Accounting Principles, 6e
Weygandt, Kieso, & Kimmel
Prepared by
Marianne Bradford, Ph. D.
Bryant College
John Wiley & Sons, Inc.
CHAPTER 18
THE STATEMENT OF CASH FLOWS
After studying this chapter, you should be able to:
1 Indicate the primary purpose of the statement
of cash flows.
2 Distinguish among operating, investing, and
financing activities.
3 Prepare a statement of cash flows using the
indirect method.
4 Prepare a statement of cash flows using the
direct method.
5 Analyze the statement of cash flows.
PREVIEW OF CHAPTER 18
THE STATEMENT OF CASH FLOWS
The Statement of Cash Flows: Purpose and Format
 Purpose

Format

Usefulness
 Classifications

Preparation
 Significant

Indirect & direct methods
 Meaning
of “cash flows”
noncash activities
PREVIEW OF CHAPTER 18
THE STATEMENT OF CASH FLOWS
Section 1:
Indirect Method
 Determining net increase/decrease in
cash
 Determining net cash provided/used
by operating activities
 Determining net cash provided/used
by investing and financing activities
OR
Section 2:
Direct Method
 Determining net increase/decrease in
cash
 Determining net cash provided/used
by operating activities
 Determining net cash provided/used
by investing and financing activities
PREVIEW OF CHAPTER 18
THE STATEMENT OF CASH FLOWS
Analysis of the Statement of Cash Flows
 Current
cash debt coverage ratio
 Cash
return on sales ratio
 Cash
debt coverage ratio
STUDY OBJECTIVE 1
Indicate the primary purpose
of the statement of cash flows.
PURPOSE OF
THE STATEMENT OF CASH FLOWS
 The primary purpose of the statement of cash flows
(SCF) is to provide information about an entity’s cash
receipts and cash payments during a period.
 A secondary objective is to provide information about
its 1) operating, 2) investing, and 3) financing activities
of an entity during a period.
 It provides answers to the following simple, but
important, questions about an enterprise:
1 Where did the cash come from during the period?
2 What was the cash used for during the period?
3 What was the change in the cash balance during the
period?
MEANING OF
CASH FLOWS
 The SCF is usually prepared using cash and cash
equivalents as its basis.
 Cash equivalents are short-term, highly liquid
investments that are both:
1 readily convertible to known amounts of cash,
and
2 so near to their maturity that their market value
is relatively insensitive to changes in interest
rates.
STUDY OBJECTIVE 2
Distinguish among operating,
investing, and financing activities.
CLASSIFICATION OF
CASH FLOWS
Transactions and other events characteristic of each
kind of activity are as follows:
1 Operating activities include the cash effects of
transactions that create revenues and expenses. They
thus enter into the determination of net income.
2 Investing activities include a) acquiring and disposing
of investments and productive long-lived assets, and
b) lending money and collecting the loans.
3 Financing activities include a) obtaining cash from
issuing debt and repaying the amounts borrowed,
and b) obtaining cash from stockholders and
providing them with a return on their investment.
CLASSIFICATION OF
CASH FLOWS
 The category of operating activities is the most
important because it shows the cash provided by
company operations.
 Note the following general guidelines:
1) Operating activities involve income determination
(income statement) items,
2) Investing activities involve cash flows resulting
from changes in investments and long-term asset
items.
3) Financing activities involve cash flows resulting
from changes in long-term liability and
stockholders’ equity items.
ILLUSTRATION 18-1
BUSINESS ACTIVITIES SHOWN ON
THE STATEMENT OF CASH FLOWS
Operating
Activities
Investing
Activities
Financing
Activities
ILLUSTRATION 18-1
TYPICAL RECEIPTS AND PAYMENTS
CLASSIFIED BY ACTIVITY
Types of Cash Inflows and Outflows
Operating activities
Cash inflows:
From sale of goods or services
From returns on loans (interest received) and on equity securities (dividends received)
Cash outflows:
To suppliers for inventory
To employees for services
To government for taxes
To lenders for interest
To others for expenses
ILLUSTRATION 18-1
TYPICAL RECEIPTS AND PAYMENTS
CLASSIFIED BY ACTIVITY
Investing activities
Cash inflows:
From sale of property, plant, and equipment
From sale of debt or equity securities of other entities
From collection of principal on loans to other entities
Cash outflows:
To purchase property, plant, and equipment
To purchase debt or equity securities of other entities
To make loans to other entities
Financing activities
Cash inflows:
From sale of equity securities (company’s own stock)
From issuance of debt (bonds and notes)
Cash outflows:
To stockholders as dividends
To redeem long-term debt or reacquire capital stock
SIGNIFICANT
NONCASH ACTIVITIES
 Not all of a company’s significant activities involve cash.
 Examples of significant noncash activities are:
1 Issuance of common stock to purchase assets.
2 Conversion of bonds into common stock.
3 Issuance of debt to purchase assets.
4 Exchange of plant assets.
 Significant financing and investing activities that do not
affect cash are not reported in the body of the SCF.
 Such activities are reported in either
1 a separate schedule at the bottom of the SCF or
2 in a separate note or supplementary schedule to the
financial statements.
ILLUSTRATION 18-2
FORMAT OF STATEMENT OF CASH FLOWS
The general
format of the SCF
Is the 3 activities
previously
discussed –
operating,
investing, and
financing – plus
the significant
noncash investing
and financing
activities.
COMPANY NAME
Statement of Cash Flows
Period Covered
Cash flows from operating activities
(List of individual items)
Net cash provided (used) by operating activities
Cash flows from investing activities
(List of individual inflows and outflows)
Net cash provided (used) by investing activities
Cash flows from financing activities
(List of individual inflows and outflows)
Net cash provided (used) by financing activities
Net increase (decrease) in cash
Cash at beginning of period
Cash at end of period
Noncash investing and financing activities
(List of individual noncash transactions)
XX
XXX
XX
XXX
XX
XXX
XXX
XXX
XXX
XXX
FORMAT OF
THE STATEMENT OF CASH FLOWS
Differences between net income and net cash provided by operating
activities are illustrated by the following results from recent annual
reports for the same fiscal year (all data are in millions of dollars).
Company
Kmart Corporation
Wal-Mart Stores, Inc.
The GAP, Inc.
J. C. Penney Company, Inc.
Sears, Roebuck and Co.
The May Department Stores Company
Net Income
$ 518
4430
1127
594
1948
849
Net Cash
from Operations
$ 1237
7580
1478
1058
3090
1505
USEFULNESS OF
THE STATEMENT OF CASH FLOWS
The information in the SCF should help investors,
creditors and others assess the following aspects of
the firm’s financial position:
1 The entity’s ability to generate future cash flows.
2 The entity’s ability to pay dividends and meet
obligations.
3 The reasons for the difference between net income
and net cash provided (used) by operating
activities.
4 The cash investing and financing transactions
during the period.
PREPARING
THE STATEMENT OF CASH FLOWS
The SCF is prepared differently from the 3 other
basic financial statements.
1 It is not prepared from the adjusted trial balance.
2 The SCF deals with cash receipts and payments, so
the accrual concept is not used in the preparation
of the SCF.
The information to prepare this statement usually
comes from 3 sources:
1 Comparative balance sheet.
2 Current income statement.
3 Additional information.
ILLUSTRATION 18-3
THREE MAJOR STEPS IN PREPARING
THE STATEMENT OF CASH FLOWS
Step 1: Determine the net increase/decrease in cash.
The difference between the
beginning and ending cash
balances can be easily computed
from comparative balance sheets.
+ or -
Step 2: Determine net cash provided/used by operating activities.
This step involves analyzing not only the current
year’s income statement but also comparative
balance sheets and selected additional data.
XYZ
Goods
Step 3: Determine net cash provided/used by investing and financing activities.
This step involves analyzing
comparative balance sheet data
and selected additional information
for their effects on cash.
For
Sale
Investing
Financing
USAGE OF INDIRECT AND
DIRECT METHODS
In order to determine net cash provided/used by operating activities, the
operating activities section must be converted from accrual basis to cash
basis. This conversion may be accomplished by 1) the indirect method or
2) the direct method. The indirect method is used extensively in practice,
as shown below. The indirect is favored by companies for 2 reasons: 1) it
is easier to prepare and 2) it focuses on the differences between net income
and net cash flow from operating activities.
1.7% Direct Method
98.3%
Indirect
Method
STUDY OBJECTIVE 3
Prepare a statement of cash
flows using the indirect method.
SECTION 1
STATEMENT OF CASH FLOWS
INDIRECT METHOD
 The transactions of the Computer Services
Company for 2002 and 2003 are used to illustrate
and explain the indirect method of preparing the
SCF.
 First Year of Operations – 2002
1 Computer Services Company started on
January 1, 2002, when it issued 50,000 shares of
$1 par value common stock for $50,000 cash.
2 The company rented its office space and
furniture and rendered consulting services
throughout the first year.
ILLUSTRATION 18-4
COMPARATIVE BALANCE SHEET, 2002,
WITH INCREASES AND DECREASES
The comparative balance sheets at the beginning and end of
2002 – showing increases and decreases – are shown below.
COMPUTER SERVICES COMPANY
Comparative Balance Sheets
Assets
Cash
Accounts receivable
Equipment
Total
Liabilities and
Stockholders’ Equity
Accounts payable
Common stock
Retained earnings
Total
Dec. 31, 2002
$ 34,000
30,000
10,000
$ 74,000
$ 4,000
50,000
20,000
$ 74,000
Change
Jan. 1, 2002 Increase/Decrease
$ –0–
$ 34,000 Increase
–0–
30,000 Increase
–0–
10,000 Increase
$ –0–
$ –0–
–0–
–0–
$ –0–
$ 4,000 Increase
50,000 Increase
20,000 Increase
ILLUSTRATION 18-5
INCOME STATEMENT AND
ADDITIONAL INFORMATION, 2002
The income statement and additional information
for Computer Services Company are shown below.
COMPUTER SERVICES COMPANY
Income Statement
For the Year Ended December 31, 2002
Revenues
Operating expenses
Income before income taxes
Income tax expense
Net income
$ 85,000
40,000
45,000
10,000
$ 35,000
Additional information:
(1) Examination of selected data indicates
that a dividend of $15,000 was declared
and paid during the year.
(2) The equipment was purchased at the
end of 2002. No depreciation was taken
in 2002.
ILLUSTRATION 18-6
NET INCOME VERSUS NET CASH
PROVIDED BY OPERATING ACTIVITIES
The indirect method starts with net income and converts it to net cash provided by
operating activities. In other words, the indirect method adjusts net income for
items that affect reported net income but do not affect cash. Noncash charges in
the income statement are added back to net income. Likewise, noncash credits are
deducted. The result is to calculate net cash provided by operating activities.
Accrual Basis of Accounting
Eliminate noncash revenues
Earned
Revenues
Net Income
Incurred
Expenses
Cash Basis of Accounting
Adjustments to
Reconcile Net
Income to Net
Cash Provided
by Operations
Net Cash Provided
by Operating
Activities
Eliminate noncash expenses
ILLUSTRATION 18-7
ANALYSIS OF ACCOUNTS RECEIVABLE
 When accounts receivable increase during the year, revenues on an accrual
basis are higher than are revenues on a cash basis.
 In other words, operations of the period caused revenues to increase, but not
all of these revenues resulted in an increase in cash.
 Some of increase in revenues had to result in an increase in accounts
receivable.
 As shown below, Computer Services Company had $85,000 in revenues, but
collected only $55,000 in cash.
 Therefore, to convert net income into net cash provided by operating
activities, the increase of $30,000 in accounts receivable must be deducted
from net income.
1/1/02
12/31/02
Balance
Revenues
Balance
ACCOUNTS RECEIVABLE
–0– Receipts from customers
85,000
30,000
55,000
ILLUSTRATION 18-8
ANALYSIS OF ACCOUNTS PAYABLE
 When accounts payable increase during the year, operating
expenses on an accrual basis are higher than they are on a cash
basis.
 For Computer Services Company, operating expenses reported in
the income statement were $40,000.
 Since Accounts Payable increased $4,000, only $36,000 ($40,000
– $4,000) of the expenses were paid in cash.
 To adjust net income to net cash provided by operating activities,
the increase of $4,000 must be added to net income.
Payments to creditors
ACCOUNTS PAYABLE
36,000 1/1/02
Balance
Operating expenses
12/31/02 Balance
–0–
40,000
4,000
ILLUSTRATION 18-9
PRESENTATION OF NET CASH PROVIDED BY
OPERATING ACTIVITIES, 2002 — INDIRECT METHOD
 The changes in accounts receivable and accounts payable were the only changes
in current assets and current liabilities during the year for Computer Services
Company.
 Therefore, any other revenues or expenses reported in the income statement
were received or paid in cash.
 The operating activities section of the SCF for Computer Services Company is
shown below.
COMPUTER SERVICES COMPANY
Partial Statement of Cash Flows — Indirect Method
For the Year Ended December 31, 2002
Cash flows from operating activities
Net income
$ 35,000
Adjustments to reconcile net income to net cash provided by operating
activities:
Increase in accounts receivable
$ ( 30,000)
Increase in accounts payable
4,000
( 26,000)
Net cash provided by operating activities
$ 9,000
ILLUSTRATION 18-10
ANALYSIS OF RETAINED EARNINGS
The reasons for the net increase of $20,000 in Retained Earnings are
determined by analysis.
1 Net income increased Retained Earnings by $35,000.
2 The additional information below the income statement in
Illustration 18-5 indicates that a cash dividend of $15,000 was
declared and paid.
The increase due to net income is reported in the operating activities
section while the cash dividend paid is reported in the financing
activities section. This analysis can also be made directly from the
Retained Earnings account as shown below.
12/31/02
Cash dividend
RETAINED EARNINGS
15,000 1/1/02
Balance
12/31/02
Net income
12/31/02
Balance
–0–
35,000
20,000
ILLUSTRATION 18-11
STATEMENT OF CASH FLOWS, 2002
— INDIRECT METHOD
COMPUTER SERVICES COMPANY
Statement of Cash Flows — Indirect Method
For the Year Ended December 31, 2002
Cash flows from operating activities
Net income
$ 35,000
Adjustments to reconcile net income to net cash provided by operating
activities:
Increase in accounts receivable
$ ( 30,000)
Operating
Increase in accounts payable
4,000
( 26,000)
Net cash provided by operating activities activities provided
9,000
Cash flows from investing activities
$9,000 cash,
Purchase of equipment
( 10,000)
investing activities
Net cash used by investing activities
( 10,000)
Cash flows from financing activities
used $10,000 cash,
Issuance of common stock
50,000
while financing
Payment of cash dividends
( 15,000)
35,000
activities
provided
Net increase in cash
34,000
$35,000 cash.
Cash at beginning of period
–0–
Cash at end of period
$ 34,000
ILLUSTRATION 18-12
COMPARATIVE BALANCE SHEET, 2003,
WITH INCREASES AND DECREASES
The
comparative
balance
sheets at the
beginning
and end of
2003 –
showing
increases
and
decreases –
are shown to
the right.
COMPUTER SERVICES COMPANY
Comparative Balance Sheets
December 31
Assets
Cash
Accounts receivable
Prepaid expenses
Land
Building
Accumulated depreciation – building
Equipment
Accumulated depreciation – equipment
Total
Liabilities and
Stockholders’ Equity
Accounts payable
Bonds payable
Common stock
Retained earnings
Total
2003
$ 56,000
20,000
4,000
130,000
160,000
( 11,000)
27,000
( 3,000)
$ 383,000
2002
$ 34,000
30,000
–0–
–0–
–0–
–0–
10,000
–0–
$ 74,000
$
$
59,000
130,000
50,000
144,000
$ 383,000
4,000
–0–
50,000
20,000
$ 74,000
Change
Increase/Decrease
$ 22,000 Increase
10,000 Decrease
4,000 Increase
130,000 Increase
160,000 Increase
11,000 Increase
17,000 Increase
3,000 Increase
$ 55,000 Increase
130,000 Increase
–0–
124,000 Increase
ILLUSTRATION 18-13
INCOME STATEMENT AND
ADDITIONAL INFORMATION, 2003
The income
statement
and
additional
information
for 2003 for
Computer
Services
Company
are shown
to the right.
COMPUTER SERVICES COMPANY
Income Statement
For the Year Ended December 31, 2003
Revenues
Operating expenses (excluding depreciation)
Depreciation expense
Loss on sale of equipment
Income from operations
Income tax expense
Net income
$ 507,000
$ 261,000
15,000
3,000
279,000
228,000
89,000
$ 139,000
Additional information:
(1) In 2003, the company declared and paid a $15,000 cash dividend.
(2) The company obtained land through the issuance of $130,000 of long-term bonds.
(3) A building costing $160,000 was purchased for cash; equipment costing $25,000
was also purchased for cash.
(4) During 2003, the company sold equipment with a book value of $7,000 (cost
$8,000, less accumulated depreciation of $1,000) for $4,000 cash.
ILLUSTRATION 18-14
ANALYSIS OF ACCUMULATED
DEPRECIATION — EQUIPMENT
 The increase in Accumulated Depreciation – Equipment was
$3,000, which does not represent depreciation expense for the
year since the account was debited $1,000 as a result a sale of
some equipment.
 Depreciation expense for 2003 was $4,000 ($3,000 + $1,000).
 This amount is added to net income to determine net cash
provided by operating activities.
 The T-account below provides information about the changes
that occurred in this account in 2003.
ACCUMULATED DEPRECIATION — EQUIPMENT
Accumulated depreciation on
1/1/03
Balance
equipment sold
1,000
Depreciation expense
12/31/03
Balance
–0–
4,000
3,000
ILLUSTRATION 18-15
PRESENTATION OF NET CASH PROVIDED BY
OPERATING ACTIVITIES, 2003 — INDIRECT METHOD
Net cash provided by operating activities
for 2003 is $218,000 as calculated below.
COMPUTER SERVICES COMPANY
Partial Statement of Cash Flows — Indirect Method
For the Year Ended December 31, 2003
Cash flows from operating activities
Net income
$ 139,000
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation expense
$ 15,000
Loss on sale of equipment
3,000
Decrease in accounts receivable
10,000
Increase in prepaid expenses
( 4,000)
Increase in accounts payable
55,000
79,000
Net cash provided by operating activities
$ 218,000
ILLUSTRATION 18-16
ANALYSIS OF EQUIPMENT
Equipment increased $17,000, which was a net increase that
resulted from 2 transactions:
1) a purchase of equipment of $25,000 and
2) the sale of equipment costing $8,000 for $4,000.
These transactions are classified as investing activities and each
should be reported separately. The purchase of equipment
should therefore be reported as an outflow of cash for $25,000 and
the sale should be reported as an inflow of cash for $4,000. The
T-account below shows the reasons for the change in this account
during the year.
1/1/03
12/31/03
Balance
Purchase of equipment
Balance
EQUIPMENT
10,000 Cost of old equipment
25,000
27,000
8,000
ILLUSTRATION 18-17
STATEMENT OF CASH FLOWS, 2003
— INDIRECT METHOD
COMPUTER SERVICES COMPANY
Statement of Cash Flows
For the Year Ended December 31, 2003
Cash flows from operating activities
Net income
$ 139,000
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation expense
$ 15,000
Loss on sale of equipment
3,000
Decrease in accounts receivable
10,000
Increase in prepaid expenses
( 4,000)
Increase in accounts payable
55,000
79,000
Net cash provided by operating activities
218,000
ILLUSTRATION 18-17
STATEMENT OF CASH FLOWS, 2003
— INDIRECT METHOD
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
Payment of cash dividends
Net cash used by financing activities
Net increase in cash
Cash at beginning of period
Cash at end of period
Noncash investing and financing activities
Issuance of bonds payable to purchase land
$(160,000)
( 25,000)
4,000
(181,000)
( 15,000)
( 15,000)
22,000
34,000
$ 56,000
$ 130,000
ILLUSTRATION 18-18
ADJUSTMENTS FOR CURRENT
ASSETS AND CURRENT LIABILITIES
The SCF prepared by the indirect method starts with net income. It
then adds or deducts items not affecting cash to arrive at net cash
provided by operating activities. The additions and deductions consist
of:
1) changes in specific current assets and current liabilities and
2) noncash charges reported in the income statement.
A summary of the adjustments for current assets and current liabilities
is provided in Illustration 18-18.
Current Assets and
Current Liabilities
Accounts receivable
Inventory
Prepaid expenses
Accounts payable
Accrued expenses payable
Adjustments to Convert Net
Income to Net Cash Provided
by Operating Activities
Add to
Deduct from
Net Income
Net Income
Decrease
Increase
Decrease
Increase
Decrease
Increase
Increase
Decrease
Increase
Decrease
ILLUSTRATION 18-19
ADJUSTMENTS FOR
NONCASH CHARGES
Adjustments for the noncash
charges reported in the
income statement are made as
shown in Illustration 18-19.
Noncash Charges
Depreciation expense
Patent amortization expense
Depletion expense
Loss on sale of asset
Adjustments to Convert Net
Income to Net Cash Provided
by Operating Activities
Add
Add
Add
Add
STUDY OBJECTIVE 4
Prepare a statement of cash
flows using the direct method.
SECTION 2
STATEMENT OF CASH FLOWS
DIRECT METHOD
 The transactions of Juarez Company for 2002 and
2003 are used to illustrate and explain the
indirect method of preparing the SCF.
 First Year of Operations – 2002
1 Juarez Company started on January 1, 2002,
when it issued 300,000 shares of $1 par value
common stock for $300,000 cash.
2 The company rented its office, sales space, and
equipment.
ILLUSTRATION 18-20
COMPARATIVE BALANCE SHEET, 2002,
WITH INCREASES AND DECREASES
The
comparative
balance
sheets at the
beginning
and end of
2002–
showing
increases
and
decreases –
are shown to
the right.
JUAREZ COMPANY
Comparative Balance Sheet
Assets
Cash
Accounts receivable
Inventory
Prepaid expenses
Land
Total
Liabilities and
Stockholders’ Equity
Accounts payable
Accrued expenses payable
Common stock
Retained earnings
Total
Dec. 31, 2002
$ 159,000
15,000
160,000
8,000
80,000
$ 422,000
$ 60,000
20,000
300,000
42,000
$ 422,000
Jan. 1, 2002
$ –0–
–0–
–0–
–0–
–0–
$ –0–
Change
Increase/Decrease
$ 159,000 Increase
15,000 Increase
160,000 Increase
8,000 Increase
80,000 Increase
$ –0– $ 60,000 Increase
–0–
20,000 Increase
–0–
300,000 Increase
–0–
42,000 Increase
$ –0–
ILLUSTRATION 18-21
INCOME STATEMENT AND
ADDITIONAL INFORMATION, 2002
The income statement and additional information
for Juarez Company are shown below.
JUAREZ COMPANY
Income Statement
For the Year Ended December 31, 2002
Revenues from sales
Cost of goods sold
Gross profit
Operating expenses
Income before income taxes
Income tax expense
Net income
$ 780,000
450,000
330,000
170,000
160,000
48,000
$ 112,000
Additional information:
(1) Dividends of $70,000 were declared and paid in cash.
(2) The accounts payable increase resulted from the purchase of merchandise.
ILLUSTRATION 18-22
MAJOR CLASSES OF CASH
RECEIPTS AND PAYMENTS
Cash Receipts – Cash Payments = Net Cash Provided
by
Operating Activities
To suppliers
From sales of
goods and services
to customers
To employees
For operating
expenses
For interest
and dividends
From receipts of
interest and
dividends on loans
and investments
For taxes
Net cash provided
by operating
activities
CASH RECEIPTS
FROM CUSTOMERS
 The income statement for Juarez Company
reported revenues from customers of $780,000.
 To determine the amount of cash receipts, the
increase in accounts receivable is deducted from
sales revenues.
 Conversely, a decrease in accounts receivable is
added to sales revenues, since cash receipts from
customers exceed sales revenues.
ILLUSTRATION 18-23
COMPUTATION OF CASH
RECEIPTS FROM CUSTOMERS
For Juarez Company, accounts
receivable increased $15,000, so
that cash receipts from customers
were $765,000, calculated as shown
Illustration
in Illustration
18-23.18-24
Computation of Cash Receipts from Customers
Revenues from sales
Deduct: Increase in accounts receivable
Cash receipts from customers
$ 780,000
15,000
$ 765,000
ILLUSTRATION 18-24
ANALYSIS OF
ACCOUNTS RECEIVABLE
Cash receipts from customers may
also be determined from an analysis
of Accounts Receivable as shown in
Illustration 18-24.
Illustration 18-25
Analysis of Accounts Receivable
1/1/02
12/31/02
ACCOUNTS RECEIVABLE
Balance
–0– Receipts from customers
Revenues from sales
780,000
Balance
15,000
765,000
ILLUSTRATION 18-25
FORMULA TO COMPUTE CASH RECEIPTS
FROM CUSTOMERS — DIRECT METHOD
The relationships among cash
receipts from customers, revenues
from sales, and changes in accounts
receivable are shown in Illustration
18-25.
Cash
receipts from
customers
=
Revenues
from sales
{
+ Decrease in accounts receivable
or
– Increase in accounts receivable
ILLUSTRATION 18-26
COMPUTATION OF PURCHASES
Juarez Company reported cost of goods sold on its
income statement of $450,000. To determine
purchases, cost of goods sold must be adjusted for
the change in inventory. An increase (decrease) in
inventory is added to (deducted from) cost of
goods sold to arrive at purchases. In 2002, Juarez
Illustration
18-27
Company’s inventory
increased
$160,000.
Computation
of Illustration
Purchases 18-26.
Purchases are
calculated in
Cost of goods sold
Add: Increase in inventory
Purchases
$ 450,000
160,000
$ 610,000
ILLUSTRATION 18-27
COMPUTATION OF CASH PAYMENTS
TO SUPPLIERS
Cash payments to suppliers are then
determined by adjusting purchases for the
change in accounts payable. An accounts
payable increase (decrease) is deducted from
(added to) purchases. Cash payments to
Illustrationin
18-28
suppliers are calculated
Illustration 18-27.
Computation of Cash Payments to Suppliers
Purchases
Deduct: Increase in accounts payable
Cash payments to suppliers
$ 610,000
60,000
$ 550,000
ILLUSTRATION 18-28
ANALYSIS OF
ACCOUNTS PAYABLE
Cash payments to suppliers may
also be determined from an analysis
of Accounts Payable as shown in
Illustration 18-28.
Illustration 18-29
Analysis of Accounts Payable
Payments to creditors
ACCOUNTS PAYABLE
550,000 1/1/02
Balance
Purchases
12/31/02 Balance
–0–
610,000
60,000
ILLUSTRATION 18-29
FORMULA TO COMPUTE CASH PAYMENTS
TO SUPPLIERS — DIRECT METHOD
The relationship among cash payments to
suppliers, cost of goods sold, changes in inventory,
and changes in accounts payable is shown in
Illustration 18-29.
Cash
payments
to suppliers
=
Cost of
goods sold
{
{
+ Increase in inventory + Decrease in accounts payable
or
or
– Decrease in inventory – Increase in accounts payable
ILLUSTRATION 18-30
COMPUTATION OF CASH PAYMENTS
FOR OPERATING EXPENSES
Operating expenses of $170,000 were reported on Juarez’s
income statement. To convert operating expenses to cash
payments for operating expenses, the increase in prepaid
expenses of $8,000 must be added to operating expenses. A
decrease in prepaid expenses would be deducted from operating
expenses. The increase in accrued expenses of $20,000 must be
deducted, while a decrease would be added. Juarez Company’s
cash payments for operating expenses are calculated in
Illustration 18-31
Illustration 18-30.
Computation of Cash Payments for Operating Expenses
Operating expenses
Add: Increase in prepaid expenses
Deduct: Increase in accrued expenses payable
Cash payments for operating expenses
$ 170,000
8,000
( 20,000)
$ 158,000
ILLUSTRATION 18-31
FORMULA TO COMPUTE CASH PAYMENTS FOR
OPERATING EXPENSES — DIRECT METHOD
Operating expenses
Cash payments
for operating
expenses
=
+ Increase in prepaid expenses
or
- Decrease in prepaid expenses
+ Decrease in accrued expenses payable
or
- Increase in accrued expenses payable
ILLUSTRATION 18-32
OPERATING ACTIVITIES SECTION
— DIRECT METHOD
 All of the revenues and expenses in the 2002 income
statement have now been adjusted to cash basis.
 The operating activities section of the SCF is shown
below.
JUAREZ COMPANY
Partial Statement of Cash Flows — Direct Method
For the Year Ended December 31, 2002
Cash flows from operating activities
Cash receipts from customers
Cash payments:
To suppliers
For operating expenses
For income taxes
Net cash provided by operating activities
$ 765,000
$ 550,000
158,000
48,000
756,000
$ 9,000
ILLUSTRATION 18-33
ANALYSIS OF RETAINED EARNINGS
The reasons for the net increase of $42,000 in Retained Earnings are
determined by analysis.
1 Net income increased Retained Earnings by $112,000.
2 The additional information below the income statement in
Illustration 18-21 indicates that a cash dividend of $70,000 was
declared and paid.
The increase due to net income is reported in the operating activities
section while the cash dividend paid is reported in the financing
activities section. This analysis can also be made directly from the
Retained Earnings account as shown below.
12/31/02
Cash dividend
RETAINED EARNINGS
70,000 1/1/02
Balance
12/31/02
Net income
12/31/02
Balance
–0–
112,000
42,000
ILLUSTRATION 18-34
STATEMENT OF CASH FLOWS, 2002
— DIRECT METHOD
JUAREZ COMPANY
Statement of Cash Flows — Direct Method
For the Year Ended December 31, 2002
Cash flows from operating activities
Cash receipts from customers
Cash payments:
To suppliers
For operating expenses
For income taxes
Net cash provided by operating activities
Cash flows from investing activities
Purchase of land
Net cash used by investing activities
Cash flows from financing activities
Issuance of common stock
Payment of cash dividend
Net cash provided by financing activities
Net increase in cash
Cash at beginning of period
Cash at end of period
The SCF for 2002
for Juarez
Company shows
that operating
activities provided
$9,000 cash,
investing activities
used $80,000 cash,
while financing
activities provided
$230,000 cash.
$ 765,000
$ 550,000
158,000
48,000
(756,000)
9,000
( 80,000)
( 80,000)
300,000
( 70,000)
230,000
159,000
–0–
$ 159,000
ILLUSTRATION 18-35
COMPARATIVE BALANCE SHEET, 2003,
WITH INCREASES AND DECREASES
The comparative balance sheets at the beginning and end of 2003
– showing increases and decreases – are shown below.
JUAREZ COMPANY
Comparative Balance Sheet
December 31
Assets
Cash
Accounts receivable
Inventory
Prepaid expenses
Land
Equipment
Accumulated depreciation – equipment
Total
2003
$ 191,000
12,000
130,000
6,000
180,000
160,000
( 16,000)
$ 663,000
2002
$ 159,000
15,000
160,000
8,0000
80,000
–0–
–0–
$ 422,000
Change
Increase/Decrease
$ 32,000 Increase
3,000 Decrease
30,000 Decrease
2,000 Decrease
100,000 Increase
160,000 Increase
16,000 Increase
JUAREZ COMPANY
Comparative Balance Sheet
December 31
ILLUSTRATION 18-35
COMPARATIVE BALANCE SHEET, 2003,
Change
WITH
INCREASES
AND
DECREASES
Assets
2000
1999
Increase/Decrease
Cash
Accounts receivable
Inventory
Prepaid expenses
Land
Equipment
Accumulated depreciation – equipment
Total
Liabilities and
Stockholders’ Equity
Accounts payable
Accrued expenses payable
Income taxes payable
Bonds payable
Common stock
Retained earnings
Total
$ 191,000
12,000
130,000
6,000
180,000
160,000
( 16,000)
$ 663,000
$ 159,000
15,000
160,000
8,0000
80,000
–0–
–0–
$ 422,000
$
$
52,000
15,000
12,000
90,000
400,000
94,000
$ 663,000
$ 32,000 Increase
3,000 Decrease
30,000 Decrease
2,000 Decrease
100,000 Increase
160,000 Increase
16,000 Increase
60,000 $ 8,000 Decrease
20,000
5,000 Decrease
–0–
12,000 Increase
–0–
90,000 Increase
300,000
100,000 Increase
52,000 Increase
42,000
$ 422,000
ILLUSTRATION 18-36
INCOME STATEMENT AND
ADDITIONAL INFORMATION, 2003
JUAREZ COMPANY
Income Statement
For the Year Ended December 31, 2003
Revenues from sales
$ 975,000
Cost of goods sold
$ 660,000
Operating expenses (excluding depreciation)
176,000
Depreciation expense
18,000
Loss on sale of store equipment
1,000
855,000
Income before income taxes
120,000
The income statement and
Income tax expense
36,000
Net income
additional information for 2003 $ 84,000
for Juarez Company are shown.
Additional information:
(1) In 2003, the company declared and paid a $32,000 cash dividend.
(2) Bonds were issued at face value for $90,000 in cash.
(3) Equipment costing $180,000 was purchased for cash.
(4) Equipment costing $20,000 was sold for $17,000 cash when the book value of the
Equipment was $18,000.
(5) Common stock of $100,000 was issued to acquire land.
ILLUSTRATION 18-37
COMPUTATION OF
CASH
RECEIPTS FROM CUSTOMERS
Revenues from sales were $975,000. Cash receipts
from customers were greater than sales revenues since
accounts receivable decreased $3,000. Cash receipts
from customers were $978,000, as calculated below.
Revenues from sales
Add: Decrease in accounts receivable
Cash receipts from customers
$ 975,000
3,000
$ 978,000
ILLUSTRATION 18-38
COMPUTATION OF
CASH
PAYMENTS TO SUPPLIERS
Purchases are calculated using cost of goods sold of
$660,000. The inventory decrease of $30,000 is deducted
from cost of goods sold. Purchases are then adjusted by
the accounts payable
decrease of18-39
$8,000. Cash payments
Illustration
toComputation
suppliers are calculated
Illustrationto
18-38.
of CashinPayments
Suppliers
Cost of goods sold
Deduct: Decrease in inventory
Purchases
Add: Decrease in accounts payable
Cash payments to suppliers
$ 660,000
30,000
630,000
8,000
$ 638,000
ILLUSTRATION 18-39
COMPUTATION OF CASH PAYMENTS
FOR OPERATING EXPENSES
Operating expenses (exclusive of depreciation expense)
was $176,000 for 2000. The $2,000 decrease in prepaid
expenses is deducted and the $5,000 decrease in accrued
expenses payable is added in determining cash payments
for operating expenses, as shown in Illustration 18-39.
Illustration 18-40
Computation of Cash Payments for Operating Expenses
Operating expenses, exclusive of depreciation
Deduct: Decrease in prepaid expenses
Add: Decrease in accrued expenses payable
Cash payments for operating expenses
$ 176,000
( 2,000)
5,000
$ 179,000
ILLUSTRATION 18-40
COMPUTATION OF CASH PAYMENTS
FOR INCOME TAXES
Income tax expense reported on the income
statement was $36,000. The $12,000
increase in income taxes payable must be
deducted from income tax expense to
determine cash payments for income taxes.
Cash payments for income taxes were
Illustration
18-41
$24,000 as shown
in Illustration
18-40.
Computation of Cash Payments for Income Taxes
Income tax expense
Deduct: Increase in income taxes payable
Cash payments for income taxes
$ 36,000
12,000
$ 24,000
ILLUSTRATION 18-41
FORMULA TO COMPUTE CASH PAYMENTS
FOR INCOME TAXES — DIRECT METHOD
The relationships among cash payments for
income taxes, income tax expense, and
changes in income taxes payable are shown in
the formula in Illustration 18-41.
Cash
payments for
income
taxes
=
Income
tax
expense
{
+ Decrease in income taxes payable
or
– Increase in income taxes payable
ILLUSTRATION 18-42
ANALYSIS OF EQUIPMENT AND RELATED
ACCUMULATED DEPRECIATION
The comparative balance sheet shows that Equipment increased
$160,000 in 2003. The additional information in Illustration 1836 that the increase resulted from 2 investing transactions: 1)
equipment costing $180,000 was purchased for cash and 2)
equipment costing $20,000 was sold for $17,000 cash when its
book value was $18,000. For Juarez Company, the investing
activities section will show: 1) the $180,000 purchase of
equipment as an outflow of cash and 2) the $17,000 sale of
equipment as an inflow of cash.
1/1/03
12/31/03
Balance
Cash purchase
Balance
EQUIPMENT
–0– Cost of equipment sold
180,000
160,000
20,000
ILLUSTRATION 18-42
ANALYSIS OF EQUIPMENT AND RELATED
ACCUMULATED DEPRECIATION
Sale of equipment
ACCUMULATED DEPRECIATION — EQUIPMENT
2,000 1/1/03
Balance
Depreciation expense
12/31/03
Balance
–0–
18,000
16,000
ILLUSTRATION 18-43
STATEMENT OF CASH FLOWS, 2003
— DIRECT METHOD
JUAREZ COMPANY
Statement of Cash Flows — Direct Method
For the Year Ended December 31, 2003
Cash flows from operating activities
Cash receipts from customers
Cash payments:
To suppliers
For operating expenses
For income taxes
Net cash provided by operating activities
Cash flows from investing activities
Purchase of equipment
Sale of equipment
Net cash used by investing activities
Cash flows from financing activities
Issuance of bonds payable
Payment of cash dividend
Net cash provided by financing activities
Net increase in cash
$ 978,000
$ 638,000
179,000
24,000
(841,000)
137,000
(180,000)
17,000
(163,000)
90,000
( 32,000)
58,000
32,000
JUAREZ COMPANY
Statement of Cash Flows — Direct Method
For the Year Ended December 31, 2000
ILLUSTRATION 18-43
STATEMENT OF CASH FLOWS, 2003
Cash flows from operating activities
— DIRECT METHOD
Cash receipts from customers
$ 978,000
Cash payments:
To suppliers
For operating expenses
For income taxes
Net cash provided by operating activities
Cash flows from investing activities
Purchase of equipment
Sale of equipment
Net cash used by investing activities
Cash flows from financing activities
Issuance of bonds payable
Payment of cash dividend
Net cash provided by financing activities
Net increase in cash
Cash at beginning of period
Cash at end of period
Noncash investing and financing activities
Issuance of common stock to purchase land
$ 638,000
179,000
24,000
(841,000)
137,000
(180,000)
17,000
(163,000)
90,000
( 32,000)
58,000
32,000
159,000
$ 191,000
$ 100,000
STUDY OBJECTIVE 5
Analyze the statement of cash flows.
ILLUSTRATION 18-45
THE GAP, INC. DATA USED IN
FLOW ANALYSIS
CASH
The GAP, Inc. reported the following
information in its 2000 annual report:
Gap, Inc.
($ in millions)
Current Liabilities
Total Liabilities
Net Sales
Net Cash provided by operating activities
Fiscal 2000
$1,753
2,956
11,635
1,478
Fiscal 1999
$1,553
2,390
9,054
1,394
ILLUSTRATION 18-45
CURRENT CASH DEBT
COVERAGE RATIO
A disadvantage of the current ratio is that it employs year-end
balances of current asset and current liability accounts. Such
year-end balances may not be representative of the company’s
current position during most of the year. The current cash debt
coverage ratio partially corrects this problem and is calculated
by dividing average current liabilities into net cash provided by
operating activities. The current cash debt coverage ratio for
The GAP, Inc. for 2000 is calculated below.
Net Cash
Provided by
Operating
Activities
$1,478
Average Current
Liabilities


÷
$1,753 + $1,553
————————
2
Current Cash Debt
Coverage Ratio
=
.89:1
ILLUSTRATION 18-46
CASH RETURN ON SALES RATIO
The cash return on sales ratio is the cash based ratio that
is the counterpart of the profit margin percentage. This
ratio is calculated by dividing net sales into net cash
provided by operating activities. The current return on
sales ratio for The GAP, Inc. for 2000 is calculated below.
Net Cash
Provided by
Operating
Activities
$1,478


Cash Return on
Sales Ratio
Net Sales
÷
$11,635
=
13%
ILLUSTRATION 18-47
CASH DEBT COVERAGE RATIO
The cash basis measure of solvency is the cash debt coverage
ratio – the ratio of net cash provided by operating activities
to average total liabilities. This ratio demonstrates a
company’s ability to repay its liabilities from net cash
provided by operating activities, without having to liquidate
the assets it employs. The cash debt coverage ratio for The
GAP, Inc. for 2000 is calculated below.
Net Cash
Provided by
Operating
Activities
$1,478


Cash Debt
Coverage Ratio
Average Total
Liabilities
÷
$2,956 + $2,390
————————
2
=
.55:1
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CHAPTER 18
THE STATEMENT OF CASH FLOWS