Chapter 17

What is cash flow? Cash inflows and cash outflows Cash receipts and cash payments

Cash Flows

What are the three financial statements that we have studied so far? Balance sheet Income statement Retained Earnings These statements fail to give us some basic information about cash movement. Balance sheet does not give us information concerning how additions were financed Income statement does not give us information concerning how much cash was generated by operating revenues Retained earnings does not give us information concerning how much cash dividends was paid during the year None of these statements shows us the net change in cash as a result of operating, investing and financing activities. What is the purpose of a cash flow statement? To provide information about an entitys cash receipts and cash payments during a period To provide information concerning its operating, investing, and financing activities The statement of cash flows answers three questions: Where did the cash come from during the period? What was the cash used during the period? What was the change in the cash balance during the period? For cash flow statements, cash means cash and cash equivalents. Cash equivalents are: Readily convertible to known amounts of cash So near their maturity that their market value is relatively insensitive to changes in interest rates Generally, cash equivalents will have a maturity date of three months or less.

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Cash Flows

Classifications of Cash Flows Operating activities cash effects of transactions that create revenues and expenses. Investing activities includes acquiring and disposing of investments and productive long lived assets and lending money and collecting the loan. Financing activities obtaining cash from issuing debt and repaying the amount borrowed and obtaining cash from stockholders and providing them with a return on their investment.

Examples of Transactions
Proceeds from the sale of an investment Investing Disbursement for the purchase of treasury stock Financing Loan to another corporation Investing Proceeds from an insurance policy for a building destroyed by fire Investing Proceeds from winning a lawsuit Operating Receipt of interest from an investment in bonds Operating Payment of dividends Financing Sale of merchandise for cash - Operating Significant Noncash Activities Significant financing and investing activities that do not affect cash are not reported in the body of the statement of cash flows. They are reported on a separate schedule at the bottom of the statement, for disclosure purposes. Examples of significant noncash activities Issuance of stock to purchase assets Conversion of bonds into common stock Issuance of debt to purchase assets Exchange of assets Why is the statement of cash flows useful? It helps us access the entitys ability to Generate future cash flows Ability to pay dividends Reasons for the difference between net income and net cash provided by operating activities Page 2

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Cash Flows

The reliability of net income can be questioned, because accrual accounting requires many estimates. Cash does not involve any estimates. Cash investing and financing transactions during the period The information for preparing the statement of cash flows comes from the: Balance Sheet Income Statement Retained Earnings The accrual concept is not used in the preparation of a statement of cash flows, for it deals with cash receipts and cash payments. There are two methods used to create the Statement of Cash Flows: the direct and indirect. Both arrive at the same answer. In the real world, most companies use the indirect method because It is easier It focuses on the difference between net income and net cash flow from operating activities. Even if you use the direct method, you still must create a cash flow statement using the indirect method as a separate schedule.

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ILLUSTRATION 17-1 TYPICAL RECEIPTS AND PAYMENTS CLASSIFIED BY ACTIVITY

Cash Flows

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Cash Flows

ILLUSTRATION 17-2 INFORMATION SOURCES FOR ACTIVITIES

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Cash Flows

ILLUSTRATION 17-7 CASH FLOWS FROM OPERATING ACTIVITIES INDIRECT METHOD

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Cash Flows

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Cash Flows

ILLUSTRATION 17-7 (Continued) CASH FLOWS FROM OPERATING ACTIVITIES INDIRECT METHOD

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Problem 1
The comparative balance sheet for Mott Company appears below: MOTT COMPANY Comparative Balance Sheet

Cash Flows

Dec. 31, 2008 Assets Cash................................................................................................. Accounts receivable........................................................................ Inventory......................................................................................... Prepaid expenses............................................................................. Building........................................................................................... Accumulated depreciationbuilding............................................. Total assets................................................................................ Liabilities and Stockholders' Equity Accounts payable............................................................................ Long-term note payable.................................................................. Common stock................................................................................ Retained earnings............................................................................ Total liabilities and stockholders' equity.................................. The income statement for the year is as follows: MOTT COMPANY Income Statement For the Year Ended December 31, 2008 Sales (all on credit)......................................................................... Expenses and losses Cost of goods sold..................................................................... $184,000 Operating expenses, exclusive of depreciation......................... 42,300 Depreciation expense................................................................ 1,000 Interest expense......................................................................... 1,200 Loss on sale of land................................................................... 2,500 Income taxes............................................................................. 9,000 Total expenses and loss....................................................... Net income...................................................................................... $ 1,000 13,000 33,000 43,000 $90,000 $54,000 6,000 11,000 2,000 20,000 (3,000) $90,000

