Financial accounting tools for business decision making 9 KIeso ppt ch12

Classification of Cash Flows 1 of 4Income Statement Items Operating Activities Changes in Investments and Long-Term Asset Items Investing Activities Changes in Long-Term Liabilities and

Financial Accounting: Tools for Business Decision Making

Chapter Outline

Learning Objectives

LO 1 Discuss the usefulness and format of the statement of cash flows.

LO 2 Prepare a statement of cash flows using the indirect method.

LO 3 Use the statement of cash flows to evaluate a company.

Learning Objective 1

Discuss the Usefulness and Format of the Statement of Cash Flows

Usefulness of the Statement of Cash Flows

Provides information to help assess

a Entity’s ability to generate future cash flows

b Entity’s ability to pay dividends and meet obligations

c Reasons for difference between net income and net cash provided (used) by operating

activities

d. Cash investing and financing transactions during the period

Classification of Cash Flows (1 of 4)

Income Statement Items

Operating Activities

Changes in Investments and Long-Term Asset

Items

Investing Activities

Changes in Long-Term Liabilities and Stockholders’ Equity

Items

Financing Activities

Operating activities —Income statement items

Cash inflows

a From sale of goods or services

b From interest received and dividends received

Cash outflows

c To suppliers for inventory

d To employees for wages

e To government for taxes

Classification of Cash Flows (2 of 4)

Investing activities —Changes in investments and long-term assets

Cash inflows

a From sale of property, plant, and equipment

b From sale of investments in debt or equity securities

c From collection of principal on loans to other entities

Cash outflows

d To purchase property, plant, and equipment

e To purchase investments in debt or equity securities

f To make loans to other entities

Classification of Cash Flows (3 of 4)

Financing activities —Changes in long-term liabilities and stockholders’ equity

Cash inflows

a From sale of common stock

b From issuance of debt (bonds and notes)

Cash outflows

c To stockholders as dividends

d To redeem long-term debt or reacquire capital stock (treasury stock)

Classification of Cash Flows (4 of 4)

Noncash activities examples

a Direct issuance of common stock to purchase assets

b Conversion of bonds into common stock

c Issuance of debt to purchase assets

d Exchanges of plant assets

Companies report noncash activities in either a

e Separate schedule (bottom of the statement) or

f Separate note to the financial statements

Significant Noncash Activities

Statement of Cash Flows For the Period Covered

Cash flows from operating activities

Cash flows from investing activities

Cash flows from financing activities

Format

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 Financing

2. Borrowed $200,000 from Castle Bank, signing a 5-year note bearing 8% interest Financing

DO IT! 1: Classification of Cash Flows

Learning Objective 2

Prepare a Statement of Cash Flows Using the Indirect Method

Three sources of information

a Comparative balance sheets

b Current income statement

c Additional information

Preparing the Statement of Cash Flows—Indirect Method

STEP 1: Determine net cash provided/used by operating activities by converting net income

from an accrual basis to a cash basis.

Involves analyzing the current year's income statement, comparative balance sheets, and selected additional data

Steps to Prepare a Statement of Cash Flows (1 of 3)

STEP 2: Analyze changes in noncurrent asset and liability accounts and stockholders’ equity

accounts and record as investing and financing activities, or disclose as noncash

STEP 3: 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.

Difference between beginning and ending cash balances is easily computed from comparative balance sheets.

Steps to Prepare the Statement of Cash Flows (3 of 3)

Companies favor the indirect method for two reasons

a Easier and less costly to prepare

b Focuses on differences between net income and net cash flow from operating activities

Indirect and Direct Methods

Computer Services Company Income Statement For the Year Ended December 31, 2022

Sources to Prepare (1 of 4)

Current assets

Property, plant, and equipment

Computer Services Company Comparative Balance Sheets

December 31

Current liabilities Blank Blank Blank

Computer Services Company Comparative Balance Sheets

December 31

Sources to Prepare (3 of 4)

Additional information for 2022

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 purchased for cash

5. Issued common stock for $20,000 cash

6. The company declared and paid a $29,000 cash dividend

Sources to Prepare (4 of 4)

