Intermediate Accounting
October 21st,2010
1.
General Course Questions
2.
Questions on Balance Sheet Homework
3.
Cash Flow Statement
A. Reporting items as Operating, Investing & Financing
B. Preparing an Indirect Statement of Cash Flows (pr. 5-6)
1.
Review Quiz #3 Chapters 4, 17 & 22
5. Assignments for Tuesday, October 26th:
A. Chapter 5 Problem 7
B. Chapter 23 Exercise 15
6. Return and Review Quiz #3 Chapters 4, 17 & 22
1
Cash Flow Statement Learning Objectives
Objectives:
1.
2.
3.
4.
5.
6.
Describe the purpose of the Cash Flow Statement (how it meets
GAAP’s Objectives of Financial Reporting)
Prepare a Statement of Cash flows under both the Direct and
Indirect Method.
Differentiate between Net Income and Cash from Operations
(CFO) and use it to assess a company’s ability to generate
future Cash Flows (CFO)
Evaluate the company’s quality of earnings by comparing and
reconciling net income to cash
Determine whether a company is expanding or contracting
using the “Investing” section of the Cash Flow Statement
Evaluate the company’s financing activity – are they relying on
internal or external financing, and debt or equity
financing?
7.
Assess a company’s need for external financing and its ability to
pay its debts and dividends
2
The Cash Flow Statement
• What is included in “cash”?
• The cash flow statement provides
information for a period of time about:
– cash receipts (cash inflows)
– uses of cash (cash outflows)
• Inflows and outflows are reported for:
–
–
–
–
operating
investing
financing activities
Summing to the net increase/decrease in cash over
the period
Cash is King
• Remember the 2nd Objective of Financial
Reporting: to “Provide Information that is useful in
assessing future ________ flows”. (see the House of
GAAP from our first class, and repeated on the next slide)
• A good place to start predicting future cash flows
is the company’s historical cash flows.
• The Statement of Cash Flows provides information
about the cash receipts and cash disbursements
during a specific time period, the same time period
covered by the income statement.
4
4
HOUSE OF GAAP
GAAP’s Objective is to provide Financial Information that is:
1.
2.
3.
Useful in investment & credit decisions
Useful in assessing future ______ flows
About the enterprise resources (assets), claims (liabilities
& owners’ equity) to resources, and _________ in them
Qualitative Characteristics
Relevance
Predictive or Feedback Value
Timeliness
Reliability
Comparability
Consistency
Assumptions
Economic Entity
Going Concern
Monetary Unit
Periodicity
Elements
Assets
Liabilities
Stockholders’ Equity
Other Comprehensive Income
Revenues
Expenses
Principles
Historical Cost
Revenue Recognition
Matching
Full Disclosure
Constraints
Cost/Benefit
Materiality
Industry Practice
Conservatism
5
Highlighting Balance Sheet Changes
• The 3rd Objective of Financial Reporting is to
“Provide Information about the enterprise
resources (assets), claims (liabilities & owners’
equity) to resources, and _________ in them”
(see the House of GAAP Prior slide and first class)
• The Cash Flow Statement also highlights how the
Balance Sheet Accounts have changed.
Changes in Balance Sheet Accounts:
1. Most Current Assets and Current
Liabilities (working capital accts)
2. Most Long-term Assets
3. Most Non-operating Liabilities
Stockholder’s Equity accounts
Located in Cash Flow Statement
Operating Section
Investing Section
Financing Section
6
Which Financial Statement
should you use?
• If you want to know the “Balance” of an Asset
account, i.e. how much inventory a company has
at the end of the period?
–
–
–
–
Income Statement
Balance Sheet
Statement of Stockholders’ Equity
Cash Flow Statement
–
–
–
–
Income Statement
Balance Sheet
Statement of Stockholders’ Equity
Cash Flow Statement
• If you want to know how much an asset account
changed during the period, i.e. how much
inventory increased or decreased?
7
Which Financial Statement
should you use?
• If you want to know the “Balance” of an Liability
account, i.e. how much a company owes its
suppliers at the end of the period?
–
–
–
–
Income Statement
Balance Sheet
Statement of Stockholders’ Equity
Cash Flow Statement
–
–
–
–
Income Statement
Balance Sheet
Statement of Stockholders’ Equity
Cash Flow Statement
• If you want to know how much liability account
has changed during the period, i.e. how much
accounts payable has increased or decreased?
