22747

Accounting for Managerial Decisions

Topic 5
Statement of Cash Flows

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 Learning objectives
LO1: Describe the purpose and format of the statement of cash
flows.
LO2: Describe the process of preparing the statement of cash
flows.
LO3: Prepare the operating activities section of the statement of
cash flows using the direct method.
LO4: Prepare the investing activities section of the statement of
cash flows.
LO5: Prepare the financing activities section of the statement of
cash flows.
LO6: Prepare the operating activities section of the statement of
cash flows using the indirect method.

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 LO1 Statement of cash flows

Describe the purpose and format of the

statement of cash flows

• The statement of cash flows reports the

impact of a firm’s operating, investing and
financing activities on cash flows.
• Some believe it is the most important of the
four required financial statements.

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 The purpose of the statement of cash flows
• The statement of cash flows summarises a company’s inflows
and outflows of cash over a period of time.
• How and why a company’s cash balance changed over the
year.
• If a company cannot generate sufficient cash, its ability to
continue operations is very limited.
• Discloses items that affect the balance sheet but don’t show
up in the income statement
• Categorises changes as operating, investing or financing
activities.

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 LO2 Preparing the statement
• The statement of cash flows is prepared with
information collected from a variety of sources,
including the examination of the changes in all non-cash
accounts.
• Information required:
• Statement of financial position (opening and closing
balances)
• Statement of profit and loss
• Additional information as necessary

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The basic structure of the statement
Cash flows provided (used) by operating activities
+/- Cash flows provided (used) by investing activities
+/- Cash flows provided (used) by financing activities
= Net increase (decrease) in cash

+ Cash, beginning of year

= Cash, end of year

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 Classification of cash flows

Operating: cash flows associated with the revenues

and expenses;
Investing: cash flows associated with buying and
selling non-current assets and investments;
Financing: cash flows associated with financing the
purchase of assets (i.e., debt or equity).

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 LO3 Operating activities
There are two methods which can be used to prepare the operating section of the
cashflow statement:
• Direct Method
• Indirect Method
• Under the direct method, a company calculates and reports its actual
cash flows (e.g., cash collections from customers). When using the direct
method, a reconciliation of cash flows from operation to profits is
required.
• Under the indirect method, a company reports its cash flows from
operating activities by adjusting its profit or loss from an accrual basis to
a cash basis.
• Both the direct and indirect methods yield the same net cash flows from
operating activities.
• AASB 107 permits either the direct or the indirect method but
‘encourages’ the direct method.

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 Using the direct method
Under the direct method:
• Cash receipts are calculated by converting revenues
from the income statement to cash collections
• Cash payments are calculated by converting
expenses from the income statement to cash
payments.
• Depreciation is ignored because it is a non-cash
expense.
• A gain or loss on the sale of PPE is ignored under the
direct method because cash flows associated with
the sale of these assets is an investing activity.

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 Operating activities: direct method
Calculating cash received from sales
Sales during the period $10,000
Less: increase in account receivable 6,000
Cash received from customers for the period $4,000

Adjustment for Cash received from Sales

- Increase in Accounts Receivable (credit sales)
OR + Decrease in Accounts Receivable (A/cs Rec. collection)
= Cash collected from Sales

Secret is to think what an increase (or decrease) in A/cs Rec means

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Operating activities: direct method
Calculating cash paid for inventory
Inventory purchased during the period $290
Less: increase in account payable 8
Cash paid to suppliers for the period $282

Secret is to think of the change in Inventory and then A/P

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Cash paid for operating expenses accrued

Cash outflows
for operating
expenses
= Operating
expenses +( Beginning
payable
–
Ending
payable )
Electricity expenses $ 5.3 m
Plus decrease in electricity payable $ 0.2 m
Cash paid for electricity $ 5.5 m

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Cash paid for operating expenses prepaid

