Accounting principles 12th willey kieso chapter 17

3.Reasons for difference between net income and net cash provided used by operating activities.. DETERMINE NET CASH PROVIDED/USED BY OPERATING ACTIVITIES BY CONVERTING NET INCOME FROM

17

Provides information to help assess:

1.Entity’s ability to generate future cash flows.

2.Entity’s ability to pay dividends and meet obligations.

3.Reasons for difference between net income and net cash

provided (used) by operating activities.

4.Cash investing and financing transactions during the period.

Usefulness of the Statement of Cash Flows

Investing

Activities

Changes in Long-Term Liabilities and Stockholders’

Operating activities—Income statement items

Cash inflows:

From sale of goods or services

From interest received and dividends received

Cash outflows:

To suppliers for inventory

To employees for wages

To government for taxes

To lenders for interest

To others for expenses

Investing activities—Changes in investments and

long-term assets

Cash inflows:

From sale of property, plant, and equipment

From sale of investments in 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 investments in debt or equity securities of other

Financing activities—Changes in long-term liabilities

and stockholders’ equity

Cash inflows:

From sale of common stock

From issuance of debt (bonds and notes)

Cash outflows:

To stockholders as dividends

To redeem long-term debt or reacquire

capital stock (treasury stock)

1.Direct 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

Companies report noncash activities in either a

separate schedule (bottom of the statement) or

separate note to the financial statements.

Significant Noncash Activities

Net What?

Accounting Across the Organization

LO 1

Format of the Statement of Cash Flows

17-10 LO 1

Illustration 17-2

Format of statement of cash flows

Illustration: Classify each of these transactions by type of cash

flow activity

1 Issued 100,000 shares of $5 par value

common stock for $800,000 cash.

2 Borrowed $200,000 from Castle Bank,

signing a 5-year note bearing 8% interest.

3 Purchased two semi-trailer trucks for

$170,000 cash.

4 Paid employees $12,000 for salaries and

wages.

Financing Financing Investing Operating

DO IT! 1 Classification of Cash Flows

Three sources of information:

1.Comparative balance sheets2.Current income statement3.Additional information

Three Major Steps:

Illustration 17-3

Preparing the Statement of Cash Flows

Illustration 17-3

LO 2

Three Major Steps:

Preparing the Statement of Cash Flows

Illustration 17-3

Three Major Steps:

Preparing the Statement of Cash Flows

Companies favor the indirect method for two reasons:

1.Easier and less costly to prepare

2.Focuses on differences between net income and net

cash flow from operating activities

Indirect and Direct Methods

LO 2

Indirect Method

Illustration 17-4

Additional information for 2017:

1 Depreciation expense was comprised of $6,000 for building and $3,000 for equipment.

2 The company sold equipment with a book value of $7,000 (cost $8,000, less accumulated

depreciation $1,000) for $4,000 cash.

3 Issued $110,000 of long-term bonds in direct exchange for land.

4 A building costing $120,000 was purchased for cash Equipment costing $25,000 was also

DETERMINE NET CASH PROVIDED/USED BY

OPERATING ACTIVITIES BY CONVERTING NET INCOME FROM ACCRUAL BASIS TO CASH

BASIS.

Common adjustments to Net Income (Loss):

Add back non-cash expenses (depreciation,

amortization, or depletion expense)

Deduct gains and add losses

Analyze changes in noncash current asset and current

liability accounts

LO 2

Step 1: Operating Activities

Which is an example of a cash flow from an operating

activity?

