Fall 2010 Class 11-12

Fall 2010 Class 11-12 - CHAPTER 22 Statement of Cash Flows...

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Unformatted text preview: CHAPTER 22 Statement of Cash Flows Cash and Cash Equivalents Cash and Cash Equivalents Cash • Cash on hand • Demand deposits Demand (checking accounts) (checking All references to Cash All include Cash Equivalents include when discussing the when Statement of Cash Flows Statement Cash Equivalents • Investments that are – Short term, – Highly liquid, and – Easily converted to a Easily known amount of cash known – Subject to an Subject insignificant risk of change in value change • Bank overdrafts (-) Usefulness of the Usefulness of the Statement of Cash Flows • The information may help users assess the The following: following: – The entity’s ability to generate future cash The flows flows – The entity’s ability to pay dividends, meet The obligations, and increase capacity obligations, – The reasons why net income and net cash why flow from operating activities differ The Cash Flow Statement The Cash Flow Statement • The cash flow statement provides The information about: information • the cash receipts (cash inflows), and (cash and • uses of cash (cash outflows) during the (cash year • Inflows and outflows are reported for: • operating activities • investing activities, and and • financing activities during the year during Cash Flow from Operating Activities Cash Flow from • The cash flows resulting from the primary The revenue generating activities of the revenue business, such as: • • • • • Collections from customers Payments to suppliers Payments to employees Payments to CRA for tax Changes Changes in working capital working accounts accounts Cash flow provided by operating activities is Cash necessary for long term sustainability of the long business business Cash Flow from Investing Activities Cash Flow from • The acquisition and disposal of long term The assets and long-term investments assets • Examples include: • • • Purchase/disposal of capital assets Acquiring an interest in another corporation Cash flow generated by investing activities Cash shows whether the business is investing in its future its Cash Flow From Financing Activities Cash Flow From • Changes in long-term debt or equity capital Changes long-term • Examples include: • • • Issuing debt, or repayment of debt Issuing new shares, or repurchase of Issuing currently outstanding shares currently Provides information to assess potential for Provides future claims to entity’s cash, iidentify major dentify future changes in capital structure. capital Statement of Cash Flows: Concept Statement of Cash Flows: Concept Operating activities Investing activities Financing activities Inflows Cash Pool Operating activities Investing activities Outflows Financing activities Significant Noncash Transactions Significant Noncash Transactions • Transactions that do not involve the direct Transactions receipt or disbursement of cash in the period receipt • Examples: – Asset purchased, paid for by assuming debt, Asset or issuance of shares or – Conversion of debt to equity – Issue shares to retire debt – Exchanges of nonmonetary assets • Noncash transactions are not reported on the Noncash not Statement of Cash Flows. Statement Preparing the Operating Section of Preparing the Operating Section of SCF • Two methods of preparing the “Cash Flow from Cash Operating Activities” section of the Statement of Operating Cash Flows: Cash – Indirect method – Direct method • Indirect method derives operating cash flows Indirect from accrual basis income statement from accrual income • Direct method determines operating cash flows Direct directly for each operating source or use of cash cash Cash Flow from Operations: Cash Flow from Operations: Indirect Method – Concept Earned Earned Revenues Revenues + Eliminate non-cash revenues non-cash & non-operating gains non-operating Net Income Expenses Incurred ­ Operating cash flow Eliminate non-cash charges non-cash & non-operating losses non-operating Structure of the Statement of Structure of the Statement of Cash Flows (Indirect Method) Cash flows from operating activities: Net Income (Loss) Adjustments (List individual adjustments) Net cash flow from operating activities $ XXX $ XX XX $ XXX Cash flows from investing activities: (List individual inflows and outflows) (List Net cash flow from investing activities $ XX $ XXX Cash flows from financing activities: (List individual inflows and outflows) Net cash flow from financing activities $ XX $ XXX Change in cash $ XXX XXX Cash Flow from Operations: Direct Cash Flow from Operations: Method—Concept Cash Payments Cash Receipts To suppliers Collections from customers To employees less less From receipts of interest and of interest dividends For operating exp For interest For taxes equals Cash flow from operations Structure of the Statement of Cash Structure of the Statement of Cash Flows (Direct Method) Cash flows from operating