Chap18[1] the Statement of Cashflows

7/22/2019 Chap18[1] the Statement of Cashflows

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Accounting Principles, 6e Weygand t, K ieso , & K immel

Prepared by

Marianne Bradford, Ph. D.

Bryant College

John Wiley & Sons , Inc .



After studying this chapter, you should be able to:

1 Indicate the primary purpose of the statement

of cash flows.

2 Distinguish among operating, investing, and

financing activities.

3 Prepare a statement of cash flows using the

indirect method.

4 Prepare a statement of cash flows using the

direct method.

5 Analyze the statement of cash flows.

CHAPTER 18 THE STATEMENT OF CASH FLOWS



PREVIEW OF CHAPTER 18

THE STATEMENT OF CASH FLOWS

The Statement of Cash Flows: Purpose and Format

Purpose

Meaning of ―cash flows‖

Classifications

Significant noncash activities

Format

Usefulness

Preparation

Indirect & direct methods




ORSection 1:

Indirect Method

Determining net increase/decrease in

cash

Determining net cash provided/used

by operating activities


by investing and financing activities

Section 2:

Direct Method

Determining net increase/decrease in

cash


by operating activities


by investing and financing activities





Analysis of the Statement of Cash Flows

Current cash debt coverage ratio

Cash return on sales ratio

Cash debt coverage ratio




STUDY OBJECTIVE 1

Indicate the primary purpose

of the statement of cash flows.



PURPOSE OF


The primary purpose of the statement of cash flows

(SCF) is to provide information about an entity’s cash

receipts and cash payments during a period.

A secondary objective is to provide information about its 1) operating, 2) investing, and 3) financing activities

of an entity during a period.

It provides answers to the following simple, but

important, questions about an enterprise:1 Where did the cash come from during the period?

2 What was the cash used for during the period?

3 What was the change in the cash balance during the

period?



MEANING OF

CASH FLOWS The SCF is usually prepared using cash and cash

equivalents as its basis.

Cash equivalents are short-term, highly liquid

investments that are both:1 readily convertible to known amounts of cash,

and

2 so near to their maturity that their market value

is relatively insensitive to changes in interest

rates.



STUDY OBJECTIVE 2

Distinguish among operating,

investing, and financing activities.



CLASSIFICATION OF

CASH FLOWSTransactions and other events characteristic of each

kind of activity are as follows:

1 Operating activities include the cash effects of

transactions that create revenues and expenses. Theythus enter into the determination of net income.

2 Investing activities include a) acquiring and disposing

of investments and productive long-lived assets, and

b) lending money and collecting the loans.

3 Financing activities include a) obtaining cash from

issuing debt and repaying the amounts borrowed,

and b) obtaining cash from stockholders and

providing them with a return on their investment.



CLASSIFICATION OF

CASH FLOWS The category of operating activities is the mostimportant because it shows the cash provided bycompany operations.

Note the following general guidelines:1) Operating activities involve income determination

(income statement) items,

2) Investing activities involve cash flows resultingfrom changes in investments and long-term assetitems.

3) Financing activities involve cash flows resultingfrom changes in long-term liability andstockholders’ equity items.



ILLUSTRATION 18-1

BUSINESS ACTIVITIES SHOWN ON


Operating

Activities

Investing

Activities

Financing

Activities



ILLUSTRATION 18-1

TYPICAL RECEIPTS AND PAYMENTS

CLASSIFIED BY ACTIVITY

Types of Cash Inflows and Outflows

Operating activities

Cash inflows:

From sale of goods or services

From returns on loans (interest received) and on equity securities (dividends received) Cash outflows:

To suppliers for inventory

To employees for services

To government for taxes

To lenders for interest

To others for expenses



ILLUSTRATION 18-1

TYPICAL RECEIPTS AND PAYMENTS

CLASSIFIED BY ACTIVITY

Investing activities

Cash inflows:

From sale of property, plant, and equipment

From sale of debt or equity securities of other entities From collection of principal on loans to other entities

Cash outflows:

To purchase property, plant, and equipment

To purchase debt or equity securities of other entities

To make loans to other entities

Financing activities Cash inflows:

From sale of equity securities (company’s own stock)

From issuance of debt (bonds and notes)

Cash outflows:

To stockholders as dividends

To redeem long-term debt or reacquire capital stock





COMPANY NAME

Statement of Cash Flows

Period Covered

Cash flows from operating activities

(List of individual items) XX Net cash provided (used) by operating activities XXX

Cash flows from investing activities

(List of individual inflows and outflows) XX

Net cash provided (used) by investing activities XXX

Cash flows from financing activities

(List of individual inflows and outflows) XX

Net cash provided (used) by financing activities XXX

Net increase (decrease) in cash XXX

Cash at beginning of period XXX

Cash at end of period XXX

Noncash investing and financing activities

(List of individual noncash transactions) XXX

The general

format of the SCF

Is the 3 activities

previouslydiscussed –

operating,

investing, and

financing – plus

the significant

noncash investing

and financing

activities.

