ay Story Got Cash? Companies must be ready to respond to changes quickly in order to survwe and thrive. Ths requires careful man- agement of cash. One company that managed cash successfully in its early years was Microsoft. During those years, the company paid much of its payroll with stock options (rights to purchase company stock in the ‘uture ata given price) instead of cash. This conserved cash and turned more than a thousand of its employees: into rilionaires. In recent years, Microsoft has had a different kind of cash problem. Now that it has reached a more “mature” stage in life, it generates so much cash—roughly $1 billion per rmonth—that it cannot ahways figure out what to do with a. At one time, Microsoft had accumulated $60 billion, ‘The company said it was accumulating cash to invest in new opportunities, buy other companies, and pay off pending lawsuits. Microsofts stockholders complained that hoiding allthis cash was putting a drag on the company’ profitability. Why? Because Microsoft had the cash invested in very low-yielding government securities. Stockholders felt that the company either Y Lee te seid Cee Cees Corrente Past] Cee Gs Leena) Pts) Ce Work Comprehensive Lee cme it Complete Assignments Go to WileyPLUS for practice and tutorials ‘Read A Look at IFRS p, 709 vo should find new investment projects that would bring higher returns, or return some of the cash to stockholders, | finaly, Microsoft announced a plan to return cash to stockholders by paying a special one-time $32 bilion div dnd, Ths special dvidend was so large that, according to the US. Commerce Department, aused total personal | income inthe United States to rise by 37% n one ronth— the largest increase ever recorded by the agency I aso | mate thle season ght specay ree the Seatte area) Microsoft also doubled its requiar annual dividend to $3.50 per share. Further, announced that it would spend another 30 billion buying treasury stock In recent years, Apple also encountered this cash “problem.” At the end of 2011, Apple had nearly $100 billon in quid assets (cash, cash equivalents, and | investment securities) At that time, it was generating $37 billon of cash per year from its operating activites | but spending only about $7 billion on plant assets and | purchases of patents. Shareholders pressured Apple to | unload some of this cash. in response, Apple announced that it would begin to pay @ quarterly dividend of $2.65 per share and it would buy back up to $10 billion ofits Learning Objectives vo After studying this chapter, you should be able to: [1] Indicate the usefulness of the statement of cash flows. [2] Distinguish among operating, investing, and financing, activities. [3] Prepare a statement of cash flows using the indiract method. {4} Analyze the statement of cash flows.the dividend consumes only leaves Apple wallowing $10 bilion of cash per year. Th incash The rest of us should have such problems. cial Preview of Chapter 13 ‘The balance sheet, income statement, and retained earnings statement do not always show = of the financial condition of a company or institution. In fact, looking at the financial state : How did Eas well-known companies, a thoughtful investor might ask questions like th ash dividends of $649 million in a year in which it earned only $17 million? How could Un ‘new planes that cost $1.9 billion in a year in which it reported a net loss of over $2 billion? How o that spent a combined fantastic $3.4 trillion on mergers and acquisitions in a recent year finance v Answers to these and similar questions can be found in this chapter, which presents the statem: The content and organization of this chapter are as follows. Easel Take) TS Peer a tiae ee ed + Free cash flow Preparing the Statement of Cash Gea) The Statement of Cash Flows: ae + Step 1: Operating activities * Usefulness * Classification * Step 2: Investing and financing * Significant noncash activities activities * Format * Step 3: Net change in cash * Preparation * Indirect and direct methods650 ‘13 Statement of Cash Flows The Statement of Cash Flows: Usefulness and tes Ea Indicate the usefulness of the statement flows. of cash = 1 Ethics Note ‘Though we would dscourege provided (used) by operating activities. Net income provides infor, reliance on cash flows to the ‘Suclusion of accrual accounting, statement users are critical of accrual-basis net income because it comparing net cash provided The balance sl income in me tdcoing, nen mre maga tf Tapa comer le hecho he a onsen or al for The nce atten teas ota aie ance ues eee eee Usefulness of the Statement of Cash Flows The statement of cash flows rej t lows reports the cash receipts, cash payments, ani change in cash resulting from operating, investing, and fnancing acted ing a period. The information in a statement of cash flows creditors, and others assess: ne 1, The entity's ability to generate future cash flows. By examining relation- ships between tems in the statement of cash Nows, investors can make prec: ions of the amounts, timing, and uncertainty of future cash flows better they can from accrual-basis data. ° ae . The entity's ability to pay dividends and meet obligations. If a company does not have adequate cash, it cannot pay employees, settle debts, or pay dividends, Employees, creditors, and stockholders should be particularly interested in hisstatement, ‘because it alone shows the flows of cash in a business ‘The reasons for the difference between net income and net cash mation on the success or failure of a business. However, some financial requires many estimates. Asa result, users often challenge the reliability by operating activities to net Of the number. Such is not the case with