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Chapter 18

Chapter 18. The Statement of Cash Flows Accounting 212. CHAPTER 18 THE STATEMENT OF CASH FLOWS. In this chapter, we will learn to:. 1 Understand the usefulness of the statement of cash flows. 2 Distinguish among operating, investing, and financing activities.

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Chapter 18

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  1. Chapter 18 The Statement of Cash Flows Accounting 212

  2. CHAPTER 18 THE STATEMENT OF CASH FLOWS In this chapter, we will learn to: 1 Understand the usefulness of the statement of cash flows. 2 Distinguish among operating, investing, and financing activities. 3 Prepare a statement of cash flows using the indirect method. 4Review a sample statement of cash flows using the direct method. 5Analyze the statement of cash flows.

  3. Purpose of the Statement of Cash Flows How does a company obtain its cash? Where does a company spend its cash? What explains the change in the cash balance?

  4. Importance of Cash Flows How did the business fund its operations? Does the business have sufficient cash to pay its debts as they mature? Did the business make any dividend payments? Did the business borrow any funds or repay any loans?

  5. Usefulness of the Statement of Cash Flows How well can the entity generate future cash flows? Does the business have sufficient cash to pay dividends and future obligations? What were the differences between net income and net cash provided (used) by operating activities? What were cash investing and financing transactions during period?

  6. Measurement of Cash Flows Cash Cash Equivalents Currency • Short-term, highly liquid investments. • Readily convertible into cash. • So near maturity that market value is unaffected by interest rate changes.

  7. Classifying Cash Flows The Statement of Cash Flows includes the following three sections: • Operating Activities • Investing Activities • Financing Activities

  8. Operating Activities • Inflows • Receipts from customers. • Cash dividends received. • Interest from borrowers. • Other. • Outflows • Salaries and wages. • Payments to suppliers. • Taxes and fines. • Interest paid to lenders. • Other.

  9. Investing Activities • Inflows • Selling long-term productive assets. • Selling equity investments. • Collecting principal on loans. • Other. • Outflows • Purchasing long-term productive assets. • Purchasing equity investments. • Purchasing debt investments. • Other.

  10. Financing Activities • Inflows • Issuing its own equity securities. • Issuing bonds and notes. • Issuing short- and long-term liabilities. • Outflows • Pay dividends. • Purchasing treasury stock • Repaying cash loans. • Paying owners’ withdrawals.

  11. Significant Non-cash Activities Items requiring separate disclosure in a separate schedule include: • Issuing debt to purchase assets. • Converting bonds to common stock. • Exchanging of plant assets. • Issuing common stock to purchase assets.

  12. Preparing the SCF • We look at changes in certain account balances between two points in time. • We adjust from accrual to cash method. • We do not use an adjusted trial balance to produce the SCF. Instead we use: • Comparative balance sheets • Current income statement • Additional information

  13. FORMAT OF STATEMENT OF CASH FLOWS The general format of the SCF Is the 3 activities previously discussed – operating, investing, and financing – plus the significant noncash investing and financing activities.

  14. USAGE OF INDIRECT AND DIRECT METHODS In order to determine net cash provided/used by operating activities, the operating activities section must be converted from accrual basis to cash basis. This conversion may be accomplished by : • the indirect method or • the direct method. The indirect method is used extensively in practice, as shown below. The indirect is favored by companies for 2 reasons: - it is easier to prepare and - it focuses on the differences between net income and net cash flow from operating activities.

  15. THREE MAJOR STEPS IN PREPARING THE STATEMENT OF CASH FLOWS

  16. Let’s briefly look at the Direct Methodfor preparing the Cash Flows from Operating Activities section.

  17. Analyzing the Cash Account Let’s use this Cash account to understand B&G Company’s Statement of Cash Flows under the Direct Method.

  18. Let’s look at the Indirect Methodfor preparing the Cash Flows from Operating Activities section.

  19. Cash Flows from Operating Activities Net Income Indirect Method of Reporting Operating Cash Flows Changes in current assets and current liabilities. + Losses and - Gains + Non-cash expenses such as depreciation and amortization. 98.7% of all companies use the indirect method.

