Accounting Principles, 12th Edition

Weygandt • Kieso • Kimmel

Chapter 17

The Statement of
Cash Flows
 CHAPTER 18
THE STATEMENT OF CASH
FLOWS
After studying this chapter, you should be able to:
1 Indicate the usefulness 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.
 THE STATEMENT OF CASH
FLOWS
STUDY OBJECTIVE 1

• Provides information about an entity’s

cash receipts and cash payments during a
period.
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
STUDY OBJECTIVE 2
Prepared using cash and cash equivalents as
its basis.
Cash equivalents - short-term, highly liquid
investments that are both:
1)readily convertible to known amounts of
cash
2)so near to their maturity that their
market value is relatively insensitive to
changes in interest rates.
 Types of Cash Flows -
Operating Activities
• Cash inflows:
– From sale of goods or services
– From return 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
 Types of Cash Flows -
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
 Types of Cash Flows -
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
 Significant
Noncash Activities...
• That do NOT affect cash are NOT reported
in the body of the statement of cash flows.
• Are reported:
– In a separate schedule at the bottom
of the statement of cash flows or
– In a separate note or supplementary
schedule to the financial statements.
 Significant
Noncash Activities...

1. Issuance of common stock to

purchase assets.
2. Conversion of bonds into common
stock.
3. Issuance of debt to purchase assets.
4. Exchanges of plant assets.
 FORMAT OF STATEMENT OF
CASH FLOWS
COMPANY NAME
Statement of Cash Flows
Period Covered
The general
format of the SCF:
Cash flows from operating activities
Is the 3 activities (List of individual items) XX
Net cash provided (used) by operating activities XXX
previously Cash flows from investing activities
(List of individual inflows and outflows) XX
discussed – Net cash provided (used) by investing activities XXX
Cash flows from financing activities
operating, (List of individual inflows and outflows) XX
Net cash provided (used) by financing activities XXX
investing, and Net increase (decrease) in cash XXX
Cash at beginning of period XXX
financing – plus Cash at end of period XXX

the significant Noncash investing and financing activities

(List of individual noncash transactions) XXX
noncash investing
and financing
activities.
 USEFULNESS OF
THE STATEMENT OF CASH
FLOWS
1) Ability to generate future cash flows.
2) Ability to pay dividends and meet obligations.
3) Reasons for the difference between net income
and net cash provided (used) by operating
activities.
4) Cash invested and financing transactions
during the period.
PREPARING
THE STATEMENT OF CASH
FLOWS
Information to prepare this statement
usually comes from 3 sources:
1) Comparative balance sheet.
2) Current income statement.
3) Additional information.
The SCF deals with cash receipts and
payments, so the accrual concept is
not used in the preparation of the SCF.
 THREE MAJOR STEPS IN
PREPARING THE STATEMENT OF
CASH FLOWS
 USAGE OF INDIRECT
AND DIRECT METHODS
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:
- it is easier to prepare and
- it focuses on the differences between net income and net cash flow from
operating activities.
COMPARATIVE BALANCE SHEET, 2005,
WITH INCREASES AND DECREASES
Study Objective 3

The
comparative
balance
sheets at the
beginning
and end of
2005 –
showing
increases
and
decreases –
are shown to
the right.
 INCOME STATEMENT AND
ADDITIONAL INFORMATION, 2005

The income
statement
and
additional
information
for 2005 for
Computer
Services
Company
are shown
to the right.
 ANALYSIS OF ACCUMULATED
DEPRECIATION — EQUIPMENT

 The increase in Accumulated Depreciation – Equipment was

$2,000, which does not represent depreciation expense for the
year since the account was debited $1,000 as a result a sale of
some equipment.
 Depreciation expense for 2005 was $3,000.
 This amount is added to net income to determine net cash
provided by operating activities.
 The T-account below provides information about the changes
that occurred in this account in 2005.
 PRESENTATION OF NET CASH PROVIDED BY
OPERATING ACTIVITIES, 2005 — INDIRECT
METHOD

Net cash provided by operating activities

for 2005 is $154,000 as calculated below.
 ANALYSIS OF
EQUIPMENT
Equipment increased $17,000, which was a net increase that
resulted 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 each
should be reported separately. The purchase of equipment should
therefore be reported as an outflow of cash for $25,000 and the
sale should be reported as an inflow of cash for $4,000. The
T-account below shows the reasons for the change in this account
during the year.
 STATEMENT OF CASH FLOWS,
2005-INDIRECT METHOD
COMPUTER SERVICES COMPANY
Statement of Cash Flows
For the Year Ended December 31, 2005
Cash flows from operating activities
Net income $145,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense $ 9,000
Loss on sale of equipment 3,000
Decrease in accounts receivable 10,000
Increase in merchandise inventory (5,000)
Increase in prepaid expenses (4,000)
Increase in accounts payable 16,000
Decrease in income tax payable (2,000) 27,000
Net cash provided by operating activities $172,000
 STATEMENT OF CASH FLOWS,
2005-INDIRECT METHOD
COMPUTER SERVICES COMPANY
Statement of Cash Flows
For the Year Ended December 31, 2005
Cash flows from investing activities
Purchase of building $(120,000)
Purchase of equipment ( 25,000)
Sale of equipment 4,000
Net cash used by investment activities $(141,000)
Cash flows from financing activities
Issuance of common stock 20,000
Payment of cash dividends (29,000)
Net cash used by financing activities (9,000)
Net increase in cash 22,000
Cash at beginning of period 33,000
Cash at end of period $ 55,000

Noncash investing and financial activities

Issuance of bonds payable to purchase land $ 110,000
 SECTION 2
STATEMENT OF CASH FLOWS
DIRECT METHOD
Study Objective 4

• The transactions of Juarez Company for 2005 and

2004 are used to illustrate and explain the
indirect method of preparing the SCF.

