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Purpose of the Statement of Cash Flows

Purpose of the Statement of Cash Flows. Explains changes in cash over a period of time Summarizes cash inflows and outflows from:. Financing Activities. Operating Activities. Investing Activities. LO1. Cash Equivalents. Readily convertible to cash Little risk of price change

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Purpose of the Statement of Cash Flows

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  1. Purpose of the Statement of Cash Flows • Explains changes in cash over a period of time • Summarizes cash inflows and outflows from: Financing Activities Operating Activities Investing Activities LO1

  2. Cash Equivalents • Readily convertible to cash • Little risk of price change • Original maturity to investor of three months or less • Examples: • Commercial paper • U.S. Treasury bills • Certain money market funds LO2

  3. outflows Statement of Cash Flows Format Cash Classified by: Operating activities Investing activities Financing activities inflows = +Beginning Cash and Cash Equivalents = Ending Cash and Cash Equivalents Increase or decrease in cash and cash equivalents LO3

  4. from balance sheets Statement of Cash Flows Format Cash flows from operating activities: Inflows $ xxx Outflows (xxx) Net cash provided (used) by operating activities $ xxx Cash flows from investing activities: Inflows $ xxx Outflows (xxx) Net cash provided (used) by investing activitiesxxx Cash flows from financing activities: Inflows $ xxx Outflows (xxx) Net cash provided (used) by financing activities xxx Net increase (decrease) in cash and cash equivalents $xxx Cash and cash equivalents at beginning of year xxx Cash and cash equivalents at end of year $xxx

  5. Operating Activities Collection of customer accounts Payment to suppliers for inventory Cash transactions concerned with acquiring and selling products and services Payment of wages Payment of taxes

  6. Investing Activities Cash transactions concerned with acquiring and disposing of long-term assets Capital expenditures Purchase/sale of another company Sale of property, plant, and equipment

  7. Financing Activities Issuance/repayment of bank note Issuance/repurchase of stock Cash transactions concerned with the raising and repayment of funds in the form of debt and equity Issuance/retirement of bonds Payment of dividends

  8. Operating Activities Investing Activities Long-term liabilities or stockholders’ equity Long-term assets Financing Activities Categorizing Cash Flow Activities Current assets and current liabilities

  9. Noncash Investing and Financing Activities Disclose important financing and investing activities which do not require cash Exchange stock for assets Buy assets through debt financing from supplier

  10. Methods to Report Cash from Operating Activities • Direct Method • Reports major classes of gross cash receipts and cash payments The amount of cash provided by operating activities is the same under both methods • Indirect Method • Adjusts net income to remove the effect of all accruals and deferrals LO4

  11. Statement of Cash Flows Format Cash flows from operating activities: Inflows $ xxx Outflows (xxx) Net cash provided (used) by operating activities $xxx Cash flows from investing activities: Inflows $ xxx Outflows (xxx) Net cash provided (used) by investing activitiesxxx Cash flows from financing activities: Inflows $ xxx Outflows (xxx) Net cash provided (used) by financing activities xxx Net increase (decrease) in cash and cash equivalents $xxx Cash and cash equivalents at beginning of year xxx Cash and cash equivalents at end of year $xxx Only section of statement that differs in form between direct and indirect method (net cash flow total is the same)

  12. Preparing the Statement Cash Flows: Direct Method • Step 1: Set up three master T accounts Cash Flows from Operating Activities Cash Flows from Investing Activities Cash Flows from Financing Activities • Step 2: Determine the cash flows from operating activities LO5

  13. Direct Method: Operating Activities Review journal entries recorded during period: Accounts Receivable 670,000 Sales Revenue* 670,000 To record sales on account. *from income statement Accounts Receivable From Balance Sheet Bal., Jan. 1 57,000 Sales on account 670,000 Bal., Dec. 31 63,000 664,000 Cash collections

