Chapter 12: Statement of Cash Flows

1. Chapter 12: Statement of Cash Flows • Pre-Statement of Cash Flows (before 1987) • Statement of Cash Flows (1987) • Research

2. Statement of Changes in Financial Position • Reported on changes in assets, liabilities, and owners’ equities account balances • Recommended, but not required for inclusion in the annual report until 1971 • Objectives • Disclosure of changes in financial position • Summarize financing and investing activity • Report funds flow from operations

3. Statement of Changes in Financial Position • Sources of resources • Transaction credits • Arise from increases in liabilities and owners’ equity and decreases in assets • Uses of resources • Transaction debits • Arise from decreases in liabilities and owners’ equity and increases in assets

4. Increases to fund balance accounts From net income From other sources Other sources of resources Decrease, if any, in the fund balance for the period Decreases to the fund balance accounts From net losses From other sources Other uses of resources Increase, if any, in the fund balance for the period Standard Format of the Statement of Changes in Financial Position Sources of Resources Uses of Resources

5. Early FASB Discussion Memo • Provide feedback on actual cash flows • Help to identify the relationship between accounting income and cash flows • Provide information about the quality of income • Improve comparability of information in financial reports • Aid in assessing flexibility and liquidity • Assist in predicting future cash flows

6. Cash Flows from Operating Activities Cash Flows from Investing Activities Cash Flows from Financing Activities Net Change in Cash & Cash Equivalents Cash & Cash Equivalents at Beginning of Year Cash & Cash Equivalents at End of Year Statement of Cash Flows

7. Definition: Cash • Literal cash on hand or on demand deposit plus cash equivalents • Cash equivalents are highly liquid assets that are convertible to known amounts of cash and have short-term maturities

8. Cash Flows from Operating Activities Cash Flows from Investing Activities Cash Flows from Financing Activities Net Change in Cash & Cash Equivalents Cash & Cash Equivalents at Beginning of Year Cash & Cash Equivalents at End of Year Statement of Cash Flows

9. Operating Activities Section • Direct method reports literal cash flows related to income statement classifications • FASB appears to favor • Cost to prepare > than with indirect method • Indirect or reconciliation method starts with accrual income and adjusts it for the noncash items in it • In 1996, 98% of American firms use • Nonarticulation problems

10. Direct vs. Indirect Method • Operating activities section is the only section that differs • The investing and financing activities sections are the same under both methods

11. Indirect Method: Nonarticulation • Working capital account changes on balance sheet do not equal working capital adjustments in the operating activities section of SCF (75% of the time in sample) • Causes • Write-up/down of working capital items • Depreciation allocations within inventories • Reclassifications of accounts between current and non current categories

12. Cash Flows from Operating Activities Cash Flows from Investing Activities Cash Flows from Financing Activities Net Change in Cash & Cash Equivalents Cash & Cash Equivalents at Beginning of Year Cash & Cash Equivalents at End of Year Statement of Cash Flows

13. Investing Activities Section: Examples • Proceeds from sale of facility • Payment received on note for sale of plant • Capital expenditures • Payment for purchase of company X, net of cash acquired

14. Cash Flows from Operating Activities Cash Flows from Investing Activities Cash Flows from Financing Activities Net Change in Cash & Cash Equivalents Cash & Cash Equivalents at Beginning of Year Cash & Cash Equivalents at End of Year Statement of Cash Flows

15. Financing Activities Section: Examples • Net borrowings under line-of-credit agreement • Principal payments under capital lease obligation • Proceeds from issuance of long-term debt • Proceeds from issuance of common stock • Dividends paid

16. SFAS No. 95 Classification Issues • Appearing in operating activities section • Interest expense • Interest revenue • Dividend revenue • Related balance sheet items (bonds payable, stock investments, and long-term notes receivable) are either financing or investing elements

17. Ingram and Lee (1997) • 1,000 firms over the period 1974-1992 • Use the income statement and the cash flow statement together • Over time growing firms will have higher income and lower cash flows • Reverse occurs for shrinking firms

18. Improving Accounting Standards • Require the direct method for the Statement of Cash Flows • If the Indirect Method is retained • Require a schedule showing noncash flow transactions affecting working capital accounts • Segregate current liability accounts into those that do and do not affect net income

19. Chapter 12: Statement of Cash Flows • Pre-Statement of Cash Flows (before 1987) • Statement of Cash Flows (1987) • Research