Financial accounting the impact on decision makers makers 9e chapter 12

Cash Flows and Accrual Accounting Statement of cash flows complements an accrual-based income statement by providing information on a company’s cash flows from operating, investing, and

Chapter 12

The Statement of Cash Flows

Cash Flows and Accrual Accounting

 Statement of cash flows complements an

accrual-based income statement by providing

information on a company’s cash flows from

operating, investing, and financing activities

 External parties have an interest in a company’s cash flows:

 Stockholders

 Creditors

LO 1

Exhibit 12.1—Cash Flows and Net Income for Four Companies (all amounts in millions of dollars)

Purpose of the Statement of Cash

Flows

 Summarizes an entity’s cash receipts and cash payments during the period from operating, investing activities, and financing activities

 Reports the changes in cash over a period of time and explains those changes

 Assess company’s performance on a cash basis

Cash Equivalents

 Readily convertible to a determinable amount

of cash

 Maturity date of three months or less

 Less degree of risk in terms of price changes

 Combined with cash on a statement of cash

flows

 Examples: Commercial paper, Money market

funds, and Treasury bills

LO 2

Operating Activities

 Activities concerned with the acquisition and

sale of products and services

 Examples:

 Collection of customer accounts

 Payment to suppliers for inventory

 Payment of wages

 Payment of taxes

LO 3

 Purchase of another company

 Sale of plant and equipment

 Sale of another company

Financing Activities

 Activities concerned with the raising and repaying

of funds in the form of debt and equity

Exhibit 12.2—Format for the Statement

of Cash Flows

Exhibit 12.3—Classification of Items on

the Statement of Cash Flows

Example 12.3—Determining Noncash

Investing and Financing Activities

 Assume that at the end of the year, Wolk Corp issues capital

stock to an inventor in return for the exclusive rights to a patent Although the patent has no ready market value, the stock could have been sold on the open market for $25,000

Example 12-3 Determining Noncash Investing

and Financing Activities (continued)

 Assume Wolk sells stock on the open market for $25,000 and then pays this amount in cash to the inventor for the rights to the patent

Example 12-3 Determining Noncash Investing

and Financing Activities (continued)

 Next, the acquisition of the patent can be identified and

analyzed as follows:

Supplemental schedule of noncash investing and financing activities

Acquisition of patent in exchange for capital stock

$25,000

Two Methods of Reporting Cash Flow

from Operating Activities

Exhibit 12.4—Boulder Company’s

Income Statement

Exhibit 12.5—Boulder Company’s

Balance Sheet

Exhibit 12.6—Statement of Cash Flows

Using the Direct Method

Exhibit 12.7—Statement of Cash Flows

Using the Indirect Method

Accounting Equation and the

Statement of Cash Flows

LO 5

Summary of Various Possibilities for Inflows (+) and Outflows (−) of Cash

An Approach to Preparing the Statement of

Cash Flows: Direct Method

 Step1: set up three schedules with the following

headings:

 a Cash Flows from Operating Activities

 b Cash Flows from Investing Activities

 c Cash Flows from Financing Activities

 Step 2: determine cash flows from operating activities

 Step 3: determine cash flows from investing activities

 Step 4: determine cash flows from financing activities

Exhibit 12.8—Julian Corp.’s Income

Statement

Exhibit 12.9—Julian Corp.’s Comparative Balance Sheets

Exhibit 12.10—Schedule of Cash Flows

from Operating Activities

Exhibit 12.11—Conversion of Income

Statement Items to Cash Basis

Exhibit 12.12—Schedule of Cash Flows

from Investing Activities

Exhibit 12.13—Schedule of Cash Flows

from Financing Activities

Exhibit 12.14—Completed Statement

of Cash Flows for Julian Corp

LO 6

Exhibit 12.14—Completed Statement

of Cash Flows (continued)

Exhibit 12.15—Indirect Method for Reporting Cash Flows from Operating

Activities

Summary of Adjustments to Net Income under the Indirect Method

Comparison of the Indirect and

Direct Methods

 The Direct method

 Provides valuable information in evaluating a company’s operating efficiency

 Reveals too much to competitors by telling them the

amount of cash receipts and cash and payments from operations

 The Indirect method

 Focuses attention on the differences between income

on an accrual basis and a cash basis

 Should separately disclose two important cash

payments—income taxes paid and interest paid

Cash Flow Adequacy

 Measures a company’s ability to meet future

debt obligations after paying taxes and interest costs and making capital expenditures

LO 7

The Ratio Analysis Model

1 Did Nordstrom generate enough cash this year from

its operations to pay for its capital expenditures and meet its maturing debt obligations?

2 Gather the information from the financial statements

3 Calculate cash flow adequacy ratio

4 Compare the ratio with prior years and with

competitors

5 Interpret the ratios

The Business Decision Model

1. If you were a banker, would you loan money to

Nordstrom, Inc.?

2. Gather information from the financial

statements and other sources

3. Compare the company's ratios with industry

averages and look at trends

4. Loan money or find an alternative use for the

money

5. Monitor your investment periodically

Work-Sheet Approach—Indirect

Method (continued)

Record the various operating,

investing, financing, and noncash

activities

Work-Sheet Approach—Indirect

Method (continued)

Enter net income

Work-Sheet Approach—Indirect

Method (continued)

Enter noncash revenues or expenses

Work-Sheet Approach—Indirect

Method (continued)

Enter changes

in noncash current assets and current liabilities

Work-Sheet Approach—Indirect

Method (continued)

Total columns

Work-Sheet Approach—Indirect

Method (continued)

Determine net cash inflow (outflow)

End of Chapter 12