GS - ACCT 2302 CH 14 : The Statement of Cash Flows

Step 5: Prepare a separate schedule reporting any non-cash investing and financing activities. This section appears as a separate schedule of the statement of cash flows or in the notes to the financial statements. So, to illustrate them, let's consider three non-cash transactions for another fictitious company, The Outdoors, Inc. How would they be reported? First, we gather the non-cash activities for the company: 1. Acquired $300,000 building by issuing common stock. 2. Acquired $70,000 land by issuing notes payable. 3. Retired $100,000 notes payable by issuing common stock.

1. Acquired $300,000 building by issuing common stock. Assets increase as land increases, and liabilities increase as notes payable increase. This transaction would not be reported on the statement of cash flows because no cash was paid or received. But the building and the common stock are important. The purchase of the building is an investing activity. The issuance of common stock is a financing activity. Taken together, this transaction is a non-cash investing and financing activity.

1. I 2. O 3. I 4. N 5. F

1. Cash receipt from the sale of equipment 2. Cash payment for salaries 3.Cash receipt from the collection of long-term notes receivable 4. Purchase of equipment in exchange for notes payable 5. Cash receipt from the issuance of common stock

Income Statement

A financial statement that reports a company's revenues and expenses and resulting net income or net loss for a specific period of time.

Balance Sheet

A financial statement that reports the assets and claims to those assets at a specific point in time. reports a company's financial position

Step 1. Cash Flows from Operating Activities Receipts Cash Collections from Customers The first item on the income statement shown in Exhibit 14-4 is Net Sales Revenue. Net Sales Revenue represents the total of all sales, whether for cash or on account. The balance sheet account related to Net Sales Revenue is Accounts Receivable.

Accounts Receivable went from $73,000 at December 31, 2017, to $90,000 at December 31, 2018, an increase of $17,000. Net Sales Revenue can be converted to cash receipts from customers as follows: = Net Sales Revenue +Beginning Accounts Receivable (2017) −Ending Account Receivable (2018) = $286K + $73k - $90K = $269k

Step 1. Cash Flows from Operating Activities Receipts Cash Receipts of Interest Revenue (from income statement) The income statement reports interest revenue of $12,000. The balance sheet account related to Interest Revenue is Interest Receivable.

Because there is no Interest Receivable account on the balance sheet, the interest revenue must have all been received in cash. So, the statement of cash flows shows interest received of $12,000.

D. current assets and current liabilities.

Operating activities are most closely related to A. ​long-term assets. B. ​long-term liabilities and​ stockholders' equity. C. dividends and treasury stock. D. current assets and current liabilities.

How is the Statement of Cash Flows Prepared Using the Direct Method? Step 1. When using the direct method, we take each line item of the income statement and convert it from accrual to cash basis.

So, in essence, the operating activities section of the direct-method cash flows statement is really just a cash-basis income statement.

C. ​operating, investing, and financing.

The main categories of cash flow activities on the statement of cash flows are A. ​non-cash investing and financing. B. direct and indirect. C. ​operating, investing, and financing. D. current and​ long-term.

D. All of the above

The purposes of the statement of cash flows are to A. predict future cash flows. B. determine ability to pay debts and dividends. C. evaluate management decisions. D. All of the above

Statement of Retained Earnings

The statement that summarizes the income earned and dividends paid over the life of a business

3 of 3 Classification of Cash Flows : Financing Activities The last category on the statement of cash flows is financing activities. Financing activities include

cash inflows and outflows involved in long-term liabilities and equity. This includes issuing stock, paying dividends, and buying and selling treasury stock. It also includes borrowing money and paying off long-term liabilities such as notes payable, bonds payable, and mortgages payable. The financing activities affect long-term liabilities and equity.

Non-cash Investing and Financing Activities

investing and financing activities that do not involve cash Examples of these activities include the purchase of equipment financed by a long-term note payable or the contribution of equipment by a stockholder in exchange for common stock. These activities are not included in the statement of cash flows. Instead, they appear either as a separate schedule at the bottom of the statement or in the notes to the financial statements.

