INTERMEDIATE
F I F T E E N T H
E D I T I O N
Intermediat
ACCOUNTING
Intermediat
e
e
Accounting
Accounting
Prepared by
Coby Harmon
Prepared by
University of California,
BarbaraPrepared by
CobySanta
Harmon
Harmon
Westmont
College SantaCoby
University
of California,
Barbara
University of California, Santa Barbara
23-1
Westmont College
kieso
weygandt
warfield
team for success
PREVIEW OF CHAPTER 23
Intermediate Accounting
15th Edition
Kieso Weygandt Warfield
23-2
23
Statement of Cash
Flows
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Describe the purpose of the statement of
cash flows.
6.
Identify sources of information for a
statement of cash flows.
2.
Identify the major classifications of cash
flows.
7.
3.
Prepare a statement of cash flows.
Contrast the direct and indirect methods of
calculating net cash flow from operating
activities.
4.
Differentiate between net income and net
cash flow from operating activities.
8.
Discuss special problems in preparing a
statement of cash flows.
5.
Determine net cash flows from investing
and financing activities.
9.
Explain the use of a worksheet in preparing
a statement of cash flows.
23-3
A Frenzied Focus on Earnings




23-4
Earnings-per-share usually makes the headlines
E.g. Yahoo!’s Earnings Scoreboard
http://biz.yahoo.com/z/extreme.html
Yet, earnings don’t tell the whole story
In fact, relying on earnings without looking at
cash flows is a recipe for misinterpretation
Cash Flow:
Shining a Light on Earnings

Problem with earnings: can be manipulated
through creative accounting


Advantage of cash flow: much harder to
fudge, provides a reality check

23-5
GAAP requires accrual accounting, full of
estimates and judgment calls . . . & gimmicks
You either got (or paid) $$ or you didn’t. Period.
Buffetology:
Mimicking the Master
Warren Buffet,
World’s Most
Famous Investor
- Uses a cash flow model as a major pillar of
investing strategy
- Hard to argue with a guy who bought Berkshire
Hathaway for $15/share and each share is worth
over $100k today (22% average compound return)
23-6
Buffetology at Work
Example
Cash Flow Track Record of
XYX Company
2003 2004 2005 2006
Free Cash Flow
2007
2008
2009
2010
AVG
290
313
274
252
238
259
2011 2012 2013 2014
2015
2016
2017
145
223
224
Avg Growth Rate in FCF = 9.4%
Projected Cash Flows of XYZ
Company
2018 2019+TOTAL
Projected Cash Flows
283
310
339
371
406
444
486
531
PV of Projected CF, 8%
262
266
269
273
276
280
283
287
Market Cap Today
(# shares times price) 9.53m * $585/sh
Discount Percentage (stock is undervalued by 29%)
23-7
5667
7863
5575
29%
Putting Earnings on Trial



23-8
When net earnings > oper. cash flow, it
raises suspicions of aggressive earnings
management and should be investigated.
Furthermore, if this condition persists for
several periods, questions about viability
need to be raised
Example: W.T. Grant
W. T. Grant Co.
“Retailing With A Difference”
23-9
A Classic Example . . .
W.T. Grant Building, NYC, 1974
W.T. Grant was the largest
U.S. retailer in 1970 and
reported profits almost right
up until it’s bankruptcy in
1975. If investors had
looked at its cash flows
instead of profits, they would
have seen a different story.
The cash flows for all years
(except two) in the decade
prior to bankruptcy were
negative. This should have
been a tell-tale sign.
23-10
What went wrong at WT Grant?
Millions of
Dollars
Working Capital
Provided By Operations
40
Net Income
20
0
1966
1968
1970
-20
-40
-100
23-11
Cash Flow Provided
by Operations
1972
1974
W.T. Grant Collapse:
A Catalyst for Change



