Chapter 16

Statement of Cash Flows

Accounting, 21st Edition
Warren Reeve Fess

© Copyright 2004 South-Western, a division

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Professor Emeritus of Accounting
Pepperdine University
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 Objectives
1. SummarizeAfterthe types of cash
studying this flow
activities reported
chapter,inyou
theshould
statement of cash
flows. be able to:
2. Prepare a statement of cash flows, using
the indirect method.
3. Prepare a statement of cash flows, using
the direct method.
4. Calculate and interpret the free cash flow.
 Reporting Cash Flows
The statement of cash flows reports cash flows
by three types of activities:
1. Cash flows from operating activities –
transactions that affect net income.
2. Cash flows from investing activities –
transactions that affect noncurrent assets.
3. Cash flows from financing activities –
transactions that affect equity and debt of the entity.
 Reporting Cash Flows
Increases in Cash Decreases in Cash

Operating Operating
(receipts from (payments for
revenues) expenses)

Investing Investing
(receipts from sales of (payments for acquiring
noncurrent assets) noncurrent assets)

Financing Financing
(receipts from issuing (payments for treasury stock,
equity and debt securities) dividends, and redemption of
debt securities)
 Cash Flows from Operating Activities
Typical cash inflows Typical cash outflows
What are some of the What are some of the
typical cash inflows from typical cash outflows from
operating activities?` operating activities?
Sales of goods Merchandise
and services purchases
Interest Payments of
revenue wages and
other expenses
Dividend
revenue Tax payments
Cash Flows from Investing Activities

Typical cash inflows Typical cash outflows

What are some of the typical What are some of the
cash inflows from investing typical cash outflows
activities? from investing
activities?
Sales of fixed
assets Purchase of
fixed assets
Sale of long-
term Purchase of
investments long-term
investments
Cash Flows from Financing Activities

Typical cash inflows Typical cash outflows

What are some of the What are some of the
typical cash inflows from typical cash outflows from
financing activities? financing activities?
Issuing bonds Paying cash
and long-term dividends
notes payable Repaying debt
Issuing Acquiring
preferred and treasury stock
common stock
 Noncash Investing and
Financing Activities
 Issuing bonds to acquire land

 Issuing common stock for

convertible preferred stock
 Issuing a long-term note to
acquire equipment
 Issuing a stock dividend
No cash flow per share is reported in
the financial statements because the
user might incorrectly interpret this as
the amount available for dividends.
 The Indirect Method
Balance Sheet
Cash
Liabilities
Noncash
Assets Stockholders’
Equity

Assets = Liabilities + Stockholders’ Equity

Cash + Noncash Assets = Liabilities + Stockholders’ Equity
Cash = Liabilities + Stockholders’ Equity – Noncash Assets
 The Indirect Method
Balance Sheet
Cash
Liabilities
Noncash
Assets Stockholders’
Equity

Assets = Liabilities + Stockholders’ Equity

Cash + Noncash Assets = Liabilities + Stockholders’ Equity
Cash = Liabilities + Stockholders’ Equity – Noncash Assets
1 2 3
The cash flows are determined by analyzing liabilities,
stockholders’ equity, and noncash assets.
 The Indirect Method

Start with the accrual basis net income

(shown in the income statement, the
Retained Earnings account, or the
statement of stockholders’ equity).
 The Indirect Method
Find the net income.
ACCOUNT Retained Earnings ACCOUNT NO. 32
Balance
Date Item Debit Credit Debit Credit
2006
To statement
Jan. 1 Balance 202,300
Dec. 31 Net income 108,000 310,300
31 Cash dividends 28,000 282,300
 Operating Activities – Indirect Method
Cash flows from operating activities:
Net income per income statement $108,000

Add:
Depreciation $ 7,000
Decrease in inventories 8,000
Increase in accrued expenses 2,200 17,200
$125,200
Inc. in accounts receivable $ 9,000
Deduct:
Dec. in accounts payable 3,200
Dec. in income taxes payable 500
Gain on sale of land 12,000 24,700
Net cash flow from operating activity $100,500
 The Indirect Method

Next, we need to determine depreciation expense

for the year. If it isn’t given on the income
statement, sometimes it can be found by analyzing
the Accumulated Depreciation account.
 The Indirect Method
Determine depreciation expense.

