Chapter 12

Chapter 12 Statement of Cash Flows
Financial Accounting
10e
Libby • Libby • Hodge
Classifications of the Statement of Cash Flows
Cash inflows and outflows directly related

Operating Activities
to earnings from normal operations.
Cash inflows and outflows related to the

acquisition or sale of productive facilities
Investing Activities and investments in the securities of other
companies.
Cash inflows and outflows related to

Financing Activities external sources of financing (owners and
creditors) for the enterprise.
Copyright ©2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
12-2
Exhibit 12.1
Consolidated
Statement of
Cash Flows
The ending cash

balance should
agree with the
balance sheet.
12-3
Direct Method vs. Indirect Method
Two Formats for Reporting Cash Flow from Operating Activities
Direct Method Indirect Method
Reports the cash effects of Starts with accrual net

each operating activity income and converts to
cash flow from operating
activities
The cash flows from operating activities are always the same,
regardless of whether the direct or indirect method is used.
12-4
Cash Flows from Operating Activities
Inflows
Inflows
Cash
Cashreceived
receivedfrom:
from:
 Customers
Customers
 Dividends and interest on
Dividends and interest on
investments
investments + Inflows
Cash
CashFlows
Flows
from
fromOperating
Operating
Outflows
Outflows Activities
Activities
Cash
Cashpaid
paidfor:
for:
 Purchase of services
Purchase of services
(electricity,
(electricity,etc.)
for resale
for resale
etc.)and
andgoods
goods _ Outflows
 Salaries and wages
Salaries and wages
 Income taxes
Income taxes
 Interest on liabilities
Interest on liabilities
12-5
Cash Flows from Investing Activities
Inflows
Inflows
Cash
Cashreceived
receivedfrom:
from:
 Sale or disposal of property,
Sale or disposal of property,
plant,
plant,and
andequipment
equipment
 Sale or maturity of investments
Sale or maturity of investments
ininsecurities
securities + Inflows
Cash
CashFlows
Flowsfrom
from
Investing
Investing
Outflows Activities
Activities
Outflows
Cash
Cashpaid
paidfor:
for:
 Purchase of property, plant, and
Purchase of property, plant, and
equipment
_ Outflows
equipment
 Purchase of investments in
Purchase of investments in
securities
securities
12-6
Cash Flows from Financing Activities
Inflows
Inflows
Cash
Cashreceived
receivedfrom:
from:
 Borrowings on notes, mortgages,
Borrowings on notes, mortgages,
bonds,
bonds,etc.,
etc.,from
fromcreditors
creditors
 Issuing stock to owners
Issuing stock to owners
+ Inflows
Cash
CashFlows
Flowsfrom
from
Financing
Financing
Activities
Activities
Outflows
Outflows
Cash
Cashpaid
paidfor:
_ Outflows
for:
 Repayment of principal to creditors
Repayment of principal to creditors
(excluding
(excludinginterest,
interest,which
whichisisan
an
operating activity)
operating activity)
 Repurchasing stock from owners
Repurchasing stock from owners
 Dividends to owners
Dividends to owners
12-7
Indirect Method
12-8
Reporting and Interpreting Cash Flows from Operating
Activities (Indirect Method)
The
Theindirect
indirectmethod
methodadjusts
adjustsnet
netincome
incomeby
by
eliminating
eliminatingnoncash
noncashitems.
items.
++Losses
Lossesand
and––Gains
Gains
Cash
CashFlows
Flows
Net
Net from
from
Income
Income Operating
Operating
Activities
Activities
++Noncash
Noncash +/−
+/−Changes
Changesinin
expenses
expensessuch
suchas
as current
currentassets
assetsand
and
depreciation
depreciationand
and current
currentliabilities.
liabilities.
amortization.
amortization.
12-9
Adjustment for Gains and Losses (Indirect Method)
Cash received from the sale or disposal of long-term assets is classified as

investing cash inflow. Gains/losses on the income statement, if any, are
subtracted from/added to net income in order to compute cash flow from
operating activities.
Gains must be subtracted from net

