Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Statement of Cash FlowsStatement of Cash Flows

Chapter 13

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Provides information about the cash receipts and cash payments of a business

entity during the accounting period.

Provides information about the cash receipts and cash payments of a business

entity during the accounting period.

Purpose of the StatementPurpose of the Statement

Helps investors with questions about the Helps investors with questions about the company’scompany’s

• Ability to generate positive cash flows.Ability to generate positive cash flows.

• Ability to meet its obligations and to pay dividends.Ability to meet its obligations and to pay dividends.

• Need for external financing.Need for external financing.

• Investing and financing transactions for the period. Investing and financing transactions for the period.

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The Statement of Cash Flows must include the following three sections:

• Cash Flows from Operating Activities

• Cash Flows from Investing Activities

• Cash Flows from Financing Activities

The Statement of Cash Flows must include the following three sections:

• Cash Flows from Operating Activities

• Cash Flows from Investing Activities

• Cash Flows from Financing Activities

Classification of Cash FlowsClassification of Cash Flows

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+

_

Inflows from:• Interest and dividends

received• Sales to customers

Inflows from:• Interest and dividends

received• Sales to customers Cash

Flows from Operating Activities

Cash Flows from Operating Activities

Operating ActivitiesOperating Activities

Outflows to:• Suppliers of merchandise and

services• Employees• Lenders for interest• Governments for taxes

Outflows to:• Suppliers of merchandise and

services• Employees• Lenders for interest• Governments for taxes

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Cash Flows from Investing Activities

Cash Flows from Investing Activities

+

_

Investing ActivitiesInvesting ActivitiesInflows from:

•Sale of investments and plant assets

•Collection of principal on loans

Outflows to:• Purchase investments and

plant assets• Purchase debt or equity

investments• Make loans

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+

_

Financing ActivitiesFinancing Activities

Inflows from:• Short-term and long-term

borrowing• Owners (for example, from

issuing stock)

Inflows from:• Short-term and long-term

borrowing• Owners (for example, from

issuing stock)

Outflows to:• Make payments on borrowed

funds• Owners for dividends• Purchase treasury stock

Outflows to:• Make payments on borrowed

funds• Owners for dividends• Purchase treasury stock

Cash Flows from Financing Activities

Cash Flows from Financing Activities

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Cash Equivalents

CashCash

Currency

• Short-term, highly liquid investments.

• Readily convertible into cash.

• So near maturity that market value is unaffected by interest rate changes.

• Short-term, highly liquid investments.

• Readily convertible into cash.

• So near maturity that market value is unaffected by interest rate changes.

Cash and Cash EquivalentsCash and Cash Equivalents

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The operating cash flows section

can be prepared using either the direct method or

the indirect method.

The operating cash flows section

can be prepared using either the direct method or

the indirect method.

Let’s look at the direct

method for preparing the Statement of Cash Flows.

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Direct Method: Cash Direct Method: Cash Received from CustomersReceived from Customers•Accrual basis revenue includes sales

that did not result in cash inflows.•Can be computed as:

Cash Received from

Customers

Cash Received from

Customers

Decrease in receivablesDecrease in receivables

Increase in receivablesIncrease in receivables

+

–

=

=

Net SalesNet Sales

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Direct Method: Cash Direct Method: Cash Received from CustomersReceived from Customers

The accounts receivable balance was $80,000 on 12/31/08 and $110,000 on 12/31/09. If accrual sales revenue for 2009 was $900,000, what was cash

basis revenue?

–

=

$30,000Increase in receivables

$30,000Increase in receivables

Net Sales

$900,000

Net Sales

$900,000$870,000

Cash Received from Customers

$870,000Cash Received

from Customers

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Direct Method: Interest and Direct Method: Interest and Dividends ReceivedDividends Received

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Direct Method: Cash Paid Direct Method: Cash Paid for Purchases of for Purchases of MerchandiseMerchandiseStep 1

Step 2

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After deducting depreciation and other noncash expenses, the cash paid for

expenses is affected by(1) whether the expense was prepaid, and(2) whether the expense was accrued.

After deducting depreciation and other noncash expenses, the cash paid for

expenses is affected by(1) whether the expense was prepaid, and(2) whether the expense was accrued.

