Chapter 21
THE STATEMENT OF
CASH FLOWS
REVISITED
McGraw-Hill /Irwin
© 2009 The McGraw-Hill Companies, Inc.
Slide 2
CASH INFLOWS
Operating Activities
Cash received
from revenues
Investing Activities
Sale of operational assets
Sale of investments
Collections of loans
Financing Activities
Issuance of stock
Issuance of bonds
and notes
Business
Cash paid for
expenses
Purchase of operational
assets
Purchase of investments
Loans to others
Payment of dividends
Repurchase of stock
Repayment of debt
CASH OUTFLOWS
21-2
Slide 3
Role of the Statement of Cash Flows
The Statement helps users assess . . .
a firm’s ability to generate cash.
 a firm’s ability to meet its obligations.
 the reasons for differences between income
and associated cash flows.
 the effect of cash and noncash investing and
financing activities on a firm’s financial
position.

21-3
Slide 4
Role of the Statement of Cash Flows
Lists inflows and outflows
of cash and cash
equivalents by category
Explains the change in cash
during the period
Required by SFAS No. 95
21-4
Slide 5
Cash and Cash Equivalents
Resources
immediately
available to
pay
obligations.
Short-term, highly liquid
investments.
 Readily convertible into
known, fixed amounts of cash.
 So near maturity that there is
insignificant risk of market
value fluctuation from interest
rate changes.

21-5
Slide 6
Primary Elements of the Statement of Cash Flows
(SCF)
Operating Activities
Investing Activities
Financing Activities
Reconciliation of the Net
Increase or Decrease in
Cash with the Change in the
Balance of the Cash
Account
Noncash Investing
and Financing
Activities
21-6
Slide 7
Primary Elements of the Statement of Cash Flows
(SCF)
Operating
Activities
Reports the cash effects of the
elements of net income.
Investing
Activities
Reports the cash effects of the
acquisition and disposition of assets
(other than inventory and cash
equivalents).
Financing
Activities
Reports the cash effects of the sale
or repurchase of shares, the
issuance or repayment of debt
securities, and the payment of cash
dividends.
21-7
Slide 8
Cash Flows from Operating Activities
Inflows from:

Sales to customers.
 Interest and dividends
received.
+
Outflows to:




Purchase of inventory.
Salaries, wages, and other
operating expenses.
Interest on debt.
Income taxes.
_
Cash
Flows
from
Operating
Activities
21-8
Slide 9
Direct Method or Indirect Method of Reporting Cash
Flows from Operating Activities
Two Formats for Reporting Operating Activities
Direct Method
Indirect Method
Reports the cash
effects of each
operating activity
Starts with
accrual net
income and
converts to cash
basis
Note that no matter which format is used, the same
amount of net cash flows operating activities is generated.
21-9
Slide 10
Direct Method or Indirect Method of Reporting Cash
Flows from Operating Activities
Cash Flows from Operating Activities--Direct Method
Cash Inflows:
From customers
$
98
From investment revenue
3
Cash Outflows:
To suppliers of goods
(50)
To employees
(11)
To bondholders
(3)
For insurance expense
(4)
For income taxes
(11)
Net cash flows from operating activities
$
22 Cash Flows from Operating Activities--Indirect Method
Net Income
$
12
Adjustments for noncash effects:
The net cash increase or
Gain on sale of land
(8)
decrease from operating
Depreciation expense
3
activities is derived indirectly
Loss on sale of equipment
2
Changes in operating assets and liabilities:
by starting with reported net
Increase in accounts receivable
(2)
income on an accrual basis
Decrease in inventory
4
and working backwards to
Increase in accounts payable
6
Increase in salaries payable
2
convert that amount to a cash
Discount on bonds payable
2
basis.
Decrease in prepaid insurance
3
Decrease in income tax payable
(2)
21-10
Net cash flows from operating activities
$
22
The cash effect of each
operating activity is
reported directly on
the statement of cash
flows.
Slide 11
Cash Flows from Investing Activities
Inflows from:



Sale of long-term assets used in
the business.
Sale of investment securities
(stocks and bonds).
Collection of nontrade
receivables.
+
Outflows to:

Purchase of long-term assets
used in the business.
 Purchase of investment
securities (stocks and bonds).
 Loans to other entities.
_
Cash
Flows
from
Investing
Activities
21-11
Slide 12
Cash Flows from Financing Activities
Inflows from:


Sale of shares to owners.
Borrowing from creditors
through notes, loans,
mortgages, and bonds.
