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Accounting Principles, 6e

Weygandt, Kieso, & Kimmel

Prepared by Marianne Bradford, Ph. D. Bryant College

John Wiley & Sons, Inc.

CHAPTER 18
THE STATEMENT OF CASH FLOWS
After studying this chapter, you should be able to: 1 Indicate the primary purpose of the statement of cash flows. 2 Distinguish among operating, investing, and financing activities. 3 Prepare a statement of cash flows using the indirect method. 4 Prepare a statement of cash flows using the direct method. 5 Analyze the statement of cash flows.

PREVIEW OF CHAPTER 18
THE STATEMENT OF CASH FLOWS

The Statement of Cash Flows: Purpose and Format
 Purpose 

Format

 Meaning

of ―cash flows‖


 

Usefulness
Preparation Indirect & direct methods

 Classifications  Significant

noncash activities

PREVIEW OF CHAPTER 18 THE STATEMENT OF CASH FLOWS Section 1: Indirect Method  Determining net increase/decrease in cash OR Section 2: Direct Method  Determining net increase/decrease in cash  Determining net cash provided/used by operating activities  Determining net cash provided/used by operating activities  Determining net cash provided/used by investing and financing activities  Determining net cash provided/used by investing and financing activities .

PREVIEW OF CHAPTER 18 THE STATEMENT OF CASH FLOWS Analysis of the Statement of Cash Flows  Current  Cash  Cash cash debt coverage ratio return on sales ratio debt coverage ratio .

STUDY OBJECTIVE 1 Indicate the primary purpose of the statement of cash flows. .

2) investing.PURPOSE OF THE STATEMENT OF CASH FLOWS  The primary purpose of the statement of cash flows (SCF) is to provide information about an entity’s cash receipts and cash payments during a period. and 3) financing activities of an entity during a period. but important.  A secondary objective is to provide information about its 1) operating. questions about an enterprise: 1 Where did the cash come from during the period? 2 What was the cash used for during the period? 3 What was the change in the cash balance during the period? .  It provides answers to the following simple.

MEANING OF CASH FLOWS  The SCF is usually prepared using cash and cash equivalents as its basis.  Cash equivalents are short-term. and 2 so near to their maturity that their market value is relatively insensitive to changes in interest rates. highly liquid investments that are both: 1 readily convertible to known amounts of cash. .

STUDY OBJECTIVE 2 Distinguish among operating. investing. . and financing activities.

. 3 Financing activities include a) obtaining cash from issuing debt and repaying the amounts borrowed.CLASSIFICATION OF CASH FLOWS Transactions and other events characteristic of each kind of activity are as follows: 1 Operating activities include the cash effects of transactions that create revenues and expenses. 2 Investing activities include a) acquiring and disposing of investments and productive long-lived assets. and b) lending money and collecting the loans. They thus enter into the determination of net income. and b) obtaining cash from stockholders and providing them with a return on their investment.

CLASSIFICATION OF CASH FLOWS  The category of operating activities is the most important because it shows the cash provided by company operations. 2) Investing activities involve cash flows resulting from changes in investments and long-term asset items. 3) Financing activities involve cash flows resulting from changes in long-term liability and stockholders’ equity items. .  Note the following general guidelines: 1) Operating activities involve income determination (income statement) items.

ILLUSTRATION 18-1 BUSINESS ACTIVITIES SHOWN ON THE STATEMENT OF CASH FLOWS Operating Activities Investing Activities Financing Activities .

ILLUSTRATION 18-1 TYPICAL RECEIPTS AND PAYMENTS CLASSIFIED BY ACTIVITY Types of Cash Inflows and Outflows Operating activities Cash inflows: From sale of goods or services From returns on loans (interest received) and on equity securities (dividends received) Cash outflows: To suppliers for inventory To employees for services To government for taxes To lenders for interest To others for expenses .

ILLUSTRATION 18-1 TYPICAL RECEIPTS AND PAYMENTS CLASSIFIED BY ACTIVITY Investing activities Cash inflows: From sale of property. and equipment From sale of debt or equity securities of other entities From collection of principal on loans to other entities Cash outflows: To purchase property. and equipment To purchase debt or equity securities of other entities To make loans to other entities Financing activities Cash inflows: From sale of equity securities (company’s own stock) From issuance of debt (bonds and notes) Cash outflows: To stockholders as dividends To redeem long-term debt or reacquire capital stock . plant. plant.