Step 3: Complete the cash flows from financing activities section by reviewing the long-term liabilities and equity sections of the balance sheet. Cash flows for financing activities are also determined by analyzing the stock accounts. For example, the amount of new issuances of stock is determined by analyzing the stock accounts and reviewing the additional information provided:

• Common & Treasury Stock • Received $120,000 cash from issuing shares of common stock. • Paid $20,000 cash for purchase of shares of treasury stock.

Step 3: Complete the cash flows from financing activities section by reviewing the long-term liabilities and equity sections of the balance sheet. • Computing Dividend Payments The amount of dividend payments can be computed by analyzing the Retained Earnings account. First, we input the balances from the balance sheet: In order for the cash dividends to be reported on the statement of cash flows, the company must have paid the dividends. In this case, we know the cash dividends are paid because there are no dividends payable reported on ShopMart's balance sheet.

• Dividends ShopMart can't have both net income and net loss for the same period; therefore, the missing value must be the amount of dividends ShopMart declared. Solving for the dividends follows: Ending Retained Earnings = Beginning Retained Earnings + Net income − Net loss − Dividends $110,000 = $80,000 + $40,000 − $0 − Dividends Dividends = $80,000 + $40,000 − $0 −$110,000 Dividends = $10,000

Under IFRS, interest revenue and dividend income may be reported either as

operating activity or as an investing activity. Interest expense and dividends paid may be reported either as an operating activity or as a financing activity.

Free cash flow

the amount of cash available from operating activities after paying for planned investments in long-term assets and after paying cash dividends to shareholders. Free cash flow can be computed as follows: Free Cash Flow = Net cash provided by operating activities − Cash payments planned for investments in long term assets* − Cash dividends *Anything not being liquid within one year

How is the Statement of Cash Flows Prepared Using the Direct Method? The Financial Accounting Standards Board (FASB) prefers the direct method of reporting cash flows from operating activities. The direct method provides clearer information about the sources and uses of cash than does the indirect method.

However, very few non-public companies use the direct method because it takes more computations than the indirect method. Investing and financing cash flows are exactly the same presentation under both direct and indirect methods. Because only the preparation of the operating activities section differs, it is all we discuss in this appendix.

Step 1: Cash Flows from Operating Activities falls under the title of - Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities. Includes the following activities: Determines if an increase or decrease

• Depreciation, Depletion, and Amortization Expenses • Gains and Losses on the Disposal of Long-term Assets • Changes in Current Assets and Current Liabilities

Step 3: Complete the cash flows from financing activities section by reviewing the long-term liabilities and equity sections of the balance sheet. Financing activities affect the long-term liability and equity accounts, such as • Long-term Notes Payable, • Bonds Payable, • Common Stock, and • Retained Earnings.

• Long-term Notes Payable To determine the cash flows from financing activities, we need to review each of these account types. • Received $90,000 cash from issuance of notes payable. (inflow -> increase) • Paid $10,000 cash to retire notes payable. (outflow -> decrease)

The statement of cash flows reports on a business's cash receipts and cash payments for a specific period. This statement does the following:

1. Reports on the cash flows of a business—where cash came from (receipts) and how cash was spent (payments). 2. Reports why cash increased or decreased during the period. 3. Covers a span of time and is dated the same as the income statement—"Year Ended December 31, 2018," for example.

Step 5: Prepare a separate schedule reporting any non-cash investing and financing activities This section appears as a separate schedule of the statement of cash flows or in the notes to the financial statements. So, to illustrate them, let's consider three non-cash transactions for another fictitious company, The Outdoors, Inc. How would they be reported? First, we gather the non-cash activities for the company: 1. Acquired $300,000 building by issuing common stock. 2. Acquired $70,000 land by issuing notes payable. 3. Retired $100,000 notes payable by issuing common stock.

2. Acquired $70,000 land by issuing notes payable. The second transaction listed indicates that The Outdoors acquired $70,000 of land by issuing a note. The journal entry to record the purchase would be as follows: This transaction would not be reported on the statement of cash flows because no cash was paid or received. But the land and the notes payable are important. The purchase of the land is an investing activity. The issuance of the note is a financing activity. Taken together, this transaction is a non-cash investing and financing activity.