+
Outflows to:



Owners in the form of dividends
or other distributions.
Owners for the reacquisition of
shares previously sold.
Creditors as repayment of the
principal amounts of debt.
_
Cash
Flows
from
Financing
Activities
21-12
Slide 13
Reconciliation with Change in Cash Balance
The net amount of cash inflows and
outflows reconciles the change in the
company’s beginning and ending cash
balances.
For example, assume the net increase in cash is $9
million and the Cash beginning balance is $20
million. The cash reconciliation would be as
follows:
Net increase in Cash
Cash balance, January 1
Cash balance, December 31
$ 9,000,000
20,000,000
$ 29,000,000
21-13
Slide 14
Noncash Investing and Financing Activities
Significant investing and financing
transactions not involving cash also are
reported (usually in a disclosure note).
1. Acquiring an asset by incurring a debt payable
to the seller.
2. Acquiring an asset by entering into a capital
lease.
3. Converting debt into common stock or other
equity securities.
4. Exchanging noncash assets or liabilities for
other noncash assets or liabilities.
21-14
Slide 15
Preparation of the Statement of Cash Flows
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.
21-15
UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
Dec. 31,
2008
Debits
Credits
2009
Balance Sheet
Assets:
Cash
Accounts receivable
Short-term investments
Inventory
Prepaid insurance
Land
Buildings and equipment
Less: Accumulated depreciation
20
30
50
6
60
75
(20)
221
29
32
12
46
3
80
81
(16)
267
Liabilities:
Accounts payable
Salaries payable
Income tax payable
Notes payable
Bonds payable
Less: Discount on bonds payable
20
1
8
50
(3)
26
3
6
20
35
(1)
Shareholders' Equity:
Common stock
100
130
Paid-in capital
20
29
Retained earnings
25
221
19
267
Slide 16
We begin by
entering the
beginning and
ending balances
for each account
on the
comparative
balance sheet and
income statement.
The changes
columns will be
used later to
explain the
increase or
decrease in each
account balance.
21-16
Slide 17
Changes
Dec. 31,
2008
Debits
Dec. 31,
Credits
2009
Income Statement
Revenues:
Sales revenue
Investment revenue
Gain on sale of land
100
3
8
Expenses:
Cost of good sold
Salaries expense
Depreciation expense
Bond interest expense
Insurance expense
Loss on sale of equipment
Income tax expense
Net income
(60)
(13)
(3)
(5)
(7)
(2)
(9)
12
The beginning balances for income
statement accounts are always zero.
21-17
Changes
Dec. 31,
2008
Statement of Cash Flows
Operating Activities:
Debits
Slide 18
Dec. 31,
Credits
2009
Next we
allocate space
on the
spreadsheet
for the
statement of
cash flows.
Investing Activities:
Financing Activities:
Spreadsheet entries duplicate the actual journal entries used
to record the transactions as they occurred during the year.
They are only entered on the spreadsheet and are not
recorded in the accounting records.
21-18
UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
Dec. 31,
2008
Debits
Credits
2009
Balance Sheet
Assets:
Cash
Accounts receivable
Short-term investments
Inventory
Prepaid insurance
Land
Buildings and equipment
Less: Accumulated depreciation
20
30
50
6
60
75
(20)
Dec. 221
31,
2008
29
32
12
46
3
80
81
Changes
(16)
Dec. 267
31,
Debits
Credits
2009
Liabilities:
Income Statement
Accounts payable
20
Revenues:
Salaries
payable
1
Sales
revenue
Income tax revenue
payable
8
Investment
Accounts
Noteson
payable
- Receivable
Gain
sale of land
Bonds payable Beg. bal.
3050
Less: Discount
on bonds
payable
Expenses:
Credit
sales
100(3)
?
Cash
Cost of good sold
End. bal.
Shareholders'
Equity:
Salaries
expense
Common stock
Depreciation
expense
Bond interest expense
Insurance
expense
Paid-in capital
Loss on sale of equipment
Income
expense
Retainedtax
earnings
Net income
32
100
20
25
221
received
26
1003
36
20
8
35
(1)
(60)
(13)
(3)
130
(5)
(7)
(2)
29
(9)
12
19
267
Slide 19
Let’s start by
analyzing Sales
Revenue and its
related account
Accounts
Receivable by
looking at the
relationship in a Taccount format.
