McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 12
Reporting and Interpreting
the Statement of Cash Flows
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Fred Phillips, Ph.D., CA
Learning Objective 1
Identify cash flows arising
from operating, investing,
and financing activities.
12-3
Business Activities and Cash Flows
The Statement of
Cash Flows focuses
attention on:
Operations
Cash received and paid
for day-to-day activities
with customers, suppliers,
and employees.
Investing
Cash paid and received
from buying and selling
long-term assets.
12-4
Financing
Cash received and paid
for exchanges with
lenders and stockholders.
Business Activities and Cash Flows
Checking and
Savings
Accounts
Cash
Currency
Cash Equivalents
Highly liquid short-term investments
within three months of maturity.
12-5
Classifying Cash Flows
UNDER ARMOUR, INC
Condensed Statement of Cash flows
For the Year Ended December 31, 2008
(in millions)
Net cash provided (used) by Operating Activities
79
Net cash provided (used) by Investing Activities
(38)
Net cash provided (used) by Financing activities
21
Net change in Cash and Cash Equivalents
62
Cash and Cash Equivalents, beginning of year
40
Cash and Cash Equivalents, end of year
12-6
$
$
102
Operating Activities
Cash inflows and outflows that directly relate
to revenues and expenses reported on the
income statement.
12-7
Direct and Indirect Reporting
of Operating Cash Flows
Same result
We will concentrate on the indirect method for now, and we
will look at the direct method again later in the chapter.
12-8
Investing Activities
Under Armour’s 2008 Investing Activities
12-9
Financing Activities
Under Armour’s 2008 Financing Activities
12-10
Relationships Between Classified
Balance Sheet and Statement of Cash
Flow (SCF) Categories
SCF Categories
Operating
Current Assets
Current Liabilities
Investing
Noncurrent Assets
Noncurrent Liabilities
Financing
12-11
Classified Balance Sheet Categories
Stockholders' Equity
Relationship to Other Financial
Statements
Information needed to prepare a
statement of cash flows:
 Comparative Balance Sheets.
 Income Statement.
 Additional details concerning
selected accounts.
12-12
Relationship to Other Financial
Statements
Recall that the basic Balance Sheet equation is:
We can recast the equation as follows:
The following equation is true:
From this basic Balance Sheet equation, we
develop our model to solve for the change in cash:
12-13
Learning Objective 2
Report cash flows from
operating activities, using
the indirect method.
12-14
Cash Flows from Operating
Activities - Indirect Method
The indirect method adjusts net income
by analyzing noncash items.
Changes in current assets
and current liabilities.
Cash Flows
from Operating
Activities Indirect Method
Net
Income
+ Noncash
expenses such as
depreciation and
amortization.
12-15
+ Losses and
- Gains
Relationships to the Balance
Sheet and the Income Statement
Change in account
balances during the year
Increase
Decrease
Current Assets
Subtract from
net income.
Add to
net income.
Current Liabilities
Add to
net income.
Subtract from
net income.
Use this table when adjusting Net Income to Operating
Cash Flows using the indirect method.
12-16
Statement of Cash Flows
Indirect Method Example
Use the following
financial statements
for Under Armour,
Inc. and prepare the
Statement of Cash
Flows for the year
ended December 31,
2008.
12-17
Statement of Cash Flows
Indirect Method Example
UNDER ARMOUR, INC.
Balance Sheet
(in millions)
ASSETS
Current assets:
Cash & Cash Equivalents
Accounts Receivable
Inventories
Prepaid Expenses
Total Current Assets
Equipment
Less: Accumulated depreciation
Intangible and Other Assets
Total Assets
12-18
December 31,
2008
$
$
102
81
182
31
396
120
(47)
18
487
December 31,
2007
$
$
40
94
166
22
322
84
(31)
16
391
Change
62
(13)
16
9
36
(16)
2
Statement of Cash Flows
Indirect Method Example
UNDER ARMOUR, INC.
Balance Sheet
(in millions)
December 31,
2008
LIABILITIES & STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts Payable
$
Accrued Liabilities
Total Current Liabilities
Long-term Debt
Total Liabilities
Stockholders' Equity:
Contributed Capital
Retained Earnings
Total Stockholders' Equity
Total Liab. & Stockholders' Equity
12-19
72
61
133
23
156
175
156
331
487
December 31,
2007
$
Change
55
41
96
14
110
17
20
163
118
281
391
12
38
9
Statement of Cash Flows
Indirect Method Example
UNDER ARMOUR, INC.