Dec. 31, 2007 $12,000 8,000 7,000 3,000 20,000 (2,000) $48,000

$ 4,000 14,000 18,000 12,000 $48,000

$280,000

240,000 $ 40,000

Cash dividends of $9,000 were paid during the year. Land costing $15,000 was acquired by the issuance of common stock. The property was subsequently sold for $12,500 cash. Instructions Prepare a statement of cash flows for the year ended December 31, 2008 using the indirect method.

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Answer

Cash Flows

MOTT COMPANY Statement of Cash Flows For the Year Ended December 31, 2008 (Indirect Method) Cash flows from operating activities Net income...................................................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense............................................................. Decrease in accounts receivable............................................ Increase in inventory.............................................................. Decrease in prepaid expenses................................................ Decrease in accounts payable................................................ Loss on sale of land................................................................ Net cash provided by operating activities..................... Cash flows from investing activities Proceeds from sale of land.............................................................. Cash flows from financing activities Payment of cash dividends.............................................................. Payment of long-term note.............................................................. Net cash used by financing activities..................................... Net increase in cash................................................................................. Cash at beginning of period..................................................................... Cash at end of period............................................................................... Noncash financing and investing activities Acquired land through issuance of common stock ........................

$40,000 $1,000 2,000 (4,000) 1,000 (3,000) 2,500

(500) 39,500 12,500

(9,000) (1,000) (10,000) 42,000 12,000 $54,000 $15,000

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Problem 2

Cash Flows

Presented below is information related to the operations of Tolbert Corporation. December 2008 2007 2008 Cash $120,000 $ 80,000 Sales $760,000 Accounts receivable 110,000 96,000 Cost of goods sold 380,000 Inventory 60,000 44,000 Gross profit 380,000 Prepaid expenses 30,000 40,000 Depreciation expense 28,000 Land 78,000 40,000 Other operating expenses 266,000 Building 200,000 200,000 Income from operations 86,000 Accumulated depreciation Loss on equipment sale 6,000 building (34,000) (16,000) Income before income taxes 80,000 Equipment 116,000 160,000 Income tax expense 24,000 Accumulated depreciation Net income $ 56,000 equipment (30,000) (40,000) Total $650,000 $604,000 Accounts payable $ 80,000 $ 58,000 Bonds payable 0 200,000 Common stock 400,000 200,000 Retained earnings 170,000 146,000 Total $650,000 $604,000 PART III STATEMENT OF CASH FLOWS (cont.) Additional information: (a) In 2008, Tolbert declared and paid a cash dividend. (b) The company converted $200,000 of bonds into common stock. (c) Equipment with a cost of $44,000 and a book value of $24,000 was sold for $20,000. Land was acquired for cash. Instructions: Prepare a statement of cash flows in proper form for 2008, using the indirect method.

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Answer (a) Indirect Method TOLBERT CORPORATION Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income ............................................................................ Adjustments to reconcile net income to net cash provided by operating activities: Increase in accounts receivable ....................................... Increase in inventory ....................................................... Decrease in prepaid expenses ......................................... Increase in accounts payable ........................................... Loss on sale of equipment ............................................... Depreciation expense ...................................................... Net cash provided by operating activities ....................... Cash flows from investing activities Sale of equipment ................................................................. Purchase of land .................................................................... Net cash used by investing activities .............................. Cash flows from financing activities Declaration and payment of dividends ........................... Net cash used by financing activities .............................. Net increase in cash .................................................................... Cash at beginning of period ........................................................ Cash at end of period .................................................................. Noncash financing activity Conversion of bonds payable into common stock ................

