StIce | StIce |Skousen
Statement of Cash Flows
Re-visited
Chapter 21
Intermediate Accounting
16E
Prepared by: Sarita Sheth | Santa Monica College
COPYRIGHT © 2007
Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are
trademarks used herein under license.
Learning Objectives
1. Prepare a complete statement of cash
flows, and provide the required
supplemental disclosures.
2. Understand the differences among cash
flow statements prepared according to
U.S. GAAP, U.K. GAAP, and IASB
standards.
3. Incorporate material from the entire text
into the preparation of a statement of
cash flows.
4. Perform a detailed case analysis of a
company’s operations and performance
using cash flow data.
Preparing a Complete
Statement of Cash Flows
You will need to refer to pages 1222 and
Exhibit 21-3 in your text for this chapter’s
presentation.
Absence of Transaction Data
• Sometimes, detailed cash
flow information, we can
create the statement by
analyzing the income
statement and balance
sheet.
• We must infer the cash
flow effects of the various
transactions during the
business period.
A 6-Step Process
1. Compute how much the cash balance
changed during the year.
2. Convert the income statement from an
accrual-basis to a cash-basis summary of
operations.
a. Eliminate expenses that do not involve the
outflow of cash, such as depreciation expense.
b. Eliminate gains and losses associated with
investing or financing activities to avoid
counting these items twice.
c. Adjust for changes in the balances of current
operating assets and operating liabilities- these
are cases where cash flow does not match
revenue or expenses reported.
A 6-Step Process
3.
4.
5.
6.
Analyze the long-term assets to identify the cash
flow effects of investing activities. Also examine
investment securities accounts.
Analyze the long-term debt and stockholders’
equity accounts to determine the cash flow
effects of any financing transactions. Also analyze
the short-term loan accounts.
Make sure that the total net cash flow is equal to
the net increase or decrease in cash as computed
in step 1. Prepare the formal statement of cash
flows by classifying all cash inflows and outflows
by their activity class.
Prepare supplemental disclosure, including the
disclosure of any significant investing or
financing transactions.
Illustration of the 6-Step
Process
will use the
Western
Step 1:We
Compute
howinformation
much the of
cash
balance
Resources
to illustrate
changed
duringthe
the6-step
year:process.
Beginning Cash Balance
$55,000
- Ending Cash Balance
(50,600)
Decrease in cash
($4,400)
The purpose of our cash flows
statement is to explain how the
decrease in cash occurred.
Illustration of the 6-Step
Process
Step 2: Convert the income statement from an
accrual to a cash-basis summary of operations:
Add: Depreciation Expense
Amortization Expense
$20,900
5,000
1. Add the amount of depreciation and
amortization expense back to net income
because no cash flow was associated with these
expenses in the current period. (Adjustments A1
and A2)
Illustration of the 6-Step
Process
Step 2: Convert the income statement from an
accrual to a cash-basis summary of operations:
Add: Loss on Sale of Building
Less: Gain on Sale of LongTerm investment
$4,000
($6,500)
2. Subtract the amount of gains and add the
amount of losses because they are included in
the computation of net income, failing to adjust
for them here would result in their being double
counted. (Adjustments B1 and B2)
Illustration of the 6-Step
Process
Step 2: Convert the income statement from an
accrual to a cash-basis summary of operations:
Add: Decrease in accounts
receivable
$3,500
3. Add the decrease in Accounts Receivable. The
accounts receivable account decreases when
customers pay for more than they purchased
this year. Thus, Western Resources has more
cash than it would have had if customers had
not paid down their accounts. (Adjustment C1)
Illustration of the 6-Step
Process
Step 2: Convert the income statement from an
accrual to a cash-basis summary of operations:
Add: Increase in Unearned Sales
Revenue
$7,000
4. Add the increase in Unearned Sales Revenue.
Unearned Sales Revenue goes up when
customers pay for goods or services in advance.
Thus, an increase in Unearned Sales Revenue
represents cash collected over and above the
sales amount. (Adjustment C2)
Illustration of the 6-Step
Process
Step 2: Convert the income statement from an
accrual to a cash-basis summary of operations:
Add: Decrease in Inventory
$1,500
5. Add the decrease in Inventory. By allowing the
Inventory amount to decrease, Western
Resources has conserved cash that otherwise
would have been used to purchase inventory.
(Adjustment C3)
Illustration of the 6-Step
Process
Step 2: Convert the income statement from an
accrual to a cash-basis summary of operations:
Subtract: Decrease in Accounts
Payable
($6,700)
6. Subtract the decrease in Accounts Payable.
Western Resources paid extra cash to reduce the
balance in Accounts Payable. (Adjustment C4)
Illustration of the 6-Step
Process
Step 2: Convert the income statement from an
accrual to a cash-basis summary of operations:
Subtract: Increase in Prepaid
Operating Expenses
($4,500)
7. Subtract the increase in Prepaid Operating
Expenses. Western Resources paid extra cash by
prepaying for services that it won’t use until a
future period. (Adjustment C5)
Illustration of the 6-Step
Process
Step 2: Convert the income statement from an
accrual to a cash-basis summary of operations:
Add: Increase in Obligation for
Employee Severance
11,700
8. Add the increase in Obligation for Employee
Severance. A restructuring charge does not
involve an immediate outlay of cash. Western
has not yet paid any cash associated with the
restructuring. (Adjustment C6)
Illustration of the 6-Step
Process
Step 2: Convert the income statement from an
accrual to a cash-basis summary of operations:
Subtract: Decrease in Income
Taxes Payable
(2,200)
9. Subtract the decrease in Income Taxes Payable.
Western Resources paid extra cash to reduce the
balance in Income Taxes Payable. (Adjustment
C7)
Illustration of the 6-Step
Process
Step 2: Convert the income statement from an
accrual to a cash-basis summary of operations:
Subtract: Decrease in Income
Taxes Payable
(2,200)
10. Add the increase in Deferred Income Tax
Liability. A portion of income tax expense relates
to income taxes that will not become payable
until a future year. Thus, this does not involve a
current cash outlay and is added back.