Insurance expense for the period $14

Less: decrease in prepaid insurance 4
Cash paid for insurance $10

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 Lecture Multiple Choice Question 1
5-1 The following information is available while preparing a
statement of cash flows:
Cash paid to owners for dividends $1,000
Cash received from customers from prior credit sales 8,600
Cash received from sale of long-term assets 2,700
Cash paid for operating expenses 3,300
What is the amount of cash flow from operations under the direct
method?
(a) $11,300
(b) $ 7,000
(c) $ 5,300
(d) $ 4,300
(e) None of the above
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 Lecture Multiple Choice Question 2
5-2 Tan’s Auto Sound Company reported 2018 sales of $640,000.
The following information is also available:
Accounts Receivable Balances; Start of year $80,000
End of year $50,000
On a statement of cash flows (direct format) what amount would be
reported for "cash collected from customers" for the year?
(a) $510,000
(b) $670,000
(c) $610,000
(d) $720,000
(e) $690,000

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 LO4 Investing activities
To calculate cash flows from investing activities, all changes in
non-current assets must be examined. In general, an increase
in a non-current asset suggests a purchase and therefore a cash
outflow. A decrease suggests a sale and therefore a cash inflow.
• Cash flows from investing activities include cash inflows from the
sale of property, plant and equipment (PPE), the sale of
investments (shares and bonds), and the receipt of loan payments.
• Cash outflows include the purchase of PPE, the purchase of
investments and making loans as investments.
– Interest and dividends received on investments are usually
classified as operating activities.

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 LO5 Financing activities
To calculate cash flows from financing activities, the balances
for non-current liabilities, equity accounts and dividends must
be examined. In general:
• Cash flows from financing activities include cash inflows
from selling shares or borrowing money.
• Cash outflows from financing activities include repayment
of loans, cash payments to repurchase shares and the
payment of dividends.
• Interest payments are (usually/always) included in cash
flows from operating activities.

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 Lecture Multiple Choice Questions 3

5-3 Which of the following is a cash flow from an investing activity?

(a) Payment for advertising

(b) Cash receipt from a customer for a previous credit sale
(c) Cash received from sale of equipment
(d) Payment of dividends
(e) Cash purchase of inventory.

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 Lecture Multiple Choice Questions 4

5-4 The issue of shares used to finance the purchase of land and
buildings is representative of:

(a) Operating and Investing activities respectively

(b) Financing and Investing activities respectively
(c) Operating and Financing activities respectively
(d) Financing and Operating activities respectively
(e) None of the above.
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 Lecture Multiple Choice Question 5

5-5 The borrowing of money used to finance a dividend payment is

representative of:

(a) Financing and Investing activities respectively

(b) Operating and Investing activities respectively
(c) Investing activities only
(d) Financing activities only
(e) None of the above.

20

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 Lecture Multiple Choice Question 5

5-6 In the long run, a firm must depend on which activities to meet
most of its cash flow needs.

(a) Operating
(b) Investing
(c) Financing
(d) Nonrecurring
(e) None of the above.
21

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 Direct method lecture demo
Using the following information to prepare a statement of cash flows
under the direct method:
Cash balance, end of 2018 $12,000
Cash paid to employees and suppliers 148,000
Cash received from sale of land 40,000
Cash paid to acquire treasury stock (share buy-back) 10,000
Cash balance, beginning of 2018 16,000
Cash received as interest 6,000
Cash paid as income taxes 11,000
Cash paid to purchase equipment 89,000
Cash received from customers 194,000
Cash received from issuing bonds payable 30,000
Cash paid as dividends 16,000