Direct Method: Cash Direct Method: Cash Payments for ExpensesPayments for Expenses

Cash Paid for Expenses

= Expenses

+ Increase in prepaid expenses - Decrease in prepaid expenses

+ Decrease in accrued liabilities - Increase in accrued liabilities

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Martin Co.Comparative Balance Sheets - Assets

December 31, 2008 2009

Cash 60,000$ 70,370$ Accounts Receivable, net 27,000 35,000 Inventory 230,000 200,000 Trading Securities - 25,000 Equipment, net 500,000 425,000 Investments 100,000 130,000

Total Assets 917,000$ 885,370$

Direct MethodDirect Method

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Martin Co.Comparative Balance Sheets - Assets

December 31, 2008 2009

Cash 60,000$ 70,370$ Accounts Receivable, net 27,000 35,000 Inventory 230,000 200,000 Trading Securities - 25,000 Equipment, net 500,000 425,000 Investments 100,000 130,000

Total Assets 917,000$ 885,370$

Direct MethodDirect MethodMartin Co.

Comparative Balance Sheets - Liabilities and Equity

December 31, 2008 2009

Accounts Payable 15,000$ 12,000$ Salaries Payable 7,000 5,000 Interest Payable 11,950 7,350 Income Tax Payable 20,000 17,000 Notes Payable, 1st Bank 70,000 60,000 Bonds Payable 250,000 150,000 Premium on Bonds Payable 5,000 4,000

Common Stock 450,000 500,000 Retained Earnings 88,050 130,020

Total Liabilities and Equity 917,000$ 885,370$

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Martin Co.Income Statement Amounts

For the Year Ending December 31, 2009

Sales Revenues 800,000$ Cost of Goods Sold 560,000 Depreciation Expense 5,000 Interest Expense 28,050 Income Tax Expense 27,980 Salary Expense 80,000 Other Expenses 71,000 Amortization of Bond Premium 1,000 Gain on Sale of Equipment 3,000 Extraordinary Loss 30,000 Equity in Investee Income 40,000

Net Income 41,970$

Direct MethodDirect Method

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Direct MethodDirect MethodAdditional Information

• Trading Securities were purchased during 2009 at a cost of $25,000.

• Equipment with a book value of $40,000 was sold during the year for $43,000.

• Equipment with a book value of $30,000 was destroyed during a freak flood in 2009. There was no insurance.

• Martin owns 25% of the common stock of another company and uses the equity method to account for this investment.

•Martin’s tax rate is 40%.•The Notes Payable to the bank carry a 12% rate. The

payments are due on the first day of each month.•The Bonds Payable carry a 9% rate. Interest is payable

semiannually on July 1 & Jan. 1.•Sold stock during 2009 for $50,000. •Received $10,000 dividends from its equity investment.

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Salary Expense 80,000$ 2000Add: Decrease in Salary Payable 2,000

Cash Paid to Employees 82,000$

Salary Expense 80,000$ 2000Add: Decrease in Salary Payable 2,000

Cash Paid to Employees 82,000$

Sales Revenues 800,000$

Less: Increase in A/R (8,000)

Cash Received from Customers 792,000$

Sales Revenues 800,000$

Less: Increase in A/R (8,000)

Cash Received from Customers 792,000$

Direct MethodDirect Method

Cash Received from Customers

Cash Paid to Employees

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Interest Expense 28,050$ 2000Add: Decrease in Interest Payable 4,600

Cash Paid for Interest 32,650$

Interest Expense 28,050$ 2000Add: Decrease in Interest Payable 4,600

Cash Paid for Interest 32,650$

Cost of Goods Sold 560,000$

Add : Decrease in A/P 3,000 Less: Decrease in Inventory (30,000)

Cash Paid for Inventory 533,000$

Cost of Goods Sold 560,000$

Add : Decrease in A/P 3,000 Less: Decrease in Inventory (30,000)

Cash Paid for Inventory 533,000$

Direct MethodDirect MethodCash Paid for Inventory

Cash Paid for Interest

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Income Tax Expense 27,980$ 2000Add: Decrease in Taxes Payable 3,000

Cash Paid for Taxes 30,980$

Income Tax Expense 27,980$ 2000Add: Decrease in Taxes Payable 3,000

Cash Paid for Taxes 30,980$

Direct MethodDirect MethodCash Paid for Taxes

Other Operating Cash Flows

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Direct MethodDirect Method

Cash Flows From Operating Activities

Cash Received from Customers 792,000$

Cash Paid to Employees (82,000)

Cash Paid for Inventory (533,000)

Cash Paid for Interest (32,650)

Cash Paid for Taxes (30,980)

Cash Paid to Other Sources (86,000)

Cash From Operating Activities 27,370$

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Martin Co.Statement of Cash Flows

For the Period Ending December 31, 2009

Operating Cash Flows 27,370$

Investing Cash Flows

Proceeds from sale of Equipment 43,000

Financing Cash Flows

Proceeds from sale of Stock 50,000$ Principal paid on Bonds (100,000) Principal paid on Notes (10,000) (60,000)

Net Cash Flows for the Period 10,370$

Add: Beginning Cash Balance 60,000

Ending Cash Balance 70,370$

Equipment with a book value of $40,000 was sold for $43,000.