cash. Many readers of the income can reveal important information about the “quality” between net income and net cash provided by operating activities. of reported net income. Such 2 ‘Thon they can assess for themselves the reliability ofthe income number. comparison can reveal the textent to which net income provides a good measure of actual performance. tt nes ingh operating, investing, financing activities. a and =) Statement of cash flows want to know the reasons for the difference ‘The cash investing and financing transactions during the period. By examining a company’s investing and financing transactions, By emer simement reader can better understand why assets and liabilities changed during the period. Classification of Cash Flows ‘The statement of cash flows classifies cash receipts and cash payments as operat- ing, investing, and financing activites. Transactions ‘and other events characteristic of 1. 2. ‘each kind of activity are as follows — i ut creat Operating activities include the cash effects of transactions t eae ans nook wipaece. iy tum enter bain toa Gates! © of ne ica, i i ing of investments Investing activities include (a) acquiring and disposing n property, plant vet Teguipment, and (b) lending money and collecting the loans.The Statement of Cai d issuing debt an include (2) obtaining cash fom Te holders, 3, Financing activities include (@) Cnt ining cas . Fit " repaying the amos dens. h . It shows the cas! ea ae eatgay isthe mast at at ally considered to ties: . of cash is inue The operating activites cone This source of t cash to continu y operations. fficien provided by company i te su ‘be the best measure of a ‘company’s ability to generat a ; i ments within * asation 13 1 cash receipts and cash pay hin each Masai as Brady the list carefully. It will prove very dl : Elon geet ‘TYPES OF CASH INFLOWS AND OUTFLOWS Operating activties—Income statement items Cash inflows: rom sale of goods or services. From interest received and dividends received, Cash outflows: To suppliers for inventory: ‘Tocmployees for wages. ‘To government for taxes Tolenders for intrest. To others for expenses Investing activities—Changes in investments and long-term assets Cash inflows: fom sale of property, plant, and equipment, From sale of investments in debtor equly securities of other entities, yom collection of principal on loans to ether erin Je purchase property, plant, and equipment, To PUI Invests nde or sly acres of other en ‘To make loans to other ‘entities, ee on Mites Financing activities—Changes in nancng act Jong-term Habit From sale of com: Cash outto ‘To stockhol To redeem | amon stock, ince of debt (bonds and note ), Iders as dividends, long-term debt or reacquire. Capital stock (treasury stock), Note the followi 1. Operating activi 2. Investing activity ‘Ng general guidelines ities involve ies involve Income statement items, and long-term nose reoM® 28 Hows romuling Irony changes tt investments 3. Financing activities involve a ies involve cash flown ren iro Tab ie no equity Henne mUlting from changes tn longsterm Companies classify as lated to Invest *wtnIent revenue (interest are PaYMenty of in * Fecelpty of Inve ing activitien, ish Flows: Usefulness and Formay, Illustration 13-1 Typical receipt and payment classifications = a Operating activities | activities852 _ 43 Statement of Cash Flows to lenders. Why are these considered operating activities? Because companies jaieae these items in the income. ‘statement, where results of operations are shown, Significant Noncash Activities Not all of a company’s significant activities involve cash, Examples of significant rnoncash activities are: 1, Direct issuance of common stock to purchase assets 2. Conversion of bonds into common stock 23. Direct issuance of debt to purchase asses. 4 Exchanges of plant assets. Companies do not report in the body of the statement of cash flows sig- Helpful Rint nificant Rnancing and investing activities that do not affect cash. Insicad. Donotincudenoncash they report these activities in either a separate schedule at the bottom of the vesting and financing statement of cash Rows or in a separate note or supplementary schedule to acti inthe bogy ofthe the financial statements. The reporting ofthese noncash activities in a separate Statementof cashflows. schedule satisfies the full disclosure principle. Report this vloemation ina In solving homework assignments, you should present significant noncash —— investing and financing activities in a separate schedule at the bottom of the tate- ‘ment of cash flows. (See the last entry in Mlustration 13-2 on the nest page for an example.) ACCOUNTING ACROSS THE ORGANIZATION a Net What? ‘Netincome isnot the same as net cash provided by operating activities Below aresome resus ‘annual reports (dollars in millions). Note the wide dsparity among these compa from recent ries, all of which engaged in retail merchandising Net Cash Provided by Company. Netincome Operating Activites Koh's Corporation 51083 $1234 WalMart Stores, nc 2a 20,169 4. Penney Company, Ie 1153 1255 ‘Costco Wholesale Corp. 11082 2078, ae Target Corporation 2849 ans ces exist between net income and net cash provides by In general, why do differen i ‘operating activities? (See page 708) Format of the Statement of Cash Flows of cash flows presents the results ofthe three investing, and financing—plus the ‘The general format of the statement istration 13-2 shows @ tivities discussed previously—operating, inve Significant noncash investing and financing activities, Ih ‘videly used form of the statement of cash flows.z 8 usefulness and Formar Mlustration 13-2 Format ofertas flows > ash flows from Operating 8 Tis ies acti sction and then fan or ye esting ar ia sections eo ee i} This amount is added 10 the beginning cs Sehr ened TSA amount pre om HE palance sheet | atthe endine: Daring its fist week, Df Classification of, Cash Flows peed 100000 shares of ar value CODEN 1 pomowed $200 000 from Case Bank, Seno s.year note bearing ‘sion Plan 3. Purchased two emi trailer trucks for $170,000 cash. of ley te ee paid em ries and Wa olen gen “A cmployes 512,00 for salaries and WEES F Gateted $20.00 cash for services performed, cof cash flow activity Sieash inflows and ‘lasifyeach ofthese transactions By 8P° ‘ations 0 Repor as operating ° CEB iecefiees Solution | econ at cg fees [eee Lam oct income. 