Chapter 16

Statement of Cash Flows

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website, in whole or in part.
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CHAPTER
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16 Statement of Cash Flows

Accounting
27e

human/iStock/360/Getty Images
Warren
Reeve 2
Duchac
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Statement 6
of Cash
Flows
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After studying this chapter, you should
be able to:
1. Summarize the types of cash flow
activities reported in the statement of
cash flows.
2. Prepare a statement of cash flows,
using the indirect method.
3. Prepare a statement of cash flows,
using the direct method.
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Objective
Objective 11
Summarize the types of
cash flow activities
reported in the
statement of cash flows.
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Statement of Cash Flows

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The statement of cash flows is invaluable in assessing
the capacity of a firm to achieve goals such as:

1. Generate cash flow from operations.

2. Maintain and expand operating capacity.
3. Pay dividends.
4. Pay debts, including interest, when due.
5. Generate future profits.
The primary attention is the flow of cash rather than net
income.

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Importance of Cashtitle style
Flows
Cash
Cashflows
flowshelps:
helps:
••users
usersdecide
decideififaacompany
companyhas
hascash
cashto
topay
payits
itsdebts.
debts.
••users
usersevaluate
evaluatecompany’s
company’sability
abilityto
topursue
pursue
unexpected
unexpectedopportunities.
opportunities.
••managers
managersplan
planday-to-day
day-to-dayoperations.
operations.
••managers
managersmake
makelong-term
long-terminvestment
investmentdecisions.
decisions.

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The statement of cash flows reports a

firm’s major cash inflows and outflows
for a period. It provides useful
information about a firm’s ability to
generate cash from operations,
maintain and expand its operating
capacity, meet its financial obligations,
and pay dividends.

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Reporting Cash Flows
1
The statement of cash flows reports cash flows
from three types of activities:
1. Cash flows from operating activities are cash flows
from transactions that affect net income.
Example: Purchase and sale of merchandise by a retailer.

2. Cash flows from investing activities are cash flows

from transactions that affect the investments in noncurrent assets.
Example: Purchase and sale of fixed assets, such as equipment and

buildings.

3. Cash flows from financing activities are cash flows

from transactions that affect the equity and debt of the business.
9
Example: Issuing or retiring equity and debt securities.
 Reporting Cash Flows (3 of 5)

2.Cash flows from (used for)

investing activities
3. Cash flows from (used
1.Cash flows from (used Cash flows received from or for) financing activities
for) operating activities used for transactions that affect
investments in the noncurrent Cash flows received from or
Cash flows from assets of the company used for transactions
transactions that affect the
that affect the debt and
net income of a company
equity of the company

Statement of
cash flows

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whole or in part.
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Cash Flows
Click to
Increases edit
in Cash Master title stylein
Decreases
Cash

Cash

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Cash Flows
Click to
Increases edit
in Cash Master Decreases
title stylein
Cash
Operating
(receipts from
revenues)

Cash

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Cash Flows
Click to
Increases edit
in Cash Master Decreases
title stylein
Cash
Operating Operating
(receipts from (payments for
revenues) expenses)

Cash

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Cash Flows
Click to
Increases edit
in Cash Master Decreases
title stylein
Cash
Operating Operating
(receipts from (payments for
revenues) expenses)

Cash
Investing
(receipts from sales of
noncurrent assets)

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Cash Flows
Click to
Increases edit
in Cash Master title stylein
Decreases
Cash
Operating Operating
(receipts from (payments for
revenues) expenses)

Cash
Investing Investing
(receipts from sales of (payments for aquiring
noncurrent assets) noncurrent assets)

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Cash Flows
Click to
Increases edit
in Cash Master Decreases
title stylein
Cash
Operating Operating
(receipts from (payments for
revenues) expenses)

Cash
Investing Investing
(receipts from sales of (payments for aquiring
noncurrent assets) noncurrent assets)

Financing
(receipts from issuing equity 16
and debt securities)
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Cash Flows
Click to
Increases edit
in Cash Master Decreases
title stylein
Cash
Operating Operating
(receipts from (payments for
revenues) expenses)

Cash
Investing Investing
(receipts from sales of (payments for aquiring
noncurrent assets) noncurrent assets)

Financing Financing
(receipts from issuing equity (payments for dividends, and17
and debt securities) redemption of debt securities)
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Cash Flows – Operating Activities

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Typical cash inflows Typical cash
outflows
What are some
of the typical
cash inflows
from operating
activities?