ILLUSTRATION 18-2 FORMAT OF STATEMENT OF CASH FLOWS



FORMAT OF


Net Cash

Company Net Income from Operations

Kmart Corporation $ 518 $ 1237

Wal-Mart Stores, Inc. 4430 7580

The GAP, Inc. 1127 1478J. C. Penney Company, Inc. 594 1058

Sears, Roebuck and Co. 1948 3090

The May Department Stores Company 849 1505

Differences between net income and net cash provided by operating

activities are illustrated by the following results from recent annual

reports for the same fiscal year (all data are in millions of dollars).



USEFULNESS OF


The information in the SCF should help investors,

creditors and others assess the following aspects of

the firm’s financial position:

1 The entity’s ability to generate future cash flows.

2 The entity’s ability to pay dividends and meet

obligations.

3 The reasons for the difference between net incomeand net cash provided (used) by operating

activities.

4 The cash investing and financing transactions

during the period.



PREPARING


The SCF is prepared differently from the 3 other

basic financial statements.

1 It is not prepared from the adjusted trial balance.

2 The SCF deals with cash receipts and payments, so

the accrual concept is not used in the preparation

of the SCF.

The information to prepare this statement usuallycomes from 3 sources:

1 Comparative balance sheet.

2 Current income statement.

3 Additional information.



ILLUSTRATION 18-3

THREE MAJOR STEPS IN PREPARING


+ or -The difference between the

beginning and ending cash

balances can be easily computed

from comparative balance sheets.

This step involves analyzing not only the current

year’s income statement but also comparative

balance sheets and selected additional data.

XYZ

Goods

This step involves analyzing

comparative balance sheet data

and selected additional informationfor their effects on cash.

For

Sale Investing Financing

Step 1: Determine the net increase/decrease in cash.

Step 2: Determine net cash provided/used by operating activities.

Step 3: Determine net cash provided/used by investing and financing activities.



USAGE OF INDIRECT AND

DIRECT METHODS

98.3%

Indirect

Method

1.7% Direct Method

In order to determine net cash provided/used by operating activities, the

operating activities section must be converted from accrual basis to cash

basis. This conversion may be accomplished by 1) the indirect method or

2) the direct method. The indirect method is used extensively in practice,

as shown below. The indirect is favored by companies for 2 reasons: 1) it

is easier to prepare and 2) it focuses on the differences between net income

and net cash flow from operating activities.



STUDY OBJECTIVE 3

Prepare a statement of cash

flows using the indirect method.



SECTION 1

STATEMENT OF CASH FLOWS

INDIRECT METHOD

The transactions of the Computer Services

Company for 2002 and 2003 are used to illustrate

and explain the indirect method of preparing the

SCF.

First Year of Operations – 2002

1 Computer Services Company started on

January 1, 2002, when it issued 50,000 shares of$1 par value common stock for $50,000 cash.

2 The company rented its office space and

furniture and rendered consulting services

throughout the first year.



ILLUSTRATION 18-4COMPARATIVE BALANCE SHEET, 2002,

WITH INCREASES AND DECREASES

COMPUTER SERVICES COMPANY

Comparative Balance Sheets

Change

Assets Dec. 31, 2002 Jan. 1, 2002 Increase/Decrease

Cash $ 34,000 $ – 0 – $ 34,000 Increase

Accounts receivable 30,000 – 0 – 30,000 Increase

Equipment 10,000 – 0 – 10,000 Increase

Total $ 74,000 $ – 0 –

Liabilities and

Stockholders’ Equity

Accounts payable $ 4,000 $ – 0 – $ 4,000 Increase

Common stock 50,000 – 0 – 50,000 Increase

Retained earnings 20,000 – 0 – 20,000 Increase

Total $ 74,000 $ – 0 –

The comparative balance sheets at the beginning and end of2002 – showing increases and decreases – are shown below.



ILLUSTRATION 18-5

INCOME STATEMENT AND

ADDITIONAL INFORMATION, 2002

The income statement and additional information

for Computer Services Company are shown below.


Income Statement

For the Year Ended December 31, 2002

Revenues $ 85,000

Operating expenses 40,000

Income before income taxes 45,000

Income tax expense 10,000

Net income $ 35,000

Additional information:

(1) Examination of selected data indicates

that a dividend of $15,000 was declared

and paid during the year.

(2) The equipment was purchased at the

end of 2002. No depreciation was takenin 2002.