Review Question

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 stockholders

d None of the above

Operating Activities (1 of 2)

Review Question

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 stockholders

d None of the above

Operating Activities (2 of 2)

Determine net cash provided/used by operating activities by converting net income from an accrual basis to a cash basis

Common adjustments to net income (loss)

a Add back non-cash expenses

• Depreciation, amortization, or depletion expense

b Deduct gains and add losses

c Analyze changes to noncash current asset and current liability accounts

Step 1: Operating Activities (1 of 12)

Depreciation Expense

Although depreciation expense reduces net income, it does not reduce cash The company must add it back to net income

Step 1: Operating Activities (2 of 12)

Cash flows from operating activities

Adjustments to reconcile net income to net

cash provided by operating activities:

Loss on Disposal of Plant Assets

Companies report as a source of cash in the investing activities section the actual amount of cash

received from the sale.

a Any loss on disposal is added to net income in operating section

b Any gain on disposal is deducted from net income in operating section

Step 1: Operating Activities (3 of 12)

Loss on Disposal of Plant Assets

Step 1: Operating Activities (4 of 12)

Cash flows from operating activities

Adjustments to reconcile net income to net cash provided by operating activities:

Changes to Noncash Current Assets

When Accounts Receivable balance decreases, cash receipts are higher than revenue earned under

accrual basis

Step 1: Operating Activities (5 of 12)

Amount of decrease in accounts receivable is added to net income

Accounts Receivable

1/1/22 Balance 30,000 517,000 Receipts from customers

Changes to Noncash Current Asset

Step 1: Operating Activities (6 of 12)

Cash flows from operating activities

Adjustments to reconcile net income to net cash provided by operating activities:

Changes to Noncash Current Asset

When Inventory balance increases, cost of merchandise purchased exceeds cost of goods sold

Step 1: Operating Activities (7 of 12)

Company deducts increase in inventory from net income.

Inventory

1/1/22 Balance 10,000 150,000 Cost of goods sold

Changes to Noncash Current Asset

Step 1: Operating Activities (8 of 12)

Cash flows from operating activities

Adjustments to reconcile net income to net cash provided by operating activities:

Changes to Noncash Current Asset

When the Prepaid Expense balance increases

a Cash paid for expenses is higher than expenses reported on an accrual basis

b Increase is deducted from net income to arrive at net cash provided by operating

activities

If prepaid expenses decrease

c Reported expenses are higher than the expenses paid

Step 1: Operating Activities (9 of 12)

Changes to Noncash Current Asset

Step 1: Operating Activities (10 of 12)

Cash flows from operating activities

Adjustments to reconcile net income to net cash provided by operating activities:

Changes in Current Liabilities

When Accounts Payable increases

a More in goods were received than paid for

b Increase is added to net income to determine net cash provided by operating activities When Income Tax Payable decreases

c Income tax expense reported on the income statement is less than amount of taxes

paid during period

Step 1: Operating Activities (11 of 12)

Changes in Current Liabilities

Step 1: Operating Activities (12 of 12)

Cash flows from operating activities

Adjustments to reconcile net income to net cash provided by operating activities:

Blank Blank

Adjustment Required to Convert Net Income to Net Cash Provided by Operating Activities

Gains Loss on disposal of plant assets Add

and Losses Gain on disposal of plant assets Deduct

Changes in Increase in current asset account Deduct

Current Assets Decrease in current asset account Add

Conversion to Net Cash Provided by Operating Activities

Indirect Method Summary

Josh’s PhotoPlus reported net income of $73,000 for 2020 Included in the income statement were depreciation expense of $7,000 and a gain on disposal of plant assets of $2,500 Josh’s comparative balance sheets show the following balances.

DO IT! 2a: Cash from Operating Activities (1 of 2)

Calculate net cash provided by operating activities.