23-12
The bankruptcy of W.T. Grant helped launch
a campaign for better disclosure of cash
flows.
A study of 45,000 firms that filed for
bankruptcy in the 1980s showed that 60%
had a profitable bottom line, but none had
positive operating cash flow.
In 1987, the FASB finally got around to
requiring the current cash flow statement
format
Summary: “Watch Cash Flow” Quoth the
Banker
Once upon a mid-night dreary as I pondered
weak and weary, over many a curious
volume of accounting lore,
Seeking gimmicks (without scruple) to squeeze
through some new loophole, suddenly I
heard a knock at the door,
Only this, and nothing more
23-13
Summary: “Watch Cash Flow” Quoth the
Banker
Then I felt a queasy tingling and I heard the
cash-a-jingling, as my fearsome banker
entered whom I’d oft’ seen before
His face was money-green and in his eyes
there could be seen dollar-signs glittering as
he reckoned up the score.
“Cash flow,” said the banker and nothing
more.
23-14
Summary: “Watch Cash Flow” Quoth the
Banker
I had always thought it fine to show a jet-black
bottom line, but the banker yelled a
resounding “No,
Your receivables are high, mounting upwards
to the sky, and write-offs loom, Watch cash
flow,” he said. “Watch cash flow!”
23-15
Summary: “Watch Cash Flow” Quoth the
Banker
Then I tried to tell the story of our lovely
inventory, which though large is full of
delightful stuff.
But the banker saw its growth and with a might
oath, waved his arms and shouted “Enough!
Pay the interest and don’t give any guff.”
23-16
Summary: “Watch Cash Flow” Quoth the
Banker
Next I looked for items not of cash to replace
the ever-outward flow of cash
But to keep things in the black, I held
depreciation back, to which the banker yelled
“Rash.”
He quivered and his teeth began to gnash
23-17
Summary: “Watch Cash Flow” Quoth the
Banker
Mustering courage, I finally asked him for a
loan and he responded with a groan, that the
rate would be prime plus eight
And to guarantee my purity he’d insist on
some security, all the assets plus the scalp
upon my pate
Only this, a sub-standard rate
23-18
Summary: “Watch Cash Flow” Quoth the
Banker
Though my bottom line is black, I am flat upon
my back, my cash goes out fast and it comes
in slow.
The growth of my receivables is almost
unbelievable, the result is certain woe
And I hear the banker utter an ominous growl
“Watch cash flow,” he said. “Watch cash
flow.”
23-19
The Statement of Cash Flows
Where Does
it Fit in?
Cash Flows
IS
BS
SCOE
23-20
Preparation of Statement of Cash Flows
Primary purpose:
To provide information about a company’s cash receipts
and cash payments during a period.
Secondary objective:
To provide cash-basis information about the company’s
operating, investing, and financing activities.
23-21
LO 1
Preparation of Statement of Cash Flows
Usefulness of the Statement of Cash Flows
Provides information to help assess:
1. Entity’s ability to generate future cash flows.
2. Entity’s ability to pay dividends and meet obligations.
3. Reasons for difference between net income and net cash
flow from operating activities.
4. Cash and noncash investing and financing transactions.
23-22
LO 1
23
Statement of Cash
Flows
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Describe the purpose of the statement of
cash flows.
6.
Identify sources of information for a
statement of cash flows.
2.
Identify the major classifications of cash
flows.
7.
3.
Prepare a statement of cash flows.
Contrast the direct and indirect methods of
calculating net cash flow from operating
activities.
4.
Differentiate between net income and net
cash flow from operating activities.
8.
Discuss special problems in preparing a
statement of cash flows.
5.
Determine net cash flows from investing
and financing activities.
9.
Explain the use of a worksheet in preparing
a statement of cash flows.
23-23
Preparation of Statement of Cash Flows
Classification of Cash Flows
Operating
Activities
Investing
Activities
Financing
Activities
Income
Changes in
Investments and
Long-Term
Asset Items
Changes in
Long-Term
Liabilities and
Stockholders’
Equity
Statement Items
23-24
LO 2
Classification of Cash Flows
Illustration 23-1
Classification of
Typical Cash Inflows
and Outflows
23-25
LO 2
Classification of Cash Flows
Illustration 23-1
Classification of
Typical Cash Inflows
and Outflows
23-26
LO 2
Statement of Cash Flows:
Connecting the Dots
Sales
Cost of Sales
Gross Profit
Oper. Expenses
Net Income
Borrowed $$
Paid Dividends
Purchased Equip.
Increase in cash
23-27
Accrual
1000
600
400
300
100
Cash
900
590
310
250
60
50
40
70
0
100 of uncollected sales
10 of unpaid inventory
50 of depreciation
Statement of Cash Flows
OPERATING ACTIVITIES
Net Income
100
Increase in Accounts Payable
Operating activities should
+50 provide cash . . . this is the cash
engine, the life blood of the
-100
company.
+10
Net Cash from Oper. Activities
+60
INVESTING ACTIVITIES
Investing activities should use
-70 cash . . . This is how the engine is
kept running smoothly
-70
Depreciation
Increase in Accounts Receivable
Purchased Equipment
Net Cash used by Invest. Activities
FINANCING ACTIVITIES
Dividends Paid
-40
Borrowed Money
+50
Net Cash from Fin. Activities
+10
NET
23-28
CHANGE IN CASH
0
Financing activities could either
provide or use cash, depending
on position in produce life cycle.
Classification of Cash Flows
The basis recommended by the FASB for the statement of
cash flows is actually “cash and cash equivalents.” Cash
equivalents are short-term, highly liquid investments that are
both:

Readily convertible to known amounts of cash, and

So near their maturity that they present insignificant risk of
changes in interest rates.
Generally, only investments with original maturities of three
months or less qualify under this definition.
23-29
LO 2
The Product Life Cycle


