new chapter 17 - cash flow

Chapter 17 Cash Flows

What is cash flow? Cash inflows and cash outflows Cash receipts and cash payments

What are the three financial statements that we have studied so far? Balance sheet Income statement Retained Earnings

These statements fail to give us some basic information about cash movement. Balance sheet – does not give us information concerning how additions were

financed Income statement – does not give us information concerning how much cash

was generated by operating revenues Retained earnings – does not give us information concerning how much cash

dividends was paid during the year

None of these statements shows us the net change in cash as a result of operating, investing and financing activities.

What is the purpose of a cash flow statement? To provide information about an entity’s cash receipts and cash payments

during a period To provide information concerning its operating, investing, and financing

activities The statement of cash flows answers three questions:

Where did the cash come from during the period? What was the cash used during the period? What was the change in the cash balance during the period?

For cash flow statements, cash means “cash and cash equivalents.”Cash equivalents are:

Readily convertible to known amounts of cash So near their maturity that their market value is relatively insensitive to

changes in interest rates

Generally, cash equivalents will have a maturity date of three months or less.


Classifications of Cash Flows Operating activities – cash effects of transactions that create revenues and

expenses. Investing activities – includes acquiring and disposing of investments and

productive long – lived assets and lending money and collecting the loan. Financing activities – obtaining cash from issuing debt and repaying the

amount borrowed and obtaining cash from stockholders and providing them with a return on their investment.

Examples of Transactions Proceeds from the sale of an investment – Investing Disbursement for the purchase of treasury stock – Financing Loan to another corporation – Investing Proceeds from an insurance policy for a building destroyed by fire –

Investing Proceeds from winning a lawsuit – Operating Receipt of interest from an investment in bonds – Operating Payment of dividends – Financing Sale of merchandise for cash - Operating

Significant Noncash ActivitiesSignificant financing and investing activities that do not affect cash are not reported in the body of the statement of cash flows. They are reported on a separate schedule at the bottom of the statement, for disclosure purposes.

Examples of significant noncash activities Issuance of stock to purchase assets Conversion of bonds into common stock Issuance of debt to purchase assets Exchange of assets

Why is the statement of cash flows useful?It helps us access the entity’s ability to

Generate future cash flows Ability to pay dividends Reasons for the difference between net income and net cash provided by

operating activities The reliability of net income can be questioned, because accrual

accounting requires many estimates. Cash does not involve any estimates.


Cash investing and financing transactions during the period

The information for preparing the statement of cash flows comes from the: Balance Sheet Income Statement Retained Earnings

The accrual concept is not used in the preparation of a statement of cash flows, for it deals with cash receipts and cash payments.

There are two methods used to create the Statement of Cash Flows: the direct and indirect. Both arrive at the same answer. In the real world, most companies use the indirect method because

It is easier It focuses on the difference between net income and net cash flow from

operating activities. Even if you use the direct method, you still must create a cash flow statement

using the indirect method as a separate schedule.

ILLUSTRATION 17-1TYPICAL RECEIPTS AND PAYMENTSCLASSIFIED BY ACTIVITY


ILLUSTRATION 17-2INFORMATION SOURCES FOR ACTIVITIES


ILLUSTRATION 17-7CASH FLOWS FROM OPERATING ACTIVITIES—INDIRECT METHOD


ILLUSTRATION 17-7 (Continued)CASH FLOWS FROM OPERATING ACTIVITIES—INDIRECT METHOD


Problem 1The comparative balance sheet for Mott Company appears below:

MOTT COMPANYComparative Balance Sheet

Dec. 31, 2008 Dec. 31, 2007Assets

Cash................................................................................................. $54,000 $12,000Accounts receivable........................................................................ 6,000 8,000Inventory......................................................................................... 11,000 7,000Prepaid expenses............................................................................. 2,000 3,000Building........................................................................................... 20,000 20,000Accumulated depreciation—building............................................. (3,000) (2,000)

Total assets................................................................................ $90,000 $48,000

Liabilities and Stockholders' Equity

Accounts payable............................................................................ $ 1,000 $ 4,000Long-term note payable.................................................................. 13,000 14,000Common stock................................................................................ 33,000 18,000Retained earnings............................................................................ 43,000 12,000

Total liabilities and stockholders' equity.................................. $90,000 $48,000

The income statement for the year is as follows:

MOTT COMPANYIncome Statement

For the Year Ended December 31, 2008

Sales (all on credit)......................................................................... $280,000Expenses and losses

Cost of goods sold..................................................................... $184,000Operating expenses, exclusive of depreciation......................... 42,300Depreciation expense................................................................ 1,000Interest expense......................................................................... 1,200Loss on sale of land................................................................... 2,500Income taxes............................................................................. 9,000

Total expenses and loss....................................................... 240,000Net income...................................................................................... $ 40,000

Cash dividends of $9,000 were paid during the year. Land costing $15,000 was acquired by the issuance of common stock. The property was subsequently sold for $12,500 cash.