4 Exchange of plant assets.  Examples of significant noncash activities are: 1 Issuance of common stock to purchase assets.SIGNIFICANT NONCASH ACTIVITIES  Not all of a company’s significant activities involve cash.  Such activities are reported in either 1 a separate schedule at the bottom of the SCF or 2 in a separate note or supplementary schedule to the financial statements. 2 Conversion of bonds into common stock.  Significant financing and investing activities that do not affect cash are not reported in the body of the SCF. 3 Issuance of debt to purchase assets. .

investing.ILLUSTRATION 18-2 FORMAT OF STATEMENT OF CASH FLOWS The general format of the SCF Is the 3 activities previously discussed – operating. COMPANY NAME Statement of Cash Flows Period Covered Cash flows from operating activities (List of individual items) Net cash provided (used) by operating activities Cash flows from investing activities (List of individual inflows and outflows) Net cash provided (used) by investing activities Cash flows from financing activities (List of individual inflows and outflows) Net cash provided (used) by financing activities Net increase (decrease) in cash Cash at beginning of period Cash at end of period Noncash investing and financing activities (List of individual noncash transactions) XX XXX XX XXX XX XXX XXX XXX XXX XXX . and financing – plus the significant noncash investing and financing activities.

The GAP. J. Sears. Penney Company. Company Kmart Corporation Wal-Mart Stores.FORMAT OF THE STATEMENT OF CASH FLOWS Differences between net income and net cash provided by operating activities are illustrated by the following results from recent annual reports for the same fiscal year (all data are in millions of dollars). Inc. Roebuck and Co. C. The May Department Stores Company Net Income $ 518 4430 1127 594 1948 849 Net Cash from Operations $ 1237 7580 1478 1058 3090 1505 . Inc. Inc.

USEFULNESS OF THE STATEMENT OF CASH FLOWS The information in the SCF should help investors. 4 The cash investing and financing transactions during the period. creditors and others assess the following aspects of the firm’s financial position: 1 The entity’s ability to generate future cash flows. . 3 The reasons for the difference between net income and net cash provided (used) by operating activities. 2 The entity’s ability to pay dividends and meet obligations.

The information to prepare this statement usually comes from 3 sources: 1 Comparative balance sheet. 3 Additional information. 1 It is not prepared from the adjusted trial balance. so the accrual concept is not used in the preparation of the SCF. .PREPARING THE STATEMENT OF CASH FLOWS The SCF is prepared differently from the 3 other basic financial statements. 2 Current income statement. 2 The SCF deals with cash receipts and payments.

+ or XYZ Goods Step 2: Determine net cash provided/used by operating activities. Step 3: Determine net cash provided/used by investing and financing activities. The difference between the beginning and ending cash balances can be easily computed from comparative balance sheets. This step involves analyzing not only the current year’s income statement but also comparative balance sheets and selected additional data. For Sale Investing Financing .ILLUSTRATION 18-3 THREE MAJOR STEPS IN PREPARING THE STATEMENT OF CASH FLOWS Step 1: Determine the net increase/decrease in cash. This step involves analyzing comparative balance sheet data and selected additional information for their effects on cash.

the operating activities section must be converted from accrual basis to cash basis. 1.USAGE OF INDIRECT AND DIRECT METHODS In order to determine net cash provided/used by operating activities.3% Indirect Method . The indirect method is used extensively in practice. This conversion may be accomplished by 1) the indirect method or 2) the direct method. The indirect is favored by companies for 2 reasons: 1) it is easier to prepare and 2) it focuses on the differences between net income and net cash flow from operating activities. as shown below.7% Direct Method 98.

.STUDY OBJECTIVE 3 Prepare a statement of cash flows using the indirect method.

000 cash. 2 The company rented its office space and furniture and rendered consulting services throughout the first year. 2002. when it issued 50. .  First Year of Operations – 2002 1 Computer Services Company started on January 1.SECTION 1 STATEMENT OF CASH FLOWS INDIRECT METHOD  The transactions of the Computer Services Company for 2002 and 2003 are used to illustrate and explain the indirect method of preparing the SCF.000 shares of $1 par value common stock for $50.

1.000 Increase –0– 10.000 Increase –0– 30.000 Increase 20.000 Increase 50. 2002 Increase/Decrease $ –0– $ 34.000 30.000 $ 74.000 $ 74.000 Increase . 2002 $ 34.000 50.000 20. COMPUTER SERVICES COMPANY Comparative Balance Sheets Change Jan. 31. 2002. WITH INCREASES AND DECREASES The comparative balance sheets at the beginning and end of 2002 – showing increases and decreases – are shown below.000 Increase $ –0– Assets Cash Accounts receivable Equipment Total Liabilities and Stockholders’ Equity Accounts payable Common stock Retained earnings Total Dec.000 $ –0– –0– –0– $ –0– $ 4.ILLUSTRATION 18-4 COMPARATIVE BALANCE SHEET.000 10.000 $ 4.

