The Statement of Cash Flows Revisited

1. The Statementof Cash Flows Revisited 21

2. Chapter 21 Statement of Cash Flows Revisited

3. 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

4. Short-term, highly liquid investments. So near maturity that there is insignificant risk of market value fluctuation from interest rate changes. Maturity of 3 months or less Cash and Cash Equivalents Cash Equivalents Resources immediately available to pay obligations.

5. Cash Equivalents Treasury bill 100,000 Cash 100,000 • Inflow or outflow of cash? • Neither – moves $100,000 from one cash account to another “cash” account

6. Cash flows from operating activities: Cash inflows: From customers $98 From investment revenue 3 Cash outflows: To suppliers of goods (50) To employees (11) For interest (3) For insurance (4) For income taxes (11) Net cash flows from operating activities $22 Cash flows from investing activities: Purchase of land ($30) Purchase of short-term investment (12) Sale of land 18 Sale of equipment 5 Net cash flows from investing activities (19) Cash flows from financing activities: Sale of common shares $26 Retirement of bonds payable (15) Payment of cash dividends (5) Net cash flows from financing activities 6 Net increase in cash $9 Cash balance, January 1 20 Cash balance, December 31 $29

7. Cash flows from operating activities are both inflows and outflows of cash that result from activities reported on the income statement. Cash Flows From Operating Activities

8. Income StatementCash Flows from Operating ActivitiesRevenues: Cash inflows: Sales and service revenue Cash received from customers Investment revenue Cash revenue received Noncash revenues and gains (e.g., gain on sale of assets) [Not reported]Less: Expenses:Less: Cash outflows:Cost of goods sold Cash paid to suppliers Salaries expense Cash paid to employees Noncash expenses and losses (depreciation, amortization, bad debts, loss on sale of assets) [Not reported] Interest expense Cash paid to creditors Other operating expenses Cash paid for expenses Income tax expense Cash paid to the governmentNet incomeNet cash flows from operating activities

9. CASH FLOWS FROM OPERATING ACTIVITIESDirect Method Cash flows from operating activities are the elements of net income, but reported on a cash basis. Cash flows from operating activities:Cash inflows: From customers $98 From investment revenue 3Cash outflows: To suppliers of goods (50) To employees (11) For interest (3) For insurance (4) For income taxes (11)Net cash flows from operating activities $22

10. CASH FLOWS FROM OPERATING ACTIVITIESIndirect Method Derived indirectly by starting with reported net income and working backwards to convert that amount to a cash basis. Cash flows from operating activities:Net income $12Adjustments for noncash effects: Gain on sale of land (8) Depreciation expense 3 Loss on sale of equipment 2Changes in operating assets and liabilities: Increase in accounts receivable (2) Decrease in inventory 4 Increase in accounts payable 6 Increase in salaries payable 2 Discount on bonds payable 2 Decrease in prepaid insurance 3 Decrease in income tax payable (2)Net cash flows from operating activities $22

11. CASH FLOWS FROM INVESTING ACTIVITIES Related to the acquisitionanddispositionof assets, other than (a) inventory and (b) assets classified as cash equivalents. Included in this classification are cash payments to acquire: Property, plant and equipment and other productive assets [except inventories]. Investments in securities [except cash equivalents]. Nontrade receivables. When these assets later are liquidated, any cash receipts from their disposition also are classified as investing activities. Cash Flows from Investing Activities: Purchase of land $(30) Purchase of short-term investments (12) Sale of land 18 Sale of equipment 5 Net cash flows from investing activities (19)

12. CASH FLOWS FROM FINANCING ACTIVITIES Inflows and outflows of cash resulting from the external financing of a business, including cash inflows from:  The sale of common and preferred stock  The issuance of bonds and other debt securities Subsequent transactions related to these financing transactions are also classified as financing activities, such as:  The repurchase of common or preferred stock (retirement or treasury stock)  The repayment of debt  The payment of cash dividends to shareholders Cash Flows from Financing Activities: Sale of common stock $26 Retirement of bonds payable (15) Payment of cash dividends (5)Net cash flows from financing activities 6

13. SignificantNoncash Activities Common noncash activities include: Retiring bonds by issuing stock. Acquiring an asset by issuing a note payable. Retiring debt by transferring noncash assets. Acquiring an asset by capital lease.