  20. Indirect Method of Reporting Operating Cash Flows Use this table when adjusting Net Income to Operating Cash Flows.

  21. Indirect MethodAlternative Example East, Inc. reports $125,000 net income for the year ended December 31, 2005. Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000. During 2005, East reported $12,500 of Depreciation Expense. What is East, Inc.’s Operating Cash Flow for 2005?

  22. Net income $ 125,000 Net income $ 125,000 Deduct: Increase in accounts Deduct: Increase in accounts receivable receivable Cash provided by operating Cash provided by operating activities activities Indirect MethodExample For the indirect method, start with net income.

  23. Net income $ 125,000 Net income $ 125,000 Add: Depreciation expense 12,500 Add: Depreciation expense 12,500 Deduct: Increase in accounts Deduct: Increase in accounts receivable receivable Cash provided by operating Cash provided by operating activities activities Indirect MethodExample Add noncash expenses such as depreciation, depletion, amortization, or bad debt expense.

  24. Net income $ 125,000 Net income $ 125,000 Add: Depreciation expense 12,500 Add: Depreciation expense 12,500 Deduct: Increase in accounts Deduct: Increase in accounts receivable (7,500) receivable (7,500) Cash provided by operating Cash provided by operating activities activities Indirect MethodExample

  25. Net income $ 125,000 Net income $ 125,000 Add: Depreciation expense 12,500 Add: Depreciation expense 12,500 Deduct: Increase in accounts Deduct: Increase in accounts receivable (7,500) receivable (7,500) Add: Increase in accounts payable 10,000 Add: Increase in accounts payable 10,000 Cash provided by operating Cash provided by operating activities activities Indirect MethodExample

  26. Net income $ 125,000 Net income $ 125,000 Add: Depreciation expense 12,500 Add: Depreciation expense 12,500 Deduct: Increase in accounts Deduct: Increase in accounts receivable (7,500) receivable (7,500) Add: Increase in accounts payable 10,000 Add: Increase in accounts payable 10,000 Cash provided by operating Cash provided by operating activities $ 140,000 activities $ 140,000 Indirect Method Example If we used the Direct Method, we would get the same $140,000 for Cash Provided by Operating Activities.

  27. Let’s look at the Indirect Method to prepare a Statement of Cash Flows for Computer Services Co.

  28. Comparative Balance Sheet, 2005, With Increases And Decreases The comparative balance sheets at the beginning and end of 2005 –showing increases and decreases – are shown to the right.

  29. INCOME STATEMENT AND ADDITIONAL INFORMATION, 2005 The income statement and additional information for 2005 for Computer Services Company are shown to the right.

  30. Additional Information for 2005: • Net income was $145,000. • Cash dividends declared and paid were $29,000. • Building of $120,000 was purchased for cash. Equipment costing $25,000 was purchased for cash. • Equipment with a book value if $7,000 (cost $8,000 w/ accumulated depreciation of $1,000) was sold for $4,000 cash. • Issued common stock for $20,000 cash. • Depreciation expense was $9,000 ($6,000 for building, $3,000 for equipment.

  31. Operating Activities Cash from operating activities Net Income $145,000 Adjustments: Depreciation Expense $ 9,000 Loss on Sale of Equipment 3,000 Decrease in Accounts Rec. 10,000 Increase in Merchand. Inv. (5,000) Increase in Prepaid Expenses (4,000) Increase in Accts. Payable 16,000 Decrease in Income Tax Pay. (2,000)27,000 Net Cash From Operating Act. $172,000

  32. Investing/Financing Activities Cash flows from operating activities 172,000 Cash flows from investing activities Purchase of building (120,000) Purchase of equipment (25,000) Sale of equipment 4,000 Net cash used by investing activities (141,000) Cash flows from financing activities Issuance of common stock 20,000 Payment of cash dividends (29,000) Net cash used by financing (9,000) activities Net increase in cash (172,000 – 141,000 – 9,000) 22,000 Cash at beginning of period 33,000 Cash at end of period $55,000

  33. Finally… • Note non-cash investing and financing activities: Issuance of bonds payable to purchase land $110,000

  34. FREE CASH FLOW FreeCash Flow – Cash provided by operating activities adjusted for capital expenditures and dividends paid.

  35. Homework for Chapter 18! See Wiley Plus!

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