(2) The equipment was purchased at the end of 2002. 2002 The income statement and additional information for Computer Services Company are shown below. No depreciation was taken in 2002. 2002 Revenues Operating expenses Income before income taxes Income tax expense Net income $ 85. COMPUTER SERVICES COMPANY Income Statement For the Year Ended December 31.000 was declared and paid during the year.000 10.000 45.000 $ 35. .000 Additional information: (1) Examination of selected data indicates that a dividend of $15.ILLUSTRATION 18-5 INCOME STATEMENT AND ADDITIONAL INFORMATION.000 40.

the indirect method adjusts net income for items that affect reported net income but do not affect cash. Accrual Basis of Accounting Earned Revenues Cash Basis of Accounting Eliminate noncash revenues Net Income Adjustments to Reconcile Net Income to Net Cash Provided by Operations Net Cash Provided by Operating Activities Incurred Expenses Eliminate noncash expenses . noncash credits are deducted. Noncash charges in the income statement are added back to net income.ILLUSTRATION 18-6 NET INCOME VERSUS NET CASH PROVIDED BY OPERATING ACTIVITIES The indirect method starts with net income and converts it to net cash provided by operating activities. Likewise. The result is to calculate net cash provided by operating activities. In other words.

the increase of $30. but not all of these revenues resulted in an increase in cash.000 in revenues.000 1/1/02 12/31/02 Balance Revenues Balance 55. Computer Services Company had $85.000 30.000 . to convert net income into net cash provided by operating activities.ILLUSTRATION 18-7 ANALYSIS OF ACCOUNTS RECEIVABLE  When accounts receivable increase during the year.  In other words. operations of the period caused revenues to increase. revenues on an accrual basis are higher than are revenues on a cash basis. but collected only $55.000 in accounts receivable must be deducted from net income. ACCOUNTS RECEIVABLE –0– Receipts from customers 85.  Therefore.  Some of increase in revenues had to result in an increase in accounts receivable.  As shown below.000 in cash.

000) of the expenses were paid in cash. only $36. operating expenses on an accrual basis are higher than they are on a cash basis.  Since Accounts Payable increased $4.000 4.000. the increase of $4.ILLUSTRATION 18-8 ANALYSIS OF ACCOUNTS PAYABLE  When accounts payable increase during the year. operating expenses reported in the income statement were $40.  To adjust net income to net cash provided by operating activities.000 1/1/02 Balance Operating expenses 12/31/02 Balance –0– 40.000 must be added to net income.000 ($40.  For Computer Services Company.000.000 – $4.000 . Payments to creditors ACCOUNTS PAYABLE 36.

000 Adjustments to reconcile net income to net cash provided by operating activities: Increase in accounts receivable $ ( 30. any other revenues or expenses reported in the income statement were received or paid in cash.000 . COMPUTER SERVICES COMPANY Partial Statement of Cash Flows — Indirect Method For the Year Ended December 31.000 ( 26.000) Increase in accounts payable 4.000) Net cash provided by operating activities $ 9. 2002 — INDIRECT METHOD  The changes in accounts receivable and accounts payable were the only changes in current assets and current liabilities during the year for Computer Services Company. 2002 Cash flows from operating activities Net income $ 35.  The operating activities section of the SCF for Computer Services Company is shown below.  Therefore.ILLUSTRATION 18-9 PRESENTATION OF NET CASH PROVIDED BY OPERATING ACTIVITIES.

RETAINED EARNINGS 15.000 was declared and paid.000 in Retained Earnings are determined by analysis.000 .000 1/1/02 Balance 12/31/02 Net income 12/31/02 Balance 12/31/02 Cash dividend –0– 35.000. 1 Net income increased Retained Earnings by $35. 2 The additional information below the income statement in Illustration 18-5 indicates that a cash dividend of $15.ILLUSTRATION 18-10 ANALYSIS OF RETAINED EARNINGS The reasons for the net increase of $20. The increase due to net income is reported in the operating activities section while the cash dividend paid is reported in the financing activities section.000 20. This analysis can also be made directly from the Retained Earnings account as shown below.

000 . Purchase of equipment ( 10.000 Cash flows from investing activities $9. 2002 Cash flows from operating activities Net income $ 35.ILLUSTRATION 18-11 STATEMENT OF CASH FLOWS.000 cash.000 cash.000 while financing Payment of cash dividends ( 15.000) 35.000 cash. 2002 — INDIRECT METHOD COMPUTER SERVICES COMPANY Statement of Cash Flows — Indirect Method For the Year Ended December 31.000 Adjustments to reconcile net income to net cash provided by operating activities: Increase in accounts receivable $ ( 30.000 activities provided Net increase in cash 34.000) Operating Increase in accounts payable 4.000) Net cash provided by operating activities activities provided 9.000 ( 26.000) Cash flows from financing activities used $10. Cash at beginning of period –0 – Cash at end of period $ 34.000 $35. Issuance of common stock 50.000) investing activities Net cash used by investing activities ( 10.

