1

Class 11
Statement of Cash Flows
 2
Recap

• Capital Structure
 Current Liabilities • A/P vs Accrued Liabilities
• Current Maturities of long-term debt
 Non-current liabilities
• Contingent Liabilities (warranty)
 Share Issuance • Lease/Loan/Bonds
 Share Repurchase
• Shareholder rights
• Authorized shares, issued, treasury and outstanding
shares.
• Ordinary vs Preference Shares
• Par value --- Additional Paid-in Capital (APIC)
• Share issuance
• Share repurchase (treasury stocks)
 3
Treasury Stocks - Example

 Kitzer Corporation acquires 200 shares of its ordinary shares for $15/share.
Dr. Treasury Stock (+xSE, - SE) 3,000
Cr. Cash (-A) 3,000
To record the purchase of 200 shares of treasury shares
 Kitzer later resells 100 shares of its treasury shares for $20/share.
Dr. Cash (+A) 2,000
Cr. Treasury Stock (-xSE, +SE) 1,500
Cr. APIC (+SE) 500
To record the sale of 100 shares of treasury shares.

 What if the re-issuance price was $10 instead of $20?

Dr. Cash (+A) 1,000
Dr. APIC (-SE) 500
Cr. Treasury Stock (-xSE, +SE) 1,500
To record the sale of 100 shares of treasury shares.
 4
Treasury Stocks - Example

 Kitzer Corporation used 50 treasury shares for employee compensation, which was
purchased at $15/share.
Dr. Share Compensation Expense 750
Cr. Treasury Shares 750
To record the reissuance of treasury shares for employee share option

 Kitzer decided to retire the rest 50 shares of its treasury shares by canceling them.

Dr. Share Capital 750

Cr. Treasury shares 750

To record the cancellation of 50 shares from treasury shares.

 5
Quick Question

CGJ Company has provided the following:

• 200,000 shares of $5 par value common stock are authorized
• 140,000 shares of common stock were issued for $11 per share
• 130,000 shares are outstanding
Which of the following statements is false?
A. Common stock is reported at $700,000 on the balance sheet.
B. Additional paid-in capital is reported at $840,000 on the balance sheet.
C. Stockholders' equity decreased $110,000 when the treasury stock was purchased.
D. There are 10,000 shares of treasury stock.
 6
Agenda

 Dividends
 Statement of Cash Flows
 Indirect method
 Direct Method
 Evaluate the company’s ability to generate cash flow
 7
Cash Dividends

 Corporations may pay out a portion of their earnings to stockholders in the

form of dividends. This is part of what many investors are paying for when
they buy shares of stock.
 But not always!
 For a corporation to pay a cash dividend, it must have:
 Retained earnings
 Adequate cash.
 Declaration by the Board of Directors.
 8
Cash Dividends

 Typically fairly stable over short periods of time. Why?

 Investors usually see it as a very bad sign if a company cuts or stops paying
dividends.
 Example from Kimberly-Clark’s 2016 10-K
 9
Cash Dividend

 Dividends require information concerning three dates:

 10
Cash Dividend

Declaration date: Sep 20, 2016

Record date: Nov 17, 2016
Payment date: Dec 8, 2016
 11
Cash Dividend - Example

 On December 1, the directors of Media General declare a $0.50 per share cash
dividend on 100,000 shares of $10 par value common stock. The dividend is payable
on January 20 to shareholders of record on December 22:
December 1 (Declaration Date)
Dr. Retained Earnings 50,000
Cr. Dividends Payable 50,000
December 22 (Record Date) No entry

January 20 (Payment Date)

Dividends Payable 50,000
Cash 50,000
 12
Cash Dividends on Preference Shares

 When a company issues both preference and ordinary shares, the preference
shareholders receive their dividends first. The ordinary shareholders receive
dividends only if the total dividend is large enough to pay the preference
shareholders first.

