Prepared by: Jan Hájek

Accounting 2

Lecture no 1

PURPOSE OF THE PURPOSE OF THE CASH FLOW STATEMENTCASH FLOW STATEMENT

PURPOSE OF THE PURPOSE OF THE CASH FLOW STATEMENTCASH FLOW STATEMENT

The primary purpose of the cash flow statement is to provide information about the cash receipts and cash payments of an entity during a period.

A secondary objective is to provide information about its

Operating activitiesInvesting activitiesFinancing activities

3

Related Standards FAS 95 Statement of cash flows FAS 102 Statement of cash flows—exemption of

certain enterprises and classification of cash flows from certain securities acquired for resale

FAS 104 Statement of cash flows—net reporting of certain cash receipts and cash payments and classification of cash flows from hedging transactions

4

Related Standards

IAS 1 Presentation of financial statements

5

IAS 7 - Overview Objective and scope Cash flows Reporting operating cash flows Reporting investing cash flows Reporting financing cash flows Specific items Disclosures

6

IAS 7 – Objective and Scope IAS 7 objective: to provide a statement to help

investors assess the prospects for future cash flows, and to confirm or change their past expectations

Statement provides historical information on the entity’s operating, investing and financing cash flows and how its cash balances have changed in the period as a result

7

IAS 7 – Cash Flows Cash and cash equivalents:

Cash on hand and on deposit and “short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value”

Can include bank overdrafts if part of cash management activities and balance fluctuates between positive and negative amounts

MEANING OF CASH FLOWSMEANING OF CASH FLOWSMEANING OF CASH FLOWSMEANING OF CASH FLOWS

The cash flow statement is usually prepared using cash and cash equivalents as its basis.

Cash equivalents are short-term, highly liquid investments that are both1. readily convertible to known amounts of cash, and2. so near to their maturity that their market value is relatively insensitive to changes in interest rates.

CLASSIFICATION OF CASH FLOWSCLASSIFICATION OF CASH FLOWSCLASSIFICATION OF CASH FLOWSCLASSIFICATION OF CASH FLOWS

Operating activities Investing activities Financing activities

IncludeCash effects of transactions that create

revenues and expenses andEnter into determination of net income

(loss)

OPERATING ACTIVITIES

Balance Sheet: Noncash Current Assets and Current Liabilities;

Income Statement Items

IncludePurchasing and disposing of

investments and productive long-lived assets using cash and

Lending money and collecting the loans

Balance Sheet: Investment and Long-Term Asset Items

INVESTING ACTIVITIES

IncludeObtaining cash from issuing debt and

repaying the amounts borrowed and Obtaining cash from

owners/shareholders and paying them drawings/dividends

FINANCING ACTIVITIES

Balance Sheet: Long-Term Liability and Equity Items

If it does not affect cash, do NOT report in body of cash flow statement

Report in separate note to the financial statements

SIGNIFICANT NONCASH ACTIVITIES

Operating, investing, and financing plus the significant noncash investing and financing activities constitute the general format of the cash flow statement, an example of which is shown on the right.

FORMAT OF CASH FLOW STATEMENTFORMAT OF CASH FLOW STATEMENTFORMAT OF CASH FLOW STATEMENTFORMAT OF CASH FLOW STATEMENT

COMPANY NAMECash Flow Statement

Period CoveredCash flows from operating activities

(List of individual items) XXNet cash provided (used) by operating activities

XXXCash flows from investing activities

(List of individual items) XXNet cash provided (used) by investing activities

XXXCash flows from financing activities

(List of individual items) XXNet cash provided (used) by financing activities

XXXNet increase (decrease) in cash

XXXCash at beginning of period

XXXCash at end of period

XXX

Note x:Noncash investing and financing activities

(List of significant noncash transactions)XXX

PREPARING PREPARING THE CASH FLOW STATEMENTTHE CASH FLOW STATEMENT

PREPARING PREPARING THE CASH FLOW STATEMENTTHE CASH FLOW STATEMENT

The cash flow statement is prepared differently from the three other basic financial statements.1. It is not prepared from the adjusted trial balance.2. The cash flow statement deals with cash receipts and payments, so the accrual concept is not used in the preparation of this statement. The information to prepare this statement usually comes from three sources:1. Comparative balance sheet2. Current income statement3. Additional information

THREE MAJOR STEPS IN PREPARING THREE MAJOR STEPS IN PREPARING THE CASH FLOW STATEMENTTHE CASH FLOW STATEMENT

THREE MAJOR STEPS IN PREPARING THREE MAJOR STEPS IN PREPARING THE CASH FLOW STATEMENTTHE CASH FLOW STATEMENT

+ or -The difference between the beginning and ending cash balances can be easily calculated from comparative balance sheets.

