Chapter 12
The Statement of Cash Flows
FEDERAL RESERVE NOTE
THE
THEUNITED
UNITEDSTATES
STATESOF
OFAMER
AMERIC
ICA
A
THIS NOTE IS LEGAL TENDER
FOR ALL DEBTS, PUBLIC AND PRIVATE
L70744629F
12
WASHINGTON, D.C.
12
A
H 29 3
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SERIES
12
1985
ONE
ONE DOLLAR
DOLLAR
Financial Accounting, Alternate 4e by Porter and Norton
1
Cash Flows and Net Income for Four
Computer Companies in 2002
(in millions)
Increase
(Decrease)
in Cash
$ 591
Dell Computer Corp.
(948)
IBM
6,995
Hewlitt-Packard Co.
(265)
Gateway, Inc.
Net Income
(Loss)
$2,122
3,579
(903)
(298)
2
Purpose of the Statement of
Cash Flows
 Explains
changes in cash
over a period of time
 Summarizes
cash inflows
and outflows from:
Operating
Activities
Investing
Activities
Financing
Activities
3
FEDERAL RESERVE NOTE
THE
THE UNITED
UNITED STATES
STATES OF
OF AMERICA
AMERICA
THI S NOTE I S LEGAL TENDER
FOR ALL DEBTS, PUBLI C AND PRI VATE
L7 074 4629 F
12
Cash Equivalents
2
3
8
9
10
H 293
5
6
7
11
12
13
14
18
19
20
2111 2212 23 13 2414
25
26
27
2818 2919 30 20 3121
4
25
15
5
26
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6
27
17
7
28
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2
3
8
9
10
15
4
16
5
17
6
7
22
11
23
12
24
13
14
29
18
30
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31
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25
26
27
28
1
2
3
8
9
10
15
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22
23
24
29
30
31
SERI ES
12
1985
ONE
ONE DOLLAR
DOLLAR

4
12
L7 074 4629 F
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
1
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SH
IN
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
Readily convertible
to cash
Little risk of price
change
Original maturity
to investor of three
months or less
Examples:
• Commercial paper
• U.S. Treasury bills
• Certain money market funds
4
Statement of Cash Flows Format
inflows
Cash
outflows
Classified by:
Operating activities
Investing activities
Financing activities
Beginning
Cash +
Increase or decrease
in cash
=
= Ending
Cash
5
Statement of Cash Flows Format
Cash flows from operating activities:
Inflows
Outflows
Net cash provided (used) by operating activities
Cash flows from investing activities:
Inflows
Outflows
Net cash provided (used) by investing activities
Cash flows from financing activities:
Inflows
Outflows
Net cash provided (used) by financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
$ xxx
(xxx)
$ xxx
$ xxx
(xxx)
xxx
$ xxx
(xxx)
xxx
$ xxx
xxx
$ xxx
from balance sheets
6
Operating Activities
Incur employee
salaries and wages
Sell products
and services
Make inventory
purchases
Cash
transactions
concerned with
acquiring and
selling products
and services
Incur utility and
other operating
costs
7
Investing Activities
Buy/Sell
property, plant
& equipment
Cash transactions
concerned with
acquiring and
disposing of longterm assets
Purchase/Sell
long-term
investments
Purchase/Sell intangible assets
(e.g., patents, trademarks)
8
Financing Activities
Sell/Repurchase
stocks
FEDERAL RESERVE NOTE
THE
THE UNITED
UNITED STATES
STATES OF
OF AMERICA
AMERICA
THI S NOTE I S LEGAL TENDER
FOR ALL DEBTS, PUBLI C AND PRI VATE
L7 074 4629 F
12
WA
SH
IN
G
TO
N
, D
. C.