 Avant Garde, Inc., has 100,000 2% preference shares (par value of $100) outstanding
in addition to its ordinary shares. The 2% designation means that the preference
shareholders receive an annual cash dividend of 2% × $100 par value per share. In
20X6, Avant Garde declares an annual dividend of $500,000. The allocation to
preference and ordinary shareholders is:
Preference dividend = 100,000 shares * (2% * $100) per share = $200,000
Ordinary dividend (remainder) = $500,000 - $200,000 = $300,000
 13
Quick Question

The payment of a previously declared cash dividend has an overall effect of:
A. Reducing retained earnings and reducing liabilities by the amount of the
dividend.
B. Reducing retained earnings and increasing contributed capital by the same
amount.
C. Reducing assets and reducing liabilities by the amount of the dividend.
D. Reducing assets and reducing retained earnings by the amount of the dividend.
 14
Stock Dividends

 Distribution of additional shares of stocks to shareholders (on a pro rata basis) at no

cost to the stockholder.
 All stockholders retain the same percentage of ownership.
 No change in total stockholders’ equity. Amounts move around between
Contributed Capital and Retained Earnings
 No economic value. Then why would firms do this?
 Companies often issue stock dividends as a way to reinvest profits back into the
business, indicating growth potential and the desire to retain cash for expansion.
 Tax advantage: only taxable when investors sell the stocks; allowing investors to
defer taxes while potentially benefiting from capital appreciation.
 15
Stock Dividend

 Suppose L’Occitane declared 5% share dividend when the share is trading at €10
per share. Assuming that there are 20,000,000 shares outstanding and par value is €
0.03 per share, L’Occitane would record the share dividend as follows:
20,000,000 * 0.05 * 10

Dr. Retained Earnings 10,000,000

Cr. Common Stock 30,000
Cr. APIC 9,970,000

20,000,000 * 0.05 * 0.03

 16
Quick Question

Katie Company had 40,000 shares of $2 par value common stock outstanding prior to
a 40% common stock dividend declaration and distribution. The market value of the
common stock on the declaration date was $10. Which of the following statements
incorrectly describes the effect of recording the common stock dividend?
A. Retained earnings decreased $160,000.
B. Additional paid-in capital increased $32,000.
C. Additional paid-in capital increased $128,000.
D. Total stockholders' equity remained the same.
 17
Summary
 18
Agenda

 Dividends
 Statement of Cash Flows
 Indirect method
 Direct Method
 Evaluate the company’s ability to generate cash flow
 19
Statement of Cash Flows

 Statement of Cash Flows shows the sources and uses of cash during the
period.
 Where did cash come from during the period?
 Where did cash go during the period?
 How do we interpret the change in the cash balance from the beginning
to the end of the period.
 SCF: (1) Reports the cash receipts and cash payments from the operating,
investing, and financing activities during a period, (2) in a format that
reconciles the beginning and ending cash balances
 20
Statement of Cash Flows

 But isn’t accrual-based accounting better than cash-based?

 Yes! But…
• Income isn’t Everything – Cash shortages are an immediate cause of failure
• Income AND cash flows together are better predictors of future income
and cash flows than either individually.
• Source of cash is important.
Banks won’t lend money and investors won’t invest if they don’t think
firm can generate cash flows from operations
• Assess the reliability of accrual-basis net income

Often based on estimates, which is more likely to subject to

manipulation.
 21
Different Business Activities

Investing Activities Financing Activities

Operating Activities
 22
Statement of Cash Flows

 Statement of Cash Flows splits activities that affect cash into three categories:

1. Cash Flows from Operations

2. Cash Flows from Investing

3. Cash Flows from Financing

 Cash Flows from Investing and Financing are easiest to define

 Cash flows from Operations include everything that’s left over

 23
Cash Flows From Investing Activities

 Change in noncurrent assets, PPE, intangible assets, and investment in other companies.
 Includes Four Activities:
 Acquiring Property, Plant, & Equipment, Intangibles, and Natural Resources with cash
 Disposing of Property, Plant, & Equipment, Intangibles, and Natural Resources for cash
 Acquiring Investments (Equities/Debts(bonds)) with cash
 Disposing of Investments (Equities/Debts(bonds)) for cash

 Does NOT include:

 Interest Paid or Received (Operating)
 Dividends Paid (Financing)
 Dividend Received (Operating)
 24
Cash Flows from Investing: Example

