mcgraw-hill/irwin copyright © 2013 by the mcgraw-hill companies, inc. all rights reserved. chapter...

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 12

Statement of Cash Flows

PowerPoint Authors:Brandy MackintoshLindsay Heiser

12-2

Learning Objective 12-1

Identify cash flows arisingfrom operating, investing,and financing activities.

12-3

OperationsCash received and paidfor day-to-day activities

with customers, suppliers,

and employees.

InvestingCash paid and

receivedfrom buying and selling

long-term assets.

FinancingCash received and paid

for exchanges withlenders and

stockholders.

Business Activities and Cash FlowsThe Statement of

Cash Flows focuses attention on:

12-4

CashChecking and Savings Accounts

Cash Equivalents

Highly liquid short-term investmentswithin three months of maturity.

Business Activities and Cash Flows

Currency

12-5

Classifying Cash FlowsUNDER ARMOUR, INC.

Statement of Cash FlowsFor the Year Ended December 31, 2010

(in millions)

Net cash provided (used) by operating activities

Net cash provided (used) by investing activities

Net cash provided (used) by financing activities

Net Change in Cash and Cash Equivalents

Cash and cash equivalents, beginning of year

Cash and cash equivalents, end of year

$ 37

(41)

7

3

187

$ 190

12-6

Cash inflows and outflows that directly relate to revenues and expenses reported on the

Income Statement.

Operating Activities

12-7

Investing Activities

Under Armour’s 2010 Investing Activities

12-8

Financing Activities

Under Armour’s 2010 Financing Activities

12-9

Relationships Between Classified Balance Sheet and Statement of Cash Flow (SCF) Categories

12-10

Relationship to Other Financial Statements

Information needed to prepare a Statement of Cash Flows: Comparative Balance Sheets. Income Statement. Additional details concerning

selected accounts.

12-11

Relationship to Other Financial Statements

Recall that the basic Balance Sheet equation is:

We can recast the equation as follows:

The following equation is true:

From this basic Balance Sheet equation, wedevelop our model to solve for the change in cash:

12-12

Direct and Indirect Reportingof Operating Cash Flows

We will concentrate on the indirect method for now, and wewill look at the direct method again later in the chapter.

Same result

12-13


Report cash flows from operating activities, using

the indirect method.

12-14

Cash Flows from Operating Activities - Indirect Method

Net Income

Cash Flows from Operating

Activities - Indirect Method

Changes in Current Assets and Current Liabilities.

+ Losses and - Gains

+ Noncash expenses such as Depreciation and

Amortization.

The indirect method adjusts Net Incomeby analyzing noncash items.

12-15

Use this table when adjusting Net Income to operating cash flows using the indirect method.

Current Assets Current Liabilities

Subtract from Add tonet income. net income.

Add to Subtract fromnet income. net income.

Increase

Decrease

Relationships to the Balance Sheet and the Income Statement

Change in accountbalances during the year

12-16

Use the following financial statements

for Under Armour, Inc. and prepare the

Statement of Cash Flows for the year

ended December 31, 2010.

Statement of Cash FlowsIndirect Method Example

12-17


12-18


12-19

The Statement of Cash Flows

using the indirect

method will begin with

Under Armor, Inc.’s Net

Income from the Income Statement.


12-20

Direct and Indirect Reportingof Operating Cash Flows

When using the indirect method, start with accrual basis Net Income and adjust it for:1. items that are included in Net Income but do not

involve cash, and 2. items that are not included in Net Income but do

involve cash.

12-21

Next, adjust for the non-cash items includedin Net Income.

For Under Armour, the only non-cash adjustmentis for Depreciation Expense.

12-22

Accumulated Depreciation increased by $17, from $70 in the 2009 Balance Sheet to $87 in the 2010 Balance sheet. The same $17 is shown as Depreciation Expense in the 2010 Income Statement.

To complete the Cash Flows from Operating Activities section, we must examine comparative Balance Sheets to determine the

changes in current assets and current liabilities from the beginning of the period to the end of the period.

