Transcript Accounting Principles Second Canadian Edition Weygandt · Kieso · Kimmel · Trenholm Prepared by: Carole Bowman, Sheridan College.

Accounting
Principles
Second Canadian Edition
Weygandt · Kieso · Kimmel · Trenholm
Prepared by:
Carole Bowman, Sheridan College
CHAPTER
18
CASH FLOW STATEMENT
PURPOSE OF THE
CASH FLOW STATEMENT
• The primary purpose of the cash flow
statement is to provide information about
the cash receipts and cash payments of an
entity during a period.
• A secondary objective is to provide
information about its
– Operating activities
– Investing activities
– Financing activities
MEANING OF CASH FLOWS
• The cash flow statement is usually prepared
using cash and cash equivalents as its basis.
• Cash equivalents are short-term, highly
liquid investments that are both
1. readily convertible to known amounts of
cash, and
2. so near to their maturity that their
market value is relatively insensitive
to changes in interest rates.
CLASSIFICATION OF CASH
FLOWS
• Operating activities
• Investing activities
• Financing activities
OPERATING ACTIVITIES
• Include
– Cash effects of transactions that create
revenues and expenses and
– Enter into determination of net income (loss)
Balance Sheet: Noncash Current
Assets and Current Liabilities;
Income Statement Items
INVESTING ACTIVITIES
• Include
– Purchasing and disposing of investments
and productive long-lived assets using cash
and
– Lending money and collecting the loans
Balance Sheet: Investment and
Long-Term Asset Items
FINANCING ACTIVITIES
• Include
– Obtaining cash from issuing debt and
repaying the amounts borrowed and
– Obtaining cash from owners/shareholders
and paying them drawings/dividends
Balance Sheet: Long-Term
Liability and Equity Items
SIGNIFICANT NONCASH
ACTIVITIES
• If it does not affect cash, do NOT report in
body of cash flow statement
• Report in separate note to the financial
statements
ILLUSTRATION 18-2
FORMAT OF CASH FLOW STATEMENT
Operating, investing,
and financing plus
the significant
noncash investing and
financing activities
constitute the general
format of the cash
flow statement, an
example of which is
shown on the right.
COMPANY NAME
Cash Flow Statement
Period Covered
Cash flows from operating activities
(List of individual items)
XX
Net cash provided (used) by operating activities
Cash flows from investing activities
(List of individual items)
XX
Net cash provided (used) by investing activities
Cash flows from financing activities
(List of individual items)
XX
Net cash provided (used) by financing activities
Net increase (decrease) in cash
Cash at beginning of period
Cash at end of period
Note x:
Noncash investing and financing activities
(List of significant noncash transactions)
XXX
XXX
XXX
XXX
XXX
XXX
XXX
PREPARING
THE CASH FLOW STATEMENT
The cash flow statement is prepared differently from
the three other basic financial statements.
1. It is not prepared from the adjusted trial balance.
2. The cash flow statement deals with cash receipts
and payments, so the accrual concept is not used in
the preparation of this statement.
The information to prepare this statement usually
comes from three sources:
1. Comparative balance sheet
2. Current income statement
3. Additional information
ILLUSTRATION 18-3
THREE MAJOR STEPS IN PREPARING
THE CASH FLOW STATEMENT
Step 1: Determine the net increase (decrease) in cash.
The difference between the
beginning and ending cash
balances can be easily calculated
from comparative balance sheets.
+ or -
Step 2: Determine net cash provided (used) by operating activities.
This step involves analysing not only the current
year’s income statement but also comparative
balance sheets and selected additional data.
XYZ
Goods
Step 3: Determine net cash provided (used) by investing and
financing activities.
This step involves analysing
comparative balance sheet data
and selected additional information
for their effects on cash.
For
Sale
Investing
Financing
STEP 1: DETERMINE NET INCOME
(DECREASE) IN CASH
STEP 2: DETERMINE NET CASH
PROVIDED (USED) BY OPERATING
ACTIVITIES
• Net income must be converted from an
accrual basis to a cash basis in the
operating activities section
• Conversion may be done by two methods:
– Indirect (used extensively in practice)
– Direct
INDIRECT AND DIRECT METHODS
• Both methods arrive at the same total
amount of cash provided (used) by
operating activities
• Methods differ in disclosing the items
that make up the total amount
• Choice of methods affects only the
operating activities section; the investing
and financing activities sections are the
same
OPERATING ACTIVITIES –
INDIRECT METHOD
Section 1
ILLUSTRATION 18-6
NET INCOME VS. NET CASH PROVIDED
BY OPERATING ACTIVITIES
The indirect method starts with net income and converts it to net
cash provided by operating activities. In other words, it adjusts net
income for items that affect reported net income but do not affect
cash, as shown below.
Accrual Basis of Accounting
Eliminate noncash revenues
Earned
Revenues
Net Income
Incurred
Expenses
Cash Basis of Accounting
Net Cash Provided
(Used) by Operating
Activities
Eliminate noncash expenses
NET INCOME TO NET CASH PROVIDED (USED) BY
OPERATING ACTIVITIES
(B/S: Noncash Current Assets and Current Liabilities)
Adjustments to Convert Net Income
to Net Cash Provided (Used) by
Operating Activities
Add*
Deduct*
Change in Current Asset Account Balance
Accounts receivable
Decrease
Inventory
Decrease
Prepaid expenses
Decrease
Other current assets
Decrease
Increase
Increase
Increase
Increase
Change in Current Liability Account Balance
Accounts payable
Increase
Accrued expenses payable
Increase
Other current liabilities
Increase
Decrease
Decrease
Decrease
* Add (deduct) change in account balance to net income