8
Using the Statement of Cash Flows
In addition to reporting the changes to each current
operating asset & liability (accounts receivable, inventory,
accounts payable) the Statement of Cash Flows also helps:
• assess a company’s ability to generate positive future
cash flows from operations,
• reconcile differences between net income and the change
in the cash balance.
• monitor a company’s investment in property, plant and
equipment – is it more or less than their depreciation
expense? Is the company expanding or contracting?
• assess a company’s need for external financing, source of
external financing (debt or equity) and its ability to pay
its debts and dividends.
9
The Cash Flow Statement
:
Beginning Operating
Cash
Cash Inflows
Investing
Financing
Ending
Cash
Cash Outflows
10
The Three Sections of the
Cash Flow Statement
• Operating - cash inflows and outflows resulting form
activities that are central to the day-to-day operation of
the business. Cash flows from Revenue and Expenses.
• Investing - cash inflows and outflows from the sale
or purchase of property, plant & equipment, investment
in other companies and loans to other companies.
(Changes in non-current and/or non-operating assets)
• Financing - cash inflows and outflows from the sale
or re-purchase of the companies stock, borrowing or
repaying interest bearing debt, and paying dividends to
stockholders. (Changes in Non-operating liabilities and
shareholders’ equity)
11
Changes to all Balance Sheet Accounts are
on the Cash Flow Statement
Decision Tree to determine where change will be:
Operating – changes to all current & operating accounts
Start with accrual accounting income and
adjust it to get cash from operations
Non-Operating – changes to all non-current and/or
non-operating accounts
Investing – non-current &/or non-operating ASSETS
Financing – interest bearing debt and non-current &/or
non-operating Liabilities & Stockholders’ Equity accts
12
Classification of Cash Flows
For each item or event listed below, indicate whether the related it
would be reported in the Operating, Investing or Financing section of
the Cash Flow Statement:
1. Payment on long-term debt
2. Issuance of bonds at a premium
3. Collection (reduction) of accounts receivable
4. Cash dividends declared and paid
5. Collection (reduction) of notes receivable, affiliated company
6. Sale of (reduction) of trading securities (marketable securities)
7. Payment of wages (decrease in wages payable)
8. Issuance of common stock for cash, C.S increases
9. Payment of income taxes (decrease in income taxes payable)
10. Purchase of equipment (equipment increases)
11. Purchase of treasury stock (T.S. increases)
12. Sale of real estate held as a long-term investment
13. Purchase of inventory (inventory increases)
Preparing a Statement of Cash Flows
The choice between methods of preparing the
statement of cash flows only affects the “Cash
from Operations” section.
– Indirect method: derives cash flows from
operations by starting with net income and
adjusting it to get Cash from Operations
• Used almost exclusively
• Most be provided as a schedule if Direct Method is Used
– Direct method: derives cash flows directly for each
source or use of cash
The Choice of Method has no effect on the other
two sections of the Cash Flow Statement (the
Cash Flows from “Investing” and “Financing”)
Operating Activities
Operating activities consist of those activities that are central to the dayto-day operation of the business. The Cash Inflows and Outflows from
the Revenues and Expenses that are reported on an accrual basis on the
Income Statement will be reported in Operating section of the Cash Flows
Statement.
•
•
•
Cash Inflows from Operating Activities include:
1. Cash from customers from the sale of products.
2. Interest and Dividends received on investments
Cash Outflows from Operating Activities include:
1. Cash paid to suppliers for purchases of inventory.
2. Cash paid to employees for wages and salaries
3. Cash paid to governments for taxes
4. Cash paid to creditors for interest on loans (but not for
repayment of principal)
Operating Activities on the Cash Flow Statement include
Normal Operating Activities + dividends received and both
interest received and interest paid.
