Chapter 10 Statement of Cash Flows 1© Paradigm Publishing, Inc

Chapter 10

Statement of Cash Flows

1© Paradigm Publishing, Inc.

1. Discuss the nature and purpose of the statement of cash flows.

2. Distinguish between operating activities, investing activities, and financing activities.

3. Analyze and calculate the effects of operating activities on cash.

© Paradigm Publishing, Inc. 2

Learning Objectives

4. Analyze and calculate the effects of investing activities on cash.

5. Analyze and calculate the effects of financing activities on cash.

6. Prepare a statement of cash flows using the direct and indirect methods.


Learning Objectives

Discuss the nature and purpose of the statement of

cash flows


Learning Objective 1

The Importance of the Statement of Cash FlowsManaging cash flow is essential to the success of any business.



A financial statement primarily intended to provide information about the cash receipts and cash payments of a business during the period of time covered by the income statement

Provides users of financial statements with information that allows them to:

Observe reasons for changes in a company’s cash balance

Judge the company’s ability to pay its debts and to pay dividends to stockholders



Assess the company’s need to borrow money

Discover the reasons for differences between a company’s net income, cash payments, and cash receipts

Observe reasons for changes in a company’s financial position, including investment and borrowing activities, during an accounting period


Distinguish between operating activities, investing activities, and financing

activities



Classification of Cash Flows

Operating Activities

Transactions that enter into the calculation of net income

Investing Activities

Transactions involving the purchase and sale of long-term assets and transactions that involve making and collecting loans


Classification of Cash Flows

Financing Activities

Transactions that involve cash receipts or payments from changes in long-term liabilities and stockholders’ equity


Classification of Cash Receipts and Payments






Cash and Cash EquivalentsThe statement of cash flows should explain changes

incash and cash equivalents.

Cash

Currency and coin on hand and in the bank

Cash equivalent

A highly liquid, short-term investment that can easily be converted to cash


Cash and Cash Equivalents

Examples of cash equivalent include

• US government Treasury bills

• Money market investments

• Commercial paper


Methods of Preparing the Statement of Cash Flows

Two acceptable methods of preparing the statement of cash flows

Direct Method

Indirect Method

Both yield identical results

The only difference is in the way cash flows from operating activities is determined


The Direct Method

A format for preparing the statement of cash flows that discloses each major class of cash inflow and cash outflow from operating activities

Shows the amount of cash received or paid for revenues and expenses reported on the income statement

Recommended by the FASB


Steps in Preparing a Statement of Cash Flows1. Determine how much cash has changed.

2. Determine the cash provided (used) by operating activities.

3. Determine the cash provided (or used) by investing activities.

4. Determine the cash provided (or used) by financing activities.


Determine How Much Cash Has Changed


We can see the change in cash based on the comparative balance sheets for Ajax Company.





Determine How Much Cash Has ChangedWhy is it important to know how much cash has changed?


Analyze and calculate the effects of operating activities on

cash



Determine Cash Flows from Operating ActivitiesWe are interested in analyzing cash inflows and outflows relating to operating activities.


Cash Received from CustomersThe Combined Statement of Income and Retained Earnings for Ajax Company


Cash Received from Customers

The formula:

Looking at the income statement and referring back to the balance sheet for Ajax Company, we can see that cash received from customers amounted to $395,000.


Cash received fromcustomers

= Sales revenue+ Decrease in Accounts Receivable

– Increase in Accounts Receivableor

Quick Check

Gilbert Corporation reports credit sales of $300,000 on its income statement for the year ending December 31, 20X3. Accounts receivable on January 1, 20X3, amounted to $55,000 and $58,500 on December 31, 20X3. The amount of cash received from customers during 20X3 amounted to

a. $303,500.

b. $300,000.

c. $296,500.

d. $299,000.

e. $302,500.


Review Quiz 15-1

Klack Company had sales of $256,000 in 20X3, accounts receivable of $45,000 at the beginning of the year, and $51,000 at the end of the year. Calculate the amount of cash received from customers:


Cash received from customers:

Sales $256,000Increase in accounts receivable (6,000)

Total $250,000

Cash Received from Interest Income

The formula:

Looking at the income statement and referring back to the balance sheet for Ajax Company, we can see that cash received from interest income amounted to $4,000.


