1-1

Reporting and Analyzing

Cash Flows
Chapter 16
Electronic Presentations in Microsoft® PowerPoint® to accompany
Fundamental Accounting Principles, 17ce
Prepared by
Regula Lewis

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Learning Objectives

1. Explain the purpose and importance of cash flow information. (L O1)

2. Distinguish among operating, investing, and financing activities. (L O2)
3. Identify and disclose non-cash investing and financing activities. (L O3)
4. Describe and prepare the statement of cash flows. (L O4)
5. Determine cash flows from both investing and financing activities.
(LO6)
6. Calculate cash flows from operating activities using the direct method.
(LO7)

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Critical Thinking Challenge

How does debt financing affect cash flow?

How does equity financing affect cash flow?
What effect does debt versus equity financing have on the strength of the
balance sheet?

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LO1: Purpose of the Statement of Cash Flows 1

• Reports detailed information about the major cash receipts (inflows)

and cash payment (outflows) during a period.
• Cash flows are classified as operating, investing, and financing
activities.
• Helps users to evaluate the liquidity and solvency of an enterprise and
its ability to generate cash from internal sources.
• Helps users answer questions such as:
• How does a company obtain its cash?
• Where does a company spend its cash?
• What is the reason behind the changes to the cash balance over a
period?
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Purpose of the Statement of Cash Flows 2

• Details the difference between the beginning and ending balances of

cash, and cash equivalents.
• It is an analytical tool used to assess, evaluate, and analyze
performance for decision making.

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Importance of Cash Flows

• Information about cash flows, and inflows and outflows, can influence
decision makers in important ways.
• Information about cash flows helps users decide whether a company
has enough cash to:
• Pay its existing debts as they mature
• Meet unexpected obligations
• Pursue unexpected opportunities
• Plan day-to-day operating activities
• Make long-term investment decisions

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Measuring Cash Flows

• The statement of cash flows details the difference between the

beginning and ending balances of cash and cash equivalents.
• While we continue to use the terms cash flows and statement of cash
flows, we must remember that both terms refer to cash and cash
equivalents.
• A cash equivalent is an investments that must:
1. Be readily convertible to a known amount of cash.
2. Have a maturity of three months or less from its date of acquisition.
• Bank overdrafts repayable on demand may be included in the cash and
cash equivalent balance.

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LO2: Classifying Cash Flows

• All individual cash receipts and payments (except cash paid/received for the
purchase/sale of cash equivalents) are classified and reported on the
statement as operating, investing, or financing activities.
• A net cash inflow (source) occurs when the receipts in a category exceed the
payments.
• A net cash outflow (use) occurs when the payments in a category exceed
receipts.

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Operating Activities 1

• Operating activities are the principal revenue-producing activities of the

entity.
• Include the cash effects of transactions that determine profit.
• Changes in current assets and current liabilities are normally the result
of operating activities.
• Include:
a. Cash sales to customers
b. Collections on credit sales (accounts receivable)
c. Receipt of dividend income and interest income
d. Paying for operating expenses including payments to employees,
suppliers, rent expense, interest expense, and taxes.
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Operating Activities 2

Common Cash Inflows and Outflows from Operating Activities:

Cash Inflows Cash Outflows

From customers’ cash sales To employees for salaries and wages
From collection on credit sales To suppliers for goods and services
From cash dividends received To governments for taxes and fines
From borrowers for interest earned To lenders for interest paid
From suppliers for refunds To customers for refunds issued
From lawsuit settlements received To charities for donations paid

EXHIBIT 16.1
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Investing Activities 1

• Changes in non-current assets are normally caused by investing

activities.
• Include:
a. Purchase and sale of property, plant and equipment
b. Purchase and sale of investments, other than cash equivalents
c. Lending and collecting on loans (receivables)

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Investing Activities 2

Cash Flows from Investing Activities:

Cash Inflows Cash Outflows

From selling capital assets To purchase capital assets
From selling equity investments To purchase equity investments
From selling debt investments To purchase debt investments
From collecting principal on loans To Provide loans to a third party
From selling (discounting) of loans

