Professional Documents
Culture Documents
The Statement of Cash Flows: Textbook Pages 178-222
The Statement of Cash Flows: Textbook Pages 178-222
The Statement of Cash Flows: Textbook Pages 178-222
Intermediate Accounting 1
Dr. Nafis Rahman
4-1
Role of the Statement of Cash
Flows
Helps
Helps users
users assess
assess .. .. ..
aa firm’s
firm’s ability
ability to
to generate
generate cash.
cash.
aa firm’s
firm’s ability
ability to
to meet
meet its
its
obligations.
obligations.
the
the reasons
reasons forfor differences
differences
between
between income
income and and associated
associated
cash
cash flows.
flows.
the
the effect
effect of
of cash
cash andand noncash
noncash
investing
investing andand financing
financing activities
activities
on
on aa firm’s
firm’s financial
financial position.
position.
4-2
3
Role of the Statement of Cash
Flows
Lists all cash inflows and
all cash outflows by
category: Operating,
Investing, and Financing
Professional investors have traded away the accrual anomaly effect in recent
times.
5 4-4
Income Statement vs Cash Flow
Statement
Income Statement reports net income calculated using
accrual accounting method.
6 4-5
Cash, Cash Equivalents, and
Restricted Cash
Cash Cash Equivalents
Resources • Short-term, highly liquid
immediately investments.
available to pay • Readily converted into cash,
obligations. with little or no risk of loss.
• Maturity date must not be
Restricted Cash longer than 3 months from
Cash set aside for date of purchase.
designated • Each company must establish
purposes. and disclose their policy
regarding which investments
are classified as cash
equivalents.
4-6
Primary Elements of the
Statement of Cash Flows
4-8
The Statement of Cash Flows
Operating Activities
Inflows from:
sales to customers.
interest and dividends
received from investments. +
Cash Flows
from
Outflows for:
Operating
purchase of inventory.
Activities
salaries, wages, and other
operating expenses.
interest on debt.
income taxes.
4-9
Direct and Indirect Methods of
Reporting
Two Formats for Reporting Operating Activities
4-12
UNITED BRANDS CORPORATION
Statement of Cash Flows
For the Year Ended December 31, 2023
($ in millions)
Net profit Indirect Method $ 12
Cash Flows from Operating Activities: Adjustments for non-cash effects:
Cash Inflows: Direct Method Gain on sale of land (8)
From customers $ 98 Depreciation expense 3
From investment revenue 3
Loss on sale of equipment 2
Cash Outflows:
To suppliers of goods (50) Changes in operating assets and liabilities:
To employees (11) Increase in accounts receivable (2)
For interest (3) Decrease in inventory 4
For insurance expense (4)
Increase in accounts payable 6
For income taxes (11)
Net cash flows from operating activities $ 22 Increase in salaries payable 2
Cash Flows from Investing Activities: Decrease in discount on bonds payable 2
Sale of land 18 Decrease in prepaid insurance 3
Sale of equipment 5 Decrease in income tax payable (2)
Purchase of short-term investments (12)
Purchase of land (30)
Net cash flows from operating activities $ 22
Net cash flows from investing activities (19)
Cash Flows from Financing Activities:
Note X:
Retirement of bonds payable (15)
Issuance of ordinary shares 26 Noncash Investing and Financing Activities
Payment of cash dividends (5) Acquired $20 million of equipment by
Net cash flows from financing activities 6 issuing a 12%, five-year note.
Net increase in cash 9
Cash balance, January 1 20
Cash balance, December 31 $ 29
6 4-13
Preparation of the
Statement of Cash Flows
• Information available to assist the statement preparer
includes:
– A statement of profit or loss for the year.
– Statements of financial position for both the current
and preceding years.
– Additional information about transactions that
caused changes in account balances during the year.
4-14
Preparation of the
Statement of Cash Flows—Direct Method
• Preparing SCF is challenging because it is not
automatically linked to other three statements, which
involve accrual accounting (not cash-based accounting)
4-16
How to Prepare a Statement of Cash
Flows—Direct Method
4-18
Comprehensive Review Exercise (Textbook page 214)
4-19
Comprehensive Review Exercise (Let’s Solve in class)
Notice that certain items in Income Statements are purely accrual (non-cash)
expenses (for example, depreciation expense).
Losses and Gains from Long term assets are excluded (The entire transaction is
reflected in Investing Activities) . We don’t want double counting.
(w1)
(w2)
(w3)
(w4)
(w5)
(w6)
(w7)
(w8)
4-20
Comprehensive Review Exercise: w1
Journal Entries for all changes in all the items Debit Credit
related to Sales Revenue & A/R
Alternatively, you can first analyze the impact of A/R using a T-Account for
A/R. That will also reveal the cash that must have been collected from
Sales.
For this exercise, you have to first assume that entire portion of the Sale
was credit sale. Essentially, a Cash sale is a credit sale where the
company could transfer their A/R to cash instantly.
4-22
Comprehensive Review Exercise: w2
4-23
Comprehensive Review Exercise: w3
4-24
Comprehensive Review Exercise: w4.T-Account Method
How much we cash did we pay to our suppliers for all the inventories we
purchased? Which T-Account(s) will answer this question?
(w4) …………………..T-Account
4-25
Comp. Review Exercise: w4. Journal Entry Method
How much we cash did we pay to our suppliers for all the inventories we
purchased?
We need to start out by listing all the accounts related to inventory. What
actions (changes in which accounts) increase or decrease inventory?