ACCOUNT Accumulated Depreciation--Building ACCOUNT NO. 17

Balance
Date Item Debit Credit Debit Credit
2006
Jan. 1 Balance 58,300
Dec. 31 Depreciation for year 7,000 65,300

to statement
 Operating Activities – Indirect Method
Cash flows from operating activities:
Net income per income statement $108,000
Add:
Depreciation $ 7,000
Decrease in inventories 8,000
Increase in accrued expenses 2,200 17,200
Deduct: $125,200
Inc.Because Depreciation
in accounts receivable Expense
$ 9,000
Dec.reduced
in accounts
net payable
income but did 3,200
not
Dec.require
in income
an taxes payable
outflow of cash, 500
it is
Gain on sale of land 12,000 24,700
added back to
Net cash flow from operating
net income.
activities $100,500
 The Indirect Method

Select current assets and current

liabilities that impact cash flow and
determine the increases and decreases.
 Changes in Current Accounts
Change
Accounts 2006 2005 Debit Credit
Accounts receivable (net) $74,000 $65,0009,000
Inventories 172,000 180,000 8,000
Accounts payable (mdse.) 43,500 46,7003,200
Accrued expenses payable 26,500 24,300 2,200
Income taxes payable 7,900 8,400 500

Determine the debit or

credit change of each
item above.
 Changes in Current Accounts
Change
Accounts 2006 2005 Debit Credit
Accounts receivable (net) $74,000 $65,0009,000
Inventories 172,000 180,000 8,000
Accounts payable (mdse.) 43,500 46,7003,200
Accrued expenses payable 26,500 24,300 2,200
Income taxes payable 7,900 8,400 500

These debit changes are subtracted from net

income in the operating activities section of
the statement of cash flows. Think of these
debits as deductions from net income in
arriving at net cash flow from operations.
 Changes in Current Accounts
Change
Accounts 2006 2005 Debit Credit
Accounts receivable (net) $74,000 $65,0009,000
Inventories 172,000 180,000 8,000
Accounts payable (mdse.) 43,500 46,7003,200
Accrued expenses payable 26,500 24,300 2,200
Income taxes payable 7,900 8,400 500

These credit changes are added to net income in the

operating activities section of the statement of cash
flows. Think of these credits as additions to net
income in arriving at net cash flow from operations.
 Operating Activities—Indirect Method
Cash flows from operating activities:
Net income per income statement $108,000
Add:
Depreciation $ 7,000
Decrease in inventories 8,000
Increase in accrued expenses 2,200 17,200
$125,200
Inc. in accounts receivable $ 9,000
Dec. in accounts payable 3,200
Dec. in income taxes payable 500
Gain on sale of land 12,000 24,700
Net cash flow from operating
activities $100,500
 The Indirect Method

Analyze the income statement to determine

if there are any gains or losses from selling
investments, equipment, etc.
 Rundell Inc.
Income Statement
For the Year Ended December 31, 2006
Sales $1,180,000
Cost of merchandise sold 790,000
Gross profit $ 390,000
Operating expenses:
Depreciation expense $ 7,000
Other operating expenses 196,000
Total operating expenses 203,000
Income from operations $ 187,000
Other income:
Gain on sale of land $12,000
$12,000
Other expense:
Interest expense 8,000 4,0000
Income before income tax $ 191,000
Income tax 83,000
Net income $ 108,000
 Operating Activities—Indirect Method
Cash flows from operating activities:
Net income, per income statement $108,000
Add:
Depreciation $ 7,000
This gain was
Decrease included in net income,
in inventories 8,000 but
didIncrease in accrued
not represent anexpenses 2,200flow.
operating cash 17,200
$125,200
Inc. in accounts receivable $ 9,000
Dec. in accounts payable 3,200
Dec. in income taxes payable 500
Gain on sale of land 12,000 24,700
Net cash flow from operating
activities $100,500
The Indirect Method
If there had been a loss on this
sale, the loss would have been
added to net income.
 Cash Flows from
Financing Activities
Dividends
ACCOUNT Dividends Payable ACCOUNT NO. 23
Balance
Date Item Debit Credit Debit Credit
2006
Jan. 1 Balance 10,000
10 Cash paid 10,000 -- --
June 20 Dividends declared 14,000 14,000
July 10 Cash paid 14,000 -- --
Dec. 20 Dividends declared 14,000 14,000