EXHIBIT 16.2
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Financing Activities 1

• Financing activities are those that affect a company’s owners and

creditors.
• Transactions with creditors that affect profit are classified as operating
activities.
• Include:
a. Cash received from issuing common and preferred stock
b. Cash inflows from issuing long-term debt (notes payable and bonds
payable)
c. Payment of dividends to shareholders
d. Paying off long-term debt (notes payable and bonds payable)

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Financing Activities 2

Cash Flows from Financing Activities:

Cash Inflows Cash Outflows

From issuing its own shares To pay cash dividends to shareholders
From issuing bonds and notes To repurchase shares
From issuing current and non-current To repay cash loans to lenders
liabilities
To pay withdrawals by owners

EXHIBIT 16.3
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LO3: Non-Cash Investing and Financing

Activities 1

• Companies sometimes enter into direct exchange transactions in which

non-current balance sheet items are exchanged but cash is not affected.
• Because of their importance and the full disclosure principle, these
important non-cash investing and financing activities are disclosed in a
note to the statement of cash flows.

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Non-Cash Investing and Financing Activities 2

Examples of Non-Cash Investing and Financing Activities:

Retirement of debt by issuing shares

Conversion of preferred shares to common shares
Purchase of a long-term asset by issuing a note payable
Exchange of non-cash assets for other non-cash assets
Purchase of non-cash assets by issuing shares or debt
Declaration and issuance of share dividend

EXHIBIT 16.4
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LO4: Format of the Statement of Cash Flows 1

• Accounting standards require companies to include a

statement of cash flows in a complete set of financial
statements.
• For example cash flow statements, refer to the partial
financial statements for Spin Master, Recipe Unlimited
International, and Indigo Books & Music in Appendix II.

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LO4: Format of the Statement of Cash Flows 2

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IMPORTANT TIP

Positive cash flows for a section are titled

net cash “provided by” or “from.” Negative
cash flows are labelled as net cash “used
by” or “for.”

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 1-20

CHECKPOINT

1. Does a statement of cash flows disclose payments of cash to

purchase cash equivalents? Does it disclose receipts of cash
from selling cash equivalents?
2. Identify the categories of cash flows reported separately on
the statement of cash flows.
3. Identify the category for each of the following cash flow
activities: (a) purchase of equipment for cash; (b) payment of
wages; (c) issuance of common shares for cash; (d) receipt of
cash dividends from share investment; (e) collection of cash
from customers; (f) issuance of bonds for cash.

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Preparing the Statement of Cash Flows 1

• The information we need to prepare a statement of cash flows comes

from:
• Comparative balance sheets at the beginning and end of the period
( two consecutive periods)
• An income statement for the period
• A careful analysis of additional information
• Non-cash investing and financing activities are disclosed in a note to the
statement or in a separate schedule to the statement

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Preparing the Statement of Cash Flows 2

Preparation of a statement of cash flows involves five steps:

1. Calculate net increase or decrease in cash and cash equivalents.
2. Calculate and report net cash inflows (outflows) from operating activities
using the
a) direct method
b) Indirect method
3. Calculate and report net cash inflows (outflows) from investing activities.
4. Calculate and report net cash inflows (outflows) from financing activities.
5. Calculate net cash flow by combining net cash inflows (outflows) from
operating, investing, and financing activities and then prove it by adding
it to the beginning cash balance to show it equals the ending cash
balance.
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Calculate the Net Increase or Decrease in Cash 1

• The increase or decrease in cash equals the current end-of-period’s

cash balance minus the prior period’s end-of-period cash balance.
• This is the bottom line figure for the statement of cash flows and is a
helpful check on the accuracy of our work.

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Cash Flow Statement

Assets Liabilities/Equity

-
Use of
Cash  Decrease
(Cash  Increase
outflow)

+
Source
of Cash  Decrease  Increase
(Cash
inflow)

(Retained earnings is an exception to the above)

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Calculate the Net Increase or Decrease in Cash 2

To illustrate, the summarized cash account of Gelato Corp. shows a net

increase in cash of $5,000 for the year ended December 31, 2023
($17,000 balance, Dec. 31, 2023, less the $12,000 balance, Dec. 31, 2022).