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 STATEMENT OF CASH FLOWS
FOR YEAR ENDED 31th December, 2018
Cash Flows from Operating Activities
Cash Received from Customers
Cash Received as Interest
Cash Paid to Employees and Suppliers
Cash Paid as Income Taxes
Net Cash Provided by Operating Activities
Cash Flows from Investing Activities
Sale of Land
Purchase of Equipment
Net Cash Used by Investing Activities
Cash Flows from Financing Activities
Issuance of Bonds Payable
Acquisition of Treasury Stock
Payment of Dividends
Net Cash Provided by Financing Activities
Net Decrease in Cash
Plus Cash at Beginning of Year
Equals Cash at End of Year
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 LO6 Indirect method
When reporting operating cash flows under the indirect
method, companies calculate and report net cash flows
from operating activities by adjusting profits from an
accrual basis to a cash basis. This requires many
adjustments, but they can be grouped into three main
types:
• Non-cash effects on profits
• Gains and losses from investing activities
• Changes in current assets and current liabilities
Depreciation is typically the largest non-cash expense that
must be added back to profits to obtain cash-based
income.
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 Adjustments for gains and losses from
investing activities

• Profit may include a gain or loss arising from the

sale of equipment.
• The entire cash inflow associated with the
transaction will be reported as an investing cash
flow.
• The effect of the gain or loss must be removed
from net income so that operating cash flows are
not affected by the transaction.

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 Indirect Method
Format for the Operating cash flows
Add (+) or Subtract (-)
From Net Income
Net Income ……………………………………………………………. $ #
Adjustments for Add: Depreciation/amortisation………………………………………… +
noncash revenues, Loss from sale of assets…………………………………………… +
expenses, gains Gain from sale of assets…………………………………………… -
and losses
Adjust for changes in current operating assets
Subtract increases in current operating assets…………………….. . -
Adjustments for Add decreases in current operating assets…………………………. +
changes in noncash
current operating Adjust for changes in current operating liabilities
assets and current
Add increases in current operating liabilities……………………… +
operating liabilities
Subtract decreases in current operating liabilities………………….. -
___
Net Cash flow from operating activities…………………………… $ #
===

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 Indirect method demonstration
The following information was reported by Petrulis Imports Company
for the financial year ended June 30:
2018 2017
Accounts receivable $55,000 $47,000
Inventory 35,000 45,000
Prepaid insurance 12,000 10,000
Accounts payable 22,000 15,000
Income tax payable 10,000 14,000
Interest payable 12,000 9,000
Profits 45,000
Depreciation expense 25,000

Prepared the operating activities section of the statement of cash

flows using the indirect method.

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 Disclosures for non-cash investing and
financing activities

Even though such transactions do not involve cash,

they are important to help properly understanding
a company’s cash flows. Therefore, they must be
disclosed in the notes to the financial statements.

Eg: purchase of an asset(s) by issuing equity

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 Direct method answer
STATEMENT OF CASH FLOWS
FOR YEAR ENDED 31 December, 2018
Cash Flows from Operating Activities
Cash Received from Customers $194,000
Cash Received as Interest 6,000 $200,000
Cash Paid to Employees and Suppliers 148,000
Cash Paid as Income Taxes 11,000 (159,000)
Net Cash Provided by Operating Activities 41,000
Cash Flows from Investing Activities
Sale of Land 40,000
Purchase of Equipment (89,000)
Net Cash Used by Investing Activities (49,000)
Cash Flows from Financing Activities
Issuance of Bonds Payable 30,000
Acquisition of Treasury Stock (10,000)
Payment of Dividends (16,000)
Net Cash Provided by Financing Activities 4,000
Net Decrease in Cash (4,000)
Cash at Beginning of Year 16,000
Cash at End of Year $ 12,000

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 Indirect method answer
Petrulis Imports Company
Statement of cash flows
For the year ended 30 June, 2018

Cash flows from operating activities

Net income $45,000
Adjustment to reconcile net income to net cash
provided by operating activities:
Add depreciation expense $25,000
Increase in accounts receivable (8,000)
Decrease in inventory 10,000
Increase in prepaid insurance (2,000)
Increase in accounts payable 7,000
Decrease in income taxes payable (4,000)
Increase in interest payable _ 3,000 31,000
Net cash provided by operating activities $76,000

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