Chapter 16 Statement of Cash Flows Accounting 21

Chapter 16 Statement of Cash Flows Accounting, 21 st Edition Warren Reeve Fess Power. Point Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electroni presentation is used with the permission of NVTech Inc.

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Objectives 1. Summarize. After the studying types ofthis cash flow activities reported in the statement of chapter, you should cash flows. be able to: 2. Prepare a statement of cash flows, using the indirect method. 3. Prepare a statement of cash flows, using the direct method. 4. Calculate and interpret the free cash flow.

Reporting Cash Flows The statement of cash flows reports cash flows by three types of activities: 1. Cash flows from operating activities – transactions that affect net income. 2. Cash flows from investing activities – transactions that affect noncurrent assets. 3. Cash flows from financing activities – transactions that affect equity and debt of the entity.

Reporting Cash Flows Increases in Cash Decreases in Cash Operating (receipts from revenues) Investing (receipts from sales of noncurrent assets) Financing (receipts from issuing equity and debt securities) (payments for expenses) Investing (payments for acquiring noncurrent assets) Financing (payments for treasury stock, dividends, and redemption of debt securities)

Cash Flows from Operating Activities Typical cash inflows What are some of the typical cash inflows from operating activities? ` Typical cash outflows What are some of the typical cash outflows from operating activities? Sales of goods and services Merchandise purchases Interest revenue Payments of wages and other expenses Dividend revenue Tax payments

Cash Flows from Investing Activities Typical cash inflows What are some of the typical cash inflows from investing activities? Sales of fixed assets Sale of longterm investments Typical cash outflows What are some of the typical cash outflows from investing activities? Purchase of fixed assets Purchase of long-term investments

Cash Flows from Financing Activities Typical cash inflows What are some of the typical cash inflows from financing activities? Typical cash outflows What are some of the typical cash outflows from financing activities? Issuing bonds and long-term notes payable Paying cash dividends Issuing preferred and common stock Repaying debt Acquiring treasury stock

Noncash Investing and Financing Activities n Issuing bonds to acquire land n Issuing common stock for convertible preferred stock n Issuing a long-term note to acquire equipment n Issuing a stock dividend

No cash flow per share is reported in the financial statements because the user might incorrectly interpret this as the amount available for dividends.

The Indirect Method Balance Sheet Cash Noncash Assets Liabilities Stockholders’ Equity Assets = Liabilities + Stockholders’ Equity Cash + Noncash Assets = Liabilities + Stockholders’ Equity Cash = Liabilities + Stockholders’ Equity – Noncash Assets

The Indirect Method Balance Sheet Cash Liabilities Noncash Assets Stockholders’ Equity Assets = Liabilities + Stockholders’ Equity Cash + Noncash Assets = Liabilities + Stockholders’ Equity Cash = Liabilities + Stockholders’ Equity – Noncash Assets 1 2 3 The cash flows are determined by analyzing liabilities, stockholders’ equity, and noncash assets.

The Indirect Method Start with the accrual basis net income (shown in the income statement, the Retained Earnings account, or the statement of stockholders’ equity).

The Indirect Method Find the net income. ACCOUNT Retained Earnings Date 2006 Jan. 1 Balance Dec. 31 Net income 31 Cash dividends Item ACCOUNT NO. 32 Debit Credit Balance Debit Credit To statement 108, 000 202, 300 310, 300 282, 300

Operating Activities – Indirect Method Cash flows from operating activities: Net income per income statement $108, 000 Add: Depreciation Decrease in inventories Increase in accrued expenses Deduct: 17, 200 $125, 200 Inc. in accounts receivable Dec. in accounts payable Dec. in income taxes payable Gain on sale of land $ 7, 000 8, 000 2, 200 $ 9, 000 3, 200 500 12, 000

The Indirect Method Next, we need to determine depreciation expense for the year. If it isn’t given on the income statement, sometimes it can be found by analyzing the Accumulated Depreciation account.

