Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Statement of Cash Flows
Revisited
21
21-2
Learning Objectives
Explain the usefulness of the statement of cash flows.
21-3
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
21-4
Role of the Statement of Cash Flows
The Statement helps users assess . . . a firm’s ability to generate cash. a firm’s ability to meet its obligations. the reasons for differences between income
and associated cash flows. the effect of cash and noncash investing and
financing activities on a firm’s financial position.
The Statement helps users assess . . . a firm’s ability to generate cash. a firm’s ability to meet its obligations. the reasons for differences between income
and associated cash flows. the effect of cash and noncash investing and
financing activities on a firm’s financial position.
21-5
Role of the Statement of Cash Flows
Lists inflows and outflows of cash and cash
equivalents by category
Explains the change in cash during the period
Required by SFAS No. 95
21-6
Evolution of the Statement of Cash Flows
Early efforts to instill the standard of accrual accounting internationally suppressed the widespread practice of cash flow reporting.
The statement of changes in financial position was the
predecessor to the statement of cash flows.
The increasingly widespread acceptance of cash flow reporting in the 1980’s, coupled with a recommendation in
1984 of FASB Concept Statement 5 that a full set of financial statements show cash flows during the period,
virtually assured the eventual requirement of a statement of cash flows.
21-7
Learning Objectives
Define cash equivalents.
21-8
Cash and Cash Equivalents
Resources immediately available to
pay obligations.
Resources immediately available to
pay obligations.
Short-term, highly liquid investments.
Readily convertible into known, fixed amounts of cash.
So near maturity that there is insignificant risk of market value fluctuation from interest rate changes.
21-9Primary Elements of the Statement of Cash Flows (SCF)
Operating Activities
Investing Activities
Financing Activities
Reconciliation of the Net Increase or Decrease in
Cash with the Change in the Balance of the Cash
Account
Noncash Investing and Financing
Activities
21-10Primary Elements of the Statement of Cash Flows (SCF)
Operating Activities
Reports the cash effects of the elements of net income.
Investing Activities
Reports the cash effects of the acquisition and disposition of assets
(other than inventory and cash equivalents).
Financing Activities
Reports the cash effects of the sale or repurchase of shares, the
issuance or repayment of debt securities, and the payment of cash
dividends.
21-11
Learning Objectives
Determine cash flows from operating activities by the direct method.
Determine cash flows from operating activities by the indirect method.
21-12
Cash Flows from Operating Activities
Cash Flows from
Operating Activities
Cash Flows from
Operating Activities
Inflows from: Sales to customers. Interest and dividends
received.
Inflows from: Sales to customers. Interest and dividends
received. +
Outflows to: Purchase of inventory. Salaries, wages, and other
operating expenses. Interest on debt. Income taxes.
Outflows to: Purchase of inventory. Salaries, wages, and other
operating expenses. Interest on debt. Income taxes.
_
21-13
Direct Method or Indirect Method of Reporting Cash Flows from Operating Activities
Two Formats for Reporting Operating Activities
Reports the cash effects of each
operating activity
Direct Method
Starts with accrual net income and
converts to cash basis
Indirect Method
Note that no matter which format is used, the same amount of net cash flows operating activities is generated.
21-14
Direct Method or Indirect Method of Reporting Cash Flows from Operating Activities
Cash Inflows: From customers 98$ From investment revenue 3 Cash Outflows: To suppliers of goods (50) To employees (11) To bondholders (3) For insurance expense (4) For income taxes (11) Net cash flows from operating activities 22$
Cash Flows from Operating Activities--Direct Method
The cash effect of each operating activity is reported directly on
the statement of cash flows.
Net Income 12$ Adjustments 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$
Cash Flows from Operating Activities--Indirect Method
The net cash increase or decrease from operating
activities is derived indirectly by starting with reported net income on an accrual basis and working backwards to
convert that amount to a cash basis.
21-15
Learning Objectives
Identify transactions that are classified as investing activities.