InstructionsPrepare a statement of cash flows for the year ended December 31, 2008 using the indirect method.


AnswerMOTT COMPANY

Statement of Cash FlowsFor the Year Ended December 31, 2008

(Indirect Method)Cash flows from operating activities

Net income...................................................................................... $40,000Adjustments to reconcile net income to net cash provided byoperating activities:

Depreciation expense............................................................. $1,000Decrease in accounts receivable............................................ 2,000Increase in inventory.............................................................. (4,000)Decrease in prepaid expenses................................................ 1,000Decrease in accounts payable................................................ (3,000)Loss on sale of land................................................................ 2,500 (500)

Net cash provided by operating activities..................... 39,500Cash flows from investing activities

Proceeds from sale of land.............................................................. 12,500Cash flows from financing activities

Payment of cash dividends.............................................................. (9,000)Payment of long-term note.............................................................. (1,000)

Net cash used by financing activities..................................... (10,000)Net increase in cash................................................................................. 42,000Cash at beginning of period..................................................................... 12,000Cash at end of period............................................................................... $54,000

Noncash financing and investing activitiesAcquired land through issuance of common stock ........................ $15,000


Problem 2

Presented below is information related to the operations of Tolbert Corporation.December

2008 2007 2008 Cash $120,000 $ 80,000 Sales $760,000Accounts receivable 110,000 96,000 Cost of goods sold 380,000Inventory 60,000 44,000 Gross profit 380,000Prepaid expenses 30,000 40,000 Depreciation expense 28,000Land 78,000 40,000 Other operating expenses 266,000Building 200,000 200,000 Income from operations 86,000Accumulated depreciation— Loss on equipment sale 6,000 building (34,000) (16,000) Income before income taxes 80,000Equipment 116,000 160,000 Income tax expense 24,000Accumulated depreciation— Net income $ 56,000 equipment (30,000) (40,000)

Total $650,000 $604,000

Accounts payable $ 80,000 $ 58,000Bonds payable 0 200,000Common stock 400,000 200,000Retained earnings 170,000 146,000

Total $650,000 $604,000PART III — STATEMENT OF CASH FLOWS (cont.)

Additional information:(a) In 2008, Tolbert declared and paid a cash dividend.(b) The company converted $200,000 of bonds into common stock.(c) Equipment with a cost of $44,000 and a book value of $24,000 was sold for $20,000. Land

was acquired for cash.

Instructions:Prepare a statement of cash flows in proper form for 2008, using the indirect method.


Answer

(a) Indirect MethodTOLBERT CORPORATION

Statement of Cash FlowsFor the Year Ended December 31, 2008

Cash flows from operating activitiesNet income ............................................................................ $ 56,000Adjustments to reconcile net income to net cashprovided by operating activities:

Increase in accounts receivable ....................................... $(14,000)Increase in inventory ....................................................... (16,000)Decrease in prepaid expenses ......................................... 10,000Increase in accounts payable ........................................... 22,000Loss on sale of equipment ............................................... 4,000Depreciation expense ...................................................... 28,000 34,000Net cash provided by operating activities ....................... 90,000

Cash flows from investing activitiesSale of equipment ................................................................. 20,000Purchase of land .................................................................... (38,000)

Net cash used by investing activities .............................. (18,000)Cash flows from financing activities

Declaration and payment of dividends ........................... (32,000)Net cash used by financing activities .............................. (32,000)

Net increase in cash .................................................................... 40,000Cash at beginning of period ........................................................ 80,000Cash at end of period .................................................................. $120,000

Noncash financing activityConversion of bonds payable into common stock ................ $200,000


Problem 3 – Cash Flow StatementCondensed financial data of Stiner Company appear below:

STINER COMPANYComparative Balance Sheet

December 31 2008 2007

AssetsCash $ 71,000 $ 35,000Accounts receivable 85,000 53,000Inventories 120,000 132,000Prepaid expenses 19,000 25,000Investments 90,000 75,000Plant assets 315,000 250,000Accumulated depreciation (65,000) (60,000)

