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Intermediate Accounting,17E
Statement of Cash
Flows Revisited
PowerPoint presented by: Douglas Cloud
Professor Emeritus of Accounting, Pepperdine University
© 2010 Cengage Learning
21-1
Absence of Transaction Data
If we do not have access to detailed
cash flow information, the
preparation of a statement of cash
flows involves analyzing the income
statement and comparative balance
sheets to determine how a business
generated and used cash.
(continues)
21-2
Absence of Transaction Data
Accounts Receivable
To demonstrate how to gather
information for a statement of cash
flows when we do not have ready
access to detailed cash inflow and
outflow information, we will use
Western Reserve’s Accounts Receivable
from Exhibit 21-2 (with the adjustments
removed).
(continues)
21-3
Absence of Transaction Data
How do we explain the change in
Accounts Receivable from $70,500 to
$67,000?
(continues)
21-4
Absence of Transaction Data
We see from Item (1) on p. 1232 of the textbook
that sales on account totaled $688,800. When
Sales is credited, the normal debit is to Accounts
Receivable. Let’s plug this into the work sheet.
688,800
(continues)
21-5
Absence of Transaction Data
688,800
692,300
?
Now we can determine the missing amount.
Accounts Receivable $70,500 (dr.) + $688,800 ─ ? = $67,000
We solve the equation to find the missing
amount, which is $692,300.
(continues)
21-6
Absence of Transaction Data
688,800
692,300
When Accounts Receivable is credited, we
can assume that Cash is debited. Examine
entry (2) in Exhibit 21-2. This is how we
arrive at the debit to Cash when the
information is not given.
21-7
6-Step Process
1. Compute how much the cash
balance changed during the year.
In Exhibit 21-2, Cash at the
beginning of 2011 was $55,000 and
$50,600 at the end of the year. Our
“target” is to explain why Cash
decreased $4,400.
(continues)
21-8
6-Step Process
2. Convert the income statement from an
accrual-basis to a cash-basis summary of
operations (see Exhibit 21-4, Slide 21-10).
 Eliminate expenses that do not involve
the outflow of cash.
 Eliminate gains and losses associated
with investing or financing activities.
 Adjust for changes in the balances of
current operating assets and operating
liabilities.
(continues)
21-9
(continues)
21-10
6-Step Process
3. Analyze the long-term assets to
identify the cash flow effects of
investing activities. Also examine
certain investment securities
accounts.
4. Analyze the long-term debt and
stockholders’ equity accounts to
determine the cash flow effects of any
financing transactions. Also examine
changes in short-term loan accounts.
(continues)
21-11
6-Step Process
5. Make sure that the total net cash
flow from operating, investing, and
financing activities is equal to the
net increase or decrease in cash as
computed in step 1. Then prepare
a formal statement of cash flows by
classifying all cash inflows and
outflows according to operating,
investing, and financing activities.
(continues)
21-12
6-Step Process
6. Prepare supplemental disclosure,
including the disclosure of any
significant investing or financing
transactions that did not involve
cash.
21-13
An Illustration of the
6-Step Process
Step 1: Compute how much the cash balance
changed during the year
Beginning Cash Balance
– Ending Cash Balance
Decrease in cash
$55,000
(50,600)
$ (4,400)
The purpose of the statement of
cash flows is to explain how the
decrease in cash occurred.
21-14
An Illustration of the
6-Step Process
Step 2: Convert the income statement from an
accrual to a cash-basis summary of
operations
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).
Add: Depreciation Expense
Amortization Expense
(continues)
$20,900
5,000
21-15
An Illustration of the
6-Step Process
Subtract the amount of gains and add
the amount of losses because they are
included in the computation of net
income. Failure to adjust for them here
would result in counting them twice.
(adjustments B1 and B2).
Add: Loss on sale of building
Less: Gain on sale of long-term
investment
(continues)
$ 4,000
$(6,500)
21-16
An Illustration of the
6-Step Process
The accounts receivable account
decreased because customers paid 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).
Add: Decrease in Accounts
Receivable
$3,500
(continues)
21-17
An Illustration of the
6-Step Process
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).
Add: Increase in Unearned Sales
Revenue
$7,000
(continues)
21-18
An Illustration of the
6-Step Process
By allowing the Inventory amount to
decrease, Western Resources has
conserved cash that otherwise
would have been used to purchase
inventory (adjustment C3).
Add: Decrease in Inventory
$1,500
(continues)
21-19
An Illustration of the
6-Step Process
Western Resources paid for more than
it bought from its suppliers during the
year. The adjustment reflects this
additional cash outflow (adjustment
C4).
Subtract: Decrease in Accounts
Payable
$(6,700)
(continues)
21-20
An Illustration of the
6-Step Process
Western Resources paid extra cash
by paying in advance for services
that it will use later (adjustment C5).
Subtract: Increase in Prepaid Operating
Expenses
$(4,500)
(continues)
21-21
An Illustration of the
6-Step Process
A restructuring charge does not
involve an immediate outlay of cash.
Western has not yet paid any cash
associated with the restructuring
(adjustment C6).
Add: Increase in Obligation for Employee
Severance
$11,700
(continues)
21-22
An Illustration of the
6-Step Process
The amount of income tax expense
reported in the financial statements is
not the same as the amount of income
tax that is owed to the taxing authorities
for the year. In 2011 the deferred income
tax liability for Western Resources
increased by $2,700, indicating that
some of the $24,000 income tax expense
reported won’t actually be payable until
some future year.