The following data is from the Nelson Company for 2018:

Loss on Sale of Equipment $4,000
Purchase of Enfield Corp. Bonds for Cash $375,000
Cash Proceeds from the Sale of Equipment $200,000
Dividends Paid $25,000
Proceeds from the Issuance of Nelson stock $100,000

What amount should be reported as net cash flows from investing activities?
-375,000 + 200,000 = -175,000
Nelson would report a net cash outflow of $175,000 from Investing
Activities
 25
Cash Flows from Financing Activities

 Relates to noncurrent liabilities and shareholders’ equity

 Includes:
 Issuing long-term debt to financial institutions and debt investors for cash
 Retiring long-term debt to financial institutions and debt investors with cash
 Issuing stock for cash
 Retiring stock with cash
 Payment of cash dividends

 Does NOT include:

 Interest Paid or Received (Operating)
 Dividends Received (Operating)
 26
Cash Flows from Financing: Example

The following data is from the Nelson Company for 2018:

Loss on Sale of Equipment $4,000
Purchase of Enfield Corp. Bonds for Cash $375,000
Cash Proceeds from the Sale of Equipment $200,000
Dividends Paid $25,000
Proceeds from the Issuance of Nelson stock $100,000

What amount should be reported as net cash flows from financing activities?
-25,000 + 100,000 = 75,000
Nelson would report a net cash inflow of $75,000 from Financing
Activities
 27
Cash Flows from Operations

Includes: Everything that’s not Investing or Financing

Cash Collections Cash Payments
• from customers • to suppliers
• of interest • to employees
• of dividends • for interest
• to the Government (taxes)

 Direct Method
 Directly record cash inflows and outflows for the period
 Indirect Method (our focus)
 Reconciliation of Net Income to Cash from Operating Activities
 Used by the majority of companies
 28
Exercise

Classify each item as an operating, investing, or financing activity. Assume all

items involve cash unless there is information to the contrary.
(a) Purchase of equipment: Investing
(b) Sale of building: Investing
(c) Redemption of bonds: Financing
(d) Payment of dividends: Financing
(e) Issuance of Capital stock: Financing
 29
Exercise

Classify each item as an operating, investing, or financing activity. Assume all items involve
cash unless there is information to the contrary.

a) Issued 100,000 shares of $5 par value common stock for $800,000 cash: F
b) Borrowed $200,000 from Castle Bank, signing a 5-year note bearing 8% interest: F
c) Purchased two semi-trailer trucks for $170,000 cash: I
d) Paid employees $12,000 for salaries and wages: O
e) Collected $20,000 cash for services performed: O
 30
Agenda

 Content and Format

 Indirect method
 Direct Method
 Evaluate the company’s ability to generate cash flow
 31
Different Approaches

 Suppose you are given a series of numbers: 2, 3, 5, 7, and 8. What’s the sum
of the prime numbers in the sequence?
 What’s the sum of the sequence? Which number is not prime number?
2+3+5+7+8=25
8

 Which numbers are prime number? What’s the sum of them?

2,3,5,7
2+3+5+7=17
 32
Different Approaches
Both approaches will give us the same value
- they’re just different methods of getting there

Indirect Method Direct Method

Cash Received from Operating

Net Income
Sources

Adjust for Non-Cash and Cash Paid for

Non-Operating Transactions Operating Resources

Net Cash Flows from Net Cash Flows from

Operations Operations
 33
Indirect Method
 34
Indirect Method

Starting with Net Income (NI), we adjust for:

 Items that Affected Net Income, but had No Cash Effects
 Depreciation
 Amortization
 Items that Affected Both Net Income AND Cash, but not from an Operating
Activity
 Gains on Sale of PP&E and Other Investing Assets
 Losses on Sale of PP&E and Other Investing Assets
 Operating Items for which Income Effect differs from Cash Flow Effect (non-cash
current assets and current liabilities)
 Increases in current liabilities and decreases in current assets
 Increases in current assets and decreases in current liabilities
 35
Indirect Method

Why add back Depreciation and Amortization?

