“How Well Am I Doing?”
Statement of Cash Flows
Chapter Fifteen
McGraw-Hill/Irwin
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15-2
Purpose of the Statement of Cash Flows
Are cash flows
sufficient to
support ongoing
operations?
Will the company
have to borrow
money to make
needed
investments?
McGraw-Hill/Irwin
Can we meet
our obligations
to creditors?
Why is there a
difference
between net
income and net
cash flow?
Can we pay
dividends?
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-3
Learning Objective 1
Classify changes in
noncash balance
sheet accounts as
sources or uses of
cash.
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15-4
Cash
The term cash on the statement of cash
flows refers broadly to both currency and
cash equivalents.
Currency and
Bank Accounts
T-bills
Cash
Money Market
Funds
McGraw-Hill/Irwin
Commercial
Paper
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-5
Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts
Changes in
Capital Stock
Dividends
Paid to
Stockholders
Changes in
Liabilities
Net Cash
Flows for a
Period
Changes in
Noncash
Assets
Net Income
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-6
Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts
Net Income
Net Loss
Changes in noncash assets
Changes in liabilities*
Changes in capital stock
accounts
Dividends paid to stockholders
Sources
Always
Decreases
Increases
Uses
Always
Increases
Decreases
Increases
Decreases
Always
Total sources - Total uses = Net cash flow
* Contra asset accounts, such as the Accumulated Depreciation and
Amortization account, follow the rules for liabilities.
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Copyright © 2008, The McGraw-Hill Companies, Inc.
15-7
Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts
Increases in noncash asset
accounts imply uses of cash.
Example: Inventory is
purchased on credit from
a supplier.
It is implied that cash
was used to acquire the
inventory.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-8
Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts
Increases in liability accounts imply
sources of cash.
Example: Inventory is
purchased on credit from
a supplier.
It is implied that an increase
in a payable has the effect
of increasing cash available
for other uses.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-9
Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts
Decreases in noncash assets
accounts imply sources of cash.
Example: Accounts receivable
decreases when a company
pays its bill.
When the customer pays the
bill, the company’s cash
increases.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-10
Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts
Decreases in liability accounts
imply uses of cash.
Example: A company
pays a note payable held
by a creditor.
When the payment is made,
cash decreases.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-11
A Simplified Statement of Cash Flows: An Example
Ed's Pizza Hut
Comparative Balance Sheet Account Balances
Cash
Accounts Receivable
Inventory
Land
Equipment
Accumulated Depr.
Accounts Payable
Salaries Payable
Note Payable - Joe Doe
Common Stock
Retained Earnings
McGraw-Hill/Irwin
3/31/2008 3/31/2007
Change
DR (CR)
DR (CR) Incr. (Decr.)
$ 71,000 $ 90,000 $ (19,000)
23,000
40,000
(17,000)
350,000
300,000
50,000
68,000
100,000
(32,000)
84,000
84,000
(45,000)
(39,000)
6,000
(38,000)
(27,000)
11,000
(9,000)
(14,000)
(5,000)
(50,000)
(50,000)
(500,000) (450,000)
50,000
(4,000)
(34,000)
(30,000)
$
- $
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-12
A Simplified Statement of Cash Flows: An Example
Additional Information:
 There was a net loss for the year of $27,000.
 Depreciation charges for the year were $6,000.
 During the year, Ed sold land originally costing
$32,000 for $32,000.
 During the year, Ed paid dividends of $3,000 to the
stockholders.
 Ed issued $50,000 of common stock to settle the
note due to Joe Doe.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-13
A Simplified Statement of Cash Flows: An Example
Here is a summary of the sources
of cash for Ed’s Pizza Hut.
Ed's Pizza Hut
Sources of Cash
Decrease in A/R
$
Decrease in Land
Increase in A/P
Depreciation charges
Total sources of cash
$
McGraw-Hill/Irwin
17,000
32,000
11,000
6,000
66,000
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-14
A Simplified Statement of Cash Flows: An Example
Here is a summary of the uses of
cash for Ed’s Pizza Hut.