Income Statement
(in millions)
Net sales
Cost of sales
Gross profit
Operating expenses:
Selling, general, and administative expenses
Depreciation
Total operating expenses
Income from Operations
Interest Expense
Income before Income Tax Expense
Income Tax Expense
Net income
12-20
Year ended
Dec. 31, 2008
$
725
370
355
$
262
16
278
77
7
70
32
38
The Statement
of Cash Flows
using the
indirect
method will
begin with
Under Armor,
Inc.’s net
income from
the Income
Statement.
Direct and Indirect Reporting
of Operating Cash Flows
Net Income
Items included in net income that do not involve cash
+ Depreciation
Changes in operating assets and liabilities
+ Decreases
Changes inincurrent
currentassets
assetsand current liabilities:
– Increases in current assets
– Decreases in current liabilities
+ Increases in current liabilities
Net cash provided (used) by operating activities
When using the indirect method, start with accrual basis
net income and adjust it for:
1. items that are included in net income but do not
involve cash, and
2. items that are not included in net income but do
involve cash.
12-21
UNDER ARMOUR, INC.
Statement of Cash flows
For the Year Ended December 31, 2008
(in millions)
Cash Flows from Operating Activities:
Net Income
$
38
Next, adjust for the non-cash items included
in net income.
For Under Armour, the only non-cash adjustment
is for depreciation.
12-22
UNDER ARMOUR, INC.
Statement of Cash flows
For the Year Ended December 31, 2008
(in millions)
Cash Flows from Operating Activities:
Net Income
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation
$
38
16
Accumulated Depreciation increased by $16, from $31 in the
2007 Balance Sheet to $47 in the 2008 Balance sheet. The
same $16 is shown as Depreciation in the 2008 Income
Statement.
To complete the cash flows from operating activities section,
we must examine comparative balance sheets to determine
the changes in current assets and current liabilities from the
beginning of the period to the end of the period.
12-23
ARMOUR,
INC.
Statement ofUNDER
Cash
Flows
Indirect
Statement of Cash flows
MethodFor
Example
the Year Ended December 31, 2008
These five items were shown earlier in the current portions of
(in millions)
Under Armour’s comparative Balance Sheets for 2007 and 2008
Cash Flows from Operating Activities:
Net Income
$
38
Current Assets
Current Liabilities
Subtract from
Add to
Adjustments
Increase to reconcile net income to net
net income.
net income.
cash provided by operating
activities:
Add to
Subtract from
Decrease
net income.
Depreciation net income.
16
Changes in current assets and current liabilities:
Decrease in Accounts Receivable
13
Increase in Inventory
(16)
Increase in Prepaid Expense
(9)
Increase in Accounts Payable
17
Increase in Accrued Liabilities
20
Net cash provided (used) by operating activities
$
79
12-24
Learning Objective 3
Report cash flows from
investing activities.
12-25
Reporting Cash Flows from
Investing Activities
We will need this additional data to prepare
the investing portion of the statement.
1. No disposals or impairments of equipment or
intangibles occurred
2. Equipment costing $36 million and intangibles
costing $2 million were purchased with cash.
12-26
Reporting Cash Flows from
Investing Activities
UNDER ARMOUR, INC.
Statement of Cash flows
For the Year Ended December 31, 2008
(in millions)
Net cash provided (used) by operating activities
Cash Flows from Investing Activities:
Purchase of equipment
Purchase of intangible and other assets
Net cash provided (used) by investing activities
$
79
(36)
(2)
(38)
Cash Flows
from Financing
Activities:
Under
Armour,
Inc.,
has two investing 16
Additional borrowings of long-term debt
Payments
long-term
debt
activities
ononthe
Statement
of Cash Flows(7)that
Proceeds from stock issuance
12
required
the use
of cash:
Net cash provided
by (used
in) financing activities
21
Net increase (decrease) in cash & cash equivalents
62
1. Purchase
of
equipment,
and
Cash & cash equivalents at beginning of period
40
Cash & cash equivalents
at end of period
$ 102
2. Purchase
of intangible
and other assets.