2. Financing activity 5, Operating activity eee eee | eee Seas at sai Dargie ct Reted exec natr Ge BF, BEID, 95,6132, 6133, and SB 1 frome ad alt loons er oan ‘them dividends.7 . a ee fae = 654 413 Statement of Cash Flows Preparing the Statement of Cash Flows Companies prepare the statement of cash f m are the statement of cash flows differently from the three ather asic financial statements. First, it is not prepared fromm an adjusted trial balance Ttrequires detailed information concerning the changes in account balances that occurred between two points in time. An adjusted trial balance will not provide the necessary data. Second, the statement of cash flows deals with cash receipts tnd payments Asa result, the company adjusts the elects ofthe use of accrual accounting to determine cash flows “The information to prepare this statement usually comes from three sources + Comparative balance sheets. information in the comparative alanis serapendicates the amount ofthe changes in assets, liablities, and sk holders’ equities from the beginning to the end of the period «Current income statement. Information in this statement helps der Cline the amount of net eash provided or used by operating activites dur ing the period « Adaitional information. Such information includes waretct) data that atid to determine how cash was provided or used during the period. Preparing the statement of cash flows from these data sources involves three ‘major steps, explained in Illustration 13-3. ee ~ STEP 1: Determine net cash provdedlused by cpoaeTe aces by comerDnE Three mao steps inprepatog ms thesatenente ash fows Deere rom an acral bass 3 cash bss itoring 057 tease) Sacre | oe dh cere arse he a | — | STEP 2: Analyze “anges noneurrecasse nd able 22°08 and record 35 Jvesting and financing actives OF idaclose as noncash transactions: ee ener L balance sheet data and selected eee rocs rent of ash lows with te 3 sates tance sheet to make Sure | SEP 3: Compare she change in the the amounts agree the begining 294 ee “The difference betwee” Te een ym -& Soe hods _ ots gay mn: wet Hel Sr ‘basis. This conversion ay be of 14 ted pivitic "They i e ovided by eran a ties” THEY aPreparing the Statement of Csh Flowing & ec ns i do not affect cash, irect method adjusts net income for items that or majong af ompanis (98%) use this method. as shown in the nem chan! Companies favor the indirect method for two reasons. (1) Itis easier and less costly to prepare, and (2) it focuses on the differences between net income ind net cash flow from operating activities. ne inet method shows operating cash ecipts and payments Its pre. pared by adjusting each item in the income statement from the accrual basis to the cash basis. The FASB has expressed a preference forthe direct method, but allows the use of either method. The net seton urate the more popular indirect method. Appendix 13A illustrates the direct method. PI Preparing the statement of Cash Flows-indirect Method To explain how to prepare a statement of cash flows using the indirect method, a > \we use financial information from Computer Services Company. lustration 13-4 Presents Computer Series’ curent and previous year balance shes is cor | Pepe asutene year” income statement, and related financial information forthe current a ash Rows ie te y indirect method year, Cees Coe omparative Balance Sheets income sateen nd eee ionaintmatn or Change in OMe Sences Company Account Balance Assets 2015 _ 2014 Increase/Decrease Current asets Cash $ 55,000 § 33,000 § 22.000 increase Accounts receivable 20,000 30,000 10,000 Decrease Inventory 15,000 10.000 5,000 inerease Prepaid expenses 5.000 1,000 4,000 Increase Proper, plant, and equipment Land 1300000 20,000 110,000 increase Buildings 180.000 40.000 120,00 inerease Bruit depresiavion—buildings (1.000) 000) "ong ese Equipment 27,000 10,000 17,000 Increase Accumulated depreition—equipment Cand) (1000) ".9qp oe Toial assets $398,000 $138,000 Liabilities and Stockholders! Equity Tibilites and Stockholders! Equity Current la ‘Accounts payable $ 28,000 Income taxes payable 6000 8000 2,000 Decrease Long-term liabilities Bonds payable 130,000 20,000 110,000 tnerease ‘Stockholders equity ‘Common stock 70,000 50,000 20,000 Increase Retained earnings, 164,000 _ 48,000 116,000 Increase ‘Total liabilities and stockholders! equity $398,000 $138,000, (continued) rate Tends and Pechniques—2012 (New Yank: American lst of Cie ubhc ‘Accounisns)56 state’ 4 nustration 1 Austration 135 ‘vee types of adusets to cover et income to net cash ‘rvided by operating activites Bw sment of Cash Flows eae ted oceans For the Year Ended December 31,2015 Sales enue Cost of goods sold ‘$150,000 | Operatngenencs (ang depecain) "110 Depesinion pens ora Tosson de of eupmen 310 Inet ene amc. Income before income tax Income tax expense Net income Additional information for 2015: 1. Depreciation expense was comprised of $6,000 for buildingand $3,000 for equipment 2. The company sold equipment with a book value of $7,000 (cost $8,000, less accumulated