Preparing The Statement of Cash Flows

Preparing the Statement of Cash Flows
Additional information for 2011:

1. The company declared and paid a $29,000 cash dividend.
2. Issued $110,000 of long-term bonds in direct exchange for land.
3. A building costing $120,000 and equipment costing $25,000 were
purchased for cash.
4. The company sold equipment with a book value of $7,000 (cost
$8,000, less accumulated depreciation $1,000) for $4,000 cash.
5. Issued ordinary shares for $20,000 cash.
6. Depreciation expense was comprised of $6,000 for building and
$3,000 for equipment.
Slide
13-1
SO 3 Prepare a statement of cash flows using the indirect method.
Indirect
Step 1: Operating Activities Method
Determine net cash provided/used by operating activities

by converting net income from an accrual basis to a cash
basis.
Common adjustments to Net Income (Loss):

Add back non-cash expenses (depreciation and
amortization expense).
Deduct gains and add losses that resulted from investing
and financing activities.
Analyze changes in non-cash current assets and current
Slide liabilities.
13-2
Operating Activities
Question
Which is an example of a cash flow from an operating
activity?
a. Payment of cash to lenders for interest.
b. Receipt of cash from the sale of shares.
c. Payment of cash dividends to the company’s
shareholders.
d. None of the above.
Slide
13-3
Depreciation Expense
Although depreciation expense reduces net income, it does not
reduce cash.
Illustration 13-7
Slide
13-4
Loss on Sale of Equipment

Because companies report as a source of cash in the investing
activities section the actual amount of cash received from the
sale:
Any loss on sale is added to net income in the operating

section.
Any gain on sale is deducted from net income in the

operating section.
Slide
13-5
Loss on Sale of Equipment
Computer Services’ income statement reports a $3,000 loss on

the sale of equipment (book value $7,000, less $4,000 cash
received from sale of equipment).
Illustration 13-8
Slide
13-6
Changes to Non-Cash Current Asset Accounts

When the Accounts Receivable balance decreases, cash
receipts are higher than revenue earned under the accrual
basis.
Illustration 13-9
Accounts Receivable
1/1/011 Balance 30,000 Receipts from customers 517,000

Revenues 507,000
12/31/11 Balance 20,000
Therefore, the company adds to net income the amount of the

decrease in accounts receivable.
Slide
13-7

Illustration 13-10
Cash flows from operating activities:
Net income $ 145,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense 9,000
Loss on sale of equipment 3,000
Decrease in accounts receivable 10,000
Net cash provided by operating activities $ 167,000
Slide
13-8

When the Inventory balance increases, the cost of
merchandise purchased exceeds the cost of goods sold.
Merchandise Inventory
1/1/11 Balance 10,000 Cost of goods sold 150,000

Purchases 155,000
12/31/11 Balance 15,000
As a result, cost of goods sold does not reflect cash payments

made for merchandise. The company deducts from net income
this inventory increase.
Slide
13-9

Illustration 13-10
Increase in inventory (5,000)
Slide
13-10

When the Prepaid Expense balance increases
 Cash paid for expenses is higher than expenses reported on

an accrual basis.
 Company deducts the increase from net income to arrive at

net cash provided by operating activities.
If prepaid expenses decrease, reported expenses are higher

than the expenses paid.
Slide
13-11

Illustration 13-10
Increase in prepaid expenses (4,000)
Slide
13-12
Changes to Non-Cash Current Liability Accounts

When Accounts Payable increases
 Company received more in goods than it actually paid for.
 Increase is added to net income.
When Income Tax Payable decreases

 Income tax expense was less than the amount of taxes paid
during the period.
 Decrease is subtracted from net income.
Slide
13-13
Changes to Non-Cash Current Liability Accounts

Illustration 13-11
Increase in accounts payable 16,000
Decrease in income taxes payable (2,000)
Slide
13-14
Summary of Conversion to Net

Illustration 13-12
Cash Provided by Operating
Activities—Indirect Method
Slide
13-15
Step 2: Investing and Financing Activities
From the additional information, the company purchased land of
$110,000 by issuing long-term bonds. This is a significant
noncash investing and financing activity that merits disclosure in
a separate schedule.
Land
1/1/11 Balance 20,000
Issued bonds 110,000
12/31/11 Balance 130,000
Bonds Payable
1/1/11 Balance 20,000
For land 110,000
12/31/11 Balance 130,000
Slide
13-16
Investing and Financing Activities
Partial statement Illustration 13-14
Net cash provided by operating activities 172,000