• 1 Juarez Company started on January 1, 2003,

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.
 COMPARATIVE BALANCE SHEETS
WITH INCREASES AND DECREASES

The
comparative
balance
sheets at the
end of 2005
and end of
2004
showing
increases
and
decreases –
are shown to
the right.
 INCOME STATEMENT AND
ADDITIONAL INFORMATION, 2005

The income statement and

additional information for 2005
for Juarez Company are shown.
MAJOR CLASSES OF CASH RECEIPTS
AND PAYMENTS
 CASH RECEIPTS FROM
CUSTOMERS

• The income statement for Juarez Company

reported revenues from customers of $975,000.
• To determine the amount of cash receipts, the
decrease in accounts receivable is added to sales
revenue.
• Conversely, an increase in accounts receivable is
deducted from sales revenues.
 COMPUTATION OF
CASH RECEIPTS FROM
CUSTOMERS

Revenues from sales were $975,000. Cash receipts

from customers were greater than sales revenues since
accounts receivable decreased $3,000. Cash receipts
from customers were $978,000, as calculated below.

Revenues fromsales $ 975,000

Add: Decrease in accounts receivable 3,000
Cash receipts fromcustomers $ 978,000
 FORMULA TO COMPUTE CASH
RECEIPTS FROM CUSTOMERS — DIRECT
METHOD

The relationships among cash

receipts from customers, revenues
from sales, and changes in accounts
receivable.

{
Cash Revenues + Decrease in accounts receivable
receipts from
customers
= from sales or
– Increase in
accounts receivable
 COMPUTATION OF
PURCHASES
Juarez Company reported cost of goods sold on its
income statement of $660,000. To determine
purchases, cost of goods sold must be adjusted for
the change in inventory. An increase (decrease) in
inventory is added to (deducted from) cost of
goods sold to arrive at purchases. In 2005, Juarez
Company’s inventory increased $10,000.
Purchases are calculated as follows.
 FORMULA TO COMPUTE CASH
PAYMENTS TO SUPPLIERS — DIRECT
METHOD

The relationship among cash payments to

suppliers, cost of goods sold, changes in inventory,
and changes in accounts payable is shown.

Cash
payments
to suppliers

=
+ Increase in inventory + Decrease in accounts payable
Cost of
or or
goods sold
– – Increase in
Decrease in inventory accounts payable
 COMPUTATION OF
PURCHASES
Juarez Company reported cost of goods sold on its income
statement of $660,000. To determine cash paid for
purchases, cost of goods sold must be adjusted for the
change in inventory and the change in accounts payable.
An increase (decrease) in inventory is added to (deducted
from) cost of goods sold and an increase (decrease) in
accounts payable is deducted from (added to) cost of goods
sold to arrive at cash payments for purchases. In 2005,
Juarez Company’s inventory increased $10,000. Accounts
payable decreased $8,000. Cash payments for purchases
are calculated as follows.

Cost of goods sold $660,000

Add: Increase in inventory 10,000
Add: Decrease in accounts payable 8,000
Cash paid for purchases $678,000
 COMPUTATION OF CASH
PAYMENTS FOR OPERATING
EXPENSES

Operating expenses (exclusive of depreciation expense) was

$176,000 for 2005. The $2,000 decrease in prepaid expenses
is deducted and the $5,000 decrease in accrued expenses
payable is added in determining cash payments for
operating expenses, as shown in Illustration 18-23.
 FORMULA TO COMPUTE CASH
PAYMENTS FOR INCOME TAXES —
DIRECT METHOD

The relationships among cash payments for

income taxes, income tax expense, and
changes in income taxes payable are as
follows.

Cash
payments for
income taxes

=
Income + Decrease in income taxes payable
tax or
expense – Increase in income
taxes payable
 COMPUTATION OF CASH
PAYMENTS FOR INCOME
TAXES
Juarez Company reported income tax
expense of $36,000. Income taxes payable
increased $12,000. Cash payments for
income taxes are calculated as follows.

Income tax expense $36,000

Less: Increase in income taxes payable 12,000
Cash paid for income tax expense $24,000
 OPERATING ACTIVITIES SECTION
— DIRECT METHOD

 All of the revenues and expenses in the 2005 income

statement have now been adjusted to cash basis.
 The operating activities section of the SCF is shown
below.
STATEMENT OF CASH FLOWS
2005 — DIRECT METHOD
 FREE CASH FLOW
Study Objective 5

Free Cash Flow – Cash provided by

operating activities adjusted for capital
expenditures and dividends paid.
Which of the following items is reported on
a cash flow statement prepared by the
direct method?

a. Loss on sale of building.

b. Increase in accounts receivable.
c. Depreciation expense.
d. Cash payments to suppliers.
Which of the following items is reported on
a cash flow statement prepared by the
direct method?

a. Loss on sale of building.

b. Increase in accounts receivable.
c. Depreciation expense.
d. Cash payments to suppliers.