The Indirect Method Determine depreciation expense. ACCOUNT Date Accumulated Depreciation--Building ACCOUNT NO. 17 Item Debit Credit Balance Debit Credit 2006 Jan. 1 Balance Dec. 31 Depreciation for year 7, 000 to statement 58, 300 65, 300

Operating Activities – Indirect Method Cash flows from operating activities: Net income per income statement $108, 000 Add : Depreciation $ 7, 000 Decrease in inventories 8, 000 Increase in accrued expenses 2, 200 Deduct: 17, 200 Because Depreciation Expense reduced net income but did not $125, 200 require an outflow of cash, it is Inc. in accounts receivable $ 9, 000 back to net income. 3, 200 Dec. inadded accounts payable Dec. in income taxes payable Gain on sale of land 500 12, 000

The Indirect Method Select current assets and current liabilities that impact cash flow and determine the increases and decreases.

Changes in Current Accounts Change Accounts receivable (net) Inventories Accounts payable (mdse. ) Accrued expenses payable Income taxes payable 2006 2005 Debit Credit $74, 000 $65, 000 9, 000 8, 000 172, 000 180, 000 43, 500 46, 700 3, 200 26, 500 24, 300 7, 900 8, 400 500 Determine the debit or credit change of each item above.

Changes in Current Accounts Change Accounts receivable (net) Inventories Accounts payable (mdse. ) Accrued expenses payable Income taxes payable 2006 2005 Debit Credit $74, 000 $65, 000 9, 000 8, 000 172, 000 180, 000 43, 500 46, 700 3, 200 26, 500 24, 300 7, 900 8, 400 500 These debit changes are subtracted from net income in the operating activities section of the statement of cash flows. Think of these debits as deductions from net income in arriving at net cash flow from operations.

Changes in Current Accounts Change Accounts receivable (net) Inventories Accounts payable (mdse. ) Accrued expenses payable Income taxes payable 2006 2005 Debit Credit $74, 000 $65, 000 9, 000 8, 000 172, 000 180, 000 43, 500 46, 700 3, 200 26, 500 24, 300 7, 900 8, 400 500 These credit changes are added to net income in the operating activities section of the statement of cash flows. Think of these credits as additions to net income in arriving at net cash flow from operations.

Operating Activities—Indirect Method Cash flows from operating activities: Net income per income statement $108, 000 Add : Depreciation Decrease in inventories Increase in accrued expenses 17, 200 $125, 200 Inc. in accounts receivable Dec. in accounts payable Dec. in income taxes payable Gain on sale of land $ 7, 000 8, 000 2, 200 $ 9, 000 3, 200 500 12, 000

The Indirect Method Analyze the income statement to determine if there any gains or losses from selling investments, equipment, etc.

Rundell Income Statement For the Year Ended December 31, 2006 Sales Cost of merchandise sold 790, 000 Gross profit Operating expenses: Depreciation expense Other operating expenses Total operating expenses 203, 000 Income operations Gainfrom on sale of land 187, 000 Other income: Gain on sale of land Other expense: Interest expense Income before income tax 191, 000 $1, 180, 000 $ 390, 000 $ 7, 000 196, 000 $ $12, 000 8, 000 4, 0000 $

Operating Activities—Indirect Method Cash flows from operating activities: Net income, per income statement $108, 000 Add : This. Depreciation gain was included in net income, but did $ 7, 000 Decrease in inventories 8, 000 not represent an operating cash flow. Increase in accrued expenses 17, 200 $125, 200 Inc. in accounts receivable Dec. in accounts payable Dec. in income taxes payable Gain on sale of land 2, 200 $ 9, 000 3, 200 500 12, 000

The Indirect Method If there had been a loss on this sale, the loss would have been added to net income.

Cash Flows from Financing Activities Dividends ACCOUNT Date 2006 Jan. Dividends Payable Item 1 10 June 20 July 10 Dec. 20 Balance Cash paid Dividends declared Total cash paid ACCOUNT NO. 23 Debit Credit 10, 000 Balance Debit Credit -- 14, 000 -14, 000 $24, 000 10, 000 -14, 000

Cash Flows from Financing Activities Because paying of dividends affects equity, it is a negative $24, 000 cash flow from financing activities transaction.

