Statement of Cash Flows
CHAPTER 13
Introduction to
Managerial Accounting
Ninth edition
Cover image credit: wavebreakmedia/Shutterstock
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13-2
External Reports
Income
Balance Sheet
Statement
Statement of
Cash Flows
The statement of cash flows highlights the
major activities that impact cash flows and,
hence, affect the overall cash balance.
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13-3
Purpose of the Statement of Cash Flows
The statement of cash flows helps answer a
variety of questions such as:
1. Are we generating sufficient cash flows from
ongoing operations to remain viable?
2. Can we pay our debts?
3. Can we pay our usual dividends?
4. Why do net income and net cash flow differ?
5. To what extent will we have to borrow money
in order to make needed investments?
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13-4
A Fundamental Principle
Cash Balance = Noncash Balance Sheet Accounts
This principle ensures that properly
analyzing the changes in
all noncash balance sheet accounts
always quantifies the
cash inflows and outflows that explain
the change in the cash balance.
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13-5
A Review of Basic Equations
Basic Equation for Asset Accounts
Beginning balance + Debits – Credits = Ending balance
Basic Equation for Contra-Asset, Liability,
and Stockholders’ Equity Accounts
Beginning balance – Debits + Credits = Ending balance
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13-6
Statement of Cash Flows: Key
Concepts
The term cash on the statement of cash flows
refers broadly to both currency and cash
equivalents.
Currency and Bank Accounts = Cash
Treasury Bills, Commercial Paper, and
Money Market Funds = Cash Equivalents
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13-7
Learning Objective 1
Classify cash inflows and
outflows as relating to
operating, investing, or
financing activities.
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13-8
Organizing a Statement of Cash Flows –
Part 1
Revenue and expense
Operating Activities transactions that affect
net income
Acquiring or disposing of
Investing Activities noncurrent assets
Borrowing from and
repaying principal to
Financing Activities creditors and transactions
with stockholders.
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13-9
Organizing a Statement of Cash Flows –
Part 2
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13-10
Operating Activities – Direct or Indirect
Method?
Direct Method Indirect Method
Reconstructs the Accrual net income is
income statement on adjusted to a cash
a cash basis from top basis; Used by 99%
to bottom
Both methods result in the
exact same amount of cash provided by
operating activities.
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13-11
The Indirect Method – A Three-Step
Process
Step 1 Add depreciation
charges to net
income.
Step 2 Analyze net changes
in noncash balance
sheet accounts.
Step 3
Adjust for gains and
losses.
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13-12
Step 1: Add Depreciation Charges – Part
1
Accumulated depreciation is a noncash balance
sheet account and we must adjust net income for
all of the changes in the noncash balance sheet
accounts that have occurred during the period.
Basic Equation for Contra-Asset, Liability,
and Stockholders’ Equity Accounts
Beginning balance – Debits + Credits = Ending balance
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13-13
Step 1: Add Depreciation Charges, Part 2
Account Activity for Accumulated
Depreciation
Beginning balance $300
Ending balance $500
Accumulated depreciation of
equipment sold $70
Basic Equation for Contra-Asset, Liability,
and Stockholders’ Equity Accounts
Accumulated Depreciation Account Analysis
Beginning balance – Debits + Credits = Ending balance
$300 – $70 + Credits = $500
Credits = $500 – $300 + $70
Credits = $270
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13-14
Step 2: Analyze Net Changes in
Noncash Balance Sheet Accounts
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13-15
Step 3: Adjust for Gains and Losses
Under U.S. GAAP and IFRS rules, gains and losses
must be included in the investing activities section of
the statement of cash flows.
Gains and losses must be removed from net income
in the operating activities section before they can be
shown in the investing activities section:
Subtract Gains
Add Losses
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13-16
Investing and Financing Activities –
Gross Cash Flows
U.S. GAAP and IFRS require that the
investing and financing sections of the
statement of cash flows disclose gross cash flows.
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13-17
Property, Plant, and Equipment
Account Activity for Property, Plant, and Equipment
Beginning balance $1,000 Original cost of equipment sold $100
Ending balance $1,800 Accumulated depreciation of $70
equipment sold
Cash proceeds from sale $40 Gain on the sale of equipment $10
of equipment (included in net income)
Basic Equation for Asset Accounts
Property, Plant, and Equipment Account Analysis
Beginning balance + Debits – Credits = Ending balance
$1,000 + Debits – $100 = $1,800
Debits = $1,800 – $1,000 + $100
Debits = $900 (cash outflow)
Report $40 Report $900
cash inflow cash outflow
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13-18
Retained Earnings
Account Activity for
Retained Earnings
Beginning balance $2,000
Ending balance $3,000
Net income $1,200
Basic Equation for Contra-Asset, Liability, and
Stockholders’ Equity Accounts
Retained Earnings Account Analysis
Beginning balance – Debits + Credits = Ending balance
$2,000 – Debits + $1,200 = $3,000
$3,200 = $3,000 + Debits
Debits = $200 (cash outflow)
Report $1,200 net income in Report $200 dividends paid
Operating Activities in Financing Activities
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13-19
Summary of Key Concepts – Part 1
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13-20
Summary of Key Concepts – Part 2
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13-21
Learning Objective 2
Prepare a
statement of cash flows
using the indirect method
to determine the
net cash provided by
operating activities.
