Statement of Cash Flows
THE CONTENT AND VALUE OF THE STATEMENT OF CASH FLOWS
The cash flow statement reconciles beginning and ending cash by presenting the cash receipts
and cash disbursements of an enterprise for an accounting period. The receipts and
disbursements are segregated into three classes of activities. Cash receipts and disbursements
from operating activities report on the cash flows of the enterprise related to its business
operations. Cash receipts and disbursements from investing activities report on the cash flows of
the enterprise related to the acquisition and disposition of noncurrent assets. Cash receipts and
disbursements from financing activities report on the cash flows of the enterprise related to the
acquisition and repayment of debt and equity. The information contained in the statement is
useful to creditors and investors for the following reasons:
1 To assess the entity’s ability to generate cash flows in the future
2 The ability of the entity to pay dividends and meet its obligations
3 Reconciliation between net income in the income statement as net cash flow from operating
activities in the statement of cash flows.
4 To assess cash and noncash investing and financing activities of the entity during the
accounting period.
Classification of Cash Flows
There are three classifications of cash flows:
1 Operating activities
Cash receipts and disbursements are transactions that relate to net income. More specifically
these transactions relate to operating income. They include cash receipts from the sale of
products or services, the payment to vendors for inventory and the payment of salaries and
wages to employees.
2 Investing activities
Cash receipts and disbursements are transactions that relate to noncurrent assets. They
include the purchase and disposition of investments and long-lived assets and loans and
collection of loans to outside parties.
3 Financing activities
Cash receipts and disbursements are transactions that relate to long-term debt and
stockholders’ equity. They include borrowing cash from creditors and repayment of such
loans and the sale of capital stock and the payment of dividends and return of capital to
equity investors.
Format of the Statement of Cash Flows
The following format is for a statement of cash flows using the indirect method of reporting cash
flows from operating activities.
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Statement of Cash Flows
Spencer Company
Statement of Cash Flows
For the Period Ended December 31, 20001
Cash flows from operating activities
Net income
Amortization
Depreciation
Changes in current assets:
Increases
Decreases
Changes in current liabilites:
Increases
Decreases
Gains from investing or financing
Losses from investing or financing
Net cash flow from operating activities
$
+
+
+
+
+
Cash flows from investing activities
Sale of long-term assets
Sales of investments
Collection of loans
Purchase of long-term assets
Purchase of investments
Loan of funds to outside entities
Net cash flow from investing activities
+
+
+
-
Cash flows from financing activities
Sale of equity securities
Issuance of long-term debt
Dividends to stockholders
Repayment of long-term debt
Reacquisition of capital stock
Net cash flow from financing activities
+
+
-
Net increase (decrease) in cash
Cash at beginning of period
Cash at ending of period
$
$
$
$
$
$
$
Steps in Preparation
The statement of cash flows is prepared using the following information:
1 Comparative balance sheets
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Statement of Cash Flows
2
3
The changes between the beginning and ending balance sheets are analyzed to determine the
sources of changes in cash flows.
Current income statement
The current income statement provides the information required to determine the sources and
uses of cash during the accounting period.
T-account analysis of selected general ledger accounts
A T-account analysis must be conducted on each account that resulted in a gain or loss from
investing or financing activities during the accounting period.
There are five steps involved in preparing the statement of cash flows:
1 Determine the change in cash
Using the work sheet approach (which will be discussed in lesson 2) we compare the
beginning and ending cash balances to determine the change in cash during the accounting
period.
2 Determine the net cash flows from operating activities
a) Direct Method
The direct method reports cash receipts from sales, cash disbursements as a result of the
cost of goods sold, operating expenses and income taxes. It is essentially a cash flow
statement using the income statement format. To determine the cash receipts from sales a
T-account analysis is conducted of the changes in accounts receivable. Any increase in
the accounts receivable during the accounting period is subtracted from sales to derive
the cash collected from sales activities for the period. Likewise, to determine the cost of
goods sold a T-account analysis of accounts payable and inventory must be conducted to
calculate the cash paid for inventory sold. The cash disbursements are segregated so that
cash payments to suppliers (vendors for inventory items), operating expenses and income
taxes are presented separately. Although the FASB recommends this approach in
practice few companies actually report using this method. Not only is this more
complicated and time consuming but entities reporting under this approach must still
provide the reconciliation that is presented using the indirect method as well.
Exercise: Spencer Company had the following 2003 income statement:
Sales
Cost of goods sold
Gross profit
Operating expenses
Deprecation
Net income
$200,000
120,000
80,000
29,000
21,000
$ 30,000
The following accounts increased during 2003:
Accounts receivable
$17,000
Inventory
11,000
Accounts payable
13,000
Prepare the cash flows from operating activities section of Azure’s 2002 statement of cash
flows using the direct method.
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Statement of Cash Flows
Cash flows from operating activities:
Cash received from customers
Cash payments:
Vendors
Operating expenses
Net cash provided by operating activities
$
$
$
$
Solution:
Cash flows from operating activities:
Cash received from customers
($200,000 - $17,000)
Cash payments:
Vendors
($120,000 + $11,000 - $13,000)
Operating expenses
Net cash provided by operating activities
183,000
118,000
29,000
147,000
$36,000
b) Indirect Method
The indirect method or reconciliation method reports cash flow from operating activities
by starting with net income. Added back are all noncash charges such as amortization
and depreciation. Next changes in most current assets and current liabilities are added or
subtracted. The last adjustment to net income includes the gains and losses from
investing and financing activities. This reconciliation clearly shows the adjustments from
the income statement that result in cash flows from operating activities for the accounting
period. This method is easier to use and is widely used in practice.