Equipment with a book value of $40,000 was sold for $43,000.

Notes Payable decreased from $70,000 to $60,000 during 2009.Notes Payable decreased from $70,000 to $60,000 during 2009.

Bonds Payable decreased from $250,000 to $150,000 during 2009.Bonds Payable decreased from

$250,000 to $150,000 during 2009.

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Martin Co.Statement of Cash Flows

For the Period Ending December 31, 2009

Operating Cash Flows 27,370$

Investing Cash Flows

Proceeds from sale of Equipment 43,000

Financing Cash Flows

Proceeds from sale of Stock 50,000$ Principal paid on Bonds (100,000) Principal paid on Notes (10,000) (60,000)

Net Cash Flows for the Period 10,370$

Add: Beginning Cash Balance 60,000

Ending Cash Balance 70,370$

Notice that the Ending Cash Balance per the Statement of Cash Flows agrees with the

12/31/09 Cash balance on the Balance Sheet.

Notice that the Ending Cash Balance per the Statement of Cash Flows agrees with the

12/31/09 Cash balance on the Balance Sheet.

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Reconciling Net Income Reconciling Net Income withwithNet Cash FlowsNet Cash Flows

There are two major categories of reconciling items. They include adjusting for:

1. Noncash Expenses.2. Timing Differences.

There are two major categories of reconciling items. They include adjusting for:

1. Noncash Expenses.2. Timing Differences.

Accounts receivableAccounts receivableDepreciation ExpenseDepreciation Expense

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Net Income

Net Income

Cash Flows from Operating Activities

Cash Flows from Operating Activities

Reporting Operating Cash Reporting Operating Cash Flows by the Indirect MethodFlows by the Indirect Method

Changes in current assets and current liabilities as shown on the following table

Changes in current assets and current liabilities as shown on the following table

+ Losses and - Gains

+ Losses and - Gains

+ Noncash expenses such as depreciation and

amortization

+ Noncash expenses such as depreciation and

amortization

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

Reconciling Net Income with Reconciling Net Income with Net Cash FlowsNet Cash Flows

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The Indirect Method: A The Indirect Method: A SummarySummary

Net IncomeAdd: Depreciation expense

Decrease in accounts receivableDecrease in inventoriesDecrease in prepaid expensesIncrease in accounts payableIncrease in accrued expenses payableNonoperating losses deducted in computing net income

Deduct: Increase in accounts receivableIncrease in inventoriesIncrease in prepaid expensesDecrease in accounts payableDecrease in accrued expenses payableDecrease in deferred income taxes payableNonoperating gains added in computing net income

Net Cash Provided by (used in) operating activities

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Cash Budgets are used by management to plan and forecast future cash flows.

Cash Budgets are used by management to plan and forecast future cash flows.

Force m anagem ent to coordinate activities.

Provide managers w ith advance notice of available resources.

Provide targets useful in evaluating performance.

Provide advance w arnings of potentia l cash shortages.

A C ash Bu d get can b e u sed to:

Managing Cash FlowsManaging Cash Flows

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Managing Cash FlowsManaging Cash Flows

Increase collection of accounts receivables.

Keep inventory low. Delay payment of liabilities. Plan timing of major expenditures. Invest idle cash.

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A Worksheet for Preparing A Worksheet for Preparing a Statement of Cash Flowsa Statement of Cash Flows

2008 2009AssetsCash 50,000$ 45,000$ Marketable securities 40,000 25,000 Accounts receivable 320,000 330,000 Inventory 240,000 235,000 Plant and equipment (net of depreciation) 600,000 640,000 Totals 1,250,000$ 1,275,000$ Liabilities & Stockholders' EquityAccounting payable 150,000$ 160,000$ Accured expenses payable 60,000 45,000 Mortage note payable (long-term) - 70,000 Bonds payable (due in 2020) 500,000 350,000 Capital stock (no par) 160,000 160,000 Retained earnings 380,000 490,000 Totals 1,250,000$ 1,275,000$

AUTO SUPPLY COMPANYComparative Balance Sheets

December 31

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A Worksheet for Preparing A Worksheet for Preparing a Statement of Cash Flowsa Statement of Cash Flows

Additional Information1.Net income for the year amounted to $250,000. cash dividends of $140,000 were declared and paid.2.Auto’s only noncash expense was depreciation, which totaled $60,000.3.Marketable securities costing $15,000 were sold for $35,000 cash, resulting in a $20,000 nonoperating gain.4.The company purchased plant assets for $100,000, making a $30,000 cash down payment and issuing a $70,000 mortgage not payable for the balance of the purchase price.