Ed's Pizza Hut
Uses of Cash
Net loss
Increase in Inventory
Increase in Salaries Payable
Dividends paid
Total uses of cash
$
$
27,000
50,000
5,000
3,000
85,000
The net cash flow for Ed’s Pizza Hut is ($19,000):
$66,000 in sources minus $85,000 in uses.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-15
A Simplified Statement of Cash Flows
Ed's Pizza Hut
Sources of Cash
Decrease in A/R
$
Decrease in Land
Increase in A/P
Depreciation charges
Total sources of cash
$
17,000
32,000
11,000
6,000
66,000
Ed's Pizza Hut
Uses of Cash
Net loss
Increase in Inventory
Increase in Salaries Payable
Dividends paid
Total uses of cash
McGraw-Hill/Irwin
$
$
27,000
50,000
5,000
3,000
85,000
This simplified
approach does
not follow the
format required
for external
reporting
purposes. It is
for illustrative
purposes only.
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-16
Learning Objective 2
Classify transactions
as operating,
investing, or
financing activities.
McGraw-Hill/Irwin
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15-17
The Full-Fledged Statement of Cash Flows:
Operating Activities
Operating activities are
those activities that enter
into the determination of
net income.
Transactions
affecting current
assets
Transactions
affecting current
liabilities
McGraw-Hill/Irwin
Changes in
noncurrent
balance sheet
accounts that
directly affect net
income
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15-18
The Full-Fledged Statement of Cash Flows:
Investing Activities
Investing activities relate to
transactions involving the
acquiring or disposing of
noncurrent assets.
Lending money to
another entity and
subsequently
collecting on the
loan
Acquiring or
selling property,
plant and
equipment
Acquiring or
selling securities
McGraw-Hill/Irwin
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15-19
The Full-Fledged Statement of Cash Flows:
Financing Activities
Financing activities relate to
transactions involving borrowing
from creditors or repaying
creditors and engaging in
transactions with the
company’s owners.
Issuing stock and
purchasing
treasury stock
Issuing long-term
debt and
repayment of debt.
McGraw-Hill/Irwin
Payment of
dividends (note
that interest on
debt is classified
as an operating
activity)
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15-20
The Full-Fledged Statement of Cash Flows: An
Overview
Operating Activities:
Net income
Changes in current assets
Changes in noncurrent assets that affect net income (e.g., depreciation)
Changes in current liabilities (except for debts to lenders and dividends
payable)
Changes in noncurrent liabilities that affect net income
Investing Activities:
Changes in noncurrent assets that are not included in net income
Financing Activities:
Changes in the current liabilities that are debts to lenders rather than
obligations to suppliers, employees, or the government
Changes in noncurrent liabilities that are not included in net income
Changes in capital stock accounts
Dividends
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Copyright © 2008, The McGraw-Hill Companies, Inc.
15-21
The Full-Fledged Statement of Cash Flows: An
Overview
Operating Activities
Investing Activities
Financing Activities
Reconciliation of the
beginning cash balance
with the ending cash
balance
Noncash Investing
and Financing
Activities
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Copyright © 2008, The McGraw-Hill Companies, Inc.
15-22
Operating Activities
Net Income (Loss)
$ XXX
Add:
XXX
XXX
XXX
XXX
(XXX)
(XXX)
(XXX)
$ XXX
Decr. in Current Noncash Assets
Incr. in Current Liabilities
Depreciation Charges
Losses
Less:
Incr. in Current Noncash Assets
Decr. in Current Liabilities
Gains
Net Cash Flows from Operating Activities
Includes those activities that enter into the
determination of net income.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
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Operating Activities
Sources of cash are added to net
income and uses of cash are
subtracted from net income.