ILLUSTRATION 18-6

NET INCOME VERSUS NET CASH

PROVIDED BY OPERATING ACTIVITIESThe indirect method starts with net income and converts it to net cash provided by

operating activities. In other words, the indirect method adjusts net income for

items that affect reported net income but do not affect cash. Noncash charges in

the income statement are added back to net income. Likewise, noncash credits are

deducted. The result is to calculate net cash provided by operating activities.

Earned

Revenues

Net Income

Incurred

Expenses

Accrual Basis of Accounting Cash Basis of Accounting

Adjustments to

Reconcile Net

Income to Net

Cash Provided

by Operations

Net Cash Provided

by Operating

Activities

Eliminate noncash revenues

Eliminate noncash expenses



ILLUSTRATION 18-7ANALYSIS OF ACCOUNTS RECEIVABLE

ACCOUNTS RECEIVABLE

1/1/02 Balance – 0 – Receipts from customers 55,000

Revenues 85,000

12/31/02 Balance 30,000

When accounts receivable increase during the year, revenues on an accrualbasis are higher than are revenues on a cash basis.

In other words, operations of the period caused revenues to increase, but notall of these revenues resulted in an increase in cash.

Some of increase in revenues had to result in an increase in accountsreceivable.

As shown below, Computer Services Company had $85,000 in revenues, butcollected only $55,000 in cash.

Therefore, to convert net income into net cash provided by operatingactivities, the increase of $30,000 in accounts receivable must be deductedfrom net income.



ILLUSTRATION 18-8ANALYSIS OF ACCOUNTS PAYABLE

ACCOUNTS PAYABLE

Payments to creditors 36,000 1/1/02 Balance – 0 –


12/31/02 Balance 4,000

When accounts payable increase during the year, operating

expenses on an accrual basis are higher than they are on a cash

basis.

For Computer Services Company, operating expenses reported inthe income statement were $40,000.

Since Accounts Payable increased $4,000, only $36,000 ($40,000

– $4,000) of the expenses were paid in cash.

To adjust net income to net cash provided by operating activities,

the increase of $4,000 must be added to net income.



COMPUTER SERVICES COMPANYPartial Statement of Cash Flows— Indirect Method



Net income $ 35,000

Adjustments to reconcile net income to net cash provided by operating

activities:

Increase in accounts receivable $ ( 30,000)

Increase in accounts payable 4,000 ( 26,000)

Net cash provided by operating activities $ 9,000

ILLUSTRATION 18-9PRESENTATION OF NET CASH PROVIDED BY

OPERATING ACTIVITIES, 2002 — INDIRECT METHOD

The changes in accounts receivable and accounts payable were the only changes

in current assets and current liabilities during the year for Computer Services

Company.

Therefore, any other revenues or expenses reported in the income statement

were received or paid in cash.

The operating activities section of the SCF for Computer Services Company is

shown below.



ILLUSTRATION 18-10ANALYSIS OF RETAINED EARNINGS

RETAINED EARNINGS

12/31/02 Cash dividend 15,000 1/1/02 Balance – 0 –

12/31/02 Net income 35,000 12/31/02 Balance 20,000

The reasons for the net increase of $20,000 in Retained Earnings aredetermined by analysis.

1 Net income increased Retained Earnings by $35,000.

2 The additional information below the income statement in

Illustration 18-5 indicates that a cash dividend of $15,000 wasdeclared and paid.

The increase due to net income is reported in the operating activitiessection while the cash dividend paid is reported in the financingactivities section. This analysis can also be made directly from theRetained Earnings account as shown below.



ILLUSTRATION 18-11

STATEMENT OF CASH FLOWS, 2002

— INDIRECT METHOD


Statement of Cash Flows— Indirect Method



Net income $ 35,000

Adjustments to reconcile net income to net cash provided by operating

activities:

Increase in accounts receivable $ ( 30,000)

Increase in accounts payable 4,000 ( 26,000)

Net cash provided by operating activities 9,000


Purchase of equipment ( 10,000)Net cash used by investing activities ( 10,000)


Issuance of common stock 50,000

Payment of cash dividends ( 15,000) 35,000

Net increase in cash 34,000

Cash at beginning of period – 0 –

Cash at end of period $ 34,000

Operating

activities provided

$9,000 cash,

investing activities

used $10,000 cash,

while financing

activities provided

$35,000 cash.





The

comparative

balance

sheets at thebeginning

and end of

2003 –

showing

increases

and

decreases –

are shown to

the right.