14. U.S. GAAP vs. IFRS Consistent with U.S. GAAP, cash flows are classified as operating, investing, or financing. Operating Activities Investing Activities Dividends Received Interest Received Financing Activities Dividends Paid Interest Paid • Operating Activities • Dividends Received • Interest Received • Interest Paid • Investing Activities • Financing Activities • Dividends Paid Typical Classification of Interest and Dividends

15. Predicting Cash Flows

16. Cash Flows from Operating Activities

17. Direct MethodAnalyzing Sales Revenue  We can compare sales and the change in accounts receivable to determine the amount of cash received from customers. This relationship can be viewed in T–account format as follows: Accounts Receivable _______________________________________ Beginning balance 30 Credit sales 100 ? Cash received (increases A/R) __________ (decreases A/R) Ending balance 32 Cash received from customers must have been $98million.

18. SUMMARY ENTRY FOR SALES AND COLLECTION ACTIVITIES Note that even if some of the year's sales were cash sales, say $40 million cash sales and $60 million credit sales, the result is the same: Accounts Receivable _______________________ Beg. bal. 30 Cash sales $40 Credit sales 60 58 Rec‘d on acct. 58 _______Cash rec‘d $98 Ending bal. 32 ($ in millions) EntryCash (received from customers) 98 Accounts receivable (given) 2 Sales revenue ($100 - 0) 100

19. Analyzing SalesReview Question Accounts Receivable was $40,000 on 1/1/11 and $52,000 on 12/31/11. If total sales revenue for 2011 was $800,000, then how much cash was received from customers? a. $800,000 b. $760,000 c. $812,000 d.$788,000 A/R increased $12,000 during 2011. Cash (received from customers) 788Accounts receivable 12 Sales revenue 800

20. { Cash Cost + Inventory Increase paid to of - Inventory Decrease Suppliers Goods + A/P Decrease Sold - A/P Increase = Cost of Goods Sold

21. Cost of Goods Sold  UBC sold goods that had cost $60 million. Inventory decreased by $4 million and accounts payable increased by $6 million. ($ in millions) Cost of goods sold 60 Inventory 4 Accounts payable 6 Cash (paid to suppliers) 50

22. Cost of Goods SoldReview Question • Determine how much was paid for inventory in 2011.Cost of goods sold $900,000 Inventory Jan. 1 $130,000 Dec. 31 $165,000Accts Pay. Jan. 1 $ 23,000 Dec. 31 $ 35,000 a. $900,000 b. $923,000 c. $947,000 d. $877,000

23. Cost of Goods SoldReview Question • Determine how much was paid for inventory in 2011.Cost of goods sold $900,000 Inventory Jan. 1 $130,000 Dec. 31 $165,000Accts Pay. Jan. 1 $ 23,000 Dec. 31 $ 35,000 a. $900,000 b. $923,000 c. $947,000 d. $877,000 Cost of goods sold 900,000Inventory 35,000 Accounts payable 12,000 Cash (paid to suppliers) 923,000 Cost of goods sold 900Inventory 35 Accounts payable 12 Cash (paid to suppliers) 923

24. { Cash paid to Salaries + Decrease in Payable Employees Expense - Increase in Payable = Direct MethodSalaries Expense • Cash paid to employees can be determined from the salaries expense. Salaries expense x Salaries payable x Salaries payable x Cash (paid to employees) ?

25. Salaries ExpenseQuestion Determine how much was paid to employees during 2011. Salaries expense $700,000 Salaries Pay. Jan. 1 $ 35,000 Dec. 31 $ 10,000 a. $700,000 b. $735,000 c. $725,000 d. $675,000 Salaries expense 700,000 Salaries payable 25,000 Cash (paid to employees) ?

26. Direct MethodEstimated Expenses Depreciation, Amortization, and Depletion Expenses • These are non-cash expenses. • They are not disclosed in the SCF using the direct method.

27. Depreciation  UBC’s income statement reports depreciation expense of $3 million. ($ in millions) Depreciation expense 3 Accumulated depreciation 3  Depreciation is a noncash expense. It is merely an allocation in the current period of a prior cash expenditure (for the depreciable asset).  Therefore, the depreciation entry has no effect on the statement of cash flows.

28. Bond Interest UBC’s bond interest expense is $5 million and $2 million of the bond discount was reduced in 2011. The entry that summarizes the recording of bond interest expense: ($ in millions) Bond interest expense 5 Discount on bonds 2 Cash (paid to bondholders) 3  If a premium were being reduced, rather than a discount, the cash outflow would be greater than the expense. ?

29. Insurance Expense UBC’s insurance expense was $7 million. Prepaid insurance decreased by $3 million indicating that cash paid for insurance coverage was $3 million less than the insurance expense for the year. ($ in millions) Insurance expense 7 Prepaid insurance 3 Cash (paid for insurance) 4 ?

