS
requires further analytical procedures for its preparation. The worksheet (spreadsheet) is
helpful in that regard.
ADDITIONAL TEACHING NOTES
1.
Point out that the CFS can be a "going concern" indicator. A company must generate cash
from operations to survive. It cannot survive very long by paying bills from borrowed monies
and stock issues. A net cash outflow from operating activities could indicate that a company
is in trouble. Analysts are very interested in the CFS. This may be the first financial
statement they look at to get a feel for a company's health.
2.
You might define the CFS categories in the reverse order of presentation on the statement.
That is, financing deals with owners and lender principal amounts. Investing deals with
buying and selling operational and investment assets (plant and equipment, intangibles, and
investments). Operating is everything else.
3.
You may wish to allow some coverage of the direct method for operating activities since it is
better conceptually. The direct method gives a better sense of the magnitude of gross cash
inflows and outflows that a company manages.
4.
Point out that the cash receipts and cash disbursements journals are sources of information
when preparing the CFS on the direct method.
© McGraw-Hill Ryerson Limited, 2003
13.9
5.
Point out that noncash expenses such as depreciation and amortization do not require
writing a check. That is, the check was written when the depreciable or amortizable asset
was acquired.
6.
Exhibit 13-3 is an excellent approach to determining account balance changes and
classifications. Its appearance is less intimidating than the spreadsheet approach presented
in Exhibit 13-8.
7.
The indirect method of reporting cash flows from operating activities closely resembles the
CFS predecessor (Statement of Changes in Financial Position). This may be one reason
that so many companies use the indirect method of reporting.
8.
The spreadsheet or worksheet approach shows students how every amount on the
comparative balance sheets is "tied out". It analyzes both cash and noncash transactions.
When the transaction details are accumulated by category at the bottom of the worksheet,
the actual CFS preparation requires little more than copying and formatting these
accumulated amounts.
9.
The CFS always has a check figure. That is, the net increase or decrease in the cash
balance is the difference of the beginning cash balance and the ending cash balance.
10. Even though a CFS may be prepared only once per year, it is sound management policy to
operate with a cash budget throughout the year.
11. Spreadsheet Approach - Cash flow statement, Direct Method
a. Under the direct method, gross cash inflows and gross cash outflows are presented in
the operating activities section of the CFS.
b. Net cash flows from operating activities (for the direct and indirect approaches) are the
same, but the details of the presentation differ. Under either the indirect or direct
methods, the investing and financing activities sections are identical.
c. Rules for DIRECT Method for cash flows:
Effect on Cash Account
Income:
Sales
Accounts Receivable
Unearned Fees (Deposits)
Expenses/Costs:
Rent Expense
Prepaid Rent
Rent Payable
13.10
Income on IS
Current assets:
Increase
Decrease
Current liabilities:
Increase
Decrease
"In" starting point
+
Less paid in
More paid in
+
Expense on I/S
Current assets:
Increase
Decrease
Current liabilities:
Increase
Decrease
"Out" starting point
-
More paid out
Less paid out
+
More paid in
Less paid in
Less paid out
More paid out
+
Gross Cash Inflow
+
Gross Cash Inflow
Cash Flow Statement
Noncash expenses, investment sales, and operational assets sales are ignored when
using the direct method for operating activities.
d. The organization of the worksheet for the direct method is similar to that of the indirect
method worksheet. However, income statement information is also presented on the
worksheet just before or just after the balance sheet items. The income statement
amounts are input in the analysis columns as debits (costs and expenses) and credits
(revenues). The reconciliation follows a similar procedure to that described under the
indirect method spreadsheet approach in Chapter Supplement B.
e. Noncash investing and financing activities must be disclosed in a schedule stating the
details of these activities. This requirement is intended to help financial statement users
predict future cash flows related to these investing and financing events. Typically, these
activities are significant in nature.
CHART OF END OF CHAPTER MATERIALS
LEARNING
OBJECTIVE
MINIEXERCISES
1
2
3
4
5
6
7
Supplement A
Supplement B
Cash Flows
Ethics
Internet
Projects
1
2
3
4
5
6
ALL
EXERCISES
PROBLEMS
ALTERNATE
PROBLEMS
1,2,3
4,5,6,7,8,9,10
11
12,13
12,13
14
15
16,17
18
ALL
1,2
1,2,3,5
1
1,2
1,2,5
1
1,2,5
1
1
1
4
ALL
3
ALL
CASES &
PROJECTS
9,10,11
1,2,4,5,7,9,11
3,7,8
1,2,4,6,11
3,11
1,2,6,11
ALL
9
2,3,4,6,7,8,9,10
,11
Notes:
ALL of the exercises and problems use the indirect method for operating activities.
