Statement of Cash Flows

Chapter 14
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Professor Emeritus of
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Pepperdine University
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 Learning Objective 1

Describe the cash

flow activities
reported in the
statement of cash
flows.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 1

Reporting Cash Flows

 The statement of cash flows reports
a firm’s major cash inflows and
outflows for a period. It provides
useful information about a
company’s ability to do the following:
1. Generate cash from operations
2. Maintain and expand its operating
capacity
3. Meet its financial obligations
4. Pay dividends
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 LO 1

Reporting Cash Flows

 The statement of cash flows reports
cash flows from three types of
activities:
1. Cash flows from operating activities
are cash flows from transactions that
affect net income.
2. Cash flows from investing activities
are cash flows from transactions that
affect investments in the noncurrent
assets of the company.
(continued)
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 LO 1

Reporting Cash Flows

3. Cash flows from financing activities
are cash flows from transactions that
affect the equity and debt of the
company.

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 LO 1
Cash Flows from Operating
Activities
 The direct method reports operating
cash inflows (receipts) and cash
outflows (payments) as follows:
The primary
operating cash
inflow is cash
received from
customers.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 1
Cash Flows from Operating
Activities
 The primary operating cash outflows
are cash payments for merchandise,
operating expenses, interest, and
income tax payments.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 1

Reporting Cash Flows

 The indirect method reports the operating
cash flows by beginning with net income and
adjusting it for revenues and expenses that
do not involve the receipt or payment of cash
as follows:

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 1
Cash Flows from Investing
Activities
 Cash inflows from investing activities
normally arise from selling fixed
assets, investments, and intangible
assets.
 Cash outflows from investing
activities normally include payments
to acquire fixed assets, investments,
and intangible assets.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 1
Cash Flows from Financing
Activities
 Cash inflows from financing activities
normally arise from issuing long-term
debt or equity securities.
 Cash outflows from financing
activities normally include paying
cash dividends, repaying long-term
debt, and acquiring treasury stock.

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 LO 1
Noncash Investing and Financing
Activities
 Noncash investing and financing
activities are transactions that do
not directly affect cash. The effect of
such transactions is recorded in a
separate schedule that appears at
the bottom of the statement of cash
flows.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 1

No Cash Flow Per Share

 Cash flow per share should not be
reported on a company’s financial
statements for the following
reasons:
1. Users may misinterpret cash flow per
share as the per-share amount available
for dividends.
2. Users may misinterpret cash flow per
share as equivalent to earnings per share.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Learning Objective 2

Prepare a
statement of
cash flows, using
the indirect
method.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 2

The Indirect Method

 The indirect method of reporting cash
flows from operating activities uses
the logic that a change in any balance
sheet account (including cash) can be
analyzed in terms of changes in other
balance sheet accounts.
 Any change in the cash account can
be determined by analyzing changes
in liability, stockholders’ equity, and
noncash asset accounts.

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 LO 2

Retained Earnings
 A good starting point for determining
the cash flows from operating
activities is to analyze the Retained
Earnings account.
The Retained Earnings account for Rundell Inc. is
shown below.

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 LO 2

Retained Earnings Rundell, Inc.

The Retained Earnings account for 2012 indicates

that the $80,000 ($108,000 – $28,000) change
resulted from net income and cash dividends. The
net income of $108,000 is the first amount reported
in the Cash Flows from Operating Activities section.

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 LO 2

Adjustments to Net Income

Rundell, Inc.

Cash flows from operating activities:

Net income $108,000
Adjustments to reconcile net income
to net cash flow from operating activities:

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 LO 2

Step 1
 Expenses that do not affect cash are
added. Such expenses decrease net
income, but do not involve cash
payments and, thus, are added to
net income. Examples include
depreciation of fixed assets and
amortization of intangible assets.

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 LO 2

Step 2
 Losses and gains on disposal of
assets are added or deducted. The
disposal (sale) of assets is an
investing activity, rather than an
operating activity.
 Losses on disposal of assets are
added back to net income. Gains on
disposal of assets are deducted from
net income.

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 LO 2

Step 3
 Changes in current operating assets
and liabilities are added or deducted
as follows:
 Increases in noncash current operating
assets are deducted.
 Decreases in noncash current operating
assets are added.
 Increases in current operating liabilities
are added.
 Decreases in current operating liabilities
are deducted.
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 LO 2

Adjustments to Net Income

Rundell, Inc.

Step 1: The account indicates that depreciation for the year

was $7,000 for the building.

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 LO 2

Adjustments to Net Income

Rundell, Inc.

STEP 2. Deduct the gain on the sale of land of $12,000. The

proceeds, which include the gain, are reported in
the Investing section of the statement of cash
flows. Thus, the gain of $12,000 is deducted from
net income in determining cash flows from
operating activities.

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 LO 2

Adjustments to Net Income

Rundell, Inc.

Accounts receivable (net): The $9,000 increase is

deducted from net income. This is because the $9,000
increase in Accounts Receivable indicates that sales
on account were $9,000 more than the cash received
from customers. Thus, sales (and net income) includes
$9,000 that was not received in cash during the year.

(continued)

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 LO 2

Adjustments to Net Income

Rundell, Inc.