21-16
Cash Flows from
Investing Activities
Cash Flows from
Investing Activities
+
Cash Flows from Investing Activities
Inflows from: Sale of long-term assets used in
the business. Sale of investment securities
(stocks and bonds). Collection of nontrade
receivables.
Inflows from: Sale of long-term assets used in
the business. Sale of investment securities
(stocks and bonds). Collection of nontrade
receivables.
_
Outflows to: Purchase of long-term assets
used in the business. Purchase of investment
securities (stocks and bonds). Loans to other entities.
Outflows to: Purchase of long-term assets
used in the business. Purchase of investment
securities (stocks and bonds). Loans to other entities.
21-17
Learning Objectives
Identify transactions that are classified as financing activities.
21-18
Cash Flows from
Financing Activities
Cash Flows from
Financing Activities
+
_
Cash Flows from Financing Activities
Inflows from: Sale of shares to owners. Borrowing from creditors
through notes, loans, mortgages, and bonds.
Inflows from: Sale of shares to owners. Borrowing from creditors
through notes, loans, mortgages, and bonds.
Outflows to: Owners in the form of dividends
or other distributions. Owners for the reacquisition of
shares previously sold. Creditors as repayment of the
principal amounts of debt.
Outflows to: Owners in the form of dividends
or other distributions. Owners for the reacquisition of
shares previously sold. Creditors as repayment of the
principal amounts of debt.
21-19
Reconciliation with Change in Cash Balance
The net amount of cash inflows and outflows reconciles the change in the
company’s beginning and ending cash balances.
Net increase in Cash 9,000,000$ Cash balance, January 1 20,000,000 Cash balance, December 31 29,000,000$
For example, assume the net increase in cash is $9 million and the Cash beginning balance is $20 million. The cash reconciliation would be as
follows:
21-20
Learning Objectives
Identify transactions that represent noncash investing and financing activities.
21-21
Noncash Investing and Financing Activities
Significant investing and financing transactions not involving cash also are
reported in the Statement of Cash Flows.
1. Acquiring an asset by incurring a debt payable to the seller.
2. Acquiring an asset by entering into a capital lease.
3. Converting debt into common stock or other equity securities.
4. Exchanging noncash assets or liabilities for other noncash assets or liabilities.
21-22
Learning Objectives
Prepare a statement of cash flows with the aid of a spreadsheet or T-accounts.
21-23
Using a Spreadsheet
A spreadsheet can be used to ensure that no reportable activities are inadvertently
overlooked.
Reconstructing the events and transactions that occurred during the period helps identify the
operating, investing and financing activities to be reported.
Let’s see how to use a spreadsheet to prepare a Statement of Cash Flows on the next few slides.
21-24
Dec. 31, 2005 Debits Credits
Dec. 31, 2006
Balance SheetAssets:Cash 20 29 Accounts receivable 30 32 Short-term investments - 12 Inventory 50 46 Prepaid insurance 6 3 Land 60 80 Buildings and equipment 75 81 Less: Accumulated depreciation (20) (16)
221 267
Liabilities:Accounts payable 20 26 Salaries payable 1 3 Income tax payable 8 6 Notes payable - 20 Bonds payable 50 35 Less: Discount on bonds payable (3) (1)
Shareholders' Equity:Common stock 100
130 Paid-in capital 20
29 Retained earnings 25
19 221 267
UNITED BRANDS CORPORATIONSpreadsheet for the Statement of Cash Flows
Changes We begin by entering the
beginning and ending balances for each account
on the comparative
balance sheet and income statement.
The changes columns will be
used later to explain the increase or
decrease in each account balance.
21-25
The beginning balances for income statement accounts are always zero.
Dec. 31, 2005 Debits Credits
Dec. 31, 2006
Income StatementRevenues:Sales revenue 100 Investment revenue 3 Gain on sale of land 8
Expenses:Cost of good sold (60) Salaries expense (13) Depreciation expense (3) Bond interest expense (5) Insurance expense (7) Loss on sale of equipment (2) Income tax expense (9) Net income 12
Changes
21-26Dec. 31,
2005 Debits CreditsDec. 31,
2006Statement of Cash FlowsOperating Activities:
Investing Activities:
Financing Activities:
Changes
Next we allocate space
on the spreadsheet
for the statement of cash flows.
