Statement of Cash Flows Purpose of the Statement

• Statement of Cash Flows • Purpose of the Statement of Cash Flows • Reports cash flows – Cash flows from operating activities – transactions that affect net income. – Cash flows from investing activities – transactions that affect noncurrent assets. – Cash flows from financing activities – transactions that affect equity and debt of the entity. 1

• Noncash Investing and Financing Activities • Operating Activities, Investing Activities & Financing Activities • Cash and Cash Equivalents • Direct Method – Cash Received from Customers – Interest and Dividends Received – Cash Paid for Merchandise – Cash Payments for Expenses 2

Chapter 13 STATEMENT OF CASH FLOWS –Indirect Method 3

Indirect Method Changes in current assets and current liabilities as shown on the following table. Cash Flows from Operating Activities Net Income + Losses and - Gains + Noncash expenses such as depreciation and amortization. 4

Indirect Method Use this table when adjusting Net Income to Operating Cash Flows. 5

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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 7

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, 8 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). 9

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 10

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 11

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. 12

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 58, 300 65, 300 to statement 13

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 14

The Indirect Method Select current assets and current liabilities that impact cash flow and determine the increases and decreases. 15

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. 16

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. 17

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. 18

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 19

The Indirect Method Analyze the income statement to determine if there any gains or losses from selling investments, equipment, etc. 20

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 $ 21

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 22

The Indirect Method If there had been a loss on this sale, the loss would have been added to net income. 23

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 10, 000 -14, 000 $24, 000 24

Cash Flows from Financing Activities Because paying of dividends affects equity, it is a negative $24, 000 cash flow from financing activities transaction. 25

Cash Flows from Financing Activities Sale of Common Stock ACCOUNT NO. 33 Date 2006 Jan. Nov. Item 1 Balance 1 4, 000 shares issued for cash Debit Credit 8, 000 Balance Debit Credit 16, 000 24, 000 26

Cash Flows from Financing Activities Sale of Common Stock ACCOUNT Paid-In Capital in Excess of Par--Common ACCT. NO. 34 Balance Date 2006 Jan. Nov. Item 1 Balance 1 4, 000 shares issued for cash Debit Credit 40, 000 Debit Credit 80, 000 120, 000 27

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. 28

Cash Flows from Financing Activities Retirement of Bonds Payable ACCOUNT Bonds Payable NO. 25 Date Item ACCOUNT. Debit 2006 Jan. 1 Balance June 30 Retired by payment of cash at face amount Credit Balance Debit Credit 150, 000 100, 000 29

Cash Flows from Financing Activities This transaction is a negative cash flows from financing activities item because longterm debt is involved. 30

Cash Flows from Investing Activities Purchased a Building ACCOUNT Building Date Item ACCOUNT NO. 18 Debit 2006 Jan. 1 Balance Dec. 27 Purchased for cash 60, 000 Credit Balance Debit Credit 200, 000 260, 000 31

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. 32

Cash Flows from Investing Activities Land Transactions ACCOUNT Land Date 2006 Item Jan. 1 Balance June 8 Sold for $72, 000 cash Oct. 12 Purchased for $15, 000 cash ACCOUNT NO. 16 Debit Credit Balance Debit Credit 125, 000 60, 000 65, 000 15, 000 80, 000 33

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. 34

Cash Flows from Investing Activities Land Transactions The $12, 000 gain was recorded earlier on previous slide as an operating activity. The purchase of land also is an investing activity. 35

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 36

Let’s prepare another Statement of Cash Flows using the Indirect Method. 37

Indirect Method - Example Joe’s Place has prepared the Balance Sheet as of March 31, 2003, and March 31, 2002. The Income Statement for the year ended 3/31/03 has also been prepared. Joe needs help preparing the Statement of Cash Flows. Joe’s Place 38

Indirect Method - Example The $8, 000 gain was the result of selling land costing $32, 000 for $40, 000 during the period. 39

Indirect Method - Example 40

Indirect Method - Example Joe’s Place issued $50, 000 of no par common stock to settle the $50, 000 note payable. 41

Indirect Method - Example 42

Indirect Method - Example With the indirect method, always start with the net income or net loss for the period. 43

Indirect Method - Example 44

Indirect Method - Example Accounts receivable decreased. 3/31/03 3/31/02 $23, 000 - $40, 000 = $(17, 000) 45

Indirect Method - Example Accounts payable increased. 3/31/03 3/31/02 $38, 000 - $27, 000 = $11, 000 46

Indirect Method - Example Inventory increased. 3/31/03 3/31/02 $350, 000 - $300, 000 = $50, 000 47

Indirect Method - Example Salaries payable decreased. 3/31/03 3/31/02 $ 9, 000 - $14, 000 = $(5, 000) 48

Indirect Method - Example Add back non-cash expenses. 49

Indirect Method - Example Subtract gains. 50

Indirect Method - Example The operating cash flows amount comes from the schedule just prepared. 51

Indirect Method - Example Land originally costing $32, 000 was sold for $40, 000. 52

Indirect Method - Example Dividends of $20, 000 were paid to owners during the year. 53

Indirect Method - Example Compute the net change in cash for the period. 54

Indirect Method - Example Complete the Statement of Cash Flows by reconciling beginning cash to ending cash. 55

Indirect Method - Example Note that the ending cash amount ties back to the Joe’s Place Balance Sheet at 3/31/03. 56

Indirect Method - Example In addition, on the face of the statement or in a supplemental schedule, disclose the $50, 000 noncash financing activity. 57

Indirect Method - Example In addition, cash interest payments and cash tax payments must also be disclosed separately. 58

Managing Cash Flows Cash Budgets are used by management to plan and forecast future cash flows. 59

Managing Cash Flows • • • Increase collection of accounts receivables. Keep inventory low. Delay payment of liabilities. Plan timing of major expenditures. Invest idle cash. 60

Cash Budgeting The ending cash balance of one month becomes the beginning cash balance of the next month. 61

Cash Budgeting Financing is needed in June because the company must maintain a minimum cash balance of $10, 000. 62

End of Chapter 13 63