Chapter 14

Statement of Cash Flows

Financial and Managerial Accounting 8th Edition

Warren Reeve Fess

PowerPoint Presentation by Douglas Cloud
Professor Emeritus of Accounting Pepperdine University Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.

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Objectives
1. Summarize the studying types of this cash flow After activities reported in the statement of chapter, you should cash flows. be able to: 2. Prepare a statement of cash flows, using the indirect method. 3. Prepare a statement of cash flows, using the direct method. 4. Calculate and interpret the free cash flow.

Reporting Cash Flows

The statement of cash flows reports cash flows by three types of activities:

1. Cash flows from operating activities transactions that affect net income. 2. Cash flows from investing activities transactions that affect noncurrent assets. 3. Cash flows from financing activities transactions that affect equity and debt of the entity.

Reporting Cash Flows

Increases in Cash Decreases in Cash

Operating
(receipts from revenues)

Operating
(payments for expenses)

Investing
(receipts from sales of noncurrent assets)

Investing
(payments for acquiring noncurrent assets)

Financing
(receipts from issuing equity and debt securities)

Financing
(payments for treasury stock, dividends, and redemption of debt securities)

Cash Flows from Operating Activities

Typical cash inflows What are some of the typical cash inflows from operating activities?` Typical cash outflows What are some of the typical cash outflows from operating activities?

Sales of goods and services

Interest revenue Dividend revenue

Merchandise purchases
Payments of wages and other expenses Tax payments

Cash Flows from Investing Activities

Typical cash inflows What are some of the typical cash inflows from investing activities? Sales of fixed assets Sale of longterm investments Typical cash outflows What are some of the typical cash outflows from investing activities? Purchase of fixed assets Purchase of long-term investments

Cash Flows from Financing Activities

Typical cash inflows What are some of the typical cash inflows from financing activities? Issuing bonds and long-term notes payable Typical cash outflows What are some of the typical cash outflows from financing activities? Paying cash dividends Repaying debt Acquiring treasury stock

Issuing preferred and common stock

Noncash Investing and Financing Activities

Issuing bonds to acquire land
Issuing common stock for

convertible preferred stock Issuing a long-term note to acquire equipment Issuing a stock dividend

No cash flow per share is reported in the financial statements because the user might incorrectly interpret this as the amount available for dividends.

The Indirect Method

Balance Sheet
Cash Liabilities
Noncash Assets Stockholders Equity

Assets = Liabilities + Stockholders Equity Cash + Noncash Assets = Liabilities + Stockholders Equity Cash = Liabilities + Stockholders Equity Noncash Assets

The Indirect Method

Balance Sheet

Cash Liabilities
Noncash Assets Stockholders Equity

Assets = Liabilities + Stockholders Equity Cash + Noncash Assets = Liabilities + Stockholders Equity Cash = Liabilities + Stockholders Equity Noncash Assets
1

The cash flows are determined by analyzing liabilities, stockholders equity, and noncash assets.

The Indirect Method

Start with the accrual basis net income (shown in the income statement, the Retained Earnings account, or the statement of stockholders equity).

The Indirect Method

Find the net income.
ACCOUNT Retained Earnings Date
2006

ACCOUNT NO. 32 Debit Credit Balance Debit Credit

Item

To statement
108,000

Jan. 1 Balance Dec. 31 Net income 31 Cash dividends

28,000

202,300 310,300 282,300

Operating Activities Indirect Method Cash flows from operating activities: Net income per income statement $108,000 Add: Depreciation $ 7,000 Decrease in inventories 8,000 Increase in accrued expenses 2,200 17,200 Deduct: $125,200 Inc. in accounts receivable $ 9,000 Dec. in accounts payable 3,200 Dec. in income taxes payable 500 Gain on sale of land 12,000 24,700 Net cash flow from operating activity. $100,500

The Indirect Method

Next, we need to determine depreciation expense for the year. If it isnt given on the income statement, sometimes it can be found by analyzing the Accumulated Depreciation account.

The Indirect Method

Determine depreciation expense.
ACCOUNT Accumulated Depreciation--Building ACCOUNT NO. 17 Date
2006

Item

Debit

Credit

Balance Debit Credit

Jan. 1 Balance Dec. 31 Depreciation for year

7,000

58,300 65,300

to statement

Operating Activities Indirect Method Cash flows from operating activities: Net income per income statement $108,000 Add: Depreciation $ 7,000 Decrease in inventories 8,000 Increase in accrued expenses 2,200 17,200 Deduct: $125,200 Depreciation Inc.Because in accounts receivable Expense $ 9,000 Dec. in accounts 3,200 reduced net payable income but did not Dec. in income taxes payable 500 require an outflow of cash, it is Gain on sale of land 12,000 24,700 added back to net income. Net cash flow from operating activities $100,500

The Indirect Method

Select current assets and current liabilities that impact cash flow and determine the increases and decreases.