The difference between the beginning and ending cash balances can be easily calculated from comparative balance sheets.

This step involves analysing not only the current year’s income statement but also comparative balance sheets and selected additional data.

This step involves analysing not only the current year’s income statement but also comparative balance sheets and selected additional data.

XYZ Goods

This step involves analysing comparative balance sheet data and selected additional information for their effects on cash.

This step involves analysing comparative balance sheet data and selected additional information for their effects on cash.

For Sale Investing Financing

Step 1: Determine the net increase (decrease) in cash.

Step 2: Determine net cash provided (used) by operating activities.

Step 3: Determine net cash provided (used) by investing and financing activities.

STEP 1: DETERMINE NET INCOME (DECREASE) IN CASH

STEP 2: DETERMINE NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES

Net income must be converted from an accrual basis to a cash basis in the operating activities section

Conversion may be done by two methods:Indirect (used extensively in

practice)Direct

INDIRECT AND DIRECT METHODS Both methods arrive at the same total

amount of cash provided (used) by operating activities

Methods differ in disclosing the items that make up the total amount

Choice of section; the investing and finamethods affects only the operating activities ncing activities sections are the same

OPERATING ACTIVITIES – INDIRECT METHOD

Section 1Section 1

NET INCOME VS. NET CASH PROVIDED NET INCOME VS. NET CASH PROVIDED BY OPERATING ACTIVITIESBY OPERATING ACTIVITIES

NET INCOME VS. NET CASH PROVIDED NET INCOME VS. NET CASH PROVIDED BY OPERATING ACTIVITIESBY OPERATING ACTIVITIES

The indirect method starts with net income and converts it to net cash provided by operating activities. In other words, it adjusts net income for items that affect reported net income but do not affect cash, as shown below.

Earned Revenues

Net Income

Incurred Expenses

Accrual Basis of Accounting Cash Basis of Accounting

Net Cash Provided (Used) by Operating

Activities

Eliminate noncash revenues

Eliminate noncash expenses

NET INCOME TO NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES(B/S: Noncash Current Assets and Current Liabilities)

Adjustments to Convert Net Incometo Net Cash Provided (Used) by

Operating ActivitiesAdd* Deduct*

Change in Current Asset Account BalanceAccounts receivable Decrease IncreaseInventory Decrease IncreasePrepaid expenses Decrease IncreaseOther current assets Decrease Increase

Change in Current Liability Account BalanceAccounts payable Increase DecreaseAccrued expenses payable Increase DecreaseOther current liabilities Increase Decrease

* Add (deduct) change in account balance to net income

NET INCOME TO NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES(I/S: Noncash Items)

Adjustments to Convert NetIncome to Net Cash

Provided (Used) by Operating

Activities

Noncash Items on Income Statement

Amortization (of capital assets) expense AddAmortization of bond discount to interest expense AddAmortization of bond premium to interest expense DeductLoss on sale of asset AddGain on sale of asset DeductIncome from long-term equity investment Deduct

NET CASH PROVIDED (USED) BY NET CASH PROVIDED (USED) BY OPERATING ACTIVITIESOPERATING ACTIVITIES

NET CASH PROVIDED (USED) BY NET CASH PROVIDED (USED) BY OPERATING ACTIVITIESOPERATING ACTIVITIES

Cash flows from operating activitiesNet income 35,000 Adjustments to reconcile net income to net cash

provided by operating activities:Increase in accounts receivable (30,000) Increase in inventory (25,000) Increase in accounts payable 15,000 Increase in accrued expenses payable 4,000 (36,000)

Net cash used by operating activities (1,000)

Computer Services CorporationCash Flow Statement - Indirect MethodFor the Year Ended December 31, 2002

