CHAPTER 11 LECTURE NOTES

Statement of Cash Flows

After studying this chapter, you should be able to:

1. Discuss the content and format of the statement of cash flows
2. Explain the preparation of a statement of cash flows using the indirect method
3. Explain the preparation cash flows from operating activities using the direct method

- Example of statement of cash flows using the INDIRECT method

- Example of statement of cash flows using the DIRECT method

more
straight
forward

As a company, indirect method, available data(from income 1statement) that the company had to prepare for the chart,
everything is ready, less costly.
As a investor, direct method, they can know where the money come and go
indirect required additional resource to get the data( costly)
 Learning Objective 1 – Discuss the Content and Format of the Statement of Cash Flows
• Why is the statement of cash flows important?
o (1) Reports the cash receipts and cash payments from the operating, investing, and
financing activities during a period, (2) in a format that reconciles the beginning and
ending cash balances – _________________________________________________
provides explanation for changes in cash
o Helps users assess:
indirect method ▪ Entity’s ability to generate future cash flows.
transform net income into CFO ▪ Entity’s ability to pay dividends and meet obligations.
▪ Reasons for the difference between net income and net cash provided (used) by
operating activities.
➢ Assess the reliability of accrual-basis net income since it is often based on
estimates, which is more likely to subject to manipulation.
▪ Cash investing and financing transactions during the period.
➢ Better understand why assets and liabilities changed during the period.
long term assets, long term liability, equity
• How statement of cash flows is interrelated with other financial statements:

• Operating Activities – _____________________________

Income Statement Items . Include the cash effects of
transactions that create revenues and expenses.
o Cash inflows from:
▪ Sale of goods or services
▪ Interest received and dividends received *
o Cash outflows to:
▪ Suppliers for inventory
▪ Employees for services/hours worked
▪ Government for taxes
▪ Lenders for interest*

2
 ▪ Others for additional expenses (i.e., utilities, etc.)
* These items are classified as operating activities because companies report them in the income
statement, where results of operations are shown.
PP&E

• Investing Activities – ________________________________________________________

Changes in investment and long-term assets
Include (a) purchase or disposal of investments and property, plant, and equipment using cash,
and (b) lending money and collecting the loans.
o Cash inflows from:
▪ Sale of property, plant, and equipment
▪ Sale of investments in debt or equity securities of other entities Selling of PP&E
▪ Collection of principal on loans to other entities
o Cash outflow to:
▪ Purchase property, plant, and equipment
▪ Purchase investments in debt or equity securities of other entities
▪ Make loans to other entities
Note: Landing money is investing

• Financing Activities – _______________________________________________________

Changes in long-term liabilities and stockholders' equity
Include (a) obtaining cash from issuing debt and repaying the amounts borrowed, and (b)
obtaining cash from stockholders, repurchasing shares, and paying dividends.
o Cash inflows from:
▪ Sale of common stock
▪ Issuance of debt
o Cash outflows to:
▪ Stockholders as dividends
▪ Redeem long-term debt or reacquire capital stock (treasury stock)

Note: Borrowing money is financing

• Significant Noncash Activities. Examples include bond= liability

common stock= equity
o Direct issuance of common stock to purchase assets however is non-cash transaction, so not
o Conversion of bonds into common stock include

o Direct issuance of debt to purchase assets

principal o Exchanges of plant assets

Note: Not include in statement of cash flow, but need to disclose it separately, at the bottom of statement of cash flow
Do not report in the body of the statement of cash flow
-In a separate schedule at the bottom of the statement of cash flows
or in a separate
Exercise 1: Classify each item as an operating, investing, or financing activity. Assume all items involve
cash unless there is information to the contrary.
(a) Purchase of equipment: PP&E -> Investing
(b) Sale of building: PP&E -> Investing
(c) Redemption of bonds: Bond payable decrease -> Financing
(d) Depreciation: Instatement -> Operating
(e) Payment of dividends: Equity decrease -> Financing
(f) Issuance of Capital stock: Common stock increase -> Financing

3
Exercise 2:
1. Issued 100,000 shares of $5 par value common stock for $800,000 cash: -> F
2. Borrowed $200,000 from Castle Bank, signing a 5-year note bearing 8% interest: -> F

3. Purchased two semi-trailer trucks for $170,000 cash: -> I

4. Paid employees $12,000 for salaries and wages: -> O
5. Collected $20,000 cash for services performed:
->O

Learning objective 2 – Explain the Preparation of a statement of Cash Flows using the Indirect
Method

• Adjust the effects of the use of accrual accounting to determine cash flows. Information needed:
(1) ____________________________:
Comprehensive Balance Sheet changes in assets, liabilities, and stockholders’ equity
(2) ________________________
Current Income statement
(3) Additional information.

• Order of Presentation
o First, ________________________________________
CFO( cash flow from operating activities) (direct method, indirect method)
o Second, _____________________________________
CFI
o Third, _______________________________________
CFF

• Step 1: Cash flows from operating activities section:

o Indirect method: start with net income, ____________________________________
convert N.I_____________________________________(98%
from accrued basis to a cash basis to determine the net of public companies use this method).
cash from operating activities.

