Accounting principles chapter 18

• Include– Cash effects of transactions that create revenues and expenses and – Enter into determination of net income loss OPERATING ACTIVITIES Balance Sheet: Noncash Current Assets a

Accounting Principles

Second Canadian Edition

Prepared by:

Carole Bowman, Sheridan College

Weygandt · Kieso · Kimmel ·

Trenholm

CASH FLOW STATEMENT

CHAPTER

18

PURPOSE OF THE

CASH FLOW STATEMENT

the cash receipts and cash payments of an entity during a period.

information about its

– Operating activities

– Investing activities

– Financing activities

MEANING OF CASH FLOWS

investments that are both

cash, and

market value is relatively insensitive to

changes in interest rates.

• Include

– Cash effects of transactions that create

revenues and expenses and

– Enter into determination of net income (loss)

OPERATING ACTIVITIES

Balance Sheet: Noncash

Current Assets and Current

Liabilities; Income Statement Items

• 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

INVESTING ACTIVITIES

• Include

– Obtaining cash from issuing debt and

repaying the amounts borrowed and

– Obtaining cash from owners/shareholders

and paying them drawings/dividends

FINANCING ACTIVITIES

Balance Sheet: Long-Term Liability and Equity Items

• If it does not affect cash, do NOT report in

body of cash flow statement

statements

SIGNIFICANT NONCASH

ACTIVITIES

the general format of

the cash flow

Cash flows from operating activities

(List of individual items) XX Net cash provided (used) by operating activities

XXX

Cash flows from investing activities

(List of individual items) XX Net cash provided (used) by investing activities

XXX

Cash flows from financing activities

(List of individual items) XX Net cash provided (used) by financing activities

Noncash investing and financing activities (List of significant noncash transactions) 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

ILLUSTRATION 18-3

THREE MAJOR STEPS IN PREPARING

THE CASH FLOW STATEMENT

+ or

-The difference between the

beginning and ending cash

balances can be easily calculated

from comparative balance sheets.

The difference between the

beginning and ending cash

balances can be easily calculated

from comparative balance sheets.

This step involves analysing not only the current

year’s income statement but also comparative

balance sheets and selected additional data.

This step involves analysing not only the current

year’s income statement but also comparative

balance sheets and selected additional data.

XYZ Goods

This step involves analysing

comparative balance sheet data

and selected additional information

for their effects on cash.

This step involves analysing

comparative balance sheet data

and selected additional information

for their effects on cash.

For Sale Investing Financing

Step 1: Determine the net increase (decrease) in cash.

Step 2: Determine net cash provided (used) by operating activities

Step 3: Determine net cash provided (used) by investing and financing activities.

STEP 1: DETERMINE NET INCOME

(DECREASE) IN CASH

STEP 2: DETERMINE NET CASH PROVIDED (USED) BY OPERATING

ACTIVITIES

accrual basis to a cash basis in the operating activities section

– Indirect (used extensively in practice)

– Direct

INDIRECT AND DIRECT METHODS

amount of cash provided (used) by

operating activities

make up the total amount

operating activities section ; the investing and financing activities sections are the

same

OPERATING ACTIVITIES –

INDIRECT METHOD

Section 1 Section 1

ILLUSTRATION 18-6

NET INCOME VS NET CASH PROVIDED

BY OPERATING ACTIVITIES

The indirect method starts with net income and converts it to net

cash provided by operating activities In other words, it adjusts net income for items that affect reported net income but do not affect

cash , as shown below

Accrual Basis of Accounting Cash Basis of Accounting

Net Cash Provided

(Used) by Operating Activities Eliminate noncash revenues

Eliminate noncash expenses

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

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)

Computer Services Corporation Cash Flow Statement - Indirect Method For the Year Ended December 31, 2002

Indirect Method – Sample Format

Indirect Method – Sample Format

OPERATING ACTIVITIES

– DIRECT METHOD

Section 2 Section 2

CASH RECEIPTS AND CASH PAYMENTS

(Direct Method)