12-23




Increase

Decrease

These five items were shown earlier in the current portions of Under Armour’s comparative Balance Sheets for 2009 and 2010

12-24


Report cash flows from investing activities.

12-25

Reporting Cash Flows from Investing Activities

We will need this additional data to preparethe investing portion of the statement.

1. No disposals or impairments of Equipment or Intangibles occurred

2. Equipment costing $30 million and Intangibles costing $11 million were purchased with Cash.

12-26

Under Armour, Inc., has two investing activities on the Statement of Cash Flows that required the use of Cash:1. Purchase of Equipment, and2. Purchase of Intangibles and Other Assets.

Reporting Cash Flows from Investing Activities

12-27


Report cash flows from financing activities.

12-28

Reporting Cash Flows from Financing Activities

We will need this additional data to preparethe financing portion of the statement.

1. No Dividends were declared or paid.2. Long-term Debt of $5 million was paid.3. $9 million in new long-term loans were issued.4. Shares of Stock were issued for $3 million.

12-29


Long-term Debt increased because of $9 innew loans during the year. The long-term Debt

increase is a Cash inflow.

12-30


Payments on Long-term Debt resulted in a Cash outflow of $5. The net effect of these two Long-term Debt

transactions increased Long-term Debt by $4, from $25 on the 2009 Balance Sheet to $29 on the 2010 Balance Sheet.

12-31


The third financing activity is the issuance of Common Stock resulting in a Cash inflow of $3. Contributed Capital increased from $224 in the 2009 Balance Sheet to $227 in the 2010 Balance Sheet.

12-32

Now we can reconcile the change in Cash to the ending $190 Cash balance that appears on the Balance Sheet.


12-33

Noncash Investing andFinancing Activities

Required Supplemental Information:

1. Cash paid for taxes and interest.

2. Significant non-cash investing and financing activities.

12-34


Interpret cash flows from operating, investing, and

financing activities.

12-35

• Operating cash flows must be positive over the long-run for a company to be successful.

• An upward trend in operating cash flows over time indicates growth and efficient operations.

• Look at the relationship between operating cash flows and Net Income.

Evaluating Operating Cash Flows

12-36

• Healthy companies tend to show negative cash flows in the investing activities section.

• Be cautious over a positive total cash flow in the investing activities section

Evaluating Investing Cash Flows

12-37

• It’s not possible to evaluate the company’s financing cash flows by simply determining whether they are positive or negative on an overall basis.

• Instead, consider detailed line items with this section to assess the company’s overall financing strategy.

Evaluating Financing Cash Flows

12-38

Overall Patterns of Cash Flows

12-39


Report and interpret cash flows from operating activities

using the direct method.

12-40

Reporting Operating Cash Flows with the Direct Method

Provides more detailed information

Identifies cash inflows and

outflows relationships

Prepared by adjusting accrual

basis to cash basis

Investing and financing sections

for the two methods are identical

12-41

When we prepared the operating section using the indirect method, we also arrived at net cash inflow of $37.

Let’s see how we arrive at these cash flows.

Direct Method Operating Activities

12-42

With the direct method, we convert each revenue and expense on the Income Statement to a cash flow.

Direct Method Operating Activities


Supplement 12A

Reporting Disposals of Property, Plant, and Equipment (Indirect Method)

12-44

Depreciation Expense

Loss on Saleof PPE

A loss on the sale of PPE is added back to Net Income just as

Depreciation Expense is added back. Adding these noncash items restores

Net Income to what it would have been had Depreciation and the loss

not been subtracted at all.

Just the opposite is true for a gain on the sale of PPE. Subtracting the gain reverses the effect of the gain having

been added to Net Income.

Gain on Saleof PPE

Reporting Sales of Property, Plant, and Equipment (PPE) (Indirect)


Supplement 12B

T-Account (Indirect Method)

12-46

Instead of creating schedules for each section of the Statement of Cash Flows, some prefer to prepare a

single large T-account to represent the changes that have taken place in Cash subdivided into the three

sections of the Statement of Cash Flows.