Impact on Net Income
Sources
Uses
Current
Noncash Assets
Current
Liabilities
McGraw-Hill/Irwin
Decreases
Increases
Increases
Decreases
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-24
Operating Activities
Net Income (Loss)
$ XXX
Add:
XXX
XXX
XXX
XXX
(XXX)
(XXX)
(XXX)
$ XXX
Decr. in Current Noncash Assets
Incr. in Current Liabilities
Depreciation Charges
Losses
Less:
Incr. in Current Noncash Assets
Decr. in Current Liabilities
Gains
Net Cash Flows from Operating Activities
Impact on Net Income
Sources
Uses
Current
Noncash Assets
Current
Liabilities
McGraw-Hill/Irwin
Decreases
Increases
Increases
Decreases
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-25
Operating Activities
Net Income (Loss)
$ XXX
Add:
XXX
XXX
XXX
XXX
(XXX)
(XXX)
(XXX)
$ XXX
Decr. in Current Noncash Assets
Incr. in Current Liabilities
Depreciation Charges
Losses
Less:
Incr. in Current Noncash Assets
Decr. in Current Liabilities
Gains
Net Cash Flows from Operating Activities
Impact on Net Income
Sources
Uses
Current
Noncash Assets
Current
Liabilities
McGraw-Hill/Irwin
Decreases
Increases
Increases
Decreases
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-26
Operating Activities
Net Income (Loss)
$ XXX
Add:
XXX
XXX
XXX
XXX
(XXX)
(XXX)
(XXX)
$ XXX
Decr. in Current Noncash Assets
Incr. in Current Liabilities
Depreciation Charges
Losses
Less:
Incr. in Current Noncash Assets
Decr. in Current Liabilities
Gains
Net Cash Flows from Operating Activities
Depreciation and Amortization charges are added back
to net income because they are decreases in noncash
assets.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-27
Operating Activities
Net Income (Loss)
$ XXX
Add:
XXX
XXX
XXX
XXX
(XXX)
(XXX)
(XXX)
$ XXX
Decr. in Current Noncash Assets
Incr. in Current Liabilities
Depreciation Charges
Losses
Less:
Incr. in Current Noncash Assets
Decr. in Current Liabilities
Gains
Net Cash Flows from Operating Activities
Gains are
subtracted from net
income.
McGraw-Hill/Irwin
Losses are added
back to net income.
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-28
Investing Activities
Add:
Proceeds from sale of land,
buildings, equipment, or other
noncurrent assets
Receipt of principal from
investments
Less:
Payments to acquire land,
buildings, equipment, or other
noncurrent assets
Payments to acquire
investments
Net Cash Flows from Investing Activities
$ XXX
XXX
(XXX)
(XXX)
$ XXX
Includes transactions that involve the
acquisition or disposal of noncurrent assets.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-29
Financing Activities
Add:
Proceeds from borrowings
Proceeds from issuing capital
stock
Proceeds from sale of bonds
Less:
Principal payments on
borrowed funds
Payments related to bond
maturities
Dividend payments
Net Cash Flows from Financing Activities
$ XXX
XXX
XXX
(XXX)
(XXX)
(XXX)
$ XXX
Includes transactions involving receipts
from or payments to creditors and owners.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-30
Other Issues: Gross or Net?
Example:
For investing and
financing
activities, items on
the statement of
cash flows should
be presented in
gross amounts
rather than in net
amounts.
McGraw-Hill/Irwin
 Assume Macy’s
purchases $50
million in property
during the year and
sells other property
for $30 million.
 Instead of showing
the net change of
$20 million, the
company must
report the gross
amounts of both
transactions.
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-31
Other Issues: Direct Method or Indirect Method?
Two Formats for Reporting Operating Activities
Direct Method
Indirect Method
Reports the
cash effects of
each operating
activity
Starts with
accrual net
income and
converts to
cash basis
No matter which format is used, the same amount of net
cash flows from operating activities is generated.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-32
Learning Objective 3
Prepare a statement
of cash flows using
the indirect method to
determine the net
cash provided by
operating activities.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-33
A Full-Fledged Statement of Cash Flows:
An Example
Ed's Pizza Hut
Comparative Balance Sheet Account Balances
Cash
Accounts Receivable
Inventory
Land
Equipment
Accumulated Depr.
