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© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
The Statementof Cash Flows Revisited
21
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Chapter 21Statement of Cash
Flows Revisited
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-3
Investing ActivitiesOperating Activities Financing ActivitiesSale of operational assets
Sale of investments
Collections of loans
Cash received from revenues
Issuance of stock
Issuance of bonds and notes
CASH INFLOWS
Business
CASH OUTFLOWS
Purchase of operational assets
Purchase of investmentsLoans to others
Cash paid for expenses
Payment of dividends
Repurchase of stock
Repayment of debt
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-4
Cash and Cash Equivalents
Resources immediately available to
pay obligations.
Resources immediately available to
pay obligations.
Short-term, highly liquid investments.
So near maturity that there is insignificant risk of market value fluctuation from interest rate changes.
Maturity of 3 months or less
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-5
Cash Equivalents
Treasury bill 100,000 Cash 100,000
Inflow or outflow of cash? Neither – moves $100,000 from
one cash account to another “cash” account
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-6
Primary Classifications in the Statement of Cash Flows
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-7 Cash flows from operating activities:
Cash inflows: From customers $98 From investment revenue 3Cash outflows: To suppliers of goods (50) To employees (11) For interest (3) For insurance (4) For income taxes (11)Net cash flows from operating activities $22 Cash flows from investing activities: Purchase of land ($30) Purchase of short-term investment (12) Sale of land 18 Sale of equipment 5Net cash flows from investing activities (19)Cash flows from financing activities: Sale of common shares $26 Retirement of bonds payable (15) Payment of cash dividends (5)Net cash flows from financing activities 6 Net increase in cash $9Cash balance, January 1 20Cash balance, December 31 $29
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-8
Cash Flows From Operating Activities Cash flows from operating
activities are both inflows and outflows of cash that result from activities reported on the income statement.
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-9
Income Statement Cash Flows from Operating Activities Revenues: Cash inflows: Sales and service revenue Cash received from customers Investment revenue Cash revenue received Noncash revenues and gains
(e.g., gain on sale of assets) [Not reported]
Less: Expenses: Less: Cash outflows: Cost of goods sold Cash paid to suppliers Salaries expense Cash paid to employees Noncash expenses and losses (depreciation, amortization, bad debts, loss on sale of assets) [Not reported] Interest expense Cash paid to creditors Other operating expenses Cash paid for expenses Income tax expense Cash paid to the government
Net income Net cash flows from operating
activities
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-10 CASH FLOWS FROM OPERATING
ACTIVITIES
Direct Method
Cash flows from operating activities are the elements of net income, but reported on a cash basis. Cash flows from operating activities:Cash inflows: From customers $98 From investment revenue 3Cash outflows: To suppliers of goods(50) To employees(11) For interest (3) For insurance (4) For income taxes (11)Net cash flows from operating activities $22
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-11 CASH FLOWS FROM OPERATING
ACTIVITIES
Indirect Method Derived indirectly by starting with reported net income and working backwards to convert that amount to a cash basis. Cash flows from operating activities:Net income $12Adjustments for noncash effects: Gain on sale of land (8) Depreciation expense 3 Loss on sale of equipment 2Changes in operating assets and liabilities: Increase in accounts receivable (2) Decrease in inventory 4 Increase in accounts payable 6 Increase in salaries payable 2 Discount on bonds payable 2 Decrease in prepaid insurance 3 Decrease in income tax payable (2)Net cash flows from operating activities $22
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-12
CASH FLOWS FROM INVESTING ACTIVITIES
Related to the acquisition and disposition of assets, other than (a) inventory and (b) assets classified as cash equivalents. Included in this classification are cash payments to acquire: Property, plant and equipment and other productive assets
[except inventories]. Investments in securities [except cash equivalents]. Nontrade receivables.
When these assets later are liquidated, any cash receipts from their disposition also are classified as investing activities.