Let’s see how to use a T-account to prepare a Statement of Cash Flows on the next slide.

T-account Approach(Indirect Method)

12-47

T-account Approach(Indirect Method)


Supplement 12C

Spreadsheet Approach (Indirect Method)

12-49

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.

Spreadsheet Approach(Indirect Method)

12-50

We begin by entering the beginning and ending

balances for each account on the comparative Balance

Sheets.

The cash inflows and outflows columns will be used later to explain the changes in each account

balance.12-50

12-5112-51

Changes in Balance Sheet accounts are

analyzed in terms of debits and

credits in the top half of the

spreadsheet and recorded as cash

inflows and outflows in the

bottom half of the spreadsheet.

We will begin with operating activities.

12-5212-52

Changes in Balance Sheet accounts are analyzed in

terms of debits and credits in the top half of

the spreadsheet and recorded as cash inflows and outflows in the bottom half of

the spreadsheet. Now we will complete the analysis with investing and

financing activities.

12-53

The top of the completed spreadsheet

is shown here.


12-53

12-54


The bottom of the completed spreadsheet

is shown here.


Chapter 12Solved Exercises

E12-2, E12-3, E12-4, E12-5, E12-6, E12-7

12-55

12-56

E12-2 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method)Suppose your company sells services of $180 in exchange for $110 cash and $70 on account.Required:1. Show the journal entry to record this transaction.

2. Identify the amount that should be reported as net cash flows from operating activities.

The $110 increase in Cash is reported asnet cash flows from operating activities.

Recorddr Cash (+A)dr Accounts Receivable (+A) cr Service Revenue (+R, +SE) 180

11070

12-57

E12-2 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method)

Required:3. Identify the amount that would be included in Net Income.

4. Show how the indirect method would convert Net Income (requirement 3) to net cash flows from operating activities (requirement 2).

5. What general rule about converting Net Income to operating cash flows is revealed by your answer to requirement 4?

$180 of Service Revenue would be included in Net Income.

When Accounts Receivable increases, Sales Revenue is greater than Cash received, so subtract the increase to

convert Net Income to cash flow from operating activities.

Net Income

Less: Accounts Receivable increase

Net cash flow from operating activities

$ 180

(70)

$ 110

12-58

E12-3 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method)Suppose your company sells services for $325 cash this month. Your company also pays $100 in wages, which includes $15 that was payable at the end of the previous month and $85 for wages of this month.Required:1. Show the journal entries to record these transactions.

Record

dr Cash (+A) cr Service Revenue (+R, +SE) 325

325

Recorddr Wages Payable (-L)dr Wages Expense (+E, -SE) cr Cash (-A) 100

1585

12-59

E12-3 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method)Required:2. Identify the amount that should be reported as net cash flows from operating activities.

3. Identify the amount that would be included in Net Income.

4. Show how the indirect method would convert Net Income (requirement 3) to Net Cash Flows from Operating Activities (requirement 2).

The $225 increase in Cash ($325 – $100) should be reportedas net cash inflow from operating activities.

$325 of Service Revenue would be included along withWages Expense of $85, for a Net Income of $240.

Net Income

Less: Wages Payable decrease


$ 240

(15)

$ 225

12-60

E12-3 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method)Required:5. What general rule about converting Net Income to operating cash flows is revealed by your answer to requirement 4?

When Wages Payable decreases, subtract that decrease to convert Net Income to cash flow from operating activities.




Increase

Decrease

12-61

E12-4 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method)Suppose your company sells services of $150 in exchange for $120 cash and $30 on account. Depreciation of $50 also is recorded.Required:1. Show the journal entries to record these transactions.


12030

Record

dr Depreciation Expense (+E, -SE) cr Accumulated Depreciation (+xA, -A) 50

50

12-62

E12-4 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method)Required:2. Identify the amount that should be reported as Net Cash Flows from Operating Activities.