12-27
Learning Objective 4
Report cash flows from
financing activities.
12-28
Reporting Cash Flows from
Financing Activities
We will need this additional data to prepare
the financing portion of the statement.
1. No dividends were declared or paid.
2. Long-term debt of $7 million was paid.
3. $16 million in new long-term loans were
issued.
4. Shares of stock were issued for $12 million.
12-29
Reporting Cash Flows from
Financing Activities
UNDER ARMOUR, INC.
Statement of Cash flows
For the Year Ended December 31, 2008
(in millions)
Net cash provided (used) by operating activities
Cash Flows from Investing Activities:
Purchase of equipment
Purchase of intangible and other assets
Net cash provided (used) by investing activities
$
79
(36)
(2)
(38)
Cash Flows from Financing Activities:
Additional borrowings of long-term debt
16
Payments on long-term debt
(7)
Proceeds from stock issuance
12
Long-term
debt
increased
because
of
$16
in
Net cash provided by (used in) financing activities
21
new
loans
duringin the
The long-term debt
Net
increase
(decrease)
cash year.
& cash equivalents
62
Cash & cash equivalents
at beginning
of period
40
increase
is a cash
inflow.
Cash & cash equivalents at end of period
$ 102
12-30
Reporting Cash Flows from
Financing Activities
UNDER ARMOUR, INC.
Statement of Cash flows
For the Year Ended December 31, 2008
(in millions)
Net cash provided (used) by operating activities
Cash Flows from Investing Activities:
Purchase of equipment
Purchase of intangible and other assets
Net cash provided (used) by investing activities
$
79
(36)
(2)
(38)
Cash Flows from Financing Activities:
Additional borrowings of long-term debt
16
Payments on long-term debt
(7)
Proceeds from stock issuance
12
Payments
on
long-term
debt
resulted
in
a
cash
outflow
of
Net cash provided by (used in) financing activities
21
Net
in cash
& cash two
equivalents
62
$7.increase
The (decrease)
net effect
of these
long-term debt
Cash & cash equivalents at beginning of period
transactions
increased long-term debt by $9, from40$14 on
Cash & cash equivalents at end of period
$ 102
the 2007 Balance sheet to $23 on the 2008 Balance Sheet.
12-31
Reporting Cash Flows from
Financing Activities
UNDER ARMOUR, INC.
Statement of Cash flows
For the Year Ended December 31, 2008
(in millions)
Net cash provided (used) by operating activities
Cash Flows from Investing Activities:
Purchase of equipment
Purchase of intangible and other assets
Net cash provided (used) by investing activities
$
79
(36)
(2)
(38)
Cash Flows from Financing Activities:
Additional borrowings of long-term debt
16
Payments on long-term debt
(7)
Proceeds from stock issuance
12
Net cash provided by (used in) financing activities
21
TheNet
third
financing
activity
is&the
increase
(decrease)
in cash
cashissuance
equivalentsof common
62 stock
resulting
in a& cash
inflow ofat$12.
Contributed
from
Cash
cash equivalents
beginning
of period Capital increased
40
cash equivalents
at end of
$ 102 Sheet.
$163 inCash
the&2007
Balance Sheet
toperiod
$175 in the 2009 Balance
12-32
Reporting Cash Flows from
Financing Activities
UNDER ARMOUR, INC.
Now we can reconcile
the change in cash to the ending
Statement of Cash flows
$102 cash balance
thatEnded
appears
on
For the Year
December
31,the
2008 Balance Sheet.
(in millions)
Net cash provided (used) by operating activities
12-33
$
79
Cash Flows from Investing Activities:
Purchase of equipment
Purchase of intangible and other assets
Net cash provided (used) by investing activities
(36)
(2)
(38)
Cash Flows from Financing Activities:
Additional borrowings of long-term debt
Payments on long-term debt
Proceeds from stock issuance
Net cash provided by (used in) financing activities
Net increase (decrease) in cash & cash equivalents
Cash & cash equivalents at beginning of period
Cash & cash equivalents at end of period
16
(7)
12
21
62
40
102
$
Noncash Investing and
Financing Activities
Required
(in millions) Supplemental Information:
Net cash provided (used) by operating activities
$
79
1. Cash paid for taxes and interest.
Cash Flows from Investing Activities:
Purchase of equipment
2. Significant
non-cash investing
Purchase of intangible and other assets
financing
activities.