Step 5: Prepare a separate schedule reporting any non-cash investing and financing activities This section appears as a separate schedule of the statement of cash flows or in the notes to the financial statements. So, to illustrate them, let's consider three non-cash transactions for another fictitious company, The Outdoors, Inc. How would they be reported? First, we gather the non-cash activities for the company: 1. Acquired $300,000 building by issuing common stock. 2. Acquired $70,000 land by issuing notes payable. 3. Retired $100,000 notes payable by issuing common stock

3. Retired $100,000 notes payable by issuing common stock The third transaction listed indicates that The Outdoors retired $100,000 of debt by issuing common stock. The journal entry to record the transaction would be as follows:

Statement of Cash Flows

A financial statement that provides financial information about the cash receipts and cash payments of a business for a specific period of time. reports the cash receipts and cash payments of the business. It shows the sources and uses of cash and helps answer the question "Where did the cash go?"

Step 1. Cash Flows from Operating Activities Depreciation, Depletion, and Amortization Expenses These adjustments include adding back non-cash expenses such as depreciation, depletion, and amortization expenses. These expenses are added back to net income to reconcile net income to net cash flow from operating activities. Suppose you had only two transactions during the period: • Cash sale of $60,000 • Depreciation expense of $20,000

Accrual basis net income is $40,000 ($60,000−$20,000), but net cash flow from operations is $60,000. To reconcile from net income, depreciation of $20,000 must be added to net income, $40,000, to determine net cash flow from operations, $60,000. *Note* : It is added back to balance the equation of ACTUAL CASH FLOW (the cash sale of $60K)

Step 1. Cash Flows from Operating Activities Receipts Cash Receipts of Dividend Revenue (from income statement) The income statement reports dividend revenue of $9,000. The balance sheet account related to Dividend Revenue is Dividends Receivable.

As with the interest, there is no Dividends Receivable account on the balance sheet. Therefore, the dividend revenue must have all been received in cash. So, the statement of cash flows shows cash received from dividends of $9,000.

Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities. When using the indirect method, the statement of cash flows operating activities section begins with net income (or net loss) because revenues and expenses, which affect net income, produce cash receipts and cash payments.

But net income as shown on the income statement is accrual-based, and the cash flows (cash basis net income) do not always equal the accrual basis revenues and expenses. For example, sales on account generate revenues that increase net income, but the company has not yet collected cash from those sales. Accrued expenses decrease net income, but the company has not paid cash if the expenses are accrued. To go from net income to net cash flow from operating activities, we must make some adjustments to net income on the statement of cash flows. These additions and subtractions follow net income and are labeled Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities.

Step 1. Cash Flows from Operating Activities Gains and Losses on the Disposal of Long-term Assets Disposals of long-term assets such as land and buildings are investing activities, and these disposals usually create a gain or a loss. The gain or loss is included in net income, which is already in the operating activities section of the statement of cash flows. The gain or loss must be removed from net income on the statement of cash flows so the total cash receipts from the sale of the asset can be shown in the investing activities section.

IMPORTANT NOTE THE INVERSE - The gain or loss is already included in "Net Income" so to account you must reflect the inverse to balance. Exhibit 14-4, ShopMart's income statement, includes a gain on disposal of plant assets. During 2018, ShopMart sold equipment, and there was a gain of $10,000 on the sale. The gain was included in the calculation of net income on the income statement, so the gain must be removed from operating cash flows. The gain increased net income, so it is subtracted in the operating activities section. ex. • Sold plant assets with a cost of $55,000 and accumulated depreciation of $15,000, yielding a gain of $10,000 Reflect ($10,000)

Step 4: Compute the net increase or decrease in cash during the year. The change in cash is the key reconciling figure for the statement of cash flows and must match the change in cash reported on the comparative balance sheet. To complete the statement of cash flows, the net change in cash and its effect on the beginning cash balance must be shown. This represents the total change in cash for the period and reconciles the statement of cash flows.