depreciation $1,000) for $4,000 cash. '3, Issued §110,000 of long-term bonds in direct exchange for land. 44. A building costing $120,000 was purchased for cash. Equipment costing $25,000 ‘was also purchased for cash, 5. Issued common stock for $20,000 cash. 66. The company declared and paid a $29,000 cash dividend. ‘We will now apply the three steps tothe information provided for Computer Services Company. Step 1: Operating Activities DETERMINE NET CASH PROVIDED/USED BY OPERATING ACTIVITIES BY ‘CONVERTING NET INCOME FROM AN ACCRUAL BASIS TO A CASH BASIS "To determine net cash provided by operating activities under the indirect method, companies adjust net income in numerous ways. A useful starting point isto under Stand why net income must be converted to net cash provided by operating activities, ‘Under generally accepted accounting principles, most companies use the accrual basis of accounting. Ths basis requires that companies record revenue when their performance obligation is satisied and record expenses when incurred. Revenues Pnclude eredit sales for which the company has not yet collected cash. Expenses incurred inchide some items that it has not yet paid in cash. Thus, under the accrual basis, net income is not the same as net cash provided by operating activities. “Therefore, under the indirect method, companies must adjust net income to convert certain items to the cash basis. The indirect method (or reconciliation tnethod) starts with net income and converts it to net cash provided by operating activities. Mlustration 13-5 lists the three types of adjustments. [Net Cash Provided/ Net income +/~ ‘Adjustments = Used by Operating Activities + Add back noneash expenses, such as depreciation expense, amortization, or depletion. + Deduct gains and add losses that resulted from investing and financing activities, + Analyze changes to noncash ‘current asset and current liability accounts. naePreparing he Statement of Cth Fog. ° We explain the three types of adjustments in the next three sections. justments in the next ve expai types of adjust Computer Scevee” ive satement reports deprecation expense of $9,000 Computer Services’ income sta So eee eens itn east nl eins Cay shown below. Nee enceceert beso toh ont ipemaig aso iene 000 $154,000, Jp the first adjustment to net income inthe statement of cash flows, compa- es Reaquenty list depreciation and similar noncash charges such a5 ammorton, ‘on of intangible assets, depletion expense, and bad debt expense 12 Gur example, Computer Services’ income statment Teports a $3,000 loss sasee disposal of equipment (book value $7,000, lag $4,000 cash received from, disposal of equipment). The company’s less of $3,000 should not be included in {Pe operating activities section ofthe stators of cash flows. Ilustration 13.7 Shows that the $3,000 losis eliminated by adding $3,000 back to net income io ‘Stvive al net cash provided by operating activities Cash Nows fom operating actives tastration 13.7 Net income $145,000 _‘Aastnet for osson spon “Acstments to reconcile net income to net ash oF euiment Provided by operating activter preciation expense $9000 {Loss on disposal of equipment 3,000 Net sh provided by operating activites CHANGES To NONCASH CURRENT Ass; UABILITY ACCOUNTS eran Curse A final adjustment activities involvesgg. statemen of Cash lows ustration 138 ral of aco recevatle the performance obliga obligation is satisfied and crag, cunts Rec ef sre oned unde cngey Pr oe tha ave een made but for which cash callections roaisag en ee spaid Insurance reflects insurance that has Goce pald tt orto ened heroes been xp) Siar a el Wan Pe is salaries an wage epee sree ered tt has oben pid i assent pee Tw adjust net income for these accruals and prepayments pbeaal ne net cash roel by operating activities, Thus, we rust analy the ee ‘and current libility acceunt to determine i's pact cunts SW NONCASH CURRENT ASSETS. The adjustments required for changes in noneash curen t accounts are as follows, Deduct from net income by ‘current asset accounts, and add to net Income decreases in current set eso ant at net cash provided by operating activi le ober rat atonships by amazing the accounts of Computer Services psn DECREASE IN ACCOUNTS RECEIVABLE Compe ‘Services Company’ acerunts receivable decreased by $10,000 (From $30,000 to $20,000) during the period. For Computer Services, this means that “cash receipts were $10,000 higher than aes aaeave The Accounts Receivable account in iusraien 13-8 shows that Gomputer Services Company had §507,00 in sles revenue (as reported on the Faroe statement), but it collected $517,000 in cash Accounts Receivable receipts from customers Wins Balance $17,000 Sales revenue _507,000. T2815 Balance 20,000 ‘As shown in lustation 13-9 (page 659) 1 adjust net income to net cash provided by operating activities, the omnFAr® ‘adds to net income the decrease of FF0,000in accounts receivable, When the -rewounts Receivable balance increases, ash receipts are lower than sales revenue ‘earned under the accrual basis. There fore, the company deducts from net income ‘he amount ofthe increase in accounts roel, wo arrive at net cash provided LY roperating activities. INCREASE IN INVENTORY Computer Sonics Company’ inventory increased $5,000 (from ‘$10,000 to $1 5,000) during | the period. The change in the Inventory anaes the difference between the mount of inventory purchased and accour unt sol. For compute Serves. this mest that the cost of merchandise purchased ‘exceeded the cost ‘of goods ‘sold by $5,000. As a ‘result, cost of goods arr goes not reflect $5,000 of cash paymens made for merchandise. The so pany det from net income hi over increase of $5,000 during the