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CHAPTER 14
Statement ofCash Flows
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Reporting Format for the Statement of Cash Flows
The Statement of Cash Flows must include the following three sections, as defined in FASB Statement 95:
Operating Activities
Investing Activities
Financing Activities
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Cash Flows from
Operating Activities
Cash Flows fromOperating Activities
Inflows Receipts from sales. Commissions and fees. Interest and dividends
received.
Outflows Payments for inventory. Salaries and wages. Operating expenses Interest on liabilities. Taxes.
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Cash Flows from
Investing Activities
Cash Flows fromInvesting Activities
Inflows Selling property, plant, and
equipment. Selling investment securities. Collecting loans.
Outflows Purchasing property, plant,
and equipment. Purchasing investment
securities. Lending to others.
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Cash Flows from
Financing Activities
Cash Flows fromFinancing Activities
Inflows Borrowing. Issuing stock.
Outflows Repaying debt (excluding
interest). Purchasing treasury stock. Paying dividends.
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Significant noncash investing and financing transactions must be reported separately.
Example: Issuing common stock in exchange for land.
Noncash Investing and Financing Transactions
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Cash flows from operating activities
can be prepared using either the direct method or
the indirect method.
Let’s look at the direct method first.
Cash Flows fromOperating Activities
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Accrual basis revenue includes sales that did not result in cash inflows.
Cash received from customers can be computed as follows:
Cash received from customers
Decrease in receivables
Increase in receivables
+
–
=
=
Net sales
Converting from Accrual to Cash-Basis Accounting
The McGraw-Hill Companies, Inc. 2008McGraw-Hill/Irwin
14-10Converting from Accrual to Cash-Basis Accounting
We will use T-accounts toanalyze changes in accounts.
Let’s look at an example.
The Accounts Receivable balance was $1,200 on The Accounts Receivable balance was $1,200 on 12/31/04 and $1,000 on 12/31/05. If accrual 12/31/04 and $1,000 on 12/31/05. If accrual Sales Revenue for 2005 was $20,600, what Sales Revenue for 2005 was $20,600, what
were cash receipts from sales?were cash receipts from sales?
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14-11Converting from Accrual to Cash-Basis Accounting
1,200
20,600
1,000
12/31/04 Balance
12/31/05 Balance
Accrual Sales Revenue
Accounts Receivable
Cash receipts = $20,800
$1,200 + $20,600 - $1,000
The Accounts Receivable balance was $1,200 on The Accounts Receivable balance was $1,200 on 12/31/04 and $1,000 on 12/31/05. If accrual 12/31/04 and $1,000 on 12/31/05. If accrual Sales Revenue for 2005 was $20,600, what Sales Revenue for 2005 was $20,600, what
were cash receipts from sales?were cash receipts from sales?
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14-12Converting from Accrual to Cash-Basis Accounting
The Salaries Payable balance was $900 on 12/31/04 and $1,000 on 12/31/05. If accrued Salaries Expense for 2005 was $2,700, what
amount of cash was paid for salaries?
Now let’s use T-account analysis for a liability account with anaccrued expense.
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14-13Converting from Accrual to Cash-Basis Accounting
12/31/04 Balance
12/31/05 Balance
Accrued Salaries Expense
Salaries Payable
Cash payments =
900
2,700
1,000
$2,600
$900 + $2,700 - $1,000
The Salaries Payable balance was $900 on 12/31/04 and $1,000 on 12/31/05. If accrued Salaries Expense for 2005 was $2,700, what
amount of cash was paid for salaries?
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Now that we have seen the T-account method of
analysis, let’s use it to prepare a Direct Method Statement of Cash Flows
for New South Corporation.
We will begin with by analyzing changes in
balance sheet accounts.
Direct Method
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Direct MethodAdditional Information
The corporation sold equipment for $300 cash during the year. The equipment had an original cost of $1,500 and accumulated depreciation of $1,100 at the time of sale.
The corporation issued a $2,500 mortgage note in exchange for land during the year.
There was a $1,500 cash dividend paid during the year.
Let’s get started analyzing the accounts. First, we willreview the T-account analysis that we completed earlier.
Then we will analyze the remaining balance sheet accounts starting with the current accounts.