Changes in Current Accounts

Accounts Accounts receivable (net) Inventories Accounts payable (mdse.) Accrued expenses payable Income taxes payable 2006 $74,000 172,000 43,500 26,500 7,900 2005 $65,000 180,000 46,700 24,300 8,400 Change Debit Credit 9,000 8,000 3,200 2,200 500

Determine the debit or credit change of each item above.

Changes in Current Accounts

Accounts Accounts receivable (net) Inventories Accounts payable (mdse.) Accrued expenses payable Income taxes payable 2006 $74,000 172,000 43,500 26,500 7,900 2005 $65,000 180,000 46,700 24,300 8,400 Change Debit Credit 9,000 8,000 3,200 2,200 500

These debit changes are subtracted from net income in the operating activities section of the statement of cash flows. Think of these debits as deductions from net income in arriving at net cash flow from operations.

Changes in Current Accounts

Accounts Accounts receivable (net) Inventories Accounts payable (mdse.) Accrued expenses payable Income taxes payable 2006 $74,000 172,000 43,500 26,500 7,900 2005 $65,000 180,000 46,700 24,300 8,400 Change Debit Credit 9,000 8,000 3,200 2,200 500

These credit changes are added to net income in the operating activities section of the statement of cash flows. Think of these credits as additions to net income in arriving at net cash flow from operations.

Operating ActivitiesIndirect Method Cash flows from operating activities: Net income per income statement $108,000 Add: Depreciation $ 7,000 Decrease in inventories 8,000 Increase in accrued expenses 2,200 17,200 $125,200 Inc. in accounts receivable $ 9,000 Dec. in accounts payable 3,200 Dec. in income taxes payable 500 Gain on sale of land 12,000 24,700 Net cash flow from operating activities $100,500

The Indirect Method

Analyze the income statement to determine if there are any gains or losses from selling investments, equipment, etc.

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales Cost of merchandise sold Gross profit Operating expenses: Depreciation expense Other operating expenses Total operating expenses Income from operations Other income: Gain on sale of land Other expense: Interest expense Income before income tax Income tax Net income $1,180,000 790,000 $ 390,000 $ 7,000 196,000 203,000 $ 187,000 $12,000 8,000 4,0000 $ 191,000 83,000 $ 108,000

Operating ActivitiesIndirect Method Cash flows from operating activities: Net income, per income statement $108,000 Add: Depreciation $ 7,000 ThisDecrease gain was in net income, in included inventories 8,000 but did Increase in accrued expenses cash 2,200 not represent an operating flow.17,200 $125,200 Inc. in accounts receivable $ 9,000 Dec. in accounts payable 3,200 Dec. in income taxes payable 500 Gain on sale of land 12,000 24,700 Net cash flow from operating activities $100,500

The Indirect Method

If there had been a loss on this sale, the loss would have been added to net income.

Cash Flows from Financing Activities

Dividends
ACCOUNT Dividends Payable Date
2006

ACCOUNT NO. 23 Debit Credit Balance Debit Credit 10,000 -14,000 -14,000

Item Balance Cash paid Dividends declared Cash paid Dividends declared

Jan.

1 10 June 20 July 10 Dec. 20

10,000 14,000 14,000 14,000

---

Total cash paid

$24,000

Cash Flows from Financing Activities

Because paying of dividends affects equity, it is a negative $24,000 cash flow from financing activities transaction.

Cash Flows from Financing Activities

Sale of Common Stock
ACCOUNT

Common Stock
Item Debit Credit

ACCOUNT NO. 33

Date
2006

Balance Debit Credit 16,000 24,000

Jan. Nov.

1 Balance 1 4,000 shares issued for cash

8,000

Cash Flows from Financing Activities

Sale of Common Stock
ACCOUNT

Paid-In Capital in Excess of Par--Common ACCT. NO. 34

Item Debit Credit Balance Debit Credit 80,000 120,000

Date
2006

Jan. Nov.

1 Balance 1 4,000 shares issued for cash

40,000

Cash Flows from Financing Activities

Issuing common stock affects equity; therefore, we have a total positive cash flow of $48,000 from this financing activities transaction.

Cash Flows from Financing Activities

Retirement of Bonds Payable
ACCOUNT

Bonds Payable
Item Debit Credit

ACCOUNT. NO. 25

Date
2006

Balance Debit Credit 150,000

Jan. 1 Balance June 30 Retired by payment of cash at face amount

50,000

100,000

Cash Flows from Financing Activities

This transaction is a negative cash flows from financing activities item because longterm debt is involved.