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Cash Flows – Operating Activities

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Typical cash inflows Typical cash
outflows
Sales of goods
and services What are some
of the typical
Interest Revenue
cash outflows
from operating
Dividend activities?
Revenue

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Cash Flows – Operating Activities

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Typical cash inflows
Typical cash outflows

Sales of goods Merchandise

and services purchases
Interest Revenue Payments of
wages & other
Dividend expenses
Revenue
Tax payments

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Cash Flows – Investing Activities

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Typical cash inflows Typical cash
outflows
What are some
of the typical
cash inflows
from investing
activities?

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Cash Flows – Investing Activities

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Typical cash inflows Typical cash
outflows
Sales of fixed assets and
other long-term
investments
What are some
of the typical
Sale of marketable cash outflows
securities and from investing
investments activities?

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Cash Flows – Investing Activities

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Typical cash inflows Typical cash
outflows
Sales of fixed assets and Purchase of fixed assets
other long-term and other long-term
investments investments

Sale of marketable Purchase of

securities and marketable securities and
investments investments

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Cash Flows – Financing Activities

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Typical cash inflows Typical cash
outflows
What are some
of the typical
cash inflows
from financing
activities?

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Cash Flows – Financing Activities

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Typical cash inflows Typical cash
outflows
Sales (issuance)
of stock
What are some
Sale (issuance) of bonds of the typical
and other money market cash outflows
debt from financing
Borrowing from banks activities?
and other lending
institutions

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Cash Flows – Financing Activities

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Typical cash inflows Typical cash
outflows
Sales (issuance) Purchase of
of stock treasury stock
Sale (issuance) of bonds Repayment and
and other money market redemption of debt (bonds,
debt notes, other)

Borrowing from banks Payment of cash

and other lending dividends
institutions

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Click
Sources
to edit
andMaster
Uses of
title
Cash
style

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Reporting
Click to edit(slideCash Flows
Master title style
4 of 4)
• The cash flows are reported in the statement of
cash flows as follows:

– The ending cash on the statement of cash flows

equals the cash reported on the company’s balance
sheet at the end of the year. 28

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Exhibit 2 Cash Flows
1
Sources (increases) of Cash Uses (decreases) of Cash

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

Investing Investing
(receipts from sales of (payments for
noncurrent assets) acquiring noncurrent
assets)
Financing
Financing
(receipts from issuing
equity and debt (payments for treasury stock, dividends,
securities) and redemption of debt securities)
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 Sources and Uses of Cash

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whole or in part.
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Preparing the Statement of Cash Flows

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Direct Method
Net cash flows from operating activities will be the
difference between the operating cash receipts and
operating cash payments.

Indirect Method
Indirect
Net cash flows from Method
operating activities is determined by
adjusting the accrual net income from operations to
reflect a cash-based net income from operations.

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Cash Flows from Operating Activities
1

The direct method reports the

sources of operating cash and
the uses of operating cash.
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Cash Flows from Operating Activities:

ClickThe
toDirect
edit Master title style
Method (slide 1 of 2)
•The direct method reports operating cash inflows (receipts)
and cash outflows (payments) as follows:

– The primary operating cash inflow is cash received from customers.

– The primary operating cash outflows are cash payments for
merchandise, operating expenses, interest, and income tax payments.
– The cash received from operating activities less the cash payments for
operating activities is the net cash flow from operating activities. 33

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 34

Advantages of Using the Direct Method

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1. Reports the sources and uses of operating cash
receipts and payments.
2. Is easier to understand for many investors.
3. Recommended by the Financial Accounting
Standards Board (FASB).
Note: The total amount of net cash flow from
operating activities will be the same for both direct
and indirect methods.
Investing and Financing activities sections will be
identical for both methods.