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13-22
Apparel, Inc. Financial Statements – Part
1
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13-23
Apparel, Inc. Financial Statements – Part
2
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13-24
An Example of a Statement of Cash
Flows
In addition to the financial statements provided,
assume the following:
1. The company sold a store that had an original cost of
$15 million and accumulated depreciation of $10
million. The cash proceeds from the sale were $8
million. The gain on the sale was $3 million.
2. The company did not issue any new bonds during the
year.
3. The company did not repurchase any of its own
common stock during the year.
4. The company paid a cash dividend during the year.
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13-25
Operating Activities – Step 1
The first step in computing Apparel’s
net cash provided by operating activities is
to add depreciation to net income.
Basic Equation for Contra-Asset, Liability,
and Stockholders’ Equity Accounts
Accumulated Depreciation Account Analysis
Beginning balance – Debits + Credits = Ending balance
$561M – $10M + Credits = $654M
Credits = $654M – $561M + $10M
Credits = $103M
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13-26
Operating Activities – Step 2
The second step in computing Apparel’s net cash
provided by operating activities is to analyze net changes
in noncash balance sheet accounts that impact net income.
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13-27
Operating Activities – Step 3
The third step in computing Apparel’s
net cash provided by operating activities is to
adjust for gains and losses included in net income.
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13-28
Operating Activities
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13-29
Investing Activities
Basic Equation for Asset Accounts
Property, Plant, and Equipment Account Analysis
Beginning balance + Debits – Credits = Ending balance
$1,394M + Debits – $15M = $1,517M
Debits = $1,517M – $1,394M + $15M
Debits = $138M (cash outflow)
Report Report
$8 million $138 million
cash inflow cash outflow
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13-30
Financing Activities
Basic Equation for Contra-Asset, Liability,
and Stockholders’ Equity Accounts
Retained Earnings Account Analysis
Beginning balance – Debits + Credits = Ending balance
$897M – Debits + $140M = $1,009M
$1,037M = $1,009M + Debits
Debits = $28M (cash outflow)
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13-31
Apparel, Inc. – Statement of Cash
Flows
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13-32
Seeing the Big Picture
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13-33
Interpreting the Statement of Cash
Flows: Specific Circumstances
A statement of cash flows
should be evaluated in the
context of a company’s
specific circumstances.
Start-up companies As start-up companies mature,
often have negative net cash the net cash provided by operating
provided by operating activities, activities should swing from
large spikes in net cash used a negative to a positive number.
for investing activities, The net cash used for investing
and net cash provided by activities should decline somewhat
financing activities. and stabilize and
the net cash provided by financing
activities should decrease.
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13-34
Interpreting the Statement of Cash
Flows: Relationships Among Numbers
Useful information can also be
derived by examining the
relationships among numbers.
Some managers study Managers also compare
their company’s trends the net cash provided by
operating activities to
in cash flow margins the ending balance of
by comparing net cash current liabilities to see if
provided by operating they generated enough cash
activities to sales. flow to pay their bills at the
end of the period.
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13-35
Interpreting the Statement of Cash
Flows: Property, Plant, and Equipment
Some managers compare
the additions to property, plant, and
equipment in the investing activities
section of the statement
to depreciation included in the
operating activities section.
If the additions to property, plant, and equipment
are less than depreciation, it suggests the company
is not investing enough money
to maintain its noncurrent assets.
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13-36
Learning Objective 3
Compute free cash flow.
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13-37
Free Cash Flows – Part 1
Free cash flow measures a company’s ability to
fund its capital expenditures and dividends from
its net cash provided by operating activities.
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13-38
Free Cash Flows – Part 2
Free cash flow measures a company’s ability to
fund its capital expenditures and dividends from
its net cash provided by operating activities.
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13-39
Earnings Quality
Managers generally perceive that earnings are
of higher quality when the earnings are:
1. Not unduly influenced by inflation,
2. Computed using conservative
accounting principles and estimates,
and
3. Correlated with net cash provided by
operating activities.
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13-40
End of Chapter 13
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