Statement Of Cash Flows

Chapter 16 Statement of Cash Flows Accounting, 21st Edition Warren Reeve Fess

PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

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Some Some of of the the action action has has been been automated, automated, so so click click the themouse mouse when when you you see see this this lightning lightning bolt bolt in in the thelower lower right-hand right-hand corner corner of of the the screen. screen. You You can can point point and and click click anywhere anywhere on on the the screen. screen.

Objectives Objectives 1. SummarizeAfter the types of cash flow activities studying this After studying this reported in chapter, the statement of cash flows. you should chapter, you should 2. Prepare a statement of to: cash flows, using be able be able to: the indirect method. 3. Prepare a statement of cash flows, using the direct method. 4. Calculate and interpret the free cash flow.

Reporting Reporting Cash Cash Flows Flows The statement of cash flows reports cash flows by three types of activities: 1. Cash flows from operating activities – transactions that affect net income. 2. Cash flows from investing activities – transactions that affect noncurrent assets. 3. Cash flows from financing activities – transactions that affect equity and debt of the entity.

Reporting Reporting Cash Cash Flows Flows Increases in Cash

Operating (receipts from revenues)

Investing (receipts from sales of noncurrent assets)

Financing (receipts from issuing equity and debt securities)

Decreases in Cash

Operating (payments for expenses)

Investing (payments for acquiring noncurrent assets)

Financing (payments for treasury stock, dividends, and redemption of debt securities)

Cash Cash Flows Flows from from Operating Operating Activities Activities Typical cash inflows What are some of the typical cash inflows from operating activities?`

Typical cash outflows What are some of the typical cash outflows from operating activities?

Sales of goods and services

Merchandise purchases

Interest revenue

Payments of wages and other expenses

Dividend revenue

Tax payments

Cash Cash Flows Flows from from Investing Investing Activities Activities Typical cash inflows What are some of the typical cash inflows from investing activities? Sales of fixed assets Sale of longterm investments

Typical cash outflows What are some of the typical cash outflows from investing activities? Purchase of fixed assets Purchase of long-term investments

Cash Cash Flows Flows from from Financing Financing Activities Activities Typical cash inflows What are some of the typical cash inflows from financing activities?

Typical cash outflows What are some of the typical cash outflows from financing activities?

Issuing bonds and long-term notes payable

Paying cash dividends

Issuing preferred and common stock

Repaying debt Acquiring treasury stock

Noncash Noncash Investing Investing and and Financing Financing Activities Activities  Issuing bonds to acquire land  Issuing common stock for

convertible preferred stock  Issuing a long-term note to

acquire equipment  Issuing a stock dividend

No No cash cash flow flow per per share share isis reported reported in in the the financial financial statements statements because because the the user user might might incorrectly incorrectly interpret interpret this this as as the the amount amount available available for for dividends. dividends.

The The Indirect Indirect Method Method Balance Sheet Cash Noncash Assets

Liabilities Stockholders’ Equity

Assets = Liabilities + Stockholders’ Equity Cash + Noncash Assets = Liabilities + Stockholders’ Equity Cash = Liabilities + Stockholders’ Equity – Noncash Assets

The The Indirect Indirect Method Method Balance Sheet

Cash

Liabilities

Noncash Assets

Stockholders’ Equity

Assets = Liabilities + Stockholders’ Equity Cash + Noncash Assets = Liabilities + Stockholders’ Equity Cash = Liabilities + Stockholders’ Equity – Noncash Assets 1

2

3

The cash flows are determined by analyzing liabilities, stockholders’ equity, and noncash assets.

The The Indirect Indirect Method Method

Start Start with with the the accrual accrual basis basis net net income income (shown (shown in in the the income income statement, statement, the the Retained Retained Earnings Earnings account, account, or or the the statement statement of of stockholders’ stockholders’ equity). equity).

