CHAPTER

18

CASH FLOW STATEMENT

 PURPOSE OF THE
CASH FLOW STATEMENT
• The primary purpose of the cash flow
statement is to provide information about
the cash receipts and cash payments of an
entity during a period.
• A secondary objective is to provide
information about its
– Operating activities
– Investing activities
– Financing activities
 MEANING OF CASH FLOWS
• The cash flow statement 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.
 CLASSIFICATION OF CASH
FLOWS

• Operating activities
• Investing activities
• Financing activities
 OPERATING ACTIVITIES

• Include
– Cash effects of transactions that create
revenues and expenses and
– Enter into determination of net income (loss)

Balance Sheet: Noncash Current

Assets and Current Liabilities;
Income Statement Items
 INVESTING ACTIVITIES

• Include
– Purchasing and disposing of investments
and productive long-lived assets using
cash and
– Lending money and collecting the loans

Balance Sheet: Investment and

Long-Term Asset Items
 FINANCING ACTIVITIES

• Include
– Obtaining cash from issuing debt and
repaying the amounts borrowed and
– Obtaining cash from owners/shareholders
and paying them drawings/dividends

Balance Sheet: Long-Term

Liability and Equity Items
 SIGNIFICANT NONCASH
ACTIVITIES
• If it does not affect cash, do NOT report in
body of cash flow statement
• Report in separate note to the financial
statements
 ILLUSTRATION 18-2
FORMAT OF CASH FLOW STATEMENT
COMPANY NAME
Operating, investing,
Cash Flow Statement
and financing plus
Period Covered
the significant Cash flows from operating activities
noncash investing (List of individual items) XX
and financing Net cash provided (used) by operating activities
XXX
activities constitute Cash flows from investing activities
the general format of (List of individual items) XX
the cash flow Net cash provided (used) by investing activities
XXX
statement, an
Cash flows from financing activities
example of which is (List of individual items) XX
shown on the right. Net cash provided (used) by financing activities
XXX
Net increase (decrease) in cash
XXX
Cash at beginning of period
XXX
 PREPARING
THE CASH FLOW STATEMENT
The cash flow statement is prepared differently from
the three other basic financial statements.
1. It is not prepared from the adjusted trial balance.
2. The cash flow statement deals with cash receipts
and payments, so the accrual concept is not used
in the preparation of this statement.
The information to prepare this statement usually
comes from three sources:
1. Comparative balance sheet
2. Current income statement
3. Additional information
STEP 1: DETERMINE NET INCOME
(DECREASE) IN CASH
 STEP 2: DETERMINE NET CASH
PROVIDED (USED) BY OPERATING
ACTIVITIES
• Net income must be converted from an
accrual basis to a cash basis in the
operating activities section
• Conversion may be done by two methods:
– Indirect (used extensively in practice)
– Direct
 INDIRECT AND DIRECT METHODS

• Both methods arrive at the same total

amount of cash provided (used) by
operating activities
• Methods differ in disclosing the items that
make up the total amount
• Choice of methods affects only the
operating activities section; the investing
and financing activities sections are the
same
 NET INCOME TO NET CASH PROVIDED (USED) BY
OPERATING ACTIVITIES
(B/S: Noncash Current Assets and Current Liabilities)

Adjustments to Convert Net Income

to Net Cash Provided (Used) by
Operating Activities
Add* Deduct*

Change in Current Asset Account Balance

Accounts receivable Decrease Increase
Inventory Decrease Increase
Prepaid expenses Decrease Increase
Other current assets Decrease Increase

Change in Current Liability Account Balance

Accounts payable Increase Decrease
Accrued expenses payable Increase Decrease
Other current liabilities Increase Decrease

* Add (deduct) change in account balance to net income

 NET INCOME TO NET CASH PROVIDED (USED) BY
OPERATING ACTIVITIES
(I/S: Noncash Items)
Adjustments to Convert Net
Income to Net Cash Provided
(Used) by Operating Activities

Noncash Items on Income Statement

Amortization (of capital assets) expense Add

Amortization of bond discount to interest expense Add
Amortization of bond premium to interest expense Deduct
Loss on sale of asset Add
Gain on sale of asset Deduct
Income from long-term equity investment Deduct
NET CASH PROVIDED (USED) BY
OPERATING ACTIVITIES

Indirect Method –
Sample Format

Computer Services Corporation

Cash Flow Statement - Indirect Method
For the Year Ended December 31, 2002
Cash flows from operating activities
Net income 35,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Increase in accounts receivable (30,000)
Increase in inventory (25,000)
Increase in accounts payable 15,000
Increase in accrued expenses payable 4,000 (36,000)
Net cash used by operating activities (1,000)
OPERATING ACTIVITIES
– DIRECT METHOD

Section 2
 NET CASH PROVIDED (USED) BY
INVESTING ACTIVITIES

• Study the balance sheet to determine changes

in investments and long-term assets
• Changes in each short-term investment
(unless incorporated as part of cash
definition) and long-term account are
analysed using selected transaction data to
determine the effect, if any, the changes had
on cash
 NET CASH PROVIDED (USED) BY
FINANCING ACTIVITIES

• Study the balance sheet to determine

changes in noncurrent liabilities and
owner’s/shareholders’ equity
• Changes in each noncurrent account are
analysed using selected transaction data
to determine the effect, if any, the
changes had on cash
ILLUSTRATION 18-8
CASH FLOW STATEMENT
INDIRECT METHOD
COMPUTER SERVICES COMPANY
Cash Flow Statement — Indirect Method Operating
For the Year Ended December 31, 2002
Cash flows from operating activities activities used
Net income $ 35,000 $1,000 cash and
Adjustments to reconcile net income to net cash
provided by operating activities: investing
Increase in accounts receivable $ (30,000) activities used
Increase in inventory (25,000)
Increase in accounts payable 15,000 $10,000 cash,
Increase in accrued expenses payable 4,000 (36,000) while financing
Net cash used by operating activities (1,000)
Cash flows from investing activities activities
Purchase of equipment $ (10,000) provided
Net cash used by investing activities (10,000)
Cash flows from financing activities $45,000 cash.
Issue of common shares $ 60,000
Payment of cash dividend (15,000)
Net cash provided by financing activities 45,000
Net increase in cash 34,000
Cash, January 1 -
Cash, December 31 $ 34,000
 ILLUSTRATION 18-23
CASH FLOW STATEMENT
DIRECT METHOD
COMPUTER SERVICES CORPORATION
Cash Flow Statement
For the Year Ended December 31, 2002
Cash flows from operating activities
Cash receipts from customers The cash flow $120,000
Cash payments: statement
To suppliers shows that $(75,000)
For operating expenses operating (36,000)
For income tax activities used (10,000) (121,000)
Net cash provided by operating activities$1,000 cash (1,000)
Cash flows from investing activities and investing
Purchase of equipment activities used $(10,000)
Net cash used by investing activities $10,000 cash, (10,000)
Cash flows from financing activities while
Issue of common shares financing $ 60,000
Payment of cash dividends (15,000)
activities
Net cash provided by financing activities 45,000
provided
Net increase in cash 34,000
$45,000 cash.
Cash, January 1 0
Cash, December 31 $ 34,000