Cash Flows from Investing Activities: Purchase of land$(30) Purchase of short-term investments (12) Sale of land 18 Sale of equipment 5 Net cash flows from investing activities (19)
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-13
CASH FLOWS FROM FINANCING ACTIVITIES
Inflows and outflows of cash resulting from the external financing of a business, including cash inflows from:
The sale of common and preferred stock The issuance of bonds and other debt securities
Subsequent transactions related to these financing transactions are also classified as financing activities, such as:
The repurchase of common or preferred stock (retirement or treasury stock)
The repayment of debt The payment of cash dividends to shareholders
Cash Flows from Financing Activities: Sale of common stock $26 Retirement of bonds payable (15) Payment of cash dividends (5)Net cash flows from financing activities 6
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-14
SignificantNoncash Activities
Common noncash activities include:
Retiring bonds by issuing stock.
Retiring bonds by issuing stock.
Retiring debt by transferring
noncash assets.
Retiring debt by transferring
noncash assets.
Acquiring an asset by issuing a note
payable.
Acquiring an asset by issuing a note
payable.
Acquiring an asset by capital
lease.
Acquiring an asset by capital
lease.
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-15
Cash Flows from Operating Activities
Recom m ended by the FASB.
Direct M ethod
M ost used m ethod.
Indirect M ethod
Operating Activities section canbe prepared using either of tw o methods.
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-16
Direct Method
Analyzing Sales Revenue We can compare sales and the change in accounts
receivable to determine the amount of cash received from customers. This relationship can be viewed in T–account format as follows:
Accounts Receivable_______________________________________
Beginning balance 30Credit sales 100 ? Cash received(increases A/R) __________ (decreases A/R)Ending balance 32
Cash received from customers must have been $98 million.
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-17
SUMMARY ENTRY FOR SALES AND COLLECTION ACTIVITIES
Note that even if some of the year's sales were cash sales, say $40 million cash sales and $60 million credit sales, the result is the same:
Accounts Receivable_______________________Beg. bal. 30 Cash sales
$40Credit sales 60 58 Rec‘d on acct. 58
_______ Cash rec‘d $98
Ending bal. 32($ in millions)
Entry Cash (received from customers) 98Accounts receivable (given) 2 Sales revenue ($100 - 0) 100
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-18
Analyzing SalesReview Question
Accounts Receivable was $40,000 on 1/1/06 and $52,000 on 12/31/06. If total sales revenue for 2006 was $800,000,
then how much cash was received from customers?
a.$800,000b.$760,000c.$812,000d.$788,000
Accounts Receivable was $40,000 on 1/1/06 and $52,000 on 12/31/06. If total sales revenue for 2006 was $800,000,
then how much cash was received from customers?
a.$800,000b.$760,000c.$812,000d.$788,000
A/R increased $12,000 during 2006.
Cash (received from customers) 788Accounts receivable 12 Sales revenue 800
A/R increased $12,000 during 2006.
Cash (received from customers) 788Accounts receivable 12 Sales revenue 800
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-19
Cost of Goods Sold
{ Cash Cost + Inventory Increase paid to of - Inventory Decrease Suppliers Goods + A/P Decrease
Sold - A/P Increase
=
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-20
Cost of Goods Sold
UBC sold goods that had cost $60 million. Inventory decreased by $4 million and accounts payable increased by $6 million.
($ in millions)
Cost of goods sold 60Inventory 4Accounts payable 6Cash (paid to suppliers) 50
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-21
Cost of Goods SoldReview Question
Determine how much was paid for inventory in 2006.
Cost of goods sold $900,000Inventory Jan. 1 $130,000 Dec. 31 $165,000Accts Pay. Jan. 1 $ 23,000 Dec. 31 $ 35,000
a.$900,000b.$923,000c.$947,000d.$877,000
Determine how much was paid for inventory in 2006.
Cost of goods sold $900,000Inventory Jan. 1 $130,000 Dec. 31 $165,000Accts Pay. Jan. 1 $ 23,000 Dec. 31 $ 35,000
a.$900,000b.$923,000c.$947,000d.$877,000
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-22
Cost of Goods SoldReview Question
Cost of goods sold 900,000Inventory 35,000
Accounts payable 12,000
Cash (paid to suppliers) 923,000
Determine how much was paid for inventory in 2006.
