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Statement of Cash Flows: Purposes, Reporting, and Preparation Methods

This chapter explores the purposes of the statement of cash flows, reporting cash flows from operating, investing, and financing activities, and the preparation methods. Learn how to calculate the cash effect of various business transactions and summarize supplementary disclosures.

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Statement of Cash Flows: Purposes, Reporting, and Preparation Methods

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  1. The Statement of Cash Flows Chapter 18 HORNGREN ♦ HARRISON ♦ BAMBER ♦ BEST ♦ FRASER ♦ WILLETT

  2. Objectives 1. Identify the purposes of the statement of cash flows. 2. Report cash flows from operating, investing and financing activities 3. Prepare a statement of cash flows by the indirect method 4. Calculate the cash effect of a wide variety of business transactions 5. Prepare a statement of cash flows by the direct method 6. Summarise supplementary disclosures required by accounting standards

  3. Purpose of The Statement ofCash Flows: Basic Concepts The statement of cash flows reports the entity’s cash flows (cash receipts and cash payments) during the period.

  4. Identify the purposes of the statement of cash flows. Objective 1

  5. Purposes of the Statementof Cash Flows 30/6/03 For the Year Ended 30/6/04 30/6/04 (a point in time) (a period of time) (a point in time) Statement of Financial Performance Statement of Financial Position Statement of Financial Position Statement of Cash Flows

  6. Purposes of the Statementof Cash Flows • The statement of cash flows is designed to fulfill the following: • predict future cash flows • evaluate management decisions • determine the ability to pay dividends plus interest and principal • show the relationship of net profit to changes in the firm’s cash

  7. Cash Balance Includes... • cash on hand. • cash in the bank. • cash equivalents.

  8. Cash Equivalents Are.... • short-term, liquid investments convertible into cash with little delay. • money market accounts. • Government bills (debentures)

  9. Report cash flows from operating,investing, and financing activities. Objective 2

  10. Basic Organization of theStatement of Cash Flows • A business may be evaluated in terms of three types of business activities: • Operating activities • Investing activities • Financing activities

  11. Operating Activities Operating activities are related to the transactions that make up net profit. Interest and dividends received are related to investing activities. However, the AASB has decided to classify the cash received from these items as operating activities.

  12. Investing Activities Investing activities increase and decrease the assets that are available to the business. Investing activities are related to the Long-term (Non-current) Asset accounts.

  13. Financing Activities These are transactions involving obtaining resources from the owners or returning resources to them. It also involves obtaining resources from long-term liabilities – creditors and repaying the amount borrowed.

  14. Format of the Statementof Cash Flows • The direct method lists cash receipts from specific operating activities and cash payments for each major operating activity. • The indirect method is a short-cut method for accrual systems.

  15. Prepare a statement of cash flows by the direct method. Objective 3

  16. The Direct Method(Exhibit 18-5) Statement of Cash Flows (DirectMethod) Year Ended June 30, 2004 (Thousands) Cash flows from operating activities: Receipts: Collections from customers $271 Interest received on bill receivable 10 Dividends received on investments in stock 9 Total receipts $290

  17. The Direct Method Statement of Cash Flows (DirectMethod) Year Ended June 30, 2004 (Thousands) Payments: To suppliers $133 To employees 58 For interest 16 For income tax 15 Total payments 222 Net cash inflows from operating activities $ 68

  18. The Direct Method Statement of Cash Flows (DirectMethod) Year Ended June 30, 2004 (Thousands) Cash flows from investing activities: Acquisition of non-current assets $(306) Loan to another company (11) Proceeds from sale of non-current assets 62 Net cash outflow from investing activities $(255)

  19. The Direct Method Statement of Cash Flows (DirectMethod) Year Ended June 30 2004 (Thousands) Cash flows from financing activities: Proceeds from issue of ordinary shares $101 Proceeds from issue of debentures 94 Payment of long-term bills payable (11) Payment of dividends (17) Net cash inflow from financing activities $167

  20. The Direct Method Statement of Cash Flows (DirectMethod) Year Ended June 30, 2004 (Thousands) Net cash inflows from operating activities $ 68 Net Cash outflow from investing activities (255) Net Cash inflow from financing activities 167 Net (decrease in cash) $(20) Cash balance, June 30, 2003 42 Cash balance, June 30, 2004 $ 22

  21. Calculate the cash effects of a wide variety of business transactions. Objective 4

  22. Calculate Individual Amounts for the Statement of Cash Flows Revenues or expenses from the Statement of Financial Performance + – Adjusted for the change in the related Statement of Financial Position account(s) = Amount for the Statement of Cash Flows

  23. Calculate Individual Amounts for the Statement of Cash Flows Statement of Financial Performance Year Ended June 30, 2004 (Thousands) (Exhibit 18-6) Revenues and gains: Sales revenue $284 Interest revenue 12 Dividend revenue 9 Gain on sale of plant assets 8 Total revenues and gains $313

  24. Calculate Individual Amounts for the Statement of Cash Flows Expenses: Cost of goods sold $150 Salary expense 56 Depreciation expense 18 Interest expense 16 Other operating expense 17 Total expenses $257

  25. Calculate Individual Amounts for the Statement of Cash Flows Statement of Financial Performance Year Ended June 30, 2004 (Thousands) Total revenues and gains $313 Total expenses 257 Net profits before tax 56 Less income tax expense 15 Net profit after tax $ 41

  26. Comparative Balance Sheets(Exhibit 18-7) Assets 2004 2003 Inc./(Dec.) Current: Cash $ 22 $ 42 $ (20) Accounts receivable 93 80 13 Interest receivable 3 1 2 Inventory 135 138 (3) Prepaid expenses 8 7 1 Long-term receivable 11 – 11 Plant, etc net 453 219 234 Total assets $725 $487 $238