Comparative Balance Sheets

December 31

Change

Assets 2003 2002 Increase/Decrease

Cash $ 56,000 $ 34,000 $ 22,000 Increase

Accounts receivable 20,000 30,000 10,000 Decrease

Prepaid expenses 4,000 – 0 – 4,000 Increase

Land 130,000 – 0 – 130,000 Increase

Building 160,000 – 0 – 160,000 Increase

Accumulated depreciation – building ( 11,000) – 0 – 11,000 Increase

Equipment 27,000 10,000 17,000 Increase

Accumulated depreciation – equipment ( 3,000) – 0 – 3,000 Increase

Total $ 383,000 $ 74,000

Liabilities and


Accounts payable $ 59,000 $ 4,000 $ 55,000 Increase

Bonds payable 130,000 – 0 – 130,000 Increase

Common stock 50,000 50,000 – 0 –

Retained earnings 144,000 20,000 124,000 IncreaseTotal $ 383,000 $ – 0 –

S O



ILLUSTRATION 18-13




Income Statement


Revenues $ 507,000

Operating expenses (excluding depreciation) $ 261,000Depreciation expense 15,000

Loss on sale of equipment 3,000 279,000

Income from operations 228,000


Net income $ 139,000


(1) In 2003, the company declared and paid a $15,000 cash dividend.

(2) The company obtained land through the issuance of $130,000 of long-term bonds.

(3) A building costing $160,000 was purchased for cash; equipment costing $25,000

was also purchased for cash.

(4) During 2003, the company sold equipment with a book value of $7,000 (cost

$8,000, less accumulated depreciation of $1,000) for $4,000 cash.

The incomestatement

andadditionalinformationfor 2003 forComputerServicesCompanyare shownto the right.



ILLUSTRATION 18-14ANALYSIS OF ACCUMULATED

DEPRECIATION — EQUIPMENT

ACCUMULATED DEPRECIATION— EQUIPMENT

Accumulated depreciation on 1/1/03 Balance – 0 –

equipment sold 1,000 Depreciation expense 4,000

12/31/03 Balance 3,000

The increase in Accumulated Depreciation – Equipment was$3,000, which does not represent depreciation expense for theyear since the account was debited $1,000 as a result a sale ofsome equipment.

Depreciation expense for 2003 was $4,000 ($3,000 + $1,000).

This amount is added to net income to determine net cashprovided by operating activities.

The T-account below provides information about the changes

that occurred in this account in 2003.



ILLUSTRATION 18-15PRESENTATION OF NET CASH PROVIDED BY

OPERATING ACTIVITIES, 2003 — INDIRECT METHOD


Partial Statement of Cash Flows— Indirect MethodFor the Year Ended December 31, 2003



Adjustments to reconcile net income to net cash provided by operatingactivities:

Depreciation expense $ 15,000

Loss on sale of equipment 3,000

Decrease in accounts receivable 10,000

Increase in prepaid expenses ( 4,000)

Increase in accounts payable 55,000 79,000


Net cash provided by operating activities

for 2003 is $218,000 as calculated below.



ILLUSTRATION 18-16

ANALYSIS OF EQUIPMENT

Equipment increased $17,000, which was a net increase thatresulted from 2 transactions:

1) a purchase of equipment of $25,000 and

2) the sale of equipment costing $8,000 for $4,000.

These transactions are classified as investing activities and eachshould be reported separately. The purchase of equipment

should therefore be reported as an outflow of cash for $25,000 andthe sale should be reported as an inflow of cash for $4,000. The

T-account below shows the reasons for the change in this accountduring the year.

EQUIPMENT

1/1/03 Balance 10,000 Cost of old equipment 8,000

Purchase of equipment 25,00012/31/03 Balance 27,000

ILLUSTRATION 18 17



ILLUSTRATION 18-17


— INDIRECT METHOD


Statement of Cash Flows



Net income $ 139,000Adjustments to reconcile net income to net cash provided by operating

activities:

Depreciation expense $ 15,000

Loss on sale of equipment 3,000

Decrease in accounts receivable 10,000

Increase in prepaid expenses ( 4,000)

Increase in accounts payable 55,000 79,000


ILLUSTRATION 18 17



ILLUSTRATION 18-17


— INDIRECT METHOD


Purchase of building $(160,000) Purchase of equipment ( 25,000)

Sale of equipment 4,000

Net cash used by investing activities (181,000)


Payment of cash dividends ( 15,000)

Net cash used by financing activities ( 15,000)Net increase in cash 22,000

Cash at beginning of period 34,000



Issuance of bonds payable to purchase land $ 130,000

ILLUSTRATION 18 18



Adjustments to Convert Net

Income to Net Cash Provided

by Operating Activities

Current Assets and Add to Deduct from

Current Liabilities Net Income Net Income

Accounts receivable Decrease Increase

Inventory Decrease Increase

Prepaid expenses Decrease Increase

Accounts payable Increase DecreaseAccrued expenses payable Increase Decrease

The SCF prepared by the indirect method starts with net income. Itthen adds or deducts items not affecting cash to arrive at net cashprovided by operating activities. The additions and deductions consistof:

1) changes in specific current assets and current liabilities and2) noncash charges reported in the income statement.