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A primary advantage of the direct
method is that it reports the sources
and uses of operating cash flows in
the statement of cash flow.
A primary disadvantage of the direct
method is that the necessary data
may not be readily available and may
be costly to gather.
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The indirect method reports the operating cash

flows by beginning with net income and
adjusting it for revenues and expenses that do
not involve the receipt or payment of cash.
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Cash Flows from Operating Activities:

ClickThe
toIndirect
edit Master title style
Method (slide 1 of 2)
The indirect method reports cash flows from operating activities
by beginning with net income and adjusting it for revenues and
expenses that do not involve the receipt of cash or payment of
cash, as follows:

– The adjustments to reconcile net income to net cash flow from operating
activities include such items as depreciation and gains or losses on fixed assets.
– Changes in current operating assets and liabilities such as accounts receivable
or accounts payable are also added or deducted, depending on their effect on
cash flows.
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 38

Advantages of Using the Indirect Method

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1. Focuses on the differences between net
income and net cash flow from operations.
2. Reveals the relationship between the income
statement, the balance sheet, and the
statement of cash flows.
3. Less costly to prepare.
4. Must be prepared as a supplemental report
even if the direct method is used.
5. 98 percent of companies surveyed use the
indirect method.
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A primary advantage of the indirect
method is that it focuses on the
differences between net income and
cash flows from operations.
Because the data are readily available,
another advantage of the indirect
method is that it is normally less costly
to use than the direct method.
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NetSolutions
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Statement of Cash Flows – Direct Method
For the Month Ended November 30, 2009

Cash flows from operating activities:

Cash received from customers $ 7,500
Deduct cash payments for expenses
and payment to creditors 4,600
Net cash flow from operating activities $ 2,900
Cash flows from investing activities:
Cash payments for acquiring land (10,000)
Cash flows from financing activities:
Cash received as owner’s investment $15,000
Deduct cash withdrawal by owner 2,000
Net cash flow from financing activities 13,000
Net cash flow and ending cash balance $ 5,900
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NetSolutions
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Statement of Cash Flows – Indirect Method
For the Month Ended November 30, 2009

Cash flows from operating activities:

Net income, per income statement $ 3,050
Add increase in accounts payable 400
Deduct increase in supplies (550)
Net cash flow from operating activities $ 2,900
Cash flows from investing activities:
Cash payments for acquiring of land (10,000)
Cash flows from financing activities:
Cash received as owner’s investment $15,000
Deduct cash withdrawal by owner 2,000
Net cash flow from financing activities 13,000
Net cash flow and ending cash balance $ 5,900
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NetSolutions
Statement of Cash Flows – Direct Method
Click to edit Master title style
For the Month Ended November 30, 2009
Cash flows from operating activities:
Cash received from customers $ 7,500
Deduct cash payments for expenses
and payment to creditors 4,600
Net cash flow from operating activities $ 2,900

NetSolutions
Statement of Cash Flows – Indirect Method
For the Month Ended November 30, 2009
Cash flows from operating activities:
Net income, per income statement $ 3,050
Add increase in accounts payable 400
Deduct increase in supplies (550)
Net cash flow from operating activities 42
$ 2,900
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NetSolutions
Statement of Cash Flows – Direct Method
Click to edit Master title style
For the Month Ended November 30, 2002
Cash flows from operating activities:
Cash received from customers $ 7,500
Deduct cash payments for expenses
and payment to creditors 4,600
Net cash flow from operating activities $ 2,900

NetSolutions
Statement of Cash Flows – Indirect Method
For the Month Ended November 30, 2002
Cash flows from operating activities:
Net income, per income statement $ 3,050
Add increase in accounts payable 400
Deduct increase in supplies (550)
Net cash flow from operating activities 43
$ 2,900
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NetSolutions
Statement of Cash Flows – Direct Method
Click to edit Master title style
For the Month Ended November 30, 2009
Cash flows from operating activities:
Cash received from customers $ 7,500
Deduct cash payments for expenses
and payment to creditors 4,600
Net cash flow from operating activities $ 2,900

