BUS780 Chapter 4 Statement of Cash Flows 2 Objectives of this Chapter I. Identify business activities which can generate or use cash and differentiate

BUS780

Chapter 4

Statement of Cash Flows

Statement of Cash Flows 2

Objectives of this Chapter

I. Identify business activities which can generate or use cash and differentiate between income flows and cash flows from operating activities.


Objectives of this Chapter (contd.)

II. Introduce the content and the usefulness of the statement of cash flows.

III. Learn how to prepare the statement of cash flows.


I. Activities which can either generate cash or use cash for a business entity

A. Operating activities.

B. Investing activities.

C. Financing activities.


I. Activities which can either generate cash or use cash for a business entity

Operating activities: Cash Inflows:

1. Collections from customers including cash received from sales (or services) and collections of A/R.

2. Cash receipts of interests or dividends.

3. Collections of other operating receipts (i.e., unearned revenue, rent revenue).


Cash Flows from Operating Activities (contd.) Cash Outflows:

1. Payments to suppliers.2. Payments to employees.3. Payments for interest expense.4. Payments for income taxes.5. Payments for other expenses(i.e.,

Prepaid expenses; rent expenses).


Differentiate between income flows and cash flows from operating activities.

All of these operating activities are also reported in the income statement (I/S).

I/S is prepared on an accrual basis.

Statement of Cash Flows is prepared on a cash basis.

Therefore, net income ǂ cash flows in most cases.


Operating Activities (contd.)

Two approaches can be used to reconcile net income to net cash flows of operating activities:

1. Indirect Method ==> Lump-Sum Adjustment

2. Direct Method ==> Individual Account Adjustment


Reconciliation: Indirect Method

Adjust net income for all differences between income flows (on an accrual basis) and cash flows (on a cash basis).


Reconciliation: Direct Method

Adjust each revenue account on I/S to cash collection and adjust each expense account to cash payment.

Subtract total cash payments from total cash collections to derive net cash flows of the operation activities.


Activities which can either generate cash or use cash for a business entity





Cash Flows from Investing Activities Transactions involving acquiring

(Investing (Cash outflows)) and selling (Disinvesting (Cash inflows)) :

a. Property, Plant and Equipment.

b. Investments (current and non-current).

c. Notes Receivable (current and non-current).


Notes Receivable

Notes Receivable (current and non-current), including:

Lending money (N/R , cash outflow);

Collecting of loan (N/R , cash inflow);

Selling of N/R (N/R, discounting N/R, cash inflow)


Activities which can either generate cash or use cash for a business entity





Cash Flows from Financing Activities Obtaining resources from owners and

creditors (cash inflows) and repaying the amount borrowed (cash outflows).

Cash inflows: Cash received from issuance of

common stock. Cash received from issuance of bonds. Cash received from issuance of N/P

(short-term or long term).


Cash Flows from Financing Activities (contd.) Cash Outflows:

Retirement of bonds.

Retirement of stock.

Payments of N/P.

Payments of dividends.


II. The Content and the Usefulness of the Statement of Cash Flows

In order to show cash flows of a company, cash flows of all three activities occurred during the reporting period should be reported in one statement.

In addition, the following questions can be answered:


The Content and the Usefulness of the Statement of Cash Flows (contd.)1. What is the relationship between net

income and cash provided by operations?

2. Why did cash decreased when net income increased?

3. What expansion (investment) activities took place and how were they financed?


The Content and the Usefulness of the Statement of Cash Flows (contd.)

4. How much is the cash provided by operating activities?

5. What happened to the proceeds received from issuance of bonds or common stock?


SFAS No. 95

SFAS No. 95, “Statement of Cash Flows,” requires companies present the statement of cash flows using a specific format.


SFAS No. 95 (contd.)

