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CHAPTER 12
STATEMENT OF CASH FLOWS
Key Terms and Concepts to Know
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.
Key Topics to Know
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.
Direct Method
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
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.
Cash
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.
Sample True / False Questions
- The statement of cash flows explains how the cash balance changed during a particular period of time. True False
- Payment of interest on a note payable is a cash flow from a financing activity. True False
- Collection of principal on a note receivable is a cash flow from financing activities. True False
- The difference between the indirect and direct methods of cash flow determination only affects the determination of investing activities cash flows. True False
- Cash collected from customers is a cash flow from operating activities, which is calculated using the indirect method in preparing the statement of cash flows. True False
- Cash flows associated with property, plant, and equipment acquisition and disposition are reported as cash flows from investing activities. True False
- Cash flows associated with issuance and retirement of long-term debt and equity are reported as cash flows from investing activities. True False
- Under the indirect method, an increase in accounts receivable during the year will be added to net income. True False
- Under the indirect method, depreciation expense is added to net income, because it decreases net income but doesn't consume a cash flow. True False
- Under the indirect method, a decrease in inventory is deducted from net income, because inventory purchases are less than cost of goods sold. True False
- Under the indirect method, an increase in prepaid expenses is deducted from net income, because the cash prepayments exceed the related expenses. True False
- When a company purchases equipment using common stock, the equipment purchase is reported as a financing activity. True False
- When a company sells equipment for cash at a loss, cash flows from investing activities decreases. True False
- Amortization of a patent reduces cash flows from investing activities. True False
- When a company both borrows $150 million during the year and repays $ million of notes, the company can disclose the $30 million net amount as excess of borrowings over repayments in the financing activities section. True False
- Cash flows from financing activities include those cash flows with respect to issuing and retiring long-term debt and equity. True False
- Cash flows from financing activities include those cash flows with respect to paying previously declared dividends. True False
SAMPLE MULTIPLE CHOICE QUESTIONS
- If a loss of $15,000 is incurred in selling (for cash) office equipment having a book value of $50,000 the total amount reported in the cash flows from investing activities section of the statement of cash flows is: a) $22, b) $78, c) $35, d) $15,
- Land costing $78,000 was sold for $100,000 cash. The gain on the sale was reported on the income statement as other income. On the statement of cash flows, what amount should be reported as an investing activity from the sale of the land? a) $22, b) $78, c) $100, d) $178,
- On the statement of cash flows, the cash flows from operating activities section would include: a) Receipts from interest on short-term notes receivable b) Receipts from the issuance of capital stock c) Payments for the acquisition of investments d) Payments for cash dividends
- A business issues 20-year bonds payable in exchange for preferred stock. This transaction would be reported on the statement of cash flows in: a) The cash flows from investing activities section b) The cash flows from operating activities section c) The cash flows from financing activities section d) A separate schedule
- A statement of cash flows would not disclose the effects of which of the following transactions? a) Purchase of treasury stock b) Bonds payable exchanged for capital stock c) Stock dividends declared d) Capital stock issued to acquire plant assets
- Depreciation on factory equipment would be reported in the statement of cash flows prepared by the indirect method in: a) The cash flows from financing activities section b) The cash flows from investing activities section c) The cash flows from operating activities section d) A separate schedule
- Which of the following would be classified as an operating activity? a) Payment of a cash dividend b) Sale of equipment c) Making a loan to another entity d) Payment of interest
- Which of the following is not an operating activity? a) Payment of taxes b) Dividends received c) Payment of a cash dividend d) Payment to suppliers
- The change in accumulated depreciation on factory equipment would be reported in the statement of cash flows prepared by the indirect method in: a) The cash flows from financing activities section b) The cash flows from investing activities section c) The cash flows from operating activities section d) Not reported as it is not a cash flow
- The indirect method of preparing the statement of cash flows begins with a) Collections from customers b) Cash sales c) Net income d) Beginning Cash Balance
- Under the indirect method of preparing the statement of cash flows, an increase in accounts receivable is: a) Added to net sales b) Deducted from net sales c) Added to net income d) Deducted from net income
- Samson Enterprises issued a ten-year, $20 million bond with a 10% interest rate for $19,500,000. The entry to record the bond issuance would have what effect on the financial statements? a) Increase assets b) Increase liabilities c) Increase equity d) a) and b)
- Megginson, Inc. issued a five-year corporate bond of $300,000 with a 5% interest rate for $330,000. What effect would the bond issuance have on Megginson, Inc.'s accounting equation? a) Increase assets and liabilities b) Increase and decrease assets c) Increase assets and equity d) Increase and decrease liabilities
- Which of the following would be classified as an investing activity? a) Purchasing an investment in bonds b) Payment of a dividend c) Issuing Common Stock d) Payment of interest
- According to the comparative balance sheet, the balance of the Dividends Payable account at the beginning and end of the year was $54,000 and $52,500 respectively. The Retained Earnings Statement indicates that $80,000 in dividends was declared during the year. What amount of dividends was paid out during the year? a) $80, b) $54, c) $78, d) $81,
- Given the following information and using the indirect method, calculate the cash flows from operating activities.
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,
- A corporation issued $2,000,000 of 20-year bonds for cash at 108. How would this transaction be reported in the statement of cash flows? a) $2,000,000 inflow in cash flows from financing activities b) $2,000,000 inflow in cash flows from investing activities c) $2,160,000 inflow in cash flows from financing activities d) $2,160,000 inflow in cash flows from investing activities