NetSolutions
Statement of Cash Flows – Indirect Method
For the Month Ended November 30, 2009
Cash flows from operating activities:
Net income, per income statement $ 3,050
Add increase in accounts payable 400
Deduct increase in supplies (550)
Net cash flow from operating activities 44
$ 2,900
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to and
edit Master
Indirect title style
3 Cash Flows from Operations:
Methods— 1
NetSolutions

same amount

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 Cash inflows from operating activities
normally arise when cash is received
from customers.
 Cash outflows from operating activities
normally arise when cash is paid to
suppliers for merchandise, supplies,
services and to employees for salaries
and wages.
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Cash Flows from Investing

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Activities
• Cash flows from investing activities show the
cash inflows and outflows related to changes
in a company’s long-term assets.
• Cash flows from investing activities are
reported on the statement of cash flows as
follows:

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Cash Flows from Investing Activities
1

 Cash inflows from investing activities

normally arise from selling fixed assets,
investments, and intangible assets.
 Cash outflows from investing activities
normally include payments to acquire
fixed assets, investments, and intangible
assets.

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Cash Flows from Financing Activities

• Cash flows from financing activities show

the cash inflows and outflows related to
changes in a company’s long-term
liabilities and stockholders’ equity.
• Cash flows from financing activities are
reported on the statement of cash flows as
follows:

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Cash Flows from Financing Activities
1
 Cash inflows from financing activities
normally arise from issuing debt or equity
securities. For example, issuing bonds, notes
payable, preferred stock, and common stock creates
cash inflows from financing activities.
 Cash outflows from financing activities
normally include paying cash dividends,
repaying long-term debt, and acquiring
treasury stock.

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Noncash Investing and Financing
Activities 1

Noncash investing and financing

activities are transactions that do not
involve cash. The effect of such
transactions is recorded in a separate
schedule that appears at the bottom of
the statement of cash flows.
For example, a company may issue
common stock to retire long-term 51
debt.
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Noncash
Click toInvesting andtitle
edit Master Financing
style
Examples of Noncash Investing and Financing Activities

52

Learning Objective C1: Distinguish between operating, investing, and financing activities, and © McGraw-Hill Education 52
describe how noncash investing and financing activities are disclosed.
Format of the Statement of Cash Flows

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whole or in part.
No Cash Flow Per Share

• Cash flow per share is computed as

follows: Cash Flow from Operations
Cash Flow per
Share = Number of Common Shares
Outstanding

• Cash flow per share should not be

reported on a company’s financial
statements for the following reasons:
o Users may misinterpret cash flow per share as
the per-share amount available for dividends.
o Users may misinterpret cash flow per share as
equivalent to (or better than) earnings per
share.
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IMPORTANT

The financial statements,

including the statement of
cash flows, should not report
cash flow per share.

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1
Click to edit
Example Exercise 16-1
Master title style
For each of the following, identify whether it would
be disclosed as an operating, financing, or investing
activity on the statement of cash flows under the
indirect method.
a. Purchase patent d. Net income
b. Pay cash dividend e. Purchase treasury stock
c. Disposal of f. Depreciation expense
equipment
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16-
1
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Follow My Example 16-1

a. Investing d. Operating
b. Financing e. Financing
c. Investing f. Operating

For Practice: PE 16-1A, PE 16-1B 19

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Objective
Objective 22
Prepare a statement of
cash flows, using the
indirect method.

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Preparing the Statement of Cash Flows—
The Indirect Method (slide 1 of 2)

• The indirect method of reporting cash

flows from operating activities uses the
logic that a change in any balance sheet
account (including cash) can be analyzed
in terms of changes in other balance sheet
accounts:

o Thus, by analyzing changes in the liability,

stockholders’ equity, and noncash asset
accounts, any change in the cash account can
be indirectly determined:
©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Preparing the Statement of Cash Flows—
The Indirect Method (slide 2 of 2)

• Under the indirect method, there is no

order in which the balance sheet accounts
must be analyzed. However, because net
income (or net loss) is a component of any
change in Retained Earnings, the first
account normally analyzed is Retained
Earnings.