Total $635,000 $510,000

Liabilities and Stockholders' EquityAccounts payable $ 93,000 $ 75,000Accrued expenses payable 29,000 24,000Bonds payable 130,000 160,000Common stock 245,000 170,000Retained earnings 138,000 81,000

Total $635,000 $510,000

Additional information:1. New plant assets costing $90,000 were purchased for cash in 2008.2. Old plant assets costing $25,000 were sold for $10,000 cash when book value was $13,000.3. Bonds with a face value of $30,000 were converted into $30,000 of common stock.4. A cash dividend of $20,000 was declared and paid during the year.5. Net income was $77,000. Depreciation expense amounted to $17,000 and a loss on the sale of assets amounted to $3,000.

InstructionsPrepare a statement of cash flows for the year using the indirect method.


STINER COMPANYStatement of Cash Flows

For the Year Ended December 31, 2008

Cash flows from operating activitiesNet Income

$77,000Adjustments

Depreciation Expense 17,000Loss 3,000A/R (32,000)Inventory 12,000

Prepaid Expense 6,000A/P 18,000Accrued Payable 5,000 29,000Net cash provided by operating activities 106,000

Cash flows from investing activitiesPurchase of investments (15,000)Purchase of plant assets (90,000)Sale of plant assets 10,000

Net cash used by investing activities (95,000)Cash flows from financing activities

Issuance of common stock 45,000Payment of cash dividends (20,000)

Net cash provided by financing activities 25,000Net increase in cash 36,000Cash at beginning of period 35,000Cash at end of period $ 71,000

Noncash investing and financing activitiesConversion of bonds payable into common stock $ 30,000


COMPLETION STATEMENTS177. A statement of cash flows summarizes the operating, ____________, and ___________ activities of an

entity.

178. The cash effects of selling goods and services appears in the ______________ activities section of a statement of cash flows.

179. The operating activities section of the statement of cash flows may be prepared using the ______________ method or the ______________ method.

180. Net income from operations is generally not the same as cash provided from operations because revenues and expenses are recognized in the income statement on the ______________ basis.

181. Using the indirect approach, noncash charges in the income statement are ______________ to net income and noncash credits are ______________ to compute cash provided by operations.

182. If accounts receivable increase during a period, revenues on an accrual basis are ______________ than revenues on a cash basis.

183. The sale of equipment at less than its book value is a(n) ______________ of cash that is reported in the ______________ activities section.

184. Free _______________ equals cash provided by operations less capital expenditures and cash dividends.

a185. Under the direct method, noncash charges, such as depreciation, are _______________ in the statement of cash flows.

a186. Under the direct method, the two largest classes of items in the operating activities section for a merchandising company are cash ________________________ and cash _________________________.

a187. Cost of goods sold for the year amounted to $150,000, and during the year, accounts payable ______________ by $8,000 and inventory ______________ by $7,000 resulting in cash paid to suppliers of $135,000.

a188. In computing cash payments for operating expenses, a decrease in prepaid expenses is ______________ and an increase in accrued expenses payable is ______________ to (from) operating expenses, exclusive of depreciation.

a189. In computing cash payments for income taxes, a decrease in income taxes payable is ______________ to (from) income tax expense.

Answers to Completion Statements177. investing, financing 184. cash flow178. operating a185. not reported179. indirect, direct (or vice versa) a186. receipts from customers, payments to suppliers180. accrual a187. increased, decreased181. added, deducted a188. deducted, deducted182. higher (greater) a189. added183. inflow, investing


MATCHINGSet 1 — Indirect Method

190. For each of the following items, indicate by using the appropriate code letter, how the item should be reported in the statement of cash flows, using the indirect method.

A. Added to net incomeB. Deducted from net incomeC. Cash outflow—investing activityD. Cash inflow—investing activityE. Cash outflow—financing activityF. Cash inflow—financing activityG. Significant noncash investing and financing activity

____ 1. Decrease in accounts payable during a period

____ 2. Declaration and payment of a cash dividend.

____ 3. Loss on sale of land.

____ 4. Decrease in accounts receivable during a period.

____ 5. Redemption of bonds for cash.

____ 6. Proceeds from sale of equipment at book value.

____ 7. Issuance of common stock for cash.

____ 8. Purchase of a building for cash.

____ 9. Acquisition of land in exchange for common stock.

____ 10. Increase in merchandise inventory during a period.

Answers to Matching

1. B 6. D2. E 7. F3. A 8. C4. A 9. G

Chapter 17 Cash Flows5. E 10. B

new chapter 17 - cash flow

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