managerial accounting - 5.1 preparing and using the statement of cash flows chapter 17

Managerial Accounting - 5.1

Preparing and Using the Statement of Cash FlowsPreparing and Using the Statement of Cash Flows

Chapter 17


W.T. Grant CompanyW.T. Grant Company W.T. Grant Company was once one of the

leading retailers in the United States.


W.T. Grant CompanyW.T. Grant Company

W.T. Grant’s income statement reported rising profits as the company slid into bankruptcy.



What went wrong? Grant’s operations simply did not generate

enough cash to pay the bills. If anyone had analyzed Grant’s cash flows,

the cash shortage would have been apparent.



Cash receipts from customers were not as high as cash payments to suppliers.

Prior to W. T. Grant’s bankruptcy, companies were not required to include a statement of cash flows in the annual report.


Chapter ObjectivesChapter Objectives

1 Identify the purposes of the statement of cash flows.

2 Distinguish among operating, investing and financing activities.

3 Prepare a statement of cash flows by the direct method.


Chapter ObjectivesChapter Objectives

4 Use the financial statements to compute the cash effects of a wide variety of business transactions.

5 Prepare a statement of cash flows by the indirect method.


Purpose of The Statement of Cash Flows: Basic ConceptsPurpose of The Statement of Cash Flows: Basic Concepts

The statement of cash flows reports the entity’s cash flows (cash receipts and cash payments) during the period.


Purpose of The Statement of Cash Flows: Basic ConceptsPurpose of The Statement of Cash Flows: Basic Concepts

The cash flow statement identifies what a company invested in during the period.

It shows how the investment was financed. It displays how cash can be generated

internally from profitable operations or from external sources.


Objective 1Objective 1

Identify the purposes of the statement of cash flows.


Purposes of the Statementof Cash FlowsPurposes of the Statementof Cash Flows

The statement of cash flows is designed to fulfill the following:

– predict future cash flows– evaluate management decisions– determine the ability to pay dividends plus

interest and principal– show the relationship of net income to

changes in the firm’s cash


Cash Balance Includes...Cash Balance Includes...

– cash on hand.– cash in the bank.– cash equivalents.


Cash Equivalents Are....Cash Equivalents Are....

– short-term, highly liquid investments convertible into cash with little delay.

– money market accounts.– U.S. Government Treasury bills.



Distinguish among operating, investing and financing

activities.


Basic Organization of the Statement of Cash FlowsBasic Organization of the Statement of Cash Flows

A business may be evaluated in terms of three types of business activities:

1 Operating activities2 Investing activities3 Financing activities


Operating Activities Are...Operating Activities Are...– day to day business transactions, such as: receiving cash from customers paying cash to suppliers Operating activities are related to the

transactions that make up net income.


Operating ActivitiesOperating Activities

Interest and dividends received are related to investing activities.

However, the FASB has decided to classify the cash received from these items as operating activities.

The FASB feels that interest expense is a cost of doing business.


Investing Activities...Investing Activities...

– are those that support operations. Investing activities increase and decrease

the assets that are available to the business.


Investing Activities...Investing Activities...

– are related to the Long-Term Asset accounts.


Financing Activities Involve...Financing Activities Involve...

– external financing, such as: obtaining resources from the owners or

returning resources to them. providing owners with a return on their

investment. obtaining resources from creditors and

repaying the amounts borrowed.


Format of the Statementof Cash FlowsFormat of the Statementof Cash Flows

FASB Statement 95 approved two methods for reporting cash flows from operating activities.

1 Direct method2 Indirect method


Format of the Statementof Cash FlowsFormat of the Statementof Cash Flows

The direct method lists cash receipts from specific operating activities and cash payments for each major operating activity.

The indirect method is a short-cut method for accrual systems.



Prepare a statement of cash flows by the direct method.


The Direct Method...The Direct Method...

– determines the amount of cash inflows and cash outflows.

– identifies the activities that increase or decrease cash.