Cash flows from investing activities:
Purchase of building (120,000)
Purchase of equipment (25,000)
Sale of equipment 4,000
Net cash used by investing activities (141,000)
Cash flows from financing activities:
Issuance of ordinary shares 20,000
Payment of cash dividends (29,000)
Net cash used by financing activities (9,000)
Net increase in cash 22,000
Cash at beginning of period 33,000
Cash at end of period $ 55,000
Disclosure: Issuance of bonds to purchase land $ 110,000
Slide
13-17
From the additional information, the company acquired an office

building for $120,000 cash. This is a cash outflow reported in
the investing section.
Building
1/1/11 Balance 40,000

Office building 120,000
12/31/11 Balance 160,000
Slide
13-18
Partial statement Illustration 13-14

Slide
13-19
The additional information explains that the equipment increase
resulted from two transactions: (1) a purchase of equipment of
$25,000, and (2) the sale for $4,000 of equipment costing $8,000.
Equipment
1/1/11 Balance 10,000 Equipment sold 8,000

Purchase 25,000
12/31/11 Balance 27,000
Cash 4,000
Journal Accumulated depreciation 1,000
Entry Loss on sale of equipment 3,000
Equipment 8,000
Slide
13-20
Statement Net income
$ 145,000
of Cash provided by operating activities:

Flows Loss on sale of equipment 3,000
Indirect Increase in accounts payable 16,000
Method Decrease in income taxes payable (2,000)
Illustration 13-14 Cash at end of period $ 55,000
Slide
13-21
The additional information notes that the increase in share

capital - ordinary resulted from the issuance of new shares.
Ordinary Shares
1/1/11 Balance 50,000

Shares sold 20,000
12/31/11 Balance 70,000
Slide
13-22
Illustration 13-14
Partial statement
Slide
13-23
Retained earnings increased $116,000 during the year. This

increase can be explained by two factors: (1) Net income of
$145,000 increased retained earnings. (2) Dividends of $29,000
decreased retained earnings
Retained Earnings
1/1/11 Balance 48,000

Dividends 29,000 Net income 145,000
12/31/11 Balance 164,000
Slide
13-24
Illustration 13-14
Statement Net income
$ 145,000
of Cash provided by operating activities:

Flows Loss on sale of equipment 3,000
Indirect Increase in accounts payable 16,000
Method Decrease in income taxes payable (2,000)
Step 3: Net Payment of cash dividends
Net cash used by financing activities
(29,000)
(9,000)
Change in Net increase in cash
Cash at beginning of period
22,000
33,000
Cash Cash at end of period $ 55,000
Slide
13-25 SO 3 Prepare a statement of cash flows using the indirect method.
Question
Which is an example of a cash flow from an investing
activity?
a. Receipt of cash from the issuance of bonds
payable.
b. Payment of cash to repurchase outstanding
shares.
c. Receipt of cash from the sale of equipment.
d. Payment of cash to suppliers for inventory.
Slide
13-26
Using Cash Flows to Evaluate a Company
Free Cash Flow
Free cash flow describes the cash remaining from

operations after adjustment for capital expenditures and
dividends.
Slide
13-27
SO 4 Analyze the statement of cash flows.
Using Cash Flows to Evaluate a Company
Illustration 13-16
Slide
13-28 SO 4 Analyze the statement of cash flows.
Understanding U.S. GAAP
Key Differences Statement of Cash Flows
Companies preparing financial statements under both IFRS and