* Question: why does difference exist between net income and net cash provided by operating
activities?
Answer: Timing difference in reporting revenues and expenses under accrued accounting versus cash accounting

CH 3.

1. Start with Net Income They are all estimated expense

2. Add back: all items that DID NOT result in cash outflow
(e.g. depreciation expense, amortization expense, bad debt expense)
Why?
cuz they reduce net income but does not involve cash flow.
3. Add back: “Loss on Sale of PPE” OR

Subtract out: “Gain on Sale of PPE”

Why? No matter gain or loss, sale of PPE should be included in the investing activity section, to eliminate
the impact (from income flow)

4
 4. Look for changes in noncash current assets and current liabilities (this will convert
revenues and expenses from accrual to cash basis)
RULE: If current asset increases, then ( - ) -> A/R increase -> -( change A/R)
If current asset decreases, then ( + ) -> A/R decrease -> +(change A/R)

If current liability increases, then ( + )

If current liability decreases, then ( - )

Why?
Current asset example:
Decrease in A/R Increase in A/R
RecEIPTS Beg Bal + Credit Sales- Cash collection = Ending Bal A/R
1/1/14 Bal 30,000 End a/r - Beg A/R = Credit sales - Cash collection
Sales Rev 507,000 A/R increses => change A/R > 0, CASH IS RECEIVED less THAN REVEUNE reported
cash is received more than revenue reported

12/31/ 14 Bal 20,000

Recalled: Dr. A/R XX CREDIT SLAES

Begining Bal.
Cr. Revenue XX
Dr. Cash XX Cash collection from customers
Cr. A/R XX + sales - cash collection

Decrease in A/R: Receive more cash than revenue reported -> add the decrease amount to net income

Increase in A/R: Receive less cash than revenue reported -> subtract the increase amount from net income

ending Bal

Current liabilities example:

Increase in A/P Decrease in A/P

Recalled: Dr. Expense XX

Cr. A/P XX
Dr. A/P XX
Cr. Cash XX Beg Bal
+Expense recording
Increase in A/P:
- cash payable

Decrease in A/P: End Bal

Beg A/P + Expense- cash paya = End A/P

End A/P - Beg A/P = Expense - cash paid
A/P increase => Change A/P > 0 => Expense > cash paid
Increase of A/P => Cash is paid less than expense reported
5
Appendix

6
7
 Example: using financial statements and additional information in Appendix
Cash flows from operating activities
145,000
Net Income
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation expense +9,000
Loss on disposal of plant assets +3,000
Decrease in accounts receivable +10,000
Changes in Increase in inventory -5,000
noncash Increase in prepaid expenses -4,000
CA/CL Increase in accounts payable +16,000
Decrease in income taxes payable -2000
Net cash provided by operating activities 172,000

• Step 2: Cash flows from investing activities section:

I. Analyze changes in long-term assets (plus additional information) to determine cash
from investing activities PP&E EACH RELEVANT ASSET CHANGES
Find out related
Example: using financial statements and additional information in Appendix
Increase in land: 2. #3 explain the change non cash tramsaction
1. incr. $10,000

Increase in building: 2. #4 cash purchase of building $120,000

1. incr. $120,000

Increase in equipment:
1. inc. $170,000 2. i)n #4 cash purchase of equipment $25,000
sale of equipment for $400 cash

Equipment

Cash flows from investing activities

Sale of equipment
Purchase of building
Purchase of equipment
Net cash used by investing activities

8
• Step 3: Cash flows from financing activities section:
I. Analyze changes in long-term liabilities and stockholders’ equity (plus additional
information) to determine cash from financing activities

Example: using financial statements and additional information in Appendix

Increase in bonds payable:
1. incr. 11000 2. add ... #3 insurance of bond of 11000 to purchase land
Increase in common stock:

Increase in retained earnings:

Cash flows from financing activities

Issuance of common stock
Payment of cash dividends
Net cash used by financing activities

• Step 4: Net change in cash

I. Compare the net change in cash on the statement of cash flows with change in cash
account reported on the balance sheet to make sure the amounts agree.

Example: using financial statements and additional information in Appendix

Net cash provided by operating activities

Net cash used by investing activities
Net cash used by financing activities
Net increase in cash

9
Format of Statement of Cash Flows
Company Name
Statement of Cash Flows - Indirect Method
For the Year/Quarter/Month Ended…

Cash flows from operating

activities
Net Income $ XX
Adjustments to reconcile net income to
net cash provided by operating activities
Depreciation expense (+) XX
Loss on sale of PPE (+) XX
Gain on sale of PPE (-) (XX)
Increase in noncash current asset (-) (XX)
Decrease in noncash current asset (+) XX
Increase in current liability (+) XX
Decrease in current liability (-) (XX) XX
Net cash provided by (used by) operating activities XX
Cash flows from investing
activities
.
.
.
Net cash provided by (used by) investing activities XX
Cash flows from financing
activities
.
.
.
Net cash provided by (used by) financing activities XX
Net Increase/Decrease in cash
Cash at beginning of period XX
Cash at end of period XX
$ XX

10
Learning objective 3 – Explain the Preparation of Cash Flows from Operating Activities Using the
Direct Method

• IAS 7 prefers the direct method

– 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

11