  14. Direct Method: Operating Activities Review journal entries recorded during period: Cost of goods sold* 390,000 Inventory 390,000 To record cost of goods sold. *from income statement Inventory From Balance Sheet Bal., Jan. 1 92,000 390,000 Cost of goods sold Bal., Dec. 31 84,000 Purchases on account 382,000

  15. Accounts Payable From Balance Sheet 31,000 Bal., Jan. 1 Cash payments 375,000 38,000 Bal., Dec. 31 Direct Method: Operating Activities Review journal entries recorded during period: Accounts Payable 375,000 Cash 375,000 To record cash payments on account. 382,000 Purchases

  16. Direct Method: Operating Activities From Balance Sheet Salaries and Wages Payable 9,000 Bal., Jan. 1 Cash payments 62,000 7,000 Bal., Dec. 31 Review journal entries recorded during period: Salaries and Wages Payable 62,000 Cash 62,000 To record cash paid to employees. 60,000 New unpaid wages

  17. Direct Method: Operating Activities Review journal entries recorded during period: Depreciation Expense 40,000 Accumulated Depreciation 40,000 To record depreciation. There is no effect on cash flow from depreciation.

  18. Prepaid Insurance From Balance Sheet Bal., Jan. 1 18,000 Cash payments 6,000 Bal., Dec. 31 12,000 Direct Method: Operating Activities Review journal entries recorded during period: Prepaid Insurance 6,000 Cash 6,000 To record cash paid for insurance. 12,000 Expense

  19. Master T Account for Cash Flows from Operating Activities Cash Flows from Operating Activities Cash receipts from: Cash payments for: 375,000 Inventory purchases 62,000 Salaries and wages 6,000 Insurance 15,000 Interest 47,000 Taxes Sales on account 664,000 Interest 15,000 Net cash inflows174,000

  20. Preparing the Statement of Cash Flows: Direct Method • Step 3: Determine the cash flows from investing activities

  21. From Balance Sheet Long-Term Investments Bal., Jan. 1 90,000 Cash payments 30,000 Bal., Dec. 31 120,000 Direct Method: Investing Activities Review journal entries recorded during period: Long-Term Investments 30,000 Cash 30,000 To record purchase of investments.

  22. Direct Method: Investing Activities Review journal entries recorded during period: Land 50,000 Notes Payable 50,000 To record acquisition of land in exchange for note. No cash was involved in this transaction so it should be reported in a separate schedule instead of directly on the statement of cash flows.

  23. From Balance Sheet Property and Equipment Bal., Jan. 1 280,000 Acquisitions 75,000 Bal., Dec. 31 320,000 Direct Method: Investing Activities Review journal entries recorded during period: Property and equipment 75,000 Cash 75,000 To record acquisition of equipment for cash. Disposals 35,000

  24. From Balance Sheet Accumulated Depreciation 75,000 Bal., Jan. 1 100,000 Bal., Dec. 31 Direct Method: Investing Activities Book value of equipment sold was $20,000. Original cost of equipment was $35,000. Disposals 15,000 40,000 Depreciation Exp.

  25. Master T Account for Cash Flows from Investing Activities Cash Flows from Investing Activities Cash receipts from: Cash payments for: Sale of machine 25,000 30,000 Purchase of investments 75,000 Purchase of property and equipment 80,000 Net cash outflows

  26. Preparing the Statement of Cash Flows: Direct Method • Step 4: Determine the cash flows from financing activities

  27. Direct Method: Financing Activities Review journal entries recorded during period: Land 50,000 Notes Payable 50,000 To record acquisition of land in exchange for note. No cash was involved in this transaction so it should be reported in a separate schedule instead of directly on the statement of cash flows.