12
A
H 293
L7 074 4629 F
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SERI ES
12
1985
ONE
ONE DOLLAR
DOLLAR
Issue/Retire
bonds
Cash
transactions
concerned with
internal and
external
financing of the
business
Borrow $/
repay loans
Issue dividends
9
Categorizing Cash Flow Activities
Operating Activities
Investing Activities
Long-Term
Assets
Current
Income
Assets
Statement
and
Transactions
Current
Liabilities
Financing
Activities
Long-Term
Liabilities
or
Stockholders’
Equity
10
Methods to Report
Cash from Operating Activities
 Direct

Method
reports major classes
of cash receipts and
payments
 Indirect

Method
adjusts net income to
remove effect of
accruals and
deferrals
both methods
arrive at same
cash from
operating
activities
11
Preparing the Statement of Cash
Flows: Direct Method
 Step
1
– Set up three schedules
Cash Flows from
Cash Flows from
Cash Flows from
Operating Activities Investing Activities Financing Activities
 Step
–
2
Determine the cash flows from operating
activities by analyzing each item on the income
statement, current assets and current liabilities
12
Direct Method - Operating Activities
Determine cash collected from customers:
Beginning accounts receivable
+ Sales revenue
– Cash collections
= Ending accounts receivable
From Income
Statement
$ 57,000
670,000
(x)
$ 63,000
From Balance
Sheet
Solve for x. Cash collections = $664,000
13
Schedule of
Cash Flows from Operating Activities
Cash receipts from:
Sales on account
664,000
14
Direct Method - Operating Activities
Interest Revenue: Since no Interest Receivable
account exists on the balance sheet, the interest
earned was received, not accrued.
Gain on Sale of Machine: Not an operating cash
flow
15
Schedule of
Cash Flows from Operating Activities
Cash receipts from:
Sales on account
Interest
664,000
15,000
16
Direct Method - Operating Activities
Calculate cash paid to suppliers by first finding
purchases:
Beginning inventory
+ Purchases
(x)
– Cost of goods sold
(390,000)
= Ending inventory
84,000 Solve for x.
$ 92,000
$
Purchases = $382,000
17
Direct Method - Operating Activities
Then examine Accounts Payable to determine cash
paid to suppliers:
Beginning accounts payable
+ Purchases
382,000
– Cash payments
(x)
= Ending accounts payable
$ 31,000
$ 38,000
Solve for x.
Cash paid to suppliers = $ 375,000
18
Schedule of
Cash Flows from Operating Activities
Cash receipts from:
Sales on account
Interest
Cash payments for:
Inventory purchases
664,000
15,000
(375,000)
19
Direct Method - Operating Activities
Salaries and wages:
Beginning salaries & wages pay.
$ 9,000
+ Salaries & wages expense
60,000
– Cash payments
to employees
(x)
= Ending salaries & wages pay.
$ 7,000
Solve for x.
Cash paid for salaries & wages = $ 62,000
20
Schedule of
Cash Flows from Operating Activities
Cash receipts from:
Sales on account
Interest
Cash payments for:
Inventory purchases
Salaries and wages
664,000
15,000
(375,000)
(62,000)
21
Direct Method - Operating Activities
Depreciation expense is not a cash flow
Insurance Expense and Prepaid Insurance:
Beginning prepaid insurance
+ Cash payments for insurance
– Insurance expense
= Ending prepaid insurance
$ 18,000
(x)
(12,000)
$ 12,000
Solve for x. Cash paid for insurance = $6,000
22
Schedule of
Cash Flows from Operating Activities
Cash receipts from:
Sales on account
Interest
Cash payments for:
Inventory purchases
Salaries and wages
Insurance
664,000
15,000
(375,000)
(62,000)
(6,000)
23
Direct Method - Operating Activities
Interest Expense: Since no Interest Payable
account exists on the balance sheet, the interest
expensed was paid, not deferred.
Income Tax Expense and Income Taxes Payable:
Beginning income taxes payable
+ Income tax expense
50,000
– Cash payments for taxes
= Ending income taxes payable
$ 5,000
(x)
$ 8,000
Solve for x. Cash paid for taxes = $47,000
24
Schedule of
Cash Flows from Operating Activities
Cash receipts from:
Sales on account
Interest
Cash payments for:
Inventory purchases
Salaries and wages
Insurance
Interest
Taxes
Net cash provided by operating
activities
$ 664,000
15,000
(375,000)
(62,000)
(6,000)
(15,000)
(47,000)
$ 174,000
25
Preparing the Statement of Cash
Flows: Direct Method
Step
–
3
Determine the cash flows from investing
activities by examining the long-term
asset accounts and any additional info
26
Direct Method – Investing Activities
Long-Term Investments: The net increase of
$30,000 matches the additional info given on the
balance sheet and required the use of cash.
Land: The additional balance sheet info
reveals that a note payable was issued.
No cash was involved in the land transaction so
it should be reported in a separate schedule
instead of on the Statement of Cash Flows
27
Direct Method – Investing Activities
Property and Equipment: The additional balance
sheet info reveals that equipment was purchased
for $75,000 and a machine was sold for $25,000.
Beginning property and equip.
+ Acquisitions
– Disposals
= Ending property and equip.
