Fundamental

Financial Accounting
Concepts
Fourth Edition
by
Edmonds, McNair, Milam, Olds

PowerPoint® presentation by
J. Lawrence Bergin
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Chapter 12

Statement of Cash Flows

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Purpose of the Statement of
Cash Flows
◆ To show how the business acquired its
cash during the current year
◆ To show how the business spent its
cash during the current year
This information is crucial for
decision makers to predict future
cash flows of the business.

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What is considered “CASH” for
the Statement of Cash Flows?
◆ Cash includes cash and cash
equivalents for purpose of the
statement.

◆ Cash Equivalents are

– Short-term, highly liquid investments, with
– Maturity dates of 3 months or less from the
date acquired by the holder, and
are
– Easily convertible into known amounts of
cash.
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Categories of Cash Flows

They are based on activities

related to cash flows:
➊ Operating the business.
➋ Investing in productive assets.
➌ Financing the business.

These are the sections of the

Statement of Cash Flows.
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Operating Activities
◆ Cash inflows and outflows that are directly
related to income from normal operations.
◆ Technically, FASB defines operating activities as
those that are not investing or financing
activities.
◆ There are two ways to compute net cash flow
from operating activities:
– Direct method
– Indirect method

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Cash Flows from Operating Activities

◆ Cash inflows and outflows that are
directly related to income from
normal operations.
◆ Inflows include:
– Receipts from customers.
– Interest on receivables.
– Dividends received.

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Cash Flows from Operating Activities

◆ Cash inflows and outflows that are
directly related to income from
normal operations.
◆ Outflows include:
of
er
ord
– Payments to suppliers. Pa
y tot
he

– Interest paid on liabilities.

– Income taxes paid.
– Salary and wages payments to
employees.
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Cash Flows from Investing Activities

◆ Cash inflows and outflows that
are related to the purchase and
sale of productive assets.
◆ Inflows include proceeds from:
– Sales of property, plant, and
equipment.
– Sales of investments in securities.
– Collection of principal on loans
made to others.
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Cash Flows from Investing Activities

◆ Cash inflows and outflows that

are related to the purchase and
sale of productive assets.
◆ Outflows include payments for:
– The purchase of property, plant and
equipment.
– The purchase of long-term
investments.
– Loans to others.
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Cash Flows from Financing Activities

◆ Cash inflows and outflows that
are related to how cash was
obtained to finance the enterprise.
◆ Inflows include:
– Proceeds from sale of stock.
– Proceeds from sale of bonds and
from borrowings.

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Cash Flows from Financing Activities

◆ Cash inflows and outflows that are related
to how cash was obtained to finance the
enterprise.
◆ Outflows include:
– Payments to purchase treasury stock.
– Principal payments to retire bonds and loans.
– Dividends paid to owners.
(Remember, INTEREST paid is NOT a financing activity;
it is an Operating Activity.)

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Cash Flows from Noncash
Activities
◆ Investing and financing activities
that do not involve cash, e.g.,
– Retirement of bonds by issuing stock.
– Settlement of debt by transferring
assets other than cash.
cash
◆ Noncash activities must be
disclosed separately in the financial
statements.

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Preparing the Statement of Cash
Flows
The face of the statement includes:
Net Cash Flows from Operating Activities
+Net Cash Flows from Investing Activities
+Net Cash Flows from Financing Activities

=Net change in Cash Flows for the period

+ Beginning Cash Balance
=End of period Cash Balance

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Two Alternative Approaches

◆ Indirect Method
– Shows net cash inflow (outflow) from
operations as an adjustment of net income.
– Used by 97% of companies.
◆ Direct Method (used in Ch. 1-11 in text.)
– Reports the components of cash from
operations as gross receipts and payments.
– Recommended by the FASB, but rarely
used.
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Converting Accrual Data to Cash Data

◆ Accounting records are kept on the

accrual basis (GAAP).
◆ Cash data must be developed before
the SCF can be prepared (especially for
operating activities).
◆ The examples that follow demonstrate
the direct method for converting accrual
data to cash data.