4-26
Comprehensive Review Exercise. w5
Cash paid to employees
4-27
Comprehensive Review Exercise. w6
Cash paid to insurance company
4-28
Comprehensive Review Exercise. w7
On the contrary, bonds paying a higher coupon rate than its interest expense are
sold at a premium. Bond Premium is a liability account
4-29
Comprehensive Review Exercise. w8
Deferred Tax Liability is created when company has IFRS income, but
some portion of that income is not recognized for tax purpose in the current
year.
At this point, you just need to know that “Deferred Tax Liability” is a liability
account. When calculating cash paid for taxes, we will have to treat it in
the same way as we treat “Income Tax Payable”.
4-30
Comprehensive Review Exercise
Let’s look back to the journal entries for the Cash items in steps 1
through 8.
We did it!!
4-31
Comprehensive Review Exercise
Instead,
1. you have to investigate changes in the long term assets, long
term liabilities, and the equity accounts from the previous year
to current year.
2. Make sure that all the additional information given have been
considered
Caution... some additional information might not have a
cash flow impact… they are included to confuse you!!)
4-32
Comprehensive Review Exercise
Item c. Machine’s original cost = 60, and it is half depreciated. Machine was
damaged by lightning (unnecessary information). Machine sold for $20M (Inflow
of cash)
4-33
Comprehensive Review Exercise
Item h. Sold bonds for $20M at principal amount or at par value (meaning no
discount or premium). So the company also received exactly $20 M cash (cash
Inflow).
Item k. Purchased treasury stocks for $7M (outflow). Purchasing treasury stock
is also called stock buy-back. It is similar to paying cash dividend. The
shareholders get some cash from the company.
4-34
Comprehensive Review Exercise
Reconciling the net change in cash, beginning cash balance, ending cash
balance…. You hope that they match!!!
You also need to disclose major non-cash investing and financing activities
Remember that the company bought land for $30M, but paid only $15M in cash.
It issued a note payable for the remaining amount (item f).
4-35
Indirect Method for Cash Flows from Operating
Activities: General Rules for Preparation
Start with Net Income
Add back depreciation expense, amortization expense and etc. The
company did not have to pay cash for the depreciation expense.
Increase (decrease) in non-cash current assets, implying a deduction
(addition) from Net Income figure. The company had to pay cash to
increase its current assets… Increase in current assets decrease in
cash.
Increase (decrease) in current liabilities, implying an addition
(deduction) to Net Income. If company has an increase in current
liability balance, that means the company has is yet to pay the cash for
expenses that occurred… Increase in current liability increase in cash.
Remove the impact of “loss on sale of long term assets”, or “gain on
sale of long term assets”. We already account for the entire transaction
in the Investing Activities (no need to double count).
4-36
General rules for indirect method
An increase of $12 in accounts receivable
The “imagined” journal entry shows that the $12 increase in AR implies a non-
cash based sales revenue of $12, which in turn implies a non-cash
component of $12 in the reported net income! Therefore, we need to
DEDUCT $12 from net income.
4-37
Indirect Method Exercise
Cemptex Corporation prepares its statement of cash flows using the indirect
method to report operating activities. Net income for 2013 financial year
was $624,000. Depreciation and amortization expense of $87,000 was
included with operating expenses in the income statement. The following
information describes the changes in current assets and current liabilities
other than cash:
4-38
Indirect Method Exercise
Start with Net Income, Add back depreciation expense.
Increase (decrease) in non-cash current assets, implying a deduction
(addition) to Net Income.
Increase (decrease) in current liabilities, implying an addition
(deduction) to Net Income.
4-39
Brief Exercise 1—Statement of Cash Flows
Tiger Enterprises
Statement of Profit & Loss
For the Year Ended December 31, 2023
4-40
Tiger Enterprises
Statement of Financial Position
(80)
Identify which items are 40
current assets 30
4-41
Brief Exercise 1
4-42
Tiger Enterprises
Notice that we have no additional information besides the financial statements.
One more thing: the changes in Note Receivables (if any) are
classified as investing activities. The changes in Note payables, as
shown here, are financing activities. 4-43
Example (KRC Co.)
4-44
Example (KRC Co)
Attention: in this case, we adjusted for the gain/loss from the sale of
fixed assets.
4-45
In-Class Exercise: Construct a Statement of Cash Flows
---based on the following information
Basic Information: The company sustained a net loss for the year of $50,000;
The Total Change in Cash is $295,000
(a): Plant assets that had cost $25,000 six years ago and were being
depreciated on a straight-line basis over 10 years with no estimated scrap
value were sold for $5,300. (cash-flow effect for part (a) is calculated for you)
(b): During the year, 10,000 shares of common stock with a stated value of
$10 a share were issued for $33 a share. (Hint: Stated Value or Par Value is
irrelevant)
(d): During the year, treasury stock costing $47,000 was purchased.
4-46
In-Class Exercise: Construct a Statement of Cash Flows
---based on the following information
(a): Plant assets that had cost $25,000 six years ago and were
being depreciated on a straight-line basis over 10 years with no
estimated scrap value were sold for $5,300.
4-47
In-Class Exercise: Construct a Statement of Cash Flows
---based on the following information
Statement of Cash Flows
Cash flow from operating activities
Net income (loss) $ (50,000)
Adjustment to reconcile net income to cash:
O Loss on sale 4,700
Depreciation expense 22,000
Gain on sale (9,000)
Cash from operations (32,300)
Cash flow from investing activities
I Sale of plant assets 5,300
Sale of land 39,000
Cash from investing activities 44,300
Cash flow from financing activities
F Sale of common stock 330,000
Purchase of company stock (47,000)
Cash from financing activities 283,000
Net Change in Cash $ 295,000
4-48