Spreadsheet entries duplicate the actual journal entries used to record the transactions as they occurred during the year.
They are only entered on the spreadsheet and are not recorded in the accounting records.
21-27
Dec. 31, 2005 Debits Credits
Dec. 31, 2006
Balance SheetAssets:Cash 20 29 Accounts receivable 30 32 Short-term investments - 12 Inventory 50 46 Prepaid insurance 6 3 Land 60 80 Buildings and equipment 75 81 Less: Accumulated depreciation (20) (16)
221 267
Liabilities:Accounts payable 20 26 Salaries payable 1 3 Income tax payable 8 6 Notes payable - 20 Bonds payable 50 35 Less: Discount on bonds payable (3) (1)
Shareholders' Equity:Common stock 100
130 Paid-in capital 20
29 Retained earnings 25
19 221 267
UNITED BRANDS CORPORATIONSpreadsheet for the Statement of Cash Flows
Changes Let’s start by analyzing Sales Revenue and its related account
Accounts Receivable by looking at the
relationship in a T-account format.
Dec. 31, 2005 Debits Credits
Dec. 31, 2006
Income StatementRevenues:Sales revenue 100 Investment revenue 3 Gain on sale of land 8
Expenses:Cost of good sold (60) Salaries expense (13) Depreciation expense (3) Bond interest expense (5) Insurance expense (7) Loss on sale of equipment (2) Income tax expense (9) Net income 12
Changes
Beg. bal. 30Credit sales 100 ? Cash receivedEnd. bal. 32
Accounts Receivable
21-28
Dec. 31, 2005 Debits Credits
Dec. 31, 2006
Balance SheetAssets:Cash 20 29 Accounts receivable 30 32 Short-term investments - 12 Inventory 50 46 Prepaid insurance 6 3 Land 60 80 Buildings and equipment 75 81 Less: Accumulated depreciation (20) (16)
221 267
Liabilities:Accounts payable 20 26 Salaries payable 1 3 Income tax payable 8 6 Notes payable - 20 Bonds payable 50 35 Less: Discount on bonds payable (3) (1)
Shareholders' Equity:Common stock 100
130 Paid-in capital 20
29 Retained earnings 25
19 221 267
UNITED BRANDS CORPORATIONSpreadsheet for the Statement of Cash Flows
Changes We can see from this analysis that
cash received from customers must have been $98
million.
Dec. 31, 2005 Debits Credits
Dec. 31, 2006
Income StatementRevenues:Sales revenue 100 Investment revenue 3 Gain on sale of land 8
Expenses:Cost of good sold (60) Salaries expense (13) Depreciation expense (3) Bond interest expense (5) Insurance expense (7) Loss on sale of equipment (2) Income tax expense (9) Net income 12
Changes
Beg. bal. 30Credit sales 100 98 Cash receivedEnd. bal. 32
Accounts Receivable
Let’s see how to post this entry to the spreadsheet.
21-29
Dec. 31, 2005 Debits Credits
Dec. 31, 2006
Balance SheetAssets:Cash 20 29 Accounts receivable 30 (1) 2 32 Short-term investments - 12 Inventory 50 46 Prepaid insurance 6 3 Land 60 80 Buildings and equipment 75 81 Less: Accumulated depreciation (20) (16)
221 267
Liabilities:Accounts payable 20 26 Salaries payable 1 3 Income tax payable 8 6 Notes payable - 20 Bonds payable 50 35 Less: Discount on bonds payable (3) (1)
Shareholders' Equity:Common stock 100
130 Paid-in capital 20
29 Retained earnings 25
19 221 267
UNITED BRANDS CORPORATIONSpreadsheet for the Statement of Cash Flows
Changes First, $2 million is debited to Accounts
Receivable to account for the
total change in the account.
