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An overview of the Statement of Cash Flows, explaining its purpose, key terms, and concepts. It also includes examples and practice problems to help students understand how to prepare the statement using both the indirect and direct methods.
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The Statement of Cash Flows reports the sources of cash inflows and cash outflow during an accounting period. The inflows and outflows are divided into three sections or categories based on the underlying cause or nature of the cash flows: Operating Activities Investing Activities Financing Activities Because the statement explains the changes in the cash balance during the period, the beginning and ending balances in Cash are not included in these three sections. Cash forms a fourth section at the bottom of the statement in which the beginning cash balance is added to the total of the three sections to determine the ending balance for cash.
At times, companies enter into investing and financing transactions that do not involve cash, such as issuing common stock to purchase land. These transactions are not reported on the statement of cash flows because they do not provide or use cash. Instead, they are reported in a separate section or note which is presented after the ending cash balance.
The statement of cash flows explains the changes in the balance sheet during an accounting period from the perspective of how these changes affect cash. As noted above, the cash inflows and outflows are divided into three sections plus a cash section based on the balance sheet accounts underlying the cause or nature of the cash flows. Investing and financing activities that do not involve cash are presented in a separate schedule.
Cash Flow Statement Section Balance Sheet Accounts Operating Activities Net Income = revenue – expenses Current assets excluding cash Current liabilities excluding dividends payable and short-term notes payable Investing Activities Non-current assets Financing Activities Long-term liabilities Short-term notes payable Capital stock and treasury stock Dividends declared and dividends payable Cash Cash
Non-cash Investing and Financing Activities
Changes in long-term liabilities, short- term notes payable, capital stock and treasury stock that do not involve cash
Practice Problem # Identify which section of the statement of cash flows each of the following events would appear in (operating, investing and financing or in a separate schedule):
a) Purchased a Patent b) Sold Treasury stock c) Net Income d) Sold long-term investments e) Purchased a building f) Issued bonds. g) Paid dividends h) Recorded depreciation expense for the year i) Issued common stock to retire a mortgage j) Purchased treasury stock
Example # Given the following information and using the indirect method prepare the Cash Flows from Operating Activities section of the statement of cash flows.
End of Year
Beginning of Year Change Cash $ 23,500 $ 37,400 (13,900) Accounts receivable (net) 84,500 80,350 4, Inventories 100,200 94,300 5, Prepaid expenses 4,970 5,300 (330) Accounts payable (creditors) 71,400 68,900 2, Salaries Payable 5,320 6,450 (1,130)
Net Income reported on the income statement for the current year was $134,800. Depreciation expense recorded on buildings and equipment was $27,400 for the year.
Solution #
Net Income $134, Add: Decrease in prepaid expenses $ 330 Increase in Accounts Payable 2, Depreciation Expense 27,400 30, 165, Deduct: Increase in Accounts Receivable $ 4, Increase in Inventories 5, Decrease in Salaries Payable 1,130 11, Net Cash Flows from Operating Activities $153,
Practice Problem # Given the following information and using the indirect method prepare the Cash Flows from Operating Activities section of the statement of cash flows.
End of Year
Beginning of Year Cash $345,000 $386, Accounts Receivable 554,300 567, Merchandise Inventory 693,000 672, Prepaid Expenses 27,000 24, Accounts Payable (creditors) 510,000 527, Wages Payable 39,500 36,
The net income reported on the income statement for the current year was $465,000, which included a gain on sale of investments of $3,000. Depreciation expense recorded on store equipment for the year amounted to $99,800.
The direct method starts with the entire accrual-basis income statement (not just net income) and converts it line-by-line to the cash basis. The resulting cash inflows and outflows are the cash flows used by or provided by normal daily activities. For example, accrual-basis sales are converted to cash collected from customers by adding the decrease or deducting the increase in trade accounts receivable.
The direct method is preferred by the FASB as it provides more useful information the users of the financial statements. The FASB requires that, if the direct method is used, that a reconciliation of net income to net cash provided or used by operating activities be provided in the footnotes or as part of the statement. This reconciliation frequently looks quite similar to the cash flow from operating activities section prepared using the indirect method.