 Remember the journal entry for depreciation expense:
Dr. Depreciation Expense (+E, -SE) XXXX
Cr. Accumulated Depreciation (+xA) XXXX

 Recording this entry:

 Reduced Net Income
 Did not affect cash
 Did not affect non-cash current assets or liabilities
 If we want to reconcile Net Income to the change in cash, we need to remove the
effects of depreciation and amortization expense (by adding them back)
 36
Indirect Method

Why subtract Gains and add back Losses from the sale of PPE and other investing
items?
 Remember the journal entry for sales of PP&E (at a gain):
Dr. Cash (+A) XXXX
Dr. Accumulated Depreciation (-xA) XXXX
Cr. Gain on Sale of PP&E(+R, +SE) XXXX
Cr. PP&E (-A) XXXX
 Recording this entry:
 Increased Net Income
 Increased Cash (BUT this is an INVESTING Cash Flow!)
The cash inflow related to “gain” is already included in investing cash flows. Thus, we need to
subtract the gain from NI.
Otherwise, we’d be double-counting the cash flow in both the operating and
investing sections
 37
Indirect Method

Why add decreases and subtract increases in non-cash current assets?

Example: Accounts Receivable
Sale for Cash Sale on Account Cash Collection
Cash A/R Cash
Journal Entry
Revenue Revenue A/R
Effect on Net Income Increase Increase No Effect
Effect on Cash Increase No Effect Increase
Effect on Non-Cash
No Effect Increase Decrease
Current Assets
Subtract the Increase in Add the Decrease in
Adjustment None Non-Cash Assets from NI Non-Cash Assets to NI
to Get to Cash to Get to Cash
 38
Indirect Method

Why add increases and subtract decreases in current liabilities?

Example: Wages Payable
Cash Purchases Purchase on Account Cash Collection
Expense Wages Expense Wages payable
Journal Entry
Cash Wages Payable Cash
Effect on Net Income Decrease Decrease No Effect
Effect on Cash Decrease No Effect Decrease
Effect on Current
No Effect Increase Decrease
Liabilities
Add the Increase in Subtract the Decrease in
Adjustment None Current Liabilities to Current Liabilities to NI
NI to Get to Cash to Get to Cash
 Change in Account Balance
During Year
39
Indirect Method Increase Decrease
Current Subtract from Add to
Assets Net Income Net Income
Current Add to Subtract from
Cash Flows from Operations: Liabilities Net Income Net Income
Net Income
The intuition for the
1 + Depreciation and Amortization indirect method can be
confusing!
+ Losses on Sales of Investing Assets
2
─ Gains on Sales of Investing Assets It’s ok to learn the steps for
+ Decreases in Non-Cash Current Assets now and build the intuition
as you practice!
─ Increases in Non-Cash Current Assets
3 + Increases in Current Liabilities
─ Decreases in Current Liabilities

Cash Flow From Operations

 40
Group Exercise

The following information has been provided by Salcha Company. What is Salcha’s net
cash flow from operating activities?

Net Income $100,000

Amortization of Patent $9,400 Add
Depreciation Expense $20,000 Add
Decrease in Inventory $7,500 Add
Decrease in Accts. Payable $38,000 Subtract
Increase in Accts. Receivable $8,000 Subtract
Increase in PP&E $75,000 no effect (non-operating)
Increase in Income Taxes Payable $6,000 Add

Answer: $96,900 ($100,000 + 9,400 + 20,000 + 7,500 – 38,000 – 8,000 + 6,000)

 41
Agenda

 Content and Format

 Indirect method
 Direct Method
 Evaluate the company’s ability to generate cash flow
 42
Direct Method

 IAS 7 prefers the direct method for cash flows of operating activities.
 Provides clearer information about the sources and users of cash
 However, very few companies actually use the direct method
 Requires more computations than the indirect method
 43
Direct Method

 E.g. Cash collection from customers

 Focus on change in Accounts Receivable
 Beginning Balance + Sales – Cash Collection = Ending Balance
 Cash Collection = Sales – (Ending Balance – Beginning Balance)
 44
Direct Method

Payment for Inventory:

 Inventory: Beginning balance + Purchase – Cost of goods sold = Ending balance
 A/P: Beginning balance + Purchase – Payment for inventory = Ending balance
 45
Direct Method
 46