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Calculate and Report Net Cash Inflows

(Outflows) from Operating Activities 1

• On the income statement, profit is calculated using accrual basis

accounting.
• Accrual basis accounting recognizes revenues when earned and
expenses when incurred.

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LO5: Indirect Method of Reporting Operating Cash

Flows

The indirect method begins with profit and adjusts for three types of
adjustments:
1. Adjustments for changes in non-cash current assets and current
liabilities relating to operating activities.
2. Adjustments to income statement items involving operating activities
that do not affect cash inflows or outflows during the period.
3. Adjustments to eliminate gains and losses resulting from investing
and financing activities (those not part of operating activities).

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IMPORTANT TIP

The ending dollar value total of net cash inflows for operating activities is
the same as that for the direct method of reporting operating cash flows
detailed later in the chapter (see Exhibit 16.10).
The direct method starts with cash receipts from customers and identifies
all categories of sources and uses of cash.

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Adjustments for Changes in Non-Cash Current Assets 1

Changes in non-cash current assets are normally the result of

operating activities. Under the indirect method for reporting
operating cash flows:

Examples: Account Receivables, Inventory

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Adjustments for Changes in Non-Cash Current Assets 2

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Adjustments for Changes in Current Liabilities 1

Changes in current liabilities are normally the result of operating

activities. Under the indirect method for reporting operating cash
flows:

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Adjustments for Changes in Current Liabilities 2

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Adjustments for Operating Items Not

Providing or Using Cash 1

The income statement usually includes certain expenses that do not

reflect cash outflows in the period. The indirect method for reporting
operating cash flows requires that:

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Adjustments for Operating Items Not

Providing or Using Cash 2

Examples of expenses that have no cash outflow:

1. Depreciation of plant and equipment assets
2. Amortization of intangible assets
3. Amortization of bond discount
4. Bad debts expense

When profit includes revenues that do not reflect cash inflows in the
period, the indirect method for reporting operating cash flows
requires that:

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Adjustments for Non-Operating Items 1

The income statement sometimes includes losses that are not part of
operating activities. Under the indirect method for reporting
operating cash flows:

Examples include:
1. A loss from the sale of property, plant, and equipment assets
2. A loss from retirement of a bond payable
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Adjustments for Non-Operating Items 2

• The cash received or paid for these transactions is not part of

operating activities but is recorded under either investing or
financing activities.
• A loss from the sale of property, plant, and equipment assets is
recognized as a reduction of profit (a loss) on the income
statement.
• A loss from retirement of a bond payable is also recorded on the
income statement as a reduction of profit.
• Because the non-operating loss is a deduction in calculating
accrual-based profit, we need to add it back to profit when
calculating the net cash flow effect from operations. Adding the
loss back to profit cancels the deduction.
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Adjustments for Non-Operating Items 3

When profit includes other income/gains that are not part of

operating activities, under the indirect method for reporting
operating cash flows:

These profit adjustments are part of calculations to get net cash

provided by operating activities.

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Summary of Adjustments for Indirect Method

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CHECKPOINT 2

6. Why are expenses such as depreciation added to profit when

cash flow from operating activities is calculated by the indirect
method?
7. A company reports profit of $15,000 that includes a $3,000
gain on the sale of land. Why is this gain subtracted from profit
in calculating cash flow from operating activities using the
indirect method?

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LO6: Cash Flows from Investing Activities

We use a three-step process in determining net cash inflows (outflows)

from investing activities:
1. Identify changes in investing-related accounts
2. Explain these changes using reconstruction analysis
3. Report cash flow effects

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Property, Plant and Equipment (PPE)

Transactions 1

• For equipment, we need to deal with both the equipment account and
its related accumulated depreciation account.
• Comparative balance sheet information for these accounts is in Exhibit
16.6.
• The first step reveals a $40,000 increase in equipment from $210,000 to
$250,000, and a $12,000 increase in accumulated depreciation from
$48,000 to $60,000. We need to explain these changes.
• The second step begins by reviewing ledger accounts and any additional
information at our disposal. An equipment account is affected by both
purchases and sales of equipment. An accumulated depreciation account is
increased by depreciation and reduced by removing accumulated
depreciation on asset disposals.
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Property, Plant and Equipment (PPE)