Dec. 31, 2005 Debits Credits
Dec. 31, 2006
Income StatementRevenues:Sales revenue (1) 100 100 Investment revenue 3 Gain on sale of land 8
Expenses:Cost of good sold (60) Salaries expense (13) Depreciation expense (3) Bond interest expense (5) Insurance expense (7) Loss on sale of equipment (2) Income tax expense (9) Net income 12
Changes
Beg. bal. 30Credit sales 100 98 Cash receivedEnd. bal. 32
Accounts ReceivableThen, $100 million is credited to Sales
Revenue to account for the
total change in the account.
21-30Dec. 31,
2005 Debits CreditsDec. 31,
2006Statement of Cash FlowsOperating Activities:Cash Inflows: From customers (1) 98
Investing Activities:
Financing Activities:
Changes
The final part of this entry is a $98 million entry on the Statement of Cash Flows under Cash Inflows from Customers.
Beg. bal. 30Credit sales 100 98 Cash receivedEnd. bal. 32
Accounts Receivable
Let’s skip ahead and look at the analysis of Short-term
Investments.
21-31
Dec. 31, 2005 Debits Credits
Dec. 31, 2006
Balance SheetAssets:Cash 20 29 Accounts receivable 30 (1) 2 32 Short-term investments - (12) 12 12 Inventory 50 46 Prepaid insurance 6 3 Land 60 80 Buildings and equipment 75 81 Less: Accumulated depreciation (20) (16)
221 267
Liabilities:Accounts payable 20 26 Salaries payable 1 3 Income tax payable 8 6 Notes payable - 20 Bonds payable 50 35 Less: Discount on bonds payable (3) (1)
Shareholders' Equity:Common stock 100
130 Paid-in capital 20
29 Retained earnings 25
19 221 267
UNITED BRANDS CORPORATIONSpreadsheet for the Statement of Cash Flows
Changes
In the textbook, entry number 12 illustrates the
analysis of the Short-term Investment account.
The $12 million increase in the
Short-term Investments
account is due to the purchase of
short-term investments
during the year.
Beg. bal. 0Purchases 12End. bal. 12
Short-term Investments
21-32Dec. 31,
2005 Debits CreditsDec. 31,
2006Statement of Cash FlowsOperating Activities:Cash Inflows: From customers (1) 98
Investing Activities:
Purchase of S-T investment (12) 12
Financing Activities:
Changes
The final part of this entry is a $12 million entry on the Statement of Cash Flows
under Investing
Activities.
Now, let’s look at a noncash transaction.
Beg. bal. 0Purchases 12End. bal. 12
Short-term Investments
21-33
Dec. 31, 2005 Debits Credits
Dec. 31, 2006
Balance SheetAssets:Cash 20 29 Accounts receivable 30 (1) 2 32 Short-term investments - (12) 12 12 Inventory 50 46 Prepaid insurance 6 3 Land 60 80 Buildings and equipment 75 (14) 20 81 Less: Accumulated depreciation (20) (16)
221 267
Liabilities:Accounts payable 20 26 Salaries payable 1 3 Income tax payable 8 6 Notes payable - (14) 20 20 Bonds payable 50 35 Less: Discount on bonds payable (3) (1)
Shareholders' Equity:Common stock 100
130 Paid-in capital 20
29 Retained earnings 25
19 221 267
UNITED BRANDS CORPORATIONSpreadsheet for the Statement of Cash Flows
Changes
x
In entry number 14, we find that a note payable was
issued as payment for a building.
Investing in a new building is a significant
investing activity and financing the acquisition with
long-term debt is a significant
financing activity.
x
x denotes a noncash transaction
21-34
Dec. 31, 2005 Debits Credits
Dec. 31, 2006
Balance SheetAssets:Cash 20 (19) 9 29 Accounts receivable 30 (1) 2 32 Short-term investments - (12) 12 12 Inventory 50 (4) 4 46 Prepaid insurance 6 (8) 3 3 Land 60 (13) 30 (3) 10 80 Buildings and equipment 75 (14) 20 (9) 14 81 Less: Accumulated depreciation (20) (9) 7 (6) 3 (16)
221 267
Liabilities:Accounts payable 20 (4) 6 26 Salaries payable 1 (5) 2 3 Income tax payable 8 (10) 2 6 Notes payable - (14) 20 20 Bonds payable 50 (15) 15 35 Less: Discount on bonds payable (3) (7) 2 (1)
Shareholders' Equity:Common stock 100 (16) 10
(17) 20 130 Paid-in capital 20 (16) 3
(17) 6 29 Retained earnings 25 (16) 13
(18) 5 (11) 12 19 221 267
UNITED BRANDS CORPORATIONSpreadsheet for the Statement of Cash Flows
Changes
x
x
After entering all the transactions, this is what the balance sheet portion of the
spreadsheet looks like.