Gains
income to avoid double counting the gain.
Losses must be added to net income to

Losses
avoid double counting the loss.
12-10
Exhibit 12.4 (1 of 2)
Schedule for Net Cash Flow from Operating Activities, Indirect Method
Step
Step11
Adjust
Adjustnet
netincome
incomefor
fordepreciation
depreciationand
andamortization
amortization
expense
expense and gains and losses on sale of investingassets.
and gains and losses on sale of investing assets.
Copyright ©2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 12-11
Exhibit 12.4 (2 of 2)
Schedule for Net Cash Flow from Operating Activities, Indirect Method
Step
Step22
Adjust
Adjustnet
netincome
incomefor
forchanges
changesinin
current
currentassets
assetsand
andcurrent
currentliabilities.
liabilities.
Summary (Indirect Method)
We can summarize the typical additions and subtractions that are
required to reconcile net income with cash flow from operating
activities as follows:
12-13
• Refer to Excel file: Cash Flow from Operating
Activities Indirect Method.
12-14
Investing Activities
12-15
Exhibit 12.1
(1 of 5)
We must report
individually the
cash used to
purchase
equipment and
the cash proceeds
received from the
sale of equipment.
12-16
Exhibit 12.1
(2 of 5)
Although short-term
investments is a
current asset, it is
reported in the
investing section on
the statement of cash
flows. The company
purchased short-term
investments for $1,463.
They company also
sold short-term
investments for $2,011,
an amount equal to
their net book value.
12-17
Refer to Excel File: Cash flow from Investing Activities
12-18
Financing Activities
12-19
Exhibit 12.1
(3 of 5)
Cash received from

issuance of long-
term debt.
12-20
Exhibit 12.1
(4 of 5)
Cash received from

issuing common
stock.
12-21
Exhibit 12.1
(5 of 5)
Retained earnings
increased by $38,398
due to the combined
effect of $107,045 of
income and $68,647 in
dividends declared and
paid.
Retained Earnings Analysis
April 30, 2016 $ 188,926

Add net income 107,045
Less dividends (68,647)
April 29, 2017 $ 227,324
12-22
Issuance and Payments of
Long-Term Notes Payable
12-23
Issuance and Payments of
Long-Term Notes Payable
• Beginning Balance = $77,000.
• Amount incurred in this year = $94,000
• The ending balance for the Long-Term Notes
Payable account was $160,000.
• 160,000 = 77,000 + 94,000 – Payments for
debts.
• Payments for debts =$11,000
12-24
Dividend Payments
• Dividend payments are computed by analyzing the Dividends
Payable and Retained Earnings account.
• Ending Balance of Retained Earnings = Beginning Retained

Earning + Net Income – Dividend declared.
• Ending Balance of Dividend Declared = Beginning Balance of
Dividend Declared + Dividend Declared – Cash Paid for
Dividend.
12-25
• Refer to Excel File: Cash flow from Financing
Activities
12-26
Completing the Statement and Additional Disclosures
Direct Method
• The use of direct method or indirect method only

affects the presentation of cash flow from operating
activities. Both methods result in the same amount
of cash flow from operating activities.
• The presentation of cash flow from investing and
financing activities are identical under both
methods.
12-28
Direct Method
A and B Company
Statement of Cash Flows
For the Year Ended 31 Dec 2020
$ $
Cash flows from operating activities
Cash received from customers 466,000
Cash paid to suppliers (150,000)
Cash paid for operating expense (145,000)

