Fundamental Financial Accounting Concepts Fourth Edition by Edmonds, McNair, Milam, Olds

1. Fundamental Financial Accounting ConceptsFourth EditionbyEdmonds, McNair, Milam, Olds PowerPoint® presentation by J. Lawrence Bergin

2. Chapter 12 Statement of Cash Flows

3. Purpose of the Statement of Cash Flows • To show how the business acquired its cash during the current year • To show how the business spent its cash during the current year This information is crucial for decision makers to predict future cash flows of the business.

4. What is considered “CASH” for the Statement of Cash Flows? • Cash includes cash and cash equivalents for purpose of the statement. • Cash Equivalents are • Short-term, highly liquid investments, with • Maturity dates of 3 months or less from the date acquired by the holder, and are • Easily convertible into known amounts of cash.

5. Categories of Cash Flows • They are based on activities • related to cash flows: • Operating the business. • Investing in productive assets. • Financing the business. • These are the sections of the Statement of Cash Flows.

6. Operating Activities • Cash inflows and outflows that are directly related to income from normal operations. • Technically, FASB defines operating activities as those that are not investing or financing activities. • There are two ways to compute net cash flow from operating activities: • Direct method • Indirect method

7. Cash Flows from Operating Activities • Cash inflows and outflows that are directly related to income from normal operations. • Inflows include: • Receipts from customers. • Interest on receivables. • Dividends received.

8. Cash Flows from Operating Activities • Cash inflows and outflows that are directly related to income from normal operations. • Outflows include: • Payments to suppliers. • Interest paid on liabilities. • Income taxes paid. • Salary and wages payments to employees. Pay to the order of

9. Cash Flows from Investing Activities • Cash inflows and outflows that are related to the purchase and sale of productive assets. • Inflows include proceeds from: • Sales of property, plant, and equipment. • Sales of investments in securities. • Collection of principal on loans made to others.

10. Cash Flows from Investing Activities • Cash inflows and outflows that are related to the purchase and sale of productive assets. • Outflows include payments for: • The purchase of property, plant and equipment. • The purchase of long-term investments. • Loans to others.

11. Cash Flows from Financing Activities • Cash inflows and outflows that are related to how cash was obtained to finance the enterprise. • Inflows include: • Proceeds from sale of stock. • Proceeds from sale of bonds and from borrowings.

12. Cash Flows from Financing Activities • Cash inflows and outflows that are related to how cash was obtained to finance the enterprise. • Outflows include: • Payments to purchase treasury stock. • Principal payments to retire bonds and loans. • Dividends paid to owners. (Remember, INTEREST paid is NOT a financing activity; it is an Operating Activity.)

13. Cash Flows from Noncash Activities • Investing and financing activities that do not involve cash, e.g., • Retirement of bonds by issuing stock. • Settlement of debt by transferring assets other than cash. • Noncash activities must be disclosed separately in the financial statements.

14. Preparing the Statement of Cash Flows The face of the statement includes: Net Cash Flows from Operating Activities +Net Cash Flows from Investing Activities +Net Cash Flows from Financing Activities =Net change in Cash Flows for the period + Beginning Cash Balance =End of period Cash Balance

15. Two Alternative Approaches • Indirect Method • Shows net cash inflow (outflow) from operations as an adjustment of net income. • Used by 97% of companies. • Direct Method (used in Ch. 1-11 in text.) • Reports the components of cash from operations as gross receipts and payments. • Recommended by the FASB, but rarely used.

16. Converting Accrual Data to Cash Data • Accounting records are kept on the accrual basis (GAAP). • Cash data must be developed before the SCF can be prepared (especially for operating activities). • The examples that follow demonstrate the direct method for converting accrual data to cash data.

17. Three information sources are used: • The income statement for the current period. • Comparative beginning of period and end of period balance sheets. • Additional transaction details not found in the financial statements.

18. Direct Method SCFConverting Revenues to Cash Basis • Accrual basis revenue includes sales that did not result in cash inflows. • Can be computed as: + decreaseor - increase in A/R Revenue, Accrual basis Revenue, Cash basis =

19. Direct Method SCFExample: The A/R balance was $45,000 on 1/1/04 and $52,000 on 12/31/04. If accrual sales revenue for 2004 was $600,000, what was cash basis revenue?

20. Direct Method SCFExample: The A/R balance was $45,000 on 1/1/04 and $52,000 on 12/31/04. If accrual sales revenue for 2004 was $600,000, what was cash basis revenue? Accounts Receivable 45,000 52,000

21. Direct Method SCFExample: The A/R balance was $45,000 on 1/1/04 and $52,000 on 12/31/04. If accrual sales revenue for 2004 was $600,000, what was cash basis revenue? Accounts Receivable 45,000 Cash collected 600,000 52,000

22. Direct Method SCFExample: The A/R balance was $45,000 on 1/1/04 and $52,000 on 12/31/04. If accrual sales revenue for 2004 was $600,000, what was cash basis revenue? So, Accrual Sales $600,000 - Increase in A/R 7,000 = Cash collected from customers $593,000 Accounts Receivable 45,000 593,000 Cash collected 600,000 52,000