21-19
UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
Dec. 31,
2008
Debits
Credits
2009
Balance Sheet
Assets:
Cash
Accounts receivable
Short-term investments
Inventory
Prepaid insurance
Land
Buildings and equipment
Less: Accumulated depreciation
20
30
50
6
60
75
(20)
Dec. 221
31,
2008
29
32
12
46
3
80
81
Changes
(16)
Dec. 267
31,
Debits
Credits
2009
Liabilities:
Income Statement
Accounts payable
20
Revenues:
Salaries
payable
1
Sales
revenue
Income tax revenue
payable
8
Investment
Accounts
Noteson
payable
- Receivable
Gain
sale of land
Bonds payable Beg. bal.
3050
Less: Discount
on bonds
payable
Expenses:
Credit
sales
100(3) 98
Cash
Cost of good sold
End. bal.
Shareholders'
Equity:
Salaries
expense
Common stock
Depreciation
expense
Bond interest expense
Insurance
expense
Paid-in capital
Loss on sale of equipment
Income
expense
Retainedtax
earnings
Net income
32
100
20
25
221
received
26
1003
36
20
8
35
(1)
(60)
(13)
(3)
130
(5)
(7)
(2)
29
(9)
12
19
267
Slide 20
We can see from
this analysis that
cash received from
customers must
have been $98
million.
Let’s see how to
post this entry to
the spreadsheet.
21-20
UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
Dec. 31,
2008
Debits
Credits
2009
Balance Sheet
Assets:
Cash
Accounts receivable
Short-term investments
Inventory
Prepaid insurance
Land
Buildings and equipment
Less: Accumulated depreciation
First, $2 million is
debited to
Accounts
29
Receivable to
32
account for the
12
46
total change in the
3
80
account.
20
30 (1)
2
50
6
60
75
81
Changes
(20)
(16)
Dec. 31,
Dec. 31,
221
267
2008
Debits
Credits
2009
Liabilities:
Income
Statement
Accounts payable
Revenues:
Salaries
payable
Sales
revenue
Income tax revenue
payable
Investment
Gain
sale of land
Notesonpayable
20
1
(1)
8
Accounts Receivable
Beg.
bal.
30
Bonds payable
50
Expenses:
Credit
sales
100 (3) 98
Cash
Less: Discount
on bonds
payable
Cost of good sold
End. bal.
Salaries
expense
Shareholders' Equity:
Depreciation
expense
Common stock
Bond interest expense
Insurance expense
Paid-in capital
Loss on sale of equipment
Income tax expense
Retained earnings
Net income
Slide 21
32
100
20
25
100
received
26
100 3
3 6
8 20
35
(1)
Then, $100 million
is credited to Sales
Revenue to
(60)
account for the
(13)
(3)
total change in the
(5)
130
(7)
account.
(2)
29
(9)
12
19
21-21
Changes
Dec. 31,
2008
Statement of Cash Flows
Operating Activities:
Cash Inflows:
From customers
Debits
(1)
Slide 22
Dec. 31,
Credits
2009
98
Investing Activities:
Accounts Receivable
Beg. bal.
30
Credit sales
100
98
Cash received
Financing Activities:
End. bal.
32
The final part
of this entry is
a $98 million
entry on the
Statement of
Cash Flows
under Cash
Inflows from
Customers.
Let’s skip
ahead and
look at the
analysis of
Short-term
Investments.
21-22
UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
Dec. 31,
2008
Debits
Credits
2009
Balance Sheet
Assets:
Cash
Accounts receivable
Short-term investments
Inventory
Prepaid insurance
Land
Buildings and equipment
Less: Accumulated depreciation
Liabilities:
Accounts payable
Salaries payable
Income tax payable
Notes payable
Bonds payable
Less: Discount on bonds payable
20
30 (1)
(12)
50
6
60
75
(20)
221
20
1
8
50
(3)
2
12
Short-term Investments
Beg.
bal.
0
Shareholders'
Equity:
Common stock
Purchases
12 100
End. bal.
12
Paid-in capital
20
Retained earnings
25
Slide 23
The $12 million
increase in the
Short-term
29
32
Investments
12
46 account is due to
3
the purchase of
80
81
short-term
(16)
267
investments
during the year.
26
3
6
20
35
(1)
In the textbook, entry
number 12 illustrates the
29 analysis of the Short19term Investment account.
130
21-23
Changes
Dec. 31,
2008
Statement of Cash Flows
Operating Activities:
Cash Inflows:
From customers
Dec. 31,
Credits
2009
Debits
(1)
Slide 24
The final part
of this entry is
a $12 million
entry on the
Statement of
Cash Flows
under
Investing
Activities.