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Three information sources are used:

➊ The income statement for the
current period.
➋ Comparative beginning of period
and end of period balance sheets.
➌ Additional transaction details not
found in the financial statements.

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Direct Method SCF

Converting Revenues to Cash Basis
◆ Accrual basis revenue includes sales
that did not result in cash inflows.
◆ Can be computed as:

+
Revenue, decrease Revenue,
or =
Accrual basis Cash basis
-
increase
in A/R

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Direct Method SCF

Example:
The A/R balance was $45,000 on 1/1/04 and
$52,000 on 12/31/04. If accrual sales
revenue for 2004 was $600,000, what was
cash basis revenue?

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Direct Method SCF

Example:
The A/R balance was $45,000 on 1/1/04 and
$52,000 on 12/31/04. If accrual sales
revenue for 2004 was $600,000, what was
cash basis revenue?

Accounts Receivable
45,000

52,000

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Direct Method SCF

Example:
The A/R balance was $45,000 on 1/1/04 and
$52,000 on 12/31/04. If accrual sales
revenue for 2004 was $600,000, what was
cash basis revenue?

Accounts Receivable
45,000
Cash
600,000 collected

52,000

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Direct Method SCF

Example:
The A/R balance was $45,000 on 1/1/04 and
$52,000 on 12/31/04. If accrual sales
revenue for 2004 was $600,000, what was
cash basis revenue?
So,
Accounts Receivable
Accrual Sales $600,000
45,000 - Increase in A/R 7,000
593,000 Cash
600,000 collected = Cash collected
from customers $593,000
52,000

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Direct Method
Converting Accrued Expenses to Cash

◆ Accrual basis expenses include

expenses that have not yet been paid.
◆ Can be computed as:

Expense,
Accrual Basis + decrease
or
- increase in
“expense” payables Expense,
Cash Basis
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Direct Method SCF

Example:
(Accrued) Salary Expense for 2004
was $500,000. Salary Payable was
$35,000 on 12/31/04 and $10,000 on
12/31/04. How much cash was paid to
employees in 2004?

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Direct Method SCF

Example:
Salary Expense for 2004 was
$500,000. Salary Payable was
$35,000 on 12/31/04 and $10,000 on
12/31/04. How much cash was paid to
employees in 2004?
Salary Expense Salary Payable

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Direct Method SCF
Example:
Salary Expense for 2004 was
$500,000. Salary Payable was
$35,000 on 12/31/04 and $10,000 on
12/31/04. How much cash was paid to
employees in 2004?
Salary Expense Salary Payable

$500,000

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Direct Method SCF

Example:
Salary Expense for 2004 was
$500,000. Salary Payable was
$35,000 on 12/31/04 and $10,000 on
12/31/04. How much cash was paid to
employees in 2004?
Salary Expense Salary Payable
35,000
$500,000

10,000

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Direct Method SCF
Example:
Salary Expense for 2004 was
$500,000. Salary Payable was
$35,000 on 12/31/04 and $10,000 on
12/31/04. How much cash was paid to
employees in 2004?
Salary Expense Salary Payable
35,000
$500,000
$500,000

10,000

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Direct Method SCF
Example:
Salary Expense for 2004 was
$500,000. Salary Payable was
$35,000 on 12/31/04 and $10,000 on
12/31/04. How much cash was paid to
employees in 2004?
Salary Expense Salary Payable
35,000
$500,000 525,000
$500,000

10,000

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Direct Method SCF
Example:
Salary Expense for 2004 was
$500,000. Salary Payable was
$35,000 on 12/31/04 and $10,000 on
12/31/04. How much cash was paid to
employees in 2004?
Salary Expense Salary Payable So,

35,000 Accrual exp. $500,000

$500,000 525,000
Cash paid + Decr. in pay. 25,000
$500,000
= Cash paid $525,000
10,000

