Learning Objectives Explain the usefulness of the statement of cash flows. LO1
CASH INFLOWS Operating Activities Investing Activities Financing Activities Sale of operational assets Sale of investments Collections of loans Issuance of stock Issuance of bonds and notes Cash received from revenues Business Cash paid for expenses Purchase of operational assets Purchase of investments Loans to others Payment of dividends Repurchase of stock Repayment of debt CASH OUTFLOWS
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. Role of the Statement of Cash Flows
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
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.
Learning Objectives Define cash equivalents. LO2
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. Cash and Cash Equivalents Cash Equivalents Cash Resources immediately available to pay obligations.
Primary Elements of the Statement of Cash Flows (SCF) Operating Activities Investing Activities Reconciliation of the Net Increase or Decrease in Cash with the Change in the Balance of the Cash Account Financing Activities Noncash Investing and Financing Activities
Reports the cash effects of the acquisition and disposition of assets (other than inventory and cash equivalents). Investing 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. Financing Activities Primary Elements of the Statement of Cash Flows (SCF) Reports the cash effects of the elements of net income. Operating Activities
Learning Objectives Determine cash flows from operating activities by the direct method. LO3 Determine cash flows from operating activities by the indirect method. LO4
Inflowsfrom: • Sales to customers. • Interest and dividends received. + Outflowsto: • Purchase of inventory. • Salaries, wages, and other operating expenses. • Interest on debt. • Income taxes. _ Cash Flows from Operating Activities Cash Flows from Operating Activities
Direct Method Indirect Method Reports the cash effects of each operating activity Starts with accrual net income and converts to cash basis Direct Method or Indirect Method of Reporting Cash Flows from Operating Activities Two Formats for Reporting Operating Activities Note that no matter which format is used, the same amount of net cash flows operating activities is generated.
The cash effect of each operating activity is reported directly on the statement of cash flows. 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. Direct Method or Indirect Method of Reporting Cash Flows from Operating Activities
Learning Objectives Identify transactions that are classified as investing activities. LO5
Inflowsfrom: Sale of long-term assets used in the business. Sale of investment securities (stocks and bonds). Collection of nontrade receivables. + Outflowsto: • 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 Cash Flows from Investing Activities
Learning Objectives Identify transactions that are classified as financing activities. LO6
Inflowsfrom: Sale of shares to owners. Borrowing from creditors through notes, loans, mortgages, and bonds. _ Cash Flows from Financing Activities + Cash Flows from Financing Activities Outflowsto: • 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.
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:
Learning Objectives Identify transactions that represent noncash investing and financing activities. LO7
Noncash Investing and Financing Activities Significant investing and financing transactions not involving cash also are reported in the Statement of Cash Flows. • Acquiring an asset by incurring a debt payable to the seller. • Acquiring an asset by entering into a capital lease. • Converting debt into common stock or other equity securities. • Exchanging noncash assets or liabilities for other noncash assets or liabilities.
Learning Objectives Prepare a statement of cash flows with the aid of a spreadsheet or T-accounts. LO8
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. Using a Spreadsheet Let’s see how to use a spreadsheet to prepare a Statement of Cash Flows on the next few slides.
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.
Next we allocate space on the spreadsheet for the statement of cash flows. 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.
Let’s start by analyzing Sales Revenue and its related account Accounts Receivable by looking at the relationship in a T-account format.
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.
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.
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.
The $12 million increase in the Short-term Investments account is due to the purchase of short-term investments during the year. In the textbook, entry number 12 illustrates the analysis of the Short-term Investment account.
The final part of this entry is a $12 million entry on the Statement of Cash Flows under Investing Activities. Now, let’s look at a noncash transaction.
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. x x x denotes a noncash transaction
After entering all the transactions, this is what the balance sheet portion of the spreadsheet looks like. x x
After entering all the transactions, this is what the income statement portion of the spreadsheet looks like.
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.
Preparing an SCF: The Indirect Method 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.
Depreciation Expense 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. Loss on Sale of Equipment Subtracting the gain reverses the effect of the gain having been added to net income. Gain on Sale of Land Components of Net Income that Do Not Increase or Decrease Cash
Components of Net Income that Do Increase or Decrease Cash 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. 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.