Accounts Payable
Salaries Payable
Note Payable - Joe Doe
Common Stock
Retained Earnings
McGraw-Hill/Irwin
3/31/2008 3/31/2007
Change
DR (CR)
DR (CR) Incr. (Decr.)
$ 71,000 $ 90,000 $ (19,000)
23,000
40,000
(17,000)
350,000
300,000
50,000
68,000
100,000
(32,000)
84,000
84,000
(45,000)
(39,000)
6,000
(38,000)
(27,000)
11,000
(9,000)
(14,000)
(5,000)
(50,000)
(50,000)
(500,000) (450,000)
50,000
(4,000)
(34,000)
(30,000)
$
- $
-
Let’s revisit the
comparative
balance sheet
account balances
for Ed’s Pizza Hut.
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-34
A Full-Fledged Statement of Cash Flows:
An Example
Let’s also refresh our memory regarding the
following additional information.
Additional Information:
 There was a net loss for the year of $27,000.
 Depreciation charges for the year were $6,000.
 During the year, Ed sold land originally costing
$32,000 for $32,000.
 During the year, Ed paid dividends of $3,000 to
the stockholders.
 Ed issued $50,000 of common stock to settle the
note due to Joe Doe.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-35
Preparing the Statement of Cash Flows: Step 1
Ed's Pizza Hut
Statement of Cash Flows Worksheet
Source Cash Flow
AdjustChange
or Use?
Effect
ments
Assets (except cash and
Current assets
Accounts receivable
Inventory
Noncurrent assets
Land
Equipment
Contra Assets, Liabilities,
Contra assets
Accumulated depreciation
Current liabilities
Accounts payable
Salaries payable
Noncurrent liabilities
Notes payable
Stockholders' equity
Common stock
Retained earnings
Net loss
Dividends
Total (net cash flow)
McGraw-Hill/Irwin
Adjusted
Effect
Classification
List each account
appearing on the
comparative balance
sheets except for cash
and cash equivalents
and retained earnings.
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-36
Preparing the Statement of Cash Flows: Step 2
Ed's Pizza Hut
Statement of Cash Flows Worksheet
Source Cash Flow
AdjustChange
or Use?
Effect
ments
Assets (except cash and
Current assets
Accounts receivable
Inventory
Noncurrent assets
Land
Equipment
Contra Assets, Liabilities,
Contra assets
Accumulated depreciation
Current liabilities
Accounts payable
Salaries payable
Noncurrent liabilities
Notes payable
Stockholders' equity
Common stock
Retained earnings
Net loss
Dividends
Total (net cash flow)
McGraw-Hill/Irwin
$
Adjusted
Effect
Classification
(17,000)
50,000
(32,000)
-
6,000
11,000
(5,000)
(50,000)
Compute the change
from the beginning
balance to the ending
balance for each
account.
50,000
(27,000)
3,000
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-37
Preparing the Statement of Cash Flows: Step 3
Ed's Pizza Hut
Statement of Cash Flows Worksheet
Source Cash Flow
AdjustChange
or Use?
Effect
ments
Assets (except cash and
Current assets
Accounts receivable
Inventory
Noncurrent assets
Land
Equipment
Contra Assets, Liabilities,
Contra assets
Accumulated depreciation
Current liabilities
Accounts payable
Salaries payable
Noncurrent liabilities
Notes payable
Stockholders' equity
Common stock
Retained earnings
Net loss
Dividends
Total (net cash flow)
McGraw-Hill/Irwin
$
Adjusted
Effect
Classification
(17,000) Source
50,000
Use
Code each entry on
the worksheet as a
source or use of
cash.