21-35Dec. 31,
2005 Debits CreditsDec. 31,
2006Income StatementRevenues:Sales revenue (1) 100 100 Investment revenue (2) 3 3 Gain on sale of land (3) 8 8
Expenses:Cost of good sold (4) 60 (60) Salaries expense (5) 13 (13) Depreciation expense (6) 3 (3) Bond interest expense (7) 5 (5) Insurance expense (8) 7 (7) Loss on sale of equipment (9) 2 (2) Income tax expense (10) 9 (9) Net income (11) 12 12
Changes
After entering all the transactions, this is what the income statement portion of the
spreadsheet looks like.
21-36Dec. 31,
2005 Debits CreditsDec. 31,
2006Statement of Cash FlowsOperating Activities:Cash Inflows: From customers (1) 98 From investment revenue (2) 3 Cash Outflows: To suppliers of goods (4) 50 To employees (5) 11 To bondholders (7) 3 For insurance expense (8) 4 For income taxes (10) 11 Net cash flows 22 Investing Activities: Sale of land (3) 18 Sale of equipment (9) 5 Purchase of S-T investment (12) 12 Purchase of land (13) 30 Net cash flows (19) Financing Activities: Retirement of bonds payable (15) 15 Sale of common stock (17) 26 Payment of cash dividends (18) 5 Net cash flows 6 Net increase in cash (19) 9 9 Totals 376 376
Changes
After entering all the
transactions, this is what
the statement of cash flows portion of the spreadsheet looks like.
21-37
Cash Flows from Operating Activities:Cash Inflows: From customers 98$ From investment revenue 3 Cash Outflows: To suppliers of goods (50) To employees (11) To bondholders (3) For insurance expense (4) For income taxes (11) Net cash flows from operating activities 22$ Cash Flows from Investing Activities: Sale of land (30) Sale of equipment (12) Purchase of S-T investment 18 Purchase of land 5 Net cash flows from investing activities (19) Cash Flows from Financing Activities: Retirement of bonds payable 26 Sale of common stock (15) Payment of cash dividends (5) Net cash flows from financing activities 6 Net increase in cash 9 Cash balance, January 1 20Cash balance, December 31 29$
UNITED BRANDS CORPORATIONStatement of Cash Flows
For the Year Ended December 31, 2006($ in millions)
Here is the Statement of Cash Flows
prepared using the direct method.
21-38
Preparing an SCF: The Indirect Method
The indirect method derives the net cash
increases or decreases from operating activities indirectly by starting with reported net income and “working backwards” to convert that amount to a
cash basis.
Net Income 12$ Adjustments 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$
Cash Flows from Operating Activities--Indirect Methodand
Reconciliation of Net Income to Net Cash Flows from Operating Activities
21-39Components of Net Income that Do Not Increase or Decrease Cash
Depreciation Expense
Loss on Sale of Equipment
Adding these items back to net income restores net income to what it would have been had
depreciation and the loss not been subtracted at all.
Subtracting the gain reverses the effect of the gain having been
added to net income.
Gain on Sale of Land
21-40Components of Net Income that Do Increase or Decrease Cash
Note: Cash and cash equivalents, short-term investments in securities available for sale, dividends payable, and short-term payables to financial institutions are excluded from this category.
For components of net income that increase or decrease cash, but by an amount different from that reported on the income statement, net income is adjusted for changes in the balances of related balance sheet accounts to convert
the effects of those items to a cash basis.
21-41
End of Chapter 21