Additional Information1.Net income for the year amounted to $250,000. cash dividends of $140,000 were declared and paid.2.Auto’s only noncash expense was depreciation, which totaled $60,000.3.Marketable securities costing $15,000 were sold for $35,000 cash, resulting in a $20,000 nonoperating gain.4.The company purchased plant assets for $100,000, making a $30,000 cash down payment and issuing a $70,000 mortgage not payable for the balance of the purchase price.

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The WorksheetThe Worksheet

Balance sheet effects:Beginning Balance

Debit Changes

Credit Changes

Ending Balance

AssetsCash 50,000 45,000 Marketable securities 40,000 25,000 Accounts receivable 320,000 330,000 Inventory 240,000 235,000 Plant and equipment (net of depreciation) 600,000 640,000 Totals 1,250,000 1,275,000 Liabilities & Stockholders' EquityAccounting payable 150,000 160,000 Accured expenses payable 60,000 45,000 Mortage note payable (long-term) - 70,000 Bonds payable (due in 2020) 500,000 350,000 Capital stock (no par) 160,000 160,000 Retained earnings 380,000 (1) 250,000 490,000 Totals 1,250,000 1,275,000

AUTO SUPPLY COMPANY

For the Year Ended December 31, 2009Effects of Transactions

Worksheet for Statement of Cash Flows

Cash effects:Sources of

CashUses of

CashOperating activities:Net income (1) 250,000

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The WorksheetThe Worksheet

Balance sheet effects:Beginning Balance

Debit Changes

Credit Changes

Ending Balance

AssetsCash 50,000 45,000 Marketable securities 40,000 25,000 Accounts receivable 320,000 330,000 Inventory 240,000 235,000 Plant and equipment (net of depreciation) 600,000 (3) 60,000 640,000 Totals 1,250,000 1,275,000 Liabilities & Stockholders' EquityAccounting payable 150,000 160,000 Accured expenses payable 60,000 45,000 Mortage note payable (long-term) - 70,000 Bonds payable (due in 2020) 500,000 350,000 Capital stock (no par) 160,000 160,000 Retained earnings 380,000 (2) 140,000 (1) 250,000 490,000 Totals 1,250,000 1,275,000

AUTO SUPPLY COMPANY

For the Year Ended December 31, 2009Effects of Transactions

Worksheet for Statement of Cash FlowsCash effects:

Sources of Cash

Uses of Cash

Operating activities:Net income (1) 250,000Depreciation expense (3) 60,000

Investing activities:

Financing activities:Dividends paid (2) 140,000

Net change in cash

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The WorksheetThe Worksheet

Balance sheet effects:Beginning

BalanceDebit

ChangesCredit

ChangesEnding Balance

AssetsCash 50,000 45,000 Marketable securities 40,000 25,000 Accounts receivable 320,000 (4) 10,000 330,000 Inventory 240,000 (5) 5,000 235,000 Plant and equipment (net of depreciation) 600,000 (3) 60,000 640,000 Totals 1,250,000 1,275,000 Liabilities & Stockholders' EquityAccounting payable 150,000 (6) 10,000 160,000 Accured expenses payable 60,000 (7) 15,000 45,000 Mortage note payable (long-term) - 70,000 Bonds payable (due in 2020) 500,000 350,000 Capital stock (no par) 160,000 160,000 Retained earnings 380,000 (2) 140,000 (1) 250,000 490,000 Totals 1,250,000 1,275,000

AUTO SUPPLY COMPANY

For the Year Ended December 31, 2009Effects of Transactions

Worksheet for Statement of Cash FlowsCash effects:Sources of

CashUses of

CashOperating activities:Net income (1) 250,000Depreciation expense (3) 60,000Increase in accounts receivable (4) 10,000Decrease in inventory (5) 5,000Increase in accounts payable (6) 10,000Decreases in accrued expenses (7) 15,000