Cost of goods sold $900,000Inventory Jan. 1 $130,000 Dec. 31 $165,000Accts Pay. Jan. 1 $ 23,000 Dec. 31 $ 35,000
a.$900,000b.$923,000c.$947,000d.$877,000
Determine how much was paid for inventory in 2006.
Cost of goods sold $900,000Inventory Jan. 1 $130,000 Dec. 31 $165,000Accts Pay. Jan. 1 $ 23,000 Dec. 31 $ 35,000
a.$900,000b.$923,000c.$947,000d.$877,000
Cost of goods sold 900Inventory 35 Accounts payable 12 Cash (paid to suppliers) 923
Cost of goods sold 900Inventory 35 Accounts payable 12 Cash (paid to suppliers) 923
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-23
Direct MethodSalaries Expense
Cash paid to employees can be determined from the salaries expense.
Cash paid to Salaries + Decrease in Payable Employees Expense - Increase in Payable= {
Salaries expense x Salaries payable x
Salaries payable xCash (paid to employees)
Salaries expense x Salaries payable x
Salaries payable xCash (paid to employees)
?
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-24
Salaries ExpenseQuestion
Determine how much was paid to employees during 2006.
Salaries expense $700,000
Salaries Pay. Jan. 1 $ 35,000 Dec. 31 $ 10,000
a. $700,000b. $735,000c. $725,000d. $675,000
Determine how much was paid to employees during 2006.
Salaries expense $700,000
Salaries Pay. Jan. 1 $ 35,000 Dec. 31 $ 10,000
a. $700,000b. $735,000c. $725,000d. $675,000
Salaries expense 700,000 Salaries payable 25,000 Cash (paid to employees)
Salaries expense 700,000 Salaries payable 25,000 Cash (paid to employees)
?
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-25
Direct MethodEstimated Expenses
Depreciation, Amortization, Depreciation, Amortization, and Depletion Expensesand Depletion Expenses
• These are These are non-cashnon-cash expenses. expenses.• They are not disclosed in the They are not disclosed in the
SCF using the direct method.SCF using the direct method.
Depreciation, Amortization, Depreciation, Amortization, and Depletion Expensesand Depletion Expenses
• These are These are non-cashnon-cash expenses. expenses.• They are not disclosed in the They are not disclosed in the
SCF using the direct method.SCF using the direct method.
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-26
Depreciation UBC’s income statement reports depreciation
expense of $3 million. ($ in millions)
Depreciation expense 3Accumulated depreciation 3
Depreciation is a noncash expense. It is merely an allocation in the current period of a prior cash expenditure (for the depreciable asset).
Therefore, the depreciation entry has no effect on the statement of cash flows.
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-27
Bond Interest UBC’s bond interest expense is $5 million and $2 million
of the bond discount was reduced in 2006.
The entry that summarizes the recording of bond interest expense:
($ in millions)
Bond interest expense 5Discount on bonds 2Cash (paid to bondholders) 3
If a premium were being reduced, rather than a discount, the cash outflow would be greater than the expense.
?
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-28
Insurance Expense
UBC’s insurance expense was $7 million. Prepaid insurance decreased by $3 million indicating that cash paid for insurance coverage was $3 million less than the insurance expense for the year.
($ in millions)
Insurance expense 7Prepaid insurance 3Cash (paid for insurance) 4?
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-29
Gains and Losses on Sale of Assets
Land that originally cost $10 million was sold for $18 million:
($ in millions)
Cash 18 Land 10 Gain on sale of land 8
The gain is simply the difference between cash received in the sale of land (reported as an investing activity) and the book value of the land. To report the $8 million gain as a cash flow from operating activities, in addition to reporting $18 million as a cash flow from investing activities, would be double counting.
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-30
LOSS ON SALE OF EQUIPMENT UBC sold equipment for $5 million that had cost $14
million and was half depreciated. ($ in millions)
Cash (from sale of equipment) 5Loss on sale of equipment 2Accumulated depreciation ($14 x 50%) 7 Buildings and equipment (given) 14
The sale of equipment is an investing activity.