A summary of the adjustments for current assets and current liabilitiesis provided in Illustration 18-18.

ILLUSTRATION 18-18

ADJUSTMENTS FOR CURRENT

ASSETS AND CURRENT LIABILITIES

ILLUSTRATION 18 19



ILLUSTRATION 18-19

ADJUSTMENTS FOR

NONCASH CHARGES

Adjustments to Convert Net

Income to Net Cash ProvidedNoncash Charges by Operating Activities

Depreciation expense Add

Patent amortization expense Add

Depletion expense Add

Loss on sale of asset Add

Adjustments for the noncashcharges reported in the

income statement are made asshown in Illustration 18-19.



STUDY OBJECTIVE 4

Prepare a statement of cash

flows using the direct method.

SECTION 2



SECTION 2

STATEMENT OF CASH FLOWS

DIRECT METHOD

The transactions of Juarez Company for 2002

and 2003 are used to illustrate and explain the

indirect method of preparing the SCF.

First Year of Operations – 2002 1 Juarez Company started on January 1, 2002,

when it issued 300,000 shares of $1 par value

common stock for $300,000 cash.

2 The company rented its office, sales space, and

equipment.

ILLUSTRATION 18 20





JUAREZ COMPANY

Comparative Balance Sheet

Change

Assets Dec. 31, 2002 Jan. 1, 2002 Increase/Decrease

Cash $ 159,000 $ – 0 – $ 159,000 Increase

Accounts receivable 15,000 – 0 – 15,000 Increase

Inventory 160,000 – 0 – 160,000 Increase

Prepaid expenses 8,000 – 0 – 8,000 Increase

Land 80,000 – 0 – 80,000 Increase

Total $ 422,000 $ – 0 –

Liabilities andStockholders’ Equity

Accounts payable $ 60,000 $ – 0 – $ 60,000 Increase

Accrued expenses payable 20,000 – 0 – 20,000 Increase

Common stock 300,000 – 0 – 300,000 Increase

Retained earnings 42,000 – 0 – 42,000 Increase

Total $ 422,000 $ – 0 –

The

comparative

balance

sheets at thebeginning

and end of

2002 –

showing

increases

and

decreases –

are shown to

the right.

ILLUSTRATION 18 21



ILLUSTRATION 18-21



JUAREZ COMPANY

Income Statement


Revenues from sales $ 780,000

Cost of goods sold 450,000

Gross profit 330,000






(1) Dividends of $70,000 were declared and paid in cash.

(2) The accounts payable increase resulted from the purchase of merchandise.

The income statement and additional information

for Juarez Company are shown below.

ILLUSTRATION 18 22



ILLUSTRATION 18-22

MAJOR CLASSES OF CASH

RECEIPTS AND PAYMENTS

From sales of

goods and services

to customers

From receipts of

interest and

dividends on loans

and investments

Net cash provided

by operating

activities

For interest

and dividends

For taxes

For operating

expenses

To suppliers

To employees

Cash Receipts – Cash Payments = Net Cash Provided

by Operating Activities

CASH RECEIPTS



CASH RECEIPTS

FROM CUSTOMERS The income statement for Juarez Company

reported revenues from customers of $780,000.

To determine the amount of cash receipts, the

increase in accounts receivable is deducted fromsales revenues.

Conversely, a decrease in accounts receivable is

added to sales revenues, since cash receipts from

customers exceed sales revenues.

ILLUSTRATION 18 23



ILLUSTRATION 18-23

COMPUTATION OF CASH

RECEIPTS FROM CUSTOMERS


Deduct: Increase in accounts receivable 15,000

Cash receipts from customers $ 765,000

For Juarez Company, accountsreceivable increased $15,000, so

that cash receipts from customerswere $765,000, calculated as shownin Illustration 18-23.

ILLUSTRATION 18 24



ILLUSTRATION 18-24

ANALYSIS OF

ACCOUNTS RECEIVABLE

ACCOUNTS RECEIVABLE1/1/02 Balance – 0 – Receipts from customers 765,000

Revenues from sales 780,000

12/31/02 Balance 15,000

Cash receipts from customers mayalso be determined from an analysis

of Accounts Receivable as shown inIllustration 18-24.

ILLUSTRATION 18 25



ILLUSTRATION 18-25FORMULA TO COMPUTE CASH RECEIPTS

FROM CUSTOMERS — DIRECT METHOD

The relationships among cashreceipts from customers, revenues

from sales, and changes in accountsreceivable are shown in Illustration18-25.