E13-4 would be an excellent discussion exercise. It contrasts earning (from the income
statement) and cash flows from operations (from the cash flow statement).
E13-5 and P13-3 compare the elements to be presented in the operating activities section under
both the direct and indirect methods.
E13-18, P13-4, and AP13-2 require the use of a CFS spreadsheet. These exercises and
problems could be assigned for the CFS schedule approach instead.
Because of the information presented, the following exercises and problems could be assigned
for the direct method presentation of net cash flows from operating activities: E13-7, E13-18,
P13-1, P13-2, P13-4, AP13-1 and AP13-2.
P13-2 is quite comprehensive.
© McGraw-Hill Ryerson Limited, 2003
13.11
CP13-5 would be good to assign since it has a net cash outflow from operating activities.
Discussion could explore start-up companies versus established companies.
CP13-4 provides an international flair by asking students to observe differences on the CFS for a
Canadian company and a UK company.
GUIDE TO OTHER CHAPTER FEATURES
Focus Company used for Primary Illustration/Management Decision Setting
Sleeman Breweries Ltd
www.sleeman.com
Financial Analysis Titles
Interpretation of Cash Flow Patterns
Income Growth and Declining Cash Flows: A Warning Sign?
Analyzing Inventory Changes and Cash Flow from Operations
Cash Flows and Product Life Cycle
Free Cash Flow
Financing Growth
Question of Ethics
Errors and Irregularities and Cash Flows from Operations
International Perspective
Australian Practices
Key Ratio Analysis
Quality of Income Ratio = Cash Flows from Operating Activities / Net Income
Capital Acquisitions Ratio = Cash Flows from Operating Activities
Cash flows paid for PP&E
Self Study Quiz Summary
1. Determine CFS categories
2. Determine the effects of operating activity items on the CFS
3. Determine if the items are reported as investing or financing activities
Determine which items are inflows and which items are outflows
Demonstration Case Summary
Prepare a CFS (indirect method)
Chapter Take Aways
Chapter summary by learning objective
Finding Financial Information
Balance Sheet, Income Statement, Cash Flow Statement, and Notes
13.12
Cash Flow Statement
SUPPLEMENTAL ENRICHMENT ACTIVITIES
Note: Many of these activities would be suitable for individual or group applications.
IN THE CLASSROOM
"Cash Journals" Exercise:
Give the students a facsimile of a cash receipts journal and a cash disbursements journal.
(A copy of each is included on page 13.16 for your convenience). Ask the students to prepare a
CFS using the direct approach.
"Both is Better" Exercise:
Assign P13-1 using the indirect method for the CFS. After discussing the results, ask
students (or groups) to prepare the CFS using the direct method. Have students present a brief
summary of similarities and differences between the two CFS approaches for operating activities.
OUTSIDE THE CLASSROOM
LIBRARY PROJECTS:
Company Update Project:
Students could locate and read articles about Sleeman Brewery Ltd. They could prepare written
or oral reports on their research.
"CFS Method" Project:
Have students research the use of the indirect method and the direct method in the most current
Accounting Trends and Techniques. The students should prepare a brief memorandum on their
findings.
Literature Reference Project:
Students could read the articles footnoted in the chapter in their entirety. They could report
additional insights they derived about the companies or subject matter.
CROSS REFERENCE TO OTHER ANCILLARY MATERIALS
Study Guide
Read and recall questions focus on each learning objective and outline title presented in the text
chapter. Students are asked to document their understanding of the material presented in the text.
A multitude of self-test quiz questions (with answers) are also available in the chapter to be used by
students individually or in groups. They would be effective for the student to use after the chapter is
completed and/or as review in preparation for an exam.
Exercise 1 provides a very comprehensive list of transactions. The student needs to determine the
category of each cash flow and its direction. Exercise 3 requires the students to prepare the
operating activities section of the cash flow statement. It includes an extensive list of items to
consider.
© McGraw-Hill Ryerson Limited, 2003
13.13
Study Team Idea: This activity requires the students to analyze a series of statements of cash flows
for a company that has had financial difficulties. This will point out the importance of this statement
in predicting “going concern” issues.
Power Point Slides
A brief summary of the contents for this chapter includes the following topics:
Business background
Classifications on the cash flow statement
Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
Relationships to the balance sheet and income statement
Cash flow statement indirect method example
Comparison of the direct and indirect methods
Test Bank
Learning
Objective
1
2
3
4
5
6
7
Supplement A
True/False
Multiple Choice
1 - 22
23 - 30
31 - 33
42
34 - 36
37
38 - 42
43
44 - 60
61 - 80
81 - 85
86
87 - 91
92
93 - 94
95 - 96
Essay/
Problem
97 - 100
101 - 105
106 - 107
Matching
111 - 112
108 - 110
An alternate method for testing with True/False questions:
If the student’s response is F (false), instruct the student to defend the false response with his/her
reason(s) why it is false. This approach allows the student to demonstrate
critical-thinking
skills as well as providing for written communication assessment. Suggested reasons are contained
in the answer section of the test bank for false answers.