Net
cash provided
(used) by investing activities
Cash Flows from Financing Activities:
Additional borrowings of long-term debt
Payments on long-term debt
Proceeds from stock issuance
Net cash provided by (used in) financing activities
Net increase (decrease) in cash & cash equivalents
Cash & cash equivalents at beginning of period
Cash & cash equivalents at end of period
Supplemental Disclosures
Cash paid for interest
Cash paid for income tax
12-34
(36)
(2)
(38)
and
$
$
16
(7)
12
21
62
40
102
7
12
Learning Objective 5
Interpret cash flows from
operating, investing, and
financing activities.
12-35
Evaluating Cash Flows
• Operating cash flows
must be positive over the
long-run for a company to
be successful.
• An upward trend in
operating cash flows over
time indicates growth and
efficient operations.
12-36
Evaluating Cash Flows
Quality of
Income
Ratio
=
Net Cash Flow from Operating Activities
Net Income
A measure for determining what portion of
a company’s income was generated in cash.
A ratio near 1.0 indicates a high likelihood that
revenues are realized in cash and that expenses
are associated with cash outflows.
Quality of
Income
Ratio
12-37
=
79
38
= 2.08 for Under Armour in 2008
Evaluating Cash Flows
Capital
Acquisitions =
Ratio
Net Cash Flow from Operating Activities
Cash Paid for Property, Plant, and Equipment
A measure for determining whether a company is generating
enough cash internally to purchase long-term assets.
A ratio greater than 1.0 indicates that outside
financing was not needed to purchase long-term assets.
Capital
Acquisitions =
Ratio
12-38
79
36
= 2.19 for Under Armour in 2008
Learning Objective 6
Report and interpret cash
flows from operating activities
using the direct method.
12-39
Reporting Operating Cash Flows
with the Direct Method
12-40
Provides more
detailed information
Identifies cash
inflows and
outflows
relationships
Prepared by
adjusting accrual
basis to cash basis
Investing and
financing sections
for the two methods
are identical
Direct Method Operating Activities
UNDER ARMOUR, INC.
Statement of Cash Flows
For the Year Ended December 31, 2008
(in millions)
Cash Flows from Operating Activities:
Cash collected from customers
Cash payments to suppliers
Cash payments for operating expenses
Cash paid for interest
Cash paid for income tax
Net cash provided by operating activities
$
$
738
(369)
(251)
(7)
(32)
79
When we prepared the operating section using the indirect
method, we also arrived at net cash inflow of $79.
Let’s see how we arrive at these cash flows.
12-41
Direct Method Operating Activities
Net Sales
+ Decrease in accounts receivable
$
725
13
Cost of goods sold
+ Increase in inventory
= Cash collected from customers
$
738
– Increase in accounts payable
= Cash payments to suppliers
Interest expense
No change in interest payable
$
7
0
SG&A expenses
+ Increase in prepaid expenses
Cash paid for interest
$
7
– Increase in accrued liabilities
= Cash payments for expenses
Income tax expense
No change in taxes payable
Cash paid for income tax
$
$
32
0
32
With the direct method, we convert each revenue and
expense on the income statement to a cash flow.
12-42
$
370
16
(17)
$
369
$
262
9
(20)
$
251
Supplement 12A
Reporting Sales of Property, Plant,
and Equipment (Indirect Method)
Reporting Sales of Property, Plant,
and Equipment (PPE) (Indirect)
Depreciation
Expense
Loss on Sale
of PPE
Gain on Sale
of PPE
12-44
A loss on the sale of PPE is added
back to net income just as
depreciation expense is added back.
Adding these noncash items restores
net income to what it would have been
had depreciation and the loss not
been subtracted at all.
Just the opposite is true for a gain on
the sale of PPE. Subtracting the gain
reverses the effect of the gain having
been added to net income.
Supplement 12B
Spreadsheet Approach (Indirect
Method)
Spreadsheet Approach
(Indirect Method)
Reconstructing the events and transactions that
occurred during the period helps identify the
operating, investing and financing activities to be
reported.
A spreadsheet can be used to ensure that
no reportable activities are inadvertently
overlooked.