$280,000
75,000
(x)
$320,000
Solve for x.
The cost of fixed assets sold = $35,000
28
Direct Method – Investing Activities
Accumulated Depreciation:
Beginning accum. depreciation
+ Depreciation expense
– Accum. depreciation on assets sold
= Ending accum. depreciation
$ 75,000
40,000
(x)
$100,000
Solve for x. The accumulated depreciation on the
assets disposed of during the year = $15,000
29
Schedule of
Cash Flows from Investing Activities
Cash inflows from:
Sale of machine
Cash outflows from:
Purchase of investment
Purchase of property and equip.
Net cash used by investing activities
$ 25,000
(30,000)
(75,000)
$(80,000)
30
Preparing the Statement of Cash
Flows: Direct Method
Step
–
4
Determine the cash flows from
financing activities
FEDERAL RESERVE NOTE
THE
THE UNITED
UNITED STATES
STATES OF
OF AMERICA
AMERICA
THI S NOTE I S LEGAL TENDER
FOR ALL DEBTS, PUBLI C AND PRI VATE
L7 074 4629 F
12
WA
SH
IN
G
TO
N
, D
. C.
12
A
H 293
L7 074 4629 F
12
SERI ES
12
1985
ONE
ONE DOLLAR
DOLLAR
31
Direct Method – Financing Activities
Notes payable: This increase is already shown on a
supplemental schedule of noncash activities.
Bonds payable: Bonds with a face value of $60,000
are retired by paying $63,000.
32
Direct Method – Financing Activities
Capital stock was issued for cash
Retained earnings:
Beginning retained earnings
$ 193,000
+ Net income
120,000
– Cash dividends
(x)
= Ending
retained
246,000
Solve
for x.
Cash earnings
paid for dividends =$ $67,000
33
Schedule of
Cash Flows from Financing Activities
Cash inflows from:
Issuance of stock
Cash outflows from:
Retirement of bonds
Payment of cash dividends
Net cash used by financing activities
$ 25,000
(63,000)
(67,000)
$(105,000)
34
Noncash Investing and
Financing Activities
 Disclose
important financing and investing
activities which do not require cash
 Examples:
Exchange Stock for Assets
Certificate of Stock
Buy Assets through Debt Financing
from Supplier
35
Statement of Cash Flows Format
Cash flows from operating activities:
Inflows
Outflows
Net cash provided (used) by operating activities
Cash flows from investing activities:
Inflows
Outflows
Net cash provided (used) by investing activities
Cash flows from financing activities:
Inflows
Outflows
Only section of statement
Net cash provided
by financing
that(used)
differs
in form activities
between
Net increase (decrease) in cash and cash equivalents
direct and indirect method
Cash and cash equivalents at beginning of year
(net cashatflow
total
Cash and cash equivalents
end of
yearis the
$ xxx
(xxx)
$ xxx
$ xxx
(xxx)
xxx
$ xxx
(xxx)
xxx
$ xxx
xxx
$ xxx
same)
36
Indirect Method Operating Activities
Income Statement
Conversion
of accrual
to cash
basis
Cash Flows from Operating Activities
37
Indirect Method - Operating Activities
Net cash flows from operating activities:
Net income
Adjustments to reconcile net income:
Increase in accounts receivable
xx,xxx
(6,000)
From balance sheet:
Accts. receivable, 2004
Accts. receivable, 2003
$63,000
57,000
$ 6,000
Decrease $6,000
38
Indirect Method - Operating Activities
Net cash flows from operating activities:
Net income
Adjustments to reconcile net income:
Increase in accounts receivable
Gain on sale of machine
Selling price of machine
Book value of machine
Gain on sale
xx,xxx
(6,000)
5,000
$25,000
20,000
$ 5,000
Increase $5,000
39
Indirect Method - Operating Activities
Net cash flows from operating activities:
Net income
Adjustments to reconcile net income:
Increase in accounts receivable
Gain on sale of machine
Decrease in inventory
Decrease $8,000
xx,xxx
( 6,000)
5,000
8,000
From balance sheet:
Inventory, 2003 $92,000
Inventory, 2004
84,000
$ 8,000
40
Indirect Method - Operating Activities
Net cash flows from operating activities:
Net income
Adjustments to reconcile net income:
Increase in accounts receivable