activities: Cash receipts (individually): Inflows Cash payments (separately): outflows Net cash flow from operating activities $ XXX ($ XXX) ($ $ XXX Cash flows from investing activities: (List individual inflows and outflows) Net cash flow from investing activities $ XX $ XXX Cash flows from financing activities: (List individual inflows and outflows) Net cash flow from financing activities $ XX $ XXX Change in cash Change $ XXX XXX 4 Steps to Prepare A Complete SCF 4 Steps to Prepare A Complete SCF • Step 1: Determine the change in cash. • Step 2: Record information from the I/S on Step the SCF. the • Step 3: Analyze the change in each B/S Step account, identify any associated cash flows, and record the them on the SCF. and • Step 4: Complete the SCF. Example — Indirect Method Example Tax Consultants Inc. began operations on January 1, 2005. The income statement and balance sheet for year 2005 follow. Income Statement Income Revenues Less: Operating expenses Less: Income before Tax Less: Income Tax Less: Net Income Net $ 125,000 85,000 40,000 6,000 $ 34,000 34,000 A dividend of $14,000 was declared and paid during the year. Indirect Method: Example Indirect Method: Example Assets: Cash Accounts Receivable Total Total Balance Sheet Balance Dec 31, 2005 Jan 1, 2005 Jan $ 49,000 36,000 $ 85,000 85,000 $-0-0-0$-0- Liabilities and Shareholders’ Equity: Accounts Payable $ 5,000 Common Shares 60,000 Retained Earnings 20,000 Total $85,000 $85,000 $-0-0-0-0$-0- Step 1: Change in Cash Step = 49,000 49,000 Operating Activities Operating Activities Cash Flow Accrual Basis Net Income Net Accounts Receivable Accounts Accounts Payable Accounts $34,000 $34,000 +$ 36,000 +$ +$ 5,000 +$ Step 2 Net Income Net $34,000 $34,000 Less: Increase in A/R Add: Increase in A/P $ 36,000 $ 5,000 5,000 Step 3 Changes between beginning and ending balances Operations: Net Inflow $3,000 See explanations next slide Adjustments to NI for non­cash Adjustments to NI for non­cash expenses and revenues Current Current Assets Assets Current Current Liabilities Liabilities Balance Balance Increase Increase Subtract Add Balance Balance Decrease Decrease Add Subtract Investing and Investing and Financing Activities Accrual Basis Cash Flow Financing Activities: Common Stock +$60,000 Common Retained Earnings+ $20,000 $20,000 Beg Bal: Net Income: lless: Dividends ess: End Balance: $ 0 34,000 (14,000) (14,000) $20,000 Issue of Shares: $60,000 Dividends paid: ( 14,000) Dividends 14,000) Inflow 46,000 Step 3 Cash Flow Statement Cash Flow Statement (Indirect Method) Net Income $34,000 Adjustment: Increase in A/R -36,000 Increase in A/P Increase Cash provided by operating activities: Cash operating Cash used by investing activities: Cash investing +5,000 +3,000 +3,000 -0-0- Cash provided by financing activities: Cash financing Proceeds from issue of common shares Proceeds +60,000 +60,000 Dividends paid -14,000 +46,000 +46,000 Increase in Cash $ 49,000 49,000 Direct Method: Direct Method: Operating Activities Operating Activities: Cash receipts from customers +125,000 ­36,000 = +$ 89000 Cash paid to suppliers ­85,000 +5,000 =­80,000 Cash paid for income taxes ­6,000 +0 =­6,000 Net cash inflow $ 3,000 Step 1 2 Step 3 Direct Method: Direct Method: Operating Activities Operating Activities: Cash receipts from customers $ 89000 Cash paid to suppliers (80,000) Cash paid for income taxes (6,000) Net cash inflow $ 3,000 Other Items­1. Amortization Expenses Other Items­1. Amortization Expenses • Amortization expenses must be adjusted in Amortization determining cash from operations. Why? determining They represent deferred costs incurred and paid They for in a previous period, and there is no cash flow in and no associated with the amortization. How to handle them? Indirect method: Amortization expenses are added Indirect back to net income. back Direct method: Amortization expenses are not Direct included. included. 2. Change of account receivable / 2. Change of baddebt allowance with bad debt write­ off • The difference between beginning balance and The ending balance does not tell the whole story. Why? Why? A/R balance can be affected by sale, collection, A/R and bad debt write-off. bad How to handle them? Indirect method: (E/B-B/B) and the write-off are Indirect subtracted from net income. subtracted Direct method: Direct Total cash receipts = Sales - (E/B-B/B) - Write-off Total 3.Determining bad debt expenses 3.Determining bad debt expenses • Estimation of bad debt expenses increase the Estimation balance of Allowance for Doubtful Accounts, while A/R write-off reduce ADA balance. How to handle them? Indirect method: Add back (E/B-B/B) and the writeoff to net income. Direct method: related expense item is reduced by Direct (E/B-B/B + write-off ) (E/B-B/B 4. Change of inventory with purchase 4. Change of inventory with purchase on account • The firm has not paid for some of the total The not purchase. But SCF only includes cash purchase. purchase. How to handle them? Indirect method: change of inventory and change Indirect of accounts payable need to be added back to (subtracted from) net income. (subtracted Direct method: Cash payment to supplier=COGS+ (E/B of inv.