Cash Flows fromOperating ActivitiesCash Flows fromOperating Activities

Cash collections from customers Cash receipts of interest Cash receipts of dividends


Cash Flows fromOperating ActivitiesCash Flows fromOperating Activities

Payments to suppliers Payments to employees Payment for interest expense Payment for tax expense


Cash Flows fromInvesting ActivitiesCash Flows fromInvesting Activities

Proceeds from the sale of plant assets Proceeds from the sale of investments Collections of loans


Cash Flows fromInvesting ActivitiesCash Flows fromInvesting Activities

Cash payments to acquire plant assets Cash payments to acquire investments Loans to other companies


Cash Flows fromFinancing ActivitiesCash Flows fromFinancing Activities

Increases in common stock, additional paid-in capital and long-term liabilities are sources of cash.

Decreases in common stock, paid-in capital and long-term liabilities are uses of cash.

Paying dividends is a use of cash.



Use the financial statements to compute the cash effects of

a wide variety of business transactions.


Computing Cash Collections from CustomersComputing Cash Collections from Customers

Collections can be computed by converting sales revenue to the cash basis.

Beginning Accounts Receivable balance + Sales on account - Collections = Ending Accounts Receivable balance



Lloyd’s Sporting Store income statement reports sales on account of $884,000 for the year.

Accounts Receivable increased from $80,000 at the beginning of the year to $93,000 at year end.

How much cash did Lloyd collect ? $871,000



$80,000 + $884,000 - x = $93,000 x = $80,000 + $884,000 - $93,000 x = $871,000 Accounts Receivable

Beginning balance 80,000 Sales 884,000 Collections 871,000

Ending balance 93,000



Another explanation: Because Accounts Receivable increased by

$13,000, Lloyd’s Sporting Store received $13,000 less cash than its sales revenue for the period.



All collections of receivables are computed following the pattern illustrated for collections from customers.


Computing Paymentsto SuppliersComputing Paymentsto Suppliers

This computation includes two parts, payments for inventory and payments for expenses other than interest and income tax.


Payments for Inventory...Payments for Inventory...

– are computed by converting cost of goods sold to the cash basis.

This is accomplished by analyzing the Inventory and Accounts Payable accounts.


Payments for InventoryPayments for Inventory

Lloyd's Sporting Store had the following account balances:

Beginning inventory: $138,000 Ending inventory: $135,000 Accounts Payable:– Beginning balance: $57,000– Ending balance: $91,000


Payments for InventoryPayments for Inventory Cost of Goods Sold was $603,000. How much were the purchases? $600,000 How much did Lloyd pay for his purchases? $566,000 How did we get these numbers?


PurchasesPurchases

$138,000 + x - $603,000 = $135,000 x = $135,000 - $138,000 + $603,000 x = $600,000 Inventory

Beg. inventory 138,000 Cost of goods sold 603,000 Purchases 600,000 End. inventory 135,000


Payments for InventoryPayments for Inventory $57,000 + $600,000 - x = $91,000 x = $57,000 + $600,000 - $91,000 x = $566,000 Accounts Payable

Beg. bal. 57,000 Payments 566,000 Purchases600,000 End. bal. 91,000


Payments for Operating Expenses...Payments for Operating Expenses...

– can be computed as plug-in figures by analyzing Prepaid Expenses and Accrued Liabilities.


Payments for Operating ExpensesPayments for Operating Expenses

Increases in prepaid expenses require cash payments, and decreases indicate that payments were less than expenses.

Decreases in accrued liabilities can occur only from cash payments, and increases mean that cash was not paid.


Payments to EmployeesPayments to Employees

Lloyd’s Sporting Store had a Salary and Wage Payable balance of $20,000 at the beginning of the year and $15,000 at year end.

During the year Lloyd had Salary and Wages expense of $60,000.

How much did Lloyd pay? $65,000


Payments to EmployeesPayments to Employees

$20,000 + $60,000 - $15,000 = $65,000 Lloyd’s Sporting Store paid for the $60,000

expense plus the $5,000 decrease in liability.


Acquisition and Salesof Plant AssetsAcquisition and Salesof Plant Assets

Lloyd’s Sporting Store had plant assets net of depreciation of $300,000 at the beginning of the year and $500,000 at year end.

Further, the acquisition of plant assets amounted to $306,000 during the year.



The income statement shows depreciation expense of $18,000 and a $10,000 gain on sale of plant assets.