Cash

receipts from

customers

Revenues

from sales{+ Decrease in accounts receivable

or

– Increase in accounts receivable=



ILLUSTRATION 18-26

COMPUTATION OF PURCHASES

Juarez Company reported cost of goods sold on its

income statement of $450,000. To determine

purchases, cost of goods sold must be adjusted for

the change in inventory. An increase (decrease) ininventory is added to (deducted from) cost of

goods sold to arrive at purchases. In 2002, Juarez

Company’s inventory increased $160,000.

Purchases are calculated in Illustration 18-26.

Cost of goods sold $ 450,000

Add: Increase in inventory 160,000

Purchases $ 610,000

ILLUSTRATION 18-27



Cash payments to suppliers are then

determined by adjusting purchases for the

change in accounts payable. An accounts

payable increase (decrease) is deducted from

(added to) purchases. Cash payments to

suppliers are calculated in Illustration 18-27.

Purchases $ 610,000

Deduct: Increase in accounts payable 60,000

Cash payments to suppliers $ 550,000

ILLUSTRATION 18-27

COMPUTATION OF CASH PAYMENTS

TO SUPPLIERS

ILLUSTRATION 18-28



ACCOUNTS PAYABLE

Payments to creditors 550,000 1/1/02 Balance – 0 –

Purchases 610,000

12/31/02 Balance 60,000

Cash payments to suppliers mayalso be determined from an analysisof Accounts Payable as shown inIllustration 18-28.

ILLUSTRATION 18-28

ANALYSIS OF

ACCOUNTS PAYABLE

ILLUSTRATION 18 29



ILLUSTRATION 18-29FORMULA TO COMPUTE CASH PAYMENTS

TO SUPPLIERS — DIRECT METHOD

Cash

payments

to suppliers

=

Cost of

goods sold

{

+ Increase in inventory

or

– Decrease in inventory

{

+ Decrease in accounts payable

or

– Increase in accounts payable

The relationship among cash payments to

suppliers, cost of goods sold, changes in inventory,

and changes in accounts payable is shown in

Illustration 18-29.

ILLUSTRATION 18-30



Operating expenses $ 170,000

Add: Increase in prepaid expenses 8,000

Deduct: Increase in accrued expenses payable ( 20,000)

Cash payments for operating expenses $ 158,000

Operating expenses of $170,000 were reported on Juarez’sincome statement. To convert operating expenses to cashpayments for operating expenses, the increase in prepaidexpenses of $8,000 must be added to operating expenses. A

decrease in prepaid expenses would be deducted from operatingexpenses. The increase in accrued expenses of $20,000 must bededucted, while a decrease would be added. Juarez Company’scash payments for operating expenses are calculated inIllustration 18-30.

ILLUSTRATION 18-30

COMPUTATION OF CASH PAYMENTS

FOR OPERATING EXPENSES

ILLUSTRATION 18 31



ILLUSTRATION 18-31FORMULA TO COMPUTE CASH PAYMENTS FOR

OPERATING EXPENSES — DIRECT METHOD

Cash payments

for operating

expenses=

Operating expenses

+ Increase in prepaid expenses

or

- Decrease in prepaid expenses

+ Decrease in accrued expenses payable

or

- Increase in accrued expenses payable

ILLUSTRATION 18-32



ILLUSTRATION 18-32

OPERATING ACTIVITIES SECTION

— DIRECT METHOD

All of the revenues and expenses in the 2002 incomestatement have now been adjusted to cash basis.

The operating activities section of the SCF is shown

below.

JUAREZ COMPANY

Partial Statement of Cash Flows— Direct Method


Cash flows from operating activitiesCash receipts from customers $ 765,000

Cash payments:

To suppliers $ 550,000

For operating expenses 158,000

For income taxes 48,000 756,000




ILLUSTRATION 18-33ANALYSIS OF RETAINED EARNINGS

RETAINED EARNINGS

12/31/02 Cash dividend 70,000 1/1/02 Balance – 0 –

12/31/02 Net income 112,000

12/31/02 Balance 42,000

The reasons for the net increase of $42,000 in Retained Earnings aredetermined by analysis.

1 Net income increased Retained Earnings by $112,000.

2 The additional information below the income statement in

Illustration 18-21 indicates that a cash dividend of $70,000 wasdeclared and paid.

The increase due to net income is reported in the operating activitiessection while the cash dividend paid is reported in the financingactivities section. This analysis can also be made directly from the

Retained Earnings account as shown below.

