Chapter 21

18th
Edition

Statement of
Cash Flows
Revisited

Intermediate
Accounting
James D. Stice

Earl K. Stice
PowerPoint presented by Douglas Cloud
Professor Emeritus of Accounting, Pepperdine
University
2012 Cengage Learning

21-1

Preparing a Statement of Cash Flows in

the Absence of Detailed Transaction Data

If we do not have access to detailed cash

flow information, the preparation of a

statement of cash flows involves analyzing
the income statement and comparative
balance sheets to determine how a
business generated and used cash.
A companys cash inflow and outflow can
be determined through a careful analysis of
each account contained in these
statements.
(continued)

21-2

Preparing a Statement of Cash Flows in

the Absence of Detailed Transaction Data
Accounts
Accounts Receivable
Receivable

To demonstrate two approaches for

gathering information for a statement of
cash flows when we do not have ready
access to detailed cash inflow and outflow
information, we will use Western Reserves
accounts receivable from Exhibit 21-2 (with
the adjustments covered).
(continued)
21-3

Preparing a Statement of Cash Flows in the

Absence of Detailed Transaction Data

How do we explain the change in accounts

receivable from $70,500 to $67,000?
(continued)
21-4

Preparing a Statement of Cash Flows in the

Absence of Detailed Transaction Data
We see from Item (1) that sales on account totaled
$688,800. When sales is credited, the normal debit is to
Accounts Receivable. Lets plug this into the work sheet.

(continued)

21-5

Preparing a Statement of Cash Flows in the

Absence of Detailed Transaction Data

Now we can determine the missing amount.

Accounts Receivable: $70,500 (dr.) + $688,800 ? = $67,000

We solve the equation to find the missing

amount, which is $692,300.
(continued)

21-6

Preparing a Statement of Cash Flows in

the Absence of Detailed Transaction Data
When accounts receivable is credited, we can
assume that cash is debited. Examine entry (2)
in Exhibit 21-2. This is how we arrive at the
debit to cash when the information is not given.

21-7

Preparing a Statement of Cash Flows in

the Absence of Detailed Transaction Data
AASecond
SecondApproach
Approach
Beginning accounts receivable (initial
amount owed to Western Resources)
+ Sales during the year ($688,800 + $65,000)
= Total amount owed to Western Resources
by customers
Ending accounts receivable (amount not
yet collected)
= Cash collections for goods and services
already provided
+ Increase in unearned sales revenue
Total cash collections for the period

$ 70,500
753,800
$824,300
67,000
$757,300
7,000
$764,300
21-8

Preparing a Statement of Cash Flows in

the Absence of Detailed Transaction Data
Western Resources buildings and equipment
account increased from $345,000 to $422,000. A
notes to the financial statement reveal that a
building with a cost of $40,000 and accumulated
depreciation of $26,000 was sold during 2013 for
$10,000. The worksheet line for building and
equipment is shown below.
$345,000 + ? $40,000 = $422,000
$117,000
21-9

6-Step Process for Preparing a

Statement of Cash Flows

1. Compute how much the cash balance

changed during the year.

(continued)
21-10

6-Step Process for Preparing a

Statement of Cash Flows

2. Convert the income statement from an

accrual-basis to a cash-basis summary of
operations.
a) Eliminate expenses that do not involve the
outflow of cash.
b) Eliminate gains and losses associated with
investing or financing activities.
c) Adjust for changes in the balances of
current operating assets and operating
liabilities.
(continued)

21-11

6-Step Process for Preparing a

Statement of Cash Flows

3. Analyze the long-term assets to identify the

cash flow effects of investing activities. Also
examine certain investment securities
accounts.

(continued)

21-12

6-Step Process for Preparing a

Statement of Cash Flows
4. Analyze the long-term debt and
stockholders equity accounts to
determine the cash flow effects of any
financing transactions. Also examine
changes in short-term loan accounts.

(continued)
21-13

6-Step Process for Preparing a

Statement of Cash Flows
5. Make sure that the total net cash flow
from operating, investing, and financing
activities is equal to the net increase or
decrease in cash as computed in step 1.
Then prepare a formal statement of cash
flows by classifying all cash inflows and
outflows according to operating, investing,
and financing activities.

(continued)
21-14

6-Step Process for Preparing a

Statement of Cash Flows
6. Prepare supplemental disclosure,
including the disclosure of any significant
investing or financing transactions that did
not involve cash.