Cash received from interestincome

= Interest income+ Decrease in Interest Receivable

– Increase in Interest Receivableor

Cash Received from Dividends

The formula:

Looking at the income statement and referring back to the balance sheet for Ajax Company, we can see that cash received from dividends amounted to $3,000.


Cash received fromdividends

= Dividend income

+ Decrease in Dividends Receivable account

– Increase in Dividends Receivable account

or

Cash Paid for Inventory

The formula:

Looking at the income statement and referring back to the balance sheet for Ajax Company, we can see that cash paid for inventory amounts to $179,000.


Payments forinventory =

Cost of goods sold

Increase ininventory

Decrease ininventory

and

Decrease inAccounts Payable

Increase inAccounts Payable

+

–

+

–

or or

Quick Check

Gilbert Corporation reports cost of goods sold of $300,000 for the year ending December 31, 20X3. Accounts payable on January 1, 20X3, amounted to $55,000 and $58,500 on December 31, 20X3. Merchandise inventory on January 1, 20X3, amounted to $45,000 and $52,500 on December 31, 20X3. The amount of cash paid for inventory during 20X3 amounted to

a. $303,500.

b. $304,000.

c. $307,500.

d. $355,500.

e. $358,500.


Review Quiz 15-2

Klack Company reported cost of goods sold of $243,000 on its income statement. Klack’s balance sheet showed that Merchandise Inventory increased by $15,400 and Accounts Payable decreased by $14,000. Calculate the amount of cash paid for inventory:


Cash paid for inventory:

Cost of goods sold $243,000Increase in merchandise inventory

+15,400

Total $272,400

Decrease in accounts payable + 14,000

Cash Paid for Operating Expenses

The formula:

Looking at the income statement and referring back to the balance sheet for Ajax Company, we can see that cash paid for operating expenses amounts to $86,000.


Paymentsfor operatingexpenses

=

Operatingexpensesother thandepreciation

Increase inPrepaid Expenses

Decrease inPrepaid Expenses

and

Decrease inAccrued Liabilities

Increase inAccrued Liabilities

+

–

+

–

or or

Cash Paid for Interest

The formula:

Looking at the income statement and referring back to the balance sheet for Ajax Company, we can see that cash paid for interest expense amounts to $6,000.


Payment forinterest expense

= Interest expense+ Decrease in Interest Payable

– Increase in Interest Payable

or

Quick Check

Gilbert Corporation reports interest expense of $25,000 for the year ending December 31, 20X3. Interest payable on January 1, 20X3, amounted to $1,500 and $2,500 on December 31, 20X3. Cash paid for interest expense during 20X3 amounted to a. $25,000.

b. $26,500.

c. $27,500.

d. $23,500.

e. $24,000.


Cash Paid for Income Taxes

The formula:

Looking at the income statement and referring back to the balance sheet for Ajax Company, we can see that cash paid for income tax amounts to $30,050.


Payment forincome taxes

= Income taxes+ Decrease in Income Tax Payable

– Increase in Income Tax Payableor

Operating Activities Section of a Statement of Cash Flows


Review Quiz 15-3

Refer to the comparative balance sheet and combined income and retained earnings statement of West Company on page 978.Calculate the net cash flow from operating activities:


Cash received from customers:

Sales $256,000Increase in accounts receivable (10,000)

Total $246,000

Review Quiz 15-3

Calculate the net cash flow from operating activities: (Continued)


Cash paid for inventory:

Cost of goods sold $97,400Increase in merchandise inventory 5,000

Total $96,400

Decrease in accounts payable (6,000)

Review Quiz 15-3



Cash paid for operating expenses:Operating expenses other than dep. $71,000Increase in prepaid expenses 1,000

Total $71,800

Increase in accrued salaries payable (200)

Cash paid for interest $2,500

Cash paid for income taxes$14,464

Review Quiz 15-3



Cash flows from operating activities:

Cash received from customers $246,000Cash paid for inventory (96,400)

Net cash inflow from operating activities $60,836

Cash paid for operating expenses (71,800)

Summary

Cash paid for interest (2,500)Cash paid for income taxes (14,464)

Analyze and calculate the effects of investing activities on cash



Determine Cash Flows from Investing ActivitiesWe are interested in analyzing cash inflows and outflows relating to investing activities.


Determine Cash Flows from Investing Activities

Referring back to the balance sheet for Ajax Company, we can see Ajax made a $60,000 purchase of the stock of Cramer Company.

