ACCT 101 Statement of Cash Flows Lecture Notes Chapter 12 The statement of cash flows is a required component of financial

al statements.
AS!CS "F CAS# FL"$ %&'"%T!N( 'urpose of the Statement of Cash Flows The statement of cash flows is one of the five financial statements required by GAAP. The other four required financial statements are: 1. Income Statement 2. etained !arnin"s Statement or Statement of Stoc#holders$ !quity %. &alance Sheet '. Statement of (om)rehensive Income The statement of cash flows answers one question the other four financial statements do not: how did the com)any "enerate* and s)end* its cash+ )easurement of Cash Flows (ash flows are defined to include both cash ,monies in chec#in" accounts and ban# savin"s accounts- and cash equivalents. (ash equivalents include: .oney mar#et funds /i"hly0liquid investments with ori"inal maturities of less than % months* such as ban# certificates of de)osit and 1.S. Treasury bills.

Classification of Cash Flows The Statement of (ash 2lows shows cash inflows and cash outflows* or"ani3ed into three different business activities. These three business activities are summari3ed below. Name of activity 4)eratin" activities Accounts analyzed 4)eratin" assets and liabilities. These include most current asset and liability accounts. 6on"0term assets What the activity presents The net cash flows "enerated* or used* by the business in their core o)erations. 5e will use the indirect method of )resentin" o)eratin" activities. This method reconciles net income to net cash flow from o)eratin" activities. The cash inflows and outflows from sales 1

Investin"

activities 2inancin" activities 6on"0term liabilities and stoc#holders$ equity.

and )urchases of lon"0term assets* such as equi)ment* )atents* and lon"0term investments. The cash inflows and outflows from issuance of debt7 re)ayment of debt7 issuance of stoc#s7 dividends )aid7 and stoc# re)urchases.

Noncash !n*estin+ and Financin+ Acti*ities &usinesses sometime en"a"e in transactions not affectin" cash. 2or e8am)le* a business can )urchase equi)ment by issuin" a lon"0term note )ayable to the vendor. In this case* cash is not affected* and this transaction would not be re)orted in the body of the statement of cash flows. This transaction* referred to as a noncash investin" and financin" activity* would instead be disclosed either at the bottom of the statement of cash flows or in a note to the financial statements. CAS# FL"$S F%") "'&%AT!N( ACT!,!T!&S -sin+ the indirect method of reportin+ operatin+ acti*ities 9early all com)anies re)ort o)eratin" activities usin" the indirect method. This is because the indirect method is easier to com)ute:althou"h you may disa"ree after com)letin" the homewor#; ,In class* we will "o over a s#eleton format that will be much easier to remember than the more formal one shown below.The followin" tem)late should )rove hel)ful to you in )re)arin" the o)eratin" activities of the statement of cash flows usin" the indirect method. 9et Income Ad>ustments to reconcile net income to net cash )rovided by o)eratin" activities ?ecrease in o)eratin" assets @@ Increase in o)eratin" liabilities A Increase in o)eratin" assets @@ ?ecrease in o)eratin" liabilities A ?e)reciation !8)ense 6oss on sale of assets or debt retirement Gain on sale of assets or debt retirement 9et (ash Provided by 4)eratin" Activities <=== = = ,=,== = ,=<====

@@!8am)les: AB * Inventory* )re)aid assets* and tradin" securities. A !8am)les: ABP* accrued liabilities* and unearned rent7 e8cludes dividends )ayable.

If the indirect method is used* income ta8es )aid and interest )aid must be disclosed in a footnote to the financial statements. 2or e8am)le* assume .ichelle (om)any re)orted the followin" for its most recent fiscal year: 9et income* <2CC*CCC ?e)reciation e8)ense* <DC*CCC Increase in accounts receivable* <1C*CCC ?ecrease in merchandise inventory* <2*CCC Increase in )re)aid e8)enses* <1*CCC ?ecrease in accounts )ayable* <E*CCC Increase in wa"es )ayable* <%*CCC 6oss on sale of equi)ment* <1*CCC The o)eratin" activities would re)ort the followin"* usin" the indirect method: Cash flows from operatin+ acti*ities 9et income Ad>ustments to reconcile net income to net cash )rovided by o)eratin" activities Increase in accounts receivable ?ecrease in merchandise inventory Increase in )re)aid e8)enses ?ecrease in accounts )ayable Increase in wa"es )ayable ?e)reciation e8)ense 6oss on sale of equi)ment 9et cash )rovided by o)eratin" activities <2CC*CCC