15
Decision Tree to determine Reporting on the
Cash Flow Statement
Operating – changes to all current & operating accounts
Start with accrual accounting income and
adjust it to get cash from operations
Net Income (accrual basis)
1. Adjustments to go from Accrual to Cash
a. Changes to all Current & Operating Assets
b. Changes to all Current & Operating Liabilities
c. Non Cash Expenses
2. Adjustments for non-operating gains and losses
Net Cash Provided (Used) by Operations
Non-Operating – changes to all non-current and/or
non-operating accounts
Investing – non-current &/or non-operating ASSETS
Financing – interest bearing debt and non-current &/or
non-operating Liabilities & Stockholders’ Equity accts
16
The changes to Current Operating
Assets & Liabilities are needed to
Convert Accrual Accounting Income
to Cash from Operations
Sales
$98,000
Cost of Goods Sold
72,000
Gross Profit
26,000
Operating Expenses
14,000
Income before Taxes
$12,000
Income Tax Expense
4,000
Net Income
$ 8,000
Adjustments (to convert Accrual Net income)
+
Cash From Operations
Accounts Receivable
End of Year
$20,000
Beg of the Year
$10,000
How did the increase in A/R
affect Cash from Operations?
Did you receive more or less
cash than is reflected in Sales?
Cash Flow Statement
starts with Net Income
17
& adjusts it to CFO
The changes to Current Operating
Assets & Liabilities are needed to
Convert Accrual Accounting Income
to Cash from Operations
Sales
$98,000
Cost of Goods Sold
72,000
Gross Profit
26,000
Operating Expenses
14,000
Income before Taxes
$12,000
Income Tax Expense
4,000
Net Income
$ 8,000
Adjustments (to convert Accrual Net income)
+
Cash From Operations
Inventory
End of Year
$8,000
Beg of the Year
$ 9,000
How did the decrease in
Inventory affect Cash from
Operations?
Did you use more or less cash
than is reflected in Cost G Sold?
Cash Flow Statement
starts with Net Income
18
& adjusts it to CFO
The changes to Current Operating
Assets & Liabilities are needed to
Convert Accrual Accounting Income
to Cash from Operations
Sales
$98,000
Cost of Goods Sold
72,000
Gross Profit
26,000
Operating Expenses
14,000
Income before Taxes
$12,000
Income Tax Expense
4,000
Net Income
$ 8,000
Adjustments (to convert Accrual Net income)
+
Cash From Operations
Accounts Payable
End of Year
$7,000
Beg of the Year
$ 17,000
How did the decrease in
Accounts Payable affect Cash
from Operations?
Did you spend more or less cash
than is reflected in income tax
expense?
Cash Flow Statement
starts with Net Income
19
& adjusts it to CFO
The changes to Current Operating
Assets & Liabilities are needed to
Convert Accrual Accounting Income
to Cash from Operations
Sales
$98,000
Cost of Goods Sold
72,000
Gross Profit
26,000
Operating Expenses
14,000
Income before Taxes
$12,000
Income Tax Expense
4,000
Net Income
$ 8,000
Adjustments (to convert Accrual Net income)
+
Cash From Operations
Taxes Payable
End of Year
$5,000
Beg of the Year
$ 3,000
How did the increase in Taxes
Payable affect Cash from
Operations?
Did you spend more or less cash
than is reflected in income tax
expense?
Cash Flow Statement
starts with Net Income
& adjusts it to CFO 20
Changes in Current & Operating
accounts & their affect on CFO
Net Income
1. Adjustments to go from Accrual to Cash caused
by changes to operating assets and liabilities:
A. Subtract changes in current operating assets and current operating
liabilities that USE up CASH:
Deduct for cash spent to increase inventory & other current op. assets
Deduct for cash used to Decrease Current Operating Liabilities
B. Add changes in current operating assets and current operating liabilities
that Provide CASH:
Add cash collected from decrease in receivables or other current op. assets
Add cash saved by not paying operating liabilities – accounts payable
increased or more money was received as unearned revenue from
customers making advance payments
Net Cash Provided (Used) by Operations
21
Changes to all Balance Sheet Accounts are
on the Cash Flow Statement
Decision Tree to determine where change will be:
Operating – changes to all current & operating accounts
Start with accrual accounting income and
adjust it to get cash from operations
Net Income (accrual basis)
1. Adjustments to go from Accrual to Cash
2. Adjustments for non-operating gains and losses
Net Cash Provided (Used) by Operations
Non-Operating – changes to all non-current and/or
non-operating accounts
Investing – non-current &/or non-operating ASSETS
Financing – interest bearing debt and non-current &/or
non-operating Liabilities & Stockholders’ Equity accts
22
Where do we find the Information for
the Statement of Cash Flows:
Indirect Method
Info from Accrual Based Stmts.