A series of phases all products go through
The phases are often referred to as the:





23-30
introductory phase
growth phase
maturity phase
decline phase.
The phase a company is in affects its cash
flows.
30
Classification of Cash Flows
Company
Product Life
Cycle
23-31
LO 2
Introductory Phase



23-32
To support asset purchases the company may
issue stock or debt. Expect:
cash from operations to be negative
cash from investing to be negative.
cash from financing to be positive.
Growth Phase
The company is striving to expand its production
and sales.
Expect:
 small amounts of cash to be generated
from operations.
 cash from investing to be negative.
 cash from financing to be positive.
23-33
Maturity Phase
Sales and production level-off
Expect:
 cash from operations to exceed investing
needs.
 cash from investing to be neutral.
 cash from financing to be negative.
23-34
Decline Phase
Sales and production decline
Expect:
 cash from operations to decline
 cash from investing to possibly become
positive.
 cash from financing to possibly become
negative
23-35
Cash Flow Patterns: Start Up
COMPANY:
Operating
Investing
Financing
Net Incr (Decr)
A
+500
-400
-100
0
B
+300
+100
+200
+600
C
+300
+200
-500
0
D
-100
-200
+300
0
MATCH: Moving ahead in faith . . . somebody
believes in you and is backing it up with bucks
(start-up pattern)
ANSWER: D, Start-up Pattern
23-36
E
-200
+400
-200
0
Cash Flow Patterns:
Normal Flow
COMPANY:
Operating
Investing
Financing
Net Incr (Decr)
A
+500
-400
-100
0
B
+300
+100
+200
+600
C
+300
+200
-500
0
D
-100
-200
+300
0
MATCH: Going strong & ensuring strength for
tomorrow (normal cash flow)
ANSWER: A, Normal Pattern
23-37
E
-200
+400
-200
0
Cash Flow Patterns: Maturity
COMPANY:
Operating
Investing
Financing
Net Incr (Decr)
A
+300
-400
+100
0
B
+300
+100
+200
+600
C
+300
+200
-500
0
D
-100
-200
+300
0
E
-200
+400
-200
0
MATCH: Making cash-hungry creditors or owners
happy (maturity pattern)
ANSWER: C, Maturity Pattern
23-38
Cash Flow Patterns:
Cash Build Up
COMPANY:
Operating
Investing
Financing
Net Incr (Decr)
A
+300
-400
+100
0
B
+300
+100
+200
+600
C
+300
+200
-500
0
D
-100
-200
+300
0
E
-200
+400
-200
0
MATCH: Hoarding cash, maybe for future takeover
or expansion .
ANSWER: B, Cash Build-Up
23-39
Cash Flow Pattern: Decline Stage
COMPANY:
Operating
Investing
Financing
Net Incr (Decr)
A
+300
-400
+100
0
B
+300
+100
+200
+600
C
+300
+200
-500
0
D
-100
-200
+300
0
MATCH: Poor health and getting ready to die
(liquidation)
ANSWER: E, Decline Stage
23-40
E
-200
+400
-200
0
Liquidity


Liquidity is the ability of a business to meet its
immediate obligations.
One measure of liquidity is the current ratio.


23-41
A disadvantage of the current ratio is that it uses
year-end balances of current assets and current
liabilities (may not be representative of a company's
position during most of the year.)
Other measures of liquidity include free cash
flow, current debt coverage ratio, and debt
coverage ratio.
Free Cash Flow
Cash Provided By Operations
–
Capital Expenditures
–
Dividends Paid
=
Free Cash Flow
This concept is used heavily by
Warren Buffet to value a
company – see slides 6-7
23-42
Using Cash Flows to Evaluate a Company
Assessing Liquidity and Solvency
is the ability to pay obligations expected to
become due within the next year.
Liquidity
Illustration
12-18
A value below 0.40 times is cause for additional
investigation.
23-43
SO 5 Use the statement of cash flows to evaluate a company.
Using Cash Flows to Evaluate a Company
Assessing Liquidity and Solvency
is the ability of a company to survive over the
long term.
Solvency
Illustration
12-19
A ratio below 0.20 times is cause for additional
investigation.
23-44
Format of the Statement of Cash Flows
Order of Presentation:
23-45
1.
Operating activities.
2.
Investing activities.
3.
Financing activities.
Direct Method
Indirect Method
LO 2 Identify the major classifications of cash flows.
Indirect and Direct Methods



23-46
The choice of methods affects only the operating
activities section; investing & financing activities
sections are the same.
Both methods arrive at the same total amount for
“Net cash” provided by operating activities.
The methods differ in disclosing the items that
make up the total operating activities amount.
Indirect and Direct Methods



23-47
Direct Method: move down the income statement
from top to bottom directly converting each
section from an accrual to a cash basis
Indirect Method: start with net income and
adjust for all non-cash revenue and expenses
If the direct method is used, a reconciliation to net
income must also be provided (which essentially
means the indirect method must also be done.)
Indirect Method

Most companies (98.8%) favor the indirect
method for the following reasons:
it is easier to prepare
 The direct method is not only harder to prepare,
but it essentially requires that the indirect method
also be done (which is twice as much work)
 it focuses on the differences between net income
and net cash flow from operating activities
 it tends to reveal less company information to
competitors.

