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Chapter 12

Reporting the Statement of Cash Flows

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Purpose of the Statement of Cash Flows


How does a company obtain its cash? Where does a company spend its cash?

What explains the change in the cash balance?

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Importance of Cash Flows

How did the business fund its operations?

Does the business have sufficient cash to pay its debts as they mature?

Did the business make any dividend payments?

Did the business borrow any funds or repay any loans?

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Measurement of Cash Flows


Cash Equivalents

Cash

Currency

Short-term, highly liquid investments. Readily convertible into cash. Sufficiently close to maturity so that market value is unaffected by interest rate changes.
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Classifying Cash Flows

The Statement of Cash Flows includes the following three sections: Operating Activities Investing Activities Financing Activities

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Operating Activities


Inflows
Receipts from customers Cash dividends received Interest from borrowers Other.

Outflows
Salaries and wages Payments to suppliers Taxes and fines Interest paid to lenders Other
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Investing Activities

Inflows
Selling long-term productive assets Selling equity investments Collecting principal on loans Other

Outflows
Purchasing long-term productive assets Purchasing equity investments Purchasing debt investments Other
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Financing Activities
Inflows
Issuing its own equity securities Issuing bonds and notes Issuing short- and long-term liabilities

Outflows
Pay dividends Purchasing treasury stock Repaying cash loans Paying owners withdrawals
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Noncash Investing and Financing


Items requiring separate disclosure include: Retirement of debt by issuing equity securities. Conversion of preferred stock to common stock. Leasing of assets in a capital lease transaction.

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Format of the Statement of Cash Flows


Company Name Statement of Cash Flows For Period Ended Date Cash flows from operating activities: [List of individual inflows and outflows] Net cash provided (used) by operating activites Cash flows from investing activities: [List of individual inflows and outflows] Net cash provided (used) by investing activites Cash flows from financing activities: [List of individual inflows and outflows] Net cash provided (used) by financing activites Net increase (decrease) in cash Cash (and equivalents) balance at beginning of period Cash (and equivalents) balance at end of period

$ #####

#####

##### $ ##### ##### $ #####

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C4

Format of the Statement of Cash Flows

There are two acceptable methods to determine Cash Flows from Operating Activities:
Direct Method
Indirect Method

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P2

Preparing the Statement of Cash Flows

Lets look at the Indirect Method for preparing the Cash Flows from Operating Activities section.
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Indirect Method
Changes in current assets and current liabilities.

Net Income

Cash Flows from Operating Activities


+ Losses and - Gains + Noncash expenses such as depreciation and amortization.

97.5% of all companies use the indirect method.


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Indirect Method
Change in Account Balance During Year Increase Decrease Subtract from net Add to net income. income. Add to net income. Subtract from net income.

Current Assets Current Liabilities

Use this table when adjusting Net Income to Operating Cash Flows.
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Indirect Method Example


East, Inc. reports $125,000 net income for the year ended December 31, 2008. Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000. During 2008, East reported $12,500 of Depreciation Expense.

What is East, Inc.s Operating Cash Flow for 2008?


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Indirect Method Example


Net income Net income $ 125,000 $ 125,000

Deduct: Increase in accounts Deduct: Increase in accounts For the indirect receivable receivable

method, start with Cash provided by operating Cash provided by operating net income.
activities activities

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Indirect Method Example


Net income Net income Add: Depreciation expense Add: Depreciation expense Deduct: Increase in accounts Deduct: Increase in accounts receivable Add noncash receivable expenses such
as depreciation, depletion, amortization, or by debt Cash provided by operating Cash provided badoperating expense. activities

$ 125,000 $ 125,000 12,500 12,500

activities

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Indirect Method Example


Net income Net income Add: Depreciation expense Add: Depreciation expense Deduct: Increase in accounts Deduct: Increase in accounts receivable receivable $ 125,000 $ 125,000 12,500 12,500 (7,500) (7,500)

Change operating Cash provided by operatingBalance During Year Cash provided by in Account Increase Decrease activities activities Current Assets Current Liabilities Subtract from net income. Add to net income.

Add to net income. Subtract from net income.