eriod to arrive at et cash provided bs porting activites (= usteation 139) ‘[finventory decre: the company adds to net ‘income the amount ‘of the change, to arrive at net cash provided by operating activities. INCREASE IN PREPAID EXPENSES Compl! ‘services’ prepaid expenses in: rate during the period by $4,000. This AT That cash paid for expenses is higher than expenses reported On ‘averval bass. nother words, the compart thas made eash payments in the cuerent perio ut wil ot charge exes 6 a ture pero (as charges 1 NE ET statement), To adjust net imme 1 net cash provided by operating arr ities, the company deducts from aa ane the 4,000 Inerease in prepaid exPenSSS ‘soe llustration 13-9.Preparing the Statement of Cash Fonda, ¢ aah ows rom operating acts — prhee st income to net cash Aiton nein Provided by operating ati Beprecatin expense Loss on daposl of equipment Decrease fn accounts recelable Increase fn inventory Increase in prepatd expenses Net cash provided by operating activities enses are higher than the expenses ss decrease, reported exp ethan pi Pe econ erode 3 decrease in prepaid expensce INCREASE IN ACCOUNTS PAYABLE For Computer oan Company, Accounts Payable increased by $16,000 (rom Stata , eed the compan Feceived $16,000 more in. ‘B00ds than it, actually paid for. As shown intlustraton 13:10 (sae }.*0 adjust net income to determine net cao Drovided by operating activities, the company adds to net income the $16,000 'ncrease in Accounts Payable, Son att Was $2,000 less than the amount of ner igbald during the period of $49,068 ‘As shown st red ustration 13-10, to adjust "the company must reduce net im toe ret ‘Net income $145,000 ‘Current lability accounts, Peete by operating activin Depreciation expense $ 9,000 mnerease in prepaid , expenses (4,000) feos, ss 'ase in income taxeg. Payable (2,000) Net cash Provided by. ‘OPerating activities Illustration 13-10 shows that after Starting : vas gor net come of $145,000 the prov ofthe adjustments ws dncome was $27,099 41° Ct 000. Thi Provided by operating, Activities of $172,099, M Thsreteinnteah60 1B5taterent of Cash Flows Summary of Conversion to Net Cash Provi of Conv rovided by Operating Activities Indirect Method As shown inthe previous hastrations, the statement ‘of cash flows prepared by firect method starts with net income. It then adds or deducts items to aa cash provided by operating activities. The required adjustments are of three types: 1, Noncash charges such as depreciation, amortization, and depletion. 2, Gains and losses on the disposal of plant asses. 3, Changes in noncash current asset and current liability accounts. Ilustration 13-11 provides a summary of these changes. aaron etna anet Ajmer test steal Storer ane mp canned Repo [Depreciation expense Add wren tn pe Mi san coe Mi Gains Loss on disposal of plant assets Add and Losses: |Gain on disposal of plant assets ‘Deduct Cer fimcincmenssetscoum elt Sian, (Sete tron saeco ‘4 tases [Doren acme a vel Current Liabilities [Decrease in current liability account For more than a decade, the top executives atthe tallan dairy products mPa ser et engaged in multiple frauds tat overstated cash and other ates by Tow Parmalat oil understating alts by between $8 and $12 lion. Much of thar ela involved creating ficou sources and uses of cash Some ofthese ais sre fomatedsopristcted franca transactions with subilaris created With the Trap ot large International financial institutions. However, much of te fraud ree ged very basic even soppy, forgery of documents. For example, wen outside cred cquested confirmation of bank accounts (such asa fake $48ilin account aac Cayman blonds), documents were ceated on scanners, with gnaturs ot in te Cay pasted from ater documents. These were then passed through « ot aera spmerous times to make them ook rea (difficult to read) simian, Fete trace were created In order to divert funds to other businesses owned by the Tana family (who controlled Parmalat). eee is ‘THE MISSING CONTROL Tdependent internal verification. internal auditors at the company should Nave indebendertl verified bank acounts and major transfers of cash to outside companies ‘that were controlled by the Tanzi family. pa So eS Cash from Joshis PhorPls reported net income of§73,00for 2015. Included inthe income sae Operatin aa ge ecilon expense of $7000 an ain on disposal of equipment of $2,500 sade] Joahs comparative balance sheets show the following balances | ActivitiesPreparing the Statement of Cash Flows—Indiec, Meth, m4 esis cunts receivable $17,000 lone fecouni payable ‘00 ¥ Aad roncash charges Such as depreciation back tonet income to compute ‘el cash provided by Solution ‘Operating activities, 1015 ‘R005 2.206 Calculate net cash provided by operating activities for Josh’s PhotoPlus 7 edocs fom ne Cah Nowe rom operating acs " Some gion ie Renee ae disposal of plant assets, Adjustments to reconcile net income to net cash | | or add losses ee tenet provided by operating activities: so \ Inspr sop net Bopreciaton expense 900 | ome uy Gain on disposal of equipment (2,500) | sities h Increase in accounts receivable (4,000) | Socata Decrease in accounts payable 38) G39) | | iability accounts to. Net cash provided by operating activities 569700 | Sa peak soe et eae eee | SSP al aran anna nS ea ea FOE BO Step 2: Investing and Financing Activities ANALYZE CHANGES IN NONCURRENT ASSET AND LIABILITY ACCOUNTS AND RECORD AS INVESTING AND FINANCING ACTIVITIES, OR AS NONCASH INVESTING AND FINANCING ACTIVITIES INGREASE IN LAND As indicated from the change in the Land account and the Rieitiona information, Computer Services Company purchased land of $110.