23-48
Statement
of Cash
Flows
Indirect
Method
23-49
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense
Loss on sale of equipment
Decrease in accounts receivable
Increase in inventory
Increase in prepaid expenses
Increase in accounts payable
Decrease in income taxes payable
Net cash provided by operating activities
Cash flows from investing activities:
Purchase of building
Purchase of equipment
Sale of equipment
Net cash used by investing activities
Cash flows from financing activities:
Issuance of common stock
Payment of cash dividends
Net cash used by financing activities
Net increase in cash
Cash at beginning of period
Cash at end of period
$
145,000
9,000
3,000
10,000
(5,000)
(4,000)
16,000
(2,000)
172,000
(120,000)
(25,000)
4,000
(141,000)
$
20,000
(29,000)
(9,000)
22,000
33,000
55,000
Statement of Cash Flows-Direct Method
Statement of cash
flows,direct
method
23-50
Format of the Statement of Cash Flows
Illustration 23-2
23-51
LO 2
Preparation of Statement of Cash Flows
Steps in Preparation
Three Sources of Information:
1. Comparative balance sheets.
2. Current income statement data.
3. Selected transaction data.
Three Major Steps:
23-52
Step 1.
Determine change in cash.
Step 2.
Determine net cash flow from operating activities.
Step 3.
Determine net cash flows from investing and financing
activities.
LO 2
23
Statement of Cash
Flows
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Describe the purpose of the statement of
cash flows.
6.
Identify sources of information for a
statement of cash flows.
2.
Identify the major classifications of cash
flows.
7.
3.
Prepare a statement of cash flows.
Contrast the direct and indirect methods of
calculating net cash flow from operating
activities.
4.
Differentiate between net income and net
cash flow from operating activities.
8.
Discuss special problems in preparing a
statement of cash flows.
5.
Determine net cash flows from investing
and financing activities.
9.
Explain the use of a worksheet in preparing
a statement of cash flows.
23-53
Illustrations—Tax Consultants Inc.
Illustration: Tax Consultants Inc. started on January 1, 2013,
when it issued 60,000 shares of $1 par value common stock
for $60,000 cash. The company rented its office space,
furniture, and equipment, and performed tax consulting
services throughout the first year.
The comparative balance sheets at the beginning and end of
the year 2013 appear in Illustration 23-3. Illustration 23-4
shows the income statement and additional information for Tax
Consultants.
23-54
LO 3
Illustrations—Tax Consultants Inc.
Illustration 23-3
Comparative
Balance Sheets, Tax
Consultants Inc.,
Year 1
Illustration 23-4
Income
Statement, Tax
Consultants Inc.,
Year 1
23-55
Illustration 23-3
Illustrations—Tax Consultants Inc.
Step 1: Determine the Change in Cash
Illustration 23-3
23-56
LO 3
23
Statement of Cash
Flows
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Describe the purpose of the statement of
cash flows.
6.
Identify sources of information for a
statement of cash flows.
2.
Identify the major classifications of cash
flows.
7.
3.
Prepare a statement of cash flows.
Contrast the direct and indirect methods of
calculating net cash flow from operating
activities.
4.
Differentiate between net income and net
cash flow from operating activities.
8.
Discuss special problems in preparing a
statement of cash flows.
5.
Determine net cash flows from investing
and financing activities.
9.
Explain the use of a worksheet in preparing
a statement of cash flows.
23-57
Illustrations—Tax Consultants Inc.
Step 2: Determine the Net Cash Flow from
Operating Activities

Company must determine revenues and expenses on a
cash basis.

Eliminate the effects of income statement transactions
that do not result in an increase or decrease in cash.