WITH INCREASES AND DECREASES The comparative balance sheets at the beginning and end of 2003 – showing increases and decreases – are shown to the right.000 Increase $ 59.000 Decrease 4.000 2002 $ 34.000 Increase 17.000 Increase – 0– 124.000 $ $ 4.000 20.000 ( 3.000) $ 383.000 –0– –0– –0– –0– 10.000 30.000 130.000 $ 383.000 50.000 20.000 Increase 160.000 4.000 130.000 Change Increase/Decrease $ 22.000 Increase 130.000 ( 11.000 Increase 3.000 Increase 10.ILLUSTRATION 18-12 COMPARATIVE BALANCE SHEET.000 144.000) 27. 2003.000 –0– $ 74.000 –0– $ 55.000 160. COMPUTER SERVICES COMPANY Comparative Balance Sheets December 31 Assets Cash Accounts receivable Prepaid expenses Land Building Accumulated depreciation – building Equipment Accumulated depreciation – equipment Total Liabilities and Stockholders’ Equity Accounts payable Bonds payable Common stock Retained earnings Total 2003 $ 56.000 Increase 11.000 Increase .000 Increase 130.000 –0– 50.

less accumulated depreciation of $1.000 $ 261.000 The income statement and additional information for 2003 for Computer Services Company are shown to the right.000 (cost $8. (2) The company obtained land through the issuance of $130.000 was also purchased for cash.000 $ 139.000 cash dividend. the company sold equipment with a book value of $7.000. the company declared and paid a $15.000 15. 2003 COMPUTER SERVICES COMPANY Income Statement For the Year Ended December 31. equipment costing $25. .000 3.000 Additional information: (1) In 2003. (4) During 2003.000 228.000 cash.ILLUSTRATION 18-13 INCOME STATEMENT AND ADDITIONAL INFORMATION.000 89.000) for $4. 2003 Revenues Operating expenses (excluding depreciation) Depreciation expense Loss on sale of equipment Income from operations Income tax expense Net income $ 507. (3) A building costing $160. 279.000 was purchased for cash.000 of long-term bonds.

000.000 as a result a sale of some equipment.  The T-account below provides information about the changes that occurred in this account in 2003.000 .000).ILLUSTRATION 18-14 ANALYSIS OF ACCUMULATED DEPRECIATION — EQUIPMENT  The increase in Accumulated Depreciation – Equipment was $3.000 + $1.000 Depreciation expense 12/31/03 Balance –0– 4.000 3.  This amount is added to net income to determine net cash provided by operating activities. which does not represent depreciation expense for the year since the account was debited $1.000 ($3.  Depreciation expense for 2003 was $4. ACCUMULATED DEPRECIATION — EQUIPMENT Accumulated depreciation on 1/1/03 Balance equipment sold 1.

000 as calculated below.000 Increase in prepaid expenses ( 4. 2003 — INDIRECT METHOD Net cash provided by operating activities for 2003 is $218. COMPUTER SERVICES COMPANY Partial Statement of Cash Flows — Indirect Method For the Year Ended December 31.000 79.000 Net cash provided by operating activities $ 218.ILLUSTRATION 18-15 PRESENTATION OF NET CASH PROVIDED BY OPERATING ACTIVITIES.000 .000) Increase in accounts payable 55. 2003 Cash flows from operating activities Net income $ 139.000 Decrease in accounts receivable 10.000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense $ 15.000 Loss on sale of equipment 3.

These transactions are classified as investing activities and each should be reported separately.000.000 for $4.000.000 1/1/03 12/31/03 Balance Purchase of equipment Balance 8.000.000 27. EQUIPMENT 10.000 .000 Cost of old equipment 25. The purchase of equipment should therefore be reported as an outflow of cash for $25. The T-account below shows the reasons for the change in this account during the year. which was a net increase that resulted from 2 transactions: 1) a purchase of equipment of $25.ILLUSTRATION 18-16 ANALYSIS OF EQUIPMENT Equipment increased $17.000 and the sale should be reported as an inflow of cash for $4.000 and 2) the sale of equipment costing $8.

000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense $ 15.000) Increase in accounts payable 55. 2003 Cash flows from operating activities Net income $ 139.000 79.000 Decrease in accounts receivable 10. 2003 — INDIRECT METHOD COMPUTER SERVICES COMPANY Statement of Cash Flows For the Year Ended December 31.000 Increase in prepaid expenses ( 4.000 Net cash provided by operating activities 218.ILLUSTRATION 18-17 STATEMENT OF CASH FLOWS.000 Loss on sale of equipment 3.000 .

000) ( 15.000) 4. 2003 — INDIRECT METHOD Cash flows from investing activities Purchase of building Purchase of equipment Sale of equipment Net cash used by investing activities Cash flows from financing activities Payment of cash dividends Net cash used by financing activities Net increase in cash Cash at beginning of period Cash at end of period Noncash investing and financing activities Issuance of bonds payable to purchase land $(160.000 (181.000) ( 15.000 34.ILLUSTRATION 18-17 STATEMENT OF CASH FLOWS.000 $ 130.000) 22.000 $ 56.000) ( 25.000 .

It then adds or deducts items not affecting cash to arrive at net cash provided by operating activities. A summary of the adjustments for current assets and current liabilities is provided in Illustration 18-18.ILLUSTRATION 18-18 ADJUSTMENTS FOR CURRENT ASSETS AND CURRENT LIABILITIES The SCF prepared by the indirect method starts with net income. Adjustments to Convert Net Income to Net Cash Provided by Operating Activities Add to Deduct from Net Income Net Income Decrease Increase Decrease Increase Decrease Increase Increase Decrease Increase Decrease Current Assets and Current Liabilities Accounts receivable Inventory Prepaid expenses Accounts payable Accrued expenses payable . The additions and deductions consist of: 1) changes in specific current assets and current liabilities and 2) noncash charges reported in the income statement.