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12/31/04 Balance
12/31/05 Balance
Accrual sales revenue
Accounts Receivable
Cash receipts = $20,800
1,200
20,600
1,000
12/31/04 Balance
12/31/05 Balance
Accrued salaries expense
Salaries Payable
Cash Payments = $2,600
900
2,700
1,000
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12/31/04 Balance
12/31/05 Balance
Cost of Goods Sold
Inventory
Purchases =
8,200
10,500
8,900
12/31/04 Balance
12/31/05 Balance
Purchases
Accounts Payable
Cash Payments =
1,100
11,200
800
$11,200
$11,500
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12/31/04 Balance
12/31/05 Balance
Interest Revenue
Interest Receivable
Cash receipts =300
700
400
12/31/04 Balance
12/31/05 Balance
Interest Expense
Interest Payable
Cash payment =
500
400
300
$600
$600
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12/31/04 Balance
12/31/05 Balance
Insurance Expense
Prepaid Insurance
Cash payment =
1,400
600
1,100
12/31/04 Balance
12/31/05 Balance
Rent Revenue
Unearned Rent
Cash receipt =
1,600 2,400
600
$300
$1,400
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12/31/04 Balance
12/31/05 Balance
Other Operating Expenses
Other Operating Expenses Payable
Cash payment =
1,300
1,400
1,500
$1,200
Now that we have analyzed the current accounts and found the cash receipts and cash payments related to
operations, we are ready to prepare the Cash Flow from Operating Activities portion of the Statement of
Cash Flows.
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Now, let’s continue to use the T-account analysis for the remaining noncurrent balance sheet accounts.
Direct Method
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12/31/04 Balance
12/31/05 Balance
Marketable Securities
Cash paid =
3,500
5,100
$1,600
12/31/04 Balance
12/31/05 Balance
Land
Mortgage issued for land =
6,000
8,500
$2,500
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12/31/04 Balance
12/31/05 Balance
Equipment
4,600 1,500
5,400
Equipment sale
Cash paid for equipment = $2,300
After completing the analysis of noncurrentassets, we are ready to prepare the Cash
Flow from Investing Activities portionof the Statement of Cash Flows.
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Next, we will analyze noncurrent liabilities and equity so that we can
prepare the Cash Flow from Financing Activities portion of the Statement of
Cash Flows.
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12/31/04 Balance
12/31/05 Balance
Mortgage Payable
Mortgage issued for Land =
-
2,500
12/31/04 Balance
12/31/05 Balance
Bonds Payable
Cash paid to retire bonds =
4,000
1,000
$2,500
$3,000
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12/31/04 Balance
12/31/05 Balance
Common Stock
Cash received from stocksale =
8,000
10,000
After completing the analysis of noncurrentliabilities and equity, we are ready to prepare
the Cash Flow from Financing Activitiesportion of the Statement of Cash Flows.
$2,000
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Next, we will put the three sections together to completethe Statement of Cash Flows.
Third item of additional information.
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Statement of Cash FlowsFor the Period Ending December 31, 2005
Cash Flows from Operating Activities 6,600$ Cash Flows from Investing Activities (3,600) Cash Flows from Financing Activities (2,500) Net Cash Flows for the Period 500$ Add: Beginning Cash Balance 400 Ending Cash Balance 900$ Noncash Investing and Financing ActivitiesIssue of Mortgage for Land 2,500$
Notice that the Ending Cash Balance on the Statement of Cash Flows agrees with the
12/31/05 Cash balance on the Balance Sheet.
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Now let’s look at the Indirect Method that is used
by over 95% of all companies.
Indirect Method
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A Comparison of the Directand Indirect Methods
Net cash flow is the same for both methods. The Direct Method provides more detail about
cash from operating activities. The investing and financing sections for the two
methods are identical.
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Net Income
Cash Flows from Operating
Activities
Indirect Method
Changes in current assets and current liabilities as shown on the following table.
+ Losses and - Gains
+ Noncash expenses such as depreciation and
amortization.
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Use this table when adjusting Net Incometo Cash Flow from Operations.
Indirect Method
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We will use the Indirect Method to prepare the Cash
Flows from Operating Activities for the New South
Corporation.
First, we will review the Balance Sheet and Income Statement for New South
Corporation.
Indirect Method
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The Indirect Method begins with Net Income, which is then adjusted for the non-cash items included in
net income.
For New South Corporation, the only non-cash items are depreciation and a loss.
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(Remember, we showed the balance sheets a few slides earlier.)
To complete the Cash Flow from Operating Activities section, we must examine comparative balance sheets
to determine the changes in current assets and current liabilities from the beginning of the period to
the end of the period.
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Statement of Cash Flows Indirect Method Example
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Remember that when we prepared the operating section using the Direct Method, we also arrived at Net Cash Flow
from Operating Activities of $6,600.
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Because the investingand financing sectionsare identical with eithermethod of preparation,
we will not repeatthose sections of the
statement.
Indirect Method
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The Financial Analyst
A rapidly growingcompany might be short of
cash in spite of largereported net income.
Because accruals anddeferrals affect operating income,cash flow from operating activities
may be stable thanoperating income.
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The Financial Analyst
The statement focusesattention on:
Ability to generate cashfrom its operations.
Management of currentassets and current liabilities.
Expenditures forlong-term assets.
Amount received fromexternal financing.
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End of Chapter 14