Total cash paid $24,000

 Cash Flows from
Financing Activities

Because paying of dividends

affects equity, it is a negative
$24,000 cash flow from
financing activities transaction.
 Cash Flows from
Financing Activities
Sale of Common Stock

ACCOUNT Common Stock ACCOUNT NO. 33

Balance
Date Item Debit Credit Debit Credit
2006
Jan. 1 Balance 16,000
Nov. 1 4,000 shares issued for cash 8,000 24,000
 Cash Flows from
Financing Activities
Sale of Common Stock

ACCOUNT Paid-In Capital in Excess of Par--Common ACCT. NO. 34

Balance
Date Item Debit Credit Debit Credit
2006
Jan. 1 Balance 80,000
Nov. 1 4,000 shares issued for cash 40,000 120,000
 Cash Flows from
Financing Activities
Issuing common stock affects equity;
therefore, we have a total positive cash
flow of $48,000 from this financing
activities transaction.
 Cash Flows from
Financing Activities
Retirement of Bonds Payable

ACCOUNT Bonds Payable ACCOUNT. NO. 25

Balance
Date Item Debit Credit Debit Credit
2006
Jan. 1 Balance 150,000
June 30 Retired by payment of cash
at face amount 50,000 100,000
 Cash Flows from
Financing Activities
This transaction is a negative
cash flows from financing
activities item because long-
term debt is involved.
 Cash Flows from
Investing Activities
Purchased a Building

ACCOUNT Building ACCOUNT NO. 18

Balance
Date Item Debit Credit Debit Credit
2006
Jan. 1 Balance 200,000
Dec. 27 Purchased for cash 60,000 260,000
 Cash Flows from
Investing Activities
Purchased a Building

Purchasing a building involves a

noncurrent asset, so this is a
negative cash flows from
investing activities item.
 Cash Flows from
Investing Activities
Land Transactions

ACCOUNT Land ACCOUNT NO. 16

Balance
Date Item Debit Credit Debit Credit
2006
Jan. 1 Balance 125,000
June 8 Sold for $72,000 cash 60,000 65,000
Oct. 12 Purchased for $15,000 cash 15,000 80,000
 Cash Flows from
Investing Activities
Land Transactions
The first transaction, the sale of
land, results in a positive cash flow
from investing activities because
land is a noncash asset.
 Cash Flows from
Investing Activities
Land Transactions

The $12,000 gain was recorded earlier on

Slide 29 as an operating activity. The
purchase of land also is an investing activity.
Click here to return to
Slide 29. To return to
this slide, type “43” and
press the “Enter” key.
 Refer to Exhibit 6 in your
textbook to see the formal
statement of cash flows using
the indirect approach.

Rundell Inc.
Statement of Cash Flows
For the Year Ended December 31, 2006

Cash flows from operating activities:

Net income $108,000
Add: Depreciation $ 7,000
Decrease in inventor. 8,000
Increase in accrued exp. 2,200 17,200
$125,000
Deduct: Increase in A/R $9,000
Decrease in accts. Pay. 3,200
Decrease in ITP 500
Gain on sale of land 12,000 24,700
Net cash flow from operating act. $100,500
Cash flows from investing activities:
Cash from sale of land $72,000
Less: Cash paid to pur. land $15,000
Cash paid for bldg. 60,000 75,000(3,000)
Cash flows from financing activities:
Cash received from sale of c.s. $48,000
Less: Cash paid to retire b. $50,000
Cash paid for divid. 24,000 74,000
Net cash flow for financing (26,000)
Increase in cash $71,500
Cash at beginning of year 26,000
Cash at end of year $97,500
 Rundell Inc.
Income Statement
For the Year Ended December 31, 2006 Cash Basis
Sales $1,180,000
Cost of merchandise sold 790,000
Gross profit $ 390,000
Operating expenses:
Depreciation expense $ 7,000
Other operating expenses 196,000
Total operating expenses 203,000
Income from operations $ 187,000
Other income:
Gain on sale of land $12,000
Other expense:
Interest expense 8,000 4,000
Income before income tax $ 191,000
This
Income tax
is an accrual basis income statement.
83,000
The
Net direct method of reporting cash
income flows will
$ 108,000
essentially convert this to a cash basis statement.
 Rundell Inc.
Income Statement
For the Year Ended December 31, 2006 Cash Basis
Sales $1,180,000
Cost of merchandise sold 790,000
Gross profit Cash collected $ 390,000
from customers Changes
Operating expenses:
Debit Credit
Depreciation expense $ 7,000
Sales 1,180,000
Other operating expenses 196,000
Receivables
Total operating expenses 9,000 203,000
Income from operations $ 187,000
Other income:
Note: The changes in$12,000
Gain on sale of land
the current balance
Other expense: sheet accounts are determined by
Interest expense 8,000
comparing the beginning 4,000ending
and
Income before income tax $ 191,000
Income tax balances. Receivables increased83,000 by
Net income $9,000 during the period. $ 108,000
 Rundell Inc.
Income Statement
For the Year Ended December 31, 2006 Cash Basis
Sales $1,180,000 $1,171,000
Cost of merchandise sold 790,000
Gross profit Cash collected $390,000
from customers Changes
Operating expenses:
Debit Credit
Depreciation expense $ 7,000
Sales 1,180,000
Other operating expenses 196,000
Receivables
Total operating expenses 9,000 203,000
Cash
Income from operations 1,171,000 $187,000
Other income:
The
Gain on sale of landincrease $12,000
in receivables
Other expense:
represents a reduction
Interest expense 8,000
in4,000
cash
inflowtax
Income before income relative to the $accrual
191,000
Income tax revenue reported on the income 83,000
Net income $ 108,000
statement.
 Rundell Inc.
Income Statement
For the Year Ended December 31, 2006 Cash Basis
Sales $1,180,000 $1,171,000
Cost of merchandise sold 790,000
Gross profit $390,000
Cash payments for
Operating expenses: Changes
merchandise
Depreciation expense $ 7,000
Debit Credit
Other operating
Cost of expenses
mdse. sold 196,000
790,000
Total operating expenses 203,000
Inventories 8,000
Income from operations $187,000
Other income:Accounts payable 3,200
Cashof land
Gain on sale $12,000
Other expense:
Interest expense 8,000 4,000
Income before income tax $ 191,000
Income tax 83,000
Net income $ 108,000
 Rundell Inc.
Income Statement
For the Year Ended December 31, 2006 Cash Basis
Sales $1,180,000 $1,171,000
Cost of merchandise sold 790,000 (785,200)
Gross profit $390,000
Cash payments for
Operating expenses: Changes
merchandise
Depreciation expense $ 7,000
Debit Credit
Other operating
Cost of expenses
mdse. sold 196,000
790,000
Total operating expenses 203,000
Inventories
Income from operations
minus 8,000
$187,000
Other income:Accounts payableplus 3,200
Cashof land
Gain on sale $12,000 785,200
Other expense:
Interest expense
A decrease in Inventories
8,000
(credit
4,000
change)
Income before income taxand an decrease in Accounts
$ 191,000
Income tax Payable (debit change)83,000 have the
Net income $ 108,000
opposite effects.
 Rundell Inc.
Income Statement
For the Year Ended December 31, 2006 Cash Basis
Sales $1,180,000 $1,171,000
Cost of merchandise sold 790,000 (785,200)
Gross profit $ 390,000
Operating expenses:
Depreciation expense $ 7,000 0
Other operating expenses 196,000
Depreciation
Total operating expenses Changes203,000
Income from operations Debit $ Credit
187,000
Other income:Depreciation expense 7,000
Gain on sale of land depreciation
Accumulated $12,000 7,000
Other expense:
Interest expense There is no8,000 cash flow4,000for
