PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Winston Kwok, Ph.D., CPA McGraw-Hill/Irwin Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved. S TATEMENT OF C ASH F LOWS Chapter 16 How does a company obtain its cash? Where does a company spend its cash? What explains the change in the cash balance? P URPOSE OF THE S TATEMENT OF C ASH F LOWS How did the business fund its operations? Did the business borrow any funds or repay any loans? Does the business have sufficient cash to pay its debts as they mature? Did the business make any dividend payments? I MPORTANCE OF C ASH F LOWS Cash Currency Cash Equivalents Short-term, highly liquid investments. Readily convertible into cash. Sufficiently close to maturity so that market value is unaffected by interest rate changes. M EASUREMENT OF C ASH F LOWS C LASSIFICATION OF C ASH F LOWS The Statement of Cash Flows includes the following three sections: Operating Activities Investing Activities Financing Activities C1 Outflows Salaries and wages Payments to suppliers Taxes and fines Outflows Salaries and wages Payments to suppliers Taxes and fines Inflows Receipts from customers Inflows Receipts from customers O PERATING A CTIVITIES C1 Outflows Purchasing long-term productive assets Purchasing equity investments Purchasing debt investments Outflows Purchasing long-term productive assets Purchasing equity investments Purchasing debt investments Inflows Selling long-term productive assets Selling equity investments Collecting principal on loans Inflows Selling long-term productive assets Selling equity investments Collecting principal on loans I NVESTING A CTIVITIES C1 Outflows Purchasing treasury shares Repaying cash loans Outflows Purchasing treasury shares Repaying cash loans Inflows Issuing its own equity securities Issuing bonds and notes Issuing short- and long-term liabilities Contributions by owners Inflows Issuing its own equity securities Issuing bonds and notes Issuing short- and long-term liabilities Contributions by owners F INANCING A CTIVITIES C1 C LASSIFICATION OF C ASH F LOW I TEMS OperatingInvestingFinancing Interest receivedYes Dividends receivedYes Interest paidYes Dividends paidYes Reporting entities have choices in classifying interest and dividends C1 N ONCASH I NVESTING AND F INANCING Items requiring separate disclosure include: Retirement of debt by issuing equity securities. Conversion of preference shares to ordinary shares. Items requiring separate disclosure include: Retirement of debt by issuing equity securities. Conversion of preference shares to ordinary shares. C1 F ORMAT OF THE S TATEMENT OF C ASH F LOWS P REPARING THE S TATEMENT OF C ASH F LOWS P1 A NALYZING THE C ASH A CCOUNT P1 The Cash account is a natural place to look for information about cash flows from operating, investing, and financing activities. A NALYZING THE C ASH A CCOUNT P1 Cash from Operating Cash from Investing Cash from Financing Cash Proved A NALYZING N ONCASH A CCOUNT P1 A second approach to preparing the statement of cash flows is analyzing noncash accounts. I NFORMATION TO P REPARE THE S TATEMENT P1 Comparative Balance Sheets Current Income Statement Additional Information Information to prepare the statement of cash flows usually comes from three sources: C ASH F LOWS FROM O PERATING I NDIRECT AND D IRECT M ETHODS OF R EPORTING The net cash amount provided by operating activities is identical under both the direct and indirect methods. Direct Method Indirect Method A PPLICATION OF THE I NDIRECT M ETHOD OF R EPORTING P2 A PPLICATION OF THE I NDIRECT M ETHOD OF R EPORTING P2 Additional information on Genesis Inc.s 2011 transactions: a) The accounts payable balances result from merchandise inventory purchases. b) Purchased $70,000 in property, plant and equipment by paying $10,000 cash and issuing $60,000 of notes payable. c) Sold property, plant and equipment with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss. d) Received $15,000 cash from issuing 3,000 shares of no-par ordinary shares. e) Paid $18,000 cash to retire notes with a $34,000 carrying amount, yielding a $16,000 gain. f) Declared and paid cash