ILLUSTRATION 18-34



ILLUSTRATION 18 34


— DIRECT METHODJUAREZ COMPANY

Statement of Cash Flows— Direct Method




Cash payments:To suppliers $ 550,000


For income taxes 48,000 (756,000)



Purchase of land ( 80,000)

Net cash used by investing activities ( 80,000)Cash flows from financing activities

Issuance of common stock 300,000

Payment of cash dividend ( 70,000)

Net cash provided by financing activities 230,000

Net increase in cash 159,000

Cash at beginning of period – 0 –


The SCF for 2002

for Juarez

Company shows

that operating

activities provided

$9,000 cash,

investing activities

used $80,000 cash,

while financing

activities provided

$230,000 cash.

ILLUSTRATION 18-35



ILLUSTRATION 18 35COMPARATIVE BALANCE SHEET, 2003,


JUAREZ COMPANY

Comparative Balance SheetDecember 31

Change

Assets 2003 2002 Increase/Decrease

Cash $ 191,000 $ 159,000 $ 32,000 Increase

Accounts receivable 12,000 15,000 3,000 DecreaseInventory 130,000 160,000 30,000 Decrease

Prepaid expenses 6,000 8,0000 2,000 Decrease

Land 180,000 80,000 100,000 Increase

Equipment 160,000 – 0 – 160,000 Increase

Accumulated depreciation – equipment ( 16,000) – 0 – 16,000 Increase

Total $ 663,000 $ 422,000

The comparative balance sheets at the beginning and end of 2003

– showing increases and decreases – are shown below.

ILLUSTRATION 18-35



ILLUSTRATION 18 35COMPARATIVE BALANCE SHEET, 2003,


Liabilities and


Accounts payable $ 52,000 $ 60,000 $ 8,000 Decrease

Accrued expenses payable 15,000 20,000 5,000 Decrease

Income taxes payable 12,000 –0– 12,000 Increase

Bonds payable 90,000 –0– 90,000 Increase

Common stock 400,000 300,000 100,000 Increase

Retained earnings 94,000 42,000 52,000 Increase

Total $ 663,000 $ 422,000

ILLUSTRATION 18-36



ILLUSTRATION 18 36


ADDITIONAL INFORMATION, 2003JUAREZ COMPANY

Income Statement




Operating expenses (excluding depreciation) 176,000Depreciation expense 18,000

Loss on sale of store equipment 1,000 855,000



Net income $ 84,000


(1) In 2003, the company declared and paid a $32,000 cash dividend.

(2) Bonds were issued at face value for $90,000 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) Common stock of $100,000 was issued to acquire land.

The income statement and

additional information for 2003

for Juarez Company are shown.

ILLUSTRATION 18-37




Add: Decrease in accounts receivable 3,000


Revenues from sales were $975,000. Cash receipts

from customers were greater than sales revenues since

accounts receivable decreased $3,000. Cash receiptsfrom customers were $978,000, as calculated below.

ILLUSTRATION 18 37

COMPUTATION OF CASH

RECEIPTS FROM CUSTOMERS

ILLUSTRATION 18-38




Deduct: Decrease in inventory 30,000

Purchases 630,000

Add: Decrease in accounts payable 8,000

Cash payments to suppliers $ 638,000

Purchases are calculated using cost of goods sold of

$660,000. The inventory decrease of $30,000 is deducted

from cost of goods sold. Purchases are then adjusted by

the accounts payable decrease of $8,000. Cash paymentsto suppliers are calculated in Illustration 18-38.

ILLUSTRATION 18 38

COMPUTATION OF CASH

PAYMENTS TO SUPPLIERS

ILLUSTRATION 18-39



ILLUSTRATION 18 39COMPUTATION OF CASH PAYMENTS

FOR OPERATING EXPENSES

Operating expenses, exclusive of depreciation $ 176,000Deduct: Decrease in prepaid expenses ( 2,000)

Add: Decrease in accrued expenses payable 5,000

Cash payments for operating expenses $ 179,000

Operating expenses (exclusive of depreciation expense)

was $176,000 for 2000. The $2,000 decrease in prepaid

expenses is deducted and the $5,000 decrease in accruedexpenses payable is added in determining cash payments

for operating expenses, as shown in Illustration 18-39.

ILLUSTRATION 18-40



Income tax expense $ 36,000

Deduct: Increase in income taxes payable 12,000

Cash payments for income taxes $ 24,000

Income tax expense reported on the incomestatement was $36,000. The $12,000increase in income taxes payable must be

deducted from income tax expense todetermine cash payments for income taxes.Cash payments for income taxes were$24,000 as shown in Illustration 18-40.