We can also see the Plant Assets section shows a $50,000 increase in the Land account.

The purchase of the stock and the land are both investing activities.


Investing Activities Section of a Statement of Cash Flows


Review Quiz 15-4

Using the financial statements of West Company in Review Quiz 22-3, prepare the Cash Flows from Investing Activities section of West’s statement of cash flows:


Cash flows from investing activities:Cash paid for purchase of equipment $(2,000)Net cash outflow from investing

activities $(2,000)

Analyze and calculate the effects of financing activities on cash



Determine Cash Flows from Financing Activities


Determine Cash Flows from Financing ActivitiesWe are interested in analyzing cash inflows and outflows relating to financing activities.



Referring back to the balance sheet and the combined income and retained earnings statement for Ajax Company, we can see Ajax has several items that involve the flow of cash from financing activities.

The Liabilities section of the balance sheet reveals that a $40,000 note payable was paid and that bonds payable of $100,000 were issued.



The Stockholders’ Equity section of the balance sheet shows an increase of $44,050, representing stock issued during the year.

Referring to the combined income and retained earnings statement, we see dividends of $11,000 were paid to stockholders.


Financing Activities Section of a Statement of Cash Flows


Financing Activities Section of a Statement of Cash Flows


Review Quiz 15-5

Using the financial statements presented for West Company in Review Quiz 22-3, determine the net cash outflow (or inflow) from financing activities:


Cash flows from financing activities:

Cash received from sale of stock $ 3,964Cash paid for notes payable (20,000)

Net cash outflow from financing activities $(33,836)

Cash paid for dividends (17,800)

Schedule of Noncash Investing and Financing ActivitiesSome investing and financing activities do not involve cash but do represent a significant change in the financial position of the company.


Example

Schedule of Noncash Investing and Financing Activities

Assume Sawyer Company purchased a building by issuing a mortgage note payable for $500,000 on Mar. 10, 20X6.Sawyer prepared the following journal entry:


20X6Mar. 10 Building 500,000

Mortgage Note Payable 500,000

Example

Schedule of Noncash Investing and Financing Activities

This transaction would appear at the bottom of the statement of cash flows as shown below:


Prepare a statement of cash flows using the direct and indirect methods



Preparing a Statement of Cash Flows—The Indirect Method

Provides less information because it does not disclose the individual cash inflows and outflows from operating activities

A format that adjusts the net income figure in order to calculate net cash flows from operating activities


Steps in Using the Indirect MethodWe start out with net income and make the following adjustments:


1. Add depreciation expense.

2. Subtract an increase in current assets other than cash.

3. Add a decrease in current assets other than cash.

4. Add an increase in current liabilities.

5. Subtract a decrease in current liabilities.

Preparing the Operating Activities Using the Indirect MethodReferring to the balance sheet and the combined income and retained earnings statement for Ajax Company, we can prepare the operating activities of the statement of cash flows using the indirect method.


Statement of Cash Flows Statement-Indirect Method


Statement of Cash Flows Statement-Indirect Method


Quick Check

Gilbert Corporation reports net income of $85,000 for the year ending December 31, 20X3. Included in the calculation of net income is depreciation expense of $5,200. Accounts receivable increased $500 and accounts payable decreased $1,200. Cash flows provided by operating activities for 20X3 amount to a. $85,000.

b. $90,200.

c. $88,500.

d. $89,500.

e. $81,500.© Paradigm Publishing, Inc. 65

Review Quiz 15-6

Using the financial statements presented for West Company in Review Quiz 22-3, prepare the Cash Flows from Operating Activities section of the statement of cash flows using the indirect method:


Cash flows from financing activities:

Add depreciation expense 8,000Subtract increase in accounts receivable (10,000)

Net cash inflow from operating activities $60,836

Subtract increase in merchandise inventory(5,000

)Subtract increase in prepaid expenses (1,000)Add increase in accounts payable 6,000

Net income $62,636

Add increase in accrued salaries payable 200

Auditors are supposed to be independent in fact and in appearance. How was this concept violated by Arthur Andersen?

Focus on Ethics


Refer to the Focus on Ethics box on page 985 in your text.

Cash Inflows and Outflows


Joining the Pieces



Joining the Pieces



Joining the Pieces

Documents

Chapter 10 Statement of Cash Flows 1© Paradigm Publishing, Inc