©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Income Statement and
Comparative Balance Sheet (slide 1 of 2)

©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Income Statement and
Comparative Balance Sheet (slide 2 of 2)

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An efficient approach to preparing the

statement of cash flows is to analyze the
changes in the noncash balance sheet
accounts. The logic of this approach is that a
change in any balance sheet account
(including Cash) can be analyzed in terms of
changes in the other balance sheet accounts.

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The analysis of Retained Earnings

provides a good starting point for
determining the cash flows from
operating activities, which is the first
section of the statement of cash flows.

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Comparative Balance Sheet
2

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65
(Continued)
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Comparative Balance Sheet
2

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(Concluded)
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Retained Earnings
2

The Retained Earnings account for Rundell Inc. reveals

that the balance increased $80,000 during the year.

ACCOUNT Retained Earnings ACCOUNT NO. 32

Balance
Date Item Debit Credit Debit Credit
2008
Jan. 1 Balance 202,300.00
Dec. 31 Net income 108,000.00 310,300.00
31 Cash dividends 28,000.00 282,300.00

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The net income of $108,000 is entered on the statement
(or working papers).

ACCOUNT Retained Earnings ACCOUNT NO. 32

Balance
Date Item Debit To statement
Credit Debit Credit
2008
To statement
Jan. 1 Balance 202,300.00
Dec. 31 Net income 108,000.00 310,300.00
31 Cash dividends 28,000.00 282,300.00

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Adjustments to Net Income (Loss)
Using the Indirect Method

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Operating Activities— Rundell Inc.
Cash flows from operating activities:
title style 2
Net income $108,000
Adjustments to reconcile net income
to net cash flow from operating activities:

This
Thisphrase
phraseisisadded
addedtotoindicate
indicate
that
thataccrual
accrualbasis
basisnet
netincome
incomeisis
being
beingadjusted
adjustedto toarrive
arriveatatcash
cash
flows
flowsfrom
fromoperations.
operations.

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Depreciation
2

Next, we need to determine

depreciation expense for the year. If it
isn’t given in the income statement,
sometimes it can be found by
analyzing the various accumulated
depreciation accounts.

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The comparative balance sheet (Exhibit 4: Slides 23 and
24) indicates that Accumulated Depreciation—Building
increased by $7,000. By analyzing the account we can see
that the increase is the result of the year-end adjusting entry.
ACCOUNT Accumulated Depreciation—Building ACCT. NO.
Balance
Date Item Debit Credit Debit Credit
2008
Jan. 1 Balance 58,300.00
Dec. 31 Depr. for year 7,000.00 65,300.00

to
to statement
statement
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The offsetting $7,000 debit is to an
expense for depreciation. The
effect on the income statement was
to reduced net income; however,
this expense did not require an
outflow of cash. Therefore, the
$7,000 is added back to net income
in determining cash flows from
operating activities.
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Operating Activities—Rundell Inc.
Cash flows from operating activities:
title style 2
Net income $108,000
Adjustments to reconcile net income
to net cash flow from operating activities:
Depreciation 7,000

Amortization is treated in
the same manner as
depreciation.

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Gain on Sale of Land
2

The ledger or income statement of Rundell

Inc. indicates that the sale of land resulted
in a gain of $12,000. This gain increased
net income by $12,000, yet cash flows was
provided by an investing activity (selling
land) rather than an operating activity, so
the gain is deducted from net income on the
statement of cash flows.
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Operating Activities—Rundell Inc.
Cash flows from operating activities:
title style 2
Net income $108,000
Adjustments to reconcile net income
to net cash flow from operating activities:
Depreciation 7,000
Gain on sale of land (12,000)

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2
Click to edit
Example Exercise 16-2
Master title style
Omni Corporation’s accumulated depreciation
increased by $12,000, while patents decreased by
$3,400 between balance sheet dates. There were
no purchases or sales of depreciable or intangible
assets during the year. In addition, the income
statement showed a gain of $4,100 from sale of
land. Reconcile a net income of $50,000 to net
cash flow from operating activities.
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16-
2
Click to edit Master title style
Follow My Example 16-2