Convert net income to net cash flow from operating
activities through either a direct method or an indirect
method.
23-58
LO 4
Illustrations—Tax Consultants Inc.
Step 2: Determine the Net Cash Flow from
Operating Activities
Illustration 23-5
Net Income versus Net Cash
Flow from Operating Activities
23-59
LO 4
Illustrations—Tax Consultants Inc.
Increase in Accounts Receivable—Indirect Method
Accounts receivable increased by $36,000 (from $0 to $36,000)
during the year.
Illustration 23-6
Accounts Receivable
1/1/13
Balance
Revenues
12/31/13
Balance
0
Receipts from customers
89,000
125,000
36,000
When the Accounts Receivable balance increases, cash receipts are
lower than revenue earned under the accrual basis.
23-60
LO 4
Illustrations—Tax Consultants Inc.
Increase in Accounts Receivable—Indirect Method
Illustration 23-6
Accounts Receivable
1/1/13
Balance
Revenues
12/31/13
Balance
0
Receipts from customers
89,000
125,000
36,000
The increase in accounts receivable is subtracted from net income to
arrive at net cash provided by operating activities.
Illustration 23-7
23-61
LO 4
Illustrations—Tax Consultants Inc.
Increase in Accounts Payable—Indirect Method
Accounts payable increased by $5,000 during the year.
When accounts payable increase during the year, expenses on an
accrual basis exceed those on a cash basis.
Illustration 23-7
23-62
LO 4
23-63
LO 4
23
Statement of Cash
Flows
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Describe the purpose of the statement of
cash flows.
6.
Identify sources of information for a
statement of cash flows.
2.
Identify the major classifications of cash
flows.
7.
3.
Prepare a statement of cash flows.
Contrast the direct and indirect methods of
calculating net cash flow from operating
activities.
4.
Differentiate between net income and net
cash flow from operating activities.
8.
Discuss special problems in preparing a
statement of cash flows.
5.
Determine net cash flows from investing
and financing activities.
9.
Explain the use of a worksheet in preparing
a statement of cash flows.
23-64
Tax
Consultants
Inc.
Step 3:
Determine Net
Cash Flows
from Investing
and Financing
Activities
23-65
Illustration 23-3
Illustration 23-8
Tax
Consultants
Inc.
Step 3:
Determine Net
Cash Flows
from Investing
and Financing
Activities
23-66
Illustration 23-3
Illustration 23-8
Tax
Consultants
Inc.
Step 3:
Determine Net
Cash Flows
from Investing
and Financing
Activities
23-67
Illustration 23-3
Illustration 23-8
Tax
Consultants
Inc.
Step 3:
Determine Net
Cash Flows
from Investing
and Financing
Activities
23-68
Illustration 23-3
Illustration 23-8
Tax
Consultants
Inc.
Step 3:
Determine Net
Cash Flows
from Investing
and Financing
Activities
23-69
Illustration 23-3
Illustration 23-8
Illustrations—Tax Consultants Inc.
Statement of Cash Flows—2013
23-70
Illustration 23-8
LO 5
Operating Activities — Indirect Method
Illustration: Norman Company’s financial statements for the year
ended December 31, 2014, contained the following condensed
information.
2014
2013
Change
Service revenue
$ 840,000
Operating expenses
624,000
Depreciation expense
60,000
Loss on sale of equipment
26,000
Income before income tax
130,000
Income tax
40,000
Net income
$
90,000
Accounts receivable
Accounts payable
Income taxes payable
23-71
$
37,000
46,000
4,000
$ 59,000
31,000
8,500
$
(22,000)
15,000
(4,500)
LO 5
Operating Activities — Indirect Method
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
23-72
Advance slide to uncover solution
$
90,000
60,000
26,000
22,000
15,000
(4,500)
208,500
LO 5
Operating Activities — Direct Method
Norman Company’s financial statements for the year ended December
31, 2014, contained the following condensed information.
23-73
Service revenue
Operating expenses
Depreciation expense
Loss on sale of equipment
2014
$ 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
2013
Change
Assume accounts
payable relates to
operating
expenses.
$ 59,000
31,000
8,500
$
(22,000)
15,000
(4,500)
LO 5
Operating Activities — Direct Method
Prepare the operating activities section of the statement of cash flows
using the Direct method (Step 2).
Illustration 23-22
Accounts Receivable
1/1/14
Balance
Revenues
12/31/14
23-74
Balance
59,000
Receipts from customers
862,000
840,000
37,000
LO 5
Operating Activities — Direct Method
Prepare the operating activities section of the statement of cash flows
using the Direct method (Step 2).
Illustration 23-24
Accounts Payable
1/1/14
Payments to suppliers
609,000
Operating expenses
12/31/14
23-75
Balance
Balance
31,000
624,000
46,000
LO 5
Operating Activities — Direct Method
Prepare the operating activities section of the statement of cash flows
using the Direct method (Step 2).
Illustration 23-24
Income Tax Payable
1/1/14
Payments for income tax
44,500
Income tax expense
12/31/14
23-76
Balance
Balance
8,500
40,000
4,000
LO 5
Operating Activities — Direct Method
Prepare the operating activities section of the statement of cash flows
using the Direct method (Step 2).
Cash flows from operating activities
Cash receipts from customers
$
Cash paid for operating expenses
(609,000)
Cash paid for income taxes
Net cash provided by operating activities
23-77
862,000
(44,500)
$
208,500
LO 5
Step 3: Determine Net Cash Flow from
Investing and Financing Activities
Illustration: (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
23-78
$
$
2,700
LO 5
Investing and Financing Activities
Statement of Cash Flows
Cash flow from operating activities
Net income (loss)
O
I
$
Adjustment to reconcile net income to cash:
Loss on sale
2,700
Depreciation expense
22,000
Gain on sale
(9,000)
Cash from operations
(34,300)
Cash flow from investing activities
Sale of plant assets
5,300
Sale of land
39,000
Cash from investing activities
F
44,300
Cash flow from financing activities
Sale of common stock
Purchase of company stock
