Chapter Twelve Statement ofCash Flows
Reporting Format for the Statement of Cash Flows The Statement of Cash Flows must include the following three sections, as defined in FASB Statement 95: Operating Activities Investing Activities Financing Activities
Inflows • Receipts from sales. • Commissions and fees. • Interest and dividends received. Outflows • Payments for inventory. • Salaries and wages. • Operating expenses • Interest on liabilities. • Taxes. Cash Flows from Operating Activities Cash Flows from Operating Activities
Inflows Selling property, plant, and equipment. Selling investment securities. Collecting loans. Outflows • Purchasing property, plant, and equipment. • Purchasing investment securities. • Lending to others. Cash Flows from InvestingActivities Cash Flows from Investing Activities
Inflows Borrowing. Issuing stock. Outflows • Repaying debt (excluding interest). • Purchasing treasury stock. • Paying dividends. Cash Flows from Financing Activities Cash Flows from Financing Activities
Noncash Investing and Financing Transactions • Significant noncash investing and financing transactions must be reported separately. • Example: issuing common stock in exchange for land.
Cash Flows from Operating Activities Cash flows from operating activities can be prepared using either the direct method or the indirect method. Let’s look at the direct methodfirst.
Accrual basis revenue includes sales that did not result in cash inflows. Cash received from customers can be computed as follows: Converting from Accrual to Cash-Basis Accounting Decrease in receivables + = Cash received from customers Net sales Increase in receivables – =
Converting from Accrual to Cash-Basis Accounting We will use T-accounts toanalyze changes in accounts. Let’s look at an example. The Accounts Receivable balance was $27,000 on 12/31/04 and $35,000 on 12/31/05. If accrual Sales Revenue for 2005 was $800,000, what were cash receipts from sales?
$27,000 + $800,000 - $35,000 Converting from Accrual to Cash-Basis Accounting Accounts Receivable 12/31/04 Balance Cash receipts = Accrual Sales Revenue $792,000 12/31/05 Balance The Accounts Receivable balance was $27,000 on 12/31/04 and $35,000 on 12/31/05. If accrual Sales Revenue for 2005 was $800,000, what were cash receipts from sales?
Converting from Accrual to Cash-Basis Accounting Now let’s use T-account analysis for a liability account with anaccrued expense. The Salaries Payable balance was $7,000 on 12/31/04 and $5,000 on 12/31/05. If accrued Salaries Expense for 2005 was $80,000, what amount of cash was paid for salaries?
$7,000 + $80,000 - $5,000 Converting from Accrual to Cash-Basis Accounting Salaries Payable 12/31/04 Balance Accrued Salaries Expense Cash payments = $82,000 12/31/05 Balance The Salaries Payable balance was $7,000 on 12/31/04 and $5,000 on 12/31/05. If accrual Salaries Expense for 2005 was $80,000, what amount of cash was paid for salaries?
Direct Method Now that we have seen the T-account method of analysis, let’s use it to prepare a Direct MethodStatement of Cash Flows for Batson Company. We will begin with by analyzing changes in balance sheet accounts.
Direct Method Additional Information • Depreciation on buildings was $6,000 in 2005. Depreciation on equipment was $4,000 in 2005. • A building addition in 2005 cost $31,000, paid in cash. • Equipment with a book value of $40,000 was sold during the year for $43,000. • Equipment with a book value of $30,000 was destroyed during a flood in 2005. There was no insurance. • Batson had no noncash financing and investing activities.
Direct Method Additional Information • Batson’s tax rate is 40%. • Interest Expense on Notes Payable was $6,500. • Interest Expense on Bonds Payable was $18,000. • Issued Common Stock during 2005 for $50,000. • Other Expenses of $71,000 were paid in cash. Let’s get started analyzing the accounts. First, we willreview the T-account analysis that we completed earlier.Then we will analyze the remaining balance sheet accounts starting with the current accounts.
Accounts Receivable 12/31/04 Balance Cash receipts = $792,000 Accrual sales revenue 12/31/05 Balance Salaries Payable 12/31/04 Balance Accrued salaries expense Cash Payments = $82,000 12/31/05 Balance
Accounts Payable 12/31/04 Balance Purchases Cash Payments = 12/31/05 Balance Inventory 12/31/04 Balance Cost of Goods Sold Purchases = $430,000 12/31/05 Balance $433,000
Income Taxes Payable 12/31/04 Balance Income Tax Expense Cash payment = 12/31/05 Balance Interest Payable 12/31/04 Balance Interest Expense Cash payments = $22,000 12/31/05 Balance $54,000
Direct Method Now, that we have analyzed the current accounts and found the cash receipts and cash payments related to operations, we are ready to prepare the Cash Flows from Operating Activities portion of the Statement of Cash Flows.
Direct Method Now, Let’s continue to use the T-account analysis for the remaining noncurrent balance sheet accounts.
Equipment, Net Equipment sale 12/31/04 Balance Flood loss Depreciation 12/31/05 Balance Buildings, Net 12/31/04 Balance Cash paid for addition = $31,000 Depreciation 12/31/05 Balance
Land 12/31/04 Balance Cash paid for land purchase = $72,000 12/31/05 Balance After completing the analysis of noncurrent assets,we are ready to prepare the Cash Flow fromInvesting portion of the Statement of Cash flows.
Cash Flow from Investing Activities Next, we will analyze noncurrent liabilities and equity so that we can prepare the Cash Flow from Financing portion of the Statement of Cash flows.
Bonds Payable 12/31/04 Balance Cash paid to retire bonds = 12/31/05 Balance Notes Payable 12/31/04 Balance Cash paid to retire notes = $10,000 12/31/05 Balance $100,000
Common Stock 12/31/04 Balance Cash received from stocksale = $50,000 12/31/05 Balance After completing the analysis of noncurrent liabilitiesand equity, we are ready to prepare the Cash Flowfrom Financing portion of the Statement of Cash flows.
Cash Flow from Financing Activities Next, we will put the three sections together to completethe Statement of Cash Flows.
Notice that the Ending Cash Balance on the Statement of Cash Flows agrees with the 12/31/05 Cash balance on the Balance Sheet.
Indirect Method Now let’s look at theIndirect Methodthat is used by over 95% of all companies.
A Comparison of the Direct and Indirect Methods • Net cash flow is the same for both methods. • The Direct Method provides more detail about cash from operating activities. • The investing and financing sections for the two methods are identical.
Indirect Method Changes in current assets and current liabilities as shown on the following table. Cash Flows from Operating Activities Net Income + Losses and - Gains + Noncash expenses such as depreciation and amortization.
Indirect Method Use this table when adjusting Net Incometo Cash Flow form Operations.
Indirect Method We will use the Indirect Methodto prepare the Cash Flows from Operating Activities for the Batson Company. First, we will review the Balance Sheet and Income Statement for Batson Company.
The Indirect Method begins with Net Income, which is then adjusted for the non-cash items included in net income. For Batson, the only non-cash items are depreciation, and gains and losses.
To complete the Cash flows from operating activities section, we must examine comparative balance sheets to determine the changes in current assets and current liabilities from the beginning of the period to the end of the period. (Remember, we showed the balance sheets a few slides earlier.)
Remember that when we prepared the operating section using the Direct Method, we also arrived at Net Cash flows from Operating Activities of $130,000.
Indirect Method Because the investingand financing sectionsare identical with eithermethod of preparation, we will not repeatthose sections of thestatement.
Ability to generate cashfrom its operations. Management of currentassets and current liabilities. Expenditures forlong-term assets. Amount received fromexternal financing. The Financial Analyst The statement focusesattention on: