Chapter 12:
Statement of Cash Flows
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General Information on SCF

Required for financial statements by SFAS
95 (1987).
 Primary purpose is to provide relevant
information about cash receipts and cash
disbursements of the company during the
year.
 Serves to complement the other financial
statements.
 Focus is on cash flows, not income.
 Reconciles the balance sheet and the
income statement.
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Content of Statement of Cash Flows

Explains change in cash and cash
equivalents.
 Cash equivalents are defined as short-term,
highly liquid investments near to maturity.
 Examples of cash equivalents are Treasury
bills commercial paper (short-term notes
issued by corporations) and money market
funds.
 Format of SCF includes the following three
sections:
A. Cash flow from operating activities.
B. Cash flow from investing activities.
C. Cash flow from financing activities.
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A. Cash Flows from Operating Activities
CF from operating activities is based on
the income statement, and converts income
activity to a cash basis in its presentation.
 There are two formats for the presentation
of CF from operating activity:
– direct method: this technique shows
cash received from customers and cash
paid to various entities for operating
activities.
– indirect method: this technique starts
with net income and makes adjustments
to net income to convert it to a cash
basis.

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Cash Flows from Operating Activities
If the direct method is used, the indirect
method must be presented in a
supplementary schedule.
 The direct method is more informative, but
the vast majority of companies present only
the indirect method.
 FASB is considering a change to require the
direct method.
 Our coverage of Chapter 12 will focus only
on the indirect method.

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B. Cash Flows from Investing Activities

CF from investing activities explain the
changes in cash from the purchase or sale of
the company’s (primarily) long-term assets.
 Examples of investing activity includes:
– cash paid for purchase of equipment, land,
buildings, investments, intangible assets, and
most other long term assets.
– cash received from sale of equipment, land,
buildings, investments, intangible assets, and
most other long term assets.
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C. Cash Flows from Financing Activities

CF from financing activities explain the
changes in cash from the issue or retirement of
the company’s (primarily) long-term liabilities
and equity.
 Examples of financing activity includes:
– cash received from issue of bonds,
mortgages and other long-term debt.
– cash received from issue of common stock
and preferred stock.
– cash paid for the retirement of long-term
debt.
– cash paid for the repurchase of treasury
stock.
– cash paid for dividends.
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Cash Flows from Financing Activities

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Note that cash paid for dividends is classified
as a financing activity, but cash paid for interest
is classified as an operating activity.
Note that cash received for dividends and cash
received for interest are both classified as
operating activities.
How is the cash paid for dividends different
from the other activities? Why did the FASB
choose to classify it as a financing activity?
FASB chose to leave income related items (int.
revenue, int. expense, div. income) in the
operating section, rather than reclassify.
However, dividends declared has nothing to do
with net income, and must be classified with
financing.
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A. CF from Operations (indirect method):
Specific Calculations
To understand the adjustments to get from net
income to CF from operations, we will classify
the adjustments into 3 categories:
(1) Noncash items.
(2) Double counted gains and losses.
(3) Change in related (accrual basis) assets
and liabilities
Remember: net income includes many activities
that are noncash, or only partly cash.
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(1) Indirect Method - Noncash Items
Noncash activities include
-Depreciation expense. For example:
Depreciation Expense
xx
Accumulated Depreciation
xx
-Amortization expense on intangible assets such as
patents.
Amortization Expense
xx
Patent
xx
-Bad debt expense on the estimation of
uncollectibles:
Bad Debt Expense
xx
Allowance for Doubtful Accts.
xx
Since these expenses originally reduced net income, the
amount of these expenses would need to be added
back to net income to get to cash from operations.
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(2)Indirect Method - Double Counted Items

The double counted items come from gains and
losses on investing and financing activity.
 For example, assume that land is sold for
$10,000 cash, and the original cost was $9,000:
Cash
10,000
Land
9,000
Gain on Sale of Land
1,000
In this case, the $10,000 cash received would
be shown in Investing. However, if the gain is
not adjusted out of net income, we would be
“double counting” that effect.
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(2)Indirect Method - Double Counted Items

Therefore, any gains or losses from sale of
investing (nonoperating) assets (equipment,
land, buildings, AFS and equity investments,
intangibles). The adjustment to reverse out
the effects would be:
– add the amount of loss to net income.
– subtract the amount of the gain from net
income.
 The same holds true for gains and losses from
the early extinguishment of debt (like the
gains/losses from the retirement of bonds).
– add the amount of loss to net income.
– subtract the amount of the gain from net
income.
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(3) Indirect Method Change in Related Assets and Liabilities
The third category examines the change
in the assets and liabilities that relate to
the remaining income statement items,
after the items in (1) and (2) have been
removed.
 The adjustment for the effect of these
changes is to effectively “squeeze” the
income statement item from the accrual
basis of accounting to the cash basis of
accounting.

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(3) Indirect Method Change in Related Assets and Liabilities
Example: Sales = 100,000, and change in A/R from
2,000 to 3,000 or 1,000 increase .
A/RB + Sales - A/RE = Cash Collections
2,000 + 100,000 - 3,000 = Cash Collections
99,000 = Cash Collections
Note that, to convert from accrual basis sales
revenues to cash basis sales revenues, an
increase in A/R should be subtracted from net
income to convert net income to a cash basis.
Correspondingly, a decrease in A/R should be
added to net income to convert net income to a
cash basis.
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(3) Indirect Method Change in Related Assets and Liabilities
This pair of rules can be expanded to a general set of
rules to convert NI from accrual to cash basis:
Subtract increases in related assets.
Add decreases in related assets.
Add increases in related liabilities.
Subtract decreases in related liabilities.
Mnemonic to help you remember:
AOLS
Assets Opposite, Liabilities Same
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(3) Indirect Method Change in Related Assets and Liabilities
The types of assets that relate to the income
statement are primarily current assets, but not
always. To decide, you must look at each asset
and its related income statement component.
Also, remember that we are looking at the
remaining assets and liabilities (after the
eliminations in part 1). Since we have already
eliminated depreciation expense and amortization
expense, etc., we would not include the changes
in these related assets (Accum. Depr., Patents,
etc.).
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(3) Indirect Method Change in Related Assets and Liabilities
(primarily current assets and liabilities)
Examples of related assets are:
Accounts Receivable.
Interest Receivable.
Inventories.
Prepaid Expenses.
Examples of related liabilities include:
Accounts Payable.
Interest Payable.
Wages Payable.
Income Tax Payable.
Other Current Liabilities.
Unearned Revenues.
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Additional Issues - SCF
The FASB requires that significant noncash
investing and financing activities be
disclosed in a note or supplementary
schedule to the SCF.
 Examples of significant noncash investing
and financing activities include:
– conversion of bonds or preferred stock to
common stock.
– purchase of assets with issue of stock.
– purchase of assets with debt.
– declaration (but not payment) of cash
dividend.

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