Operating
Activities
(Indirect Method)

Investing
And
Financing
Activities
(Direct Method)
 47
Cash Flows from Investing Activities

 Receipts of Cash
 Sale of PPE
 Sale of Investment
 Collection of Notes Receivable
 Payments of Cash
 Acquisition of PPE
 Purchase of Investment
 New loans made
 48
Cash Flows from Financing Activities

 Receipts of Cash
 Issuance of long-term debt (bonds)
 Issuance of Share
 Payments of Cash
 Payment of long-term debt
 Purchase of treasury stocks
 Payment of dividends
 49
Group Exercise

 Asay Company purchased a piece of equipment on 1/1/2017 for $100,000,

that will be depreciated equally over an estimated useful life of 10 years
(Residual value is 0).

1) What would be recorded gain or loss if Asay sells the equipment on 31st Dec
2018 for $95,000 cash?
2) Assuming this is the only transaction for Asay in 2018 and Net Income is
$5,000, construct the 2018 SCF for Asay.
 50
Group Exercise

 Asay Company purchased a piece of equipment on 1/1/2017 for $100,000, that

will be depreciated equally over an estimated useful life of 10 years.
1) What would be recorded gain or loss if Asay sells the equipment on 31st Dec 2018
for $95,000 cash?
What Journal Entries have been made so far?
1/1/17: Equipment (+A) 100,000
Cash (-A) 100,000
12/31/17: Depreciation Expense (+E, -SE) 10,000
Accumulated Depreciation (+xA) 10,000
12/31/18: Depreciation Expense (+E, -SE) 10,000
Accumulated Depreciation (+xA) 10,000
What Journal Entry is used to record the sale?
12/31/18: Cash (+A) 95,000
Accumulated Depreciation (-xA) 20,000
Equipment (-A) 100,000
Gain on Sale of Equipment (+R, +SE) 15,000
 51
Group Exercise

2) Assuming this is the only transaction for Asay in 2018 and Net Income is
$5,000, construct the 2018 SCF for Asay.

Operating Activities:
Net Income $5,000
+ Depreciation Expense 10,000
- Gains (15,000)
Net Cash Flow from Operating Activities 0

Investing Activities:
Sale of equipment 95,000
Net Cash Flow from Investing Activities 95,000

Financing Activities:
Net Cash Flow from Financing Activities 0

Net Increase in Cash $95,000

 The Boeing Company and Subsidiaries
Consolidated Statements of Financial Position 52
Group Exercise (Dollars in millions, except per share data)
December 31, 2018 2017
Assets
Cash and Cash Equivalents $ 7,637 $ 8,813
Accounts Receivable 13,904 11,088
Below are (heavily) adapted financial Inventories 62,567 61,388
statement data from Boeing’s Feb. 8, Other Current Assets 3,722 3,905
2019 10-K Filing. Using the information Total Current Assets 87,830 85,194

provided, prepare Boeing’s 2018 Property, Plant and Equipment, gross 31,213 30,313
Statement of Cash Flows Accumulated Depreciation (18,568) (17,641)
Total Assets $ 100,475 $ 97,866

Financial Statement Highlights Liabilities

Current Liabilities:
• 2018 Net Income was $10,535 Accounts Payable $ 12,916 $ 12,202
Accrued Liabilities $ 14,808 $ 13,069
• Depreciation on PP&E was $927 Total Current Liabilities 27,724 25,271
• Purchased equipment for $1,900. Long-Term Debt 10,657 9,782
Immediately sold $1,000 of this Total Liabilities 38,381 35,053
equipment for $1,075 cash. Stockholders' Equity
• Borrowed a new long-term note of Contributed Capital 21,236 18,865
$875 Retained Earnings 40,858 43,948
Total Stockholders' Equity 62,094 62,813
• Received $2,371 for issuance of new
shares of common stock Total Liabilities and Stockholders' Equity $ 100,475 $ 97,866
Step 1: Mark Balance Sheet Accounts O, I, or F and Compute Δ
The Boeing Company and Subsidiaries
Consolidated Statements of Financial Position
(Dollars in millions, except per share data)
Related
SCF
53
December 31, 2018 2017 Change Section(s)
Assets
Cash and Cash Equivalents $ 7,637 $ 8,813
Accounts Receivable 13,904 11,088 2,816 O
Inventories 62,567 61,388 1,179 O
Other Current Assets 3,722 3,905 (183) O
Total Current Assets 87,830 85,194
Property, Plant and Equipment, gross 31,213 30,313 900 I
Accumulated Depreciation (18,568) (17,641) (927) O
Total Assets $ 100,475 $ 97,866