dividends of $14,000. Income before taxes Cash Flows from Operating Activities Changes in noncash current assets and current liabilities + Losses and - Gains + Noncash expenses such as depreciation and amortization A PPLICATION OF THE I NDIRECT M ETHOD OF R EPORTING P2 1 23 W HY START WITH INCOME BEFORE TAXES ? International Financial Reporting Standards (IFRS) Cash flows arising from taxes on income should be separately disclosed and should be classified as cash flows from operating activities. P2 Income before taxes Cash Flows from Operating Activities Use this table when adjusting income before taxes to operating cash flows Change in Account Balance During Year IncreaseDecrease Noncash Current Assets Subtract from income Add to income Current Liabilities Add to income Subtract from income P2 A DJUSTMENTS FOR C HANGES IN N ONCASH C URRENT A SSETS AND C URRENT L IABILITIES P2 A DJUSTMENTS FOR C HANGES IN N ON CASH C URRENT A SSETS AND C URRENT L IABILITIES P2 A DJUSTMENTS FOR O PERATING I TEMS N OT P ROVIDING OR U SING C ASH P2 A DJUSTMENTS FOR N ONOPERATING I TEMS I NTEREST R EVENUES, D IVIDEND R EVENUES, I NTEREST E XPENSES AND I NCOME T AXES Under IFRS, interest and dividends received, interest paid and income taxes must be separately shown. Since interest and dividend revenues are added to derive income amount, adjustments involve deducting these amounts from income. Interest expenses are added to income to cancel the earlier deduction. P2 P2 COMPLETING THE OPERATING SECTION P2 S UMMARY OF A DJUSTMENTS FOR I NDIRECT M ETHOD Common adjustments to income when computing net cash provided or used by operating activities under the indirect method: P3 C ASH F LOWS FROM I NVESTING Identify changes in investing-related accounts Explain these changes using reconstruction analysis Report their cash flow effects A three-stage process to determine cash provided or used by investing activities: P3 C ASH F LOWS FROM I NVESTING This analysis reveals a $40,000 increase in property, plant and equipment from $210,000 to $250,000 and a $12,000 increase in accumulated depreciation from $48,000 to $60,000. P3 C ASH F LOWS FROM I NVESTING Item b: Genesis purchased property, plant and equipment of $70,000 by issuing $60,000 in notes payable to the seller and paying $10,000 in cash. Item c: Genesis sold property, plant and equipment costing $30,000 (with $12,000 of accumulated depreciation) for $12,000 cash, resulting in a $6,000 loss. We also reconstruct the entry for Depreciation Expense using information from the income statement. P3 C ASH F LOWS FROM I NVESTING P3 C ASH F LOWS FROM F INANCING Identify changes in financing-related accounts Explain these changes using reconstruction analysis Report their cash flow effects A three-stage process to determine cash provided or used by financing activities: P3 C ASH F LOWS FROM F INANCING This analysis reveals: 1.an increase in notes payable from $64,000 to $90,000, 2.an increase in share capital from $80,000 to $95,000, and 3.an increase in retained earnings from $88,000 to $112,000. P3 C ASH F LOWS FROM F INANCING Item e: Notes with a carrying amount of $34,000 are retired for $18,000 cash, resulting in a $16,000 gain. Item b: Genesis purchased property, plant and equipment of $70,000 by issuing $60,000 in notes payable to the seller and paying $10,000 in cash. P3 C ASH F LOWS FROM F INANCING Item d: Issued 3,000 no-par ordinary shares for $5 per share. Item f: Cash dividends of $14,000 are paid. P3 P3 A NALYZING C ASH S OURCES AND U SES A1 Most managers stress the importance of understanding and predicting cash flows for business decisions. Used, along with income-based ratios, to assess company performance. Cash flow on total assets = Operating cash flows Average total assets C ASH F LOW ON T OTAL A SSETS A1 A PPENDIX 16A: D IRECT M ETHOD OF R EPORTING O PERATING C ASH F LOWS P4 Adjust income statement accounts related to operating activities for changes in their related balance sheet accounts: Framework for reporting cash receipts and cash payments A PPENDIX 16A: D IRECT M ETHOD OF R EPORTING O PERATING C ASH F LOWS P4 E ND OF C HAPTER 16