  27. Comparative Balance Sheets Liabilities 2004 2003 Inc./(Dec.) Current: Accounts payable $ 91 $ 57 $ 34 Salary payable 4 6 (2) Accrued liabilities 1 3 (2) Long-term bills payable 160 77 83 Shareholders’ equity: Ordinary shares 359 258 101 Retained earnings 110 86 24 Total liabilities and shareholders’ equity $725 $487 $238

  28. Calculating Cash Collectionsfrom Customers • Collections can be calculated by converting sales revenue to the cash basis. • Beginning Accounts Receivable balance + Sales on account – Collections = Ending Accounts Receivable balance

  29. Calculating Cash Collectionsfrom Customers • $80,000 + $284,000 – 93,000 = $271,000 • Because Accounts Receivable increased by $13,000, the business received $13,000 less cash than its sales revenue for the period. • All collections of receivables are computed following the pattern illustrated for collections from customers.

  30. Calculating Paymentsto Suppliers • This calculation includes two parts, payments for inventory and payments forexpenses other than interest and income tax. • Payments for inventory are calculated by converting cost of goods sold to the cash basis. • This is accomplished by analysing the Inventory and Accounts Payable accounts.

  31. Payments for Inventory Inventory Beg. inventory 138,000 Cost of goods sold 150,000 Purchases X End. inventory 135,000

  32. Payments for Inventory • How much were the purchases? • $138,000 + X – $150,000 = $135,000 • X = $135,000 – $138,000 + $150,000 • X = $147,000

  33. Payments for Inventory Accounts Payable Beg. balance 57,000 Payments for inventory Y Purchases 147,000 End. balance 91,000

  34. Payments for Inventory • How much did the business pay for this inventory? • $57,000 + $147,000 – Y = $91,000 • Y = $57,000 + $147,000 – $91,000 • Y = $113,000

  35. Payments for Operating Expenses • Increases in prepaid expenses require cash payments, and decreases indicate that payments were less than expenses. • Decreases in accrued liabilities can occur only from cash payments, and increases mean that cash was not paid.

  36. Payments to Employees • Salary Payable was $6,000 at the beginning of the year and $4,000 at year end. • During the year Salary and Wages Expense was $56,000. • How much did the business pay? • $58,000

  37. Acquisition and Salesof Non-current Assets • The business had non-current assets net of depreciation of $219,000 at the beginning of the year and $453,000 at year end. • Further, the acquisition of non-current assets amounted to $306,000 during the year.

  38. Acquisition and Salesof Non-current Assets • The statement of financial performance shows depreciation expense of $18,000 and a $8,000 gain on sale of plant assets. • What is the book value of the assets sold? • Beginning net balance + Acquisitions – Depreciation – Book value of assets sold = Ending balance

  39. Acquisition and Salesof Non-current Assets • $219,000 + $306,000 – $18,000 – Z = $453,000 • Z = $219,000 + $306,000 – $18,000 – $453,000 • Z = $54,000 (book value) • How much are the proceeds from the sale of plant assets?

  40. Acquisition and Salesof Non-current Assets • Book value + Gain or – Loss = Proceeds • $54,000 + $8,000 = $62,000 • How do we determine acquisitions? • Beginning net balance + Acquisitions – Depreciation – Book value of assets sold = Ending balance

  41. Calculating the Cash Amountsof Financing Activities • Financing activities affect liability and stockholders’ equity accounts. • Bills Payable • Debentures Payable • Long-Term Debt • Common Stock • Paid-in Capital • Retained Earnings

  42. Issue and Payments ofLong-Term Bills Payable • Beginning balance was $77,000. • New debt amounting to $94,000 was issued during the year. • The ending balance for the Long-Term Bills Payable account was $160,000. • How much was the payment? • $11,000

  43. Issue and Buy-back of Shares • Beginning balance was $258,000. • New shares issued during the year $101,000. • Minus any buy-backs (in this case zero). • Equals the closing balance.

  44. Calculating Dividend Payments • Dividend payments are calculated by analysing the Dividends Payable account. • Beginning balance + Dividends declared – Dividend payments = Ending balance

  45. Prepare a statement of cash flows by the indirect method. Objective 5

  46. Format of the Statementof Cash Flows • AASB 1026 requires statements of cash flows to be prepared by the direct method. • So why do we look at the indirect method? • Aids our understanding of cash flows. • The information calculated using the indirect method is required to be disclosed as supplementary information. • We don’t know what the new international standards will require.

  47. The Indirect Method Current Assets Add to Net Profit if this account has decreased Deduct from Net Profit if this account has increased

  48. The Indirect Method Current Liabilities Add to Net Profit if this account has increased Deduct from Net Profit if this account has decreased

  49. The Indirect Method(Exhibit 18-12) Statement of Cash Flows (IndirectMethod) Year Ended June 30, 2004 (Thousands) Cash flows from operating activities: Net Profit $41 Add (deduct) items that affect net profits and cash flows differently: Depreciation 18 Gain on sale of non-current 8 Increase in accounts receivable (13) Increase in interest receivable (2) Decrease in inventory 3

  50. The Indirect Method Statement of Cash Flows (IndirectMethod) Year Ended June 30, 2004 (Thousands) Add (deduct) items that affect net profit and cash flows differently: Increase in prepaid expenses (1) Increase in accounts payable 34 Decrease is salary payable (2) Decrease in accrued liabilities (2) Net cash inflow from operating activities $ 68

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