(32,000) Source
-
6,000
Source
11,000 Source
(5,000)
Use
(50,000)
Use
50,000
Source
(27,000)
3,000
Use
Use
{
Recall that the transaction
involving the Notes Payable and
Common Stock was noncash.
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-38
Preparing the Statement of Cash Flows: Step 4
Ed's Pizza Hut
Statement of Cash Flows Worksheet
Source Cash Flow
AdjustChange
or Use?
Effect
ments
Assets (except cash and
Current assets
Accounts receivable
Inventory
Noncurrent assets
Land
Equipment
Contra Assets, Liabilities,
Contra assets
Accumulated depreciation
Current liabilities
Accounts payable
Salaries payable
Noncurrent liabilities
Notes payable
Stockholders' equity
Common stock
Retained earnings
Net loss
Dividends
Total (net cash flow)
McGraw-Hill/Irwin
$
(17,000) Source
50,000
Use
$
(32,000) Source
-
6,000
Classification
17,000
(50,000)
32,000
-
Source
6,000
11,000 Source
(5,000)
Use
11,000
(5,000)
(50,000)
Use
(50,000)
50,000
Source
50,000
(27,000)
3,000
Use
Use
(27,000)
(3,000)
(19,000)
$
Adjusted
Effect
Code sources
of cash as
positive
numbers and
uses of cash
as negative
numbers.
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-39
Preparing the Statement of Cash Flows: Step 5
Ed's Pizza Hut
Statement of Cash Flows Worksheet
Source Cash Flow
AdjustChange
or Use?
Effect
ments
Assets (except cash and
Current assets
Accounts receivable
Inventory
Noncurrent assets
Land
Equipment
Contra Assets, Liabilities,
Contra assets
Accumulated depreciation
Current liabilities
Accounts payable
Salaries payable
Noncurrent liabilities
Notes payable
Stockholders' equity
Common stock
Retained earnings
Net loss
Dividends
Total (net cash flow)
McGraw-Hill/Irwin
$
(17,000) Source
50,000
Use
$
Adjusted
Effect
17,000
(50,000)
-
32,000
-
-
32,000
-
Source
6,000
-
6,000
11,000 Source
(5,000)
Use
11,000
(5,000)
-
11,000
(5,000)
(50,000)
Use
(50,000)
50,000
50,000
Source
50,000
(50,000)
(27,000)
3,000
Use
Use
(32,000) Source
-
6,000
$
(27,000)
(3,000)
(19,000) $
-
$
17,000
(50,000)
{
Make any
necessary
adjustments,
including
adjustments
for gains and
losses. The
net effect of
these should
equal zero.
Classification
-
We need to make an adjustment
for
- the noncash transaction
relating to Notes Payable and
(27,000) Common Stock.
$
(3,000)
(19,000)
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-40
Preparing the Statement of Cash Flows: Step 6
Ed's Pizza Hut
Statement of Cash Flows Worksheet
Source Cash Flow
AdjustChange
or Use?
Effect
ments
Assets (except cash and
Current assets
Accounts receivable
Inventory
Noncurrent assets
Land
Equipment
Contra Assets, Liabilities,
Contra assets
Accumulated depreciation
Current liabilities
Accounts payable
Salaries payable
Noncurrent liabilities
Notes payable
Stockholders' equity
Common stock
Retained earnings
Net loss
Dividends
Total (net cash flow)
McGraw-Hill/Irwin
$
(17,000) Source
50,000
Use
$
17,000
(50,000)
-
32,000
-
Source
Adjusted
Effect
17,000
(50,000)
Operating
Operating
-
32,000
-
Investing
6,000
-
6,000
Operating
11,000 Source
(5,000)
Use
11,000
(5,000)
-
11,000
(5,000)
Operating
Operating
(50,000)
Use
(50,000)
50,000
-
50,000
Source
50,000
(50,000)
-
(27,000)
3,000
Use
Use
-
(27,000)
(3,000)
(19,000)
(32,000) Source
-
6,000
$
(27,000)
(3,000)
(19,000) $
$
Classification
$
Classify
each
entry as
operating,
investing
or
financing
activity.
