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Prepared by: Jan Hájek
Accounting 2
Lecture no 1
PURPOSE OF THE PURPOSE OF THE CASH FLOW STATEMENTCASH FLOW STATEMENT
PURPOSE OF THE PURPOSE OF THE CASH FLOW STATEMENTCASH FLOW STATEMENT
The primary purpose of the cash flow statement is to provide information about the cash receipts and cash payments of an entity during a period.
A secondary objective is to provide information about its
Operating activitiesInvesting activitiesFinancing activities
3
Related Standards FAS 95 Statement of cash flows FAS 102 Statement of cash flows—exemption of
certain enterprises and classification of cash flows from certain securities acquired for resale
FAS 104 Statement of cash flows—net reporting of certain cash receipts and cash payments and classification of cash flows from hedging transactions
4
Related Standards
IAS 1 Presentation of financial statements
5
IAS 7 - Overview Objective and scope Cash flows Reporting operating cash flows Reporting investing cash flows Reporting financing cash flows Specific items Disclosures
6
IAS 7 – Objective and Scope IAS 7 objective: to provide a statement to help
investors assess the prospects for future cash flows, and to confirm or change their past expectations
Statement provides historical information on the entity’s operating, investing and financing cash flows and how its cash balances have changed in the period as a result
7
IAS 7 – Cash Flows Cash and cash equivalents:
Cash on hand and on deposit and “short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value”
Can include bank overdrafts if part of cash management activities and balance fluctuates between positive and negative amounts
MEANING OF CASH FLOWSMEANING OF CASH FLOWSMEANING OF CASH FLOWSMEANING OF CASH FLOWS
The cash flow statement is usually prepared using cash and cash equivalents as its basis.
Cash equivalents are short-term, highly liquid investments that are both1. readily convertible to known amounts of cash, and2. so near to their maturity that their market value is relatively insensitive to changes in interest rates.
CLASSIFICATION OF CASH FLOWSCLASSIFICATION OF CASH FLOWSCLASSIFICATION OF CASH FLOWSCLASSIFICATION OF CASH FLOWS
Operating activities Investing activities Financing activities
IncludeCash effects of transactions that create
revenues and expenses andEnter into determination of net income
(loss)
OPERATING ACTIVITIES
Balance Sheet: Noncash Current Assets and Current Liabilities;
Income Statement Items
IncludePurchasing and disposing of
investments and productive long-lived assets using cash and
Lending money and collecting the loans
Balance Sheet: Investment and Long-Term Asset Items
INVESTING ACTIVITIES
IncludeObtaining cash from issuing debt and
repaying the amounts borrowed and Obtaining cash from
owners/shareholders and paying them drawings/dividends
FINANCING ACTIVITIES
Balance Sheet: Long-Term Liability and Equity Items
If it does not affect cash, do NOT report in body of cash flow statement
Report in separate note to the financial statements
SIGNIFICANT NONCASH ACTIVITIES
Operating, investing, and financing plus the significant noncash investing and financing activities constitute the general format of the cash flow statement, an example of which is shown on the right.
FORMAT OF CASH FLOW STATEMENTFORMAT OF CASH FLOW STATEMENTFORMAT OF CASH FLOW STATEMENTFORMAT OF CASH FLOW STATEMENT
COMPANY NAMECash Flow Statement
Period CoveredCash flows from operating activities
(List of individual items) XXNet cash provided (used) by operating activities
XXXCash flows from investing activities
(List of individual items) XXNet cash provided (used) by investing activities
XXXCash flows from financing activities
(List of individual items) XXNet cash provided (used) by financing activities
XXXNet increase (decrease) in cash
XXXCash at beginning of period
XXXCash at end of period
XXX
Note x:Noncash investing and financing activities
(List of significant noncash transactions)XXX
PREPARING PREPARING THE CASH FLOW STATEMENTTHE CASH FLOW STATEMENT
PREPARING PREPARING THE CASH FLOW STATEMENTTHE CASH FLOW STATEMENT
The cash flow statement is prepared differently from the three other basic financial statements.1. It is not prepared from the adjusted trial balance.2. The cash flow statement deals with cash receipts and payments, so the accrual concept is not used in the preparation of this statement. The information to prepare this statement usually comes from three sources:1. Comparative balance sheet2. Current income statement3. Additional information
THREE MAJOR STEPS IN PREPARING THREE MAJOR STEPS IN PREPARING THE CASH FLOW STATEMENTTHE CASH FLOW STATEMENT
THREE MAJOR STEPS IN PREPARING THREE MAJOR STEPS IN PREPARING THE CASH FLOW STATEMENTTHE CASH FLOW STATEMENT
+ or -The difference between the beginning and ending cash balances can be easily calculated from comparative balance sheets.