Noncash Charges Depreciation expense Patent amortization expense Depletion expense Loss on sale of asset Adjustments to Convert Net Income to Net Cash Provided by Operating Activities Add Add Add Add .ILLUSTRATION 18-19 ADJUSTMENTS FOR NONCASH CHARGES Adjustments for the noncash charges reported in the income statement are made as shown in Illustration 18-19.

STUDY OBJECTIVE 4

Prepare a statement of cash flows using the direct method.

SECTION 2 STATEMENT OF CASH FLOWS DIRECT METHOD
 The transactions of Juarez Company for 2002 and 2003 are used to illustrate and explain the indirect method of preparing the SCF.  First Year of Operations – 2002 1 Juarez Company started on January 1, 2002, when it issued 300,000 shares of $1 par value common stock for $300,000 cash. 2 The company rented its office, sales space, and equipment.

ILLUSTRATION 18-20
COMPARATIVE BALANCE SHEET, 2002, WITH INCREASES AND DECREASES
The comparative balance sheets at the beginning and end of 2002– showing increases and decreases – are shown to the right.
JUAREZ COMPANY Comparative Balance Sheet Change Increase/Decrease $ 159,000 Increase 15,000 Increase 160,000 Increase 8,000 Increase 80,000 Increase

Assets Cash Accounts receivable Inventory Prepaid expenses Land Total Liabilities and Stockholders’ Equity Accounts payable Accrued expenses payable Common stock Retained earnings Total

Dec. 31, 2002 $ 159,000 15,000 160,000 8,000 80,000 $ 422,000

Jan. 1, 2002 $ –0 – –0 – –0 – –0 – –0 – $ –0 –

$ 60,000 20,000 300,000 42,000 $ 422,000

$ –0– $ 60,000 Increase –0 – 20,000 Increase –0 – 300,000 Increase –0 – 42,000 Increase $ –0 –

JUAREZ COMPANY Income Statement For the Year Ended December 31.000 $ 112.000 330. 2002 Revenues from sales Cost of goods sold Gross profit Operating expenses Income before income taxes Income tax expense Net income $ 780.ILLUSTRATION 18-21 INCOME STATEMENT AND ADDITIONAL INFORMATION. (2) The accounts payable increase resulted from the purchase of merchandise.000 160. 2002 The income statement and additional information for Juarez Company are shown below.000 48.000 450.000 were declared and paid in cash.000 170.000 Additional information: (1) Dividends of $70. .

ILLUSTRATION 18-22 MAJOR CLASSES OF CASH RECEIPTS AND PAYMENTS Cash Receipts – Cash Payments = Net Cash Provided by Operating Activities To suppliers From sales of goods and services to customers To employees For operating expenses Net cash provided by operating activities For interest and dividends From receipts of interest and dividends on loans and investments For taxes .

.000.CASH RECEIPTS FROM CUSTOMERS  The income statement for Juarez Company reported revenues from customers of $780.  Conversely.  To determine the amount of cash receipts. the increase in accounts receivable is deducted from sales revenues. a decrease in accounts receivable is added to sales revenues. since cash receipts from customers exceed sales revenues.

000. Revenues from sales Deduct: Increase in accounts receivable Cash receipts from customers Computation of Cash Receipts from Customers $ 780.000.000 15.000 $ 765. accounts receivable increased $15. calculated as shown Illustration 18-24 in Illustration 18-23.000 .ILLUSTRATION 18-23 COMPUTATION OF CASH RECEIPTS FROM CUSTOMERS For Juarez Company. so that cash receipts from customers were $765.

000 .000 1/1/02 12/31/02 765. Illustration 18-25 Analysis of Accounts Receivable ACCOUNTS RECEIVABLE Balance –0– Receipts from customers Revenues from sales 780.ILLUSTRATION 18-24 ANALYSIS OF ACCOUNTS RECEIVABLE Cash receipts from customers may also be determined from an analysis of Accounts Receivable as shown in Illustration 18-24.000 Balance 15.

and changes in accounts receivable are shown in Illustration 18-25.ILLUSTRATION 18-25 FORMULA TO COMPUTE CASH RECEIPTS FROM CUSTOMERS — DIRECT METHOD The relationships among cash receipts from customers. Cash receipts from customers = Revenues from sales { + Decrease in accounts receivable or – Increase in accounts receivable . revenues from sales.

000. In 2002. Juarez Illustration 18-27 Company’s inventory increased $160.000.000 .000 160. To determine purchases. Purchases are calculated in Cost of goods sold Add: Increase in inventory Purchases $ 450. An increase (decrease) in inventory is added to (deducted from) cost of goods sold to arrive at purchases.000 $ 610. Computation of Illustration Purchases 18-26. cost of goods sold must be adjusted for the change in inventory.ILLUSTRATION 18-26 COMPUTATION OF PURCHASES Juarez Company reported cost of goods sold on its income statement of $450.

