Lecture Intermediate accounting (IFRS/e) - Chapter 21: The statement of cash flows revisited

The objective of financial reporting is to provide investors and creditors with useful information, primarily in the form of financial statements. The balance sheet and the income statement - the focus of your study in earlier chapters - do not provide all the information needed by these decision makers. Here you will learn how the statement of cash flows fills the information gap left by the other financial statements.

THE STATEMENT OF CASH FLOWS

REVISITED

Chapter 21

Investing Activities

Sale of property, plant, and equipment, and intangible assets

Sale of investments Collections of loans

Cash received

from revenues

Issuance of shares Issuance of bonds

Role of the Statement of Cash Flows

Helps users assess

 a firm’s ability to generate cash.

 a firm’s ability to meet its

obligations.

 the reasons for differences

between income and associated

cash flows.

 the effect of cash and noncash

investing and financing activities

on a firm’s financial position.

Helps users assess

 a firm’s ability to generate cash.

 a firm’s ability to meet its

obligations.

 the reasons for differences

between income and associated

cash flows.

 the effect of cash and noncash

investing and financing activities

on a firm’s financial position.

Role of the Statement of Cash Flows

Lists all cash inflows and

all cash outflows by category: Operating, Investing, and Financing

Explains the change in

cash during the period

Required by IFRS

Cash is King!

Especially during

an economic downturn

Cash and Cash Equivalents

• Short-term, highly liquid investments.

• Readily converted into

cash, with little or no risk of loss

• Examples: money market

funds, Treasury bills

• Maturity date must not be

longer than 3 months from date of purchase.

Resources immediately available to pay obligations.

Significant Noncash Investing and Financing Activities are disclosed

in the notes to the financial statements.

Primary Elements of the Statement of

Cash Flows

Investing

Activities

Reports the cash effects of the acquisition and disposition of assets (other than inventory and cash

equivalents).

Financing

Activities

Reports the cash effects of the sale

or repurchase of shares, and the issuance or repayment of debt

Reports the cash effects of the

elements of net income.

Cash Flows from Operating Activities

Cash Flows from Operating Activities

+

Inflows from:

 customers.

 interest and dividends

received from investments.

Direct Method or Indirect Method of Reporting

Cash Flows from Operating Activities

Reports the cash effects of each operating

activity

Direct Method

Starts with accrual net income and converts to cash basis

Indirect Method

Two Formats for Reporting Operating

Activities

Note that no matter which format is used, the same amount

of net cash flows operating activities is generated.

Direct Method

Under the direct method, the cash effect of each operating activity is reported directly in the

statement.

Indirect Method

By the indirect method, we arrive at net cash flow from operating activities indirectly by starting with reported net income and working backwards to convert that amount to a

cash basis.

Cash Flows from Investing Activities

 Sale of investment securities

(shares and bonds).

 Collection of nontrade receivables.

 Interest or dividends received from

 Purchase of investment securities

(shares and bonds).

 Create nontrade receivables, loans

to other entities.

Cash Flows from Financing Activities

 Issuance of ordinary and

preference shares.

 Borrowing from creditors

through notes, loans,

Flows from Financing Activities

 Owners for the reacquisition of

shares previously sold.

 Creditors as repayment of the

principal amounts of debt.

 Creditors for the payment of

interest on debt.

Reconciliation with Change in Cash Balance

The net amount of cash inflows and outflows reconciles the change in the company’s beginning and ending cash

balances.

For example, assume that UBC’s net increase in cash

is $9 million and the Cash beginning balance is $20 million The cash reconciliation would be as follows:

Noncash Investing and Financing Activities

Significant investing and financing transactions not involving

cash are also disclosed in a disclosure note.

1 Acquiring an asset by incurring a debt payable to the

seller.

2 Acquiring an asset by entering into a lease agreement.

3 Converting debt into ordinary shares or other equity

securities.

4 Exchanging noncash assets or liabilities for other

noncash assets or liabilities.

Note X:

Noncash Investing and Financing Activities

     Acquired $20 million of equipment by issuing a 12%, five­

year 

Preparation of the Statement of Cash Flows

A spreadsheet can be used to ensure that

no reportable activities are inadvertently

overlooked

Reconstructing the events and transactions that occurred during the period helps identify the operating, investing and financing activities to be

reported

Let’s see how to use a spreadsheet to prepare a Statement of Cash Flows on the next few slides.

We begin by entering the beginning and ending balances for each account on the

comparative statement of financial position and income

statement.

The changes columns will be used later to explain the increase or decrease in each account balance.