GAAP must prepare a statement of cash flows as an integral
part of the financial statements.
Both IFRS and GAAP require that the statement of cash flows
should have three major sections—operating, investing, and
financing—along with changes in cash and cash equivalents.
Similar to IFRS, the cash flow statement can be prepared using

either the indirect or direct method under GAAP. In both U.S.
and international settings, most companies choose the indirect
method for reporting net cash flows from operating activities.
Slide
13-29
Key Differences Statement of Cash Flows
The definition of cash equivalents used in GAAP is similar to

that used in IFRS. A major difference is that in certain
situations, bank overdrafts are considered part of cash and
cash equivalents under IFRS, which is not the case in GAAP.
Under GAAP, bank overdrafts are classified as financing
activities.
IFRS requires that non-cash investing and financing activities

be excluded from the statement of cash flows. Non-cash
investing and financing activities should be disclosed in the
notes instead of in the financial statements. Under GAAP,
companies may present this information at the bottom of the
Slide cash flow statement.
13-30
Looking to the Future Statement of Cash Flows
Presently, the FASB and the IASB are involved in a joint project on
the presentation and organization of information in the financial
statements. One interesting approach, revealed in a published
proposal from that project, is that in the future the income
statement and statement of financial position would adopt headings
similar to those of the statement of cash flows. That is, the income
statement and statement of financial position would be broken into
operating, investing, and financing sections. With respect to the
cash flow statement specifically, the notion of cash equivalents will
probably not be retained. That is, cash equivalents will not be
combined with cash but instead will be reported as a form of highly
continued
Slide
13-31
Looking to the Future Statement of Cash Flows
liquid, low-risk investments. The definition of cash in the existing

literature would be retained, and the statement of cash flows would
present information on changes in cash only. In addition, the FASB
favors presentation of operating cash flows using the direct method
only. However, the majority of IASB members express a preference
for not requiring use of the direct method of reporting operating
cash flows. So, the two Boards will have to resolve their differences
in this area in order to issue a converged standard for the statement
of cash flows.
Slide
13-32
Using a Worksheet to Prepare the Statement of Cash
Flows-Indirect Method
Appendix A
Illustration 13A-1
Slide SO 5 Explain how to use a worksheet to prepare the statement of cash flows
13-33 using the indirect method.
Using a Worksheet to Prepare the Statement of Cash
Flows-Indirect Method
Preparing a Worksheet
1. Enter in the statement of financial position accounts section the
statement of financial position accounts and their beginning and
ending balances.
2. Enter in the reconciling columns of the worksheet the data that

explain the changes in the statement of financial position accounts
other than cash and their effects on the statement of cash flows.
3. Enter the cash line and at the bottom of the worksheet the increase
or decrease in cash. This entry should enable the totals of the
reconciling columns to be in agreement.
Slide SO 5 Explain how to use a worksheet to prepare the statement of cash flows
13-34 using the indirect method.
Using a Worksheet
to Prepare the
Statement of Cash
Flows-Indirect
Method
Illustration 13A-3
Completed worksheet—
Slide indirect method
13-35
Statement of Cash Flows-Direct Method
Appendix B
1. Under the direct method, companies compute net cash

provided by operating activities by adjusting each item in the
income statement from the accrual basis to the cash basis.
2. To simplify and condense the operating activities section,
companies report only major classes of operating cash
receipts and cash payments.
3. For these major classes, the difference between cash receipts

and cash payments is the net cash provided by operating
activities.
Slide
13-36 SO 6 Prepare a statement of cash flows using the direct method.
Step 1: Operating Activities

Illustration 13B-2
Slide
Illustration 13B-1
Slide
Illustration 13B-1
Additional information:
1. In 2011, the company declared and paid a $32,000 cash dividend.
2. Bonds were issued at face value for $130,000 in cash.
3. Equipment costing $180,000 was purchased for cash.
4. Equipment costing $20,000 was sold for $17,000 cash when the book value of the
equipment was $18,000.
5. Ordinary shares of $60,000 were issued to acquire land.
Slide
Cash Receipts from Customers

For Juarez Company, accounts receivable decreased $3,000.
Illustration 13B-3
Illustration 13B-5
Slide
Cash Payments to Suppliers

In 2011, Juarez Company’s inventory increased $10,000
and cash payments to suppliers were $678,000.
Illustration 13B-6 Illustration 13B-7
Illustration 13B-9
Slide
Cash Payments for Operating Expenses

Cash payments for operating expenses were $179,000,
Illustration 13B-10
Illustration 13B-11
Slide
Cash Payments for Income Taxes

Cash payments for income taxes were $24,000,
Illustration 13B-12
Illustration 13B-13
Slide