-B/B of inv.)-(E/B of A/P-B/B of A/P) 5. Change in long­term assets (land, 5. Change in long­term assets (land, building, equipments, long­term investment) • Increase in these accounts often involves nonIncrease noncash transactions. cash • Decrease in these accounts often causes gains or Decrease losses. 6. Long­term assets increased with 6. Long­term assets increased with financing • Invest in long-term assets by assuming longInvest longterm debts or issuing shares. issuing • Non-cash transaction. • No effect on SCF 7. Asset Disposal Gain/Loss 7. Asset Disposal Gain/Loss • Income statement gains and losses on disposal of longterm assets must be adjusted in determining cash from term operations. Why? operations. These result from investing activities, not operating activities, These investing and the amount of the cash flow is the proceeds on disposal, proceeds not the gain or loss How to handle them? Indirect method: Losses (Gains) are added back (subtracted Indirect from) to net income. from) Direct method: Gains/Losses are not included. Cash receipts included in investing activities Cash investing activities 8. Reduced accumulated amortization 8. Reduced accumulated amortization due to…. • Asset disposal • Major repair – Direct method: amortization has to be deduct amortization from expense item from – Indirect method: amortization expense added amortization back to NI back – Total amortization amount =E/B-B/B+Acc. Amort. of diposed assets +repair costs Amort. – Cash paid for repair as investing outflow 9. Loans to other companies 9. Loans to other companies • Pay back of principal cash flow from Pay investing investing • Payment of interests operating cash inflow – Direct method: included as an operating inflow – Indirect method: Cash-based, no adjustment 10. Long­term equity investment 10. Long­term equity investment • • • Equity method vs. cost method (the 20% rule) If using equity method: – Investment income is recognized by % of invested entity’s Investment net income net – Investment account balance increases by the same amount – Cash dividends reduce investment balance Effect: – Cash dividends received are included as operating inflow Cash (not investing inflow) – Indirect method: non-cash investment income is deducted Indirect from NI from – Direct method: only the cash dividends received is included 11. Interest/ dividend expenses and 11. Interest/ interest revenue • To keep the comparability between SCF and To I/S, this items are treated as part of the firm’s operating activity operating • Dividend expenses?? 12. Dividend payout / Dividend payable 12. Dividend payout / Dividend payable • Dividend payout on equity instruments are Dividend equity financing outflow financing • Dividend payable is a current liability, but is Dividend not part of the adjustment to NI not 13. Lease payment 13. Lease payment • Capital lease – First payment, 100% financing outflow – Subsequent payments • Pay back of principal financing outflow financing • Interest payment operating outflow operating • Operating lease – 100% rental payment is operating outflow 100% operating 14. Future income tax expenses / 14. Future income tax expenses / benefits • Total tax expenses=current expense + future Total expense expense – Direct method: Tax payment =current Direct Tax expenses- (E/B of tax payable-B/B of tax payable) payable) – Indirect method: add back future expense / Indirect add expense subtract benefits from NI. subtract benefits 15. Debt Redemption Gain/Loss 15. Debt Redemption Gain/Loss These result from financing activities, not These financing operating activities, and the amount of the cash flow is the amount paid to redeem the debt, not amount not the gain or loss How to handle them? Indirect method: Losses (Gains) are added back Indirect (subtracted from) to net income. (subtracted Direct method: Gains/Losses are not included. Exercise E22­3 Exercise E22­3 Summary of SCF Summary of SCF • Three types of adjustments to net income: – Some expenses / revenues that are not 100% cashbased (e.g. purchase on account, credit sales) based (e.g. – Some expenses that are not cash-based (amortization) Some (amortization) – Gains and losses that is not part of the operating Gains activities (asset disposal gain or loss). • Changes in working capital accounts are usually Changes related to operating activities related • Changes in long-term assets are usually related to Changes investing activities investing • Changes in long-term debts and equity accounts are Changes related to financing activities related ...
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This note was uploaded on 03/15/2012 for the course BUS 303 taught by Professor Brown during the Spring '11 term at Simon Fraser.

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