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Direct Method
Converting Cost of Goods Sold to Cash Basis

◆ Requires analysis of two balance sheet

accounts: inventory and accounts payable.
◆ Can be computed as:

+ Increase or - Decrease in
Cost of Goods
Sold Expense inventory
and
+ Decrease or - Increase in
accounts payable

Cash payments
to suppliers
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12- 32 Suppose C of GS was $20,000; Beg. Inv. was $12,000 and
End. Inv. was $10,000; Accounts Payable had a
beginning balance of $13,000 and an ending balance of
$13,600. What was the cash paid to suppliers?

Inventory Cost of Gds Sold

12,000 20,000

10,000
Accounts Payable
13,000

13,600

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12- 33 Suppose C of GS was $20,000; Beg. Inv. was $12,000 and
End. Inv. was $10,000; Accounts Payable had a
beginning balance of $13,000 and an ending balance of
$13,600. What was the cash paid to suppliers?

Inventory Cost of Gds Sold

12,000 20,000

10,000
Accounts Payable
13,000

13,600
What increases and decreases each account?
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12- 34 Suppose C of GS was $20,000; Beg. Inv. was $12,000 and
End. Inv. was $10,000; Accounts Payable had a
beginning balance of $13,000 and an ending balance of
$13,600. What was the cash paid to suppliers?

Purchases Inventory Cost of Gds Sold

Inv. sold
on credit 12,000 20,000

10,000
Accounts Payable
Purchases
13,000 on credit

13,600

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12- 35 Suppose C of GS was $20,000; Beg. Inv. was $12,000 and
End. Inv. was $10,000; Accounts Payable had a
beginning balance of $13,000 and an ending balance of
$13,600. What was the cash paid to suppliers?

Purchases Inventory Cost of Gds Sold

Inv. sold
on credit 12,000 20,000

10,000

Cash paid Accounts Payable Purchases

to suppliers 13,000 on credit

13,600

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12- 36 Suppose C of GS was $20,000; Beg. Inv. was $12,000 and
End. Inv. was $10,000; Accounts Payable had a
beginning balance of $13,000 and an ending balance of
$13,600. What was the cash paid to suppliers?

Purchases Inventory Cost of Gds Sold

Inv. sold
on credit 12,000 20,000
20,000

10,000

Cash paid Accounts Payable Purchases

to suppliers 13,000 on credit

13,600

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12- 37 Suppose C of GS was $20,000; Beg. Inv. was $12,000 and
End. Inv. was $10,000; Accounts Payable had a
beginning balance of $13,000 and an ending balance of
$13,600. What was the cash paid to suppliers?

Purchases Inventory Cost of Gds Sold

Inv. sold
on credit 12,000 20,000
20,000
18,000
10,000

Cash paid Accounts Payable Purchases

to suppliers 13,000 on credit
18,000

13,600

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12- 38 Suppose C of GS was $20,000; Beg. Inv. was $12,000 and
End. Inv. was $10,000; Accounts Payable had a
beginning balance of $13,000 and an ending balance of
$13,600. What was the cash paid to suppliers?

Purchases Inventory Cost of Gds Sold

Inv. sold
on credit 12,000 20,000
20,000
18,000
10,000

Cash paid Accounts Payable Purchases

to suppliers 13,000 on credit
17,400 18,000
Cash
13,600 paid

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Direct Method
Converting Deferrals to Cash Basis
◆ Accounts like unearned revenue and prepaid
insurance may cause the cash received or
disbursed to be different from the revenue or
expense shown on the income statement.
◆ Cash for a deferred expense can be
computed as:
Expense + Increase
Accrual Basis or
- Decrease in Expense,
related PREPAID = Cash Basis
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Direct Method
Converting Deferrals to Cash Basis
◆ Accounts like unearned revenue and prepaid
insurance may cause the cash received or
disbursed to be different from the revenue or
expense shown on the income statement.
◆ Cash from an unearned revenue
(deferred revenue) can be computed as:
Revenue, + Increase
Accrual Basis or
- Decrease in Revenue,
Unearned rev. = Cash Basis
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Direct Method
Example:
Suppose the Unearned Revenue account
showed a beginning balance of $200 and an
ending balance of $900. The income
statement indicates that $1,200 is the
amount of Revenue (earned) for the period.
How much cash was collected for revenue
(assuming A/R did not change)?
Unearned Revenue Revenue

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Calculate the CASH!