NET INCOME TO NET CASH PROVIDED (USED) BY
OPERATING ACTIVITIES
(I/S: Noncash Items)
Adjustments to Convert Net
Income to Net Cash Provided
(Used) by Operating Activities
Noncash Items on Income Statement
Amortization (of capital assets) expense
Amortization of bond discount to interest expense
Amortization of bond premium to interest expense
Loss on sale of asset
Gain on sale of asset
Income from long-term equity investment
Add
Add
Deduct
Add
Deduct
Deduct
NET CASH PROVIDED (USED) BY
OPERATING ACTIVITIES
Indirect Method –
Sample Format
Computer Services Corporation
Cash Flow Statement - Indirect Method
For the Year Ended December 31, 2002
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Increase in accounts receivable
(30,000)
Increase in inventory
(25,000)
Increase in accounts payable
15,000
Increase in accrued expenses payable
4,000
Net cash used by operating activities
35,000
(36,000)
(1,000)
OPERATING ACTIVITIES
– DIRECT METHOD
Section 2
CASH RECEIPTS AND CASH PAYMENTS
(Direct Method)
CASH RECEIPTS FROM
CUSTOMERS
• The relationships among cash receipts from
customers, revenues from sales, and
changes in accounts receivable is:
Cash
receipts from
customers
=
{
Revenues
from sales
+ Decrease in accounts receivable
or
– Increase in accounts receivable
CASH PAYMENTS TO SUPPLIERS
• The relationship among cash payments to
suppliers, cost of goods sold, changes in
inventory, and changes in accounts payable is:
Cash
payments
to suppliers
=
Cost of
goods sold
{
+ Increase in inventory
or
– Decrease in inventory
{
+ Decrease in accounts payable
or
– Increase in accounts payable
CASH PAYMENTS FOR OPERATING
EXPENSES
• The relationship among cash payments for
operating expenses, changes in prepaid
expenses, and changes in accrued expenses
payable is:
Cash
payments
for services
=
Operating
dxpenses
{
+ Increase in prepaid
expenses
or
– Decrease in prepaid
expenses
{
+ Decrease in accrued expenses
payable
or
– Increase in accrued expenses
payable
CASH PAYMENTS FOR INCOME TAX
• The relationships among cash payments for
income tax, income tax expense, and
changes in income tax payable is:
Cash
payments for
income tax
=
Income
tax
expense
{
+ Decrease in income tax payable
or
– Increase in income tax payable
NET CASH PROVIDED (USED) BY
OPERATING ACTIVITIES
Direct Method –
Sample Format
COMPUTER SERVICES CORPORATION
Cash Flow Statement – Direct Method
For the Year Ended December 31, 2002
Cash flows from operating activities
Cash receipts from customers
Cash payments:
To suppliers
For operating expenses
For income tax
Net cash used by operating activities
$120,000
($75,000)
(36,000)
(10,000)
(121,000)
(1,000)
STEP 3: DETERMINE NET CASH
PROVIDED (USED) BY INVESTING AND
FINANCING ACTIVITIES
NET CASH PROVIDED (USED) BY
INVESTING ACTIVITIES
• Study the balance sheet to determine changes
in investments and long-term assets
• Changes in each short-term investment
(unless incorporated as part of cash
definition) and long-term account are
analysed using selected transaction data to
determine the effect, if any, the changes had
on cash
NET CASH PROVIDED (USED) BY
FINANCING ACTIVITIES
• Study the balance sheet to determine
changes in noncurrent liabilities and
owner’s/shareholders’ equity
• Changes in each noncurrent account are
analysed using selected transaction data
to determine the effect, if any, the
changes had on cash
ILLUSTRATION 18-8
CASH FLOW STATEMENT
INDIRECT METHOD
COMPUTER SERVICES COMPANY
Cash Flow Statement — Indirect Method
For the Year Ended December 31, 2002
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Increase in accounts receivable
Increase in inventory
Increase in accounts payable
Increase in accrued expenses payable
Net cash used by operating activities
Cash flows from investing activities
Purchase of equipment
Net cash used by investing activities
Cash flows from financing activities
Issue of common shares
Payment of cash dividend
Net cash provided by financing activities
Net increase in cash
Cash, January 1
Cash, December 31
$ 35,000
$ (30,000)
(25,000)
15,000
4,000
(36,000)
(1,000)
$ (10,000)
(10,000)
$ 60,000
(15,000)
45,000
34,000
$ 34,000
Operating
activities used
$1,000 cash and
investing
activities used
$10,000 cash,
while financing
activities
provided
$45,000 cash.
ILLUSTRATION 18-23
CASH FLOW STATEMENT
DIRECT METHOD
COMPUTER SERVICES CORPORATION
Cash Flow Statement
For the Year Ended December 31, 2002
Cash flows from operating activities
The cash flow
Cash receipts from customers
$120,000
statement
Cash payments:
shows that
To suppliers
$(75,000)
For operating expenses
(36,000)
operating
For income tax
activities used (10,000) (121,000)
Net cash provided by operating activities$1,000 cash
(1,000)
Cash flows from investing activities
and investing
Purchase of equipment
activities used $(10,000)
Net cash used by investing activities
(10,000)
$10,000 cash,
Cash flows from financing activities
while
Issue of common shares
$ 60,000
financing
Payment of cash dividends
(15,000)
activities
Net cash provided by financing activities
45,000
provided
Net increase in cash
34,000
$45,000
cash.
Cash, January 1
0
Cash, December 31
$ 34,000
USING CASH FLOWS TO EVALUATE
COMPANY
• Liquidity
– Cash current debt coverage ratio
• Profitability
– Cash return on sales ratio
– Cash flow per share
• Solvency
– Cash total debt coverage
These ratios are cash-based instead of
accrual-based
CASH CURRENT DEBT COVERAGE
• Cash current debt coverage indicates the amount
of cash to pay off current debt that is generated
from operating activities.
• The ratio provides a better picture of liquidity
than using the current ratio because it uses cash
provided by operating activities rather than the
year-end asset balance.
Cash
Provided
by
Operating
Activities