ILLUSTRATION 18 40COMPUTATION OF CASH PAYMENTS

FOR INCOME TAXES

ILLUSTRATION 18-41



ILLUSTRATION 18 41FORMULA TO COMPUTE CASH PAYMENTS

FOR INCOME TAXES — DIRECT METHOD

Cash

payments for

income

taxes

Income

tax

expense{+ Decrease in income taxes payable

or

– Increase in income taxes payable

=

The relationships among cash payments forincome taxes, income tax expense, andchanges in income taxes payable are shown inthe formula in Illustration 18-41.

ILLUSTRATION 18-42



ILLUSTRATION 18 42ANALYSIS OF EQUIPMENT AND RELATED

ACCUMULATED DEPRECIATION

EQUIPMENT

1/1/03 Balance – 0 – Cost of equipment sold 20,000

Cash purchase 180,000

12/31/03 Balance 160,000

The comparative balance sheet shows that Equipment increased

$160,000 in 2003. The additional information in Illustration 18-

36 that the increase resulted from 2 investing transactions: 1)

equipment costing $180,000 was purchased for cash and 2)

equipment costing $20,000 was sold for $17,000 cash when its

book value was $18,000. For Juarez Company, the investing

activities section will show: 1) the $180,000 purchase of

equipment as an outflow of cash and 2) the $17,000 sale of

equipment as an inflow of cash.

ILLUSTRATION 18-42



ILLUSTRATION 18 42ANALYSIS OF EQUIPMENT AND RELATED

ACCUMULATED DEPRECIATION

ACCUMULATED DEPRECIATION— EQUIPMENT

Sale of equipment 2,000 1/1/03 Balance – 0 –

Depreciation expense 18,000

12/31/03 Balance 16,000

ILLUSTRATION 18-43




— DIRECT METHOD

JUAREZ COMPANY

Statement of Cash Flows— Direct Method



Cash receipts from customers $ 978,000Cash payments:

To suppliers $ 638,000


For income taxes 24,000 (841,000)


ILLUSTRATION 18-43




— DIRECT METHOD


Purchase of equipment (180,000)

Sale of equipment 17,000

Net cash used by investing activities (163,000)


Issuance of bonds payable 90,000

Payment of cash dividend ( 32,000)

Net cash provided by financing activities 58,000

Net increase in cash 32,000Cash at beginning of period 159,000



Issuance of common stock to purchase land $ 100,000



STUDY OBJECTIVE 5

Analyze the statement of cash flows.

ILLUSTRATION 18-45



THE GAP, INC. DATA USED IN CASH

FLOW ANALYSIS

The GAP, Inc. reported the following

information in its 2000 annual report:

Gap, Inc.

($ in millions) Fiscal 2000 Fiscal 1999

Current Liabilities $1,753 $1,553

Total Liabilities 2,956 2,390

Net Sales 11,635 9,054

Net Cash provided by operating activities 1,478 1,394

ILLUSTRATION 18-45



CURRENT CASH DEBT

COVERAGE RATIO

Net CashProvided by

Operating

Activities

Average Current

Liabilities

Current Cash Debt

Coverage Ratio

A disadvantage of the current ratio is that it employs year-end

balances of current asset and current liability accounts. Such

year-end balances may not be representative of the company’s

current position during most of the year. The current cash debt

coverage ratio partially corrects this problem and is calculatedby dividing average current liabilities into net cash provided by

operating activities. The current cash debt coverage ratio for

The GAP, Inc. for 2000 is calculated below.

$1,753 + $1,553

$1,478 ÷ ———————— = .89:12

ILLUSTRATION 18-46



ILLUSTRATION 18-46

CASH RETURN ON SALES RATIO

The cash return on sales ratio is the cash based ratio that

is the counterpart of the profit margin percentage. This

ratio is calculated by dividing net sales into net cash

provided by operating activities. The current return on

sales ratio for The GAP, Inc. for 2000 is calculated below.

Net CashProvided by

Operating

Activities

Cash Return on

Sales RatioNet Sales

$1,478 ÷ $11,635 = 13%

ILLUSTRATION 18-47



ILLUSTRATION 18-47

CASH DEBT COVERAGE RATIO

The cash basis measure of solvency is the cash debt coverage

ratio – the ratio of net cash provided by operating activities

to average total liabilities. This ratio demonstrates a

company’s ability to repay its liabilities from net cash

provided by operating activities, without having to liquidate

the assets it employs. The cash debt coverage ratio for The

GAP, Inc. for 2000 is calculated below.

Net CashProvided by

Operating

Activities

Cash Debt

Coverage RatioAverage Total

Liabilities

$2,956 + $2,390

$1,478 ÷ ———————— = .55:12



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CHAPTER 18



CHAPTER 18 THE STATEMENT OF CASH FLOWS

Documents

Chap18[1] the Statement of Cashflows