15: Chapter Statement of Cash Flows
Cornerstones of Managerial Accounting, 4e
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Learning Objectives
1. Explain the basic elements of a statement of cash flows. 2. Prepare a statement of cash flows using the indirect method. 3. Calculate operating cash flows using the direct method. 4. Prepare a statement of cash flows using a worksheet approach.
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All firms that are registered with the U.S. Securities and Exchange Commission (SEC) must issue a statement of cash flows. The statement of cash flows provides information regarding the sources and uses of a firm's cash.
Activities that increase cash are sources of cash and are referred to as cash inflows. Activities that decrease cash are uses of cash and referred to as cash outflows.
Overview of the Statement of Cash Flows
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Cash Defined
Cash is defined as both currency and cash equivalents. Cash equivalents are highly liquid investments such as Treasury bills, money market funds, and commercial paper. Many firms, as part of their cash management programs, invest their excess cash in these short-term securities. Because of their high liquidity, these short-term investments are treated as cash for the statement of cash flows.
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Statement of Cash Flows Categories
Operating activities are the ongoing, day-to-day, revenuegenerating activities of an organization. Typically, operating cash flows involve increases or decreases in either current assets or current liabilities. Investing activities are those activities that involve the acquisition or sale of long-term assets. Long-term assets may be productive assets (e.g., acquiring new equipment) or long-term activities (e.g., acquiring stock in another company). Financing activities are those activities that raise (provide) cash from (to) creditors and owners. Although interest payments could be seen as financing outflows, the statement includes these payments in the operating section.
The statement provides additional information by classifying cash flows into three categories:
This classification, called the activity format, is the 2012 Cengage Learning. All preparing not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a formatdistributedRightsa Reserved. May orthe statement. for with certain product service or otherwise on a password-protected website for classroom use. license
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Classifying Activities and Identifying Them as Sources or Uses of Cash
Cornerstone 151
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Noncash Exchanges
Occasionally, investing and financing activities take place without affecting cash. These are referred to as noncash investing and financing activities. A direct exchange of noncurrent balance sheet items may occur, like land exchanged for common stock. These noncash transactions must also be disclosed in a supplementary schedule attached to the statement.
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Methods for Calculating Operating Cash Flows
The indirect method computes operating cash flows by adjusting net income for items that do not affect cash flows. The direct method computes operating cash flows by adjusting each line on the income statement to reflect cash flows.
There are two approaches for calculating operating cash flows.
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Methods for Calculating Operating Cash Flows (continued)
If the direct method is used, companies must also provide a supplementary schedule that shows how net income is reconciled with operating cash flows. This requirement means that direct method users must also provide the information associated with the indirect method. On the other hand, if the indirect method is used, there is no need to provide a line-by-line adjustment as found in the direct method. The indirect method is the most commonly used method.
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Five basic steps are followed in preparing a statement of cash flows:
Preparation of the Statement: Indirect Method
Step 1. Compute the change in cash for the period. Step 2. Compute the cash flows from operating activities. Step 3. Identify the cash flows from investing activities. Step 4. Identify the cash flows from financing activities. Step 5. Prepare the statement of cash flows based on the previous four steps.
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Step 1: Compute Change in Cash Flows
The first basic step in preparing a statement of cash flows is to compute the change in cash for the period. This figure is the difference between the ending and beginning cash balances shown on the balance sheets. It must equal the net cash inflow or outflow shown on the statement of cash flows. This number serves as a control figure for the statement of cash flows.
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Computing the Change in Cash Flow
Cornerstone 152
Information: Lemmons Company's balance sheet showed the following information on cash and cash equivalents:
Required: Calculate the change in cash flow.
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Step 2: Compute Operating Cash Flows
The accrual income statement can be converted to an operating cash flow basis by making four adjustments to net income: A. Add to net income any increases in current liabilities and decreases in noncash current assets. B. Deduct from net income any decreases in current liabilities and increases in noncash current assets. C. Add to or deduct from net income the remaining net income items that do not affect cash flows (e.g., add back noncash expenses). D. Eliminate any income items that belong in either the investing or financing section.
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Calculating Operating Cash Flows Using the Indirect Method
Information: Lemmons Company's balance sheet showed the following information on current assets and liabilities:
Cornerstone 153
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Calculating Operating Cash Flows Using the Indirect Method (continued)
Cornerstone 153
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Step 3: Compute Investing Cash Flows
Identify the cash flows from investing activities. Use the period's beginning and ending balance sheets and information about other events and transactions to identify the cash flows associated with the sale and purchase of longterm assets.
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Computing Investing Cash Flows
Cornerstone 154
Information: Equipment with a book value of $50,000 was sold for $70,000 (original purchase cost of $90,000). New equipment was purchased. Lemons Company's balance sheet showed the following information on investing transactions:
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Computing Investing Cash Flows (continued)
Cornerstone 154
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Step 4: Compute Financing Cash Flows
Identify the cash flows from financing activities. Use the period's beginning and ending balance sheets to identify the cash flows associated with long-term debt and capital stock.
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Computing Financing Cash Flows
Cornerstone 155
Information: Net income of $180,000 was earned in 2012. Lemmons Company's balance sheet showed the following information on financing transactions:
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Computing Financing Cash Flows (continued)
Cornerstone 155
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Step 5: Prepare the Statement of Cash Flows
The final step is to prepare the statement of cash flows based on the previous four steps. The outcomes of Steps 2 through 4 correspond to the individual sections needed for the statement of cash flows. Notice that the change in cash flow computed in Step 1 from the comparative balance sheets corresponds to the net increase in cash identified in the statement of cash flows. The computation produced by Step 1 serves as a control on the accuracy of Steps 2 through 4.
