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Financial Accounting
John J. Wild
Sixth Edition McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
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Chapter 12
Reporting and AnalyzingCash Flows
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Conceptual Learning Objectives
C1: Distinguish between operating, investing, and financing activities, and describe how noncash investing and financing activities are disclosed.
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Analytical Learning Objectives
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A1: Analyze the statement of cash flows and apply the cash flow on assets total ratio.
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Procedural Learning Objectives
P1: Prepare a statement of cash flows.P2: Compute cash flows from operating
activities using the indirect method.P3: Determine cash flows from both investing
and financing activities.P4: Appendix 12A – Illustrate use of a
spreadsheet to prepare a statement of cash flows (see text for details).
P5: Appendix 12B – Compute cash flows from operating activities using the direct method.
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How does a company obtain its
cash?
Where does a company spend its
cash?
What explains the change in the cash
balance?
Purpose of theStatement of Cash Flows
C1
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How did the business fund its
operations?
Did the business borrow any funds or
repay any loans?
Does the business have sufficient cash to pay its debts as
they mature?
Did the business make any dividend
payments?
Importance of Cash FlowsC1
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CashCurrency
Cash Equivalents
● Short-term, highly liquid investments.● Readily convertible into cash.● Sufficiently close to maturity so that market value is
unaffected by interest rate changes.
Measurement of Cash FlowsC1
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The statement of cash flows includes the following three sections:• Operating activities• Investing activities• Financing activities
Classifying Cash FlowsC1
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Outflows• Salaries and wages• Payments to suppliers• Taxes and fines• Interest paid to lenders• Other
Inflows• Receipts from customers• Cash dividends received• Interest from borrowers• Other
Operating ActivitiesC 1
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Outflows• Purchasing long-term
productive assets• Purchasing equity
investments• Purchasing debt investments• Other
Inflows• Selling long-term productive
assets• Selling equity investments• Collecting principal on loans• Other
Investing ActivitiesC1
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Outflows• Pay dividends• Purchasing treasury stock• Repaying cash loans• Paying owners’ withdrawals
Inflows• Issuing its own equity
securities• Issuing bonds and notes• Issuing short- and long-term
liabilities
Financing ActivitiesC 1
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Items requiring separate disclosure include:
• Retirement of debt by issuing equity securities.
• Conversion of preferred stock to common stock.
• Leasing of assets in a capital lease transaction.
NoncashInvesting and Financing
C 1
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Format of theStatement of Cash Flows
C1
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There are two acceptable methods to determine cash flows from operating activities:
• Direct method• Indirect method
Format of theStatement of Cash Flows
C 1
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Net Income
Cash Flows from Operating
Activities
97.5% of all companies use the indirect method.
Changes in current assets and current liabilities.
+ Losses and - Gains
+ Noncash expenses such as depreciation and
amortization.
Indirect MethodP2
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Use this table when adjusting net income to operating cash flows.
Indirect MethodP2
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Let’s look at the indirect method for preparing the cash flows from operating activities section.
Preparing the Statement of Cash Flows – Indirect Method
P2
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➢ East, Inc. reports $125,000 net income for the year ended December 31, 2011.
➢ Accounts receivable increased by $7,500 during the year and accounts payable increased by $10,000.
➢ During 2011, East reported $12,500 of depreciation expense.
What is East, Inc.’s operating cash flow for 2011?
Indirect MethodExample – East, Inc.
P2
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Net income 125,000$
Deduct: Increase in accounts receivable
Cash provided by operating activities
Net income 125,000$
Deduct: Increase in accounts receivable
Cash provided by operating activities
For the indirect method, start with net income.
P2
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Indirect MethodExample – East, Inc.
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Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable
Cash provided by operating activities
Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable
Cash provided by operating activities
Add noncash expenses such as depreciation, depletion, amortization, or bad debt expense.
P2
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Indirect MethodExample – East, Inc.
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Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500)
Cash provided by operating activities
Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500)
Cash provided by operating activities
P2
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Indirect MethodExample – East, Inc.
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Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500) Add: Increase in accounts payable 10,000 Cash provided by operating activities
Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500) Add: Increase in accounts payable 10,000 Cash provided by operating activities
P2
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Indirect MethodExample – East, Inc.
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Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500) Add: Increase in accounts payable 10,000 Cash provided by operating activities 140,000$
Net income 125,000$ Add: Depreciation expense 12,500 Deduct: Increase in accounts receivable (7,500) Add: Increase in accounts payable 10,000 Cash provided by operating activities 140,000$
If we used the direct method, we would get the same $140,000 for cash provided by operating activities.
P2
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Indirect MethodExample – East, Inc.
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Let’s prepare a statement of cash flows for B&G Company using the indirect method.
Indirect MethodP2
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P2
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Indirect MethodExample – B&G Company
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Additional Information for 2011:
• Net income was $105,000.
• Cash dividends declared and paid were $40,000.
• Bonds payable of $50,000 were redeemed for $50,000 cash.
• Common stock was issued for $35,000 cash.
P2
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Indirect MethodExample – B&G Company
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Add noncash expenses and losses.Subtract noncash revenues and gains.
Start with accrual-basis net income.
Then, analyze the changes in current assets and current liabilities. →
P2
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Indirect MethodExample – B&G Company
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P2
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Indirect MethodExample – B&G Company
Here’s the completed operating section. Next, let’s complete the investing section.
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Here’s the completed investing section. Next, let’s complete the financing section.
P3
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Indirect MethodExample – B&G Company
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P3
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Indirect MethodExample – B&G Company
Here’s the completed financing section. Next, let’s prove the cash balances.
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P3
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Indirect MethodExample – B&G Company
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P3
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Indirect MethodExample – B&G Company
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AnalyzingCash Sources and Uses
A1
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Used, along with income-based ratios, to assess company performance.
Cash flow on total assets =
Cash flow from operations Average total assets
Cash Flow on Total AssetsA1
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Let’s look at the direct method for preparing the cash flows from operating activities section.
Preparing the Statement of Cash Flows – Direct Method
P5
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We analyze the cash account to prepare the statement under the direct method. Let’s use B&G’s cash account to prepare the company’s statement of cash flows.
P5
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Direct MethodExample – B&G Company
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P5
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Direct MethodExample – B&G Company
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End of Chapter 12
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