Net Change in Cash and Cash Balances 1. First, the net increase or decrease in cash is computed by combining the cash provided by or used for operating, investing, and financing activities. Net increase (decrease) in cash = Net cash provided by operating activities − Net cash used for investing activities + Net cash provided by financing activities = $70,000 − $260,000 + $170,000 = $(20,000) 2. Next, the beginning cash from December 31, 2017, is listed at $42,000, as shown on the comparative balance sheet. The net decrease of $20,000 is subtracted from beginning cash of $42,000, which equals the ending cash balance on December 31, 2018, of $22,000. This is the key to the statement of cash flows—it explains why the cash balance for ShopMart decreased by $20,000, even though the company reported net income for the year.

Non-cash Expenses and Gains or Losses on Disposal of Long-term Assets Non-cash expenses and gains or losses on disposal of long-term assets are reported on the income statement but are not included in the operating activities when using the direct method.

Non-cash expenses are not reported because these items do not affect cash. The cash received from the disposal of long-term assets is reported in the investing activities section, not the operating activities section.

Step 5: Prepare a separate schedule reporting any non-cash investing and financing activities

Non-cash investing and financing activities are reported in a separate part of the statement of cash flows. Exhibit 14-7 illustrates non-cash investing and financing activities for The Outdoors. This information is either reported as a separate schedule following the statement of cash flows or can be disclosed in a note.

Step 1. Cash Flows from Operating Activities Payments for Interest Expense and Payments for Income Tax These cash payments are reported separately from the other expenses.

Payments for Interest Expense The accounts related to interest payments are • Interest Expense from the income statement and • Interest Payable from the balance sheet. Because there is no Interest Payable account on the balance sheet, the Interest Expense account from the income statement must represent all amounts paid in cash for interest. So, the statement of cash flows shows cash payments for interest of $15,000. Payments for Income Tax The accounts related to income tax payments are • Income Tax Expense from the income statement and • Income Tax Payable from the balance sheet. Because there is no Income Tax Payable account on the balance sheet, the Income Tax Expense account from the income statement must represent all amounts paid in cash for income tax. So, the statement of cash flows shows cash payments for income tax of $14,000.

Step 1. Cash Flows from Operating Activities Payments Suppliers, also called vendors, are those entities that provide the business with its merchandise inventory and essential services.

Payments to suppliers include all payments for the following: • Merchandise inventory • Operating expenses except employee compensation, • interest, and income taxes

Exhibit 14-5 Statement of Cash Flows—Indirect Method Started with $40K Income (from income statement) • Purchased $310,000 in plant assets by paying cash. • Sold plant assets with a cost of $55,000 and accumulated depreciation of $15,000, yielding a gain of $10,000. • Received $90,000 cash from issuance of notes payable. • Paid $10,000 cash to retire notes payable. • Received $120,000 cash from issuing shares of common stock. • Paid $20,000 cash for purchase of shares of treasury stock.

Step 1. Operating Activities • Sold plant assets with a cost of $55,000 and accumulated depreciation of $15,000, yielding a gain of $10,000. Step 2: Investing Activities • Purchased $310,000 in plant assets by paying cash. • Sold plant assets with a cost of $55,000 and accumulated depreciation of $15,000, yielding a gain of $10,000. Step 3: Financing Activities • Received $90,000 cash from issuance of notes payable. • Paid $10,000 cash to retire notes payable. • Received $120,000 cash from issuing shares of common stock. • Paid $20,000 cash for purchase of shares of treasury stock. *NOTE* Not all transactions are listed for the Statement of Cash Flows - some line items are provided as examples for learning purposes, such as the Depreciation Expense - Plant Assets.

Step 1. Cash Flows from Operating Activities Payments to Employees This category includes payments for salaries, wages, and other forms of employee compensation. • Accrued amounts are not cash flows because they have not yet been paid.

The accounts related to employee payments are: • Salaries and Wages Expense from the income statement and Salaries and • Wages Payable from the balance sheet. Because there is not a Salaries and Wages Payable account on the balance sheet, the Salaries and Wages Expense account must represent all amounts paid in cash to employees. So, the statement of cash flows shows cash payments to employees of $56,000.

Step 2: Complete the cash flows from investing activities section Investing activities affect long-term assets, such as • Plant Assets, • Investments, and • Notes Receivable. When computing investing cash flows, it is helpful to evaluate the T-accounts for each long-term asset. The T-account will show if there was an acquisition or disposal that happened during the year.