  28. Direct Method: Financing Activities Review journal entries recorded during period: Loss on Retirement of Bonds (Retained Earnings) 3,000 Bonds Payable 60,000 Cash 63,000 To record retirement of bonds. From Balance Sheet Bonds Payable 260,000 Bal., Jan. 1 Retirement 60,000 200,000 Bal., Dec. 31

  29. Direct Method: Financing Activities From Balance Sheet Capital Stock 75,000 Bal., Jan. 1 25,000 Stock issued 100,000 Bal., Dec. 31 Review journal entries recorded during period: Cash 25,000 Capital Stock 25,000 To record issuance of stock in exchange for cash.

  30. Direct Method: Financing Activities From Balance Sheet Retained Earnings 193,000 Bal., Jan. 1 Cash dividends 67,000 246,000 Bal., Dec. 31 Review journal entries recorded during period: Retained Earnings 67,000 Cash 67,000 To record cash dividends paid. 120,000 Net income 2012

  31. Master T Account for Cash Flows from Financing Activities Cash Flows from Financing Activities Cash receipts from: Cash payments for: 63,000 Retirement of bonds 67,000 Payment of cash dividends Issuance of stock 25,000 105,000 Net cash outflows

  32. Indirect Method: Operating Activities Income Statement Conversion of accrual to cash basis Cash Flows from Operating Activities LO6

  33. Accounts Receivable Bal. Jan. 1 57,000 Decrease $6,000 Bal. Dec. 31 63,000 Indirect Method: Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Net increase 6,000

  34. Inventory Bal. Jan. 1 92,000 Bal. Dec. 31 84,000 Increase $8,000 Indirect Method: Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 8,000 Net decrease

  35. Accounts Payable 31,000 Bal. Jan. 1 Increase $7,000 38,000 Bal. Dec. 31 Indirect Method: Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 7,000 Net increase

  36. Salaries and Wages Payable 9,000 Bal. Jan. 1 Increase $2,000 7,000 Bal. Dec. 31 Indirect Method: Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries and wages payable (2,000) Net decrease 2,000

  37. Prepaid Insurance Bal. Jan. 1 18,000 Bal. Dec. 31 12,000 Decrease $6,000 Indirect Method: Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries and wages payable (2,000) Decrease in prepaid insurance 6,000 6,000 Net decrease

  38. Income Taxes Payable 5,000 Bal. Jan. 1 Increase $3,000 8,000 Bal. Dec. 31 Indirect Method: Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries and wages payable (2,000) Decrease in prepaid insurance 6,000 Increase in income taxes payable 3,000 3,000 Net increase

  39. Report entire outflow as a financing activity Add back noncash expense Gain is not part of operating activities Indirect Method: Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries and wages payable (2,000) Decrease in prepaid insurance 6,000 Increase in income taxes payable 3,000 Gain on sale of machine (5,000) Depreciation expense 40,000 Loss on retirement of bonds 3,000

  40. Cash Flow Adequacy • Measures company’s ability to meet principal and interest obligations • Creditors concerned with cash available to repay debts after company has replaced and updated its existing base of long-term assets Cash Flow from Operating Activities – Capital Expenditures Average Amount of Debt Maturing over Next Five Years LO7

  41. Appendix Accounting Tools: A Work-Sheet Approach to the Statement of Cash Flows

  42. Indirect Method: Using a Work Sheet 12/31/12 12/31/11 Enter account balances LO8

  43. Indirect Method: Using a Work Sheet Record investing and financing activities 12/31/12 12/31/11

  44. Indirect Method: Using a Work Sheet 12/31/12 12/31/11 Enter net income

  45. Indirect Method: Using a Work Sheet 12/31/12 12/31/11 Enter noncash revenues or expenses

  46. Indirect Method: Using a Work Sheet 12/31/12 12/31/11 Extend current assets and current liabilities

  47. Indirect Method: Using a Work Sheet 12/31/12 12/31/11 Total columns

  48. Indirect Method: Using a Work Sheet 12/31/12 12/31/11 Determine net cash inflow (outflow)

  49. End of Chapter 12

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