The The Indirect Indirect Method Method Find Find the the net net income. income. ACCOUNT

Retained Earnings

Date 2006

Jan. 1 Balance Dec. 31 Net income 31 Cash dividends

Item

ACCOUNT NO. 32 Debit

Credit

Balance Debit Credit

To To statement statement 108,000

28,000

202,300 310,300 282,300

Operating Activities – Indirect Method Cash flows from operating activities: Net income per income statement

$108,000

Add: Depreciation $ 7,000 Decrease in inventories 8,000 Increase in accrued expenses 2,200 17,200 $125,200 Inc. in accounts receivable $ 9,000 Deduct: Dec. in accounts payable 3,200 Dec. in income taxes payable 500 Gain on sale of land 12,000 24,700 Net cash flow from operating activity $100,500

The The Indirect Indirect Method Method

Next, Next, we we need need to to determine determine depreciation depreciation expense expense for for the the year. year. IfIf itit isn’t isn’t given given on on the the income income statement, statement, sometimes sometimes itit can can be be found found by by analyzing analyzing the the Accumulated Accumulated Depreciation Depreciation account. account.

The The Indirect Indirect Method Method Determine Determine depreciation depreciation expense. expense. ACCOUNT Accumulated Date

Depreciation--Building ACCOUNT NO. 17

Item

Debit

Credit

Balance Debit Credit

2006

Jan. 1 Balance Dec. 31 Depreciation for year

7,000

to to statement statement

58,300 65,300

Operating Activities – Indirect Method Cash flows from operating activities: Net income per income statement $108,000 Add: Depreciation $ 7,000 Decrease in inventories 8,000 Increase in accrued expenses 2,200 17,200 Deduct: $125,200 Depreciation Inc.Because in accounts receivable Expense $ 9,000 Dec.reduced in accounts 3,200 net payable income but did not Dec.require in income payable an taxes outflow of cash, 500 it is Gain on sale of land 12,000 24,700 added back to net income. Net cash flow from operating activities $100,500

The The Indirect Indirect Method Method

Select Select current current assets assets and and current current liabilities liabilities that that impact impact cash cash flow flow and and determine determine the the increases increases and and decreases. decreases.

Changes in Current Accounts Change Accounts

2006

Credit Accounts receivable (net) Inventories Accounts payable (mdse.) Accrued expenses payable Income taxes payable

$74,000 172,000 43,500 26,500 7,900

2005 $65,000 180,000 46,700 24,300 8,400

Debit 9,000 8,000 3,200 2,200 500

Determine the debit or credit change of each item above.

Changes in Current Accounts Change Accounts Credit Accounts receivable (net) Inventories Accounts payable (mdse.) Accrued expenses payable Income taxes payable

2006 $74,000 172,000 43,500 26,500 7,900

2005 $65,000 180,000 46,700 24,300 8,400

Debit 9,000 8,000 3,200 2,200 500

These debit changes are subtracted from net income in the operating activities section of the statement of cash flows. Think of these debits as deductions from net income in arriving at net cash flow from operations.

Changes in Current Accounts Change Accounts Credit Accounts receivable (net) Inventories Accounts payable (mdse.) Accrued expenses payable Income taxes payable

2006

2005

$74,000 172,000 43,500 26,500 7,900

$65,000 180,000 46,700 24,300 8,400

Debit 9,000 8,000 3,200 2,200 500

These credit changes are added to net income in the operating activities section of the statement of cash flows. Think of these credits as additions to net income in arriving at net cash flow from operations.

Operating Activities—Indirect Method Cash flows from operating activities: Net income per income statement Add: Depreciation $ Decrease in inventories Increase in accrued expenses

$108,000 7,000 8,000 2,200

17,200 $125,200

Inc. in accounts receivable $ 9,000 Dec. in accounts payable 3,200 Dec. in income taxes payable 500 Gain on sale of land 12,000 24,700 Net cash flow from operating activities $100,500

The The Indirect Indirect Method Method

Analyze Analyze the the income income statement statement to to determine determine ifif there there are are any any gains gains or or losses losses from from selling selling investments, investments, equipment, equipment, etc. etc.