Cash Flows from Financing Activities Sale of Common Stock ACCOUNT Date 2006 Jan. Nov. Common Stock Item 1 Balance 1 4, 000 shares issued for cash ACCOUNT NO. 33 Debit Credit 8, 000 Balance Debit Credit 16, 000 24, 000

Cash Flows from Financing Activities Sale of Common Stock ACCOUNT Date 2006 Jan. Nov. Paid-In Capital in Excess of Par--Common ACCT. NO. 34 Item 1 Balance 1 4, 000 shares issued for cash Debit Credit 40, 000 Balance Debit Credit 80, 000 120, 000

Cash Flows from Financing Activities Issuing common stock affects equity; therefore, we have a total positive cash flow of $48, 000 from this financing activities transaction.

Cash Flows from Financing Activities Retirement of Bonds Payable ACCOUNT Date Bonds Payable Item ACCOUNT. NO. 25 Debit 2006 Jan. 1 Balance June 30 Retired by payment of cash at face amount Credit Balance Debit Credit 150, 000 100, 000

Cash Flows from Financing Activities This transaction is a negative cash flows from financing activities item because longterm debt is involved.

Cash Flows from Investing Activities Purchased a Building ACCOUNT Date Building Item ACCOUNT NO. 18 Debit 2006 Jan. 1 Balance Dec. 27 Purchased for cash 60, 000 Credit Balance Debit Credit 200, 000 260, 000

Cash Flows from Investing Activities Purchased a Building Purchasing a building involves a noncurrent asset, so this is a negative cash flows from investing activities item.

Cash Flows from Investing Activities Land Transactions ACCOUNT Date 2006 Land ACCOUNT NO. 16 Item Jan. 1 Balance June 8 Sold for $72, 000 cash Oct. 12 Purchased for $15, 000 cash Debit Credit Balance Debit Credit 125, 000 60, 000 65, 000 15, 000 80, 000

Cash Flows from Investing Activities Land Transactions The first transaction, the sale of land, results in a positive cash flow from investing activities because land is a noncash asset.

Cash Flows from Investing Activities Land Transactions The $12, 000 gain was recorded earlier on Slide 29 as an operating activity. The purchase of land also is an investing activity. Click here to return to Slide 29. To return to this slide, type “ 43” and press the “Enter” key.

Refer to Exhibit 6 in your textbook to see the formal statement of cash flows using the indirect approach. Rundell Inc. Statement of Cash Flows For the Year Ended December 31, 2006 Cash flows from operating activities: Net income $108, 000 Add: Depreciation $ 7, 000 Decrease in inventor. 8, 000 Increase in accrued exp. 2, 200 17, 200 $125, 000 Deduct: Increase in A/R $9, 000 Decrease in accts. Pay. 3, 200 Decrease in ITP 500 Gain on sale of land 12, 000 24, 700 Net cash flow from operating act. $100, 500 Cash flows from investing activities: Cash from sale of land $72, 000 Less: Cash paid to pur. land $15, 000 Cash paid for bldg. 60, 000 75, 000(3, 000) Cash flows from financing activities: Cash received from sale of c. s. $48, 000 Less: Cash paid to retire b. $50, 000 Cash paid for divid. 24, 000 74, 000 Net cash flow for financing (26, 000) Increase in cash $71, 500 Cash at beginning of year 26, 000 Cash at end of year $97, 500

Rundell Income Statement For the Year Ended December 31, 2006 Cash Basis Sales $1, 180, 000 Cost of merchandise sold 790, 000 Gross profit $ 390, 000 Operating expenses: Depreciation expense $ 7, 000 Other operating expenses 196, 000 Total operating expenses 203, 000 Income from operations $ 187, 000 Other income: Gain on sale of land $12, 000 This is an accrual basis income statement. Other expense: The direct method of reporting 8, 000 cash flows 4, 000 will Interest expense Income before incomethis tax to a cash basis statement. $ essentially convert 191, 000