Let’s see how to use a spreadsheet to prepare a
Statement of Cash Flows on the next few slides.
12-46
UNDER ARMOUR, INC.
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
2007
Debits
Credits
Items from Balance Sheet
Cash and Cash Equivalents (A)
40
Accounts Receivable (A)
94
Inventories (A)
166
Prepaid Expenses (A)
22
Equipment (A)
84
Accumulated Depreciation (xA)
31
Intangible and other Assets (A)
16
Accounts Payable (L)
55
Accrued Liabilities (L)
41
Long-term Debt (L)
14
Contributed Capital (SE)
163
Retained Earnings (SE)
118
Dec. 31,
2008
102
81
182
31
120
47
18
72
61
23
175
156
We begin by
entering the
beginning and
ending balances
for each account
on the
comparative
balance sheets.
Cash
Inflows
Statement of Cash Flows
12-47
Outflows
The cash inflows
and outflows
columns will be
used later to
explain the
changes in each
account balance.
UNDER ARMOUR, INC.
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
2007
Debits
Credits
Items from Balance Sheet
Cash and Cash Equivalents (A)
40
Accounts Receivable (A)
94
C
13
Inventories (A)
166
D
16
Prepaid Expenses (A)
22
E
9
Equipment (A)
84
Accumulated Depreciation (xA)
31
B
16
Intangible and other Assets (A)
16
Accounts Payable (L)
55
F
17
Accrued Liabilities (L)
41
G
20
Long-term Debt (L)
14
Contributed Capital (SE)
163
Retained Earnings (SE)
118
A
38
Cash
Inflows
Statement of Cash Flows
Operating Activities:
Net income
Adjustments to reconcile net income to cash
Depreciation
Changes in assets and liabilities
Accounts Receivable decrease
Inventories increase
Prepaid Expenses increase
Accounts Payable increase
Accrued Liabilities increase
12-48
A
38
B
16
C
13
Outflows
17
20
102
81
182
31
120
47
18
72
61
23
175
156
We will begin with
operating
activities.
D
E
F
G
Dec. 31,
2008
Changes in
balance sheet
accounts are
analyzed in terms
of debits and
credits in the top
half of the
spreadsheet and
recorded as cash
inflows and
outflows in the
bottom half of the
spreadsheet.
16
9
UNDER ARMOUR, INC.
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
2007
Debits
Credits
Items from Balance Sheet
Cash and Cash Equivalents (A)
40
M
62
Accounts Receivable (A)
94
Inventories (A)
166
Prepaid Expenses (A)
22
Equipment (A)
84
H
36
Accumulated Depreciation (xA)
31
Intangible and other Assets (A)
16
I
2
Accounts Payable (L)
55
Accrued Liabilities (L)
41
Long-term Debt (L)
14
K
7
J
16
Contributed Capital (SE)
163
L
12
Retained Earnings (SE)
118
Cash
Inflows
Statement of Cash Flows
Investing activities
Purchase of equipment
Purchase of intangible and other assets
Financing activities
Additional borrowings of long-term debt
Payments of long-term debt
Proceeds from stock issuance
Net increase in cash and cash equivalents
12-49
J
L
Outflows
H
I
36
2
K
7
M
62
16
12
Dec. 31,
2008
102
81
182
31
120
47
18
72
61
23
175
156
Changes in
balance sheet
accounts are
analyzed in terms
of debits and
credits in the top
half of the
spreadsheet and
recorded as cash
inflows and
outflows in the
bottom half of the
spreadsheet. Now
we will complete
the analysis with
investing and
financing
activities.
Spreadsheet Approach
(Indirect Method)
UNDER ARMOUR, INC.
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
2007
Debits
Credits
Items from Balance Sheet
Cash and Cash Equivalents (A)
40
M
62
Accounts Receivable (A)
94
C
13
Inventories (A)
166
D
16
Prepaid Expenses (A)
22
E
9
Equipment (A)
84
H
36
Accumulated Depreciation (xA)
31
B
16
Intangible and other Assets (A)
16
I
2
Accounts Payable (L)
55
F
17
Accrued Liabilities (L)
41
G
20
Long-term Debt (L)
14
K
7
J
16
Contributed Capital (SE)
163
L
12
Retained Earnings (SE)
118
A
38
132
132
12-50
Dec. 31,
2008
102
81
182
31
120
47
18
72
61
23
175
156
The top of the
completed
spreadsheet
is shown here.