What is the book value of the assets sold? $88,000



Beginning net balance + Acquisitions - Depreciation - Book value of assets sold = Ending balance

$300,000 + $306,000 - $18,000 - x = $500,000 x = $300,000 + $306,000 -$18,000 - $500,000 x = $88,000 (book value)



Plant Assets (net) Beg. balance 300,000 Depreciation 18,000 Acquisitions 306,000 Book value of assets

sold 88,000 End. balance 500,000



How much are the proceeds from the sale of plant assets?

Book value + Gain - Loss = Proceeds $88,000 + $10,000 - 0 = $98,000



To determine the amounts paid for the acquisition of plant assets one must solve for acquisitions first.

Beginning net balance + Acquisitions - Depreciation - Book value of assets sold = Ending balance


Computing the Cash Amounts of Financing ActivitiesComputing the Cash Amounts of Financing Activities

Financing activities affect liability and stockholders’ equity accounts.

– Notes Payable– Bonds Payable– Long-Term Debt– Common Stock– Paid-in Capital– Retained Earnings


Issuance and Payments of Long-Term Notes PayableIssuance and Payments of Long-Term Notes Payable

Debt payment is computed by analyzing the Long-Term Notes Payable account.



Assume that the beginning balance was $77,000.

New debt amounting to $94,000 was incurred during the year.

The ending balance for the Long-Term Notes Payable account was $160,000.

How much was the payment? $11,000



Long-Term Notes Payable Beg. balance 77,000

Paid 11,000 Issued 94,000 Balance 160,000


Issuance and Retirementof StockIssuance and Retirementof Stock

The cash effect of these activities is determined by analyzing the stock account.

Common Stock Beginning balance

- Retirement + Issuance of new stock = Ending balance


Purchases and Salesof Treasury StockPurchases and Salesof Treasury Stock

Treasury Stock Beginning balance + Purchases of - Cost of treasury

treasury stock stock sold

Ending balance


Computing Dividend PaymentsComputing Dividend Payments Dividend payments are computed by analyzing

the Dividends Payable account. Beginning balance + Dividends declared -

Dividend payments = Ending balance


Noncash Investing and Financing Activities...Noncash Investing and Financing Activities...

– are not reported in the statement of cash flows.

The FASB requires that significant non-cash investing and financing activities be shown in a separate schedule at the bottom of the statement.


Reconciling Net Incometo Net Cash FlowReconciling Net Incometo Net Cash Flow

The FASB requires companies that format operating activities by the direct method to report a reconciliation from net income to net cash inflow (or outflow).



Prepare a statement of cash flows by the indirect method.


The Indirect Method...The Indirect Method...

– begins with accrual based net income. Adjustments are made to income for

revenues that did not generate cash and expenses that did not use cash.


The Indirect MethodThe Indirect Method

Depreciation, depletion and amortization expenses must be added back to the net income figure.

Gains and losses on the sale of assets are also adjustments to income.



Remember when Lloyd’s Sporting Store sold assets for $98,000 that had a book value of $88,000, realizing a gain of $10,000?



The $10,000 gain is reported on the income statement and is included in net income.

The cash received from the sale is $98,000, which includes the gain.

To avoid counting the gain twice, it is subtracted from net income.



A loss on the sale of plant assets is also an adjustment to net income on the statement of cash flows.

A loss is added back to income to compute cash flow from operations.

The proceeds from selling the plant assets are reported under investing activities.


Changes in the Current Asset and Current Liability AccountsChanges in the Current Asset and Current Liability Accounts

An increase in a current asset other than cash is subtracted from net income.

Suppose a company makes a sale of $100,000.

Income is increased by the sale amount. What if $20,000 were not collected? Collections of less than the full amount

increases Accounts Receivable.



The $20,000 increase in Accounts Receivable must be subtracted from net income.

Why? $20,000 was included in net income but was

not collected.



A decrease in a current asset other than cash is added to net income.

Cash collections cause the Accounts Receivable balance to decrease.



A decrease in a current liability is subtracted from net income.

The payment of a current liability causes both cash and the current liability to decrease.



An increase in a current liability is added to net income.

The Accounts Payable account increases only if cash is not spent to pay the liability.

This means that cash payments are less than the related expense.


Computers and theIndirect MethodComputers and theIndirect Method

Computers can easily generate the statement of cash flows.

After the income statement is prepared, the computer picks up net income, depreciation and other noncash expenses.

managerial accounting - 5.1 preparing and using the statement of cash flows chapter 17

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