Statement of Cash Flows

What is a Cash flow statement?

The Statement deals with the provision of information about the historical changes in cash and cash equivalents of an enterprise by means of a cash flow statement which classifies cash flows during the period from

operating, investing and financing activities

Objective

Useful in providing users of financial statements with a basis to assess the ability of the enterprise to generate cash and cash equivalents and the needs of the enterprise to utilise those cash flows.

Economic decisions that are taken by users require an evaluation of the ability of an enterprise to generate cash and cash equivalents and the timing and certainty of their generation.

Objective

The company’s need for external financing

Causes and of the change in the amount of cash and cash equivalents between the beginning and the end of the accounting period

Why Cash Flow Statement

Accounting Standard (AS) 3, ‘Cash Flow Statements’ (revised 1997), issued by the Council of the Institute of Chartered Accountants of India, comes into effect in respect of accounting periods commencing on or after 1-4-1997.

This Standard supersedes Accounting Standard (AS) 3, ‘Changes in Financial Position’, issued in June 1981.

This Standard is mandatory in nature in respect of accounting periods commencing on or after 1-4-2004 for the enterprises which fall in any one or more of the following categories, at any time during the accounting period:

Components of Cash flow

Operating activities are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities.

Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.

Financing activities are activities that result in changes in the size and composition of the owners’ capital (including preference share capital in the case of a company) and borrowings of the enterprise

Diamond Chapter 6 7

Major Cash Flows:Operating Activities

Cash receipts from: Sale of goods or

services Sale of trading securities Interest revenue Dividend revenue

Cash payments for: Inventory purchases Wages and salaries Taxes Interest expense Other expenses (e.g.,

utilities, rent) Purchase of trading

securities

Implications of Operating Activities

Ability to decide a strategy that generates positive cash flow

Ability to raise cash from financing activities depends highly on ability to generate cash from its normal business operations

Diamond Chapter 6 9

Investing Activities

Includes cash inflows and outflows from changes in noncurrent assets:

Productive assets Investment securities Loans to others

Diamond Chapter 6 10

Major Cash Flows:Investing Activities

Cash receipts from: Sale of plant assets Sale of a business

segment Sale of nontrading

securities Collection of principal on

loans

Cash payments for: Purchase plant assets Purchase of nontrading

securities Making loans to other

entities

Examples of Financing Activities

cash proceeds from issuing shares or other similar instruments;

cash proceeds from issuing debentures, loans, notes, bonds, and other short or long-term borrowings; and

cash repayments of amounts borrowed

Diamond Chapter 6 12

Financing Activities

Includes obtaining resources from owners and providing them a return on their

investment creditors and repaying those borrowings

Diamond Chapter 6 13

Major Cash Flows:Financing Activities

Cash receipts from: Issuance of stock Borrowing (e.g., bonds,

notes, mortgages)

Cash payments for: Cash dividends Repayment of loans Repurchase of stock

(treasury stock)

Relationship of the SCF to theBalance Sheet and Income Statement

Balance Sheet Stmt of Cash Flows

Income Statement

Current Assets

Current Liabilities

Revenues

Expenses

Operating

Investing

Financing

Net Change in CashLong-term Assets

Long-term Liabilities

Stockholders’ Equity Net Income

Accts Pay & Accrued LiabilShort-term Loans PayCurrent Portion Long-term

Accrual Adjustments

Diamond Chapter 6 15

Cash Flow Pattern

Cash from...

Cash flow is typically

Inflow (positive) Outflow (negative)

Operations Investing Financing or

Cash Flow Pattern

A company’s cash flow pattern is a general reflection of where the company is in its life cycle ...

Investing

Financing

Operating

Cash Flow Pattern

Start-Up, High Growth Company

Dividends

Investing

Financing

Operating

Cash Flow Pattern

Steady-State Company

Dividends

Share Repurchases

Loan Repayment

Investing

Financing

Operating

Cash Flow Pattern

Cash Cow

Reporting Cash Flows from Operating Activities An enterprise should report cash flows from

operating activities using either:

the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or

the indirect method, whereby net profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows

Direct method Under the direct method, information about major classes of gross cash

receipts and gross cash payments may be obtained either:

from the accounting records of the enterprise; or

by adjusting sales, cost of sales (interest and similar income and interest expense and similar charges for a financial enterprise) and other items in the statement of profit and loss for:

changes during the period in inventories and operating receivables and payables;

other non-cash items; and

other items for which the cash effects are investing or financing cash flows.

Indirect method

Under the indirect method, the net cash flow from operating activities is determined by adjusting net profit or loss for the effects of:

changes during the period in inventories and operating receivables and payables;

non-cash items such as depreciation, provisions, deferred taxes, and unrealised foreign exchange gains and losses; and

all other items for which the cash effects are investing or financing cash flows.

Reporting Cash Flows from Investing and Financing Activities

An enterprise should report separately major classes of gross cash receipts and gross cash payments arising from investing and financing activities

PROBLEM : 1Selected transactions of the Davis Company are listed below.

1. Common stock is sold for cash above par value. 2. Bonds payable are issued for cash at a discount. 3. Interest on a short-term note receivable is collected. 4. Merchandise is sold to customers for cash. 5. Cash is paid to purchase inventory. 6. Equipment is purchased by signing a 3-year, 10% note payable. 7. Cash dividends on common stock are declared and paid. 8. One hundred shares of XYZ common stock are purchased for cash. 9. Land is sold for cash at book value. 10. Bonds payable are converted into common stock.