(excluding interest and tax)
Cash paid for interest (10,000)
Cash paid for tax (20,000)
Net cash provided by operating activities 141,000
12-29
Computing Cash received
from Customers
Cash sales
• Sales
Credit sales
• Cash received from customers = sales –

change in accounts receivables
12-30
Computing Cash received
from Customers
• Beginning balance of AR = $80,000
• Ending balance of AR = $93,000
• Sales = $284,000
• Cash received from customers = $284,000 –
($93,000 - $80,000)
• Cash received from customers = $271,000
12-31
Computing Cash Paid to Suppliers
• This is accomplished by analyzing two

accounts
• 1) Purchase
• 2) Accounts payable.
12-32
Cash Paid to Suppliers
• What if you do not know the amount of
purchase?
• Cost of goods sold = Beginning inventory +
Purchase – Ending inventory.
• Purchase = Cost of goods sold – Beginning
inventory + Ending inventory
• Purchase = Cost of goods sold + (Ending
Inventory – Beginning Inventory)
• Purchase = Cost of goods sold + Change in
Inventory
12-33
• Cost of goods sold = $150,000

• Beginning Inventory = $138,000
• Ending Inventory = $ 135,000
• Purchase = $150,000 + (135,000-138,000)
• Purchases = $147,000
12-34
• However, not all purchases are paid by cash. How do
you find cash payments for purchase?
Cash purchase
• Purchases
Credit purchase
• Cash payments to suppliers (suppliers) = Purchases –

(changes in accounts payable)
12-35
• Purchase = $147,000
• Beginning Accounts Payable = 57,000
• Ending Accounts Payable = 91,000
• Cash Paid to Suppliers = $147,000 – ($91,000 –
57,000)
• Cash Paid to Suppliers = $113,000
12-36
Payments for Operating Expenses
Expenses incurred
in this period but
Accrued expenses not yet paid
E.g Wages payable
Expenses paid in this

Expenses Prepaid expenses period but not yet
E.g Prepaid insurance incurred
Expenses incurred
and paid in this
period
Other expenses
Expenses incurred in
this period but paid
in last period
12-37
• Payments for Operating Expenses =Operating
Expenses + Change in Prepaid Expenses - Change in
Accrued Liabilities (e.g wages payable).
• If prepaid expenses increase, cash has been paid, but

the amount has not been included in operating
expenses. Therefore, add it back
• If accrued liabilities increase, the amount has been

included in operating expenses but cash has not been
paid. Therefore, subtract it.
12-38
• Operating expenses = $17,000
• Beginning prepaid expenses = $7,000
• Ending prepaid expenses = $8,000
• Beginning accrued expenses = $ 3,000
• Ending accrued expenses = $1,000
• Payments for Operating Expenses = 17,000+
(8,000 – 7,000) – (1,000-3,000)
• Payments for Operating Expenses = 17,000+
1,000 + 2,000
12-39
• Payments for Operating Expenses = 17,000+ 1,000 +
2,000
• Payments for Operating Expenses = $20,000
• Why do we add $1,000 of increased prepaid
expenses? $1,000 has been paid but not included in
$17,000 (add it back).
• Why do we add $2,000 of decreased accrued
expenses to $17,000? $2,000 has been paid but not
included in $17,000 (When did it incur?)
12-40
Cash paid for interest
• Ending balance of interest payable = beginning

balance of interest payable + interest expense
– cash paid for interest
12-41
Cash paid for tax
• Ending balance of tax payable = beginning

balance of tax payable + tax expense – cash
paid for tax.
12-42

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Chapter 12

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Chapter 12 Statement of Cash Flows

Cash inflows and outflows directly related

Cash inflows and outflows related to the

Cash inflows and outflows related to

The ending cash

Two Formats for Reporting Cash Flow from Operating Activities

Direct Method Indirect Method

Reports the cash effects of Starts with accrual net

Cash received from the sale or disposal of long-term assets is classified as

Gains must be subtracted from net

Losses must be added to net income to

Cash received from

Cash received from

Retained Earnings Analysis

April 30, 2016 $ 188,926

• Ending Balance of Retained Earnings = Beginning Retained

• The use of direct method or indirect method only

Cash paid for operating expense (145,000)

• Cash received from customers = sales –

• This is accomplished by analyzing two

• Cost of goods sold = $150,000

• Cash payments to suppliers (suppliers) = Purchases –

Expenses paid in this

• If prepaid expenses increase, cash has been paid, but

• If accrued liabilities increase, the amount has been

• Ending balance of interest payable = beginning

• Ending balance of tax payable = beginning

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