Dec 31,

2012 Debits Credits

Dec 31,

2013

Balance Sheet

Assets:

Cash 20 29

Accounts receivable 30 32

Short-term investments - 12

Inventory 50 46

Prepaid insurance 6 3

Land 60 80

Buildings and equipment 75 81

Less: Accumulated depreciation (20) (16)

221 267

Liabilities: Accounts payable 20 26

Salaries payable 1 3

Income tax payable 8 6

Notes payable - 20

Bonds payable 50 35

Less: Discount on bonds payable (3) (1)

Shareholders' Equity: Ordinary share capital 100

130

Share premium 20

29

Retained earnings 25

19

221 267

UNITED BRANDS CORPORATION Spreadsheet for the Statement of Cash Flows

Changes

The beginning balances for income statement accounts are always zero.

Dec 31,

2012 Debits Credits

Dec 31,

2013

Income Statement

Revenues:

Sales revenue 100

Investment revenue 3

Gain on sale of land 8

Expenses: Cost of good sold (60)

Salaries expense (13)

Depreciation expense (3)

Bond interest expense (5)

Insurance expense (7)

Loss on sale of equipment (2)

Income tax expense (9)

Net income 12

Changes

on the spreadsheet for the statement of cash flows.

Spreadsheet entries duplicate the actual journal entries used to record the transactions as they occurred during

the year.

They are only entered on the spreadsheet and are not

recorded in the accounting records.

Dec 31,

2012 Debits Credits

Dec 31, 2013 Balance Sheet

Assets:

Cash 20 29

Accounts receivable 30 32

Short-term investments - 12

Inventory 50 46

Prepaid insurance 6 3

Land 60 80

Buildings and equipment 75 81

Less: Accumulated depreciation (20) (16)

221 267

Liabilities: Accounts payable 20 26

Salaries payable 1 3

Income tax payable 8 6

Notes payable - 20

Bonds payable 50 35

Less: Discount on bonds payable (3) (1)

Shareholders' Equity: Ordinary share capital 100

130

Share premium 20

29

Retained earnings 25

19

221 267

UNITED BRANDS CORPORATION Spreadsheet for the Statement of Cash Flows Changes Let’s start by analyzing Sales Revenue and its related account Accounts Receivable by looking at the relationship in a T-account format. Dec 31, 2012 Debits Credits Dec 31, 2013 Income Statement Revenues: Sales revenue 100

Investment revenue 3

Gain on sale of land 8

Expenses: Cost of good sold (60)

Salaries expense (13)

Depreciation expense (3)

Bond interest expense (5)

Insurance expense (7)

Loss on sale of equipment (2)

Income tax expense (9)

Net income 12

Changes

Accounts Receivable

Dec 31,

2012 Debits Credits

Dec 31, 2013 Balance Sheet

Assets:

Cash 20 29

Accounts receivable 30 32

Short-term investments - 12

Inventory 50 46

Prepaid insurance 6 3

Land 60 80

Buildings and equipment 75 81

Less: Accumulated depreciation (20) (16)

221 267

Liabilities: Accounts payable 20 26

Salaries payable 1 3

Income tax payable 8 6

Notes payable - 20

Bonds payable 50 35

Less: Discount on bonds payable (3) (1)

Shareholders' Equity: Ordinary share capital 100

130

Share premium 20

29

Retained earnings 25

19

221 267

UNITED BRANDS CORPORATION Spreadsheet for the Statement of Cash Flows Changes We can see from this analysis that cash received from customers must have been $98 million. Dec 31, 2012 Debits Credits Dec 31, 2013 Income Statement Revenues: Sales revenue 100

Investment revenue 3

Gain on sale of land 8

Expenses: Cost of good sold (60)

Salaries expense (13)

Depreciation expense (3)

Bond interest expense (5)

Insurance expense (7)

Loss on sale of equipment (2)

Income tax expense (9)

Net income 12

Changes

Accounts Receivable

Let’s see how

to post this entry to the spreadsheet.

Dec 31,

2012 Debits Credits

Dec 31, 2013 Balance Sheet

Assets:

Cash 20 29

Accounts receivable 30 (1) 2 32

Short-term investments - 12

Inventory 50 46

Prepaid insurance 6 3

Land 60 80

Buildings and equipment 75 81

Less: Accumulated depreciation (20) (16)

221 267

Liabilities: Accounts payable 20 26

Salaries payable 1 3

Income tax payable 8 6

Notes payable - 20

Bonds payable 50 35

Less: Discount on bonds payable (3) (1)

Shareholders' Equity: Ordinary share capital 100

130

Share premium 20

29

Retained earnings 25

19

221 267

UNITED BRANDS CORPORATION Spreadsheet for the Statement of Cash Flows Changes First, $2 million is debited to Accounts Receivable to account for the total change in the account. Dec 31, 2012 Debits Credits Dec 31, 2013 Income Statement Revenues: Sales revenue (1) 100 100