98
Investing Activities:
Purchase of S-T investment
(12)
12
Financing Activities:
Short-term Investments
Beg. bal.
0
Purchases
12
End. bal.
12
Now, let’s look
at a noncash
transaction.
21-24
UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
Dec. 31,
2008
Debits
Credits
2009
Balance Sheet
Assets:
Cash
Accounts receivable
Short-term investments
Inventory
Prepaid insurance
Land
Buildings and equipment
Less: Accumulated depreciation
20
30 (1)
(12)
50
6
60
75 (14)
(20)
221
Liabilities:
Accounts payable
Salaries payable
Income tax payable
Notes payable
Bonds payable
Less: Discount on bonds payable
20
1
8
50
(3)
Shareholders' Equity:
Common stock
100
29
32
12
46
3
80
81
(16)
267
2
12
20 x
(14)
20 x
26
3
6
20
35
(1)
Slide 25
In entry number 14,
we find that a note
payable was issued
as payment for a
building.
Investing in a new
building is a
significant investing
activity and
financing the
acquisition with
long-term debt is a
significant financing
activity.
130
Paid-in capital
20
29
Retained earnings
x denotes a noncash transaction
25
221
19
267
21-25
UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31,
Dec. 31,
2008
Debits
Credits
2009
Balance Sheet
Assets:
Cash
Accounts receivable
Short-term investments
Inventory
Prepaid insurance
Land
Buildings and equipment
Less: Accumulated depreciation
20
30
50
6
60
75
(20)
221
(19)
(1)
(12)
9
2
12
(13)
(14)
(9)
(4)
(8)
30 (3)
20 x (9)
7 (6)
4
3
10
14
3
(4)
(5)
6
2
(14)
20 x
(7)
2
(16)
(17)
(16)
(17)
10
20
3
6
13
5 (11)
12
Liabilities:
Accounts payable
Salaries payable
Income tax payable
Notes payable
Bonds payable
Less: Discount on bonds payable
20
1
8 (10)
50 (15)
(3)
Shareholders' Equity:
Common stock
100
Paid-in capital
Retained earnings
20
25 (16)
(18)
221
2
15
29
32
12
46
3
80
81
(16)
267
Slide 26
After entering all
the transactions,
this is what the
balance sheet
portion of the
spreadsheet looks
like.
26
3
6
20
35
(1)
130
29
19
267
21-26
Slide 27
Changes
Dec. 31,
2008
Debits
Income Statement
Revenues:
Sales revenue
Investment revenue
Gain on sale of land
Expenses:
Cost of good sold
Salaries expense
Depreciation expense
Bond interest expense
Insurance expense
Loss on sale of equipment
Income tax expense
Net income
Dec. 31,
Credits
2009
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
100
3
8
100
3
8
60
13
3
5
7
2
9
12
(60)
(13)
(3)
(5)
(7)
(2)
(9)
12
After entering all the transactions, this is
what the income statement portion of the
spreadsheet looks like.
21-27
Changes
Dec. 31,
2008
Statement of Cash Flows
Operating Activities:
Cash Inflows:
From customers
From investment revenue
Cash Outflows:
To suppliers of goods
To employees
To bondholders
For insurance expense
For income taxes
Net cash flows
Investing Activities:
Sale of land
Sale of equipment
Purchase of S-T investment
Purchase of land
Net cash flows
Financing Activities:
Retirement of bonds payable
Sale of common stock
Payment of cash dividends
Net cash flows
Net increase in cash
Totals
Dec. 31,
Credits
2009
Debits
(1)
(2)
Slide 28
98
3
(4)
(5)
(7)
(8)
(10)
50
11
3
4
11
22
(3)
(9)
18
5
(12)
(13)
After entering
all the
transactions,
this is what
the statement
of cash flows
portion of the
spreadsheet
looks like.
12
30
(19)
(17)
(15)
15
(18)
5
26
(19)
376
9
376
6
9
21-28
Here is the
Statement of
Cash Flows
prepared using
the direct
method.