Following SFAS No. 95, the statement of cash flows should have three sections:

1. Cash flows from operating activities.

2. Cash flows from investing activities.

3. Cash flows from financing activities.


III. Procedures for Preparation of the Statement of Cash Flows

1. Operating Cash Flows (indirect method).

2. Investing Cash Flows.

3. Financing Cash Flows.


1. Operating Cash Flows (Indirect Method; Reconciliation Method)

Net Income

Adjustments

+ Any increase in current Liabilities (except for N/P)

+ Any decrease in current assets (except for cash and N/R)

- Any decrease in current liabilities (except for N/P)

- Any increase in current assets (except for cash and N/R)


Adjustments to Convert Net Income to Net Cash Flow from Operating Activities

+ Depreciation expense, Bad Debt expense

+ Loss on disposal of assets or liabilities

- Gain on disposal of assets or liabilities

Net Income

Adjustments


2. Investing Cash Flows

Inflows: decrease in noncurrent assets (i.e., long-term investments, P.P.E.) and certain current assets (i.e., trading securities, N/R).

Outflows: increases in noncurrent assets and certain current assets


3. Financing Cash Flows

Inflows: increases in noncurrent liabilities (i.e., B/P, N/P), stockholders’ equity and certain current liability (i.e., N/P).

Outflows: decreases in noncurrent liabilities, stockholders’ equity, certain current liability and dividend payment.


Adjustments:+ Loss on Disposal of Assets or Liability Example: Sale a piece of land with a cost

of $9,000 for $7,000

Cash 7,000

Loss on Sale of Landa 2,000

Land 9,000

a. This transaction results in a cash increase of $7,000.


Data needed to prepare statement of cash flows

1. Comparative balance sheet statements.

2. The income statement.

3. The retained earnings statement.

4. Other supplemental information concerning the reasons for the changes in the B/S accounts (other than cash).


Example 1Layton Company Balance Sheet (12/31/x2)

Balance Balance ChangeAccounts 1/1/x2 12/31/x2Cash 4,000 6,600A/R 6,300 9,000 2,700

Land 9,000 6,000 3000a

Buildings & Equipment 48,000 60,000 12,000b

Accummulated Depreciation (12,500) (14,800)

Total Assets 54,800$ 66,800$ a. Land was sold at cost for cash during the year.b. A building was purchased for cash during the year

and no building or equipment was sold during the year.


Example 1 (contd.) Layton Company Balance Sheet (12/31/x2)

Balance Balance ChangeAccounts 1/1/x2 12/31/x2A/P 7,500 9,000 1,500

B/P 14,000 21,000 7000a

Common Stock, $10 22,000 22,000 0Retained Earnings 11,300 14,800Total Liabilities & Stockholdrs' Equity $54,800 $66,800

a. Bonds were issued at the end of year.


Example 1 (contd.) Income Statement (for the year ended 12/31x2)

Sales Revenue $31,800Opeating ExpensesDepreciation Expense 2,300Interest Expense 1,400Other Expenses 18,100 (21,800)

Income before Income Tax 10,000Income Tax Expense (3,000)

Net Income $7,000


Example 1 (contd.)Layton Company Retained Earnings (20x2)

Beginning Retained Earnings $11,300Add: Net Income 7,000

$18,300Less: Dividends (3,500)

Ending Retained Earnings $14,800


Layton CompanyStatement of Cash Flows

For the Year Ended December 31, 20x2

Net cash flow from operating activities:Net Income $7,000 Adjustments to reconcile net income to net cash provided by operating activities:Add: Depreciation expense 2,300

Increase in A/P 1,500 Less: Increase in A/R (2,700)Net cash provided by operating activities

$8,100


Layton CompanyStatement of Cash Flows (contd.)

Cash flows from investing activities:Proceeds from sale of land $3,000Payments for purchase of building (12,000)Net cash used by investing activities (9,000)Cash flows from financing activities:Proceeds from issuance of bonds 7,000Payments of dividends (3,500)Net cash provided by financing activities 3,500


Layton CompanyStatement of Cash Flows (contd.)