4. Show how the indirect method would convert Net Income (requirement 3) to net cash flows from operating activities (requirement 2).

The $120 increase in Cash should be reportedas net cash flows from operating activities.

Net Income would include $150 of Service Revenueand $50 of Depreciation Expense, or $100 in total.

Net Income

Add: Depreciation



$ 100

50

(30)

$ 120

12-63

E12-4 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method)Required: 5. What general rules about converting Net Income to operating cash flows are revealed by your answer to requirement 4?

Two general rules are revealed:1.Always add back the amount of Depreciation Expense

subtracted in the Income Statement to convert Net Income to cash flow from operating activities.

2.When Accounts Receivable increases, Sales Revenue is greater than Cash received, so subtract the increase to convert Net Income to cash flow from operating activities.

12-64

E12-5 Understanding the Computation of Cash Flows from Operating Activities Indirect Method)Suppose your company sells goods for $300, of which $200 is received in cash and $100 is on account. The goods cost your company $125 in a previous period. Your company also recorded wages of $70, of which only $30 has been paid in cash.Required:1. Show the journal entries to record these transactions


200100

Record

dr Cost of Goods Sold (+E, -SE) cr Inventory (-A) 125

125

12-65

E12-5 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method)Required:1. Show the journal entries to record these transactions

2. Identify the amount that should be reported as net cash flows from operating activities.


Net cash flows from operating activities would be $170, which equalsthe $200 received from customers minus the $30 paid to employees.

Net Income would be $105, which equals $300 of Sales Revenueminus Cost of Goods Sold ($125) and Wages Expense ($70).

Recorddr Wages Expense (+E, -SE) cr Wages Payable (+L) cr Cash (-A)

4030

70

12-66

E12-5 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method)Required: 4. Show how the indirect method would convert Net Income (requirement 3) to net cash flows from operating activities (requirement 2).

5. What general rules about converting Net Income to operating cash flows are revealed by your answer to requirement 4?

Three general rules are revealed:1.Add back decreases in noncash Current Assets. 2.Add back increases in Current Liabilities3.Deduct increases in noncash Current Assets.

Net Income

Add: Inventory decrease

Wages Payable increase



$ 105

125

40

(100)

$ 170

12-67

E12-6 Preparing and Evaluating a Simple Statement of Cash Flows(Indirect Method)Suppose your company’s Income Statement reports $160 of Net Income, and its comparative Balance Sheet indicates the following.

Required:1. Prepare the operating activities section of the Statement of Cash Flows, using the indirect method.2. Identify the most important cause of the difference between the company’s Net Income and Net Cash Flows from Operating Activities.

12-68

E12-6 Preparing and Evaluating a Simple Statement of Cash Flows(Indirect Method)Required:1. Prepare the operating activities section of the Statement of Cash Flows, using the indirect method.

First, let’s determine the changes in Balance Sheet accounts.

ASSETS

Current assets:

Cash

Accounts Receivable

Inventory

Total

Wages Payable

Retained Earnings

Total

Beginning

$ 35

75

245

$ 355

10

345

$ 355

Change

$ 170

100

(110)

$ 40

120

Ending

$ 205

175

135

$ 515

50

465

$ 515

12-69

E12-6 Preparing and Evaluating a Simple Statement of Cash Flows(Indirect Method)Required:1. Prepare the operating activities section of the Statement of Cash Flows, using the indirect method.

Cash Flows from Operating Activities:

Net Income

Changes in Current Assets and Current Liabilities:

Accounts Receivable increase

Inventory decrease



$ 160

-100

110

40

$ 210

Decrease

Increase


Subtract fromNet Income.


Add toNet Income.

Add toNet Income.

12-70

E12-6 Preparing and Evaluating a Simple Statement of Cash Flows(Indirect Method)Required:2. Identify the most important cause of the difference between the company’s Net Income and Net Cash Flows from Operating Activities.