Inventories: The $8,000 decrease is added to net

income. This is because the $8,000 decrease in
inventories indicates that the cost of merchandise sold
exceeds the cost of merchandise purchased during the
year by $8,000.
Accounts payable (merchandise creditors): The
$3,200 decrease is deducted from net income. This is
because a decrease in Accounts Payable indicates that
the cash payments to merchandise creditors exceed
the merchandise purchased on account by $3,200.
(continued)
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 LO 2

Adjustments to Net Income

Rundell, Inc.

Accrued expenses payable (operating expenses):

The $2,200 increase is added to net income. This is
because an increase in Accrued Expenses Payable
indicates that operating expenses reported on the
income statement exceed the cash payments for
operating expenses by $2,200.
Income taxes payable: The $500 decrease is
deducted from net income. This is because a decrease
in Income Taxes Payable indicates that taxes paid
exceed the amount of taxes incurred during the year by
$500.
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 LO 2

Dividends Rundell, Inc.

Cash dividends of $28,000 were declared during 2012.

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 LO 2

Dividends Rundell, Inc.

However, as can be seen from the Dividends

Payable account, only $24,000 was paid.

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 LO 2

Common Stock Rundell, Inc.

Rundell Inc.’s Common Stock account increased

by $8,000 during 2012.

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 LO 2

Common Stock Rundell, Inc.

The Paid-in Capital in Excess of Par—Common

Stock account increased by $40,000 during the year.

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 LO 2

Bonds Payable Rundell, Inc.

Bonds Payable decreased by $50,000 during

2012, due to retiring the bonds. A check of
Rundell’s income statement shows that there was
no gain or loss on the retirement.

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 LO 2

Building Rundell, Inc.

The Building account increased by $60,000.

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 LO 2

Land Rundell, Inc.

The $45,000 decline in the Land account was

from two transactions.

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 LO 2

Land Rundell, Inc.

The October 12 transaction is the purchase of land

for cash of $15,000. This transaction is reported as
an outflow of cash in the Investing Activities section.

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 Learning Objective 3

Prepare a
statement of
cash flows, using
the direct
method.

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 LO 3

The Direct Method

 The direct method reports cash flows
from operating activities as follows:

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 LO 3

The Direct Method

 The final amount reported in the
Cash Flows from Operating Activities
section will be the same whether the
direct or indirect method is used. The
methods differ in how the data are
obtained, analyzed, and reported.

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 LO 3

The Direct Method

 Under the direct method, the income
statement is adjusted to cash flows
from operating activities as follows:

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 LO 3

The Direct Method

 Depreciation Expense is not adjusted
or reported as part of cash flows
from operating activities.
 This is because depreciation does not
involve a cash outflow.

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 LO 3

The Direct Method

 Gains and losses are also not
adjusted, because the cash flow from
operating activities is determined
directly, rather than by reconciling
net income.
 Proceeds from the sale of land, which
include any gains or losses, are
reported as an investing activity.

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 LO 3

Cash Received from Customers

Rundell, Inc.

Rundell Inc. reports sales of $1,180,000 for 2010.

To determine the cash received from customers,
sales are adjusted by any increase or decrease in
Accounts Receivable.

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 LO 3
Cash Payments for Operating
Expenses
Rundell, Inc.

Rundell Inc. reports total operating expenses of

$203,000, which includes depreciation of $7,000.
To determine cash payments for operating
expenses, the other operating expenses
(excluding depreciation) of $196,000 are adjusted
for any increase or decrease in Accrued Expenses
Payable.

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 LO 3

Interest Expense Rundell, Inc.

Rundell Inc. reports interest expense of $8,000. To

determine the cash payments for interest, the
$8,000 is adjusted for any increases or decreases
in Interest Payable.

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 LO 3
Cash Payments for Income
Taxes
Rundell, Inc.

Rundell Inc. reports income tax expense of $83,000.

To determine the cash payments for income taxes,
the $83,000 is adjusted for any increases or
decreases in Income Taxes Payable.

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 Learning Objective 4

Describe and
illustrate the use of
free cash flow in
evaluating a
company’s cash
flow.

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 LO 4

Free Cash Flow

 Free cash flow measures the
operating cash flow available for a
company to use after purchasing the
property, plant, and equipment
(PP&E) necessary to maintain current
productive capacity.

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 LO 4

Free Cash Flow

Cash flow from operating activities
Less: Investments in fixed assets
to maintain current
production
Free cash flow

 Positive free cash flow is considered

favorable. A company that has free
cash flow is able to fund internal
growth, retire debt, pay dividends, and
enjoy financial flexibility.

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 LO 4

Free Cash Flow

Research in Motion, Inc., maker of BlackBerry®
smartphones, had cash flow from operating
activities of $1,452 million in a recent fiscal year.
The statement of cash flows indicated that the
cash invested in property, plant, and equipment
was $834 million. The free cash flow would be
computed as follows (in millions):
Cash flow from operating activities $1,452
Less: Investment in PP&E needed to maintain
current production 834
Free cash flow $ 618

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Statement of Cash Flows

The End
Prepared by: C. Douglas
Cloud
Professor Emeritus of
Accounting
Pepperdine University
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.