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Preparing the Statement of Cash Flows
Cornerstone 156
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The Importance of Cash Flow Analysis for Acquisition Decisions
You Decide
When trying to determine information about cash flows, the statement of cash flows is the most valuable source of information because it shows the cash flows from operating, financing, and investing activities.
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The Direct Method: An Alternative Approach
Some individuals prefer to show operating cash flows as the difference between cash receipts and cash payments. To do so, each item on the accrual income statement is adjusted to reflect cash flows. However, if a company chooses to prepare the statement of cash flows using this direct method, it must also present the indirect method in a separate schedule. The same adjustments and the same reasoning are used to produce the operating cash flows for both the direct and indirect methods, but the presentation is different.
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Calculating Operating Cash Flows Using the Direct Method
Cornerstone 157
Information: Lemmons Company's balance sheet showed the following information on current assets and liabilities:
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Calculating Operating Cash Flows Using the Direct Method (continued)
Cornerstone 157
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As transactions increase in number and complexity, a worksheet becomes useful in preparing the statement of cash flows. The approach minimizes confusion and allows careful consideration of all the details underlying an analysis of cash flows. One advantage of a worksheet is the fact that it uses a spreadsheet format, allowing the preparer to use a computer and spreadsheet software like Excel. Furthermore, a worksheet offers the user an efficient, logical means to organize the data needed to prepare a statement of cash flows. Although the worksheet itself is not the statement of cash flows, the statement can be easily extracted from the 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a worksheet. with a certain product or service or otherwise on a password-protected website for classroom use. license distributed
Worksheet Approach to the Statement of Cash Flows
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Cornerstone 158 Preparing a Statement of Cash Flows Using a Worksheet Approach
Information: The comparative balance sheets for Porterman Company follow:
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Cornerstone 158 Preparing a Statement of Cash Flows Using a Worksheet Approach (continued)
Other transactions (2012) include the following:
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Cornerstone 158 Preparing a Statement of Cash Flows Using a Worksheet Approach (continued)
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Analysis of Transactions: Change in Cash
The summary transactions on the worksheet will be explained by examining the items on the worksheet in order of their appearance (essentially equivalent to the numerical order of the entries).
The information here refers to that of Portermart Company.
Change in Cash:
Entry (1): Identifies the total change in cash during 2012.
(1) Cash
93,000 Net Increase in cash 93,000
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Change in Accounts Receivable
Analysis of Transactions Change in Accounts Receivable & Decrease in Inventory
Entry (2): Reflects the increase in accounts receivable.
(2) Accounts Receivable Operating Cash
5,000 5,000
Decrease in Inventory
Entry (3): Reflects the effect of a decrease in inventory on operating cash flow.
(3) Operating Cash Inventory
25,000 25,000
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Sale of Equipment
Analysis of Transactions: Sale of Equipment & Depreciation Expense
Entry (4): The sale of equipment affects two balance sheet accounts and two cash flow accounts.
(4)
Operating Cash Cash from Investing Activities Accumulated Depreciation Plant & Equipment
7,000 8,000 15,000 30,000
Depreciation Expense
Entry (5): Shows an increase in operating cash flow because depreciation expense, a noncash expense, is added back to net income.
(5) Operating Cash Accumulated Depreciation
10,000 10,000
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Analysis of Transactions: Land for Common Stock
Three balance sheet accounts are affected in the noncash transaction that acquires land in exchange for common stock. To balance transactions columns, two separate entries [(6) and (11)] are needed.
Land for Common Stock:
(6) Land Noncash investing activities (11) Noncash investing activities Common Stock Paid-in Capital in Excess Par
40,000 40,000 40,000 10,000 30,000
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Analysis of Transactions: Accounts Payable & Wages Payable
Entry (7): Provides the adjusting entry for an increase in accounts payable.
Accounts Payable
(7) Operating Cash Accounts Payable
20,000 20,000
Wages Payable
Entry (8): Wages payable decreased by $2,000 during 2012.
(8) Wages Payable Operating Cash
2,000 2,000
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Bonds Payable
Analysis of Transactions: Bonds Payable & Preferred Stock
Entry (9): Bonds payable decreased by $10,000, indicating a cash outflow belonging to the financing section.
(9)
Bonds Payable Cash Flow from Financing Activities
10,000 10,000
Preferred Stock
Entry (10): Reflects the cash inflow that resulted from the issuance of preferred stock.
(10) Cash Flow From Financing Activities Preferred Stock
10,000 10,000
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Net Income:
Analysis of Transactions: Net Income & Payment of Dividends
Entry (12): Net income is assigned to the operating cash flow section.
(12) Operating Cash Retained Earnings
40,000 40,000
Payment of Dividends
Entry (13): The payment of dividends.
(13) Retained Earnings Cash Flow From Financing Activities 10,000 10,000
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The Final Step
Once the worksheet is completed, the final step in preparing the statement of cash flows is relatively straightforward. The lower half of the worksheet contains all of the sections needed. The debit column provides the cash inflows, and the credit column provides the cash outflows. The noncash section is an exception; either column may be used to provide the information. The only additional effort needed is to compute subtotals for each section.
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The Final Step
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