CHAPTER 13

Statement of Cash Flows


Chapter 10
Reporting and Analyzing
Liabilities
• Account for Current
Liabilities.
• Account for Instalment
Notes Payable.
• Identify the Requirements
for the Financial
Statement Presentation
and Analysis of Liabilities.
• Appendix 10A: Account
for Bonds Payable.
Milestones
Chapter 13 Chapter 14
Statement of Cash Flows Statement of Cash Flows
• Describe the Content and
Format of the Statement
of Cash Flows.
• Prepare the Operating
Activities Section of a
Statement of Cash Flows
Using the Indirect
Method.
• Prepare the Investing and
Financing Activities
Sections and Complete
the Statement of Cash
Flows.
• Use the Statement of
Cash Flows to Evaluate a
Company.
• Explain and Apply
Comparative Analysis.
• Calculate and Interpret
Ratios That Are Used to
Analyze Liquidity.
• Calculate and Interpret
Ratios That Are Used to
Analyze Solvency.
• Calculate and Interpret
Ratios That Are Used to
Analyze Profitability.
• Understand the
Limitations of Financial
Analysis.
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 Set of Financial Statements

• The financial statements we have studied so far only present partial information about a
company’s cash flows because these statements are prepared on an accrual basis

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 Set of Financial Statements
• The financial statements we have studied so far only present partial information about a
company’s cash flows because these statements are prepared on an accrual basis

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 Purpose of the Statement of Cash Flows

• Helps users assess:

• A company’s ability to generate cash

• What the company did with the cash

• This is useful in determining:

• Company’s ability to generate future cash flows
• Investing and financing transactions during the period, and effect upon capital structure

• Making comparisons with other companies

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Content and Format of the
Statement of Cash Flows

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 Definition of Cash

• The statement of cash flows is often prepared with cash and cash equivalents as its basis
rather than just cash
• Cash: cash at hand or at bank, checks, money orders

• Cash Equivalents: short-term, highly liquid trading investments that are readily convertible
into cash within a three month period

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 Format of the Statement of Cash Flows

• Three Sections:
• Operating activities
• Investing activities
• Financing activities
• Subtotals of each section show net cash either provided
from or used by each activity.
• Net increase/decrease in cash for the period is the
sum of subtotals from three sections.
• Cash at the end of the period is the sum of net
increase/decrease plus cash at the beginning of the
period.
The statement of cash flows covers the same period of time as the income statement and statement of
changes in equity

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 Activities Reported on the Statement of Cash
Flows
• Operating Activities
• Principal income-producing activities
• All other activities that are not investing or financing activities.

• Investing activities
• Acquisition and disposal of non-current assets.
• Purchasing and disposing of long-lived assets and investments not held for trading
• Lending money and collecting the loans.

• Financing activities
• Activities that result in changes in the size and composition of the equity and borrowings
• Obtaining cash from issuing debt and repaying the amounts borrowed
• Cash received from issuing shares and cash paid for dividends and buying back shares.

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 Indirect vs Direct method

• The SCF can be prepared using two different methods:

• Indirect method

• Direct method

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 Indirect vs Direct method

• Both methods are permissible choices to present cash flows

• The direct method is encouraged, although not required, by standard setters because it is
considered to be more informative for users and is easier to compare with other financial
statements.

• Most companies still use the indirect method because it is easier to prepare and it reveals
less company information to competitors.

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 13-1 Cash Flow Activities

Plano Moulding Corp. had the following transactions:

(a) Issued common shares.

(b) Sold a long-term debt investment.
(c) Purchased a tractor-trailer truck.
(d) Paid interest on the bank loan.
(e) Collected cash for services provided.
(f) Acquired equipment by issuing common shares.
(g) Paid salaries to employees.

Classify each of these transactions by type of cash flow activity.

Indicate whether the transaction would be reported as a cash receipt or cash payment, or as a noncash
activity.

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Preparing Statement of Cash Flows
Operating Activities Section

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 Operating Activities (Primary activities of a
business)

• These activities are separately reported on a multi-step income

statement

• In the statement of cash flows we present only cash affects of

operating activities

• Let’s learn how do we do it…

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 Preparing the Statement of Cash Flows
Operating Activities
• To determine the net cash provided (used) by operating activities under the indirect method, net
income must be adjusted for
• Items that do not affect cash.
• Items that are not related to operating activities.
• Net income is essentially adjusted for three broad items
 Preparing the Statement of Cash Flows
Operating Activities
Three step process:
1. Start with net profit / net income amount from income statement
2. Make adjustments
a) Add back noncash expenses such as depreciation and losses
b) Add noncash losses, Subtract noncash gains
c) Add decreases in current asset accounts and subtract increases in current asset accounts
d) Add increases in current liability accounts and subtract decreases in current liability accounts
3. Total the numbers to determine the Net Cash Provided (Used) by Operating Activities

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 Step 1 – Start with Net Income

• We do this because most revenues and expenses that generate profit also generate
operating cash flows

• We identify and remove any non-cash items that would have been included in profit

• We know that profit has been calculated using the accrual method of accounting, we
simply want the cash portion of profit

• Essentially we want to know what net income would in cash basis of accounting, so we
adjust the affect of noncash items.

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 Step 2a – Adjust Noncash Expenses

Adding back Depreciation expense

• This entry has no effect on cash, so although it has reduced profit, it did not reduce cash.
• Since the indirect method starts with Net Profit, we add back $9,000 expenses

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 Step 2b – Adjust Gains and Losses

Add back Loss on disposal

• The receipt of cash proceeds of $4,000 is an investing activity because selling equipment is
not part of the company's primary activities. There is therefore no cash receipt (or
payment) from operating activities.
• By the same reason, the loss on disposal is also not operating activity. Therefore, we add
back $3,000 to net income.

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 Operating Activities Section

• After adding noncash cash expenses and loss on disposal

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 Step 2c – Adjust changes in Current Assets

Add decrease in accounts receivable to net income (subtract increase)

• Because cash received from customers is $10,000 higher than sales on account, we add
cash receipts.

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Step 2c – Adjust changes in Current Assets

Subtract increase in prepaid expenses from net income (add decrease)

• The amount of cash spent on prepayments and their related other operating expenses (cash
basis operating expenses) exceeds the accrual-based operating expenses shown on the
income statement.

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 Step 2c – Adjust changes in Current Assets

Subtract increase in inventory from net income (add decrease)

• The increase in inventory means that the cash-based expense must be increased.

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 Step 2d – Adjust changes in Current Liabilities

Add increase in accounts payable to net income (subtract decrease)

• The increase in accounts payable means that company has made more noncash purchases than
payments made to suppliers.

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 Step 2d – Adjust changes in Current Liabilities

Subtract decrease in Income Tax Payable from net income (add increase)

• The decrease in tax payable means that company has paid more taxes than reported on income
statement.

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Step 3 – Totaling additions and subtractions

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 13-2 Operating Activities – Indirect Method

Selected financial information follows for Denham Ltd. at December 31. Prepare the operating
activities section of the statement of cash flows using the indirect method.

Increase
2018 2017
  (Decrease)
Current assets
Cash $61,000 $37,000 $24,000
Accounts receivable 68,000 26,000  42,000
Inventory 54,000 10,000  44,000
Prepaid expenses 4,000 6,000  (2,000)
Current liabilities
Accounts payable 35,000 55,000 -20,000
Accrued liabilities 4,000 5,000  (1,000)
Salaries payable 6,000 4,000   2,000
Income tax payable 20,000 10,000  10,000

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 Relationship of Cash Flows with Accounting
Equation
•  

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