Note: The loss is simply the difference between cash received in the sale of equipment (reported as an investing activity) and the book value of the equipment.
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-31
Now, let’s look at the Indirect Method for presenting the Cash Flows from
Operating Activities section.
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-32
INDIRECT METHOD By the indirect method, the net cash increase or decrease from
operating activities is derived indirectly by starting with reported net income and "working backwards" to convert that amount to a cash basis.
Net income $12Adjustments for noncash effects: Increase in accounts receivable (2) Gain on sale of land (8) Decrease in inventory 4 Increase in accounts payable 6 Increase in salaries payable 2 Depreciation expense 3 Discount on bonds payable 2 Decrease in prepaid insurance 3 Loss on sale of equipment 2 Decrease in income tax payable (2)Net cash flows from operating activities$22
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-33
Net Income Adjustments for Noncash Components
Amounts that were increases
in net income
Gains Subtract from net income
Amounts that were
reductions of net
income
Depreciation, depletion, and amortizationLosses
Add backto net
income
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-34
Some IS Items Don’t Affect Cash
Cash Flows from Operating Activities
INCOME STATEMENT INDIRECT METHODDIRECT METHOD
Net income $12Adjustments :
Sales $100
Investment rev. 3
Gain - sale of land 8 Gain - sale of land (8) [Not reported–no cash effect]
Cost of goods sold (60)
Salaries expense (13)
Depreciation exp. (3) Depreciation exp. 3 [Not reported – no cash effect]
Interest exp. (5)Insurance exp. (7)
Loss - sale of equip. (2) Loss - sale of equip. 2 [Not reported – no cash effect]
Income tax exp. (9)
Net cash flows from Net cash flows from Net Income $ 12 operating activities operating activities
No effect on Cash
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-35 Net Income Adjustments for
Changes in Assets and Liabilities
Increase Decrease
Asset - +
Liability + -
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-36 Others Affect Cash, but by an
Amount Different from the Expense
Cash Flows from Operating Activities
INCOME STATEMENT INDIRECT METHOD DIRECT METHOD
Net income $12Adjustments :
Sales $100 Increase in A/R (2) Cash from customers $98
Investment rev. 3 [No adjustment] Cash from investments 3
Gain - sale of land 8
Cost of goods sold (60) Decr. in inventory 4Increase in A/P 6 Cash to suppliers (50)
Salaries expense (13) Increase in sal. pay. 2 Cash to employees (11)
Depreciation exp. (3)
Interest exp. (5) Decr. in bond disc. 2 Cash for interest (3)
Insurance exp. (7) Decr. in pre‘d ins. 3 Cash for insurance (4)
Loss - sale of equip. (2)
Income tax exp. (9) Decrease in I.Tax/P (2) Cash paid for taxes (11)
Net cash flows from Net cash flows from Net Income $ 12 operating activities operating activities
Convert from
Accrual to
Cash
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-37
COMPARISON OF DIRECT AND INDIRECT METHODS
Cash Flows from Operating Activities
INCOME STATEMENT INDIRECT METHOD DIRECT METHOD
Net income $12Adjustments :
Sales $100 Increase in A/R (2) Cash from customers $98
Investment rev. 3 [No adjustment] Cash from investments 3
Gain - sale of land 8 Gain - sale of land (8) [Not reported–no cash effect]
Cost of goods sold (60) Decr. in inventory 4Increase in A/P 6 Cash to suppliers (50)
Salaries expense (13) Increase in sal. pay. 2 Cash to employees (11)
Depreciation exp. (3) Depreciation exp. 3 [Not reported – no cash effect]
Interest exp. (5) Decr. in bond disc. 2 Cash for interest (3)
Insurance exp. (7) Decr. in pre‘d ins. 3 Cash for insurance (4)
Loss - sale of equip. (2) Loss - sale of equip. 2 [Not reported – no cash effect]
Income tax exp. (9) Decrease in I.Tax/P (2) Cash paid for taxes (11)
Net cash flows from Net cash flows from Net Income $ 12 operating activities $22 operating activities $22
© 2007 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide22-38
End of Chapter 21
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