21-15

An Illustration of the
6-Step Process
Step
Step 1:
1: Compute
Compute how
how much
much the
the cash
cash balance
balance
changed
changed during
during the
the year
year
Beginning Cash Balance
Ending Cash Balance
Decrease in cash

$55,000
(50,600)
$ (4,400)

The purpose of the statement of

cash flows is to explain how the
decrease in cash occurred.
(continued)

21-16

An Illustration of the
6-Step Process
Step
Step 2:
2: Convert
Convert the
the Income
Income Statement
Statement from
from an
an
accrual
accrual to
to aa cash-basis
cash-basis summary
summary of
of
operations
operations

Depreciation and amortization (adjustments

A1 and A2). Add the amount of depreciation
and amortization expense back to net income
because no cash flow was associated with
these expenses in the current period.
Add: Depreciation Expense
Amortization Expense
(continued)

$20,900
5,000
21-17

An Illustration of the
6-Step Process
Gains and losses (adjustments B1 and B2).
Subtract the amount of gains and add the
amount of losses because they are included in
the computation of net income. Failure to adjust
for them here would result in counting them
twice.
Add: Loss on sale of building
Less: Gain on sale of long-term
investment

$ 4,000
$(6,500)

(continued)
21-18

An Illustration of the
6-Step Process
Accounts receivable (adjustment C1). The
accounts receivable account decreased
because customers paid for more than they
purchased this year. Thus, Western Resources
exceeded sales by $3,500, which explains why
the accounts receivable account decreased by
$3,500.
Add: Decrease in Accounts
Receivable

$3,500

(continues)
21-19

An Illustration of the
6-Step Process
Unearned sales revenue (adjustment C2).
The unearned sales revenue account increased
by $7,000 (from $25,000 to $32,000),
representing cash received from customers in
2013 that wont be reflected in sales and
included in the computation of net income until
the subsequent year.
Add: Increase in Unearned Sales
Revenue

$7,000

(continued)
21-20

An Illustration of the
6-Step Process
Inventory (adjustment C3). The statement of
cash flows should reflect the amount of cash
paid for inventory during the year, which is not
necessarily the same as the cost of inventory
sold. Western Resources inventory
decreased from $76,500 to $75,000 during
2013, indicating that the amount of inventory
purchased during 2013 was less than the
amount of inventory sold.
Add: Decrease in Inventory
(continued)

$1,500
21-21

An Illustration of the
6-Step Process
Accounts payable (adjustment C4). Western
Resources paid for more than it bought from its
suppliers during the year. The adjustment
necessary to reflect this additional cash outflow
is to subtract $6,700 in computing cash from
operations.
Subtract: Decrease in Accounts
Payable

$(6,700)

(continued)
21-22

An Illustration of the
6-Step Process
Prepaid operating expenses (adjustment
C5). Prepaid operating expenses increased
from $12,000 to $16,500 during 2013. Prepaid
expenses are increased when a company pays
cash in advance for a service that it will use
later.
Subtract: Increase in Prepaid Operating
Expenses
$(4,500)

(continued)
21-23

An Illustration of the
6-Step Process
Restructuring charge (adjustment C6). A
restructuring charge is an accounting estimate
of the decrease in value of some assets and the
creation of future obligations as a result of the
decision to restructure part of the business.
Western Resources restructuring charge of
$11,700 is still unpaid as of the end of the year.
Add: Increase in Obligation for Employee
Severance
$11,700
(continues)
21-24

An Illustration of the
6-Step Process
Interest expense. Because an interest payable
account does not exist on the Western
Resources balance sheet, we can safely
assume that all interest expense was paid for in
cash. Therefore, there is no need for an
adjustment for interest expense.

(continues)
21-25

An Illustration of the
6-Step Process
Income tax expense (adjustments C7 and
C8). The amount of income tax expense
reported in the financial statements is not the
same as the amount of income tax that is
owed to the taxing authorities for the year.
In 2013 the deferred income tax liability for
Western Resources increased by $2,700,
indicating that some of the $24,000 income tax
expense reported wont actually be payable
until some future year.
(continued)

21-26

An Illustration of the
6-Step Process

This means that the income taxes owed for

2013 operations are just $21,300
($24,000 $2,700).

The effect of the increase in the deferred

income tax liability is to reduce the amount of
cash paid for income taxes this year; this is
shown in adjustment C8.

Western Resources balance sheet indicates

that income tax payable decreased by $2,200
during the year (see adjustment C7).
(continued)

21-27

The Indirect and Direct Methods

The indirect method begins with net income

as reported in the income statement and then
details the adjustments needed to arrive at
cash flow from operations.

The direct method involves simply reporting

the information contained in the last column of
the adjusted work sheet.

(continued)

21-28

Illustration of the 6Step Process

Long-Term
Long-Term Investments
Investments

The long-term investments account was reduced

by $96,000 ($106,000 $10,000) during the year.
Since no long-term investments were purchased,
the entire $96,000 reduction represents the book
value of the long-term investments sold during
the year.