Operating
Financing
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-41
Preparing the Statement of Cash Flows:
Step 7
Ed's Pizza Hut
Statement of Cash Flows
For the Period Ending 3/31/2008
Operating Activities
Net Loss
$
Add: Decrease in A/R
Increase in A/P
Increase in Depr. Charges
Less: Increase in Inventory
Decrease in Salaries Payable
Net Cash Flow from Operations
Investing Activities
Proceeds from sale of Land
Financing Activities
Dividends paid
Net change in cash
McGraw-Hill/Irwin
(27,000)
17,000
11,000
6,000
(50,000)
(5,000)
(48,000)
32,000
Copy the data from
the worksheet into
the Statement of
Cash Flows section
by section.
(3,000)
(19,000)
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-42
Preparing the Statement of Cash Flows:
Step 8
Ed's Pizza Hut
Statement of Cash Flows
For the Period Ending 3/31/2008
Operating Activities
Net Loss
$
Add: Decrease in A/R
Increase in A/P
Increase in Depr. Charges
Less: Increase in Inventory
Decrease in Salaries Payable
Net Cash Flow from Operations
Investing Activities
Proceeds from sale of Land
Financing Activities
Dividends paid
Net change in cash
Cash, beginning
Cash, ending
$
McGraw-Hill/Irwin
(27,000)
17,000
11,000
6,000
(50,000)
(5,000)
(48,000)
Prepare a cash
reconciliation at the
bottom of the
statement.
32,000
(3,000)
(19,000)
90,000
71,000
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-43
Example – Indirect Method
Ed's Pizza Hut
Statement of Cash Flows
For the Period Ending 3/31/2008
Operating Activities
Net Loss
$
Add: Decrease in A/R
Increase in A/P
Increase in Depr. Charges
Less: Increase in Inventory
Decrease in Salaries Payable
Net Cash Flow from Operations
Investing Activities
Proceeds from sale of Land
Financing Activities
Dividends paid
Net change in cash
Cash, beginning
Cash, ending
$
McGraw-Hill/Irwin
(27,000)
17,000
11,000
6,000
(50,000)
(5,000)
(48,000)
32,000
(3,000)
(19,000)
90,000
71,000
In addition, on the
face of the statement
or in a supplemental
schedule, disclose
the issuance of
$50,000 of stock to a
creditor, a noncash
financing activity.
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-44
Interpretation of the Statement of Cash Flows
Examine the operating activities
section carefully.
 Ed’s Pizza Hut generated a negative
cash flow from operations of $48,000.
This is usually a sign of fundamental
difficulties.
 Ultimately, a positive cash flow is
necessary to avoid liquidating assets or
borrowing money to pay for day-to-day
activities.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
The Direct Method of
Determining the Net Cash
Provided by Operating
Activities
Appendix 15A
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-46
Learning Objective 4
Use the direct method
to determine the net
cash provided by
operating activities.
(Appendix 15A)
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-47
Computing Net Cash Provided by Operating
Activities
The direct method computes
net cash provided by operating
activities by reconstructing the
income statement on a cash
basis from top to bottom.
Cash provided by operating activities
under the direct method will always
agree with the amount computed using
the indirect method.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-48
Similarities and Differences in Handling Data
Revenue or Expense Item
Sales revenue (as reported)
Adjustments to a cash basis:
Increases in accounts receivable
Decreases in accounts receivable
Cost of goods sold (as reported)
Adjustments to a cash basis:
Increase in merchandise inventory
Decrease in merchandise inventory
Increase in accounts payable
Decrease in accounts payable
Operating expenses (as reported)
Adjustments to a cash basis:
Increase in prepaid expenses
Decrease in prepaid expenses
Increase in accrued liabilities
Decrease in accrued liabilities
Period's depreciation, depletion and
amortization charges
Income tax expense (as reported)
Adjustments to a cash basis:
Increase in accrued taxes payable
Decrease in accrued taxes payable
Increase in deferred income taxes
Decrease in deferred income taxes
McGraw-Hill/Irwin
Add (+) or
Deduct (-) to
Adjust to a
Cash Basis
+
+
+
+
+
-
Adjustments for accounts
that affect revenue are the
same in the direct and
indirect methods.