Exercise: Use the information from the exercise above for Spencer Company. Prepare the
cash flows from operating activities section of Spencer Company’s 2003 statement of cash
flows using the indirect method.
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation
Increase in accounts payable
Increase in accounts receivable
Increase in inventory
Net cash provided by operating activities
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$
$
$
$
$
$
$
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Statement of Cash Flows
Solution:
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation
Increase in accounts payable
Increase in accounts receivable
Increase in inventory
Net cash provided by operating activities
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30,000
21,000
13,000
(17,000)
(11,000)
6,000
$36,000
Determine the net cash flows from investing activities
Cash flows from investing activities requires an analysis of the purchase or disposition of
noncurrent assets. This is accomplished by conducting a T-account analysis of the general
ledger accounts affected by the transaction. For example, if we disposed of a piece of
equipment, we would need to look at the change in the equipment account, the change in the
accumulated deprecation account and the reported gain or loss on the income statement. To
determine the cash flow we would need to start with the gain or loss, add the original cost of
the equipment that was removed from the general ledger account and subtract the
accumulated deprecation that was removed from the general ledger account. The result
would be the actual cash flow from the sale of the piece of equipment.
Exercise: Spencer Company had the following activities in 2003:
Sale of long
Purchase of inventory
Purchase of treasury stock
Purchase of equipment
Issuance of common stock
Purchase of available-for-sale securities
$130,000
845,000
72,000
415,000
320,000
59,000
Compute the amount Spencer Company should report as net cash provided (used by
investing activities in its statement of cash flows.
Cash flows from investing activities:
Sale of land
Purchase of equipment
Purchase of available-for-sale securities
Net cash used by investing activities
$
$
Solution:
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Statement of Cash Flows
Cash flows from investing activities:
Sale of land
Purchase of equipment
Purchase of available-for-sale securities
Net cash used by investing activities
4
130,000
(415,000)
(59,000)
(344,000)
Determine the net cash flows from financing activities
Cash flows from financing activities requires an analysis of the issuance or repayment of
long-term debt, issuance or repurchase of equity securities and the payment of dividends.
This is accomplished by conducting a T-account analysis of the general ledger accounts
affected by the transaction. For example, if the entity issued 100 shares of common stock
with a par value of $5 for $45 per share, we would analyze the changes in the capital stock
account and the additional paid-in capital accounts to determine the cash received from the
sale of stock.
Exercise: Spencer Company had the following activities in 2003:
Payment of accounts payable
Issuance of common stock
Payment of dividends
Collection of note receivable
Issuance of bonds payable
Purchase of treasure stock
$770,000
250,000
300,000
100,000
510,000
46,000
Compute the amount Spencer Company should report as net cash provided (used) by
financing activities in its 2003 statement of cash flows.
Cash flows from financing activities:
Issuance of common stock
Issuance of bonds payable
Payment of dividends
Purchase of treasury stock
Net cash provided by financing activities
$
$
$
$
$
Solution:
Cash flows from financing activities:
Issuance of common stock
Issuance of bonds payable
Payment of dividends
Purchase of treasury stock
Net cash provided by financing activities
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250,000
510,000
(300,000)
(46,000)
414,000
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Statement of Cash Flows
5
Determine the noncash transactions that explain changes in some of the balance sheet
accounts
Every once in a while we will notice a change in a general ledger account that was not the
result of a cash transaction. For example, if an entity acquires a piece of land worth
$100,000 by issuing 10,000 share of $5 par value common stock, we would have a debit to
the land account for $100,000, a credit to the common stock account for $50,000 and a credit
to additional paid-in capital for $50,000. There was no cash that changed hands but we need
to reconcile this in our analysis and report if at the bottom of the cash flow statement as a
noncash transaction that took place during the accounting period.
Exercise: In 2002, Spencer Company issued 1,000 shares of $10 par value common stock
for land worth $50,000. Prepare the journal entry to record the transaction.
ACCOUNT
DEBIT
CREDIT
Land
Common stock
Additional paid-in capital, common stock
To record the purchase of land through the
issuance of 1,000 shares of $10 par value
common stock.
Solution:
ACCOUNT
Land
Common stock
Additional paid-in capital, common stock
DEBIT
50,000
CREDIT
10,000
40,000
To record the purchase of land through the issuance
of 1,000 shares of $10 par value common stock.
Sources of Information for the Statement of Cash Flows
The comparative balance sheets provide the foundation for analyzing changes in cash.
Information contained in the current year income statement and analysis of selected general
ledger accounts will be necessary in order to complete the analysis. One of the more difficult
accounts to analyze will be the change in retained earning from the beginning to the end of the
period. The two basic entries will include a credit for net income and a debit for dividends
declared. We will discuss additional analysis when we get to C22b where we introduce the use
of the work sheet method. Writedowns, amortization charges, deprecation and amortization are
among those items that have no affect on cash flow although they are include in the income
statement. They must be backed out of net income in order to get cash flows.
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