Transactions 2

• Items (b) and (c) from the additional information reported with Exhibit 16.6
for Gelato are relevant for these accounts.
• To explain changes in these accounts and to help us understand the cash
flow effects, we prepare reconstructed entries. A reconstructed entry is our
reproduction of an entry from a transaction; it is not the actual entry made
by the preparer.
• Item (b) reports that Gelato purchased equipment costing $70,000 by
issuing $60,000 in bonds payable to the seller and paying $10,000 in cash.
The reconstructed entry for our analysis of item (b) is:
Equipment 70,000
Bonds Payable 60,000
Cash 10,000
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Property, Plant and Equipment (PPE)

Transactions 3

• Item (c) reports that Gelato sold equipment costing $30,000 (with
$12,000 of accumulated depreciation) for cash received of $12,000,
resulting in a loss of $6,000. The reconstructed entry for item (c) is:

Cash 12,000
Accumulated Depreciation 12,000
Loss on Sale of Equipment 6,000
Equipment 30,000

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Property, Plant and Equipment (PPE)

Transactions 4

• We can also reconstruct the entry for depreciation expense using

information from the income statement:

Depreciation Expense 24,000

Accumulated Depreciation 24,000

• This entry shows that depreciation expense results in no cash flow

effects.

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Property, Plant and Equipment (PPE)

Transactions 5

• These reconstructed entries are reflected in the ledger accounts for

both equipment and accumulated depreciation.

Equipment Accumulated Depreciation, Equipment

Balance, Dec. 31/22 210,000 48,000 Balance, Dec. 31/22

Purchases 70,000 30,000 Sale Sale 12,000 24,000 Deprec Expense

Balance, Dec. 31/23 250,000 60,000 Balance, Dec. 31/23

• In performing an actual cash flow analysis we have the entire ledger

and additional information at our disposal.

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Property, Plant and Equipment (PPE)

Transactions 6

• The third step is to make the necessary disclosures on the statement of

cash flows.
• Disclosure of the two cash flow effects in the investing section of the
statement appears as (also see Exhibit 16.8):

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CHECKPOINT

8. Equipment costing $80,000 with accumulated depreciation of

$30,000 is sold at a loss of $10,000. What is the cash receipt
from the sale? In what category of the statement of cash flows
is it reported?

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Cash Flows from Financing Activities

• The fourth step in preparing the statement of cash flows is to calculate

and report net cash flows from financing activities.
• We normally do this by identifying changes in all notes payable (current
and non-current), non-current liabilities, and equity accounts.
• These accounts include Long-Term Debt, Notes Payable, Bonds Payable,
Owner’s Capital, Common Shares, and Retained Earnings.
• Changes in these accounts are then analyzed using available
information to determine their effect, if any, on cash.
• Results of this analysis are reported in the financing activities section of
the statement.

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Bonds Payable Transactions 1

• Comparative balance sheet information from Exhibit 16.6 for bonds

payable is our starting point.
• The first step reveals an increase in bonds payable from $64,000 to
$90,000. We need to explain this change.
• The second step is to review the Bonds Payable ledger account and any
additional information available.
• Item (e) is relevant to bonds payable and reports that bonds with a carrying
value of $34,000 are retired for $18,000 cash, resulting in a $16,000 gain.
The reconstructed entry for our analysis of item (e) is:

Bonds Payable 34,000

Gain on Retirement of Debt 16,000
Cash 18,000
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Bonds Payable Transactions 2

• Item (b) also involves bonds payable. It reports that Gelato purchased
equipment costing $70,000 by issuing $60,000 in bonds payable to the
seller and paying $10,000 in cash.
• We already reconstructed its entry for our analysis of investing activities.
Recall it increased bonds payable by $60,000 and is reported as a non-cash
investing and financing transaction. These reconstructed entries are
reflected in the ledger account for bonds payable:

Bonds Payable
64,000 Balance, Dec. 31/22
Retired bonds 34,000 60,000 Issued bonds
90,000 Balance, Dec. 31/23

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Bonds Payable Transactions 3

• The third step is to make the necessary disclosures on the statement of

cash flows. Disclosure of the cash flow effect from the bond retirement
in the financing section of the statement appears as (also see Exhibit
16.8):

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Common Shares Transactions 1

• We use comparative balance sheet information from Exhibit 16.6 for

the first step in analyzing the Common Shares account.
• This reveals an increase in common shares from $80,000 to $95,000.
We need to explain this change.
• Our second step is to review the Common Shares ledger account and any
additional information available. Item (d) reports that it issued 3,000
common shares for $5 per share. The reconstructed entry for our analysis
of item (d) is:

Cash 15,000
Common shares 15,000

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Common Shares Transactions 2

• This entry reveals a $15,000 cash inflow from the issuance of shares.
This reconstructed entry is reflected in the ledger account for common
shares:

Common Shares
80,000 Balance, Dec. 31/22
15,000 Issued shares
95,000 Balance, Dec. 31/23

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 1-54

Common Shares Transactions 3

• The third step is to make the necessary disclosure on the statement of

cash flows. Disclosure of the cash flow effect from share issuance in the
financing section of the statement appears as (also see Exhibit 16.8):

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Retained Earnings Transactions 1

• The first step in analyzing the Retained Earnings account is to review

comparative balance sheet information from Exhibit 16.6. We need to
explain the increase in retained earnings from $88,000 to $112,000.
• Our second step is to analyze the Retained Earnings account and any
additional information available. Item (f) reports that cash dividends of
$14,000 were paid. The reconstructed entry for our analysis of item (f) is:

Retained Earnings 14,000

Cash 14,000

OR

Cash Dividends 14,000

Cash 14,000
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Retained Earnings Transactions 2

• This entry reveals a $14,000 cash outflow to pay cash dividends. We must
also remember that retained earnings are affected by profit from the
income statement. Profit was already dealt with under the operating
section of the statement of cash flows. This reconstruction analysis is
reflected in the ledger account for retained earnings:
Retained Earnings
88,000 Balance, Dec. 31/22
Cash dividend 14,000 38,000 Profit
112,000 Balance, Dec. 31/23

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Retained Earnings Transactions 3

• The third step is to make the necessary disclosure on the statement of

cash flows. Disclosure of the cash flow effect from the cash dividend
appears in the financing section of the statement as (also see Exhibit
16.8):

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 1-58

Proving Cash Balances

• The fifth and final step in preparing the statement is to report the
beginning and ending cash balances and prove the net change in cash
as explained by operating, investing, and financing net cash flows. This
step is highlighted below for Gelato:

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CHECKPOINT

9. Identify which of the following represent financing activities:

a. Paid $1,000 of interest on the bank loan.
b. Purchased $25,000 of equipment by paying cash of $25,000.
c. Issued a $75,000 bond payable.
d. Issued $50,000 of common shares in exchange for land valued
at $50,000.
e. Made a $10,000 payment on the bank loan.

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Analysis of Other Operating Expenses 1

Gelato reports three other operating expenses on its income

statement: $24,000 of depreciation, a $6,000 loss on sale of
equipment, and a $16,000 gain on retirement of debt. We
consider each of these for its potential cash effects.

• Depreciation Expense
• Loss on Sale of Assets
• Gain on Retirement of Bonds

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 1-61

ETHICAL IMPACT 1

Presentation of Cash Concerns

You work for a new clothing distributor, Endurance Inc., which focuses on
quality sustainable materials that are designed to last in order to attract
consumers who are avoiding fast fashion. The company has an aggressive
expansion strategy to build 20 new stores across Canada in 2024—the next
fiscal year. To maintain a controlling interest, the current owners have decided
to pursue debt financing offered by QueCity, a local bank that provides special
financing to support new business initiatives.

In a discussion the president and founder of the company, Jacob River,

mentions that the bank is highly concerned with cash flow from operating
activities and will be looking for higher levels over the previous fiscal year
when determining whether to give approvals for Endurance’s $2 million debt
application.