The beginning and ending balances for each account are taken directly from the comparative balance sheet. Depreciation expense has been included in the Accumulated Depreciation account, and this was taken from the income statement. The acquisition and disposal information came from the additional information provided when we introduced the example: • Purchased $310,000 in plant assets by paying cash. We now know that ShopMart paid $310,000 cash to purchase plant assets. This item is listed first in the investing activities section and shown as an outflow of cash, as indicated by the parentheses.

How is the Statement of Cash Flows Prepared Using the Indirect Method? To prepare the statement of cash flows, you need: • the income statement for the current year, • the balance sheets from the current and prior years. In addition, you need to review the transactions for some additional information.

To prepare the statement of cash flows by the indirect method, we follow Steps 1-5: Step 1: Complete the cash flows from operating activities section using net income and adjusting for increases or decreases in current assets (other than cash) and current liabilities. Also adjust for gains or losses from long-term assets and non-cash expenses such as depreciation expense. Step 2: Complete the cash flows from investing activities section by reviewing the long-term assets section of the balance sheet. Step 3: Complete the cash flows from financing activities section by reviewing the long-term liabilities and equity sections of the balance sheet. Step 4: Compute the net increase or decrease in cash during the year. The change in cash is the key reconciling figure for the statement of cash flows and must match the change in cash reported on the comparative balance sheet. Step 5: Prepare a separate schedule reporting any non-cash investing and financing activities.

Step 2: Complete the cash flows from investing activities section Next we need to determine the amount of cash received for the disposal of plant assets. Using the information provided, we can recreate the journal entry for the disposal and solve for the missing cash amount. • Sold plant assets with a cost of $55,000 and accumulated depreciation of $15,000, yielding a gain of $10,000. Note : Don't be confused by the word "cost", we "sold" this asset for $50,000, and made a profit of $10,000. Since we are reversing cash flows (to determine where the money went) these are listed as credits to the Net Income amount. Depreciation is normally a credit but here we list as a debit to balance the equations.

We compute the cash receipt from the disposal as follows: Cash received = = Cost − Accumulated Depreciation + Gain − Loss = $55,000 − $15,000 + $10,000 = $50,000 NOTE : BALANCE OUT The cash receipt from the sale of plant assets of $50,000 is shown next in the investing activities section. As there are no other changes to long-term assets, the net cash from investing activities is determined. Notice that this is a net cash outflow, as indicated by the parentheses, and is reported as Net Cash Used for Investing Activities.

1 of 3 Classification of Cash Flows : Operating activities Operating activities is the first section on the statement of cash flows and is often the most important category. The operating activities section reports The operating activities section (indirect method) always starts with accrual basis net income. Adjustments are then made to determine the cash basis net income.

activities that create revenue or expense in the entity's business. It reflects the day-to-day operations of the business such as cash receipts (cash inflows) from customers for the sales of merchandise inventory and services and the cash payments (cash outflows) for purchases of merchandise inventory or payment of operating expenses. The operating activities section also includes cash receipts (cash inflows) for interest revenue and dividend income and cash payments (cash outflows) for interest expense and income tax expense. The operating activities section reports on how cash flows affect the current accounts—current assets and current liabilities.

2 of 3 Classification of Cash Flows : Investing activities Investing activities is the second category listed on the statement of cash flows. This section reports

cash receipts and cash payments that increase or decrease long-term assets such as property, plant, equipment, notes receivable, and investments. It includes the cash inflow from selling and the cash outflow for the purchase of these long-term assets. In addition, it includes the lending (cash outflow) and collection (cash inflow) of long-term notes receivable. Investing activities affect the long-term assets.