Income Statement:
(Non Cash Exp. & Non-Op Gains &Losses)
Balance Sheet:
(changes in Current & Op .Assets
and Current Operating Liabilities)
Balance Sheet:
Changes in Non-Current and
Non-operating Assets
Balance Sheet:
Changes in Non-Current and
Non-operating Liabilities
And Equity
Used on Cash Flow Statement
Operating activities:
Adjust net income to CFO
Adjustment to go from accrual
to cash & eliminate Non-Op items
Investing activities:
Inflows and Outflows from sales
and purchases of Non-operating
and Non-current assets
Financing activities:
Inflows and outflows
from debt and equity
Transactions excluding income
SCF: Indirect Preparation Guide
1.
Calculate changes in balance sheet accounts (they will all need
to be reflected on the Statement of Cash Flows to balance
back to the change in cash, which is your reconciling number).
2.
Use the Decision Tree to determine which section of the Cash
Flow Statement should be used to reflect the change in each
Balance Sheet account.
3.
Calculate and Prepare the Cash from Operations by:
A. Start with Net Income (which is based on accrual
accounting)
B. Adjust it to Cash from Operations by:
1. Adding back Non-cash Expenses (depreciation,
amortization)
2. Eliminating non-operating gains and losses
(excluding Dividend Income, Interest Income, and
Interest Expense)
3. Adjust it for changes in Current & Operating Assets
4. Adjust if for changes in Current & Operating Liabilities
Steps 4-6 continued on the next slide
SCF: Indirect Preparation Guide
4.
Prepare the Investing Section:
A. Allocate the change in PP&E between current year
depreciation, purchases of PP&E and sales of PP&E,
recording the cash received and paid for PP&E separately
B. Account for the changes in all non-current and
non-operating assets
5. Prepare the Financing Section
A. Allocate change in RE between dividends and Net Income
B. Allocate change in debt between new borrowings and
repayments, recording cash received and paid separately
C. Account for changes in all non-current & non operating
(interest bearing) liabilities & equity
6. Reconcile the net change in cash from all three sections to
the change in cash on the balance sheet
Prepare Statement of Cash Flows
(Indirect using Ch 5 problem 6)
Lansbury Inc.
Balance Sheet
December 31, 2010
Assets
2010
Cash
$
32,000
increase
(decrease)
2009
$
20,000
$
12,000
Accounts Receivable
41,600
21,200
20,400
Investments
20,400
32,000
(11,600)
Plant Assets (net)
70,000
81,000
(11,000)
Land
88,000
40,000
48,000
252,000
$ 194,200
total assets
$
$
57,800
$
-
Liabilities and Stockholders's Equity
Accounts payable
$
30,000
$
30,000
41,000
Notes Payable
25,000
Bonds Payable
30,000
Common Stock
120,000
100,000
20,000
47,000
23,200
23,800
252,000
$ 194,200
Retained Earnings
$
(16,000)
30,000
$
57,800
Prepare Statement of Cash Flows
(Indirect using Ch 5 problem 6)
1. Net Income for 2010 was $32,000, after depreciation
of $11,000.
2. Lansbury sold part of its investment portfolio for
$15,000 resulting in a gain of $3,400.
3. A tract of land was purchased for $18,000 cash.
4. Land was purchased through the issuance of $30,000
bonds.
5. Long-term notes payable in the amount of $16,000
were retired before maturity by paying $16,000 cash.
6. An additional $20,000 in common stock was issued at
par.
7. Dividends totaling $8,200 were declared and paid to
stockholders.
Computing Cash from Operations
Start with Net Income and Adjust it to get Cash from Operations.
Net Income (accrual basis)
$_______
1. Adjustments to go from Accrual to Cash:
A. Add back non-cash expenses (Expenses that
reduce net income but do not use up any cash)
_____________________________
$______
_____________________________
$______
B. Changes in Operating Assets & Liabilities
_____________________________
_____________________________
$______
$______
2. Adjustments for non-operating gains and losses:
We want only operating cash so add back non-operating losses which have
reduced net income and subtract out gains from non-operating activities
Loss on disposition of assets
_____________________________
Net Cash Provided by Operations
$______
________
$ ______
28
Computing
Cash
from
Operations
Computing
Cash
from
Operations
Start with Net Income and Adjust it to get Cash from Operations.