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ETHICAL IMPACT 2

Later in the week you present Jacob with a draft cash flow statement for the
fiscal year ending February 1, 2024. He stops by your office and suggests
there are a couple of errors he would like you to correct. The errors are listed
as follows:
1. In December 2023, the company sold $25,000 worth of hoodies to T.C.
Bank with a right to return the inventory up to March 31, 2024. You classified
this transaction as a financing activity, as it looked like a creative borrowing
initiative, but Jacob indicates it should be included in cash flow from
operations.
2. He has asked that you move the cost relating to building maintenance,
$19,800, to another assets account, transferring the balance out of an
outflow from the statement of operating expenses to an outflow of investing
activities on the statement of cash flow.

What are your thoughts on each of these requests? Why do you think Jacob is
concerned about these issues? What will you do?
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CHECKPOINT 1

10. Net sales in a period is $590,000, beginning accounts

receivable is $120,000, and ending accounts receivable is
$90,000. What amount is collected from customers in the
period?
11. The Merchandise Inventory account balance decreases in a
period from a beginning balance of $32,000 to an ending
balance of $28,000. Cost of goods sold for the period is
$168,000. If the Accounts Payable balance increases $2,400 in
the period, what is the amount of cash paid for merchandise?

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CHECKPOINT 2

12. Reported wages and other operating expenses incurred total

$112,000. At the end of the prior year, prepaid expenses
totaled $1,200, and this year the balance is $4,200. The
current balance sheet shows wages payable of $5,600,
whereas last year’s did not show any accrued liabilities. How
much is paid for wages and other operating expenses this
year?

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 1-65

Critical Thinking Challenge

Refer to the Critical Thinking Challenge questions at the beginning

of the chapter.

Did your answers change after reading the chapter?

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 1-66

Summary 1

1. Explain the purpose and importance of cash flow information.

The main purpose of the statement of cash flows is to report the major
cash receipts and cash payments for a period. This includes identifying
cash flows as relating to operating, investing, or financing activities. Many
business decisions involve evaluating cash flows. Users’ evaluations
include focusing on the transactions that cause cash inflows (outflows).

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Summary 2

2. Distinguish among operating, investing, and financing activities.

Operating activities include the cash effects of transactions and events
that determine profit. Investing activities include (a) purchase and sale of
non-current assets, (b) purchase and sale of short-term investments other
than cash equivalents, and (c) lending and collecting on loans. Financing
activities include (a) getting cash from issuing debt and repaying the
amounts borrowed, and (b) getting cash from or distributing cash to
owners and giving owners a return on investment.

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Summary 3

3. Identify and disclose non-cash investing and financing activities.

For external reporting, a company must supplement its statement of cash
flows with a description of its non-cash investing and financing activities.
These activities are disclosed either in a note to the statement or in a
separate schedule usually reported at the bottom of the statement.

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Summary 4

4. Describe and prepare the statement of cash flows.

The statement of cash flows reports cash inflows and outflows in one of
three categories: operating, investing, or financing activities. Preparation
of a statement of cash flows involves five steps: (1) calculate the net
increase or decrease in cash, (2) calculate net cash inflows (outflows) from
operating activities, (3) calculate net cash inflows (outflows) from
investing activities, (4) calculate net cash inflows (outflows) from financing
activities; and (5) report the beginning and ending cash balances and
prove the change is explained by operating, investing, and financing net
cash flows. Non-cash investing and financing activities are disclosed either
in a note or in a separate schedule to the statement.

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Summary 6

6. Determine cash flows from both investing and financing activities.

Cash flows from both investing and financing activities are determined by
identifying the cash flow effects of transactions affecting each balance
sheet account related to these activities.

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Summary 7

7. Calculate cash flows from operating activities using the direct

method.
The direct method for reporting net cash inflows (outflows) from
operating activities, encouraged in IAS 7, involves separately listing the
major classes of operating cash inflows and outflows. The operating cash
outflows are then subtracted from operating cash inflows to get the net
inflow or outflow from operating activities.

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 1-72

End of Chapter

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