Chapter 11 Statement of Cash Flows
Part A Formatting the Statement of Cash Flows
Statement of Cash Flows Provides a summary of cash inflows and cash outflows during the reporting period
LO1 Classification of Cash Flows Categories of Cash Flows Operating activities Investing activities Financing activities Include cash receipts and cash payments for transactions relating to revenue and expense activities Include cash transactions involving the purchase and sale of long-term assets and current investments Inflows and outflows of cash resulting from the external financing of a business
Reporting Noncash Activities • Transactions that don’t increase or decrease cash • Excluded from the statement of cash flows • Reported in a separate note to the financial statements as noncash activities Examples: Purchase of long-term assets by issuing debt Purchase of long-term assets by issuing stock Conversion of bonds payable into common stock. Exchange of long-term assets
Begin with net income and then list adjustments to net income in order to arrive at operating cash flows. More popular method. Easier and less costly. Adjust the items on the income statement to directly show the cash inflows and outflows from operations. Conceptually better method. More difficult and more costly. Operating Activities – Indirect and Direct Methods • Differ only in the presentation format for operating activities. • We report investing, financing, and noncash activities identically under both methods. Indirect Method Direct Method
Part B Preparing the Statement of Cash Flows
Illustration The income statement, balance sheets, and additional information for E-Games, Inc., are provided in the following Illustration. We will use this information in preparing the statement of cash flows following the four basic steps.
Illustration (continued) • Additional Information for 2010: • Purchased stock in Intendo Corporation for $35,000. • Sold land originally costing $10,000 for $6,000, resulting in a $4,000 loss on sale of land. • Purchased $20,000 in equipment by issuing a $20,000 note payable due in three years. No cash was exchanged in the transaction. • Issued common stock for $5,000 cash. • Declared and paid a cash dividend of $12,000.
LO2 Operating Activities – Indirect Method • Both net income and cash flows from operating activities represent the same operating activities. • The income statement reports net income on an accrual basis. On the other hand, the statement of cash flows reports the very same activities on a cash basis. • We remove the noncash components from net income so that what’s left is cash flows from operating activities. • We can classify the noncash components as: • revenues and expenses that don’t affect cash at all (adjustments for noncash components of net income). • revenues and expenses that do affect cash, but not by the amount reported as the revenue or expense (adjustments for changes in current assets and current liabilities).
Adjustments for noncash components of net income Depreciation Expense and Loss on Sale of Land Add back Depreciation Expense and Loss on Sale of Land which was earlier subtracted from the net income.
Adjustments for Changes in Current Assets and Current Liabilities Increase in Accounts Receivable (Increase in a current asset) Subtract
Adjustments for Changes in Current Assets and Current Liabilities Decrease in Inventory (Decrease in a Current Asset) Add Back
Adjustments for Changes in Current Assets and Current Liabilities Decrease in Accounts Payable (Decrease in a Current Liability) Subtract
Adjustments for Changes in Current Assets and Current Liabilities Increase in Interest Payable (Increase in a Current Liability) Add Back
LO3 Investing Activities Cash Outflow Cash Inflow Noncash activity disclosed in the footnote
LO3 Financing Activities Cash Inflow Cash Outflow Retained earnings, beg. Balance $41,000 + Net income 42,000 – Dividends (12,000) Retained earnings, ending balance $71,000
LO4 Cash Flow Analysis Analysis based on net cash flows from operating activities (CFFO)
Cash Return on Assets Return on Assets Cash Return on Assets is higher than the Return on Assets Cash Return on Assets
Appendix Operating Activities-Direct Method
LO5 Operating Activities-Direct Method • We report the cash inflows and cash outflows directly on the statement of cash flows. For instance, we report cash received from customers as the cash effect of sales activities, and cash paid to suppliers as the cash effect of cost of goods sold. • Income statement items that have no cash effect—such as depreciation expense or gains and losses on the sale of assets—are simply not reported under the direct method.
Operating Activities-Direct Method Cash Received from Customers
Operating Activities-Direct Method Cash Paid to Suppliers Inventory Accounts Payable
Operating Activities-Direct Method Cash Paid to Suppliers
Operating Activities-Direct Method Depreciation Expense and Loss on Sale of Land Not reported on the statement of cash flows
Operating Activities-Direct Method Cash Paid for Interest
Operating Activities-Direct Method Cash Paid for Income Taxes