cash flow statement chapter 14. copyright © 2003 mcgraw-hill ryerson limited, canada 14-2 explains...

Cash Flow Statement

Chapter 14

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada14-2

Explains how a company obtained and used cash during a period of time.

Helps managers answers questions such as:

Are ongoing operations generating sufficient cash

flows to remain viable?

Are ongoing operations generating sufficient cash

flows to remain viable?

Cash Flow Statement

Will we be able to meetour financial obligations?

Will we be able to meetour financial obligations?

Will we be able to paythe usual dividend?

Will we be able to paythe usual dividend?

Why is there a difference between net income and net cash flow?

Why is there a difference between net income and net cash flow?

Will we have toborrow funds to makeneeded investments?

Will we have toborrow funds to makeneeded investments?


Cash Flow Statement

Classifies cash inflows and outflows

into three categories.

Classifies cash inflows and outflows

into three categories.

Also includes reconciliation of beginning

cash to ending cash.

Also includes reconciliation of beginning

cash to ending cash.


Direct Method or Indirect Method?Direct Method

Net income is reconstructed on a cash basis.

Requires a supplemental reconciliation of net income to cash flow from operating activities.

Used by less than 5% of companies.

Indirect Method Net income is reconciled

to cash flow from operating activities.

No supplemental schedule is required.

Used by more than 95% of companies.


Increases in noncash asset accountsimply uses of cash.

Increases in noncash asset accountsimply uses of cash.

Example: The inventory balance increases.

It is implied that cash was used to acquire the

additional inventory.

Cash Flow Statement


Increases in liability accounts implysources of cash.

Increases in liability accounts implysources of cash.

Example: Accounts payable increases due to purchases on credit from a supplier.

It is implied that an increase in a payable has the effect

of increasing cash available for other uses.

Cash Flow Statement


Decreases in noncash assets accountsimply sources of cash.

Decreases in noncash assets accountsimply sources of cash.

Example: A customer paid his bill.

Cash Flow Statement

When the customer pays his bill, the company’s

cash increases.


Decreases in liability accountsimply uses of cash.

When the company makes the payment, its cash

decreases.I.O.U.

Example: The company made a payment on a note payable held by a creditor.

Cash Flow Statement


Includes those activities that enter into the

determination of net income

Includes those activities that enter into the

determination of net income

Operating Activities


Changes in current assets and current liabilities imply changes in cash.

Changes in current assets and current liabilities are treated as indicated below:



Change in Account Balance during PeriodIncrease Decrease

Current Subtract from Add toNoncash Assets net income net income

Current Add to Subtract fromLiabilities net income net income

Change in Account Balance during PeriodIncrease Decrease

Current Subtract from Add toNoncash Assets net income net income

Current Add to Subtract fromLiabilities net income net income



Amortization expense is added

back to net income because it is a non-

cash expense.

Amortization expense is added

back to net income because it is a non-

cash expense.



Losses are added back to net income.

Losses are added back to net income.

Gains are subtracted from net

income.

Gains are subtracted from net

income.



Investing Activities

Includes transactions

that involve the acquisition or

disposal of noncurrent

assets


that involve the acquisition or

disposal of noncurrent

assets


Financing Activities


involving receipts from

or payments to creditors and

owners


involving receipts from

or payments to creditors and

owners


Example: Bobo, Inc. acquires a

building in exchange for 2,000 shares of common stock.

This is reported in a separate supplemental schedule attached to the statement of cash flows.

Example: Bobo, Inc. acquires a

building in exchange for 2,000 shares of common stock.

This is reported in a separate supplemental schedule attached to the statement of cash flows.

Direct exchange transactions occurwhen noncurrent balance sheet itemsare swapped.

Such exchangesmust be disclosed.

Noncash Investing and Financing Transactions


Cash Flow Statement

Let’s preparea Cash Flow Statement using the

T-account method.