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Indirect Method Example


Net income $ 125,000 Net income $ 125,000 Add: Depreciation expense 12,500 Add: Depreciation expense 12,500 Deduct: Increase in accounts Deduct: Increase in accounts receivable (7,500) receivable (7,500) Add: Increase in accounts payable 10,000 Add: Increase in accounts payable 10,000 Cash provided by operating Cash provided by operating Change in Account Balance During Year activities activities Increase Decrease
Current Assets Current Liabilities Subtract from net income. Add to net income. Add to net income. Subtract from net income.
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Indirect Method Example


Net income $ 125,000 Net income $ 125,000 Add: Depreciation expense 12,500 Add: Depreciation expense 12,500 Deduct: Increase in accounts Deduct: Increase in accounts receivable (7,500) receivable (7,500) Add: Increase in accounts payable 10,000 Add: Increase in accounts payable 10,000 Cash provided by operating Cash provided by operating activities $ 140,000 activities $ 140,000

If we used the Direct Method, we would get the same $140,000 for Cash Provided by Operating Activities.
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Indirect Method

Lets prepare a Statement of Cash Flows for B&G Company using the Indirect Method.

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B&G Company Comparative Balance Sheets December 31 Increase or (Decrease)

2008 Assets Cash Accounts receivable Inventories Land Equipment Accumulated depreciation-equipment Total Assets Liabilities and Stockholders' Equity Accounts payable Bonds payable Common stock, $1 par Retained earnings Total Liabilities and Stockholders' Equity
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63,000 $ 85,000 170,000 75,000 270,000 (66,000) 597,000 $

22,000 $ 41,000 76,000 9,000 189,000 (19,000) 100,000 (25,000) 200,000 70,000 (32,000) (34,000) 555,000 $ 42,000

39,000 150,000 209,000 199,000 597,000

47,000 200,000 174,000 134,000 555,000

(8,000) (50,000) 35,000 65,000 $ 42,000

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Additional Information for 2008: Net income was $105,000. Cash dividends declared and paid were $40,000. Bonds payable of $50,000 were redeemed for $50,000 cash. Common stock was issued for $35,000 cash.

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B&G Company Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income Adjustments to accrual-basis net income:

105,000

Add noncash expenses and losses. Subtract noncash revenues and gains. Then, analyze the changes in current assets and current liabilities.

Start with accrual-basis net income.

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B&G Company Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income $ Adjustments to accrual-basis net income: Depreciation expense $ 34,000 Increase in accounts receivable (9,000) Decrease in inventory 19,000 Decrease in accounts payable (8,000) Total adjustments Net cash provided by operating activities Cash flows from investing activities

105,000

36,000 141,000

Current Assets Current Liabilities

Change in Account Balance During Year Increase Decrease Subtract from net Add to net income. income. Add to net income. Subtract from net income.
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B&G Company Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income $ Adjustments to accrual-basis net income: Depreciation expense $ 34,000 Increase in accounts receivable (9,000) Decrease in inventory 19,000 Decrease in accounts payable (8,000) Total adjustments Net cash provided by operating activities Cash flows from investing activities

105,000

36,000 141,000

Now, lets complete the investing section.

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B&G Company Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income $ Adjustments to accrual-basis net income: Depreciation expense $ 34,000 Increase in accounts receivable (9,000) Decrease in inventory 19,000 Decrease in accounts payable (8,000) Total adjustments Net cash provided by operating activities Cash flows from investing activities Proceeds from sale of land 25,000 Purchase of equipment (70,000) Net cash used by investing activities Cash flows from financing activities

105,000

36,000 141,000

(45,000)

Now, lets complete the financing section.


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B&G Company Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income $ Adjustments to accrual-basis net income: Depreciation expense $ 34,000 Increase in accounts receivable (9,000) Decrease in inventory 19,000 Decrease in accounts payable (8,000) Total adjustments Net cash provided by operating activities Cash flows from investing activities Proceeds from sale of land 25,000 Purchase of equipment (70,000) Net cash used by investing activities Cash flows from financing activities Proceeds from issuance of common stock 35,000 Redemption of bonds (50,000) Payment of dividends (40,000) Net cash used by financing activities Net increase in cash Cash, January 1, 2008 Cash, December 31, 2008 $