Net Income (accrual basis)
$32,000
1. Adjustments to go from Accrual to Cash:
A. Add back non-cash expenses (Expenses that
reduce net income but do not use up any cash)
Depreciation Expense
$ 11,000
_____________________________
$______
B. Changes in Operating Assets & Liabilities
Increase in Accounts Receivable
_____________________________
(20,400)
$______
2. Adjustments for non-operating gains and losses:
We want only operating cash so add back non-operating losses which have
reduced net income and subtract out gains from non-operating activities
Loss on disposition of assets
Gain on sale of Investments
Net Cash Provided by Operations
( 3,400)
$ 19,200
29
Finding Investing Activity - Changes to
what accounts?
Decision Tree to determine where change will be:
Operating – changes to all current & operating accounts
Start with accrual accounting income and adjust it to
get cash from operations
Non-Operating – changes to all non-current and/or
non-operating accounts
Investing – non-current &/or non-operating ASSETS
cash inflows and outflows from :
1) the sale or purchase of property, plant & equipment,
2) investment in other companies (marketable securities)
3) loans to other individuals or companies.
Financing – non-current &/or non-operating
Liabilities & Stockholders’ Equity Accounts
30
Investing Activities
Investing activities come in two basic forms:
1) Investments in your own company, including the
purchase of long-term productive assets such as
property, plant and equipment
2) Investments in others by purchasing stocks and bonds
of another corporation, or a partnership interest, or
making loans to another entity
•
•
Cash Inflows result from the Sale of:
1. Property, Plant & Equipment
2. Investments in other companies
3. Collecting money loaned to other companies
Cash Outflows result from the Purchase of:
1. Property, Plant & Equipment
2. Investment in other companies
3. Loaning money to other companies
31
Computing Cash Investing & Financing
Net Cash Provided by Operations
$_______
Cash from Investing:
(cash received or paid from changes in non-current & non-operating
assets, including the affect of gains & losses)
_____________________________
$______
_____________________________
$______
_____________________________
$______ $______
Cash from Financing:
(cash received or paid from changes in non-current & non-operating
Liabilities & Stockholders’ Equity, excluding income)
_____________________________
$______
_____________________________
$______
_____________________________
$______ $______
Net Increase in Cash
$ ______
32
Computing Cash Investing & Financing
Net Cash Provided by Operations
$ 19,200
Cash from Investing:
(cash received or paid from changes in non-current & non-operating
assets, including the affect of gains & losses)
Sale of Investments
$15,000
Purchase of Land
(18,000) (3,000)
Cash from Financing:
(cash received or paid from changes in non-current & non-operating
Liabilities & Stockholders’ Equity, excluding income)
_____________________________
$______
_____________________________
$______
_____________________________
$______ $______
Net Increase in Cash
$ ______
33
Finding Financing Activity - Changes to
what accounts?
Decision Tree to determine where change will be:
Operating – changes to all current & operating accounts
Start with accrual accounting income and adjust it to get cash
from operations
Non-Operating – changes to all non-current and/or
non-operating accounts
Investing – non-current &/or non-operating ASSETS
cash inflows and outflows from :
Financing – non-current &/or non-operating
Liabilities & Stockholders’ Equity Accounts
1) the sale or re-purchase of the companies own stock,
2) borrowing or repaying interest bearing debt, and
3) paying dividends
34
Financing Activities
This section focuses on the external financing activities
of the company which come in two basic forms:
1) Equity financing includes the use of both Common &
Preferred Stock.
2) Debt financing includes the use of notes (loans) and
bonds.