Average
Current
Liabilities
Cash
Current
Debt
Coverage
CASH RETURN ON SALES
• Cash return on sales indicates how quickly
sales are turned into cash.
• The company is efficient at turning sales
into cash when its cash return on sales is
greater than its accrual-based counterpart,
the profit margin.
Cash
Provided
by
Operating
Activities

Net Sales
Cash
Return
on Sales
CASH FLOW PER SHARE
• Cash flow per share indicates the cash flow
generated for each common share.
Cash Flow
from
Operating,
Investing, and
Financing
Activities

Number of
Common
Shares
Cash Flow per
Share
CASH TOTAL DEBT COVERAGE
• Cash total debt coverage indicates the
amount of cash to pay off total debt that is
generated from operating activities.
• The ratio is the cash based counterpart to
the debt to total assets ratio.
Cash
Provided
by
Operating
Activities

Average
Total
Liabilities
Cash Total
Debt
Coverage
COPYRIGHT
Copyright © 2002 John Wiley & Sons Canada, Ltd. All rights reserved.
Reproduction or translation of this work beyond that permitted by
CANCOPY (Canadian Reprography Collective) is unlawful. Request for
further information should be addressed to the Permissions Department,
John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies
for his / her own use only and not for distribution or resale. The author and
the publisher assume no responsibility for errors, omissions, or damages,
caused by the use of these programs or from the use of the information
contained herein.