(Adjustment C8)
Illustration of the 6-Step
Process
Illustration of the 6-Step
Process
The Direct Method
Illustration of the 6-Step
Process
Step 3: Analyze the Long-Term Assets to
Identify the Cash Flow Effects of Investing
Activities
Book Value of long term investment sold
Plus: Gain on sale
Cash proceeds
$96,000
6, 500
$102,000
The long-term investments account was reduced by
$96,000 ($106,000 – $10,000). To calculate the
amount of cash collected from this sale, use
income statement information to determine
whether there was a gain or loss on the sale.
Illustration of the 6-Step
Process
Step 3: Analyze the Long-Term Assets to
Identify the Cash Flow Effects of Investing
Activities
Increase in land account
Less: payment with common stock
Cash outlay
$108,500
(40, 000)
$68,500
The land account increased by $108,500 ($183,500
– $75,000). Supplemental information tells us
that payment for the land was a combination of
$68,500 of cash and common stock valued at
$40,000. Only the $68,500 cash outlay will be
Illustration of the 6-Step
Process
Step 3: Analyze the Long-Term Assets to
Identify the Cash Flow Effects of Investing
Activities
Beginning buildings and equipment balance $345,000
Original cost of building and equipment sold (40, 000)
Ending balance without additional purchases $305,000
Buildings and equipment account increased by
$77,000 ($422,000 – $345,000). Additional
information shows buildings and equipment with
an original cost of $40,000 were sold for $10,000.
This $10,000 cash proceeds will be shown.
Illustration of the 6-Step
Process
Step 3: Analyze the Long-Term Assets to
Identify the Cash Flow Effects of Investing
Activities
Actual ending balance
$442,000
Ending balance without additional purchases (305,000)
Equipment was purchased
$117,000
The actual ending balance reports buildings and
equipment at $422,000. Therefore buildings and
equipment were purchased for $117,000
($422,000 – $305,000). This purchase represents
cash used for investing activities.
Illustration of the 6-Step
Process
Step 3: Analyze the Long-Term Assets to
Identify the Cash Flow Effects of Investing
Activities
Beginning Patents
-Patent amortization
+ New Patents purchased
Ending Patents
$40,000
(305,000)
???
$117,000
The patents account began the year with a $40,000
balance and ended with a $35,000 balance. The
numbers indicate that no new patents were
purchased during the year.
Illustration of the 6-Step
Process
Cash flows from investing activities:
Sold building
$ 10,000
Sold long-term investment
102,500
Purchased available-for-sale securities
(2,000)
Purchased land
68,500
Purchased buildings and equipment
(117,000)
Net cash used by investing activities
$ (75,000)
Illustration of the 6-Step
Process
Step 4: Analyze the Long-Term Debt and
Stockholders’ Equity Accounts to Identify the
Cash Flow Effects of Financing Activities
Cash flows from financing activities:
Issued common stock
Borrowed short-term debt
Borrowed long-term debt
Paid dividends
Treasury stock purchases
Net cash used by financing activities
$ 10,000
7,500
20,000
20,700
(3,200)
$ (13,600)
Illustration of the 6-Step
Process
Step 5: Prepare a Formal Statement of Cash Flows
Illustration of the 6-Step
Process
Step 6: Prepare Supplemental Disclosures
Three categories of supplemental disclosure
are associated with the statement of cash
flows:
1.Cash paid for interest and income taxes
2.Reconciliation schedule
3.Noncash investing and financing
activities
International Cash Flow
Statements
• The primary differences in cash flow reporting
around the world relate to interest and income
tax payments.
• International Accounting Standard 7 (IAS 7)
opted to allow more company discretion in
deciding how to classify items like interest and
dividends paid and received.
• Within the FASB there was great debate about
how these items should be classified.
• The final version of SFAS No. 95 says that they
must be classified as operating activities.
International Cash Flow
Statements
• Interest and dividends received: IAS 7 allows
companies to classify them as either operating
or investing activities.
• Interest paid: IAS 7 classifies it as either an
operating activity or a financing activity; but it
must be applied consistently.
• Dividends paid: IAS 7 allows classification as
either a financing activity or as an operating
activity.
• Income Taxes: IAS 7 allows classification as
either operating activity unless the income
taxes can be identified with a financing or
investing activity.
Cash Flow Analysis
• Analysis of cash flow data can add insight
into the performance of a company, beyond
what we can see from the income statement
and balance sheet.
• When a company has a strong incentive to
favorably bias its accrual assumptions to
make it look good on paper, cash flow data
can provide a reality check on the
performance of the company.
• Make sure you go through the analysis in
the case of Kamila Software to see these
techniques at work.