• Cash Inflows result from:
1. Selling shares of our own stock
2. Borrowing, bank loans, issuing bonds or other debt
• Cash Outflows result from:
1. Dividend payments to stockholders
2. Reacquiring shares of the company’s own stock
(Treasury stock)
3. Repaying principal on loans, bonds or other debt
35
Computing Cash Investing & Financing
Net Cash Provided by Operations
$ 19,200
Cash from Investing:
(cash received or paid from changes in non-current & non-operating
assets, including the affect of gains & losses)
Sale of Investments
$15,000
Purchase of Land
(18,000) (3,000)
Cash from Financing:
(cash received or paid from changes in non-current & non-operating
Liabilities & Stockholders’ Equity, excluding income)
Issuance of Common Stock
$ 20,000
Repayment of notes payable
(16,000)
Payment of cash dividends
( 8,200) (4,200)
Net Increase in Cash
$ 12,000
36
SCF Comments
• Non-cash transactions are not shown on the face of the
SCF – but material non-cash transactions must be
disclosed (usually in the notes)
– E.g. the firm trades $1M of common stock for a warehouse
• Dividends are shown under financing activities, but these
are dividends paid, not necessarily dividends declared
– So if you see dividends on the R/E Statement, and dividends
payable on the B/S, you must determine what was actually paid
during the year
How to Read a SCFs
•
•
•
•
Know where a company is in lifecycle
Focus on subtotals
Dig into “larger items”
Consider if is healthy/unhealthy given lifecycle
Typical Company Cash Flow Life Cycle
LO 2 Identify the major classifications of cash flows.
Using The Cash Flow Statement
Objectives:
1.
2.
3.
4.
Use the Cash Flow Statement to assess the company’s
ability to generate Cash from Operations
Evaluate the company’s quality of earnings by
comparing net income to cash
Determine whether a company is expanding or
contracting using the “Investing” section of the Cash
Flow Statement. Investing internally or externally?
Evaluate the company’s financing activity – are they
relying on internal or external financing, and debt
or equity financing?
5.
Assess a company’s need for external financing and its
ability to pay its debts and dividends
40
Using the Statement of Cash Flows
Net cash flow from operating activities
Net cash provided (used) in investing activities
Net cash provided (used) in financing activities
Net increase or decrease in cash for the year
Cash balance beginning of year
Ending Cash Balance
1.
2.
3.
4.
5.
6.
Co. A Co. B Co. C
$ (300) $ (400) $ 300
(900)
500
(90)
1,200
(10) (240)
150
150
150
Calculate each company’s cash balance at the end of the year.
Would you prefer to own company A, B or C? Why?
Which company would you least like to own? Why?
Which companies have net income and which have a net loss?
Explain what might cause company C’s net cash from financing
activities to be negative.
Explain what might cause company A’s net cash from financing
activities to be positive.
41
Using the Statement of Cash Flows
Net Income (Loss)
Adjustments to convert Net Income to Cash from Operations
Net cash flow from operating activities
Co. X
$ 200
Co. Y Co. Z
$ (400) $ 100
$ (300) $ 300
1.
Would you prefer to own company X, Y or Z ? Why?
2.
Which company would you least like to own? Why?
3.
What could cause Co X’s net income to differ from its cash from
operations?
4.
What could cause Co Y’s net income to differ from its cash from
operations?
5.
What could cause Co Z’s net income to differ from its cash from
operations?
$ 200
42
Summary story from the Cash Flow Statement
2010 2009 2008
Cash provided by Operations
Cash (required) by Investing Activity
3,919
7,000
3,670
(14,031) (4,600) (3,650)
Net effect on Cash from issuing (retiring) debt
(6,154) (2,339) 2,876
Net effect on Cash from issuing (retiring) stock
23,082
141
(4)
14
Effect of exchange rate changes on cash
Net increase (decrease) in Cash
$6,812
639
-
$216 $3,535
What is Company’s major source of cash?
Is the company relying upon internal or external financing?
Is the Company generating enough cash to pay its debt obligations?
43
The Cash Flow Statement
Objectives:
1. Use the Cash Flow Statement to assess the
company’s ability to generate Cash from
Operations
2. Evaluate the company’s quality of earnings
by comparing net income to cash
• Determine whether Cash From Operations
(CFO) is positive and growing.
• For Quality Earnings CFO should be greater
than Net Income
44
The Cash Flow Statement
Objectives:
3. Determine whether a company is
expanding or contracting using the
“Investing” section of the Cash Flow
Statement
•
Compare the amount a company is spending
on long-term assets to the amount they are
expensing to determine whether they are
growing.
45
The Cash Flow Statement
Objectives:
4. Evaluate the company’s financing activity
– are they relying on internal or
external financing, and debt or
equity financing?
•
Compare Cash From Operations to the
amount of Cash received from new debt
and/or from the sale of additional shares
of stock. If CFO is greater the company
is relying on internal financing.