CASH RECEIPTS FROM

CUSTOMERS

from customers , revenues from sales , and

changes in accounts receivable is:

Cash

receipts from

customers = from sales Revenues {+ Decrease in accounts receivable

or – Increase in accounts

receivable

Cash payments

or – Increase in accounts

payable

CASH PAYMENTS TO SUPPLIERS

suppliers , cost of goods sold , changes in

inventory , and changes in accounts payable

is:

Cash payments for services

+ Increase in prepaid expenses

or – Decrease in prepaid expenses

+ Decrease in accrued expenses payable

or – Increase in accrued

operating expenses , changes in prepaid expenses , and changes in accrued expenses payable is:

CASH PAYMENTS FOR INCOME TAX

income tax , income tax expense , and

changes in income tax payable is:

Cash flows from operating activities

Cash receipts from customers $120,000 Cash payments:

For operating expenses (36,000)

For income tax (10,000) (121,000)

COMPUTER SERVICES CORPORATION

Cash Flow Statement – Direct Method For the Year Ended December 31, 2002

NET CASH PROVIDED (USED) BY

OPERATING ACTIVITIES

Direct Method – Sample Format

Direct Method – Sample Format

STEP 3: DETERMINE NET CASH

PROVIDED (USED) BY INVESTING AND

FINANCING ACTIVITIES

• Study the balance sheet to determine changes in

investments and long-term assets

incorporated as part of cash definition) and term account are analysed using selected

long-transaction data to determine the effect, if any,

NET CASH PROVIDED (USED) BY

INVESTING ACTIVITIES

NET CASH PROVIDED (USED) BY

FINANCING ACTIVITIES

changes in noncurrent liabilities and

owner’s/shareholders’ equity

analysed using selected transaction data to determine the effect, if any, the changes

For the Year Ended December 31, 2002

Cash flows from operating activities

Adjustments to reconcile net income to net cash

provided by operating activities:

Cash flows from investing activities

Cash flows from financing activities

ILLUSTRATION 18-23

CASH FLOW STATEMENT

DIRECT METHOD

Cash flows from operating activities

Cash receipts from customers $120,000 Cash payments:

To suppliers $(75,000) For operating expenses (36,000) For income tax (10,000) (121,000) Net cash provided by operating activities (1,000) Cash flows from investing activities

Purchase of equipment $(10,000)

Net cash used by investing activities (10,000) Cash flows from financing activities

Issue of common shares $ 60,000

Payment of cash dividends (15,000)

Net cash provided by financing activities 45,000 Net increase in cash 34,000

Cash, December 31 $ 34,000

COMPUTER SERVICES CORPORATION

Cash Flow Statement For the Year Ended December 31, 2002

The cash flow statement shows that operating activities used

$1,000 cash

and investing activities used

while financing activities

provided

USING CASH FLOWS TO EVALUATE

COMPANY

These ratios are cash-based instead of

accrual-based

CASH CURRENT DEBT COVERAGE

of cash to pay off current debt that is generated from operating activities.

• The ratio provides a better picture of liquidity

than using the current ratio because it uses cash provided by operating activities rather than the year-end asset balance.

Cash Provided

by Operating

Activities

Average Current Liabilities

Cash Current Debt Coverage

÷

CASH RETURN ON SALES

sales are turned into cash.

into cash when its cash return on sales is

greater than its accrual-based counterpart, the profit margin.

Cash Provided

by Operating

Activities

Net Sales

Cash Return

on Sales

÷

CASH FLOW PER SHARE

generated for each common share.

Cash Flow

from Operating,

Investing, and

Financing

Activities

Number of Common Shares

Cash Flow per Share

÷

CASH TOTAL DEBT COVERAGE

amount of cash to pay off total debt that is generated from operating activities.

the debt to total assets ratio.

Cash Provided

by Operating

Activities

Average Total Liabilities

Cash Total Debt Coverage

÷

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