Instructions Classify each transaction as either (a) an operating activity, (b) an investing activity, (c) a financing activity, or (d) a noncash investing and financing activity.

PROBLEM : 2Selected transactions for the Eldon Company are listed below.

1. Collected accounts receivable. 2. Declared and paid dividends on common stock. 3. Sold long-term investments for cash. 4. Issued stock for equipment. 5. Repaid five year note payable. 6. Paid employee wages. 7. Converted bonds payable to common stock. 8. Acquired long-term investment with cash. 9. Sold buildings and equipment for cash.

10. Sold merchandise to customers.

Instructions Classify each transaction as either (a) an operating activity, (b) an investing activity, (c) a financing activity, or (d) a noncash investing and financing activity.

PROBLEM : 3Assuming a statement of cash flows is prepared using the indirect method, indicate the reporting of the transactions and events listed below by major categories on the statement. Use the following code letters to indicate the appropriate category under which the item would appear on the statement of cash flows.

Code Cash Flows From Operating Activities Add to Net Income A Deduct from Net Income D Cash Flows From Investing Activities IA Cash Flows From Financing Activities FA Category 1. Common stock is issued for cash at an amount above par value. _____ 2. Merchandise inventory increased during the period. _____ 3. Depreciation expense recorded for the period. _____ 4. Building was purchased for cash. _____ 5. Bonds payable were acquired and retired at their carrying value. _____ 6. Accounts payable decreased during the period. _____ 7. Prepaid expenses decreased during the period. _____ 8. Treasury stock was acquired for cash. _____ 9. Land is sold for cash at an amount equal to book value. _____ 10. Patent amortization expense recorded for a period. _____

PROBLEM : 4Assume the indirect method is used to compute cash flows from operations. For each item listed below, indicate the effect on net income in arriving at cash flows from operations by choosing one of the following code letters.

Code Cash Flows From Operating Activities

Add to Net Income A Deduct from Net Income D

1. Increase in accounts receivable 2. Increase in inventory 3. Decrease in prepaid expenses 4. Decrease in accounts payable 5. Increase in accrued liabilities 6. Increase in income taxes payable 7. Depreciation expense 8. Loss on sale of investment 9. Gain on disposal of equipment 10. Amortization expense

PROBLEM : 5

The Hendley Company reported net income of $240,000 for the current year. Depreciation recorded on buildings and equipment amounted to $75,000 for the year. Balances of the current asset and current liability accounts at the beginning and end of the year are as follows:

End of Year Beginning of Year Cash $20,000 $15,000 Accounts receivable 19,000 32,000 Inventories 50,000 65,000 Prepaid expenses 7,500 5,000 Accounts payable 12,000 18,000 Income taxes payable 1,600 1,200

Instructions Prepare the cash flows from the operating activities section of the statement of cash flows using the indirect method.

PROBLEM : 6Using the indirect method, calculate the amount of cash flows from operating activities from the following data:

Net income $260,000

Beginning accounts receivable 22,000 Ending accounts receivable 25,000 Beginning prepaid expenses 5,000 Ending prepaid expenses 3,000 Beginning accounts payable 15,000 Ending accounts payable 14,000 Depreciation expense 51,000 Amortization of intangible asset 4,000 Dividends declared and paid 11,000

Problem No. 7

Use the following information to perform the calculations below (using the indirect method). Clearly label the amount of each answer as positive or negative and show all your calculations.

Net income $375,000 Beginning accounts payable $119,000 Depreciation expense 97,000 Ending accounts payable 146,000 Beginning accounts receivable 420,000 Purchase of long-term assets 616,000 Ending accounts receivable 439,000 Issuance of long-term debt 200,000 Beginning inventory 516,000 Issuance of stock for cash 160,000 Ending inventory 560,000 Issuance of stock for long-term assets 110,000 Beginning prepaid expenses 42,000 Purchase of treasury stock 64,000 Ending prepaid expenses 48,000 Sale of long-term investment at cost 39,000

a.Calculate the amount of cash flows from operations _____________

b. Calculate the amount of cash flows from investing activities. _____________ c.Calculate the amount of cash flows from financing activities _____________

d. Calculate the net change in cash _____________

Problem No 8The comparative balance sheets for Drexler Company appear below:

DREXLER COMPANY Comparative Balance Sheet

Dec. 31, 2004 Dec. 31, 2003 Assets

Cash $ 28,000 $15,000 Accounts receivable 18,000 14,000 Prepaid expenses 7,000 9,000 Inventory 25,000 15,000 Long-term investments -0- 18,000 Equipment 60,000 30,000 Accumulated depreciation—equipment (18,000) (14,000) Total assets $120,000 $87,000

Liabilities and Stockholders' Equity Accounts payable $ 25,000 $ 9,000 Bonds payable 37,000 45,000 Common stock 40,000 23,000 Retained earnings 18,000 10,000 Total liabilities and stockholders' equity $120,000 $87,000

Additional information: 1. Net income for the year ending December 31, 2004, was $20,000. 2. Cash dividends of $12,000 were declared and paid during the year. 3. Long-term investments that had a book value of $18,000 were sold for $16,000. 4. Sales for 2004 are $120,000.