Spreadsheet Approach
(Indirect Method)
Cash
Inflows
Statement of Cash Flows
Operating Activities:
Net income
Adjustments to reconcile net income to cash
Depreciation
Changes in assets and liabilities
Accounts Receivable decrease
Inventories increase
Prepaid Expenses increase
Accounts Payable increase
Accrued Liabilities increase
A
38
B
16
C
13
F
G
J
L
16
9
H
I
36
2
K
7
M
62
132
16
12
Net change in cash and cash equivalents
132
12-51
D
E
17
20
Investing activities
Purchase of equipment
Purchase of intangible and other assets
Financing activities
Additional borrowings of long-term debt
Payments of long-term debt
Proceeds from stock issuance
Outflows
The bottom of the
completed
spreadsheet
is shown here.
Chapter 12
Solved Exercises
E12-2, E12-3, E12-4, E12-5, E12-6,
E12-7
E12-2 Understanding the Computation of Cash Flows from Operating
Activities (Indirect Method)
Suppose your company sells services of $150 in exchange for $100 cash
and $50 on account.
Required:
1. Show the journal entry to record this transaction.
Record
dr Cash (+A)
dr Accounts Receivable (+A)
cr Service Revenue (+R) (+SE)
100
50
150
2. Identify the amount that should be reported as net cash flows from
operating activities.
The $100 increase in cash is reported as
net cash flows from operating activities.
12-53
E12-2 Understanding the Computation of Cash Flows from Operating
Activities (Indirect Method)
Required:
3. Identify the amount that would be included in net income.
$150 of service revenue would be included in net income.
4. Show how the indirect method would convert net income (requirement
3) to net cash flows from operating activities (requirement 2).
Net Income
Less: Accounts Receivable increase
Net Cash Flow from Operating Activities
$ 150
(50)
$ 100
5. What general rule about converting net income to operating cash flows
is revealed by your answer to requirement 4?
When Accounts Receivable increases, Sales Revenue is
greater than cash received, so subtract the increase to
convert Net Income to Cash Flow from Operating Activities.
12-54
E12-3 Understanding the Computation of Cash Flows from Operating
Activities (Indirect Method)
Suppose your company sells services for $300 cash this month. Your
company also pays $100 in wages, which includes $20 that was payable
at the end of the previous month and $80 for wages of this month.
Required:
1. Show the journal entries to record these transactions.
Record
dr Cash (+A)
cr Service Revenue (+R) (+SE)
300
300
Record
dr Wages Payable (-A)
dr Wages Expense (+E) (-SE)
cr Cash (-A)
12-55
20
80
100
E12-3 Understanding the Computation of Cash Flows from Operating
Activities (Indirect Method)
Required:
2. Identify the amount that should be reported as Net Cash Flows from
Operating Activities.
The $200 increase in Cash ($300 – $100) should be reported
as Net Cash Inflow from Operating Activities.
3. Identify the amount that would be included in Net Income.
$300 of Service Revenue would be included along with
Wages Expense of $80, for a Net Income of $220.
4. Show how the indirect method would convert Net Income (requirement
3) to Net Cash Flows from Operating Activities (requirement 2).
Net Income
Less: Wages Payable decrease
Net Cash Flow from Operating Activities
12-56
$ 220
(20)
$ 200
E12-3 Understanding the Computation of Cash Flows from Operating
Activities (Indirect Method)
Required:
5. What general rule about converting Net Income to operating cash flows is
revealed by your answer to requirement 4?
When Wages Payable decreases, subtract that decrease to
convert Net Income to Cash Flow from Operating Activities.
Increase
Decrease
12-57
Current Assets
Subtract from
net income.
Add to
net income.
Current Liabilities
Add to
net income.
Subtract from
net income.
E12-4 Understanding the Computation of Cash Flows from Operating
Activities (Indirect Method)
Suppose your company sells services of $150 in exchange for $100 cash
and $50 on account. Depreciation of $40 also is recorded.