Cash from financing activities
Net Change in Cash
23-79
(50,000)
330,000
(47,000)
283,000
$
293,000
Investing and Financing Activities
(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
23-80
10,000
Market value per share
$
33.00
Value of shares
$
330,000
LO 5
Investing and Financing Activities
Statement of Cash Flows
Cash flow from operating activities
Net income (loss)
O
I
$
Adjustment to reconcile net income to cash:
Loss on sale
2,700
Depreciation expense
22,000
Gain on sale
(9,000)
Cash from operations
(34,300)
Cash flow from investing activities
Sale of plant assets
5,300
Sale of land
39,000
Cash from investing activities
F
44,300
Cash flow from financing activities
Sale of common stock
Purchase of company stock
Cash from financing activities
Net Change in Cash
23-81
(50,000)
330,000
(47,000)
283,000
$
293,000
Investing and Financing Activities
(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.
23-82
LO 5
Investing and Financing Activities
Statement of Cash Flows
Cash flow from operating activities
Net income (loss)
O
I
$
Adjustment to reconcile net income to cash:
Loss on sale
2,700
Depreciation expense
22,000
Gain on sale
(9,000)
Cash from operations
(34,300)
Cash flow from investing activities
Sale of plant assets
5,300
Sale of land
39,000
Cash from investing activities
F
44,300
Cash flow from financing activities
Sale of common stock
Purchase of company stock
Cash from financing activities
Net Change in Cash
23-83
(50,000)
330,000
(47,000)
283,000
$
293,000
Investing and Financing Activities
(h): During the year, treasury stock costing $47,000 was
purchased.
23-84
LO 5
Investing and Financing Activities
Statement of Cash Flows
Cash flow from operating activities
Net income (loss)
O
$ (50,000.0)
Adjustment to reconcile net income to cash:
Loss on sale
2,700
Depreciation expense
22,000
Gain on sale
(9,000)
Cash from operations
I
(34,300)
Cash flow from investing activities
Sale of plant assets
5,300
Sale of land
39,000
Cash from investing activities
F
Cash flow from financing activities
Sale of common stock
Purchase of company stock
Cash from financing activities
Net Change in Cash
23-85
44,300
330,000
(47,000)
283,000
$
293,000
23
Statement of Cash
Flows
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Describe the purpose of the statement of
cash flows.
6.
Identify sources of information for a
statement of cash flows.
2.
Identify the major classifications of cash
flows.
7.
3.
Prepare a statement of cash flows.
Contrast the direct and indirect methods of
calculating net cash flow from operating
activities.
4.
Differentiate between net income and net
cash flow from operating activities.
8.
Discuss special problems in preparing a
statement of cash flows.
5.
Determine net cash flows from investing
and financing activities.
9.
Explain the use of a worksheet in preparing
a statement of cash flows.
23-86
Sources of Information for the
Statement of Cash Flows
1. Comparative balance sheets.
2. An analysis of the Retained Earnings account.
3. Write-downs, amortization charges, and similar “book”
entries, such as depreciation, because they have no
effect on cash.
23-87
LO 6
23
Statement of Cash
Flows
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Describe the purpose of the statement of
cash flows.
6.
Identify sources of information for a
statement of cash flows.
2.
Identify the major classifications of cash
flows.
7.
3.
Prepare a statement of cash flows.
Contrast the direct and indirect methods of
calculating net cash flow from operating
activities.
4.
Differentiate between net income and net
cash flow from operating activities.
8.
Discuss special problems in preparing a
statement of cash flows.
5.
Determine net cash flows from investing
and financing activities.
9.
Explain the use of a worksheet in preparing
a statement of cash flows.
23-88
Net Cash Flow from Operating
Activities—Indirect Versus Direct Method
Indirect Method
Adjustments Needed to Determine Net Cash Flow
from Operating Activities.
Illustration 23-18
23-89
LO 7
Net Cash Flow from Operating
Activities—Indirect Versus Direct Method
Direct Method
Companies adjust each item in the income
statement from the accrual basis to the cash basis.
Illustration 23-21
23-90
LO 7
23-91
LO 7
Net Cash Flow from Operating
Activities—Indirect Versus Direct Method
Special Rules Applying to Direct and Indirect
Methods
Companies that use the direct method are required, at a minimum, to
report separately:
Receipts
1. Cash collected from customers (including lessees, licensees,
etc.).
2. Interest and dividends received.
3. Other operating cash receipts, if any.
23-92
LO 7
Net Cash Flow from Operating
Activities—Indirect Versus Direct Method
Special Rules Applying to Direct and Indirect
Methods
Companies that use the direct method are required, at a minimum, to
report separately:
Payments
1. Cash paid to employees and suppliers of goods or services
(including suppliers of insurance, advertising, etc.).
2. Interest paid.
3. Income taxes paid.
4. Other operating cash payments, if any.
23-93
LO 7
23
Statement of Cash
Flows
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Describe the purpose of the statement of
cash flows.
6.
Identify sources of information for a
statement of cash flows.
2.
Identify the major classifications of cash
flows.
7.
3.
Prepare a statement of cash flows.
Contrast the direct and indirect methods of
calculating net cash flow from operating
activities.
4.
Differentiate between net income and net
cash flow from operating activities.
8.
Discuss special problems in preparing a
statement of cash flows.
5.
Determine net cash flows from investing
and financing activities.
9.
Explain the use of a worksheet in preparing
a statement of cash flows.
23-94
Special Problems in Statement
Preparation
Adjustments to Net Income
Depreciation and Amortization