Unearned Revenue
200

900
So,
Revenue Accrual based Revenue $1,200
1200 Increase in Unearn.Rev.
= Cash collected from
1200 customers $

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Direct Method
Example:
What is cash-basis revenue??
Unearned Revenue
200

900

Revenue
1,200

1,200

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12- 44 Determine what causes increases and
decreases to each account, and find the
CASH!

Unearned Revenue
1200 200 CASH

900

Revenue
1200

1200

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Calculate the CASH!

Unearned Revenue
1200 200 CASH
1900
900

Revenue
1200

1200

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Calculate the CASH!

Unearned Revenue
1200 200 CASH
1900
900
So,
Revenue Accrual based Revenue $1,200
1200 + Increase in Unearn.Rev. 700
= Cash collected from
1200 customers $1,900

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To summarize:
◆ What kinds of accounts need to
be examined to see if there is a
difference between our accrual
accounting records and actual
cash?

versus

General Ledger

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To summarize:
◆ Accounts Receivable
◆ Prepaids
◆ Inventory
◆ Accounts Payable
◆ Other Payables

All current assets (except cash) and

current liabilities, related to operations,
need to be examined in conjunction with
related revenue and expense accounts.
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Indirect Method
◆ Net cash flows from operating activities
are determined by . . .
◆Starting with net income, then . . .
◆Adding and subtracting items that reconcile
net income to operating cash flows.
◆ Requires an analysis of changes in all
current asset and current liability accounts
[related to operations], except cash.

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Indirect Method: Conversion from Net Income to

Net Cashflow from Operating Activities
◆ Additions to net income:
✚ Depreciation, depletion, and amortization.
✚ All losses.
✚ Decreases in current assets (other than cash).
✚ Increases in current liabilities.
◆ Deductions from net income:
- All gains.
- Increases in current assets (other
than cash).
- Decreases in current liabilities.
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T-account approach
◆ Set up a t-account for every balance
sheet account
– Put beginning and ending balances in the
accounts, using comparative balance
sheets
◆ Make the CASH T-account a BIG one,
with room for the three sections of the
Statement of Cash Flows

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T-account approach:
◆ Make every balance sheet
account balance, using the
income statement accounts to
calculate increases and
decreases to the accounts.
◆ When the cash number is
calculated for various increases
or decreases in balance sheet
accounts, put the appropriate
debit or credit in the big cash
T-account.
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T-account approach:
◆ Problem 12-16A (Pacific
Company) is a good Let’s do
demonstration problem
of using the T-account 12-16A
approach to prepare a
Statement of Cash
Flows using the direct
method.
But first, there are just a few
more slides to summarize things.
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Summary of Differences Between

Direct and Indirect Methods
◆ The direct method provides more detail about cash
from operating activities.
– Shows individual operating cash flows.
– Shows reconciliation of operating cash flows to
net income in a supplemental schedule.
◆ The investing and financing sections for the two
methods are identical.
◆ Net cash flow from Operating Activities and total
net cash flow are the same for both methods.
◆ The schedule of Noncash Investing/Financing
Activities is identical for both methods.
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How important is the Statement
of Cash Flows?
◆ It is crucial to the presentation
of a complete picture of the
financial status of a business.
◆ Many businesses with great
ideas and potential have failed
due to their failure to manage
their cash flows.
◆ Remember, the statement is
REQUIRED by GAAP.

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Chapter 12

This course is FINISHED!!

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