Indirect Method – Sample Format

Indirect Method – Sample Format

OPERATING ACTIVITIES– DIRECT METHOD

Section 2Section 2

CASH RECEIPTS AND CASH PAYMENTS(Direct Method)

CASH RECEIPTS FROM CUSTOMERS The relationships among cash receipts

from customers, revenues from sales, and changes in accounts receivable is:

Cash receipts from

customers=

Revenues from sales { + Decrease in accounts receivable

or – Increase in accounts receivable

Cash payments to

suppliers

=

Cost of goods sold {

+ Increase in inventory or

– Decrease in inventory

{+ Decrease in accounts payable or

– Increase in accounts payable

CASH PAYMENTS TO SUPPLIERS The relationship among cash payments to

suppliers, cost of goods sold, changes in inventory, and changes in accounts payable is:

Cash payments

for services

+ Increase in prepaid expenses or

– Decrease in prepaid expenses

+ Decrease in accrued expenses payable or

– Increase in accrued expenses payable

{Operating expenses {

=

CASH PAYMENTS FOR OPERATING EXPENSES The relationship among cash payments for

operating expenses, changes in prepaid expenses, and changes in accrued expenses payable is:

Cash payments for income tax

{=Income tax

expense+ Decrease in income tax payable or – Increase in income tax payable

CASH PAYMENTS FOR INCOME TAX The relationships among cash

payments for income tax, income tax expense, and changes in income tax payable is:

Cash flows from operating activities

Cash receipts from customers $120,000Cash payments:

To suppliers ($75,000)For operating expenses (36,000)For income tax (10,000) (121,000)Net cash used by operating activities (1,000)

COMPUTER SERVICES CORPORATIONCash Flow Statement – Direct Method

For the Year Ended December 31, 2002

NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES

Direct Method – Sample Format

Direct Method – Sample Format

STEP 3: DETERMINE NET CASH PROVIDED (USED) BY INVESTING AND FINANCING ACTIVITIES

Study the balance sheet to determine changes in investments and long-term assets

Changes in each short-term investment (unless incorporated as part of cash definition) and long-term account are analysed using selected transaction data to determine the effect, if any, the changes had on cash

NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES

NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES

Study the balance sheet to determine changes in noncurrent liabilities and owner’s/shareholders’ equity

Changes in each noncurrent account are analysed using selected transaction data to determine the effect, if any, the changes had on cash

Operating activities used $1,000 cash and investing activities used $10,000 cash, while financing activities provided $45,000 cash.

CASH FLOW STATEMENT INDIRECT CASH FLOW STATEMENT INDIRECT METHODMETHOD

CASH FLOW STATEMENT INDIRECT CASH FLOW STATEMENT INDIRECT METHODMETHOD

COMPUTER SERVICES COMPANYCash Flow Statement — Indirect Method

For the Year Ended December 31, 2002Cash 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 inventory (25,000) Increase in accounts payable 15,000 Increase in accrued expenses payable 4,000 (36,000)

Net cash used by operating activities (1,000) Cash flows from investing activities

Purchase of equipment (10,000)$ Net cash used by investing activities (10,000)

Cash flows from financing activitiesIssue of common shares 60,000$ Payment of cash dividend (15,000)

Net cash provided by financing activities 45,000 Net increase in cash 34,000 Cash, January 1 - Cash, December 31 34,000$

CASH FLOW STATEMENT CASH FLOW STATEMENT DIRECT METHODDIRECT METHOD

CASH FLOW STATEMENT CASH FLOW STATEMENT DIRECT METHODDIRECT METHOD

Cash flows from operating activitiesCash receipts from customers $120,000Cash payments:

To suppliers $(75,000)For operating expenses (36,000)For income tax (10,000) (121,000)Net cash provided by operating activities (1,000)

Cash flows from investing activitiesPurchase of equipment $(10,000)

Net cash used by investing activities (10,000)Cash flows from financing activities

Issue of common shares $ 60,000Payment of cash dividends (15,000)

Net cash provided by financing activities 45,000Net increase in cash 34,000Cash, January 1 0Cash, December 31 $ 34,000

COMPUTER SERVICES CORPORATIONCash Flow Statement

For the Year Ended December 31, 2002

The cash flow statement shows that operating activities used $1,000 cash and investing activities used $10,000 cash, while financing activities provided $45,000 cash.