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The WorksheetThe Worksheet

Balance sheet effects:Beginning

BalanceDebit

ChangesCredit

Changes Ending BalanceAssetsCash 50,000 45,000 Marketable securities 40,000 (8) 15,000 25,000 Accounts receivable 320,000 (4) 10,000 330,000 Inventory 240,000 (5) 5,000 235,000 Plant and equipment (net of depreciation) 600,000 (9) 100,000 (3) 60,000 640,000 Totals 1,250,000 1,275,000 Liabilities & Stockholders' EquityAccounting payable 150,000 (6) 10,000 160,000 Accured expenses payable 60,000 (7) 15,000 45,000 Mortage note payable (long-term) - (9) 70,000 70,000 Bonds payable (due in 2020) 500,000 (10) 150,000 350,000 Capital stock (no par) 160,000 160,000 Retained earnings 380,000 (2) 140,000 (1) 250,000 490,000 Totals 1,250,000 415,000 410,000 1,275,000

AUTO SUPPLY COMPANY

For the Year Ended December 31, 2009Effects of Transactions

Worksheet for Statement of Cash FlowsCash effects: Sources of Cash Uses of CashOperating activities:Net income (1) 250,000Depreciation expense (3) 60,000Increase in accounts receivable (4) 10,000Decrease in inventory (5) 5,000Increase in accounts payable (6) 10,000Decreases in accrued expenses (7) 15,000Gain on sale of securities (8) 20,000Investing activities:Preceeds for sale of securities (8) 35,000Plant acquired for cash (9) 30,000Financing activities:Dividends paid (2) 140,000Retirement of bonds payable (10) 150,000Net decrease in cash 5,000

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The WorksheetThe Worksheet

Balance sheet effects:Beginning

BalanceDebit

ChangesCredit

Changes Ending BalanceAssetsCash 50,000 (x) 5,000 45,000 Marketable securities 40,000 (8) 15,000 25,000 Accounts receivable 320,000 (4) 10,000 330,000 Inventory 240,000 (5) 5,000 235,000 Plant and equipment (net of depreciation) 600,000 (9) 100,000 (3) 60,000 640,000 Totals 1,250,000 1,275,000 Liabilities & Stockholders' EquityAccounting payable 150,000 (6) 10,000 160,000 Accured expenses payable 60,000 (7) 15,000 45,000 Mortage note payable (long-term) - (9) 70,000 70,000 Bonds payable (due in 2020) 500,000 (10) 150,000 350,000 Capital stock (no par) 160,000 160,000 Retained earnings 380,000 (2) 140,000 (1) 250,000 490,000 Totals 1,250,000 415,000 415,000 1,275,000

AUTO SUPPLY COMPANY

For the Year Ended December 31, 2009Effects of Transactions

Worksheet for Statement of Cash FlowsCash effects: Sources of Cash Uses of CashOperating activities:Net income (1) 250,000Depreciation expense (3) 60,000Increase in accounts receivable (4) 10,000Decrease in inventory (5) 5,000Increase in accounts payable (6) 10,000Decreases in accrued expenses (7) 15,000Gain on sale of securities (8) 20,000Investing activities:Preceeds for sale of securities (8) 35,000Plant acquired for cash (9) 30,000Financing activities:Dividends paid (2) 140,000Retirement of bonds payable (10) 150,000Net decrease in cash (x) 5,000 5,000

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Statement of Cash FlowsStatement of Cash Flows

Cash flows from operating activities:Net income 250,000$ Add: Depreciation expense 60,000 Decrease in inventory 5,000 Increase in accounts payable 10,000 Less: Increase in accounts receivable (10,000) Decrease in accrued expenses (15,000) Gain on sale of securities (20,000) Net cash provided by operating activities 280,000 Cash flows from investing activities: Proceeds from sale of securities 35,000$ Cash paid for plant assets (30,000) Net cash provided by investing activities 5,000 Cash flows from financing activities: Dividends paid (140,000) Retirement of bonds payable (150,000) Net cash used for financing activities (290,000) Net decrease in cash (5,000) Cash and cash equivalents, January 1, 2009 50,000 Cash and cash equivalents, December 31, 2009 45,000$

AUTO SUPPLY COMPANYStatement of Cash Flows

For the Year Ended December 31, 2009

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Supplemental InformationSupplemental Information

Purchases of plant assets 100,000$ Less: Portion financed by issuance of long-term debt 70,000 Cash paid to acquire plant assets 30,000$

AUTO SUPPLY COMPANYSupplementary Schedule: Noncash Investing and Financing Activities

We are required to disclose information concerning major investing and financing activities that do not

involve cash.

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End of Chapter 13End of Chapter 13