(continues)

21-29

Illustration of the 6Step Process

By checking the income statement, we
determine there was a $6,500 gain on the sale
of long-term investments. The cash proceeds of
$102,000 can be determined as follows:
Book value of long-term investments sold
Plus: Gain on sales
Cash proceeds

$ 96,000
6,500
$102,000

21-30

Illustration of the 6Step Process

Land
Land

The land account increased by $108,500

($183,500 $75,000) during the year. Because
there is no indication of land sales during the
year, we conclude that the $108,500 represents
the price of new land purchased during the year.
Supplemental information tells us that payment
was a combination of $68,500 cash and
common stock valued at $40,000.
(continued)
21-31

Illustration of the 6Step Process

Only the $68,500 cash outlay for the land will be
shown in the cash flow statement.
Increase in land account
Less: Payment with common stock
Cash outlay

$108,500
(40,000)
$ 68,500

21-32

Illustration of the 6Step Process

Building
Building and
and Equipment
Equipment

The balance in buildings and equipment account

increased by $77,000 ($422,000 $345,000)
during 2013. A building costing $40,000 was sold
for $10,000 during the year. With this data we
can make the following computation:

Beginning balance
Cost of building and equipment sold during

the year

Ending balance without additional purchases

(continued)

$345,000

(40,000)
$305,000
21-33

Illustration of the 6Step Process

A useful way to summarize all purchase and sale
information for buildings and equipment is to
reconstruct the T-accounts for the buildings and
equipment account and the associated
accumulated depreciation account.

Purchased buildings and equipment for

cash of $117,000.
(continued)

21-34

Illustration of the 6Step Process

With this information, we can compute whether
the sale of buildings and equipment resulted in a
gain or in a loss as follows:
Cash proceeds
Book value of items sold ($40,000 $26,000)
Loss on sale of buildings and equipment

$10,000
(14,000)
$ (4,000)

(continued)
21-35

Illustration of the 6Step Process

The patents account began the year with a
$40,000 balance and ended with a $35,000
balance. The data indicate that no new patents
were purchased during the year. However,
amortization was applied to the patent as shown
below:
Beginning Patents
$40,000
$40,000

Patent amortization recognized during year

(5,000)
(5,000)
0
+
New patents purchased
???
$35,000
Ending Patents
$35,000

21-36

Illustration of the 6Step Process

Although investment securities are now always

long-term assets, their purchase and sale are
sometimes reported as investing activities.

Specifically, purchases and sales of availablefor-sale and held-to-maturity securities are

reported as part of investing activities whereas
purchases and sales of trading securities are
usually part of operating activities.

The balance in the available-for-sale securities

increased by $2,000.
(continued)

21-37

Illustration of the 6Step Process

The Investing Activities section of the statement
of cash flows for Western Resources is as
follows:
Cash flows from investing activities:
Sold building
Assumed
Assumed
Sold long-term investment
available-for-sale
available-for-sale
Purchased available-for-sale
securities
securities
were
securities
were
Purchased land
purchased
purchased
Purchased buildings and equipment
Net cash used by investing activities

$ 10,000
102,500
(2,000)
(68,500)
(117,000)
$ (75,000)

21-38

Illustration of the 6Step Process

Step
Step 4:
4:Analyze
Analyze the
the long-term
long-term debt
debt and
and
stockholders
stockholdersequity
equity accounts
accounts to
to identify
identify the
the
cash
cash flow
flow effects
effects of
of financing
financing transactions
transactions

Western Resources balance in long-term debt

increased by $20,000 ($20,000 0) during the
year. Accordingly, we infer that the company
borrowed an additional $20,000 during 2013, a
a cash provided by financing activity.
(continued)
21-39

Illustration of the 6Step Process

The common stock account increased

$50,000 ($300,000 $250,000) during the
year. We learned earlier that $40,000 of this
increase arose from the exchange of common
stock for land.

The actual cash generated by issuance of

new shares during the year is just $10,000.
This cash inflow is report as part of cash from
financing activities.
(continued)
21-40

Illustration of the 6Step Process

The treasury stock account increased by

$3,200 ($59,700 $56,500) during the year.
Thus, the company should report a cash
outflow of $3,200 from treasury stock
purchases in the Financing Activities section.