30. Gains and Losses on Sale of Assets Land that originally cost $10 million was sold for $18 million: ($ in millions) Cash 18 Land 10 Gain on sale of land 8 The gain is simply the difference between cash received in the sale of land (reported as an investing activity) and the book value of the land. To report the $8 million gain as a cash flow from operating activities, in addition to reporting $18 million as a cash flow from investing activities, would be double counting.

31. LOSS ON SALE OF EQUIPMENT UBC sold equipment for $5 million that had cost $14 million and was half depreciated. ($ in millions) Cash (from sale of equipment) 5 Loss on sale of equipment 2 Accumulated depreciation ($14 x 50%) 7 Buildings and equipment (given) 14 The sale of equipment is an investing activity. Note: The loss is simply the difference between cash received in the sale of equipment (reported as an investing activity) and the book value of the equipment.

32. Now, let’s look at the Indirect Method for presenting the Cash Flows from Operating Activities section.

33. INDIRECT METHOD  By the indirect method, the net cash increase or decrease from operating activities is derived indirectly by starting with reported net income and "working backwards" to convert that amount to a cash basis. Net income $12Adjustments for noncash effects: Gain on sale of land (8) Depreciation expense 3 Loss on sale of equipment 2 Changes in operating assets or liabilities: Increase in accounts receivable (2) Decrease in inventory 4 Increase in accounts payable 6 Increase in salaries payable 2 Discount on bonds payable 2 Decrease in prepaid insurance 3 Decrease in income tax payable (2) Net cash flows from operating activities $22

34. Net Income Adjustments for Noncash Components

35. Some IS Items Don’t Affect Cash Cash Flows from Operating Activities INCOME STATEMENT INDIRECT METHOD DIRECT METHOD Net income $12 Adjustments :Sales $100 Investment rev. 3 Gain - sale of land 8 Gain - sale of land (8)[Not reported–no cash effect] Cost of goods sold (60) Salaries expense (13) Depreciation exp. (3) Depreciation exp. 3[Not reported – no cash effect] Interest exp. (5) Insurance exp. (7) Loss - sale of equip. (2) Loss - sale of equip. 2[Not reported – no cash effect]Income tax exp. (9)Net cash flows from Net cash flows from Net Income $ 12 operating activities operating activities No effect on Cash

36. Net Income Adjustments for Changes in Assets and Liabilities

37. Others Affect Cash, but by an Amount Different from the Expense Cash Flows from Operating Activities INCOME STATEMENT INDIRECT METHOD DIRECT METHOD Net income $12 Adjustments :Sales $100 Increase in A/R (2) Cash from customers $98Investment rev. 3 [No adjustment] Cash from investments 3 Gain - sale of land 8 Cost of goods sold (60) Decr. in inventory 4 Increase in A/P 6 Cash to suppliers (50)Salaries expense (13) Increase in sal. pay. 2 Cash to employees (11)Depreciation exp. (3) Interest exp. (5) Decr. in bond disc. 2 Cash for interest (3)Insurance exp. (7) Decr. in pre‘d ins. 3 Cash for insurance (4)Loss - sale of equip. (2) Income tax exp. (9) Decrease in I.Tax/P (2) Cash paid for taxes (11)Net cash flows from Net cash flows from Net Income $ 12 operating activities operating activities Convert from Accrual to Cash

38. COMPARISON OF DIRECT AND INDIRECT METHODS Cash Flows from Operating Activities INCOME STATEMENT INDIRECT METHOD DIRECT METHOD Net income $12 Adjustments :Sales $100 Increase in A/R (2) Cash from customers $98Investment rev. 3 [No adjustment] Cash from investments 3 Gain - sale of land 8 Gain - sale of land (8) [Not reported–no cash effect] Cost of goods sold (60) Decr. in inventory 4 Increase in A/P 6 Cash to suppliers (50)Salaries expense (13) Increase in sal. pay. 2 Cash to employees (11)Depreciation exp. (3) Depreciation exp. 3 [Not reported – no cash effect] Interest exp. (5) Decr. in bond disc. 2 Cash for interest (3)Insurance exp. (7) Decr. in pre‘d ins. 3 Cash for insurance (4)Loss - sale of equip. (2) Loss - sale of equip. 2 [Not reported – no cash effect]Income tax exp. (9) Decrease in I.Tax/P (2) Cash paid for taxes (11)Net cash flows from Net cash flows from Net Income $ 12 operating activities $22 operating activities $22

39. End of Chapter 21