¢6¢ Py directly exchanging bonds for land. The issuance of bonds pevalse for foo has no effect on cash. But, it i a significant noncash investing ned financing activity that merit disclosure in a separate schedule. (See Mlustration 13:1) 0 INCREASE IN BUILDINGS As the addi Company acquired a building for $120, in the investing activities section. (See litional data indicate, Computer Services 000 cash, This is a cash outflow reported Mlustration 13-13 on page 662.) Equipment ui eee MAS Balance 410,000 | Cost of equipment sold 8,000 Purchase of equipment 25,000 ee 123115 Balance 27,000 Mustration 13-12 ‘Analysis of equipmentgg2__ 13 Statement of Cash Flows The follows following entry shows the details ofthe equipment sale transaction ash “somaya Depton—Eaupment tom Sn 3000 | oy Gaflows M 000 INCREASE IN BONDS PAYABLE The Bonds Payable account increased $110,000. As indicated inthe additional information, the company acquired land from the issuance ofthese bonds, reports this noncash transaction ina separate schedule at the bottom of the statement. Nap tae NCHEASE IN COMMON STOCK The balance sheet reports an increase in Com- Ween ompare us mon Stockf§20,00, The adda! informtion ‘section notes that this increase sot ae ca uled from the issuance of new share of stock ‘This is a cash inflow reported in the financing activities section. appes inthe statement of sh lows a financing cows sarc INCREASEIIN RETAINED EARNINGS Retained earings increases $116,000 during into (ate te she year This increase can be explained by two factors. (1) Wer ieort of talue of bonds). $142,000 increased retained earings. 2) Dividends of $28,000 decreased retained earings, The company adjusts net income to net cash provided by oper ting activities inthe operating activites section. Payment of the dividend (fot See acation) isa each outflow that the company reports as a financing activity. STATEMENT OF CASH FLOWS—2015 Using the previous information, we can now for 2015 for Computer Services Company, ass prepare a statement of cash flows Fhown in Mustration 13-13. Step 3: Net Change in Cash COMPARE THE NET CHANGE IN CASH ON THE STATEMENT OF CASH (ows WITH THE CHANGE IN THE CASH ACCOUNT REPORTED ON THE BALANCE SHEET TO MAKE SURE THE AMOUNTS AGREE Illustration 13-13 indicates that the net change in cash during the period was an increase of $22,000. This agrees with the ‘change in Cash account reported on the balance sheet in Illustration 13-4 (page 655). ores Statement of Cash Flows—Indirect For the Year Ended December 31, 2015 Statement of ash ws, 2015 irc method ‘Cash flows from operating activites ‘Net income 145,000 ‘Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense $9,000 Helpful wnt Loss on disposal of equipment 3,000 Note that inthe investing Decrease in accounts receivable 10,000 snd ang Increase in inventory (5,000) seis poste nabs Increase in prepaid expenses (4,000) ee Increase in accounts payable 16,000 cp, and eatin Decrease in income taxes payable 27,000 = Net eash provided by operating activites 172,000 cuttows (payment)rer DP HO ripen gt! wegeG 00 2 50 “De aed 00 Bun 9) energies oo ce eg ering ‘elon sd cm pe to prepare a atement of cash Bows using tis REYNOLDS COMPANY buildings 125,000 Increase 18,000 Increase “avipment $ 17,000 Decrease 10,000 Increase 40,000 Decrease 160,000 Increase 70,000 Increaseot wa statement of Cash Flows otter ees mae eta Pe Sales revenue $490,000 Cont of goods wold 405,000 Operating expenses 721,000 Interest expense 12000 Loss on disposal of equipment —_ 2,000 700,000 Income before income taxes 190,00 Income tax expense 65,000 Net income $125,000 Additonal formation: 1” Operating expenses include deprecation expense o $33,000 and charges fom prepaid expenses of $2,000. 2. Land wa sold tis book value forcsh 3: Cah vend of $500 were care and pad 205, 4: Trost expense of $12,000 spl inc 5; Egupmen with a ont of 166,000 was purchased fo eas. Eauipment wth 2 com a $1,000 and a book valet $36,000 wa od for $3400 cath, 6, Bands of S10000 wer redeemed terface value for eas. Bonds of 30.000 were converte into comman stock 1. Common stock (Spa) of 513000 was sed fr cash 3. enum pyablepran to merchandise supplies Solution ‘tion Plan |W Determine net cash Panes reseed by opening Rrra estate ee ead oar ee) | come fortes that id ea ale notaflect cas Cash flows from operating activities |v Determine net cash re aed $125,000, Providedused by investing | adjustments to reconcile net income to net Sctivies and financing ¥ Determine the net increaseldecrease in cash cash provided by operating atviis Depreciation expense {oss on disposal of equipment Increase in accounts receivable Tnerease in inventory Decrease in prepaid expenses Decrease in accounts payable ee eae Teerease in accrued expenses payable operating actives gener Net cash provided by operating act SRraetecaneain | Cash lows from investing activities farrentasetsangcurent | Sale ofland | abit Sale of equipment 2, Determine net cash Purchase of equipment providedtsed by investing Net cash used by investing actives betes, recogizng that | Cash lows fom financing activities investing acts Redemption of bonds (10,000) | generally relate to changes Sale of common stock 130,000 | Innoncurent ae. Payment of dividends (55,000) | 3. Determine net cash ‘Net cash provided by financing activities oe i Helpful Hint 1, Determine net cash providedlsed by operating | providedsed by financingUsing Cash Flows to Evaluate 4 ‘2ctvtes, recognizing that financing activities generally relate to changes inlong-term labiltes {and stockholders’ equity accounts cash Net increase in Cash at beginning of period Cash at end of period Noncash investing and financing activities Conversion of bonds into common stock ACCOUNTING ACROSS THE ORGANIZATION Burning