23. Direct Method Converting Accrued Expenses to Cash • Accrual basis expenses include expenses that have not yet been paid. • Can be computed as: Expense, Accrual Basis + decrease or - increase in “expense” payables Expense, Cash Basis

24. Direct Method SCFExample: (Accrued) Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004?

25. Direct Method SCFExample: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004? Salary Payable Salary Expense

26. Direct Method SCFExample: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004? Salary Payable Salary Expense $500,000

27. Direct Method SCFExample: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004? Salary Payable Salary Expense 35,000 $500,000 10,000

28. Direct Method SCFExample: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004? Salary Payable Salary Expense 35,000 $500,000 $500,000 10,000

29. Direct Method SCFExample: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004? Salary Payable Salary Expense 35,000 $500,000 525,000 $500,000 10,000

30. Direct Method SCFExample: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004? So, Accrual exp. $500,000 + Decr. in pay. 25,000 = Cash paid $525,000 Salary Expense Salary Payable 35,000 $500,000 525,000 Cash paid $500,000 10,000

31. Direct MethodConverting Cost of Goods Sold to Cash Basis • Requires analysis of two balance sheet accounts: inventoryand accounts payable. • Can be computed as: + Increase or - Decrease in inventory and + Decrease or - Increase in accounts payable Cost of Goods Sold Expense Cash payments to suppliers

32. Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers? Inventory Cost of Gds Sold 20,000 12,000 10,000 Accounts Payable 13,000 13,600

33. Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers? Inventory Cost of Gds Sold 20,000 12,000 10,000 Accounts Payable 13,000 13,600 What increases and decreases each account?

34. Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers? Inventory Cost of Gds Sold Purchases on credit Inv. sold 20,000 12,000 10,000 Accounts Payable Purchases on credit 13,000 13,600

35. Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers? Inventory Cost of Gds Sold Purchases on credit Inv. sold 20,000 12,000 10,000 Accounts Payable Cash paid to suppliers Purchases on credit 13,000 13,600

36. Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers? Inventory Cost of Gds Sold Purchases on credit Inv. sold 20,000 12,000 20,000 10,000 Accounts Payable Cash paid to suppliers Purchases on credit 13,000 13,600

37. Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers? Inventory Cost of Gds Sold Purchases on credit Inv. sold 20,000 12,000 20,000 18,000 10,000 Accounts Payable Cash paid to suppliers Purchases on credit 13,000 18,000 13,600

38. Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers? Inventory Cost of Gds Sold Purchases on credit Inv. sold 20,000 12,000 20,000 18,000 10,000 Accounts Payable Cash paid to suppliers Purchases on credit 13,000 17,400 18,000 Cash paid 13,600

39. Direct Method Converting Deferrals to Cash Basis • Accounts like unearned revenue and prepaid insurance may cause the cash received or disbursed to be different from the revenue or expense shown on the income statement. • Cash for a deferred expense can be computed as: Expense Accrual Basis + Increase or - Decrease in related PREPAID = Expense, Cash Basis

40. Direct Method Converting Deferrals to Cash Basis • Accounts like unearned revenue and prepaid insurance may cause the cash received or disbursed to be different from the revenue or expense shown on the income statement. • Cash from an unearned revenue (deferred revenue) can be computed as: Revenue, Accrual Basis + Increase or - Decrease in Unearned rev. = Revenue, Cash Basis

41. Direct MethodExample: Suppose the Unearned Revenue account showed a beginning balance of $200 and an ending balance of $900. The income statement indicates that $1,200 is the amount of Revenue (earned) for the period. How much cash was collected for revenue (assuming A/R did not change)? Unearned RevenueRevenue

42. Direct MethodExample: What is cash-basis revenue?? Unearned Revenue 200 900 Revenue 1,200 1,200

43. Determine what causes increases and decreases to each account, and find the CASH! Unearned Revenue 200 1200 CASH 900 Revenue 1200 1200

44. Calculate the CASH! Unearned Revenue 200 1200 CASH 1900 900 Revenue 1200 1200

45. Calculate the CASH! Unearned Revenue 200 1200 CASH 1900 900 So, Accrual based Revenue $1,200 + Increase in Unearn.Rev. 700 = Cash collected from customers $1,900 Revenue 1200 1200

46. To summarize: • What kinds of accounts need to be examined to see if there is a difference between our accrual accounting records and actual cash? versus General Ledger

47. To summarize: • Accounts Receivable • Prepaids • Inventory • Accounts Payable • Other Payables All current assets (except cash) and current liabilities, related to operations, need to be examined in conjunction with related revenue and expense accounts.

48. Indirect Method • Net cash flows from operating activities are determined by . . . • Starting with net income, then . . . • Adding and subtracting items that reconcile net income to operating cash flows. • Requires an analysis of changes in all current asset and current liability accounts [related to operations], except cash.

49. Indirect Method: Conversion from Net Income to Net Cashflow from Operating Activities • Additions to net income: • Depreciation, depletion, and amortization. • All losses. • Decreases in current assets (other than cash). • Increases in current liabilities. • Deductions from net income: - All gains. - Increases in current assets (other than cash). - Decreases in current liabilities.

50. T-account approach • Set up a t-account for every balance sheet account • Put beginning and ending balances in the accounts, using comparative balance sheets • Make the CASH T-account a BIG one, with room for the three sections of the Statement of Cash Flows