Accounting Chapter 11: the Statement of Cash Flows
Cash Flows from Financing Activities
-Affect liabilities and stockholders' equity -Notes Payable, Bonds Payable, Long-Term Debt, Common Stock, Paid-in Capital in Excess of Par, and Retained Earnings -Most data from balance sheet -Increases are offset by increases in cash -Decreases are offset by decreases in cash
Gains and Losses on the Sale of Long-Term Assets
-An adjustment to net income -Subtract gains from operating activities -Add losses from operating activities TRRS sold equipment for $62,000. The book value was $54,000, so there was a gain of $8,000. Sales of long-term assets are investing activities and there's often a gain or loss on the sale. On the statement of cash flows, the gain or loss is an adjustment to net income.
FASB and IASB prefer the direct method because
-Provides clearer information about the sources and uses of cash -Very small percentage of companies actually use direct -Requires more computations than the indirect method -Investing and financing cash flows are unaffected by the method used
Positive and negative operating, investing, and financing activities
Exhibit 11-3 part 2 shows how certain transactions affect each section of the statement of cash flows. This is important and will be very helpful in preparing a statement of cash flows. Review each section and the activities that affect it.
Computing Cash Flows from Financing Activities
Exhibit 11-9 summarizes the cash flows from TRRS's financing activities, which are highlighted in color.
Computing Cash Flows from Investing Activities
Figure 11-8 summarizes the investing section of the Statement of Cash Flows from investing activities.
Financing activities under the Direct method
Financing activities * = indicates a cash flow to be reported on the statement of cash flows *16. Proceeds from issuance of long-term debt *17. Proceeds from issuance of common stock *18. Payment of long-term debt *19. Declaration and payment of cash dividends
3 types of business activities
1. Operating 2. Investing 3. Financing
4 purposes of the statement of cash flows
1. Predicts future cash flows 2. evaluates management decisions 3. Determines ability to pay dividends and interest 4. Shows the relationship of net income to cash flows
cash flow from operating activities: how income statement and comparative balance sheets contribute
From Income statement -Net Income -depreciation, depletion, and amortization expense -gains and losses on sale of long-term assets From Comparative Balance Sheets -increase or decrease in each current asset -increase or decrease in each current liability
Computing Dividend Declarations and Payments
If dividend declarations and payments are not given elsewhere, they can be computed.
Investing activities under the Direct method
Investing activities * = indicates a cash flow to be reported on the statement of cash flows *13. Cash payments to acquire plant assets *14. Loan to another company *15. Proceeds from sale of plant assets
Operating activities under the Direct method
Operating activities * = indicates a cash flow to be reported on the statement of cash flows 1. Sales on credit *2. Collections from customers *3. Interest revenue and receipts 4. Cost of goods sold 5. Purchases of inventory on credit *6. payments to suppliers 7. salary and wage expense *8. payments of salary and wages 9. depreciation expense 10. other operating expense *11. income tax expense and payments *12. interest expense and payments
How operating, investing, and financing activities affect the balance sheet
Operating cash flows -> Current assets Operating cash flows -> Current liabilities Investing cash flows ->Long term assets Financing cash flows -> Long term liabilities Financing cash flows -> Stockholders' equity
Indirect method
Reconciles from net income to net cash provided by operating activities Net income - depreciation etc. = net cash provided by operating activities A method of preparing a statement of cash flows in which net income is adjusted for items that do not affect cash, to determine net cash provided by operating activities.
Direct Method
Reports all cash receipts and cash payments from operating activities Collections from customers - payments to suppliers etc. = Net cash provided by operating activities adjusts the items on the income statement to directly show the cash inflows and outflows from operations, such as cash received from customers and cash paid for inventory, salaries, rent, interest, and taxes
Computing Purchases and Sales of Investments, and Loans and Collections
The cash amounts of investment transactions can be computed the same way that cash amounts from plant assets are computed. However, computing investments is easier because, unlike plant assets, there is no depreciation. TRRS does not have investments, but we will assume it does to illustrate this example.
Noncash Investing and Financing Activities
This section is the same as it was in the indirect method.
Statement of cash flows using indirect method tips
Use the balance sheet to determine the increase or decrease in cash during the period. Use Exhibit 11-4. From the income statement take net income, depreciation, depletion, and amortization expense, and any Gains or Losses on the sale of long-term assets. Use the income statement and balance sheet data to prepare the statement of cash flows.
Cash Flows from Investing Activities and Cash Flows from Financing Activities using the DIRECT method
same as the indirect method
Free Cash Flow formula
free cash flow = (net cash provided by operating activities) - (Cash payments earmarked for investments in plant assets)
cash flows from Financing activities
+ Issuance of stock + sale of treasury stock - purchase of treasury stock + borrowing (issuance of notes or bonds payable) - Payment of notes or bonds payable - Payment of dividends Net cash provided by (used for) financing activities.
cash flows from investing activities
+ Sales of long term assets (investments, land, building, equipment, etc.) - purchases of notes receivable + collections of notes receivable - loans to others Net cash provided by (used for) investing activities.
Depreciation, Depletion, & Amortization Expenses
- Added back to net income to convert net income to cash flow - No effect on cash, decreases net income - Add-back cancels the deduction on the income statement TRRS reports depreciation expense on its income statement of $18,000 (Exhibit 11-5). - These expenses are added back to net income to convert net income to cash flow. Depreciation is recorded as Depreciation Expense and has no effect on Cash. But depreciation, like all other expenses, decreases net income. Therefore, to convert net income to cash flows, we add depreciation to net income, canceling the earlier deduction.