Increase in Equipment. (1) Juarez purchased for cash equipment
costing $180,000. And (2) it sold for $17,000 cash equipment
costing $20,000, whose book value was $18,000.
Illustration 13B-15
Slide

Increase in Land. Juarez’s land
increased $60,000. The additional Significant non-cash
information section indicates that the investing and financing
company issued ordinary shares to transaction.
purchase the land.
Increase in Bonds Payable. Bonds

Payable increased $130,000. The
additional information indicated that Financing activity.
Juarez issued, for $130,000 cash,
bonds with a face value of $130,000.
Slide

Increase in Share Capital - Ordinary.
The Share Capital - Ordinary account Significant non-cash
increased $60,000. The additional investing and financing
information indicated that Juarez transaction.
acquired land from the issuance of
ordinary shares.
Increase in Retained Earnings. The

$52,000 net increase in Retained
Earnings resulted from net income of Financing activity (cash
$84,000 and the declaration and dividend).
payment of a cash dividend
of $32,000.
Slide
Step 2:
Investing
and
Financing
Activities
Step 3: Net
Change in
Cash
Illustration 13B-16
Slide
Copyright
“Copyright © 2011 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no responsibility for
errors, omissions, or damages, caused by the use of these
programs or from the use of the information contained herein.”
Slide
13-48

Preparing The Statement of Cash Flows

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Preparing The Statement of Cash Flows

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Preparing the Statement of Cash Flows

Additional information for 2011:

Determine net cash provided/used by operating activities

Common adjustments to Net Income (Loss):

Loss on Sale of Equipment

Any loss on sale is added to net income in the operating

Any gain on sale is deducted from net income in the

Loss on Sale of Equipment

Computer Services’ income statement reports a $3,000 loss on

Changes to Non-Cash Current Asset Accounts

1/1/011 Balance 30,000 Receipts from customers 517,000

12/31/11 Balance 20,000

Therefore, the company adds to net income the amount of the

Changes to Non-Cash Current Asset Accounts

Changes to Non-Cash Current Asset Accounts

1/1/11 Balance 10,000 Cost of goods sold 150,000

12/31/11 Balance 15,000

As a result, cost of goods sold does not reflect cash payments

Changes to Non-Cash Current Asset Accounts

Changes to Non-Cash Current Asset Accounts

 Cash paid for expenses is higher than expenses reported on

 Company deducts the increase from net income to arrive at

If prepaid expenses decrease, reported expenses are higher

Changes to Non-Cash Current Asset Accounts

Changes to Non-Cash Current Liability Accounts

 Increase is added to net income.

When Income Tax Payable decreases

 Decrease is subtracted from net income.

Changes to Non-Cash Current Liability Accounts

Summary of Conversion to Net

Net cash provided by operating activities 172,000

Disclosure: Issuance of bonds to purchase land $ 110,000

From the additional information, the company acquired an office

1/1/11 Balance 40,000

12/31/11 Balance 160,000

Net cash provided by operating activities 172,000

Disclosure: Issuance of bonds to purchase land $ 110,000

1/1/11 Balance 10,000 Equipment sold 8,000

12/31/11 Balance 27,000

of Cash provided by operating activities:

The additional information notes that the increase in share

1/1/11 Balance 50,000

12/31/11 Balance 70,000

Disclosure: Issuance of bonds to purchase land $ 110,000

Retained earnings increased $116,000 during the year. This

1/1/11 Balance 48,000

12/31/11 Balance 164,000

of Cash provided by operating activities:

Free Cash Flow

Free cash flow describes the cash remaining from

Key Differences Statement of Cash Flows

Companies preparing financial statements under both IFRS and

Similar to IFRS, the cash flow statement can be prepared using

Key Differences Statement of Cash Flows

The definition of cash equivalents used in GAAP is similar to

IFRS requires that non-cash investing and financing activities

Looking to the Future Statement of Cash Flows

Looking to the Future Statement of Cash Flows

liquid, low-risk investments. The definition of cash in the existing

2. Enter in the reconciling columns of the worksheet the data that

1. Under the direct method, companies compute net cash

3. For these major classes, the difference between cash receipts

Step 1: Operating Activities