a Payment of cash to lenders for interest

b Receipt of cash from the sale of capital stock

c Payment of cash dividends to the company’s

DEPRECIATION EXPENSE

Although depreciation expense reduces net income, it does

not reduce cash The company must add it back to net

income

Illustration 17-6

Step 1: Operating Activities

LO 2

LOSS ON DISPOSAL OF EQUIPMENT

Companies report as a source of cash in the investing

activities section the actual amount of cash received from

Illustration 17-7

Step 1: Operating Activities

LOSS ON DISPOSAL OF EQUIPMENT

LO 2

CHANGES TO NONCASH CURRENT ASSET

When the Accounts Receivable balance decreases, cash

receipts are higher than revenue earned under the accrual basis

Company adds to net income the amount of the decrease in

When the Inventory balance increases, the cost of

merchandise purchased exceeds the cost of goods sold

Inventory 1/1/17 Balance

Cost of goods sold does not reflect cash payments made for

merchandise The company deducts from net income this

Step 1: Operating Activities

CHANGES TO NONCASH CURRENT ASSET

When the Prepaid Expense balance increases, cash paid for

expenses is higher than expenses reported on an accrual

basis The company deducts the decrease from net income

to arrive at net cash provided by operating activities

If prepaid expenses decrease, reported expenses are higher

than the expenses paid

Step 1: Operating Activities

CHANGES TO NONCASH CURRENT ASSET

CHANGES IN CURRENT LIABILITIES

When Accounts Payable increases, the company received

more in goods than it actually paid for The increase is added

to net income to determine net cash provided by operating

activities

When Income Tax Payable decreases, the income tax

expense reported on the income statement was less than the

amount of taxes paid during the period The decrease is

subtracted from net income to determine net cash provided by

operating activities

Step 1: Operating Activities

Summary of Conversion to Net Cash Provided

by Operating Activities—Indirect Method

Step 1: Operating Activities

Illustration 17-11

Josh’s PhotoPlus reported net income of $73,000 for 2017

Included in the income statement were depreciation expense of

$7,000 and a gain on disposal of equipment of $2,500 Josh’s

comparative balance sheets show the following balances

Josh’s PhotoPlus reported net income of $73,000 for 2017, which included depreciation expense of $7,000 and a gain on disposal

of equipment of $2,500 Accounts receivable increased $4,000

and accounts payable decreased by $3,800 Calculate net cash provided by operating activities

DO IT! 2a Cash from Operating Activities

Company purchased land of $110,000 by issuing long-term

bonds This is a significant noncash investing and financing

activity that merits disclosure in a separate schedule

110,000

12/31/17 Balance 130,000

Step 2: Investing and Financing Activities

LO 2

Illustration 17-13

Partial statement

Step 2: Investing and Financing Activities

Net cash provided by operating activities 172,000 Cash flows from investing activities:

Purchase of building (120,000) Purchase of equipment (25,000) Sale of equipment 4,000 Net cash used by investing 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

Illustration 17-13

Partial statement

Step 2: Investing and Financing Activities

Net cash provided by operating activities 172,000 Cash flows from investing activities:

Purchase of building (120,000)

Purchase of equipment (25,000) Sale of equipment 4,000 Net cash used by investing 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

The additional information explains that the equipment increase

resulted from two transactions: (1) a purchase of equipment of

$25,000, and (2) the sale for $4,000 of equipment costing $8,000

Accumulated Depreciation 1,000

Loss on Disposal of Equipment 3,000

Equipment 8,000

Illustration 17-13

Partial statement

Step 2: Investing and Financing Activities

Net cash provided by operating activities 172,000 Cash flows from investing activities:

Purchase of building (120,000) Purchase of equipment (25,000) Sale of equipment 4,000 Net cash used by investing 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

Retained earnings increased $116,000 during the year This

increase can be explained by two factors: (1) Net income of

$145,000 increased retained earnings, and (2) Dividends of

$29,000 decreased retained earnings

1/1/17 Balance 48,000 Net income 145,000

12/31/17 Balance 164,000

Dividends 29,000

Retained Earnings

Step 2: Investing and Financing Activities

LO 2

Which is an example of a cash flow from an investing

activity?

a.Receipt of cash from the issuance of bonds payable

b.Payment of cash to repurchase outstanding capital

stock

c.Receipt of cash from the sale of equipment

d.Payment of cash to suppliers for inventory

Step 2: Investing and Financing Activities

Question

LO 2

Compare the net change in cash on the Statement of Cash

Flows with the change in the cash account reported on the

Balance Sheet to make sure the amounts agree

Step 3: Net Change in Cash

Illustration 17-4

2017 2016

Burning Through Our Cash

Box (cloud storage), Cyan (game creator), Fireeye (cyber security), and Mobile Iron (mobile security of data) are a few of the tech companies that recently have issued or are about to issue stock to the public Investors now have to determine whether these tech companies have viable products and high chances for success

An important consideration in evaluating a tech company is determining its financial flexibility—its ability to withstand adversity if an economic setback occurs One way

to measure financial flexibility is to assess a company’s cash burn rate, which determines how long its cash will hold out if the company is expending more cash than it is receiving Fireeye, for example, burned cash in excess of $50 million in

2013 But the company also had over $150 million as a cash cushion, so it would take over 30 months before it runs out of cash And even though Box has a much lower cash burn rate than Fireeye, it still has over a year’s cushion Compare that to the tech companies in 2000, when over one-quarter of them were on track to run out

of cash within a year And many did Fortunately, the tech companies of today seem

to be better equipped to withstand an economic setback

Source: Shira Ovide, “Tech Firms’ Cash Hoards Cool Fears of a Meltdown,” Wall Street

Journal (May 14, 2014).