The retained earnings account increases from

the recognition of net income, decreases as a
result of net losses, and decreases through
the payment of dividends.
(continued)
21-41

Illustration of the 6Step Process

It is possible to infer the amount of dividends

declared by identifying the unexplained
change in the retained earnings balance. Lets
recreate the retained earnings T-account as
follows:

(continued)
21-42

Illustration of the 6Step Process

The increase in Western Resources dividends
payable account indicates that not all of the
$25,100 in dividends declared were paid in cash
during the year. We can see this in the following
calculation:
Dividends declared
Less: Increase in dividends payable
Cash paid for dividends

$25,100
4,400
$20,700

(continued)
21-43

Illustration of the 6Step Process

The following information summarizes the cash
flow effects of Western Resources financing
activities in 2013:
Cash flows from financing activities:
Issued common stock
Borrowed short-term debt
Borrowed long-term debt
Paid dividends
Treasury stock purchases
Net cash provided by financing activities

$10,000
7,500
20,000
(20,700)
(3,200)
$13,600

21-44

Illustration of the 6Step Process

Step
Step 5:
5: Prepare
Prepare aa formal
formal statement
statement of
of
cash
cash flows
flows

(continued)
21-45

Illustration of the 6Step Process

Step
Step 6:
6: Prepare
Prepare supplemental
supplemental disclosures
disclosures

Three categories of supplemental disclosure

are associated with the statement of cash
flows:
1. Cash paid for interest and income taxes
2. Reconciliation schedule
3. Noncash investing and financing activities
(continued)
21-46

Illustration of the 6Step Process

Cash
Cash Paid
Paid For
For Interest
Interest and
and Income
Income Taxes
Taxes

When the direct method is used, the amount

of cash paid for interest and for income taxes
are part of the Operating Activities section, so
no additional disclosure is needed.

When the indirect method is used, the

amounts must be shown separately at the
bottom of the cash flow statement or in an
accompanying note.
(continued)

21-47

Illustration of the 6Step Process

Reconciliation
Reconciliation Schedule
Schedule

When the direct method is used, a schedule

should be included that reconciles net
income to cash from operations.

The schedule is the same as the Operating

Activities section prepared using the indirect
method.
(continued)
21-48

Illustration of the 6Step Process

Noncash
Noncash Investing
Investing and
and Financing
FinancingActivities
Activities

When a company has a significant noncash

transaction, such as purchasing property,
plant, and equipment by issuing debt or in
exchange for shares of stock, these
transactions must be disclosed in the notes
to the financial statements.

Western Resources exchanged common

stock for land valued at $40,000.
21-49

International Cash Flow Statements

The majority of the FASB decided in pre-

codification SAFS No. 95 that since interest

and dividends received are included in the
computation of net income, they should be
classified as operating activities.
In IAS 7, the IASB allowed companies to
classify interest and dividends received either
as operating or investing activities.
The majority of the FASB members ruled that
interest paid should be treated as an
operating activity.
(continued)

21-50

International Cash Flow Statements

IAS 7 allows dividends paid to be classified

as either a financing activity (as in the U.S.)
or as an operating activity.
According to IAS 7, the amount of income
taxes paid should be reported as an
operating activity unless the income taxes
can be specifically identified with a financing
or investing activity.
(continued)
21-51

International Cash Flow Statements

The U.K. Accounting Standards Board

revised its standards concerning the
statement of cash flows in the revised
version of FRS 1.
The revised version specifies eight different
categories for classifying cash flow
transactions and represents the most
innovate and, probably, the most useful
standard for cash flow reporting currently in
existence in the world.
(continued)

21-52

International Cash Flow Statements

The eight cash flow categories specified in
FRS 1 are as follows:

1. Operating activities
2. Returns on investments and servicing of

finance
3. Taxation
4. Capital expenditures and financial investments
5. Acquisitions and disposals
6. Equity dividends paid
7. Management of liquid resources
8. Financing
21-53

Kamila Software Illustration

Kamila Software develops, produces, and
sells software. The company headquarters is
located in Panaca, Nevada.

(continued)
21-54

Kamila Software Illustration

1. In 2013, Kamila Softwares accounts receivable
balance includes amounts related to both
regular software sales and consulting projects.

(continued)

21-55

Kamila Software Illustration

2. Over the past three years, Kamilas systems
consultants have worked on a total of nine
projects (designated A through I). The total
contract prices, and the amount of revenue
recognized in each year with respect to these
projects are given on Slide 21-57.

(continued)

21-56

Kamila Software Illustration

(continued)

21-57

Kamila Software Illustration

3. Both of Kamilas buildings are leased. Both
leases were signed on January 1, 2010. The
factory is leased under a capital lease
arrangement; the office building is leased under
an operating lease arrangement. The office
building lease payments are $100 per year.
Under the office building lease contract, Kamila
can elect to defer an annual payment for one
year in exchange for a 20% payment surcharge.
The factory lease payment is $30 per year.
(continued)

21-58

Kamila Software Illustration

21-59

Chapter 21

The
The End
End

$
21-60

21-61