Exhibit 14-2


Exhibit 14-3


Exhibit 14-4


Exhibit 14-5


Cash Flow Statement-Indirect Method

The previous statement of cash flow was presented under the direct method, a method recommended by the Canadian Institute of Chartered Accountants.

Most companies, however, use the indirect method. The main difference is in the presentation of the

operating activities section. The indirect method starts with net income as reported on the income

statement; then, shows the adjustments necessary to convert the

accrual-based net income figure to a cash-basis equivalent.


Cash Flow Statement-Indirect Method

The conversion process is accomplished by the application of three basic rules.

Rule 1: Increases in current assets are deducted from net income, and decreases in current assets

are added to net income. Rule 2: Increases in current liabilities are added to

net income, and decreases in current liabilities are deducted from net income.

Rule 3: All noncash expenses and losses are added to net income, and all noncash revenue and gains are subtracted from net income.


Cash Flow Statement

Let’s preparea

Cash Flow Statementusing the

indirect method.


Al’s Bakery supplies a variety of pastry products to restaurants in a large city. Al’s

Bakery has prepared an adjusted trial balance as of 12/31/X1 and needs help preparing the Cash Flow Statement.

Examine the information provided and prepare a Cash Flow Statement using the

indirect method.

Cash Flow Statement – Indirect Method


Statement of Cash Flows – Indirect Method


Additional Information

During the year, Al’s Bakery: Sold land originally costing $32,000 for

$32,000. Paid dividends of $20,000 to the

stockholders. Issued $50,000 of common stock to settle

the note due to Smith Supplies.




Al's BakeryOperating Activities

Net Loss (27,000)$

Always start with the net income or net loss for the

period.

Always start with the net income or net loss for the

period.

NL = Revenue – ExpensesNL = $727,000 – ($748,000 + $6,000)NL = $727,000 – $754,000NL = $27,000 Loss

NL = Revenue – ExpensesNL = $727,000 – ($748,000 + $6,000)NL = $727,000 – $754,000NL = $27,000 Loss




Net Loss (27,000)$ Add: Decrease in Accounts Receivable 17,000

Increase in Accounts Payable 11,000


Depreciation expense is a noncash expense that must be added back to

net income.

Depreciation expense is a noncash expense that must be added back to

net income.




Increase in Accounts Payable 11,000 Amortization Expense 6,000





Increase in Accounts Payable 11,000 Depreciation Expense 6,000

Subtract: Increase in Inventory (50,000) Decrease in Salaries Payable (5,000)

Net Cash Flow from Operations (48,000)$




Increase in Accounts Payable 11,000 Amortization Expense 6,000

Subtract: Increase in Inventory (50,000) Decrease in Salaries Payable (5,000)

Net Cash Flow from Operations (48,000)$




The Statement of Cash Flows has

three major sections and shows a reconciliation of

beginning cash with ending cash.

The Statement of Cash Flows has

three major sections and shows a reconciliation of

beginning cash with ending cash.



Cash flow from operating activities

comes from the schedule just

prepared.

Cash flow from operating activities

comes from the schedule just

prepared.



Cash flows from financing and investing activities may come from sources other than the

trial balance.

Cash flows from financing and investing activities may come from sources other than the

trial balance.



These amounts come from the trial balance and can be used as “check figures” to verify the completeness

of the statement.

These amounts come from the trial balance and can be used as “check figures” to verify the completeness

of the statement.


Importance of Cash Flow From Operations

Negative cash flow from operations is usually a sign of fundamental

difficulties.

Ultimately, a positive cash flow is necessary to avoid liquidating assets or borrowing money to pay for day-to-day

activities.


Cash

The term cash on the statement of cash flows refers broadly to both currency

and cash equivalents.

Cash

T-bills

Money Market Funds

Commercial Paper

Currency and Bank Accounts


This is my kind of CA$H

FLOW!

End of Chapter 14

cash flow statement chapter 14. copyright © 2003 mcgraw-hill ryerson limited, canada 14-2 explains...

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