,1C*CCC2*CCC ,1*CCC,E*CCC%*CCC DC*CCC 1*CCC <2%F*CCC

CAS# FL"$S F%") !N,&ST!N( ACT!,!T!&S Investin" activities include cash inflows from: Sale of lon"0term assets Sale of investments ,e8ce)t tradin" securities (ollections of notes receivable Investin" activities include cash outflows from: Purchase of lon"0term assets Purchase of investments ,e8ce)t tradin" securities 6oanin" cash to others 4btainin" the data for the investin" activities section involves three ste)s: 1. (alculate the increase or decrease in the lon"0term asset accounts 2. econstruct the chan"es in the accounts %. e)ort their effects in the investin" activities %

As an e8am)le* assume the balance of !qui)ment for .ichelle (om)any was <1CC*CCC at the be"innin" of the year* and <12C*CCC at the end of the year. 5e can say !qui)ment increased by <2C*CCC durin" the year. /owever* a detailed reconstruction of !qui)ment revealed the followin": !qui)ment* be"innin" of year Purchases of equi)ment Sales of equi)ment !qui)ment* end of year <1CC*CCC %C*CCC ,1C*CCC<12C*CCC

The equi)ment sold had an ori"inal cost of <1C*CCC and accumulated de)reciation of <'*CCC* so its boo# value was <F*CCC. Assumin" the equi)ment was sold for <D*CCC* a loss of <1*CCC on sale of equi)ment was incurred. The investin" activities section for .ichelle (om)any would re)ort the followin": Cash flows from in*estin+ acti*ities (ash received from sale of equi)ment (ash )aid for )urchase of equi)ment 9et cash used in investin" activities <D*CCC ,%C*CCC,2D*CCC-

The loss on sale of equi)ment of <1*CCC would be added to net income in o)eratin" activities. CAS# FL"$S F%") F!NANC!N( ACT!,!T!&S 2inancin" activities include cash inflows from: Issuin" stoc# Issuin" debt 2inancin" activities include cash outflows from: Purchasin" treasury stoc# etirin" stoc# by )urchase ?ebt )ayments ?ividend )ayments 2or e8am)le* if a com)any issued stoc# for <DC*CCC but re)aid debt of <2C*CCC* the financin" activities section would re)ort the followin". Cash flows from financin+ acti*ities (ash received from issuin" stoc# (ash )aid to retire debt 9et cash )rovided by financin" activities ' <DC*CCC ,2C*CCC%C*CCC

'%",!N( CAS# ALANC&S After )re)arin" the o)eratin"* investin" and financin" activities of the statement of cash flows* one final ste) remains. 5e must re)ort the be"innin" and endin" balances of cash and cash equivalents* and )rove that the net chan"e in cash is e8)lained by summin" the o)eratin"* investin"* and financin" activities. Assume the be"innin" of year cash balance for .ichelle (om)any was <1CC*CCC* and the end of year cash balance was <%'1*CCC. The net increase in cash would be <2'1*CCC. .ichelle (om)any$s statement of cash flow* once com)leted* would a))ear as follows. (ash flows from o)eratin" activities 9et income Ad>ustments to reconcile net income to net cash )rovided by o)eratin" activities Increase in accounts receivable ?ecrease in merchandise inventory Increase in )re)aid e8)enses ?ecrease in accounts )ayable Increase in wa"es )ayable ?e)reciation e8)ense 6oss on sale of equi)ment 9et cash )rovided by o)eratin" activities (ash flows from investin" activities (ash received from sale of equi)ment (ash )aid for )urchase of equi)ment 9et cash used in investin" activities (ash flows from financin" activities (ash received from issuin" stoc# (ash )aid to retire debt 9et cash )rovided by financin" activities 9et increase in cash (ash and cash equivalents at )rior year0end (ash and cash equivalents at current year0end <2CC*CCC

,1C*CCC2*CCC ,1*CCC,E*CCC%*CCC DC*CCC 1*CCC <2%F*CCC <D*CCC ,%C*CCC,2D*CCC<DC*CCC ,2C*CCC%C*CCC 2'1*CCC 1CC*CCC <%'1*CCC

The cash and cash equivalents balance at current year0end must a"ree with the balance for cash and cash equivalents re)orted on the balance sheet.