Accounting Across the Organization

LO 2

Free Cash Flow

Free cash flow describes the cash remaining from

operations after adjustment for capital expenditures and

$21,863 Less: Expenditures on property, plant, and equipment

4,257

Dividends paid 7,455

Cash provided by operating activities

Free cash flow

LO 3

Microsoft’s cash flow information ($ in millions)

1.Compute net cash provided by operating activities by

adjusting each item in the income statement from the accrual basis to the cash basis

2.Companies report only major classes of operating

cash receipts and cash payments

3.For these major classes, the difference between

cash receipts and cash payments is the net cash provided by operating activities

17-52 LO 4

Step 1: Operating Activities Illustration 17A-2

Major classes of cash receipts and payments

Direct Method

Illustration 17-4

Additional information for 2017:

1 Depreciation expense was comprised of $6,000 for building and $3,000 for equipment.

2 The company sold equipment with a book value of $7,000 (cost $8,000, less accumulated

depreciation $1,000) for $4,000 cash.

3 Issued $110,000 of long-term bonds in direct exchange for land.

4 A building costing $120,000 was purchased for cash Equipment costing $25,000 was also

Illustration 17A-4

Cash Receipts from Customers

For Computer Services, accounts receivable decreased $10,000.

Cash Payments to Suppliers

Illustration 17A-8

In 2017, Computer Services Company’s inventory increased $5,000

and cash payments to suppliers were $139,000.

Step 1: Operating Activities

Illustration 17A-10

Formula to compute cash payments

to suppliers—direct method

Cash Payments to Suppliers

In 2017, Computer Services Company’s inventory increased $5,000

and cash payments to suppliers were $139,000.

LO 4

Step 1: Operating Activities

Illustration 17A-11

Cash Payments for Operating Expenses

Cash payments for operating expenses were $115,000.

Illustration 17A-12

Step 1: Operating Activities

Cash Payments for Interest

In 2017, Computer Services’ had interest expense of $42,000.

Cash paid for interest

1/1/17 Balance

8,000 Income tax expense 47,000

12/31/17 Balance

6,000

Cash paid for taxes

49,000

Cash Payments for Income Taxes

Cash payments for income taxes were $49,000.

Illustration 17A-15

Income Tax Payable

Step 1: Operating Activities

Illustration 17A-16

Operating activities section

of the statement of cash flows

LO 4

Step 1: Operating Activities

Equipment sold

1,000

Equipment 1/1/17 Balance

10,000

12/31/17 Balance

27,000

Purchases 25,000

Cost of equipment sold 8,000

Increase in Equipment (1) Equipment purchased for $25,000, and

(2) equipment sold for $4,000, cost $8,000, book value $7,000.

Illustration 17A-17

Step 2: Investing and Financing

Activities

Increase in Equipment (1) Equipment purchased for $25,000, and

(2) equipment sold for $4,000, cost $8,000, book value $7,000.

LO 4

Step 2: Investing and Financing

Activities

Increase in Land Land increased

$110,000 The company purchased land

of $110,000 by issuing bonds

Significant noncash investing and

financing transaction.

Increase in Bonds Payable Bonds

Payable increased $110,000 The

company acquired land by exchanging

bonds for land.

Significant noncash investing and

financing transaction.

Increase in Building Acquired building

for $120,000 cash. Investing transaction.

Step 2: Investing and Financing

Activities

Increase in Common Stock Increase

in Common Stock of $20,000 Increase

resulted from the issuance of new

shares of stock

Increase in Retained Earnings The

$116,000 net increase in Retained

Earnings resulted from net income of

$145,000 and the declaration and

payment of a cash dividend

of $29,000.

Financing transaction (cash dividend)

Financing transaction.

LO 4

Step 2: Investing and Financing

Activities

Illustration 17A-18

Statement of cash flows, 2017—direct method

Compare the net change in cash on the Statement of Cash Flows

with the change in the cash account reported on the Balance Sheet to make sure the amounts agree.

LO 4

Step 3: Net Change in Cash

Illustration 17-4

2017 2016