UNITED BRANDS CORPORATION
Statement of Cash Flows
For the Year Ended December 31, 2009
($ in millions)
Cash Flows from Operating Activities:
Cash Inflows:
From customers
$
98
From investment revenue
3
Cash Outflows:
To suppliers of goods
(50)
To employees
(11)
To bondholders
(3)
For insurance expense
(4)
For income taxes
(11)
Net cash flows from operating activities
$
Cash Flows from Investing Activities:
Sale of land
(30)
Sale of equipment
(12)
Purchase of S-T investment
18
Purchase of land
5
Net cash flows from investing activities
Cash Flows from Financing Activities:
Retirement of bonds payable
26
Sale of common stock
(15)
Payment of cash dividends
(5)
Net cash flows from financing activities
Net increase in cash
Cash balance, January 1
Cash balance, December 31
$
Slide 29
22
(19)
6
9
20
29
21-29
Slide 30
Preparing an SCF: The Indirect Method
Cash Flows from Operating Activities--Indirect Method
and
Reconciliation of Net Income to
Net Cash Flows from Operating Activities
Net Income
$
12
Adjustments for noncash effects:
Increase in accounts receivable
(2)
Gain on sale of land
(8)
Decrease in inventory
4
Increase in accounts payable
6
Increase in salaries payable
2
Depreciation expense
3
Discount on bonds payable
2
Decrease in prepaid insurance
3
Loss on sale of equipment
2
Decrease in income tax payable
(2)
Net cash flows from operating activities
$
22
The indirect method
derives the net cash
increases or decreases
from operating activities
indirectly by starting with
reported net income and
“working backwards” to
convert that amount to a
cash basis.
21-30
Slide 31
Components of Net Income that Do Not Increase or
Decrease Cash
Depreciation
Expense
Loss on Sale
of Equipment
Gain on Sale
of Land
Adding these items back to net
income restores net income to
what it would have been had
depreciation and the loss not been
subtracted at all.
Subtracting the gain reverses the
effect of the gain having been
added to net income.
21-31
Slide 32
Components of Net Income that Do Increase or
Decrease Cash
For components of net income that increase or decrease
cash, but by an amount different from that reported on the
income statement, net income is adjusted for changes in the
balances of related balance sheet accounts to convert the
effects of those items to a cash basis.
Account
Type
Current
Assets
Current
Liabilities
Change in Account Balance During Year
Increase
Decrease
Subtract from net
Add to net income.
income.
Add to net income.
Subtract from net
income.
Note: Cash and cash equivalents, short-term investments in securities
available for sale, dividends payable, and short-term payables to financial
institutions are excluded from this category.
21-32
Slide 33
Comparison with the Direct Method
Income Statement
Sales
Investment revenue
$ 100
3
Gain on sale of land
Cost of goods sold
8
(60)
Salaries expense
Depreciation expense
Interest expense
Insurance expense
Loss on sale of equipment
Income tax expense
(13)
(3)
(5)
(7)
(2)
(9)
Net income
$ 12
Cash Flows from Operating Activities
Indirect Method
Direct Method
Net income
$ 12
Adjustments
Increase in accounts receivable
(2) Cash received from customers $ 98
(No adjustment--no investment
Cash received from
3
revenue receivable or long-term
investments
investments)
Gain on sale of land
(8) (Not reported--no cash effect)
Decrease in inventory
4
Increase in accounts payable
6 Cash paid to suppliers
(50)
Increase in salaries payable
2 Cash paid to employees
(11)
Depreciation expense
3 (Not reported--no cash effect)
Decrease n bond discount
2 Cash paid for interest
(3)
Decrease in prepaid insurance
3 Cash paid for insurance
(4)
Loss on sale of equipment
2 (Not reported--no cash effect)
Decrease in income tax payable
(2) Cash paid for income taxes
(11)
Net cash flow from operating
Net cash flow from operating
activities
$ 22 activities
$ 22
21-33
Slide 34
Appendix 21A: Spreadsheet for the Indirect Method
A spreadsheet is
equally useful in
preparing a
statement of cash
flows whether we use
the direct or the
indirect method of
determining cash
flows from operating
activities.
21-34
Slide 35
Appendix 21B: The T-Account Method of Preparing
the Statement of Cash Flows
The T-Account
method serves the
same purpose as a
spreadsheet in
assisting in the
preparation of a
statement of Cash
Flows.
21-35
Slide 36
Appendix 21B: The T-Account Method of Preparing
the Statement of Cash Flows
1. Draw a T-account for each income statement and balance
sheet account.
2. The T-account for cash should be drawn considerably
larger.
3. Enter each account’s net change on the appropriate side
(debit or credit) of the uppermost portion of each Taccount.
4. Reconstruct the transactions that caused changes in
each account balance during the year and record the
entries for those transactions directly in the T-accounts.
5. After all account balances have been explained by Taccount entries, prepare the statement of cash flows from
the cash T-account, being careful also to report noncash
investing and financing activities.
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End of Chapter 21
McGraw-Hill /Irwin
© 2009 The McGraw-Hill Companies, Inc.