(continues)
21-23
An Illustration of the
6-Step Process
• This means that the income taxes owed
for 2011 operations are just $21,300
($24,000 – $2,700).
• In Exhibit 21-2, Income Taxes Payable,
which relates to the taxes that are
payable right now decreased by $2,200
($9,500 – $7,300) from December 31,
2010 to December 31, 2011 (adjustment
C7).
(continues)
21-24
An Illustration of the
6-Step Process
Subtract: Decrease in Income Taxes
Payable
$(2,200)
The increase in Deferred Income Tax
Liability of $2,700 (adjustment C8) does
not affect cash flow from operations.
21-25
21-26
The Indirect and Direct Methods
• The indirect method begins with net
income as reported in the income statement
and then details the adjustments needed to
arrive at cash flow from operations. This
method is shown in Exhibit 21-6 (Slide 2128).
• The direct method involves simply
reporting the information contained in the
last column of the adjusted work sheet. The
resulting Operating Activities section is
shown in Exhibit 21-7 (Slide 21-29).
(continues)
21-27
21-28
21-29
21-30
Illustration of the
6-Step Process
Step 3: Analyze the long-term assets to identify the
cash flow effects of investing activities
The long-term investments account was
reduced during the year by $96,000
($106,000 – $10,000). Since no long-term
investments were purchased, the entire
$96,000 reduction represents the book value
of the long-term investments sold during the
year.
(continues)
21-31
Illustration of the
6-Step Process
By checking the income statement (Exhibit
21-2), we determine that there was a $6,500
gain on the sale of long-term investments.
The cash proceeds of $102,000 can be
determined as follows:
Book Value of long-term investments sold
Plus: Gain on sales
Cash proceeds
$ 96,000
6,500
$102,000
(continues)
21-32
Illustration of the
6-Step Process
Land 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
(shown below) will be displayed in the
statement of cash flows.
Increase in land account
– Payment with common stock
Cash outlay
$108,500
(40,000)
$ 68,500
(continues)
21-33
Illustration of the
6-Step Process
Buildings and Equipment increased by
$77,000 ($422,000 – $345,000) during 2011.
A building costing $40,000 was sold for
$10,000 during the year. With this data we
can make the following computation:
Beginning balance
– Cost of building and equipment sold during
the year
Ending balance without additional purchases
$345,000
(40,000)
$305,000
(continues)
21-34
Illustration of the
6-Step Process
A useful way to summarize all purchase and
sale information for buildings and equipment is
to reconstruct the T-accounts for the buildings
and equipment account and the associated
accumulated depreciation account.
Purchased buildings and equipment for
cash of $117,000.
(continues)
21-35
Illustration of the
6-Step Process
The patents account began the year with a
$40,000 balance and ended with a $35,000
balance. The data indicate that no new
patents were purchased during the year.
However, amortization was applied to the
patent as shown below:
Beginning Patents
– Patent amortization recognized during year
+ New patents purchased
Ending Patents
$0
(continues)
$40,000
(5,000)
???
$35,000
21-36
Illustration of the
6-Step Process
The Investing Activities section of the SCF for
Western Resources is as follows:
Cash flows from investing activities:
Sold building
Assumed
Sold long-term investment
available-for-sale
Purchased available-for-sale
securities
securities were
Purchased land
purchased
Purchased buildings and
equipment
Net cash used by investing activities
$ 10,000
102,500
(2,000)
(68,500)
(117,000)
$ (75,000)
21-37
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 transactions
In the absence of detailed information, it is
possible to infer the amount of dividends
declared, as follows:
(continues)
21-38
Illustration of the
6-Step Process
The increase in Western Resources’
dividends payable account indicates
that not all of the $25,100 in dividends
declared were paid in cash during the
year. We can see this in the following
calculation:
Dividends declared
Less: Increase in Dividends Payable
Cash paid for dividends
$25,100
4,400
$20,700
(continues)
21-39
Illustration of the
6-Step Process
The following information summarizes the cash
flow effects of Western Resources’ financing
activities in 2011:
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
21-40
Illustration of the
6-Step Process
Step 5: Prepare a formal statement of
cash flows
You will find the resulting statement
of cash flows using the indirect
method on Slides 21-42 and 21-43.
21-41
(continues)
21-42
21-43
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
21-44
International Cash Flow
Statements
• The primary differences in cash flow
reporting around the world relate to
interest and income tax payments.
• IAS 7 allows dividends paid to be
classified as either a financing activity
(as in the United States) or as an
operating activity.
(continues)
21-45
International Cash Flow
Statements
• Within the FASB there was great
debate about how these items should
be classified.
• The final version of SFAS No. 95
mandates that these items be
classified as operating activities.
• Some have criticized IAS 7 because it
allows too much classification
flexibility.
(continues)
21-46
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.
(continues)
21-47
International Cash Flow
Statements
• Dividends paid: IAS 7 allows
classification as either a financing
activity or as an operating activity.
• Income taxes: IAS 7 requires
classification as an operating activity,
unless the income taxes can be
specifically identified with a financing
or investing activity.
21-48
United Kingdom Cash Flow
Standard, FRS 1
1. Operating activities
2. Returns on investments and servicing of
finance
3. Taxation
4. Capital expenditures and financial
investments
5. Acquisitions and disposals
6. Equity dividends paid
7. Management of liquid resources
8. Financing
21-49