Rundell Income Statement For the Year Ended December 31, 2006 Cash Basis Sales $1, 180, 000 Cost of merchandise sold Cash collected 790, 000 Changes from customers Gross profit $ 390, 000 Debit Credit Operating expenses: Sales 1, 180, 000 Depreciation expense $ 7, 000 9, 000 Other operating. Receivables expenses 196, 000 Total operating expenses 203, 000 Note: The changes in the current balance Income from operations $ sheet accounts are determined by 187, 000 Other income: comparing the beginning and ending Gain on sale of land $12, 000 Other expense: balances. Receivables increased by Interest expense 8, 000 4, 000 $9, 000 during the period. Income before income tax $ 191, 000

Rundell Income Statement For the Year Ended December 31, 2006 Cash Basis Sales $1, 180, 000 $1, 171, 000 Cost of merchandise sold Cash collected 790, 000 Changes from customers Gross profit $390, 000 Debit Credit Operating expenses: Sales 1, 180, 000 Depreciation expense $ 7, 000 9, 000 Other operating. Receivables expenses 196, 000 Cash 1, 171, 000 Total operating expenses 203, 000 Income from operations The increase in receivables $187, 000 represents a reduction in cash Other income: the accrual Gain on sale inflow of land relative to $12, 000 Other expense: revenue reported on the income Interest expense 8, 000 4, 000 Income before income tax statement. $ 191, 000

Rundell Income Statement For the Year Ended December 31, 2006 Sales $1, 171, 000 Cost of merchandise sold Cash payments for 790, 000 merchandise Gross profit Operating expenses: Cost of mdse. sold Depreciation expense Inventories Other operating expenses Total operating expenses 203, 000 Accounts payable Income from. Cash operations $187, 000 Other income: Gain on sale of land Other expense: Interest expense Income before income tax Cash Basis $1, 180, 000 Changes Debit Credit 790, 000 $ 7, 000 196, 000 8, 000 3, 200 $390, 000 $12, 000 8, 000 4, 000

Rundell Income Statement For the Year Ended December 31, 2006 Cash Basis Sales $1, 180, 000 $1, 171, 000 (785, 200) Cost of merchandise sold Cash payments for 790, 000 Changes merchandise Gross profit $390, 000 Debit Credit Operating expenses: Cost of mdse. sold 790, 000 Depreciation expense $ 7, 000 minus Inventories Other operating expenses 196, 000 8, 000 plus Total operating expenses 3, 200 203, 000 Accounts payable Income from. Cash operations A decrease in Inventories (credit 785, 200 $187, 000 Other income: change) and an decrease in Accounts Gain on sale of Payable land $12, 000 have the (debit change) Other expense: opposite effects. Interest expense 8, 000 4, 000 Income before income tax

Rundell Income Statement For the Year Ended December 31, 2006 Cash Basis Sales $1, 180, 000 $1, 171, 000 Cost of merchandise sold 790, 000 (785, 200) 0 Gross profit $ 390, 000 Operating expenses: Depreciation Changes Depreciation expense $ 7, 000 Debit Credit Other operating expenses 196, 000 Depreciation expense 7, 000 Total operating expenses 203, 000 Accumulated depreciation Income from operations $ 7, 000 187, 000 Other income: Gain on sale of land $12, 000 Other expense: Interest expense 8, 000 4, 000 Income before income tax There is no cash flow for depreciation expense.