Net income $50,000

Adjustments to reconcile net income
from operating activities:
Depreciation 12,000
Amortization 3,400
Gain on sale of land (4,100)
Net cash flow from operating activities $61,300

For Practice: PE 16-2A, PE 16-2B 35

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Changes in Current Operating Assets
and Liabilities 2

Next, select current assets and

current liabilities that impact cash
flows and determine their increases
and decreases. Exhibit 5 in the next
slide my prove to be helpful in
determining how to treat increases
and decreases in noncash current
operating assets and current
operating liabilities.
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Adjustments to Net Income
(Loss) Using the Indirect Method 2

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Changes in Current Accounts
December 31 Increase
Accounts 2008 2007 Decrease*
Accounts receivable (net) $ 74,000 $ 65,000 9,000
Inventories 172,000 180,000 8,000*
Accounts payable (mdse.) 43,500 46,700 3,200*
Accrued expenses payable 26,500 24,300 2,200
Income taxes payable 7,900 8,400 500*

Note that Cash and Dividends Payable are not

included in this analysis. 38
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Operating Activities—Indirect Method
Cash flows from operating activities:
title style 2
Net income $108,000
Adjustments to reconcile net income
to net cash flow from operating activities:
Depreciation 7,000
Gain on sale of land (12,000)
Changes in current operating assets
and liabilities:
Increase in accounts receivable (9,000)
Decrease in inventory 8,000
Decrease in accounts payable (3,200)
Increase in accrued expenses 2,200
Decrease in income taxes payable (500)
You will notice that increases actually decrease cash flows from 39
82
operating activities, and decreases do just the opposite.
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Statement of Cash Flows—
Indirect Method for Rundell Inc. 2
(Operating Activities Section)

40
83
Same information as Slide 39, only in final form.
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2
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Example Exercise 16-3
Master title style
Victor Corporation’s comparative balance sheet for
current assets and current liabilities was as follows:
Dec. 31, 2009 Dec. 31, 2008
Accounts receivable $ 6,500 $ 4,900
Inventory 12,300 15,000
Accounts payable 4,800 5,200
Dividends payable 5,000 4,000
Adjust net income of $70,000 for changes in
operating assets and liabilities.
41
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16-
2
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Follow My Example 16-3

Net income $70,000

Adjustments to reconcile net income to net
cash from from operating activities:
Increase in accounts receivable (1,600)
Decrease in inventory 2,700
Decrease in accounts payable (400)
Net cash flow from operating activities $70,700

For Practice: PE 16-3A, PE 16-3B 42

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2
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Example Exercise 16-4
Master title style
Omicron, Inc. reported the following data:
Net income $120,000
Depreciation expense 12,000
Loss on disposal of equipment 15,000
Increase in Accounts receivable 5,000
Decrease in Accounts payable (2,000)
Prepare the cash flow for operating activities
section of the statement of cash flows using the
indirect method.
43
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16-
Follow My Example 16-4 2
Click to edit Master title style
Cash flows from operating activities:
Net income $120,000 Adjustments
to reconcile net income to net cash
flow from operating activities:
Depreciation 12,000
Loss from disposal of equipment 15,000
Changes in current operating assets
and liabilities:
Increase in accounts receivable (5,000)
Decrease in accounts payable (2,000)
Net cash flow from operating activities $140,000
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For Practice: PE 16-4A, PE 16-4B
 88

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Cash Flows Used for Payment of
Dividends 2

ACCOUNT Dividends Payable ACCOUNT NO.

Balance
Date Item Debit Credit Debit Credit
2008
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

Note that while $28,000 in dividends were

declared, only $24,000 were paid during the year. 45
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Because paying of dividends

affects equity and is an
outflow of cash, it is a
negative $24,000 cash flows
from financing activities
transaction.

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Common Stock
2

Common Stock increased by $8,000.