Amortization of limited-life intangible assets.

Amortization of bond discount or premium.
Postretirement Benefit Costs

Company must adjust net income by the difference
between cash paid and the expense reported.
23-95
LO 8
Adjustments to Net Income
Changes in Deferred Income Taxes

Affect net income but have no effect on cash.
Equity Method of Accounting

Net increase in the investment account does not affect
cash flows.

Company must deduct the net increase from net income
to arrive at net cash flow from operating activities.
23-96
LO 8
Adjustments to Net Income
Loss and Gains

A loss is added to net income to compute net cash flow
from operating activities because the loss is a noncash
charge in the income statement.

Company reports a gain in the statement of cash flows as
part of the cash proceeds from the sale of equipment
under investing activities, thus it deducts the gain from
net income to avoid double-counting—once as part of net
income and again as part of the cash proceeds from the
sale.
23-97
LO 8
Adjustments to Net Income
Stock Options

Cash is not affected by recording the expense.

The company must increase net income by the amount of
compensation expense from share options in computing
net cash flow from operating activities.
23-98
LO 8
Adjustments to Net Income
Extraordinary Items

Companies should report either as investing activities or
as financing activities cash flows from extraordinary
transactions and other events whose effects are included
in net income, but which are not related to operations.
23-99
LO 8
Special Problems
Accounts Receivable (Net)
Indirect Method
Because an increase in Allowance for Doubtful Accounts results from
a charge to bad debt expense, a company should add back an
increase in Allowance for Doubtful Accounts to net income to arrive at
net cash flow from operating activities.
Illustration 23-28
Accounts Receivable
Balances, Redmark Co.
23-100
LO 8
Accounts Receivable (Net)
Indirect Method
One method of presenting this information in the statement of
cash flows:
Illustration 23-29
REDMARK CO.
Statement of Cash Flows (Partial)
For The Year 2014
23-101
LO 8
Accounts Receivable (Net)
Indirect Method
Alternate method (net approach) of presenting this
information in the statement of cash flows:
Illustration 23-30
REDMARK CO.
Statement of Cash Flows (Partial)
For The Year 2014
23-102
LO 8
Accounts Receivable (Net)
Direct Method
Company should not net Allowance for Doubtful Accounts
against Accounts Receivable.
Illustration 23-31
REDMARK CO.
Income Statement
For The Year 2014
23-103
LO 8
Accounts Receivable (Net)
Direct Method
Illustration 23-31
REDMARK CO.
Income Statement
For The Year 2014
Company should not net Allowance
for Doubtful Accounts against
Accounts Receivable.
REDMARK CO.
Statement of Cash Flows (Partial)
For The Year 2014
Illustration 23-32
Cash sales should be reported at $85,000 ($100,000 - 9,000 - 6,000).
23-104
Increase in Accounts Receivable
LO 8
Special Problems
Other Working Capital Changes
Some changes in working capital, although they affect cash,
do not affect net income.
23-105

Purchase of short-term available-for-sale securities.

Issuance of a short-term nontrade note payable for cash.