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales Cost of merchandise sold Gross profit Operating expenses: Depreciation expense Other operating expenses Total operating expenses Income from operations Other income: Gain on sale of land Other expense: Interest expense Income before income tax Income tax Net income

$1,180,000 790,000 $ 390,000 $ 7,000 196,000 203,000 $ 187,000 $12,000 $12,000 8,000

4,0000 $ 191,000 83,000 $ 108,000

Operating Activities—Indirect Method Cash flows from operating activities: Net income, per income statement $108,000 Add: Depreciation $ 7,000 This gain was included in net income, Decrease in inventories 8,000 but Increase in accrued 2,200flow. 17,200 did not represent anexpenses operating cash $125,200 Inc. in accounts receivable $ 9,000 Dec. in accounts payable 3,200 Dec. in income taxes payable 500 Gain on sale of land 12,000 24,700 Net cash flow from operating activities $100,500

The The Indirect Indirect Method Method IfIf there there had had been been aa loss loss on on this this sale, sale, the the loss loss would would have have been been added added to to net net income. income.

Cash Cash Flows Flows from from Financing Financing Activities Activities Dividends Dividends ACCOUNT Date 2006

Jan.

1 10 June 20 July 10 Dec. 20

Dividends Payable Item

Balance Cash paid Dividends declared Cash paid Dividends declared

Total Total cash cash paid paid

ACCOUNT NO. 23 Debit

Credit

10,000

Balance Debit Credit --

14,000 14,000

-14,000

$24,000 $24,000

10,000 -14,000 -14,000

Cash Cash Flows Flows from from Financing Financing Activities Activities Because Because paying paying of of dividends dividends affects affects equity, equity, itit isis aa negative negative $24,000 $24,000 cash cash flow flow from from financing financing activities activities transaction. transaction.

Cash Cash Flows Flows from from Financing Financing Activities Activities Sale Sale of of Common Common Stock Stock ACCOUNT

Date 2006

Jan. Nov.

Common Stock Item

1 Balance 1 4,000 shares issued for cash

ACCOUNT NO. 33

Debit

Credit 8,000

Balance Debit Credit 16,000 24,000

Cash Cash Flows Flows from from Financing Financing Activities Activities Sale Sale of of Common Common Stock Stock ACCOUNT

Date 2006

Jan. Nov.

Paid-In Capital in Excess of Par--Common ACCT. NO. 34 Item

1 Balance 1 4,000 shares issued for cash

Debit

Credit 40,000

Balance Debit Credit 80,000 120,000

Cash Cash Flows Flows from from Financing Financing Activities Activities Issuing Issuing common common stock stock affects affects equity; equity; therefore, therefore, we we have have aa total total positive positive cash cash flow flow of of $48,000 $48,000 from from this this financing financing activities activities transaction. transaction.

Cash Cash Flows Flows from from Financing Financing Activities Activities Retirement Retirement of of Bonds Bonds Payable Payable ACCOUNT

Date

Bonds Payable Item

ACCOUNT. NO. 25

Debit

2006

Jan. 1 Balance June 30 Retired by payment of cash at face amount

Credit

Balance Debit Credit 150,000

50,000

100,000

Cash Cash Flows Flows from from Financing Financing Activities Activities This This transaction transaction isis aa negative negative cash cash flows flows from from financing financing activities activities item item because because longlongterm term debt debt isis involved. involved.

Cash Cash Flows Flows from from Investing Investing Activities Activities Purchased Purchased aa Building Building ACCOUNT

Date

Building Item

ACCOUNT NO. 18 Debit

2006

Jan. 1 Balance Dec. 27 Purchased for cash

60,000

Credit

Balance Debit Credit 200,000 260,000

Cash Cash Flows Flows from from Investing Investing Activities Activities Purchased Purchased aa Building Building Purchasing Purchasing aa building building involves involves aa noncurrent noncurrent asset, asset, so so this this isis aa negative negative cash cash flows flows from from investing investing activities activities item. item.

Cash Cash Flows Flows from from Investing Investing Activities Activities Land Land Transactions Transactions ACCOUNT

Date 2006

Land

ACCOUNT NO. 16 Item

Jan. 1 Balance June 8 Sold for $72,000 cash Oct. 12 Purchased for $15,000 cash

Debit

Credit

Balance Debit Credit

125,000 60,000 65,000 15,000 80,000

Cash Cash Flows Flows from from Investing Investing Activities Activities Land Land Transactions Transactions The The first first transaction, transaction, the the sale sale of of land, land, results results in in aa positive positive cash cash flow flow from from investing investing activities activities because because land land isis aa noncash noncash asset. asset.