The Investing Activities section would appear as follows:
Cash inflows from: Sale of Long-term Assets o Property, Plant or Equipment o Intangible assets o Investments Less: Cash outflows from: Purchase of Long-term Assets o Property, Plant or Equipment o Intangible assets o Investments =Net Cash Flows from Investing Activities
Example # Given the following selected information, determine the net cash flows from investing activities and the net cash flows from financing activities: a) Net income was $189,500 for the period. b) Purchased 10,000 shares of common stock at $15 per share for the treasury. c) Sold equipment with a carrying value of $32,500 at a gain of $6,000. d) Purchased land and a building worth $450,000 by signing a ten-year note payable. e) Issued $1,000,000 in bonds at par. f) The beginning and ending retained earnings account balances were $418, and $534,000, respectively. There were no prior period adjustments during the period. g) Wrote a check for $648,000 for the purchase of machinery. h) Sold long-term investments in marketable securities with a $50,000 carrying value, at a loss of $17,500. i) Cash dividends were declared and paid during the period.
Solution #
Investing Activities Cash received from sale of equipment $32,000 – 6,000 = $38, Cash received from sale of investments $50,000 – 17,500 = 32, Cash paid for machinery (648,000) Net cash flows from investing activities ($577,000)
Financing Activities include events and transactions that affect long-term liabilities and equity other than net income.
For example, the journal entry to record the issuance of bonds with a face value of $100,000 would be:
Cash 100, Bonds payable 100,
The effect of this transaction is to increase long-term liabilities by $100,000. On the statement of cash flows, the cash proceeds are reported as an inflow in the financing activities section.
If the bonds are subsequently retired at 101, the journal entry would be
Loss on retirement 1, Bonds payable 100, Cash 101,
The effect of this transaction is to reduce long-term liabilities by $100,000. On the statement of cash flows, the cash spent is reported as an outflow in the financing activities section and the loss is added to net income in the operating activities section as noted above.
Dividends paid are also included in the financing activities section. Dividends paid are not part of the operating activities section because dividends do not appear in the income statement. They are reported in the financing activities section because they relate to the equity section of the balance sheet and cash flows from changes in equity are reported in this section.
Whenever the beginning balance does not equal the ending balance for dividends payable, the dividends paid will have to be calculated using the following formula:
beginning balance
= dividends paid
If the beginning balance equals the ending balance for dividends payable or there are no beginning and ending balances for dividends payable, then the dividends paid equals the dividends declared.
Solution #
Financing Activities Cash paid to purchase treasury stock 10,000 shares x $15 = ($150,000) Cash received from sale of bonds 1,000, Cash paid for dividends $418,000 + 189,500 - 534,000 = (73,500) Net cash flows from financing activities $776,
Practice Problem # For each of the following situations indicate the items to be reported on the statement of cash flows, the section of the statement in which the item would appear and the amount.
a) The board of directors declared cash dividends totaling $240,000 during the current year. The comparative balance sheet indicates dividends payable of $50,000 at the beginning of the year and $60,000 at the end of the year. b) Office equipment, which had cost $245,000 and on which accumulated depreciation totaled $95,000 on the date of sale, was sold for $130, during the year. c) Delivery equipment, which had cost $39,000 and on which accumulated depreciation totaled $23,000 on the date of sale, was sold for $20, during the year. d) The company issued 5,000 shares of $10 par Common Stock for $50 per share. e) The company purchased land with a mortgage note payable. f) Depreciation expense reported on the income statement was $55,000. g) Bonds Payable of $60,000 were retired.
After the Operating, Investing and Financing sections have been completed, the Cash account must be analyzed. The sum of the net cash flows from each of the three activities sections represents the change in cash, i.e., the net cash flows for the period. Adding the change in cash to the beginning cash balance from the balance sheet must equal the ending cash balance on the balance sheet.
Practice Problem # Charlotte Company's net income last year was $91,000. Changes in the company's balance sheet accounts for the year appear below:
Cash ($13,000) Accounts receivable 16, Inventory 21, Prepaid expenses (8,000) Long-term investments 30, Property, plant and equipment 60, Accumulated depreciation 36,
Accounts payable (21,000) Accrued expenses 14, Income taxes payable 42, Bonds payable (50, Common stock 20, Retained earnings 65,
The company did not dispose of any property, plant, and equipment, sell any long- term investments, issue any bonds payable, or repurchase any of its own common stock during the year. The company declared and paid a cash dividend. The beginning and ending cash balances were $20,000 and $7,000, respectively.
Required: Prepare a statement of cash flows using the indirect method.
End of Year
Beginning of Year Cash $ 38,500 $ 44, Accounts receivable (net) 79,200 68, Inventories 90,700 81, Prepaid expenses 4,500 6, Accounts payable 65,000 72, Salaries Payable 5,900 5, Net Income reported on the Income Statement for the current year was $115,000, which included a loss on sale of land of $8,000. Depreciation recorded on office equipment for the year amounted to $48,000. a) $129, b) $137, c) $144, d) $145,