Many of the multiple choice questions include a “None of the above is correct” answer. This should
somewhat minimize the student narrowing down the selections and then trying to “back in” to an
answer.
Several of the problems contain essay components. This should allow the student to conceptualize
a solution. Again, written communication skills can be assessed.
Questions 97, 111, and 112 provide several transactions to be identified by the student by the type
or category of cash flow.
Questions 98, 99, and 104 require the preparation of the entire cash flow statement using the
indirect method.
Question 100 requires the preparation of the entire cash flow statement using the direct method.
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Cash Flow Statement
Question 105 requires the preparation of the operating activities section of the cash flow statement
using the indirect method.
Question 110 requires an understanding of noncash investing and financing activities and how they
are reported.
© McGraw-Hill Ryerson Limited, 2003
13.15
Savidge Corporation
Cash Receipts Journal for the Year Ended December 31, 20A
Collections
from
Customers
Sales of
Equipment
(previously
used in
operations)
Sale of
Savidge
Common
Stock
Collections
of Interest
on Note
Receivable
Borrowing
Proceeds
of Longterm Debt
Collections
of Dividends
on Stock
Investments
xxxx
Total for
Year
xxxxxx
xxxxx
xx
281,000
xxxx
xxx
xx
58,000
xxxxx
xxxxx
xxxx
111,000
xxxxx
Xxxx
Xxxx
9,000
84,000
8,000
Savidge Corporation
Cash Payments Journal for the Year Ended December 31, 20A
Purchase of
Stock in
Snyder
Corporation
Total
for
Year
xxxx
xxx
xx
12,000
Payments
to
Suppliers
xxxxx
xxxx
xxxxx
123,000
Payments
to
Employees
Purchases
of
Equipment
(to use in
the
business)
Xxxx
Payments
for Principal
on Longterm Debt
Payments
for Interest
on LongTerm Debt
Payments to
Shareholders
for Dividends
xxx
xxxxxx
xxxx
xxxx
xxxx
10,000
14,000
19,000
xxxxx
xxxx
60,000
Xxxx
304,000
In addition to the above:
$42,000 -- Beginning cash balance on January 1, 20A
$400,000 -- New building acquired on May 24, 20A, by signing a 15 year mortgage payable.
REQUIRED:
Prepare in good form the Cash flow statement for the Savidge Corporation from the information
given above. USE THE DIRECT METHOD
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Cash Flow Statement
SUGGESTED READING LIST
Listed below are some relevant readings for this chapter. Check the internet for more.
Smith, Keith, Whitis, Robert, and London, Coy, "Treatment of certain practice problems in the
Statement of Cash Flows," The CPA Journal May 1992: 60.
Pava, Moses L. and Epstein Marc J., "How Useful is the Statement of Cash Flows?" Accounting
Horizons July 1992: 52.
Kochanek, Richard F. and Norgaard, Corine T., "Analyzing the Components of Operating Cash
Flow: The Charter Company," Accounting Horizons March 1988: 58.
Giacomino, Don E. and Mielke, David E., "Cash Flows: Another Approach to Ratio Analysis,"
Journal of Accountancy March 1993: 55.
Burlingham, Bo, "How to Succeed in Business in 4 Easy Steps," Inc. July 1995: 30.
Collings, William A., "Statement of Cash Flows," Journal of Accountancy May 1990: 126.
Wallace, R.S. Olusegun and Collier, Paul A., "The 'Cash' in Cash Flow Statements: A MultiCountry Comparison, “Accounting Horizons December 1991: 44.
Akasie, Jay, “Learning From Mistakes,” Forbes April 7, 1997: 20.
Smith, G. Robert Jr. and Freeman, Robert J., “Statement of Cash Flows: the Direct vs.
Indirect Method Debate Continues,” Government Finance Review February 1996: 17.
Pfeiffer, Ray J., Elgers, Pieter T., Lo, May H., and Rees, Lynn L., “Additional Evidence on the
Incremental Information Content of Cash Flows and Accruals: The Impact of Errors in Measuring
Market Expectations” The Accounting Review July 1998: 373.
Boer, Germain,”Managing the Cash Gap,” Journal of Accountancy October 1999: 27.
Miles, John R. And Yamamura, Jeanne H., “The Power of Cash Flow Ratios,” Journal of
Accountancy October 1998: 53.
© McGraw-Hill Ryerson Limited, 2003
13.17