Through Our Cash 5 my to = ec es * Ment for capt -xaMple, Su raph er this ear ree SEPPOS that Me, "Feported $199, 000 net ea and ‘ld 10,009 led bywe nytt 19 4 sesh stration 1869 ena ash aang ros end tlustration 13-16 akulaton of Miso’ fee cash fw inion) aa serve oF ah Pye suites toute to mata etn 18.0% sompters, MPC invested 1.040 tn este at AN Howe fy 00 i ily Ths free cash how was SL CNN (S TOO NT $15,000 48.000 Th company const ise hve $0.4100 either te utr hae ewe masets to vapid the huistiess 6 pay an $0,000 diet AVoiwt a contin te previ HAO computers tn practice, Frew cab flow te jafioa caleatated with the formed Mlasteation AY-14 (Alternative eetinitions cls oto) evo Coal Not Canh Provided hy Capital Cash How "Operating Aitivitieg Expo bividends ata 14-08 proton ate trations) excerped Fram the 2012 statement of ean Hoyos af Mic Hasall Cope Mieco ne Peete ken or ano 12 $31,026 ‘Cant pve by operating aetiles {an hes fo venga ONS ‘ritons to gwoperty a eget § (2,308) ‘ruta of Investments ($1280 ‘Sales of tnvestnents 293 Acquisitions of companies (10,12) Matuaites of tnvestments 15.575 other (G94) cash used by lavesting aettvtion (24,786) ash pal for dividends (6,385) Microsofts free cash flow is calculated as shown in Mustration 13-16. ‘cash provided by operating ativites $31,626 Less: Expenditures on property, plant, and equipment 2.308, Dividends pald 6385, Free cash flow Microsoft generated approximately $23 billion of free eash flow This is a tremendous amount of cash generated in a single year, It is available for the equisition of new assets, the retirement of stock or debt, or the payment of dividends. ‘Also note that Microsoft’ cash from operations of $31.6 billion exceeds its 2012 net income of $17 billion. This lends additional credibility to Microsofts income number as an indicator of potential future performance. If anything, Microsofts net income might understate its actual performance, Oracle Corporation is one of the world’s largest sellers of database software and information management services. Like Microsoft, its suecess depends onelows to Evaluate 2 Company , oducts 19 ile developing 7 er 2012 WS ift's amazing of eash flows for 2015 following statement Free Cash Flow PeLccacialee ae oad Depreciation expens ‘Loss on disposal of plant assets Decrease in accounts receivable Increase in inventory Decrease in accounts payable Net cash provided by operating activites ‘cash lows from investing activities ‘Sale ofivestments Purchase of equipment Net cash used by investing activities ‘cash lows from financing activities Issuance of stock Payment on long-term note payable Payment for di [Net cash used by financing activities Netincrease in cash Cash at beginning of year Ccash at end of year (@) Compute free cash low for Chicago Corporation. (b) Explain why free cash ow Sten provides better information than "Net cash provided by operating activities” (17,900) scion ton © compare ash SoS as |) Neen rv by ope ces als tae naan ht acne repre | ma mar no at ty matin te cent eof pein, Geli ip mt ss matin der ot cae eset The Imesurement of fe cashflow provides adional insight regarding a compar -cash-generating ability. i a a Related exercise materia C178, OF129, E130, BEV7-11, F107 £199 and GAM 7s a4a statement of Cash Flows The income statement for the 5s forthe er ended Bcer ‘Company contains the following pis an alee tmanti COU kara remreeenras Geren ecu eed Sales revenue $6,583,000 Operating expenses (excliding depresiation) $4,920,000 Depreciation expense ‘80,000 5,800,000 Income before income taxes 7300 Tncome tax expense 353000 Net income pe Included in operating expenses is a $24,000 los resulting from the sale of equipment for {$270,000 cash, Equipment was purchased at a cost of $750,000. ‘The following balances are reported on Kosinskis comparative balance sheets at December 31. POE eel lance Sheets (partial) et 2015; 2014 cash $672,000 $130,000 ‘Accounts receivable 775,000 610,000 Inventory 834,000 367,000 521,000 501,000 ‘Accounts payable treome tx expense of $353,000 represents the amount pad in 201, Dividends dectared and paid in 2015 totaled $200,000. Instructions Prepare the statement of Solution to Comprehensive Gi 1 POT cc kA d J cash lows using the indireet method. ‘tion Plan Y Determine net cash From operating activites Operating acts pneraly felate to changes in cu ent assets and current Habits. Y Determine net cash Statement of Cash em Cash lows rom operating acts : : $430,000 ¢ Dace, | Netincome tng sees Mejatennsto recone et comet nt ash Irs changes | “Molded by operating nls: Srencuren ac ae 880000 ¥ Determine net cash Loss on disposal of equipment 24,000 fun racing ates Increase in account receivable (165,000) Tmng soe, 3.00 Decrease in invent ‘ roe Preven scounts payable 20000 _792,000 7222000 Inlong-erm liabilities and stockholders equity ‘Net cash provided by operating activitiessom investing activities : Aes from invest Cah flow rm Rise Milne of equipment 270.000 activities etched cg et cas cing ativit rom nance et Canh flaws from nent Payment o sh Chsh'rbesnning of period Casha nd of period 4 statement of cash . The preparation af ‘ment of additional dividends os f flows using the indirect 4 statement of cash flows, 'nvesting activities Cash flow activities that include (a) cenit t more consistent wih Plane ssi88 and disposing of investments and propery, acta Siement of cash noe (p. 655), Plant, and equipmene tSing cash and (b) lending money ‘activities Cash flow activites that include @ lecting the loans (p. 650). oun pcath from issuing a and repaying the 11d 2ctivities Cash flowy activities that include the and (b) obtaining cash from stock "eaet SUES Of transaction, that create "purchasing shares, and Paying dividends *MPeNSeS and thus Tanah 0 Net cash provid adjusted for Tevenues and ‘nler into the determ: income. (p. 650). Wot BY Oerating activities Statement of Pla expenditures and in dividends aid. (p. 665), NOW! A basic Gnancia) Statement that Provides information about the cash receipts, cash Pesaran’ 8nd net chee in sash during a periat, rect method & me ome anatment of fea. and eran. vce ig fae Git flows in which noe income is adjusted for items activ ies. (b. 650), . {hat do not affect cash determine net cash Provided by operating activitice (p. 655, 656),agasiatement of Cash Flows APPENDIX 13A Statement of cash cad ery FB} To explain and illustra 7 lain and illustrate the direc! method, we will use the 1 Computer Services Company for 2015, to pre - ee nn prepaeastatement of TMustration 131 presente ink med 20 for Camper See reper presents information rea Caen 1d 10.2015 for Computer Services iret method, iystration 13-1 Congarae balance sheets, income statement, and ‘tonal information for eked eats ae Computer Services Company ‘Change in ‘Aceanmt Balance Assets 2015 _ 2014 Increase/Decrease Current assets Cash $55,000 $ 33,000 $ 22,000 Increase Accounts receivable 20,000 30.000 10.000 Decrease Inventory 15,000 5,000 Increase Prepaid expenses 5,000 $000 Increase Property, plant and equipment ad . 130,000 110,900 tncrease Buildings 160,000 120,000 increase ‘Accumulated deprecation—buildings (11,000) {6,000 Increase Equipment 27,000 17.000 increase ‘Accumulated depreciation—equipment _(3.000) 2,000 Increase ‘Tal assets $398,000 Liabilities and Stockholders’ Equity Current liabilities ‘Accounts payable $ 28,000 § 12,000 $ 16,000 Increase income taxes payable 6000 8,000 2,000 Decrease ‘Longe-term liabilities ‘Bonds payable 130,000 20,000 110,000 Increase Stockholders equity ‘Common stock 70.000 $0,000 20,000 Increase Retained earnings 164,000 _ $8,000 116,000 Increase ‘Total liabilities and stockholders) equity {$398,000 $138,000 Ream teneskeon Deomeeceanat eR EEC Sales revenue $507,000 Cost of goods sold $150,000 Operating expenses (excluding depreciation) 111,000 Depreciation expense Loss on disposal of equipment Interest expense 42,000 315,000 192,000 47,000 $3195,000 Income before income tax Tncome tax expense Net incomeappendix 134: stateme! aniona information FOF 2015 aon orbs and $3,000 for 1, Depreciation expense WS comprised 0 equipment. ety eh equipment wi , Te ee a ail of lo in iret on t ee ‘Stato ws purchased for eas “Equipment costing $25,000 ‘was also purchased for 5, Teun common tock fr $20000 cash The company desard and pad a $29. 100 cash dividend. ‘To prepare a statement of cash flows under the direct approach, we will apply the thre steps outlined in lustraton 13-3 (page 654); Step 1: Operating Activities even DETERMINE NE CASH PROMEDIUSED BY OPERATING ACTS BY CONVERTING NET INCOME ROM AN ACCRUAL BASI TO ACASH BASS Unde th dest mend, compare compte et cash proved ope spe gem cece bt tothabass esi an cones peraingsttessitn Somes rep jor classes of operatin cei h Lect fash payments is the ships are net cash provi eer pee ar dh a ee a OY operating scien, These relation | _ From sles of g00ds and services to customers From receipts of nterest and vidends on loans and investments tof Cash Flows—Direct Mer, llustration 134-2 Majo cases of cash exe = recs Net Cash Provided by Operating Activities Neceashagsoteent of Cash Fle om RECEIPTS FROM CUSTOMERS The income statement for Computer Services many reported sales revenue from customers of $507,000. How much ofthat ‘as cash receipts? To answer that, companies need to consider the change in accounts receivable during the year. When accounts receivable increase during the ‘Yeas, revenues on an accrual basis are higher than cash receipts from customers. Operations led to revenues, but not all of those revenues resulted in cash receipts. ‘To determine the amount of cash receipts, the company deducts from sales Tevenue the increase in accounts receivable. On the other hand, there may be 2 decrease in accounts receivable. That would occur if cash receipts from custom ers exceeded sales revenue. in that case the company adds to sales revenue the decrease in accounts recivable. For Computer Services Company, accounts receivable decreased $10,000. Thus, cash receipts from customers were $517,000, computed as shown in Illustration 13A-3. stration 1343 ‘Cmputton of cth Sales revenue $507,000 mutation of cash ects 7 00 ‘Add: Decrease in accounts receivable from astoness Cash receipts from customers $517,000 sipts from customers from an Computer Services can also determine cash receipts : analysis ofthe Accounts Receivable account, as shoven in Illustration 134-4 terse es i a Wins Balance "30,000 | Receipts from customers 517,000 pe rs Tetacoureshowthat 25475 20900 ares Imacountsreiale sation 1345 shows the relationships among cash receipts from customers, ‘sales revenue, and changes in accounts receivable. sete AS [ans gg” | FOS A ee recep fon csares— from anni or direct method ‘Customers Increase in Accounts Receivable ‘CASH PAYMENTS TO SUPPLIERS Computer Services Company reported cost of goods sold of $150,000 on its income statement. How much of that was cash pay- ‘ments to suppliers? To answer that, i is first necessary to find purchases for the yar. To find purchases, companies adjust cost of goods sold for the change in inventory. When inventory increases during the year, purchases for the year have exceeded cost of goods sold, Asa result, to determine the amount of purchases, the company adds to cost of goods sold the increase in inventory. Jn 2015, Computer Services Company's inventory increased $5,000. It com- putes purchases as follows.