Cash Flows from Investing Activities

Purchased a Building
ACCOUNT

Building
Item Debit

ACCOUNT NO. 18 Credit Balance Debit Credit 200,000 260,000

Date
2006

Jan. 1 Balance Dec. 27 Purchased for cash

60,000

Cash Flows from Investing Activities

Purchased a Building Purchasing a building involves a noncurrent asset, so this is a negative cash flows from investing activities item.

Cash Flows from Investing Activities

Land Transactions
ACCOUNT

Land
Item Debit

ACCOUNT NO. 16 Credit Balance Debit Credit

Date
2006

Jan. 1 Balance June 8 Sold for $72,000 cash Oct. 12 Purchased for $15,000 cash

125,000 60,000 65,000 15,000 80,000

Cash Flows from Investing Activities

Land Transactions The first transaction, the sale of land, results in a positive cash flow from investing activities because land is a noncash asset.

Cash Flows from Investing Activities

Land Transactions The $12,000 gain was recorded earlier on Slide 27 as an operating activity. The purchase of land also is an investing activity.
Click here to return to Slide 27. To return to this slide, type 40 and press the Enter key.

Refer to Exhibit 6 in your textbook to see the formal statement of cash flows using the indirect approach.

Rundell Inc. Statement of Cash Flows For the Year Ended December 31, 2006 Cash flows from operating activities: Net income $108,000 Add: Depreciation $ 7,000 Decrease in inventor. 8,000 Increase in accrued exp. 2,200 17,200 $125,000 Deduct: Increase in A/R $9,000 Decrease in accts. Pay. 3,200 Decrease in ITP 500 Gain on sale of land 12,000 24,700 Net cash flow from operating act. $100,500 Cash flows from investing activities: Cash from sale of land $72,000 Less: Cash paid to pur. land $15,000 Cash paid for bldg. 60,000 75,000 (3,000) Cash flows from financing activities: Cash received from sale of c.s. $48,000 Less: Cash paid to retire b. $50,000 Cash paid for divid. 24,000 74,000 Net cash flow for financing (26,000) Increase in cash $71,500 Cash at beginning of year 26,000 Cash at end of year $97,500

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 This is an accrual basis income statement. Income tax 83,000 The direct method of reporting cash flows will Net income $ 108,000

Cash Basis

essentially convert this to a cash basis statement.

Rundell Inc. Income Statement For the Year Ended December 31, 2006

Cash Basis

Sales $1,180,000 Cost of merchandise sold 790,000 Cash collected Gross profit $ 390,000 Changes Operating expenses: from customers Debit Credit Depreciation expense $ 7,000 Sales 1,180,000 Other operating expenses 196,000 Receivables 9,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Note: The changes in $12,000 the current balance Gain on sale of land Other expense: sheet accounts are determined by Interest expense 8,000 4,000 comparing the beginning and ending Income before income tax $ 191,000 balances. Receivables increased by Income tax 83,000 Net income $ 108,000 $9,000 during the period.

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Cash collected Gross profit $390,000 Changes Operating expenses: from customers Debit Credit Depreciation expense $ 7,000 Sales 1,180,000 Other operating expenses 196,000 Receivables 9,000 Total operating expenses 203,000 Cash 1,171,000 $187,000 Income from operations Other income: Gain on sale of land $12,000 The increase in receivables Other expense: represents a reduction in 4,000 cash Interest expense 8,000 inflow Income before income tax relative to the accrual $ 191,000 Income tax 83,000 revenue reported on the income Net income $ 108,000

Cash Basis
$1,171,000

statement.

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales Cost of merchandise sold Gross profit Cash payments for Operating expenses: merchandise Depreciation expense Other operating expenses Cost of mdse. sold Total operating expenses Inventories Income from operations Accounts payable Other income: Cash Gain on sale of land Other expense: Interest expense Income before income tax Income tax Net income $1,180,000 790,000 $390,000 Changes $ Debit 7,000 Credit 196,000 790,000 203,000 8,000 $187,000 3,200 $12,000 8,000 4,000 $ 191,000 83,000 $ 108,000

Cash Basis
$1,171,000

Rundell Inc. Income Statement For the Year Ended December 31, 2006

Cash Basis

Sales $1,180,000 $1,171,000 Cost of merchandise sold 790,000 (785,200) Gross profit $390,000 Cash payments for Operating expenses: Changes merchandise Depreciation expense $ Debit 7,000 Credit Other operating expenses 196,000 Cost of mdse. sold 790,000 Total operating expenses 203,000 minus Inventories 8,000 Income from operations $187,000 Accounts payable 3,200 plus Other income: Cash Gain on sale of land $12,000 785,200 Other expense: A decrease in Inventories (credit Interest expense 8,000 4,000 change) in Accounts Income before income tax and an decrease $ 191,000 Income tax Payable (debit change)83,000 have the Net income $ 108,000

opposite effects.