Investment revenue 3

Gain on sale of land 8

Expenses: Cost of good sold (60)

Salaries expense (13)

Depreciation expense (3)

Bond interest expense (5)

Insurance expense (7)

Loss on sale of equipment (2)

Income tax expense (9)

Net income 12

Changes

Accounts Receivable

Then, $100 million is credited

to Sales Revenue

to account for the total change in the account

Dec 31,

2012 Debits Credits

Dec 31, 2013 Statement of Cash Flows

$98 million entry on the Statement

of Cash Flows under Cash Inflows from Customers

Accounts Receivable

Dec 31,

Dec 31, 2013 Balance Sheet

Assets:

Cash 20 29

Accounts receivable 30 (1) 2 32

Short-term investments - (12) 12 12

Inventory 50 46

Prepaid insurance 6 3

Land 60 80

Buildings and equipment 75 81

Less: Accumulated depreciation (20) (16)

221 267

Liabilities: Accounts payable 20 26

Salaries payable 1 3

Income tax payable 8 6

Notes payable - 20

Bonds payable 50 35

Less: Discount on bonds payable (3) (1)

Shareholders' Equity: Ordinary share capital 100

130

Share premium 20

29

Retained earnings 25

19

221 267

UNITED BRANDS CORPORATION Spreadsheet for the Statement of Cash Flows

Changes

Note that in the textbook, entry number 12 illustrates the analysis of the Short-term Investments account.

The $12 million increase in the Short-term Investments account is due

to the purchase

of short-term investments during the year.

Short-term Investments

Dec 31,

2012 Debits Credits

Dec 31, 2013 Statement of Cash Flows

$12 million entry on the Statement

of Cash Flows under Investing Activities

Short-term Investments

Dec 31,

2012 Debits Credits

Dec 31, 2013 Balance Sheet

Assets:

Cash 20 29

Accounts receivable 30 (1) 2 32

Short-term investments - (12) 12 12

Inventory 50 46

Prepaid insurance 6 3

Land 60 80

Buildings and equipment 75 (14) 20 81

Less: Accumulated depreciation (20) (16)

221 267

Liabilities: Accounts payable 20 26

Salaries payable 1 3

Income tax payable 8 6

Notes payable - (14) 20 20

Bonds payable 50 35

Less: Discount on bonds payable (3) (1)

Shareholders' Equity: Ordinary share capital 100

130

Share premium 20

29

Retained earnings 25

19

221 267

UNITED BRANDS CORPORATION Spreadsheet for the Statement of Cash Flows

Changes

In entry number 14,

we find that a note payable was issued

as payment for a

building.

Investing in a new building is a significant investing

activity and financing the acquisition with long-term debt is a significant financing

activity.

x x

Dec 31,

2012 Debits Credits

Dec 31, 2013 Balance Sheet

Assets:

Cash 20 (19) 9 29

Accounts receivable 30 (1) 2 32

Short-term investments - (12) 12 12

Inventory 50 (4) 4 46

Prepaid insurance 6 (8) 3 3

Land 60 (13) 30 (3) 10 80

Buildings and equipment 75 (14) 20 (9) 14 81

Less: Accumulated depreciation (20) (9) 7 (6) 3 (16)

221 267

Liabilities: Accounts payable 20 (4) 6 26

Salaries payable 1 (5) 2 3

Income tax payable 8 (10) 2 6

Notes payable - (14) 20 20

Bonds payable 50 (15) 15 35

Less: Discount on bonds payable (3) (7) 2 (1)

Shareholders' Equity: Ordinary share capital 100 (16) 10

(17) 20 130

Share premium 20 (16) 3

(17) 6 29

Retained earnings 25 (16) 13

(18) 5 (11) 12 19

221 267

UNITED BRANDS CORPORATION Spreadsheet for the Statement of Cash Flows

Changes

x x

After entering

all the transactions, this is what the statement of financial position portion

of the spreadsheet looks like.

Dec 31,

2012 Debits Credits

Dec 31, 2013 Income Statement

Revenues:

Sales revenue (1) 100 100

Investment revenue (2) 3 3

Gain on sale of land (3) 8 8

Expenses: Cost of good sold (4) 60 (60)

Salaries expense (5) 13 (13)

Depreciation expense (6) 3 (3)

Bond interest expense (7) 5 (5)

Insurance expense (8) 7 (7)

Loss on sale of equipment (9) 2 (2)

Income tax expense (10) 9 (9)

Net income (11) 12 12

Changes

After entering all the transactions, this is what the income statement portion of the

spreadsheet looks like.