Rundell Income Statement For the Year Ended December 31, 2006 Cash Basis Sales $1, 180, 000 $1, 171, 000 Cost of merchandise sold 790, 000 (785, 200) Gross profit $ 390, 000 Operating expenses: (193, 800) Depreciation $ 7, 000 0 Cashexpense payments for Changes Other operating expenses 196, 000 operating expenses Changes Debit Credit Total operating expenses 203, 000 Operating expenses 196, 000 Income from operations $ Accrued expenses minus 187, 000 2, 200 193, 800 Other income: Cash Gain on sale of land $12, 000 Other expense: Interest expense 8, 000 4, 000 Income before income tax

Rundell Income Statement For the Year Ended December 31, 2006 Cash Basis Sales $1, 180, 000 $1, 171, 000 Cost of merchandise sold Changes Gain on sale of 790, 000 (785, 200) investments Debit Credit Gross profit $ 390, 000 72, 000 Operating Cash expenses: Investments Depreciation expense $ 7, 000 0 60, 000 Other operating expenses 196, 000 (193, 800) Gain on sale of invest. 0 Total operating expenses 12, 000 203, 000 Income from $ Theoperations cash inflow of $72, 000 will 187, 000 be shown in the investing section Other income: of sale the statement of cash flows Gain on of land $12, 000 and Other expense: the gain is ignored. Interest expense 8, 000 4, 000

Rundell Income Statement For the Year Ended December 31, 2006 Cash Basis Sales $1, 180, 000 $1, 171, 000 Cost of merchandise sold 790, 000 (785, 200) Gross profit $ 390, 000 Cash paid for Changes Operating expenses: interest expense Debit Credit Depreciation expense $ 7, 000 0 Interest expense Other operating expenses 196, 000 8, 000 (193, 800) Cash Total operating expenses 203, 000 Income from operations $ (8, 000) 187, 000 Other income: There is no interest payable Gain on saleaccount of land at the end of $12, 000 0 the year. Other expense: Interest expense 8, 000 4, 000

Rundell Income Statement For the Year Ended December 31, 2006 Cash Basis Sales $1, 180, 000 $1, 171, 000 Cost of merchandise sold 790, 000 (785, 200) Gross profit $ 390, 000 Operating expenses: Depreciation expense $ 7, 000 0 Cash paid for Changes Other operating expenses 196, 000 income taxes Debit Credit (193, 800) tax expense Total. Income operating expenses 83, 000 Income tax payable plus 500 203, 000 Cash (83, 500) Income from operations $ 187, 000 Other income: (83, 500) Gain on sale of land $12, 000 Other expense: Interest expense 8, 000 4, 000 (8, 000)

Rundell Income Statement For the Year Ended December 31, 2006 Sales $1, 171, 000 Cost of merchandise sold 790, 000 Gross profit Operating expenses: Depreciation expense Other operating expenses (193, 800) Total operating expenses 203, 000 Income from operations 187, 000 Other income: Gain on sale of land Other expense: Interest expense Cash Basis $1, 180, 000 Two different viewpoints $ 390, 000 $ of 7, 000 0 income from 196, 000 operations (785, 200) Accrual Basis $12, 000 8, 000 Cash Basis $ 0 4, 000 (8, 000)

Operating Activities—Direct Method Cash flows from operating activities: Cash inflows: Cash received from customers $1, 171, 000 Cash outflows: Cash payments for merchandise Cash payments for operating expenses Cash payments for interest Cash payments for income tax Net cash flow from operating activities $ 100, 500 $785, 200 193, 800 8, 000 83, 5001, 070, 500

Financial Analysis and Interpretation Free Cash Flow Dell Corporation Cash flow from operations Less: Cash used to purchase fixed assets to maintain productive capacity used up in producing income during the period Less: Cash used for dividends Free cash flow as a percent of cash flow from operating activities $4, 195, 000 (482000) —– $3, 713, 000 89%

Financial Analysis and Interpretation Free Cash Flow Dell Corporation Cash operations $4, 195, 000 Use: flow To from measure the financial strength of a Less: Cash used to. Apurchase fixed business. company that has positive assets to maintain productive free cash flow is able to fund internal capacity used up in producing growth, retire debt, and enjoy financial income during the period (482000) flexibility. Less: Cash used for dividends (—) Free cash flow $3, 713, 000 Free cash flow as a percent of cash flow from operations 89%

Chapter 16 The End