000 .000 $ 550. Cash payments to Illustrationin 18-28 suppliers are calculated Illustration 18-27.000 60. Computation of Cash Payments to Suppliers Purchases Deduct: Increase in accounts payable Cash payments to suppliers $ 610.ILLUSTRATION 18-27 COMPUTATION OF CASH PAYMENTS TO SUPPLIERS Cash payments to suppliers are then determined by adjusting purchases for the change in accounts payable. An accounts payable increase (decrease) is deducted from (added to) purchases.

000 1/1/02 Balance Purchases 12/31/02 Balance Payments to creditors –0– 610.000 .ILLUSTRATION 18-28 ANALYSIS OF ACCOUNTS PAYABLE Cash payments to suppliers may also be determined from an analysis of Accounts Payable as shown in Illustration 18-28.000 60. Illustration 18-29 Analysis of Accounts Payable ACCOUNTS PAYABLE 550.

changes in inventory. and changes in accounts payable is shown in Illustration 18-29. Cash payments to suppliers = Cost of goods sold { + Increase in inventory + Decrease in accounts payable or or – Decrease in inventory – Increase in accounts payable { . cost of goods sold.ILLUSTRATION 18-29 FORMULA TO COMPUTE CASH PAYMENTS TO SUPPLIERS — DIRECT METHOD The relationship among cash payments to suppliers.

000 must be added to operating expenses. while a decrease would be added. The increase in accrued expenses of $20.000) $ 158.000 . Juarez Company’s cash payments for operating expenses are calculated in Illustration 18-31 Illustration 18-30.000 8.ILLUSTRATION 18-30 COMPUTATION OF CASH PAYMENTS FOR OPERATING EXPENSES Operating expenses of $170. Computation of Cash Payments for Operating Expenses Operating expenses Add: Increase in prepaid expenses Deduct: Increase in accrued expenses payable Cash payments for operating expenses $ 170.000 ( 20.000 were reported on Juarez’s income statement. A decrease in prepaid expenses would be deducted from operating expenses.000 must be deducted. To convert operating expenses to cash payments for operating expenses. the increase in prepaid expenses of $8.

Decrease in prepaid expenses + Decrease in accrued expenses payable or .ILLUSTRATION 18-31 FORMULA TO COMPUTE CASH PAYMENTS FOR OPERATING EXPENSES — DIRECT METHOD Operating expenses Cash payments for operating expenses = + Increase in prepaid expenses or .Increase in accrued expenses payable .

000 .  The operating activities section of the SCF is shown below.000 756. JUAREZ COMPANY Partial Statement of Cash Flows — Direct Method For the Year Ended December 31.ILLUSTRATION 18-32 OPERATING ACTIVITIES SECTION — DIRECT METHOD  All of the revenues and expenses in the 2002 income statement have now been adjusted to cash basis.000 158.000 48.000 $ 550.000 $ 9. 2002 Cash flows from operating activities Cash receipts from customers Cash payments: To suppliers For operating expenses For income taxes Net cash provided by operating activities $ 765.

2 The additional information below the income statement in Illustration 18-21 indicates that a cash dividend of $70.000 was declared and paid.000 1/1/02 Balance 12/31/02 Net income 12/31/02 Balance 12/31/02 Cash dividend –0– 112.000 in Retained Earnings are determined by analysis.000 . This analysis can also be made directly from the Retained Earnings account as shown below.ILLUSTRATION 18-33 ANALYSIS OF RETAINED EARNINGS The reasons for the net increase of $42. The increase due to net income is reported in the operating activities section while the cash dividend paid is reported in the financing activities section.000 42. RETAINED EARNINGS 70.000. 1 Net income increased Retained Earnings by $112.

000 .000 cash.000 158.000 ( 80.000) ( 80. 2002 Cash flows from operating activities Cash receipts from customers Cash payments: To suppliers For operating expenses For income taxes Net cash provided by operating activities Cash flows from investing activities Purchase of land Net cash used by investing activities Cash flows from financing activities Issuance of common stock Payment of cash dividend Net cash provided by financing activities Net increase in cash Cash at beginning of period Cash at end of period The SCF for 2002 for Juarez Company shows that operating activities provided $9.000 ( 70.000) 9. while financing activities provided $230.000 (756. $ 765.000 48.000 cash. investing activities used $80.000 cash.000 –0– $ 159.ILLUSTRATION 18-34 STATEMENT OF CASH FLOWS. 2002 — DIRECT METHOD JUAREZ COMPANY Statement of Cash Flows — Direct Method For the Year Ended December 31.000 159.000 $ 550.000) 300.000) 230.