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Depreciation Changes Total operating expenses 203,000 Debit $Credit Income from operations 187,000 Depreciation expense 7,000 Other income: Accumulated depreciation 7,000 Gain on sale of land $12,000 Other expense: There is no8,000 cash flow Interest expense 4,000for Income before income tax $ 191,000 depreciation expense. Income tax 83,000 Net income $ 108,000

Cash Basis
$1,171,000 (785,200) 0

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales Cost of merchandise sold Gross profit Operating expenses: Depreciation expense Other operating expenses Total operating expenses Cash payments for Income from operating operationsexpenses Other income: expenses Gain on Operating sale of land Other expense: Accrued expenses Interest expense Cash Income before income tax Income tax Net income $1,180,000 790,000 $ 390,000 $ 7,000 196,000 203,000 Changes $ 187,000 Changes Debit Credit 196,000 $12,000 2,200 minus 8,000 193,800 4,000 $ 191,000 83,000 $ 108,000

Cash Basis
$1,171,000 (785,200)

0 (193,800)

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Changes Gain on sale of Operating expenses: investments Debit Credit Depreciation expense $ 7,000 Cash expenses 72,000 Other operating 196,000 Investments 60,000 Total operating expenses 203,000 Gain on sale of invest. 12,000 Income from operations $ 187,000 Other income: Gain on sale of land $12,000 Other expense: Interest expense 8,000 will 4,000 The cash inflow of $72,000 Income before income tax $ 191,000 be shown in the investing section Income tax 83,000 of the statement of cash flows Net income $ and 108,000

Cash Basis
$1,171,000 (785,200)

0 (193,800)

the gain is ignored.

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Cash paid for Changes Other operating expenses 196,000 interestexpenses expense Debit Credit Total operating 203,000 Interest expense Income from operations 8,000 $ 187,000 Cash Other income: Gain on sale of land $12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 There is no interest payable Income tax 83,000 Net income $ year. 108,000 account at the end of the

Cash Basis
$1,171,000 (785,200)

0 (193,800)

0 (8,000)

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Cash paid for Changes Income from operations $ 187,000 income taxes Debit Credit Other income: Income tax expense 83,000 Gain on sale of land $12,000 Income tax payable plus 500 Other expense: Cash Interest expense 8,000 (83,500) 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000

Cash Basis
$1,171,000 (785,200)

0 (193,800)

(8,000) (83,500)

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales Cost of merchandise sold Gross profit Operating expenses: Depreciation expense Other operating expenses Total operating expenses Income from operations Other income: Gain on sale of land Other expense: Interest expense Income before income tax Income tax Net income $1,180,000 790,000 $ 390,000

Cash Basis
$1,171,000 (785,200)

Two different $ 7,000 viewpoints 0 196,000 (193,800) 203,000 from of income $ 187,000 operations
$12,000 8,000

Accrual 4,000 Basis

$ 191,000 83,000 $ 108,000

Cash (8,000) Basis

(83,500) $ 100,500

Operating ActivitiesDirect Method

Cash flows from operating activities:
Cash inflows: Cash received from customers $1,171,000 Cash outflows: Cash payments for merchandise $785,200 Cash payments for operating expenses 193,800 Cash payments for interest 8,000 Cash payments for income tax 83,500 1,070,500 Net cash flow from operating activities $ 100,500

Financial Analysis and Interpretation

Free Cash Flow Dell Corporation $4,195,000

Cash flow from operations Less: Cash used to purchase fixed assets to maintain productive capacity used up in producing income during the period Less: Cash used for dividends Free cash flow Free cash flow as a percent of cash flow from operating activities

(482000) $3,713,000 89%

Financial Analysis and Interpretation

Free Cash Flow Dell Corporation

Cash flow operations $4,195,000 Use: To from measure the financial strength of a Less: Cash used toA purchase fixed business. company that has positive assets to maintain productive free cash flow is able to fund internal capacity used up in producing growth, retire debt, and enjoy income during the period (482000) financial flexibility. Less: Cash used for dividends () Free cash flow $3,713,000 Free cash flow as a percent of cash flow from operations 89%

Chapter 14

The End