Cash Cash Flows Flows from from Investing Investing Activities Activities Land Land Transactions Transactions The The $12,000 $12,000 gain gain was was recorded recorded earlier earlier on on Slide Slide 29 29 as as an an operating operating activity. activity. The The purchase purchase of of land land also also is is an an investing investing activity. activity. Click here to return to Slide 29. To return to this slide, type “43” and press the “Enter” key.

Refer Refer to to Exhibit Exhibit 66 in in your your textbook textbook to to see see the the formal formal statement statement of of cash cash flows flows using using the the indirect indirect approach. approach.

Rundell Inc. Statement of Cash Flows For the Year Ended December 31, 2006 Cash flows from operating activities: Net income $108,000 Add: Depreciation $ 7,000 Decrease in inventor. 8,000 Increase in accrued exp. 2,200 17,200 $125,000 Deduct: Increase in A/R $9,000 Decrease in accts. Pay. 3,200 Decrease in ITP 500 Gain on sale of land 12,000 24,700 Net cash flow from operating act. $100,500 Cash flows from investing activities: Cash from sale of land $72,000 Less: Cash paid to pur. land $15,000 Cash paid for bldg. 60,000 75,000(3,000) Cash flows from financing activities: Cash received from sale of c.s. $48,000 Less: Cash paid to retire b. $50,000 Cash paid for divid. 24,000 74,000 Net cash flow for financing (26,000) Increase in cash $71,500 Cash at beginning of year 26,000 Cash at end of year $97,500

Rundell Inc. Income Statement For the Year Ended December 31, 2006

Cash Basis

Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 This is an accrual basis income statement. This Income taxis an accrual basis income statement. 83,000 The direct flows Net income $ 108,000 The directmethod methodof ofreporting reportingcash cash flowswill will

essentially essentiallyconvert convertthis thisto toaacash cashbasis basisstatement. statement.

Rundell Inc. Income Statement For the Year Ended December 31, 2006

Cash Basis

Sales $1,180,000 Cost of merchandise sold 790,000 Cash collected Gross profit $ 390,000 Changes from customers Operating expenses: Debit Credit Depreciation expense $ 7,000 Other operatingSales expenses 196,000 1,180,000 Receivables 9,000 203,000 Total operating expenses Income from operations $ 187,000 Other income: Note: The changes in$12,000 the Note: The the current current balance balance Gain on sale of landchanges in Other expense: sheet sheet accounts accounts are are determined determined by by Interest expense 8,000 4,000ending comparing the beginning and comparing the beginning and ending Income before income tax $ 191,000 balances. by balances. Receivables Receivables increased increased by Income tax 83,000 Net income $ 108,000 $9,000 $9,000 during during the the period. period.

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Cash collected Gross profit $390,000 Changes from customers Operating expenses: Debit Credit Depreciation expense $ 7,000 Other operatingSales expenses 196,000 1,180,000 Receivables 9,000 203,000 Total operating expenses Cash 1,171,000 $187,000 Income from operations Other income: Gain on sale of landincrease The in The increase$12,000 in receivables receivables Other expense: represents in cash represents aa reduction reduction in4,000 cash Interest expense 8,000 inflow relative Income before income 191,000 inflowtax relative to to the the$accrual accrual Income tax revenue reported on the income 83,000 income Net income revenue reported on the $ 108,000

statement. statement.

Cash Basis $1,171,000

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $390,000 Cash payments for Operating expenses: Changes merchandise Depreciation expense $ 7,000 Debit Credit Other operating 196,000 Cost of expenses mdse. sold 790,000 Total operating expenses 203,000 Inventories 8,000 Income from operations $187,000 Accounts payable 3,200 Other income: Cashof land Gain on sale $12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000

Cash Basis $1,171,000

Rundell Inc. Income Statement For the Year Ended December 31, 2006

Cash Basis

Sales $1,180,000 $1,171,000 Cost of merchandise sold 790,000 (785,200) Gross profit $390,000 Cash payments for Operating expenses: Changes merchandise Depreciation expense $ 7,000 Debit Credit Other operating 196,000 Cost of expenses mdse. sold 790,000 Total operating expenses 203,000 minus Inventories 8,000 Income from operations $187,000 Accounts payable 3,200 plus Other income: Cashof land Gain on sale $12,000 785,200 Other expense: A decrease in Inventories (credit (credit Interest expenseA decrease in Inventories 8,000 4,000 change) in Income before income taxand $ 191,000 change) and an an decrease decrease in Accounts Accounts Income tax 83,000 Payable (debit change) have the Payable (debit change) have the Net income $ 108,000

opposite opposite effects. effects.