Gain on sale of machine
Decrease in inventory
Increase in accounts payable
Increase $7,000
xx,xxx
( 6,000)
5,000
8,000
7,000
From balance sheet:
Accts. payable, 2004 $38,000
Accts. payable, 2003
31,000
$ 7,000
41
Indirect Method - Operating Activities
Net cash flows from operating activities:
Net income
Adjustments to reconcile net income:
Increase in accounts receivable
Gain on sale of machine
Decrease in inventory
Increase in accounts payable
Decrease in salaries & wages payable
Salaries & wages payable, 2003
Salaries & wages payable, 2004
xx,xxx
( 6,000)
5,000
8,000
7,000
( 2,000)
$9,000
7,000
$2,000
Decrease $2,000
42
Indirect Method - Operating Activities
Net cash flows from operating activities:
Net income
Adjustments to reconcile net income:
Increase in accounts receivable
Gain on sale of machine
Decrease in inventory
Increase in accounts payable
Decrease in salaries & wages payable
Decrease in prepaid insurance
xx,xxx
( 6,000)
5,000
8,000
7,000
( 2,000)
6,000
Prepaid insurance, 2003
Prepaid insurance, 2004
$18,000
12,000
$ 6,000
Decrease $6,000
43
Indirect Method - Operating Activities
Net cash flows from operating activities:
Net income
Adjustments to reconcile net income:
Increase in accounts receivable
Gain on sale of machine
Decrease in inventory
Increase in accounts payable
Decrease in salaries & wages payable
Decrease in prepaid insurance
Depreciation expense
xx,xxx
( 6,000)
5,000
8,000
7,000
( 2,000)
6,000
40,000
Add back
noncash expense
44
Indirect Method - Operating Activities
Net cash flows from operating activities:
Net income
Adjustments to reconcile net income:
Increase in accounts receivable
Gain on sale of machine
Decrease in inventory
Increase in accounts payable
Decrease in salaries & wages payable
Decrease in prepaid insurance
Depreciation expense
Increase in income taxes payable
xx,xxx
( 6,000)
5,000
8,000
7,000
( 2,000)
6,000
40,000
3,000
Inc. taxes payable, 2004
Inc. taxes payable, 2003
$8,000
5,000
$3,000
Increase $3,000
45
Indirect Method - Operating Activities
Net cash flows from operating activities:
Net income
Adjustments to reconcile net income:
Increase in accounts receivable
Gain on sale of machine
Decrease in inventory
Increase in accounts payable
Decrease in salaries & wages payable
Decrease in prepaid insurance
Increase in income taxes payable
Depreciation expense
Loss on retirement of bonds
xx,xxx
( 6,000)
( 5,000)
8,000
7,000
( 2,000)
6,000
3,000
40,000
3,000
Report entire
outflow as a
financing activity
46
FEDERAL RESERVE NOTE
THE
THE UNITED
UNITEDSTATES
STATES OF
OF AMERICA
AMERICA
TH
IS N
O
TE IS LEG
A
L TEN
D
ER
FO
RA
LL D
EBTS, PU
BLIC A
N
DPRIV
A
TE
Cash Flow Adequacy
L70744629F
12
WASHINGTON, D.C.
12
A
H293
L70744629F
12
SERIES
12
1985
ONE
ONE DOLLAR
DOLLAR
 Measures
company’s ability to meet
principal and interest obligations
 Creditors concerned with cash available to
repay debts after company has replaced its
long-term assets
Cash Flow from Operating Activities
- Capital Expenditures
.
Avg. Debt Maturing over Next Five Years
47
Appendix
Accounting Tools:
A Work-Sheet Approach to the
Statement of Cash Flows
48
Indirect Method: Using a Work Sheet
Enter account
balances
49
Indirect Method: Using a Work Sheet
50
Indirect Method: Using a Work Sheet
Enter net
income
51
Indirect Method: Using a Work Sheet
Enter noncash
revenues or expenses
52
Indirect Method: Using a Work Sheet
Extend current assets
& current liabilities
53
Indirect Method: Using a Work Sheet
Total
columns
54
Indirect Method: Using a Work Sheet
Determine net
cash inflow
(outflow)
55
End of Chapter 12
FEDERAL RESERVE NOTE
THE
THEUNITED
UNITEDSTATES
STATESOF
OFAMERICA
AMERICA
THIS NOTE IS LEGAL TENDER
FOR ALL DEBTS, PUBLIC AND PRIVATE
L70744629F
12
WASHINGTON, D.C.
12
A
H 293
L70744629F
12
SERIES
12
19 85
ONE
ONE DOLLAR
DOLLAR
56