The difference between the beginning and ending cash balances can be easily calculated from comparative balance sheets.
This step involves analysing not only the current year’s income statement but also comparative balance sheets and selected additional data.
This step involves analysing not only the current year’s income statement but also comparative balance sheets and selected additional data.
XYZ Goods
This step involves analysing comparative balance sheet data and selected additional information for their effects on cash.
This step involves analysing comparative balance sheet data and selected additional information for their effects on cash.
For Sale Investing Financing
Step 1: Determine the net increase (decrease) in cash.
Step 2: Determine net cash provided (used) by operating activities.
Step 3: Determine net cash provided (used) by investing and financing activities.
STEP 1: DETERMINE NET INCOME (DECREASE) IN CASH
STEP 2: DETERMINE NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES
Net income must be converted from an accrual basis to a cash basis in the operating activities section
Conversion may be done by two methods:Indirect (used extensively in
practice)Direct
INDIRECT AND DIRECT METHODS Both methods arrive at the same total
amount of cash provided (used) by operating activities
Methods differ in disclosing the items that make up the total amount
Choice of section; the investing and finamethods affects only the operating activities ncing activities sections are the same
OPERATING ACTIVITIES – INDIRECT METHOD
Section 1Section 1
NET INCOME VS. NET CASH PROVIDED NET INCOME VS. NET CASH PROVIDED BY OPERATING ACTIVITIESBY OPERATING ACTIVITIES
NET INCOME VS. NET CASH PROVIDED NET INCOME VS. NET CASH PROVIDED BY OPERATING ACTIVITIESBY OPERATING ACTIVITIES
The indirect method starts with net income and converts it to net cash provided by operating activities. In other words, it adjusts net income for items that affect reported net income but do not affect cash, as shown below.
Earned Revenues
Net Income
Incurred Expenses
Accrual Basis of Accounting Cash Basis of Accounting
Net Cash Provided (Used) by Operating
Activities
Eliminate noncash revenues
Eliminate noncash expenses
NET INCOME TO NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES(B/S: Noncash Current Assets and Current Liabilities)
Adjustments to Convert Net Incometo Net Cash Provided (Used) by
Operating ActivitiesAdd* Deduct*
Change in Current Asset Account BalanceAccounts receivable Decrease IncreaseInventory Decrease IncreasePrepaid expenses Decrease IncreaseOther current assets Decrease Increase
Change in Current Liability Account BalanceAccounts payable Increase DecreaseAccrued expenses payable Increase DecreaseOther current liabilities Increase Decrease
* Add (deduct) change in account balance to net income
NET INCOME TO NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES(I/S: Noncash Items)
Adjustments to Convert NetIncome to Net Cash
Provided (Used) by Operating
Activities
Noncash Items on Income Statement
Amortization (of capital assets) expense AddAmortization of bond discount to interest expense AddAmortization of bond premium to interest expense DeductLoss on sale of asset AddGain on sale of asset DeductIncome from long-term equity investment Deduct
NET CASH PROVIDED (USED) BY NET CASH PROVIDED (USED) BY OPERATING ACTIVITIESOPERATING ACTIVITIES
NET CASH PROVIDED (USED) BY NET CASH PROVIDED (USED) BY OPERATING ACTIVITIESOPERATING ACTIVITIES
Cash flows from operating activitiesNet income 35,000 Adjustments to reconcile net income to net cash
provided by operating activities:Increase in accounts receivable (30,000) Increase in inventory (25,000) Increase in accounts payable 15,000 Increase in accrued expenses payable 4,000 (36,000)
Net cash used by operating activities (1,000)
Computer Services CorporationCash Flow Statement - Indirect MethodFor the Year Ended December 31, 2002
Indirect Method – Sample Format
Indirect Method – Sample Format
OPERATING ACTIVITIES– DIRECT METHOD
Section 2Section 2
CASH RECEIPTS AND CASH PAYMENTS(Direct Method)
CASH RECEIPTS FROM CUSTOMERS The relationships among cash receipts
from customers, revenues from sales, and changes in accounts receivable is:
Cash receipts from
customers=
Revenues from sales { + Decrease in accounts receivable
or – Increase in accounts receivable
Cash payments to
suppliers
=
Cost of goods sold {
+ Increase in inventory or
– Decrease in inventory
{+ Decrease in accounts payable or
– Increase in accounts payable
CASH PAYMENTS TO SUPPLIERS The relationship among cash payments to
suppliers, cost of goods sold, changes in inventory, and changes in accounts payable is:
Cash payments
for services
+ Increase in prepaid expenses or
– Decrease in prepaid expenses
+ Decrease in accrued expenses payable or
– Increase in accrued expenses payable
{Operating expenses {
=
CASH PAYMENTS FOR OPERATING EXPENSES The relationship among cash payments for
operating expenses, changes in prepaid expenses, and changes in accrued expenses payable is:
Cash payments for income tax
{=Income tax
expense+ Decrease in income tax payable or – Increase in income tax payable
CASH PAYMENTS FOR INCOME TAX The relationships among cash
payments for income tax, income tax expense, and changes in income tax payable is:
Cash flows from operating activities
Cash receipts from customers $120,000Cash payments:
To suppliers ($75,000)For operating expenses (36,000)For income tax (10,000) (121,000)Net cash used by operating activities (1,000)
COMPUTER SERVICES CORPORATIONCash Flow Statement – Direct Method
For the Year Ended December 31, 2002
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES
Direct Method – Sample Format
Direct Method – Sample Format
STEP 3: DETERMINE NET CASH PROVIDED (USED) BY INVESTING AND FINANCING ACTIVITIES
Study the balance sheet to determine changes in investments and long-term assets
Changes in each short-term investment (unless incorporated as part of cash definition) and long-term account are analysed using selected transaction data to determine the effect, if any, the changes had on cash
NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES
Study the balance sheet to determine changes in noncurrent liabilities and owner’s/shareholders’ equity
Changes in each noncurrent account are analysed using selected transaction data to determine the effect, if any, the changes had on cash
Operating activities used $1,000 cash and investing activities used $10,000 cash, while financing activities provided $45,000 cash.
CASH FLOW STATEMENT INDIRECT CASH FLOW STATEMENT INDIRECT METHODMETHOD
CASH FLOW STATEMENT INDIRECT CASH FLOW STATEMENT INDIRECT METHODMETHOD
COMPUTER SERVICES COMPANYCash Flow Statement — Indirect Method
For the Year Ended December 31, 2002Cash flows from operating activities
Net income 35,000$ Adjustments to reconcile net income to net cash
provided by operating activities:Increase in accounts receivable (30,000)$ Increase in inventory (25,000) Increase in accounts payable 15,000 Increase in accrued expenses payable 4,000 (36,000)
Net cash used by operating activities (1,000) Cash flows from investing activities
Purchase of equipment (10,000)$ Net cash used by investing activities (10,000)
Cash flows from financing activitiesIssue of common shares 60,000$ Payment of cash dividend (15,000)
Net cash provided by financing activities 45,000 Net increase in cash 34,000 Cash, January 1 - Cash, December 31 34,000$
CASH FLOW STATEMENT CASH FLOW STATEMENT DIRECT METHODDIRECT METHOD
CASH FLOW STATEMENT CASH FLOW STATEMENT DIRECT METHODDIRECT METHOD
Cash flows from operating activitiesCash receipts from customers $120,000Cash payments:
To suppliers $(75,000)For operating expenses (36,000)For income tax (10,000) (121,000)Net cash provided by operating activities (1,000)
Cash flows from investing activitiesPurchase of equipment $(10,000)
Net cash used by investing activities (10,000)Cash flows from financing activities
Issue of common shares $ 60,000Payment of cash dividends (15,000)
Net cash provided by financing activities 45,000Net increase in cash 34,000Cash, January 1 0Cash, December 31 $ 34,000
COMPUTER SERVICES CORPORATIONCash Flow Statement
For the Year Ended December 31, 2002
The cash flow statement shows that operating activities used $1,000 cash and investing activities used $10,000 cash, while financing activities provided $45,000 cash.