Net increase in cash$2,600

Cash, Jan 1, 19x2$4,000

Cash, Dec 31, 19x2$6,600


Example 2: Green Company Balance Sheet

Accounts 1/1/x2 12/31/x2 DifferenceCash $3,500 $5,500A/R 4,400 3,600 800 Inventory 5,000 6,600 1,600 Land 8,200 12,200 4,000c Building & Equip 35,700 48,700 13,000a,d Acc. Depr. (6,000) (8,700)Total Assets $50,800 $67,900


Green Company Balance Sheet (contd.)

A/P $5,100 $3,200 1,900Salary Payable 1,400 1,800 400B/P, 10% 7,000 15,000 8,000bCommon Stock, $10 par 8,000 9,000 1,000Paid-in Capital 16,000 19,000 3,000R/E 13,300 19,900Total Liabilities & Equity $50,800 $67,900


Income Statement For the Year Ended 12/31/20x2

Sales Revenue $80,000 CGS (48,600)Gross Profit $31,400 Operating Expenses:

Deprecation Expense $3,400Other Expenses 15,900 (19,300)

$12,100 Other Revenues & Expenses

Gains on Sale of Equipment $600Interest Expense (700) (100)

Income Before Income Tax $12,000 Income Tax Expense (3,600)

Net Income $8,400 .

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Retained Earnings (20x2)

Beginning balance of retained earnings $13,300

Add: Net Income 8,400

21,700

Less: Dividends (1,800)

Ending balance of retained earning $19,900


Supplemental Information for 20x2

(a) Equipment was purchased for cash at a cost of $15,200.

(b) Ten-year bonds payable with a face value of $8,000 were issued for $8,000 at the end of the year.

(c) Land was acquired through the issuance of 100 shares of $10 par common stock when the stock was selling at a market price of $40 per share.

(d) Equipment with a cost of $2,200 and a book value of $1,500 was sold for $2,100 cash.


GREEN CompanyStatement of Cash Flows

For the Year Ended December 31, 20x2

Net cash flows from operating activities:Net Income $8,400Adj. To reconcile net income to net cash provided by operating activities:Add: Depreciation Expense 3,400

Decrease in A/R 800Increase in S/P 400

Less: Increase in Inventory (1,600) Decrease in A/P (1,900)

Gain on sale of Equipment (600)Net cash provided by operating activities

$8,900


Cash flows from investing activities:Payments for purchase of equip. (15,200)Proceeds from sale of equipment 2,100

Net cash used by investing activities (13,100)

Cash flows from financing activities:Proceeds from issuance of bonds 8,000Payments of dividends (1,800)

Net cash provided by financing activities 6,200Net increase in cash (see Schedule 1) $2,000

Cash, Jan 1, 19x2 $3,500Cash, Dec 31, 19x2 $5,500

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GREEN Company Statement of Cash Flows (contd.)


Schedule 1: Investing & financing activities not affecting cash flows:

Investing activities:

Acquisition of land by Issuance of common stock ($4,000)

Financing Activities:

Issuance of common stock for land $4,000

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GREEN Company Statement of Cash Flows (contd.)


1. Direct Exchange

Direct exchange: An example of a direct exchange is issuing bonds to acquire a building. This transaction should appear in the schedule of the cash flow statement as an investing activity (i.e., acquisition of building) and as a financing activity (i.e., issue bonds for building).


2. Partial Cash Investing and Financing Activities

Example: acquiring land costing $10,000 by paying $1,000 down and signing a $9,000 notes payable.


2. Partial Cash Investing and Financing Activities (contd.)

Presentation on Cash Flow Statement for Partial Investing & Financing Activities:

Cash Flows from Investing Activities:Purchase of land by issuance

of note and cash ($10,000)Less: issuance of note 9,000 Cash payment for purchase of land ($1,000)


V. Cash Flows from the Operating Activities

Activities can be presented using:a. Indirect Method (as used in examples 1,2):

N/I Adjustments to reconcile net income to cash flows.

b. Direct Method: The operating cash outflows are deducted from the operating cash inflows to determine the net cash provided by (or used in) operating activities.


Cash Flows from the Operating Activities (contd.) SFAS No. 95 allows the use of both

methods, but encourages the use of the direct method.