46
The Cash Flow Statement
Objectives:
5. Assess a company’s need for external financing
and its ability to pay its debts and
dividends.
•
Compute the amount of cash available to pay
debts and dividends by deducting the cash
needed for fixed asset purchases from the Cash
from Operations. Is the remaining Cash From
Operations sufficient to cover debt and
dividend payments?
47
SCF: Interest, Dividends and Taxes
Classification

Interest Paid:
US GAAP: operating activity (cash from the associated debt is financing activity)
IFRS: operating or financing activities

Interest Received:
US GAAP: operating activity (cash from the related asset is investing activity)
IFRS: operating or as investing activities

Dividends Paid:
US GAAP: financing activity, consistent with the placement of proceeds from selling stock.
IFRS: financing or operating
•
Dividends Received:
US GAAP: operating activities (cash from related outflows was investing activity)
IFRS: financing or operating
•
Tax payments/refunds:
US GAAP: operating activity, regardless of whether underlying taxable income relates to
operations or not (e.g. if a firm has a taxable capital gain on the sale of equipment)
IFRS: operating unless specifically associated with financing or investing activities
Format of the Statement of Cash Flows
Computing Cash from Operations
Start with Net Income and Adjust it to get Cash from Operations.
Net Income (accrual basis)
$_______
1. Adjustments to go from Accrual to Cash:
A. Add back non-cash expenses (Expenses that
reduce net income but do not use up any cash)
_____________________________
$______
_____________________________
$______
B. Changes in Operating Assets & Liabilities
_____________________________
_____________________________
$______
$______
2. Adjustments for non-operating gains and losses:
We want only operating cash so add back non-operating losses which have
reduced net income and subtract out gains from non-operating activities
Loss on disposition of assets
_____________________________
Net Cash Provided by Operations
$______
________
$ ______
50
Computing Cash Investing & Financing
Net Cash Provided by Operations
$_______
Cash from Investing:
(cash received or paid from changes in non-current & non-operating
assets, including the affect of gains & losses)
_____________________________
$______
_____________________________
$______
_____________________________
$______ $______
Cash from Financing:
(cash received or paid from changes in non-current & non-operating
Liabilities & Stockholders’ Equity, excluding income)
_____________________________
$______
_____________________________
$______
_____________________________
$______ $______
Net Increase in Cash
$ ______
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Operating Activities — Indirect Method
E23-6: KRC Company’s financial statements for the year ended
December 31, 2010, contained the following condensed information.
Revenues from fees
Operating expenses
Depreciation expense
Loss on sale of equipment
2010
$ 840,000
624,000
60,000
26,000
Income before income tax
Income tax
Net income
130,000
40,000
$ 90,000
Accounts receivable
Accounts payable
Income taxes payable
$ 37,000
46,000
4,000
2009
Change
$ 59,000
31,000
8,500
$(22,000)
15,000
(4,500)
Operating Activities — Indirect Method
E23-6: Prepare the operating activities section of the statement of
cash flows using the indirect method (Step 2).
Cash flows from operating activities
Net income
Adjustment to reconcile net income
to net cash provided by operating activities:
Depreciation expense
Loss on sale of equipment
Decrease in accounts receivable
Increase in accounts payable
Decrease in income taxes payable
Net cash provided by operating activities
$ 90,000
60,000
26,000
17,000
10,000
(4,500)
198,500
Operating Activities — Indirect Method
E23-6: Prepare the operating activities section of the statement of
cash flows using the indirect method (Step 2).
Cash flows from operating activities
NetIncome
income
Net
Adjustment to reconcile net income
to net cash provided by operating activities:
Depreciation
expense
Depreciation
Expense
on of
sale
of equipment
LossLoss
on Sale
Equip
Decrease
in accounts
receivable
Accounts
Receivable
Decreased
Increase in accounts payable
A/P increased
in income taxes payable
TaxesDecrease
Pay. Decreased
Net cash
provided by operating activities
Cash
from Operations
$ 90,000
$90,000
60,000
$60,000
26,000
26,000
17,000
22,000
10,000
15,000
(4,500)
(4,500)
198,500
$208,500
Practice Determining Net Cash Flow from
Investing and Financing Activities
(a): Plant assets that had cost $25,000 6 years before and were being
depreciated on a straight-line basis over 10 years with no estimated scrap
value were sold for $5,300.