105,000

36,000 141,000

(45,000)

(55,000) 41,000 22,000 63,000

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A1

Analyzing Cash Sources and Uses

Cash Flows of Competing Companies


all numbers in thousands Cash provided (used) by operating activities Cash provided (used) by investing activities: Proceeds from sale of operating assets Purchase of operating assets Cash provided (used) by financing activities: Proceeds from issuance of debt Repayment of debt Net increase (decrease) in cash BMX $ 90,000 $ ATV 40,000 $ Trex (24,000)

26,000 (48,000) (25,000)

13,000 $ (27,000) 15,000 $ 15,000 $ 15,000

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Cash Flow on Total Assets


Used, along with income-based ratios, to assess company performance.

Cash flow on total assets

Operating cash flows Average total assets

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P5

Preparing the Statement of Cash Flows

Lets look at the Direct Method for preparing the Cash Flows from Operating Activities section.
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Analyzing the Cash Account


Cash 22,000 Payments for merchandise 466,000 Payments for wages 25,000 Payments for interest 35,000 Payments for taxes Payments for equipment Payments for bond retirement Payments for dividends 63,000 150,000 145,000 10,000 20,000 70,000 50,000 40,000

Balance, Jan. 1, 2008 Receipts from customers Receipts from sale of land Receipts from stock issuance

Balance, Dec. 31, 2008

Lets use this Cash account to prepare B&G Companys Statement of Cash Flows under the Direct Method.
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B&G Company Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Cash received from customers $ 466,000 Cash paid for merchandise (150,000) Cash paid for wages (145,000) Cash paid for interest (10,000) Cash paid for taxes (20,000) Net cash provided by operating activities Cash flows from investing activities Proceeds from sale of land 25,000 Purchase of equipment (70,000) Net cash used by investing activities Cash flows from financing activities Proceeds from issuance of common stock 35,000 Redemption of bonds (50,000) Payment of dividends (40,000) Net cash used by financing activities Net increase in cash Cash, January 1, 2008 Cash, December 31, 2008 $
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141,000

(45,000)

(55,000) 41,000 22,000 63,000

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In preparing a companys statement of cash flows for the most recent year on the indirect method, the following information is available: Net income for the year was $52,000 Accounts payable decreased by $18,000 Accounts receivable decreased by $25,000 Inventories increased by $ 5,000 Cash dividends paid were $14,000 Depreciation expense was $30,000 Net cash provided by operating activities was:

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For each of the following items, indicate whether it would be classified as an (O) operating activity, an (I) investing activity, a (F) financing activity, or a significant (N) noncash financing and investing activity. __________ (1) Received cash dividends from investments in trading securities. __________ (2) Collected accounts receivable from customers. __________ (3) Issued bonds payable for cash. __________ (4) Paid wages to employees. __________ (5) Issued stock for cash. __________ (6) Sold equipment for cash. __________ (7) Purchased land in exchange for a note payable. __________ (8) Paid cash dividends. __________ (9) Received interest from investments in trading securities. _________ (10) Purchases of land for cash.
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Based on the following income statement and balance sheet for Rashid Corporation, determine the cash flows from operating activities using the indirect method.
Rashid Corporation Income Statement For Year Ended December 31, 2007 Sales Cost of goods sold Depreciation expense Other operating expenses Other gains (losses): Gain on sale of equipment Income before taxes Income tax expense Net income $504,000 $327,600 42,000 125,500

(495,100 )

7,200 $ 16,100 (4,800 ) $ 11,300

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Rashid Corporation Balance Sheets At December 31 Assets Cash Accounts receivable Inventory Equipment Accumulated depreciation Total assets Liabilities: Accounts payable Income taxes payable Total liabilities Equity: Common stock Contributed Capital in excess of par value Retained earnings Total equity Total liabilities and equity
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2007 $ 64,650 21,000 58,000 240,000 (106,000 ) $277,650

2006 $ 55,800 29,000 52,100 222,000 ( 96,000 ) $262,900

$ 28,400 1,050 $ 29,450 $106,000 18,000 124,200 $248,200 $277,650

$ 23,700 1,200 $ 24,900 $106,000 18,000 114,000 $238,000 $262,900

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End of Chapter 16

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