3 steps To prepare the statement of cash flows using the direct method:
1. Lay out the template as shown in Part 1 of Exhibit 11-11. Part 2 gives a visual representation. 2. Use the balance sheet to determine increase or decrease in cash during the period. 3. Use the available data to prepare the statement of cash flows.
Cash Flow from Investing Activities
Affect long-term assets - Plant assets, long-term Investments Increase represents purchase of long-term assets - Decreases cash Decrease represents sale of long-term assets - Increases cash Investing activities affect long-term assets, such as plant assets and long-term investments including the debt and equity securities of other companies a business owns. Increases in these accounts represent purchases of these assets and are offset by decreases to cash. Decreases to these accounts represent sales of these assets and are offset by increases to cash. Data needed to complete the investing activities section are computed by analyzing changes in non-current assets accounts on the balance sheet.
Purchases and Sales of Plant Assets
Combine all plant assets into a single account to compute cash flows. Companies keep a separate account for each plant asset. But for computing cash flows, it is helpful to combine all the plant assets into a single summary account because it's easier to work with. Also, we subtract accumulated depreciation and use the net figure.
cash flows from operating activities
Net income Adjustments to reconcile the net income to net cash provided by operating activities + Depreciation/depletion/ amortization expense + Loss on sale of long term assets - Gain on sale of long term assets - increases in current assets other than cash + decreases in current assets other than cash + Increases in current liabilities - Decreases in current liabilities Net cash provided by (used for) operating activities.
ANOTHER WAY TO Compute Purchases and Sales of Investments, and Loans and Collections (LONG TERM NOTES RECEIVABLE)
TRRS has a long-term note receivable and the cash flows from loan transactions on notes receivables can be determined as shown above.
Computing Issuances of Stock and Purchases of Treasury Stock
TRRS has no treasury stock, but cash flows from purchasing treasury stock can be computed as shown above. Increases of treasury stock are represented by offsetting decreases in cash. If treasury stock is reissued for cash, the decrease in treasury stock is offset by an increase in cash.
Measuring Cash Adequacy: Free Cash Flow
The amount of cash available from operations after paying for planned investments in plant assets Some investors want to know how much cash a company can "free up" for new opportunities. Free cash flow is the amount of cash available from operations after paying for planned investments in plant assets.
Computing Issuance and Payments of Long-Term Debt
The beginning and ending balances come from the balance sheet. If either new issuances or payments are known, the other amount can be computed.
Computing Issuances of Stock and Purchases of Treasury Stock
These cash flows can be determined from the stock accounts.
Comparative Balance Sheet example
a balance sheet that presents the current and prior year amounts in comparative form
Operating Activities
- create revenues, expenses, gains and losses - net income, which is a product of accrual basis accounting. A successful business must generate cash from operating activities. This is the most important section of the statement. (Cash flow activities that include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income.)
Investing activities
- increase and decrease long-term assets, such as computers, land, buildings, equipment, and investments in other companies. Purchases and sales of these assets are investing activities. These are less critical than operating activities. Includes cash transactions involving the purchase and sale of long-term assets and current investments
Financing activities
- obtain cash from investors and creditors. Issuing stock, borrowing money, buying and selling treasury stock, and paying dividends are financing activities. (Cash flow activities that include (a) obtaining cash from issuing debt and repaying the amounts borrowed and (b) obtaining cash from stockholders, repurchasing shares, and paying dividends.)
2 formats for operating activities
1. indirect method 2. direct method The two methods use different computations but they produce the same figure for Net cash provided by operating activities.
Cash Flows from Operating Activities using the DIRECT method
Cash Receipts (Positive) -Cash collections from customers -Cash receipts of Interest and Dividends -Other operating receipts Cash Payments (Negative) -Payments to suppliers -Payments to employees -Payments of interest and income taxes -Other operating expenses Depreciation, depletion, and amortization expenses are not listed on the direct-method statement of cash flows because they do not affect cash
Changes in Current Assets and Current Liabilities, Excluding Cash
Most current assets and current liabilities result from operating activities. For example, A/R result from sales, inventory relates to COGS, and so on. Except for Cash, changes in the current accounts are adjustments to net income on the cash flow statement. -An increase in a noncash current asset decreases cash. -A decrease in noncash current assets increases cash. -An increase in a current liability increases cash. -A decrease in current liabilities decreases cash. Increase in a noncash current asset decreases cash -Accounts Receivable increased by $15,000 Prepaid -Expenses increased by $1,000 Decrease in noncash current assets increases cash -Inventory decreased by $3,000 Increase in a current liability increases cash -Accounts Payable increased by $34,000 Decrease in current liabilities decreases cash -Salary and Wages Payable decreased by $2,000 -Accrued Liabilities decreased by $2,000
Non-cash investing and finance activities
Non-cash investing and finance activities + Acquisition of Building by issuing common stock + Acquisition of land by issuing note payable + Payment of long-term = Total non-cash investing and financing activities Companies make investments that do not require cash. They also obtain financing other than cash. An example would be issuing stock for a warehouse. Exhibit 11-10 illustrates noncash investing and financing activities with assumed amounts.
cash equivalents
On a statement of cash flows, cash means more than just cash in the bank. It includes cash equivalents, which are highly liquid short-term investments that can be converted into cash immediately. Examples include money-market accounts and investments in US securities. Short-term, highly liquid investments that can be readily converted to a specific amount of cash and which are relatively insensitive to interest rate changes.
timing of financial statements
a point in time : balance sheet a period of time : I/S, SSE, SCF
The statement of cash flows reports cash flows:
cash receipts AND cash payments in other words, where cash came from and how it was spent. covers a span of time (month, quarter year)