Cash Flows

$ 56,000 $(14,000) (16,000) 10,000 22,000 4,000 28,000 20,000 (38,000) (18,000) (32,000) (32,000) 40,000 80,000 $120,000 $200,000

34,000 90,000

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Cash Flows

Problem 3 Cash Flow Statement

Condensed financial data of Stiner Company appear below: STINER COMPANY Comparative Balance Sheet December 31 2008 Assets Cash Accounts receivable Inventories Prepaid expenses Investments Plant assets Accumulated depreciation Total Liabilities and Stockholders' Equity Accounts payable Accrued expenses payable Bonds payable Common stock Retained earnings Total $ 93,000 29,000 130,000 245,000 138,000 $635,000 $ 75,000 24,000 160,000 170,000 81,000 $510,000 $ 71,000 85,000 120,000 19,000 90,000 315,000 (65,000) $635,000 $ 35,000 53,000 132,000 25,000 75,000 250,000 (60,000) $510,000 2007

Additional information: 1. New plant assets costing $90,000 were purchased for cash in 2008. 2. Old plant assets costing $25,000 were sold for $10,000 cash when book value was $13,000. 3. Bonds with a face value of $30,000 were converted into $30,000 of common stock. 4. A cash dividend of $20,000 was declared and paid during the year. 5. Net income was $77,000. Depreciation expense amounted to $17,000 and a loss on the sale of assets amounted to $3,000. Instructions Prepare a statement of cash flows for the year using the indirect method.

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STINER COMPANY Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net Income $77,000 Adjustments Depreciation Expense Loss A/R Inventory Prepaid Expense A/P Accrued Payable Net cash provided by operating activities Cash flows from investing activities Purchase of investments Purchase of plant assets Sale of plant assets Net cash used by investing activities Cash flows from financing activities Issuance of common stock Payment of cash dividends Net cash provided by financing activities Net increase in cash Cash at beginning of period Cash at end of period Noncash investing and financing activities Conversion of bonds payable into common stock

Cash Flows

17,000 3,000 (32,000) 12,000 6,000 18,000 5,000 (15,000) (90,000) 10,000 (95,000) 45,000 (20,000) 25,000 36,000 35,000 $ 71,000 $ 30,000 29,000 106,000

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Cash Flows

COMPLETION STATEMENTS
177. 178. 179. 180. 181. 182. 183. 184.
a

A statement of cash flows summarizes the operating, ____________, and ___________ activities of an entity. The cash effects of selling goods and services appears in the ______________ activities section of a statement of cash flows. The operating activities section of the statement of cash flows may be prepared using the ______________ method or the ______________ method. Net income from operations is generally not the same as cash provided from operations because revenues and expenses are recognized in the income statement on the ______________ basis. Using the indirect approach, noncash charges in the income statement are ______________ to net income and noncash credits are ______________ to compute cash provided by operations. If accounts receivable increase during a period, revenues on an accrual basis are ______________ than revenues on a cash basis. The sale of equipment at less than its book value is a(n) ______________ of cash that is reported in the ______________ activities section. Free _______________ equals cash provided by operations less capital expenditures and cash dividends. Under the direct method, noncash charges, such as depreciation, are _______________ in the statement of cash flows. Under the direct method, the two largest classes of items in the operating activities section for a merchandising company are cash ________________________ and cash _________________________. Cost of goods sold for the year amounted to $150,000, and during the year, accounts payable ______________ by $8,000 and inventory ______________ by $7,000 resulting in cash paid to suppliers of $135,000. In computing cash payments for operating expenses, a decrease in prepaid expenses is ______________ and an increase in accrued expenses payable is ______________ to (from) operating expenses, exclusive of depreciation. In computing cash payments for income taxes, a decrease in income taxes payable is ______________ to (from) income tax expense.

185. 186. 187.

188.

189.

Answers to Completion Statements

177. 178. 179. 180. 181. 182. 183. investing, financing operating indirect, direct (or vice versa) accrual added, deducted higher (greater) inflow, investing 184. 185. a 186. a 187. a 188. a 189.
a

cash flow not reported receipts from customers, payments to suppliers increased, decreased deducted, deducted added

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Cash Flows

MATCHING Set 1 Indirect Method

190. For each of the following items, indicate by using the appropriate code letter, how the item should be reported in the statement of cash flows, using the indirect method. A. B. C. D. E. F. G. ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Added to net income Deducted from net income Cash outflowinvesting activity Cash inflowinvesting activity Cash outflowfinancing activity Cash inflowfinancing activity Significant noncash investing and financing activity

Decrease in accounts payable during a period Declaration and payment of a cash dividend. Loss on sale of land. Decrease in accounts receivable during a period. Redemption of bonds for cash. Proceeds from sale of equipment at book value. Issuance of common stock for cash. Purchase of a building for cash. Acquisition of land in exchange for common stock. Increase in merchandise inventory during a period.

Answers to Matching
1. 2. 3. 4. B E A A 6. 7. 8. 9. D F C G

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5. E 10. B

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