Adjustments for accounts
that affect expenses are
handled in opposite ways
for the direct and indirect
methods.
+
+
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-49
Direct Method: Gains and Losses
Under the direct method,
no adjustments for gains
and losses on the sale of
assets are needed.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-50
The Direct Method: An Example
Ed's Pizza Hut
Comparative Balance Sheet Account Balances
Cash
Accounts Receivable
Inventory
Land
Equipment
Accumulated Depr.
Accounts Payable
Salaries Payable
Note Payable - Joe Doe
Common Stock
Retained Earnings
McGraw-Hill/Irwin
3/31/2008 3/31/2007
Change
DR (CR)
DR (CR) Incr. (Decr.)
$ 71,000 $ 90,000 $ (19,000)
23,000
40,000
(17,000)
350,000
300,000
50,000
68,000
100,000
(32,000)
84,000
84,000
(45,000)
(39,000)
6,000
(38,000)
(27,000)
11,000
(9,000)
(14,000)
(5,000)
(50,000)
(50,000)
(500,000) (450,000)
50,000
(4,000)
(34,000)
(30,000)
$
- $
-
Let’s revisit the
comparative
balance sheet
account balances
for Ed’s Pizza Hut.
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-51
The Direct Method: An Example
Ed's Pizza Hut
Income Statement
For the Year Ended 3/31/2008
Sales
$
1,000,000
Cost of goods sold
750,000
Gross margin
250,000
Operating expenses
277,000
Net loss
$
(27,000)
Let’s assume that Ed’s Pizza Hut
prepared this income statement.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-52
The Direct Method: An Example
Step 1: Translate sales revenue into cash
collected from customers.
Sales (as reported)
Add: Decrease in accounts receivable
Cash collected from customers
McGraw-Hill/Irwin
$
$
1,000,000
17,000
1,017,000
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-53
The Direct Method: An Example
Step 2: Translate cost of goods sold into
cash disbursements for purchases.
Cost of goods sold (as reported)
$
Add: Increase in inventory
Less: Increase in accounts payable
Cash paid for purchases
$
McGraw-Hill/Irwin
750,000
50,000
(11,000)
789,000
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-54
The Direct Method: An Example
Step 3: Translate operating expenses into
cash paid for operating expenses.
Operating expenses (as reported)
Add: Decrease in salaries payable
Less: Increase in depreciation
Cash paid for operating expenses
$
$
277,000
5,000
(6,000)
276,000
No adjustment for income taxes is
required because Ed’s Pizza Hut has a net
loss of $27,000.
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-55
The Direct Method: An Example
Ed's Pizza Hut
Statement of Cash Flows
For the Period Ending 3/31/2008
Operating Activities
Cash received from customers
$ 1,017,000
Cash paid for purchases
(789,000)
Cash paid for operating expenses
(276,000)
Net Cash Flow from Operations
(48,000)
Investing Activities
Proceeds from sale of land
32,000
Financing Activities
Dividends paid
(3,000)
Net change in cash
(19,000)
Cash, beginning
90,000
Cash, ending
$
71,000
McGraw-Hill/Irwin
Notice that the
net cash
provided by
operating
activities agrees
with that
computed using
the indirect
method.
Copyright © 2008, The McGraw-Hill Companies, Inc.
15-56
End of Chapter 15
McGraw-Hill/Irwin
Copyright © 2008, The McGraw-Hill Companies, Inc.