Income before income tax
Income tax
depreciation expense.
$ 191,000
83,000
Net income $ 108,000
 Rundell Inc.
Income Statement
For the Year Ended December 31, 2006 Cash Basis
Sales $1,180,000 $1,171,000
Cost of merchandise sold 790,000 (785,200)
Gross profit $ 390,000
Operating expenses:
Depreciation expense $ 7,000 0
Other operating expenses 196,000 (193,800)
Total operating expenses
Cash payments for 203,000
Income fromoperating
operations Changes
$ 187,000
expenses Changes
Other income: Debit Credit
Gain onOperating
sale of land
expenses $12,000
196,000
Other expense:
Accrued expenses
InterestCash
expense
minus 2,200
8,000 193,800
4,000
Income before income tax $ 191,000
Income tax 83,000
Net income $ 108,000
 Rundell Inc.
Income Statement
For the Year Ended December 31, 2006 Cash Basis
Sales $1,180,000 $1,171,000
Cost of merchandise sold 790,000 (785,200)
Gross profit $ 390,000
Gain on sale of
Operating expenses: Changes
investments
Depreciation expense $Debit
7,000 Credit 0
Cash
Other operating expenses 72,000
196,000 (193,800)
TotalInvestments
operating expenses 60,000
203,000
Income from Gain on sale of invest.
operations $ 12,000
187,000
Other income:
Gain on sale of land $12,000 0
Other expense:
The
Interest cash inflow of $72,000
expense 8,000 will 4,000
Income before income tax $ 191,000
be
Income tax
shown in the investing section83,000
of the statement of cash flows
Net income and
$ 108,000
the gain is ignored.
 Rundell Inc.
Income Statement
For the Year Ended December 31, 2006 Cash Basis
Sales $1,180,000 $1,171,000
Cost of merchandise sold 790,000 (785,200)
Gross profit $ 390,000
Operating expenses:
Depreciation expense $ 7,000 0
Cash paid
Other operating for
expenses Changes
196,000 (193,800)
interest expense
Total operating expenses Debit Credit
203,000
Income fromInterest expense
operations 8,000 $ 187,000
Other income:
Cash
Gain on sale of land $12,000 0
Other expense:
Interest expense 8,000 4,000 (8,000)
Income before income tax $ 191,000
Income tax There is no interest payable83,000
Net income account at the end of the year.
$ 108,000
 Rundell Inc.
Income Statement
For the Year Ended December 31, 2006 Cash Basis
Sales $1,180,000 $1,171,000
Cost of merchandise sold 790,000 (785,200)
Gross profit $ 390,000
Operating expenses:
Depreciation expense $ 7,000 0
Other operating expenses 196,000 (193,800)
Total operating
Cash paidexpenses
for 203,000
Changes
Income from operations
income taxes $ 187,000
Debit Credit
Other income:
Gain onIncome
sale oftax expense
land 83,000
$12,000
Income tax payable plus
Other expense: 500
InterestCash
expense 8,000 (83,500)
4,000 (8,000)
Income before income tax $ 191,000
Income tax 83,000 (83,500)
Net income $ 108,000
 Rundell Inc.
Income Statement
For the Year Ended December 31, 2006 Cash Basis
Sales $1,180,000 $1,171,000
Cost of merchandise sold 790,000 (785,200)
Gross profit $ 390,000
Operating expenses: Two different
Depreciation expense
Other operating expenses
$ 7,000
196,000
viewpoints 0
(193,800)
Total operating expenses of income
203,000 from
Income from operations $ 187,000
Other income: operations
Gain on sale of land $12,000 0
Other expense: Accrual Cash
Interest expense 8,000 Basis
4,000 Basis
(8,000)
Income before income tax $ 191,000
Income tax 83,000 (83,500)
Net income $ 108,000 $ 100,500
Operating Activities—Direct Method

Cash flows from operating activities:

Cash inflows:
Cash received from customers $1,171,000
Cash outflows:
Cash payments for merchandise $785,200
Cash payments for operating expenses 193,800
Cash payments for interest 8,000
Cash payments for income tax 83,5001,070,500
Net cash flow from operating activities $ 100,500
 Financial Analysis and Interpretation

Free Cash Flow Dell Corporation

Cash flow from operations $4,195,000
Less: Cash used to purchase fixed
assets to maintain productive
capacity used up in producing
income during the period (482000)
Less: Cash used for dividends —–
Free cash flow $3,713,000
Free cash flow as a percent of cash
flow from operating activities 89%
 Financial Analysis and Interpretation

Free Cash Flow Dell Corporation

Cash
Use:flow
To from operations
measure $4,195,000
the financial strength of a
Less: Cash used toApurchase
business. companyfixed
that has
assets to maintain productive
positive free cash flow is able to fund
capacity used up in producing
internal
income growth,
during retire debt, and
the period enjoy
(482000)
financial
Less: Cash flexibility.
used for dividends (—)
Free cash flow $3,713,000
Free cash flow as a percent of cash
flow from operations 89%
Chapter 16

The End