Step 1. Cash Flows from Operating Activities Changes in Current Assets and Current Liabilities Most current assets and current liabilities result from operating activities. For example: Accounts receivable result from sales. Merchandise inventory relates to cost of goods sold, and so on. Changes in the current asset and current liability accounts create adjustments to net income on the statement of cash flows, as follows:

• An increase in a current asset other than cash causes a decrease adjustment to net income. For example, ShopMart's balance sheet in Exhibit 14-3 shows that Accounts Receivable increased by $17,000. Accounts Receivable is increased when the company makes sales on account and decreases when the company collects cash from customers. • A decrease in a current asset other than cash causes an increase adjustment to net income. ShopMart's Merchandise Inventory decreased by $2,000. What caused the decrease? ShopMart must have sold more merchandise inventory than it purchased. Therefore, we add the decrease in Merchandise Inventory of $2,000 to net income on the statement of cash flows. • An increase in a current liability causes an increase adjustment to net income. ShopMart's Accounts Payable increased by $40,000. This means there were more purchases on account than cash paid for the purchases, resulting in an increase to the liability. Accordingly, even though net income was reduced by the expense, cash was not reduced as much. Therefore, an increase in a current liability is added to net income in the statement of cash flows. • A decrease in a current liability causes a decrease adjustment to net income. The payments of the current liabilities were more than the accrual of the expenses. Therefore, we subtract decreases in current liabilities from net income to get net cash flow from operating activities. ShopMart's Accrued Liabilities decreased by $5,000. That change shows up as a $5,000 decrease adjustment to net income.

Step 1. Cash Flows from Operating Activities Payments to Suppliers -> 1 line item from 2 parts • Cash paid for merchandise inventory + • Other Operating Expenses The accounts related to supplier payments for merchandise inventory are • Cost of Goods Sold, • Merchandise Inventory, and • Accounts Payable. + Other Operating Expenses

• Cash paid for merchandise inventory = Cost of Goods Sold −Beg. Merchandise Inventory +Ending Merchandise Inventory +Beginning Accounts Payable −Ending Accounts Payable = $156K (Income Statement) - $145K (2017 Balance Sheet) + $143K (2018 Balance Sheet) + $50K (2017 Balance Sheet) - $90K (2018 Balance Sheet) = $114K • Other Operating Expense = =Other Operating Expense +Beg. Accrued Liabilities -End. Accrued Liabilities =$16K (Income Statement 2018) +$10K (2017 Balance Sheet) -$ 5K (2018 Balance Sheet) =$21K Supplier Payments = =$114K + 21K =$135K as a negative (outflow)

(continued) Step 3: Complete the cash flows from financing activities section by reviewing the long-term liabilities and equity sections of the balance sheet. • Computing Dividend Payments

• Dividends In order for the cash dividends to be reported on the statement of cash flows, the company must have paid the dividends. In this case, we know the cash dividends are paid because there are no dividends payable reported on ShopMart's balance sheet. A stock dividend has no effect on Cash and is not reported in the financing activities section of the statement of cash flows. ShopMart had no stock dividends, only cash dividends, which will be shown as an outflow in the financing activities section of the statement of cash flows.

Classification of Cash Flows There are three basic types of cash flow activities, and the statement of cash flows has a section for each:

• Operating activities • Investing activities • Financing activities The three sections of the statement of cash flows report only activities that involve cash. Companies do make investments that do not require cash. They also obtain financing that does not involve cash. Such transactions are called non-cash investing and financing activities.

Purpose of the Statement of Cash Flows The statement of cash flows explains why net income as reported on the income statement does not equal the change in the cash balance. How do people use cash flow information? The statement of cash flows helps do the following:

• Predict future cash flows. Past cash receipts and payments help predict future cash flows. • Evaluate management. Wise investment decisions help the business prosper, while unwise decisions cause the business to have problems. Investors and creditors use cash flow information to evaluate managers' decisions. • Predict ability to pay debts and dividends. Lenders want to know whether they will collect on their loans. Stockholders want dividends on their investments. The statement of cash flows helps make these predictions.

Two Formats for Operating Activities There are two ways to format the operating activities section of the statement of cash flows:

○ The indirect method starts with net income and adjusts it to net cash provided by operating activities. ○ The direct method restates the income statement in terms of cash. The direct method shows all the cash receipts and all the cash payments from operating activities. The indirect and direct methods use different computations but produce the same amount of net cash flow from operating activities. Both methods present investing activities and financing activities in exactly the same format. Only the operating activities section is presented differently between the two methods. IFRS permits the use of either the direct or indirect method.