Transcript Chapter 4, Statement of Cash Flows

Chapter 13 -- Statement of Cash
Flows: Another Look
FINANCIAL ACCOUNTING
AN INTRODUCTION TO CONCEPTS,
METHODS, AND USES
12th Edition
Clyde P. Stickney and Roman L. Weil
Learning Objectives
1. Review the rationale for the
statement of cash flows,
particularly regarding why net
income differs from cash flows.
2. Review the T-account procedure for
preparing the statement of cash
flows introduced in Chapter 4.
Learning Objectives
3. Cement an understanding of the
effect on the statement of cash
flows of various transactions
studied in Chapters 6 through 12.
4. Develop more effective skills in
analyzing and interpreting the
statement of cash flows.
Chapter Outline
1. Review of Concepts Underlying the
Statement of Cash Flows
2. Review of T-Account Procedure for
Preparing the Statement of Cash Flows
3. Comprehensive Illustration of the
Statement of Cash Flows
4. Illustration of the Direct Method for Cash
Flows from Operations
5. Interpreting the Statement of Cash Flows
Chapter Summary
Review of Concepts Underlying
The Statement of Cash Flows
The statement of cash flows …
a) explains the reasons for a change in
cash.
b) classifies the reasons for the
change as an operating, investing
or financing activity.
c) reconciles net income with cash
flow from operations.
Classifications of Cash Flows
1. Operations –
cash flows related to selling goods and
services; that is, the principle business of the
firm.
2. Investing –
cash flows related to the acquisition or sale of
noncurrent assets.
3. Financing –
long term and short term cash flows related to
liabilities and owners’ equity; dividends are a
financing cash outflow.
Example
of a
Statement
of Cash
Flows
Exhibit 4.1
Preparing the Statement of Cash Flows
Firms could prepare the cash flow statement
directly from the cash account. Most,
however, find it more efficient to prepare
the cash flow statement from the balance
sheet and income statement.
1. Direct and indirect methods
2. Algebraic formulation will present the
underlying concept of the cash flow
statement
3. Two approaches to producing the cash flow
statement: columnar worksheet and taccount worksheet
Direct and Indirect Method

Direct method
of presentation calculates cash flow from
operations by subtracting cash disbursements to
supplies, employees, and others from cash
receipts from customers.

Indirect method
calculates cash flow from operations by
adjusting net income for noncash revenues and
expenses.

Most firms present their cash flows using
the indirect method.
Algebraic Formulation
Recall the basic accounting equation:
Assets = Liabilities + Shareholders’ Equity
or A = L + SE
Assets are either cash (C) or not cash assets
(N$A), so
C + N$A = L + SE
 C +  N$A =  L +  SE
Where  means the change in the balance,
Rearranging gives the basic equation for the
statement of cash flows:
 C =  L +  SE -  N$A
Algebraic Formulation (Cont.)
 C =  L +  SE -  N$A



The change in cash,  C, is the increase
or decrease in the cash account.
This amount must equal changes in
liabilities plus changes in shareholders’
equity minus changes in assets other
than cash.
Thus, we can identify the causes in the
change in the cash account by studying
the changes in non-cash accounts.
Two Approaches to Producing the Cash
Flow Statement
The basic formula can be
implemented using either of two
approaches:
1. Columnar worksheet - changes in
balance sheet accounts are
classified by definition using a
multicolumn worksheet.
2. T-Account worksheet - changes
are classified by analysis of the taccounts.
Columnar Worksheet



Works well for relatively simple
situations involving few transactions.
Enhances understanding of the cash
flow statement.
Does not work as well as the Taccount method when the number
and complexity of transactions
increases.
Columnar Worksheet (Cont.)
Begin with a comparative balance sheet.
1. Compute the change in each balance
sheet account.
2. Classify each change as operating,
investing or financing activity.
2. Make any needed adjustments (for
example, for a sale of a long-lived
asset).
4. Recast the classified changes in the
form of a cash flow statement.
Noncash Expenses