Liabilities
Current Liabilities:
Accounts Payable $ 12,916 $ 12,202 714 O
Accrued Liabilities $ 14,808 $ 13,069 1,739 O
Total Current Liabilities 27,724 25,271
Long-Term Debt 10,657 9,782 875 F
Total Liabilities 38,381 35,053
Stockholders' Equity
Contributed Capital 21,236 18,865 2,371 F
Retained Earnings 40,858 43,948 (3,090) O&F
Total Stockholders' Equity 62,094 62,813
Total Liabilities and Stockholders' Equity $ 100,475 $ 97,866
Step 2: Start with Operating Section
54

The Boeing Company and Subsidiaries

Consolidated Statement of Cash Flows
(Dollars in millions, except per share data)
Year ended December 31, 2018
Cash flows - operating activities:
Net earnings $ 10,535 Start with Net Income
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Non-cash items -
Depreciation 927 Add Back Depreciation
(Gain)/loss on dispositions, net (75) Subtract Gains/
Changes in assets and liabilities - Add Back Losses
Accounts receivable (2,816) Subtract Increases in CA
Inventories (1,179)
Other current assets 183 Add Decreases in CA
Accounts payable 714 Add Increases in CL
Accrued liabilities 1,739
Net cash provided by operating activities 10,028
Step 3: Complete Investing and Financing Sections 55

Cash flows - investing activities:

Purchase of Property, Plant, and Equipment (1,900)
Sale of Property, Plant, and Equipment 1,075
Net cash used by investing activities (825)

• Purchased $1,900 of Equipment for Cash

• Immediately Sold $1,000 of the Equipment, receiving $1,075 Cash

Note: Purchase of Equipment for $1,900 – Sale of Equipment with $1,000 BV ties to the
$900 increase in “Property, Plant, and Equipment, gross” on the Balance Sheet
Step 3: Complete Investing and Financing Sections 56

Cash flows - financing activities:

New borrowings 875
Proceeds from issuance of common shares 2,371
Dividends paid (13,625)
Net cash used by financing activities (10,379)

• Borrowed a new $875 Long-Term Note Payable

• Received $2,371 for issuance of new shares of common stock

• Dividend?

We aren’t explicitly told whether the company paid dividends, but we know Retained Earnings
decreased by $3,090, despite the company having Net Income of $10,535.
Step 4: Reconcile – Ensure Total Change in Cash is Accounted for
The Boeing Company and Subsidiaries
Consolidated Statement of Cash Flows
(Dollars in millions, except per share data) 57
Year ended December 31, 2018
Cash flows - operating activities:
Net earnings $ 10,535
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Non-cash items -
Depreciation 927
(Gain)/loss on dispositions, net (75) 10,028 CFO
Changes in assets and liabilities -
Accounts receivable
Inventories
(2,816)
(1,179)
-825 CFI
Other current assets 183
Accounts payable 714 -10,379 CFF
Accrued liabilities 1,739
Net cash provided by operating activities 10,028
Cash flows - investing activities: (1,176)
Purchase of Property, Plant, and Equipment (1,900)
Sale of Property, Plant, and Equipment 1,075 net cash decrease
Net cash used by investing activities (825)
Cash flows - financing activities:
New borrowings 875
Proceeds from issuance of common shares 2,371
Dividends paid (13,625)
Net cash used by financing activities (10,379)
Reconciles with the Change
Net (decrease)/increase in cash (1,176) in Cash for the Year from
Cash and cash equivalents - beginning of year 8,813
Cash and cash equivalents - end of year $ 7,637 the Balance Sheet