Chapter 13 Review

Preparing Step 2 for cash flow statement

Analyze changes in non current asset and liability accounts and record as investing and financing activities, or disclose as non cash transactions. This step involves analyzing comparative balance sheet data and selected additional information for their effects on cash.

Companies classify as operating activities some cash flows related to investing or financing activities. For example, receipts of investment revenue (interest and dividends) are classified as operating activities. So are payments of interest to lenders. Why are these considered operating activities?

Because companies report these items in the income statement, where results of operations are shown.

Preparing step 3 for cash flow statements

Compare the net change in cash on the statement of cash flows with the change in the cash account reported on the balance sheet to make sure the amounts agree

Borrowed $200,000 from Castle Bank, signing a 5-year note bearing 8% interest

Financing activity

Issued 100,000 shares of $5 par value common stock for $800,000 cash

Financing activity

Purchased two semi-trailer trucks for $170,000 cash

Investing activity

Free cash flow equation

Net cash provided by operating activities - Capital Expenditures - Cash Dividends

Collected $20,000 cash for services performed

Operating activity

Paid employees $12,000 for salaries and wages

Operating activity

The statement of cash flows classifies cash receipts and cash payments by

Operating, Investing, and Financing activities

Additional information

Such information includes transaction data that are needed to determine how cash was provided or used during the period

b. If the account, Common Stock, increases $100,000 and the transaction data indicates that additional capital stock was issued for cash,

a cash inflow from a financing activity has resulted.

a. If the account, Land, increases $50,000 and the transaction data indicates that land was purchased for cash,

a cash outflow from an investment activity has occurred.

The net change in cash for the period is then

added to or subtracted from the beginning-of-the-period cash balance to arrive at the ending cash balance

The primary purpose of the statement is to provide information about

an entity's cash receipts and cash payments during a period

The redemption of debt and the retirement or reacquisition of capital stock are

cash outflows from financing activities

Free cash flow describes the

cash remaining from operations after adjustment for capital expenditures and dividends

The first step- Indirect

determine net cash provided/used by operating activities

Companies do not report in the body of the statement of cash flows significant financing and investing activities that

do not affect cash

The indirect method is used extensively

in practice

Operating activities involve

income statement items

Investing activities involve cash flows resulting from changes in

investments and long-term asset items

The fourth basic financial statement

is the statement of cash flows

The Third Step—Indirect

is to determine the net change in cash on the statement of cash flows with the change in the cash account reported on the balance sheet to make sure the amounts agree.

Financing activities involve cash flows resulting from changes in

long-term liability and stockholders' equity items

The operating activities category is the

most important.

The Second Step—Indirect

net cash provided/used by investing and financing activities is generally determined from changes in non current accounts reported in the comparative balance sheets and selected additional data.

Under generally accepted accounting principles the accrual basis of accounting is used which results in

recognizing revenues when earned and expenses when incurred

In order to determine cash provided from operations it is necessary to

report revenues and expenses on a cash basis. This is determined by adjusting net income for items that did not affect cash.

Operating activities include

the cash effects of transactions that create revenues and expenses. They thus enter into the determination of net income

Operating activities include

the cash effects of transactions that create revenues and expenses. They thus enter into the determination of net income.

Both methods arrive at the same total amount for "net cash provided by operations" but they differ in how

they arrive at the total amount

Investing activities which include

(1) acquiring and disposing of investments and (2) lending money and collecting the loans

Financing activities which involve liability and stockholders' equity items and include

(1) obtaining cash from issuing debt and repaying the amounts borrowed, and (2) obtaining cash from stockholders, repurchasing shares, and paying dividends.

The information to prepare the cash flow statement usually comes from three sources

(a) comparative balance sheets (b) the current income statement, and (c) additional information

The operating section of the statement of cash flows should begin with

(a) net income, (b) add (or deduct) items not affecting cash, and (c) show net cash provided by operating activities.

Three types of adjustments to convert net income to net cash provided by operating activities

-Add back non cash expenses, such as depreciation expense and and amortization expense -Deduct gains and add losses, that resulted from investing and financing -Analyze changes, to non cash asset and current liability accounts

to prepare cash flow statement usually comes from three sources

-Comparative balance sheets -Current income statement -Additional information

Cash inflows from financing activities- changes in long-term liabilities and stockholders' equity

-From sale of common stock -From issuance of debt (bonds and notes).

Cash inflows from Operating activities

-From sale of goods or services -From interest received and dividends received

Cash inflows from investing activities- changes in investments and long-term assets

-From sale of property, plant, and equipment -From sale of investments in debt or equity securities of other entities -From collection of principal on loans to other entities

Cash outflows from investing activities

-To purchase property, plant, and equipment -To purchase investments in debt or equity -To make loans to other entities

Cash outflows from financing activities

-To stockholders as dividends -To redeem long-term debt or reacquire capital stock (treasury stock)

Cash outflows from Operating activities

-To suppliers for inventory -To employees for wages -To government for taxes -To lenders for interest -To others for expenses

Examples of significant non cash activities are as follows.

1) Direct issuance of common stock to purchase assets. 2)Conversion of bonds into common stock. 3) Direct issuance of debt to purchase assets. 4) Exchanges of plant assets

The information in a statement of cash flows should helps investors, creditors, and others assess the following

1) The entity's ability to generate future cash flows. 2) The entity's ability to pay dividends and meet obligations 3) The reasons for the difference between net income and net cash provided (used) by operating activities 4)The cash investing and financing transactions during the period

Preparing Step 1 for cash flow statement

Determine net cash provided/used by operating activities. This step involves analyzing not only the current year's income statement, but also comparative balance sheets and selected additional data.

Comparative balance sheets

Information in the comparative balance sheets indicates the amount of the changes in assets, liabilities, and stockholders' equities from the beginning to the end of the period.

Current income statement

Information in this statement helps determine the amount of net cash provided or used by operating activities during the period

The operating activities source of cash is generally considered to be the best measure of

a company's ability to generate sufficient cash to continue as a going concern.

The information in the statement of cash flows should help investors to assess the

a. entity's ability to generate future cash flows. b. entity's ability to pay dividends and meet obligations. c. reasons for the difference between net income and net cash provided (used) by operating activities. d. cash investing and financing transactions during the period.

In determining net cash provided by operating activities,

a. increases in specific current assets other than cash are deducted from net income, and decreases are added to net income. b. increases in specific current liabilities are added to net income, and decreases are deducted from net income. c. expenses for depreciation, amortization, and depletion and a loss on a sale of equipment are added to net income, and a gain on a sale of equipment is deducted from net income.

In performing step 1, the operating activities section must be converted from an

accrual basis to a cash basis. This may be done by either the indirect method or the direct method.

The statement of cash flows

reports the cash receipts, cash payments, and net change in cash resulting from operating, investing, and financing activities during a period

Finally, any significant non cash investing and financing activities are reported in a

separate schedule at the bottom of the statement

Significant non cash transactions are reported in a

separate schedule at the bottom of the statement of cash flows or they may appear in a separate note or supplementary schedule to the financial statements

The operating activities shows

the cash provided by company operations.

Significant non cash transactions will include

the conversion of bonds into common stock and the acquisition of assets through the issuance of debt or capital stock

The FASB has expressed a preference for

the direct method

The three classes of activities constitute the general format of the statement with the operating activities section appearing first, followed by

the investing activities and financing activities sections

The net cash provided or used by each activity is totaled to show the

the net increase (decrease) in cash for the period