DO IT! 2a: Cash from Operating Activities (2 of 2)

cash provided by operating activities:

Increase in Land

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

Step 2: Investing and Financing Activities (1 of 11)

Partial Statement:

Cash flows from financing activities:

Noncash investing and financing activities

Step 2: Investing and Financing Activities (2 of 11)

Increase in Building

From the additional information, the company acquired an office building for $120,000 cash

Cash outflow reported in the investing section

Step 2: Investing and Financing Activities (3 of 11)

Building

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

Cash flows from financing activities:

Step 2: Investing and Financing Activities (4 of 11)

Increase in Equipment

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.

Step 2: Investing and Financing Activities (5 of 11)

Equipment

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:

Step 2 (7 of 11)

Increase in Common Stock

The increase in common stock resulted from the issuance of new shares.

Step 2: Investing and Financing Activities (8 of 11)

Common Stock

Step 2: Investing and Financing Activities (9 of 11)

Cash flows from investing activities:

Cash flows from financing activities:

Increase in Retained Earnings

Retained earnings increased $116,000 during the year.

Explained by two factors

a Net income of $145,000 increased retained earnings

b Dividends of $29,000 decreased retained earnings

Step 2: Investing and Financing Activities (10 of 11)

Retained Earnings

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:

Step 2

Computer Services Company Comparative Balance Sheets (partial)

December 31

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 - Indirect

Current assets

Learning Objective 3

Use the Statement of Cash Flows to Evaluate a Company

Corporate Life Cycle

Analyzing the Statement of Cash Flows

Free Cash Flow

Describes the cash remaining from operations after adjustment for capital expenditures and dividends

Free Cash Flow Net Cash Provided by

Net cash provided by operating activities $ 63,598

Calculate Apple’s free cash flow.

Free Cash Flow

Learning Objective 4

Appendix 12A

Prepare a Statement of Cash Flows Using the Direct Method

Statement of Cash Flows—Direct Method

a Cash provided by operating activities

• Adjust each item in the income statement from accrual basis to cash basis

b Only major classes of operating cash receipts and cash payments

c For each major class

• Difference between cash receipts and cash payments is net cash provided by operating

activities

Cash Receipts

Step 1: Operating Activities

From sales of goods and services

Computer Services Company Income Statement For the Year Ended December 31, 2022

Sources to Prepare (1 of 4)

Computer Services Company Comparative Balance Sheets December 31

Property, plant, and equipment

Computer Services Company Comparative Balance Sheets

December 31

Current liabilities

Long-term liabilities

Stockholders’ equity

Sources to Prepare (3 of 4)

Additional information for 2022:

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 purchased for cash

5. Issued common stock for $20,000 cash

6. The company declared and paid a $29,000 cash dividend

Sources to Prepare (4 of 4)

Cash Receipts from Customers

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

Step 1: Operating Activities (1 of 7)

Cash Receipts from

+ Decrease in Accounts Receivable or

- Increase in Accounts Receivable

Cash Payments to Suppliers

Inventory increased $5,000, cash payments to suppliers were $139,000.

Step 1: Operating Activities (2 of 7)

Cash Payments to Suppliers

Inventory increased $5,000, cash payments to suppliers were $139,000.

Step 1: Operating Activities (3 of 7)

- Increase in Accrued Expenses

Cash Payments for Operating Expenses

Step 1: Operating Activities (4 of 7)

Cash Payments for Interest

Computer Services reported interest expense of $42,000 on the income statement.

Step 1: Operating Activities (5 of 7)

Interest Payable

Cash paid for interest 42,000 0 Balance 1/1/22

Cash Payments for Income Taxes

Computer Services reported income tax expense of $47,000 on the income statement.

Step 1: Operating Activities (6 of 7)

Cash

Income + Decrease in Income Taxes Payable

Income Tax Payable

Cash paid for taxes 49,000 8,000 Balance 1/1/22

Cash flows from operating activities Blank

Step 1: Operating Activities (7 of 7)

Increase in Equipment (1) Equipment purchased for $25,000, and (2) equipment sold for $4,000, cost

Increase in Equipment

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

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

Step 2: Investing and Financing Activities (2 of 4)