Required:
1. Show the journal entries to record these transactions.
Record
dr Cash (+A)
dr Accounts Receivable (+A)
cr Service Revenue (+R) (+SE)
100
50
150
Record
dr Depreciation Expense (+E) (-SE)
cr Accumulated Depreciation (+xA) (-A)
12-58
40
40
E12-4 Understanding the Computation of Cash Flows from Operating
Activities (Indirect Method)
Required:
2. Identify the amount that should be reported as Net Cash Flows from
Operating Activities.
The $100 increase in cash should be reported
as Net Cash Flows from Operating Activities.
3. Identify the amount that would be included in Net Income.
Net Income would include $150 of Service Revenue
and $40 of Depreciation Expense, or $110 in total.
4. Show how the indirect method would convert Net Income (requirement
3) to Net Cash Flows from Operating Activities (requirement 2).
Net Income
Add: Depreciation
Less: Accounts Receivable increase
Net Cash Flow from Operating Activities
12-59
$ 110
40
(50)
$ 100
E12-4 Understanding the Computation of Cash Flows from Operating
Activities (Indirect Method)
Required:
5. What general rules about converting Net Income to operating cash flows
are revealed by your answer to requirement 4?
Two general rules are revealed:
1.Always add back the amount of depreciation subtracted in
the Income Statement to convert Net Income to Cash Flow
from Operating Activities.
2.When Accounts Receivable increases, Sales Revenue is
greater than cash received, so subtract the increase to
convert Net Income to Cash Flow from Operating Activities.
12-60
E12-5 Understanding the Computation of Cash Flows from Operating
Activities Indirect Method)
Suppose your company sells goods for $300, of which $200 is received in
cash and $100 is on account. The goods cost your company $125. Your
company also recorded wages of $70, of which only $30 has been paid in
cash.
Required:
1. Show the journal entries to record these transactions
Record
dr Cash (+A)
dr Accounts Receivable (+A)
cr Sales Revenue (+R) (+SE)
200
100
300
Record
dr Cost of Goods Sold (+E) (-SE)
cr Inventory (-A)
12-61
125
125
E12-5 Understanding the Computation of Cash Flows from Operating
Activities (Indirect Method)
Required:
1. Show the journal entries to record these transactions
Record
dr Wages Expense (+E) (-SE)
cr Wages Payable (+L)
cr Cash (-A)
70
40
30
2. Identify the amount that should be reported as Net Cash Flows from
Operating Activities.
Net Cash Flows from Operating Activities would be $170, which equals
the $200 received from customers minus the $30 paid to employees.
3. Identify the amount that would be included in Net Income.
Net income would be $105, which equals $300 of Sales Revenue
minus Cost of Goods Sold ($125) and Wages Expense ($70).
12-62
E12-5 Understanding the Computation of Cash Flows from Operating
Activities (Indirect Method)
Required:
4. Show how the indirect method would convert Net Income (requirement 3)
to Net Cash Flows from Operating Activities (requirement 2).
Net Income
Add: Inventory decrease
Wages Payable increase
Less: Accounts Receivable increase
Net Cash Flow from Operating Activities
$ 105
125
40
(100)
$ 170
5. What general rules about converting Net Income to operating cash flows
are revealed by your answer to requirement 4?
Three general rules are revealed:
1.Add back decreases in noncash Current Assets.
2.Add back increases in Current Liabilities
3.Deduct increases in noncash current Assets.
12-63
E12-6 Preparing and Evaluating a Simple Statement of Cash Flows
(Indirect Method)
Suppose your company’s Income Statement reports $105 of Net Income,
and its comparative Balance Sheet indicates the following.
Required:
1. Prepare the operating activities section of the Statement of Cash Flows,
using the indirect method.
2. Identify the most important cause of the difference between the
company’s Net Income and Net Cash Flows from Operating Activities.
12-64
E12-6 Preparing and Evaluating a Simple Statement of Cash Flows
(Indirect Method)
Required:
1. Prepare the operating activities section of the Statement of Cash Flows,
using the indirect method.
First, let’s determine the changes in Balance Sheet accounts.
Beginning
ASSETS
Current assets:
Cash
Accounts Receivable
Inventory
Total Current Assets
Wages Payable
Retained Earnings
Total Assets
12-65
$
$
35
75
260
370
10
360
370
Ending
$
$
Change
205
175
135
515
170
100
(125)
50
465
515
40
105
E12-6 Preparing and Evaluating a Simple Statement of Cash Flows
(Indirect Method)
Required:
1. Prepare the operating activities section of the Statement of Cash Flows,
using the indirect method.