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Depreciation Changes Total operating expenses 203,000 Debit $ Credit Income from operations 187,000 Depreciation expense 7,000 Other income: Gain on sale of land depreciation $12,000 Accumulated 7,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000

Cash Basis $1,171,000 (785,200)

There There isis no no cash cash flow flow for for depreciation depreciation expense. expense.

0

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Cash payments for Changes Income fromoperating operations $ 187,000 expenses Changes Debit Credit Other income: Gain onOperating sale of land $12,000 expenses 196,000 Other expense: Accrued expenses 2,200 minus InterestCash expense 8,000 193,800 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000

Cash Basis $1,171,000 (785,200) 0 (193,800)

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Gain on sale of Changes Operating expenses: investments Depreciation expense $Debit 7,000 Credit Cash 72,000 Other operating expenses 196,000 60,000 TotalInvestments operating expenses 203,000 Gain on sale of invest. Income from operations $ 12,000 187,000 Other income: Gain on sale of land $12,000 Other expense: Interest expense 8,000 will 4,000 The cash The cash inflow inflow of of $72,000 $72,000 will Income before income tax $ 191,000 be shown in the investing section be shown in the investing section Income tax 83,000 of and Net income $ 108,000 of the the statement statement of of cash cash flows flows and

the the gain gain isis ignored. ignored.

Cash Basis $1,171,000 (785,200) 0 (193,800)

0

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Cash paid for Changes Other operating expenses 196,000 interest expense Debit Credit Total operating expenses 203,000 Interest expense Income from operations 8,000 $ 187,000 Other income: Cash Gain on sale of land $12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 There Income tax 83,000 There isis no no interest interest payable payable Net income $ 108,000 account at the end of the year.

account at the end of the year.

Cash Basis $1,171,000 (785,200) 0 (193,800)

0 (8,000)

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating 203,000 Cash paidexpenses for Changes Income from operations $ 187,000 income taxes Debit Credit Other income: expense 83,000 Gain onIncome sale oftax land $12,000 Income tax payable plus 500 Other expense: InterestCash expense 8,000 (83,500) 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000

Cash Basis $1,171,000 (785,200) 0 (193,800)

(8,000) (83,500)

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $12,000 Accrual Accrual Other expense: Interest expense 8,000 4,000 Basis Basis Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000

Cash Basis $1,171,000 (785,200)

Two Two different different 0 viewpoints viewpoints(193,800) of of income income from from operations operations 0

Cash Cash (8,000) Basis Basis (83,500) $ 100,500

Operating Activities—Direct Method Cash flows from operating activities: Cash inflows: Cash received from customers $1,171,000 Cash outflows: Cash payments for merchandise $785,200 Cash payments for operating expenses 193,800 Cash payments for interest 8,000 Cash payments for income tax 83,5001,070,500 Net cash flow from operating activities $ 100,500

Financial Analysis and Interpretation Free Free Cash Cash Flow Flow Dell Corporation Cash flow from operations $4,195,000 Less: Cash used to purchase fixed assets to maintain productive capacity used up in producing income during the period (482000) Less: Cash used for dividends —– Free cash flow $3,713,000 Free cash flow as a percent of cash flow from operating activities

89%

Financial Analysis and Interpretation Free Free Cash Cash Flow Flow Dell Corporation Cash operations $4,195,000 Use: To measure the of Use:flow Tofrom measure the financial financial strength strength of aa Less: Cash used toA purchase fixed business. company business. A company that that has has assets to maintain productive positive free cash flow isis able to fund positive free cash flow able to fund capacity used up in producing internal growth, retire enjoy internal growth, retire debt, debt, and and enjoy income during the period (482000) financial flexibility. financial flexibility. Less: Cash used for dividends (—) Free cash flow $3,713,000 Free cash flow as a percent of cash flow from operations

89%

Chapter 16 The The End End