Cash dividend payable.
LO 8
Special Problems
Net Losses
Illustration: If the net loss is $50,000 and the total amount of
charges to add back is $60,000, then net cash provided by
operating activities is $10,000.
Illustration 23-33
Computation of Net Cash
Flow from Operating
Activities—Cash Inflow
23-106
LO 8
Special Problems
Significant Noncash Transactions
Common noncash transactions that a company should report
or disclose:
1. Acquisition of assets by assuming liabilities (including capital
lease obligations) or by issuing equity securities.
2. Exchanges of nonmonetary assets.
3. Refinancing of long-term debt.
4. Conversion of debt or preferred stock to common stock.
5. Issuance of equity securities to retire debt.
23-107
LO 8
23
Statement of Cash
Flows
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1.
Describe the purpose of the statement of
cash flows.
6.
Identify sources of information for a
statement of cash flows.
2.
Identify the major classifications of cash
flows.
7.
3.
Prepare a statement of cash flows.
Contrast the direct and indirect methods of
calculating net cash flow from operating
activities.
4.
Differentiate between net income and net
cash flow from operating activities.
8.
Discuss special problems in preparing a
statement of cash flows.
5.
Determine net cash flows from investing
and financing activities.
9.
Explain the use of a worksheet in preparing
a statement of cash flows.
23-108
Use of a Worksheet
A worksheet involves the following steps.
Step 1. Enter the balance sheet accounts and their beginning and
ending balances in the balance sheet accounts section.
Step 2. Enter the data that explain the changes in the balance
sheet accounts and their effects on the statement of cash flows in
the reconciling columns of the worksheet.
Step 3. Enter the increase or decrease in cash on the cash line
and at the bottom of the worksheet. This entry should enable the
totals of the reconciling columns to be in agreement.
23-109
LO 9
RELEVANT FACTS - Similarities
23-110

Both GAAP and IFRS require that companies prepare a statement of
cash flows.

Both IFRS and GAAP require that the statement of cash flows should
have three major sections—operating, investing, and financing—along
with changes in cash and cash equivalents.

Similar to GAAP, the cash flow statement can be prepared using either
the indirect or direct method under IFRS. For both IFRS and GAAP,
most companies use the indirect method for reporting net cash flow from
operating activities.

The definition of cash equivalents used in IFRS is similar to that used in
GAAP.
LO 10 Compare the statement of cash flows under GAAP and IFRS.
RELEVANT FACTS - Differences
23-111

A major difference in the definition of cash and cash equivalents is that
in certain situations, bank overdrafts are considered part of cash and
cash equivalents under IFRS(which is not the case in GAAP). Under
GAAP, bank overdrafts are classified as financing activities.

IFRS requires that non-cash investing and financing activities be
excluded from the statement of cash flows. Instead, these non-cash
activities should be reported elsewhere. This requirement is interpreted
to mean that non-cash investing and financing activities should be
disclosed in the notes to the financial statements instead of in the
financial statements. Under GAAP, companies may present this
information in the cash flow statement.
LO 10
RELEVANT FACTS - Differences

23-112
One area where there can be substantive differences between IFRS and
GAAP relates to the classification of interest, dividends, and taxes. IFRS
provides more alternatives for disclosing these items, while GAAP
requires that except for dividends paid (which are classified as a
financing activity), these items are all reported as operating activities.
LO 10
ON THE HORIZON
Presently, the IASB and the FASB are involved in a joint project on the
presentation and organization of information in the financial statements. With
respect to the cash flow statement specifically, the notion of cash equivalents
will probably not be retained. The definition of cash in the existing literature
would be retained, and the statement of cash flows would present information
on changes in cash only. In addition, the IASB and FASB favor presentation of
operating cash flows using the direct method only. This approach is generally
opposed by the preparer community.
23-113
LO 10
IFRS SELF-TEST QUESTION
Which of the following is true regarding the statement of cash flows
under IFRS?
a. The statement of cash flows has two major sections—operating
and nonoperating.
b. The statement of cash flows has two major sections—financing
and investing.
c.
The statement of cash flows has three major sections—
operating, investing, and financing.
d. The statement of cash flows has three major sections—
operating, non-operating, and financing.
23-114
LO 11
IFRS SELF-TEST QUESTION
In the case of a bank overdraft:
a. GAAP typically includes the amount in cash and cash
equivalents.
b. IFRS typically includes the amount in cash equivalents but not
in cash.
c.
GAAP typically treats the overdraft as a liability, and reports the
amount in the financing section of the statement of cash flows.
d. IFRS typically treats the overdraft as a liability, and reports the
amount in the investing section of the statement of cash flows.
23-115
LO 11
IFRS SELF-TEST QUESTION
For purposes of the statement of cash flows, under IFRS interest paid
is treated as:
a. an operating activity in all cases.
b. an investing or operating activity, depending on use of the
borrowed funds.
c.
either a financing or investing activity.
d. either an operating or financing activity, but treated consistently
from period to period.
23-116
LO 11
Copyright
Copyright © 2013 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for
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errors, omissions, or damages, caused by the use of these
programs or from the use of the information contained herein.
23-117