Cash Flows from Operating Activities:
Net Income
Changes in current assets and current liabilities:
Accounts Receivable increase
Inventory decrease
Wages Payable increase
Net cash provided (used) by operating activities
Increase
Decrease
12-66
Current Assets
Subtract from
net income.
Add to
net income.
$
105
(100)
125
40
$ 170
Current Liabilities
Add to
net income.
Subtract from
net income.
E12-6 Preparing and Evaluating a Simple Statement of Cash Flows
(Indirect Method)
Required:
2. Identify the most important cause of the difference between the
company’s Net Income and Net Cash Flows from Operating Activities.
Cash Flows from Operating Activities:
Net Income
Changes in current assets and current liabilities:
Accounts Receivable increase
Inventory decrease
Wages Payable increase
Net cash provided (used) by operating activities
$
105
(100)
125
40
$ 170
The most important cause of the difference is the $125 decrease in Inventory.
• The Inventory decrease indicates that Cost of Goods Sold
(deducted in the Income Statement) was $125 more than the
cash paid to purchase Inventory.
• In other words, the company sold Inventory but did not
replace it, creating a net cash inflow for the period.
12-67
E12-7 Preparing and Evaluating a Simple Statement of Cash Flows
(Indirect Method)
Suppose the income statement for Goggle Company reports $70 of net
income, after deducting depreciation of $35. The company bought
equipment costing $60 and obtained a long-term bank loan for $60. The
company’s comparative balance sheet, at December 31, indicates the
following.
12-68
E12-7 Preparing and Evaluating a Simple Statement of Cash Flows
(Indirect Method)
Required:
1. Calculate the change in each balance sheet account, and indicate whether
each account relates to operating, investing, and/or financing activities.
2009
12-69
Cash
Accounts Receivable
Inventory
Equipment
Accumulated Depreciation
Total
$
Wages Payable
Long-term Debt
Contributed Capital
Retained Earnings
Total
$
$
$
205
175
135
560
(80)
995
170
100
(125)
60
35
Type
Cash
Operating
Operating
Investing
Operating
50
505
10
430
995
40
60
70
Operating
Financing
Financing
Operating
2010
35
75
260
500
(45)
825
$
10
445
10
360
825
$
$
$
Change
E12-7 Preparing and Evaluating a Simple Statement of Cash Flows
(Indirect Method)
Required:
2. Prepare a statement of cash flows using the indirect method.
Goggle Company
Statement of Cash flows
For the Year Ended December 31, 2010
Cash Flows from Operating Activities:
Net Income
Add Depreciation
Subtract Accounts Receivable increase
Add Inventory decrease
Add Wages Payable increase
Net cash provided (used) by operating activities
$
70
35
(100)
125
40
170
Cash Flows from Investing Activities:
Equipment purchased
(60)
Net cash providedCurrent
(used) byAssets
investing activities
(60)
Current Liabilities
SubtractActivities:
from
Add to
Cash
Flows from Financing
Increase
net income. 60
Obtained long-termnet
bankincome.
loan
Net cash provided (used)
by to
financing activitiesSubtract from60
Add
Decrease
net income.
Net change in cash
Cash, Beginning of 2010
Cash, End of 2010
12-70
net income.170
$
35
205
E12-7 Preparing and Evaluating a Simple Statement of Cash Flows
(Indirect Method)
Required:
3. In one sentence, explain why an increase in Accounts Receivable is
subtracted.
The increase in Accounts Receivable indicates that
sales on account were greater than cash collections.
4. In one sentence, explain why a decrease in Inventory is added.
A decrease in Inventory indicates that Cost of Goods Sold (subtracted
in the Income Statement) was greater than Inventory purchases.
12-71
E12-7 Preparing and Evaluating a Simple Statement of Cash Flows
(Indirect Method)
Required:
5. In one sentence, explain why an increase in Wages Payable is added.
The Wages Payable increase is added because more wages
were subtracted when calculating net income than actually paid.
6. Are the cash flows typical of a start-up, healthy, or troubled company?
Explain.
A healthy company since operating cash flows are positive and
financing inflows are sufficient to cover investing outflows.
12-72
End of Chapter 12