000 12.000 6.000 Increase 16. JUAREZ COMPANY Comparative Balance Sheet December 31 Assets Cash Accounts receivable Inventory Prepaid expenses Land Equipment Accumulated depreciation – equipment Total 2003 $ 191.000 Change Increase/Decrease $ 32.000 8.000 Decrease 100.000 Decrease 30.0000 80.000 ( 16.000 15.000 Increase 160.000 – 0– – 0– $ 422.000 Decrease 2.000) $ 663. WITH INCREASES AND DECREASES The comparative balance sheets at the beginning and end of 2003 – showing increases and decreases – are shown below.000 Increase 3.000 130. 2003.000 Increase .ILLUSTRATION 18-35 COMPARATIVE BALANCE SHEET.000 180.000 2002 $ 159.000 160.000 160.

000 Decrease –0– 12.000 6.000 130.000 100.000 $ 663.000 12.000 $ 32.000 Decrease 100.000 $ 422.000 Decrease 20.000 Decrease 2.000) $ 663.0000 80.000 Increase JUAREZ COMPANY Comparative Balance Sheet December 31 $ 52.ILLUSTRATION 18-35 COMPARATIVE BALANCE SHEET.000 400.000 Increase 3.000 180.000 15.000 90.000 Decrease 30.000 160.000 Increase 300.000 160.000 $ 60.000 5.000 8.000 ( 16.000 Increase –0– 90.000 . Change WITH INCREASES AND DECREASES Assets 2000 1999 Increase/Decrease Cash Accounts receivable Inventory Prepaid expenses Land Equipment Accumulated depreciation – equipment Total Liabilities and Stockholders’ Equity Accounts payable Accrued expenses payable Income taxes payable Bonds payable Common stock Retained earnings Total $ 191.000 –0– –0– $ 422.000 Increase 52.000 Increase 42. 2003.000 15.000 94.000 $ 159.000 Increase 160.000 $ 8.000 12.000 Increase 16.

000. 2003 Revenues from sales $ 975.000 Income before income taxes 120. . the company declared and paid a $32. (5) Common stock of $100.000 was purchased for cash. (3) Equipment costing $180.000 Additional information: (1) In 2003.000 Depreciation expense 18.000 Cost of goods sold $ 660. (2) Bonds were issued at face value for $90.000 in cash.000 Loss on sale of store equipment 1.000 The income statement and Income tax expense 36.000 cash when the book value of the Equipment was $18.000 Net income additional information for 2003 $ 84. for Juarez Company are shown.000 855.000 was issued to acquire land. 2003 JUAREZ COMPANY Income Statement For the Year Ended December 31.000 cash dividend. (4) Equipment costing $20.ILLUSTRATION 18-36 INCOME STATEMENT AND ADDITIONAL INFORMATION.000 was sold for $17.000 Operating expenses (excluding depreciation) 176.

000.000 3.000.ILLUSTRATION 18-37 COMPUTATION OF CASH RECEIPTS FROM CUSTOMERS Revenues from sales were $975.000.000 $ 978. Cash receipts from customers were $978. Revenues from sales Add: Decrease in accounts receivable Cash receipts from customers $ 975. as calculated below.000 . Cash receipts from customers were greater than sales revenues since accounts receivable decreased $3.

ILLUSTRATION 18-38 COMPUTATION OF CASH PAYMENTS TO SUPPLIERS Purchases are calculated using cost of goods sold of $660.000 8. Purchases are then adjusted by the accounts payable decrease of $8.000.000. Cash payments Illustration 18-39 to suppliers are calculated Illustrationto 18-38.000 $ 638.000 30.000 is deducted from cost of goods sold.000 630. The inventory decrease of $30. Computation of Cashin Payments Suppliers Cost of goods sold Deduct: Decrease in inventory Purchases Add: Decrease in accounts payable Cash payments to suppliers $ 660.000 .

000 ( 2.000 decrease in accrued expenses payable is added in determining cash payments for operating expenses.000 decrease in prepaid expenses is deducted and the $5.000 $ 179. The $2.000 . as shown in Illustration 18-39.000) 5.ILLUSTRATION 18-39 COMPUTATION OF CASH PAYMENTS FOR OPERATING EXPENSES Operating expenses (exclusive of depreciation expense) was $176.000 for 2000. exclusive of depreciation Deduct: Decrease in prepaid expenses Add: Decrease in accrued expenses payable Cash payments for operating expenses $ 176. Illustration 18-40 Computation of Cash Payments for Operating Expenses Operating expenses.

000 . Computation of Cash Payments for Income Taxes Income tax expense Deduct: Increase in income taxes payable Cash payments for income taxes $ 36. The $12.ILLUSTRATION 18-40 COMPUTATION OF CASH PAYMENTS FOR INCOME TAXES Income tax expense reported on the income statement was $36.000 12.000 increase in income taxes payable must be deducted from income tax expense to determine cash payments for income taxes.000. Cash payments for income taxes were Illustration 18-41 $24.000 $ 24.000 as shown in Illustration 18-40.

income tax expense. Cash payments for income taxes = Income tax expense { + Decrease in income taxes payable or – Increase in income taxes payable . and changes in income taxes payable are shown in the formula in Illustration 18-41.ILLUSTRATION 18-41 FORMULA TO COMPUTE CASH PAYMENTS FOR INCOME TAXES — DIRECT METHOD The relationships among cash payments for income taxes.