• The Inventory decrease indicates that Cost of Goods Sold (deducted in the Income Statement) was $110 more than the cash paid to purchase Inventory.

• In other words, the company sold Inventory but did not replace it, creating a net cash inflow for the period.

Cash Flows from Operating Activities:

Net Income

Changes in current assets and current liabilities:

Accounts Receivable increase

Inventory decrease



$ 160

-100

110

40

$ 210

The most important cause of the difference is the $110 decrease in Inventory.

12-71

E12-7 Preparing and Evaluating a Simple Statement of Cash Flows(Indirect Method)Suppose the Income Statement for Goggle Company reports $95 of Net Income, after deducting depreciation of $35. The company bought equipment costing $60 and obtained a long-term bank loan for $70. The company’s comparative balance sheet, at December 31, indicates the following.

12-72

E12-7 Preparing and Evaluating a Simple Statement of Cash Flows(Indirect Method)Required:1. Calculate the change in each balance sheet account, and indicate whether each account relates to operating, investing, and/or financing activities.

Cash

Accounts Receivable

Inventory

Equipment

Accumulated Depreciation

Total

Wages Payable

Long-term Debt

Contributed Capital

Retained Earnings

Total

2012

$ 35

75

260

500

(45)

$ 825

$ 10

445

10

360

$ 825

2013

$ 240

175

135

560

(80)

$ 1,030

$ 50

515

10

455

$ 1,030

TypeChange

205

100

(125)

60

35

40

70

-

95

Cash

Accounts Receivable

Inventory

Equipment

Accumulated Depreciation

Total

Wages Payable

Long-term Debt

Contributed Capital

Retained Earnings

Total

2012

$ 35

75

260

500

(45)

$ 825

$ 10

445

10

360

$ 825

2013

$ 240

175

135

560

(80)

$ 1,030

$ 50

515

10

455

$ 1,030

Type

Cash

Operating

Operating

Investing

Operating

Operating

Financing

Financing

Operating

Change

205

100

(125)

60

35

40

70

-

95

12-73

E12-7 Preparing and Evaluating a Simple Statement of Cash Flows(Indirect Method)Required:2. Prepare a statement of cash flows using the indirect method.

Google Company

Statement of Cash flows

For the Year Ended December 31, 2013

Cash Flows from Operating Activities:Net IncomeAdd DepreciationSubtract Accounts Receivable increaseAdd Inventory decreaseAdd Wages Payable increaseNet cash provided (used) by operating activities

$ 9535

(100)125

40 195

Decrease

Increase




Add toNet Income.

Add toNet Income.

Google Company




Cash Flows from Investing Activities:Equipment purchasedNet cash provided (used) by investing activities

$ 9535

(100)125

40 195

(60) (60)

Google Company




Cash Flows from Investing Activities:Equipment purchasedNet cash provided (used) by investing activities

Cash Flows from Financing Activities:Obtained long-term bank loanNet cash provided (used) by financing activities

Net change in cashCash, Beginning of 2013Cash, End of 2013

$ 9535

(100)125

40 195

(60) (60)

70 70

205 35$ 240

12-74

E12-7 Preparing and Evaluating a Simple Statement of Cash Flows(Indirect Method)Required:3. In one sentence, explain why an increase in Accounts Receivable is subtracted.

4. In one sentence, explain why a decrease in Inventory is added.

The increase in Accounts Receivable indicates thatsales on account were greater than cash collections.

A decrease in Inventory indicates that Cost of Goods Sold (subtractedin the Income Statement) was greater than Inventory purchases.

12-75

E12-7 Preparing and Evaluating a Simple Statement of Cash Flows(Indirect Method)Required:5. In one sentence, explain why an increase in Wages Payable is added.

6. Are the cash flows typical of a start-up, healthy, or troubled company? Explain.

The Wages Payable increase is added because more wages were subtracted when calculating Net Income than actually paid.

A healthy company since operating cash flows are positive andfinancing inflows are sufficient to cover investing outflows.

12-76

End of Chapter 12

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