However, if the direct method is used, a reconcile of net income and cash using the indirect method must also be provided in the supplementary statement.


Using The Direct Method in Preparing The Operating Cash Flows

Cash inflows from operating activities:

1. Collections from customers.

2. Interest & dividends collected.

3. Other operating receipts.


Using The Direct Method in Preparing The Operating Cash Flows (contd.)

Cash outflows from operating activities:

1. Payments to suppliers.

2. Payments to employees.

3. Payments of interest.

4. Other operating payments.

5. Payments of income taxes.


Adjustments to Convert I/S Amount to Operating Cash Flows -- A Direct Approach

I/S Cash Flows fromAmounts Adjustments Operating Activities Net

CollectionsSales +Dec. in A/R; or = from Revenue -Inc. in A/R Customers

Cash+Dec. in Int. Rec.; Inflows-Inc. in Int. Rec. from

OperatingInterest Interest

Activities


I/S Cash Flows fromAmounts Adjustments Operating Activities Net Dividend +Dec. in Dividend Rec. = Dividend Revenue -Inc. in Dividend Rec. Collected

Cash+Inc. in Unearned Rev.; Inflowsor from

Other -Dec. in Unearned Rev. Operating Other Activities

Revenue = Operating Receipts

+Dec. (-Inc.) in Other Receivable Accounts

* Ignore gain from sale of PPE because it does not have any cash inflows.52

Adjustments to Convert I/S Amount to Operating Cash Flows (contd.)



+Inc. in Inventory; Cost of or Payments Goods -Dec. in Inventory = to Sold +Dec. in A/P; or Suppliers Cash

-Inc. in A/P Outflowsfrom

Salary +Dec. in Sal. Payable; Payments Operating or = to Activities

Expense -Inc. in Sal. Payable Employees

53




+Dec. in Int. Payable Interest -Inc. in Int. Payable = Payments Expense of Interest

Cash Outflows

from+Inc. in Prepaids Operating-Dec. in Prepaids Activities

Other Other = Operating

Expense Payments +Dec.

(-Inc.) in Other Payable Accounts

54




+Dec. in I/T Payable; or

Income -Inc. in I/T Payable Payments Cash Tax = of Income OutflowsExpense Tax from

OperatingActivities

Note: Ignore Bad Debt Expense, depreciation expense and loss from sale of PPE since those accounts do not have any cash outflows,

55



Green CompanyStatement of Cash Flows

(Using the direct method in preparing the operating activities section of a cash flow statement for Example 1)

Cash flows from Operating Activities:Cash inflows:

Collections from customers $29,1001

Cash inflows from operating activities $29,100

1. 31,800 -2,700 = 29,100


Green CompanyStatement of Cash Flows (contd.)

Cash outflows:Payments of interest (1,400)Other operating payments (16,600) 2

Payments of income tax (3,000)Cash outflows from operating activities

(21,000)Net Cash inflows from Operating $8,100Activities18,100 - 1,500 = 16,600 * A reconciliation of net income and cash flows using

indirect method must also be presented.


Green CompanyStatement of Cash Flows

(Using the direct method in preparing the operating activities section of a cash flow statement of Example 2.)

Cash flows from Operating Activities:Cash inflows:

Collections from customers $80,8001

Cash inflows from operating activities $80,800

1. 80,000 + 800 = 80,800.



Cash outflows:Payments to suppliers $(52,100) 1

Payments of interest (700)Other operating payments (15,500) 2

Payments of income tax (3,600)Cash outflows from operating activities (71,900)Net Cash Flows from Operating $8,900Activities1. 48,600 + 1600 + 1900 = 52,100.2. 15,900 - 400 = 15,500.



Net cash inflow from operating activities $8,900Cash flows from investing activities

::

Cash flows from Financing Activities::

* A reconciliation of net income and cash flows using indirect method must also be presented.

Documents

BUS780 Chapter 4 Statement of Cash Flows 2 Objectives of this Chapter I. Identify business activities which can generate or use cash and differentiate