(b): During the year, 10,000 shares of common stock with a stated value of
$10 a share were issued for $33 a share.
(d): The company sustained a net loss for the year of $50,000.
Depreciation amounted to $22,000, and a gain of $9,000 was realized on
the sale of land for $39,000 cash.
(h): During the year, treasury stock costing $47,000 was purchased
The Cash Flow Statement
Statement of Cash Flows
Cash flow from operating activities
O
Net income (loss)
Adjustment to reconcile net income to cash:
Loss on sale
Depreciation expense
Gain on sale
Cash from operations
$ (50,000)
2,700
22,000
(9,000)
(34,300)
Cash flow from investing activities
I
F
Sale of plant assets
Sale of land
Cash from investing activities
5,300
39,000
44,300
Cash flow from financing activities
Sale of common stock
Purchase of company stock
Cash from financing activities
Net Change in Cash
330,000
(47,000)
283,000
$ 293,000
Practice Determining Net Cash Flow from
Investing and Financing Activities
E23-2 (a): Plant assets that had cost $25,000 6 years before
and were being depreciated on a straight-line basis over 10
years with no estimated scrap value were sold for $5,300.
Plant assets (cost)
$ 25,000
Accumulated depreciation ([$25,000 / 10] x 6)
15,000
Book value at date of sale
10,000
Sale proceeds
(5,300)
Loss on sale
$ 2,700
Practice Determining Net Cash Flow from
Investing and Financing Activities
E23-2 (b): During the year, 10,000 shares of common
stock with a stated value of $10 a share were issued for
$33 a share.
Shares sold
10,000
Market value per share
$
Value of shares
$ 330,000
LO 5
33
Determine net cash flows from investing and financing activities.
The Cash Flow Statement
Statement of Cash Flows
Cash flow from operating activities
O
I
F
Net income (loss)
Adjustment to reconcile net income to cash:
Loss on sale
Depreciation expense
Gain on sale
Cash from operations
$ (50,000)
2,700
22,000
(9,000)
(34,300)
Cash flow from investing activities
Sale of plant assets
Sale of land
Cash from investing activities
5,300
39,000
44,300
Cash flow from financing activities
Sale of common stock
Purchase of company stock
Cash from financing activities
Net Change in Cash
330,000
(47,000)
283,000
$ 293,000
Direct Versus Indirect Controversy
In Favor of the Indirect Method
Focuses on the differences between net income and
net cash flow from operating activities.
Provides link between the statement of cash flows
and the income statement and balance sheet.
Special Rules Applying to Indirect Methods
Disclose Interest paid.
Disclose Income taxes paid.
LO 7 Identify sources of information for a statement of cash flows.
Direct Versus Indirect Controversy
In Favor of the Direct Method
Shows operating cash receipts and payments.
Information about cash receipts and payments is
more revealing of a company’s ability
1. to generate sufficient cash from operating activities to
pay its debts,
2. to reinvest in its operations, and
3. to make distributions to its owners.
LO 7 Identify sources of information for a statement of cash flows.
Special Problems in Statement Preparation
1. Adjustments similar to depreciation
Amortization of limited-life intangible assets.
Amortization of deferred costs.
Amortization of bond discount or premium.
Changes in deferred income taxes.
Change related to an investment when recording
income or loss under the equity method.
LO 8 Discuss special problems in preparing a statement of cash flows.
Special Problems in Statement Preparation
2. Accounts receivable, net
3. Other working capital changes
4. Net losses
5. Gains
6. Stock options
7. Postretirement benefits
8. Extraordinary items
9. Significant noncash transactions
LO 8 Discuss special problems in preparing a statement of cash flows.
What can the Investing Section of the Cash
Flow Statement tell us about the company?
• How much did the company invest in itself (how much cash was used
on capital expenditures –PP&E)?
$__________
• Two questions to ask to determine if the Co. expanded or contracted?
1) Did they invest more in property, plant and equipment
than they reported as depreciation & amortization expense?
Depreciation & Amortization expense $__________
2) How much cash did the company receive from selling
property, plant and equipment?
$__________
• Did Beta expand or contract? (Did the invest more than the sum of 1 & 2?)
___________
• Why is the purchase of Marketable Securities in the Investing section?
• Is the Investing activity generating or using up cash? __________
64