000 sale of equipment as an inflow of cash. 1/1/03 12/31/03 Balance Cash purchase Balance EQUIPMENT –0– Cost of equipment sold 180.000 cash when its book value was $18.000 .000.000 in 2003.000 was purchased for cash and 2) equipment costing $20.000 160.000 was sold for $17. the investing activities section will show: 1) the $180. The additional information in Illustration 1836 that the increase resulted from 2 investing transactions: 1) equipment costing $180.000 purchase of equipment as an outflow of cash and 2) the $17.000 20.ILLUSTRATION 18-42 ANALYSIS OF EQUIPMENT AND RELATED ACCUMULATED DEPRECIATION The comparative balance sheet shows that Equipment increased $160. For Juarez Company.

000 1/1/03 Balance Depreciation expense 12/31/03 Balance –0– 18.ILLUSTRATION 18-42 ANALYSIS OF EQUIPMENT AND RELATED ACCUMULATED DEPRECIATION Sale of equipment ACCUMULATED DEPRECIATION — EQUIPMENT 2.000 .000 16.

000 32.000 ( 32.000) 90.000 179.000) 58.000 (180.000 (163. 2003 Cash flows from operating activities Cash receipts from customers Cash payments: To suppliers For operating expenses For income taxes Net cash provided by operating activities Cash flows from investing activities Purchase of equipment Sale of equipment Net cash used by investing activities Cash flows from financing activities Issuance of bonds payable Payment of cash dividend Net cash provided by financing activities Net increase in cash $ 978.000 24.000) 137.000 .000 $ 638.ILLUSTRATION 18-43 STATEMENT OF CASH FLOWS.000) 17. 2003 — DIRECT METHOD JUAREZ COMPANY Statement of Cash Flows — Direct Method For the Year Ended December 31.000 (841.

2003 Cash flows from operating activities Cash receipts from customers $ 978. 2000 (180.000 24.000 32.000 $ 191.000 ( 32.000) 17.000 JUAREZ COMPANY Statement of Cash Flows — Direct Method For the Year Ended December 31.000 $ 100.000 179.000 .000 (841.000 (163.ILLUSTRATION 18-43 STATEMENT OF CASH FLOWS.000) 137.000 159.000) 58.000) 90.000 — DIRECT METHOD Cash payments: To suppliers For operating expenses For income taxes Net cash provided by operating activities Cash flows from investing activities Purchase of equipment Sale of equipment Net cash used by investing activities Cash flows from financing activities Issuance of bonds payable Payment of cash dividend Net cash provided by financing activities Net increase in cash Cash at beginning of period Cash at end of period Noncash investing and financing activities Issuance of common stock to purchase land $ 638.

.STUDY OBJECTIVE 5 Analyze the statement of cash flows.

Inc. INC.390 9. DATA USED IN FLOW ANALYSIS CASH The GAP.635 1. ($ in millions) Fiscal 2000 Fiscal 1999 Current Liabilities Total Liabilities Net Sales Net Cash provided by operating activities $1.394 .553 2.753 2.054 1. reported the following information in its 2000 annual report: Gap. Inc.956 11.478 $1.ILLUSTRATION 18-45 THE GAP.

for 2000 is calculated below. Inc.89:1 . Such year-end balances may not be representative of the company’s current position during most of the year.553 ———————— = .753 + $1. The current cash debt coverage ratio for The GAP. Net Cash Provided by Operating Activities   ÷ Average Current Liabilities Current Cash Debt Coverage Ratio $1.ILLUSTRATION 18-45 CURRENT CASH DEBT COVERAGE RATIO A disadvantage of the current ratio is that it employs year-end balances of current asset and current liability accounts. The current cash debt coverage ratio partially corrects this problem and is calculated by dividing average current liabilities into net cash provided by operating activities.478 2 $1.

ILLUSTRATION 18-46 CASH RETURN ON SALES RATIO The cash return on sales ratio is the cash based ratio that is the counterpart of the profit margin percentage.478 ÷ $11. This ratio is calculated by dividing net sales into net cash provided by operating activities. Inc. The current return on sales ratio for The GAP. Net Cash Provided by Operating Activities   Net Sales Cash Return on Sales Ratio $1.635 = 13% . for 2000 is calculated below.

390 ———————— = .55:1 .478 2 $2. without having to liquidate the assets it employs. for 2000 is calculated below.ILLUSTRATION 18-47 CASH DEBT COVERAGE RATIO The cash basis measure of solvency is the cash debt coverage ratio – the ratio of net cash provided by operating activities to average total liabilities. The cash debt coverage ratio for The GAP. This ratio demonstrates a company’s ability to repay its liabilities from net cash provided by operating activities.956 + $2. Net Cash Provided by Operating Activities   ÷ Average Total Liabilities Cash Debt Coverage Ratio $1. Inc.

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CHAPTER 18 THE STATEMENT OF CASH FLOWS .