37

IAS 7 – Specific Items No netting of inflows and outflows Interest and dividends received and interest and

dividends paid – choice of operating, investing or financing flows as appropriate

Income tax cash flows – generally operating flows Non-cash transactions – not included in statement;

disclosed instead Cash flows between an entity and its subsidiaries,

associates and joint ventures reported only if accounted for by the cost or equity method

Acquisition/loss of control of subsidiary – investing cash flow

Exchange rate changes on foreign cash balances – reconciling item at bottom of statement

Purpose of Statement of Owner Equity To reconcile the owner equity

amount stated at the beginning of the time period, with the owner equity amount determined at the end of the time period.

Statement of Owner Equity

Components should include:1. Beginning owner equity

2. Plus net income amount

3. Minus owner withdrawals

4. Plus contributions received by business

5. Minus contributions distributed to others

6. Equals Change in Retained Earnings/Contributed Capital

7. Ending Owner Equity (Cost Value Basis)

Statement of Owner Equity

Components should include:7. Ending Owner Equity (Cost Value Basis)

8. Adjustment for change in Asset Values (Ending market value - cost value) -

(Beginning market value - cost value)

from beginning to end of time period

and adjustment for change in Deferred Debt

(+Beginning - Ending Deferred Liabilities)

9. Equals change in market valuation equity

10. Ending Owner Equity (Market Value Basis)

Statement of Owner Equity

Market Cost

1. Owner Equity, Beginning of Period

__________

__________

2a. Net Farm Income/Loss

_________

2b. Non-farm Income Contributed to Farm Business

________

3a. Withdrawals for Family Living Expenses

________

3b. - Income and Social Security Taxes

________

3. Owner Withdrawals (net)

________

= Total Change in Retained Earnings _____________ ______________

4. + Other Capital Contributions/Gifts/ Inheritance received

___________

5. - Other Capital Distributions/Dividends/Gifts Made

_____________

______________

6. = Total Change in Contributed Capital & Retained Earnings

7. Ending Owner Equity (cost value basis)

______________

Statement of Owner Equity8. Change in Excess of Market Value over Cost Basis of Marketable Securities

and Farm Capital Assets

Beg. -

End +

Change

Market Cost

Intermediate Assets _________ __________ _________ _________ ___N.A.

Real Estate _________ __________ _________ _________ ___N.A.

Beg. +

End -

Change Market Cost

Change in:

Deferred Liabilities _________ _________ _________ _________ ___N.A.

9. Total Change in Valuation Equity

_________

_________

_________

_________ ___N.A.

10. Owner Equity, End of Period

_________ _________ ___N.A.

Statement of Owner Equity (net worth) Cash Grain Farm -- Jan. to Dec. 2000

Market Cost

1. Owner Equity, Beginning of Period

833,030

385,250

2. Net Farm Income/Loss 97,897

3. Non-farm Income Contributed to Farm Business

______

3a. Withdrawals for Family Living Expenses

(28,389)

3b. - Income and Social Security Taxes

(24,280)

3. Owner Withdrawals (net) (52,669)

= Total Change in Retained Earnings (Line 2 – Line 3)

45,228 45,228

4. + Other Capital Contributions/Gifts/ Inheritance received

________

5. - Other Capital Distributions/Dividends/Gifts Made

(1,300)

6. Total Change in Contributed Capital & Retained Earnings

- 1,300 - 1,300

7. Ending Owner Equity (cost value basis)

429,178

Statement of Owner Equity

Beg. -

End +

Change

Market Cost

Intermediate Assets 202,750 236,053 +33,303

Real Estate 725,000 725,000 0.0

Beg. +

End -

Change Market Cost

Change in:

Deferred Liabilities 479,970 508,635 -28,665

9. Total Change in Valuation Equity

+ 4,638 N/A

10. Owner Equity, End of Period $ 881,596 $ 429,178

Statement of Owner Equity -- Summary

Can determine CHANGE in Owner Equity from beginning to end of time period

Components of change are:1 Retained earnings from profit2 Contributed capital from sources outside the

business3 Inflation/Deflation -- Change in Market Values