Noncash expenses, such as
depreciation expense, are added
back.
Not truly sources of cash, even
though they are associated with
cash inflows; rather, a reversal of
the accrual process that required
the expenses to be recognized
without regard for the cash flow.
Changes in Specific Accounts
increase
Noncash
Assets
If noncash assets
are increased,
then cash was spent,
so cash is an outflow,
so negative sign.
decrease
If noncash assets
are decreased,
then they provided cash
so cash is an inflow,
so positive sign.
Liabilities
and
Shareholders’
Equity
If liab. or S.E.
increased, then cash
was obtained,
so cash in an inflow,
so positive sign.
If liab. or S.E.
decreased, then cash
was spent,
so cash in an outflow,
so negative sign.
T-account Worksheet



The columnar works well when the change in
each balance sheet account affects only one
of the three types of activities. It becomes
cumbersome for more complex (and realistic)
situations.
The T-account approach is a direct extension
of T-accounts - facilitates analysis of a
transaction which involves more than one
activity.
For example, the change in Retained Earnings
can be due to both net income (operating
activity) and dividends (financing activity).
T-account Worksheet
1. Obtain beginning and ending balance sheets.
2. Prepare a T-account worksheet with a master
account, cash, divided into operating,
investing and financing sections.
3. Explain the change in the master cash
account by reconstructing the original entries
in a summary form.
4. Make any necessary adjustments.
5. Recast the master account in the format of a
cash flow statement.
T-account Worksheet (Cont.)
Various Balance Sheet Accounts Cash
beginning
balance
beginning
balance
######
ending
Operations
2. these are
balance
####
offset by an
opposite entry Investing
1. adjustments are
made to all balance in the cash
Financing
account.
sheet accounts to
bring the beginning
balance to the ending
balance.
ending
balance
3. this
part of the
cash
account
becomes
the cash
flow
statement.
Effects of a Sale of a Long-Term
Assets on Cash Flows


A few transactions complicate the derivation
of a cash flow statement from a comparative
balance sheet, for example, the sale of a longterm (or fixed) asset.
Recall the journal entry for the sale of an
asset:
Cash
Accumulated Depreciation
Asset
Gain (or loss) on sale
###
###
###
###
Sale of an Asset (Cont.)





Each of the four parts of the above journal entry
require an adjustment in the cash flow statement.
The first line, cash, adds a line to the investing
section.
The second line, a debit to accumulated
depreciation, increases the depreciation expense
above the change in the change in the
accumulated depreciation account.
The third line, a credit to the asset, increases the
amount of cash invested in long-lived assets
above the change in the fixed asset accounts.
The fourth line, a gain or loss, is reversed out in
the operating sections since this is not a cash
flow.
Comparison of Cash Flow to Net
Income




Net income is an accrual based concept
and purports to show the long-term.
Cash flows attempt to show the short
term.
Consider the outlook for both shortterm and long-term and consider that
each is either good or poor.
A strong growing firm shows both good
long- and short-term outlooks.
Comparison of Cash Flow to Net
Income



A failing firm shows both poor long- and
short-term outlooks.
What about a firm with good cash flows
(short-term) but poor net income (longterm)?
What about a firm with poor cash flows
(short-term) but good net income (longterm)?
An International Perspective


The International Accounting
Standards Board (IAS No. 7)
recommends but does not require
a statement of cash flows.
An approximation to a cash flow
statement can be prepared from a
comparative balance sheet with
some additional information.
Chapter Summary


The statement of cash flows is presented. It
reports the effects on cash flows of a firm’s
operating, investing and financing activities.
Information in this statement helps in
understanding:
– How operations affect liquidity,
– The level of capital expenditures needed to
support growth, and
– The major changes in financing.

Two methods are presented to produce a cash
flow statement from a comparative balance sheet.
Rapid Review – True False
1. The investing
section shows the cash
flows from the sale
and purchase of the
companies own
common stock.
2. The preferred method
is the direct method by
GAAP and most firms
use that method to
prepare their Statement
of Cash Flows.