37
IAS 7 – Specific Items No netting of inflows and outflows Interest and dividends received and interest and
dividends paid – choice of operating, investing or financing flows as appropriate
Income tax cash flows – generally operating flows Non-cash transactions – not included in statement;
disclosed instead Cash flows between an entity and its subsidiaries,
associates and joint ventures reported only if accounted for by the cost or equity method
Acquisition/loss of control of subsidiary – investing cash flow
Exchange rate changes on foreign cash balances – reconciling item at bottom of statement
Purpose of Statement of Owner Equity To reconcile the owner equity
amount stated at the beginning of the time period, with the owner equity amount determined at the end of the time period.
Statement of Owner Equity
Components should include:1. Beginning owner equity
2. Plus net income amount
3. Minus owner withdrawals
4. Plus contributions received by business
5. Minus contributions distributed to others
6. Equals Change in Retained Earnings/Contributed Capital
7. Ending Owner Equity (Cost Value Basis)
Statement of Owner Equity
Components should include:7. Ending Owner Equity (Cost Value Basis)
8. Adjustment for change in Asset Values (Ending market value - cost value) -
(Beginning market value - cost value)
from beginning to end of time period
and adjustment for change in Deferred Debt
(+Beginning - Ending Deferred Liabilities)
9. Equals change in market valuation equity
10. Ending Owner Equity (Market Value Basis)
Statement of Owner Equity
Market Cost
1. Owner Equity, Beginning of Period
__________
__________
2a. Net Farm Income/Loss
_________
2b. Non-farm Income Contributed to Farm Business
________
3a. Withdrawals for Family Living Expenses
________
3b. - Income and Social Security Taxes
________
3. Owner Withdrawals (net)
________
= Total Change in Retained Earnings _____________ ______________
4. + Other Capital Contributions/Gifts/ Inheritance received
___________
5. - Other Capital Distributions/Dividends/Gifts Made
_____________
______________
6. = Total Change in Contributed Capital & Retained Earnings
7. Ending Owner Equity (cost value basis)
______________
Statement of Owner Equity8. Change in Excess of Market Value over Cost Basis of Marketable Securities
and Farm Capital Assets
Beg. -
End +
Change
Market Cost
Intermediate Assets _________ __________ _________ _________ ___N.A.
Real Estate _________ __________ _________ _________ ___N.A.
Beg. +
End -
Change Market Cost
Change in:
Deferred Liabilities _________ _________ _________ _________ ___N.A.
9. Total Change in Valuation Equity
_________
_________
_________
_________ ___N.A.
10. Owner Equity, End of Period
_________ _________ ___N.A.
Statement of Owner Equity (net worth) Cash Grain Farm -- Jan. to Dec. 2000
Market Cost
1. Owner Equity, Beginning of Period
833,030
385,250
2. Net Farm Income/Loss 97,897
3. Non-farm Income Contributed to Farm Business
______
3a. Withdrawals for Family Living Expenses
(28,389)
3b. - Income and Social Security Taxes
(24,280)
3. Owner Withdrawals (net) (52,669)
= Total Change in Retained Earnings (Line 2 – Line 3)
45,228 45,228
4. + Other Capital Contributions/Gifts/ Inheritance received
________
5. - Other Capital Distributions/Dividends/Gifts Made
(1,300)
6. Total Change in Contributed Capital & Retained Earnings
- 1,300 - 1,300
7. Ending Owner Equity (cost value basis)
429,178
Statement of Owner Equity
Beg. -
End +
Change
Market Cost
Intermediate Assets 202,750 236,053 +33,303
Real Estate 725,000 725,000 0.0
Beg. +
End -
Change Market Cost
Change in:
Deferred Liabilities 479,970 508,635 -28,665
9. Total Change in Valuation Equity
+ 4,638 N/A
10. Owner Equity, End of Period $ 881,596 $ 429,178
Statement of Owner Equity -- Summary
Can determine CHANGE in Owner Equity from beginning to end of time period
Components of change are:1 Retained earnings from profit2 Contributed capital from sources outside the
business3 Inflation/Deflation -- Change in Market Values