ACCOUNT Common Stock ACCOUNT NO.
Balance
Date Item Debit Credit Debit Credit
2008
Jan. 1 Balance 16,000
Nov. 1 4,000 shares issued/cash 8,000 24,000

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Analyzing the two accounts together, we can
determine that the 4,000 shares were sold for $48,000.
ACCOUNT Paid-in Capital in Excess of Par—Common Stock
Balance
Date Item Debit Credit Debit Credit
2008
Jan. 1 Balance 80,000
Nov. 1 4,000 shares issued/cash 40,000 120,000

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Issuing common stock affects

equity; therefore, we have a
positive $48,000 cash flows from
financing activities item.

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Bonds Payable
2

Bonds Payable decreased by $50,000.

ACCOUNT Bonds Payable ACCOUNT NO.
Balance
Date Item Debit Credit Debit Credit
2008
Jan. 1 Balance 150,000
June 30 Retired by payment of
cash at face amount 50,000 100,000

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50
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Retiring bonds is a cash outflow

reported as a negative item
under cash flows from
financing activities.

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Building
2
By examining the Building account, we can determine
that Rundell Inc. bought a building for $60,000 cash.
ACCOUNT Building ACCOUNT NO.
Balance
Date Item Debit Credit Debit Credit
2008
Jan. 1 Balance 200,000
Dec. 27 Purchased for cash 60,000 260,000

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Purchasing a building involves a

noncurrent asset, so this is a
negative cash flows from
investing activity.

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Land
2
The $45,000 decline in the Land account resulted from
two separate transactions: a sale and a purchase.

ACCOUNT Land ACCOUNT NO.

Balance
Date Item Debit Credit Debit Credit
2008
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

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The first transaction, the sale of

land, is classified as a positive
cash flows from investing activity
because land is a noncash asset.

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The $12,000 gain was
recorded earlier on Slide 34
as an operating activity. The
purchase of land also is an
investing activity.
Click the button to view
Slide 34. To return to
this slide, type “56” and
press the “Enter” key.
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The second transaction is the

purchase of land for cash of
$15,000. This transaction is
reported as an outflow of
cash in the cash flows from
investing activities section.

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Statement of Cash Flows—
Indirect Method for Rundell Inc. 2
(Partial Statement)

58
101
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16-
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Statement of Cash Flows—
Indirect Method for Rundell Inc. 2
(Partial Statement)

The ending balance in the Cash account 59

102
should match this amount.
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16-
2
Click to edit
Example Exercise 16-5
Master title style
Alpha Corporation purchased land for
$125,000. Later in the year the company sold
land with a book value of $165,000 for
$200,000. How are the effects of these
transactions are reported on the statement of
cash flows?

60
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16-
2
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Follow My Example 16-5

The gain on sale of land is deducted

from net income as shown below:
Gain on sale of land
The purchase and sale of land is
$(35,000)
reported as part of cash inflow form
investing activities as shown below:
Cash received for sale of land $200,000
Cash paid for purchase of land (125,000)
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For Practice: PE 16-5A, PE 16-5B
 105

16-
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Objective
Objective 33
Prepare a statement of
cash flows, using the
direct method.

105
 Preparing the Statement of Cash Flows—
The Direct Method (2 of 2)

• The Cash Flows from Investing and Financing Activities sections of the
statement of cash flows are the same under both the direct and indirect
methods.
• The amount of net cash flow from operating activities is also the same, but
the way it is reported is different.
• Depreciation expense is not adjusted or reported as part of cash flows from operating
activities.
• This is because depreciation expense does not involve a cash outflow .
• The gain on the sale of the land is also not adjusted and is not reported as part of cash
flows from operating activities.
• This is because the cash flow from operating activities is determined directly, rather
than by reconciling net income. The cash proceeds from the sale of the land are
reported as an investing activity.

© 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in
whole or in part.
 107

Converting Income Statement to Cash Flows from Operating

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Activities using the Direct Method

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16-
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The Direct Method
3

The final amount for cash

flows from operating
activities will be the same
whether the direct or
indirect approach is used.
The methods differ in
how the data are obtained,
analyzed, and reported.
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Exhibit 8 Data for Direct Method
3
Rundell Inc.
Schedule of Changes in Current Accounts
December 31 Increase
Accounts 2008 2007 Decrease*
Cash $ 97,500 $ 26,000 $71,500
Accounts receivable (net) 74,000 65,000 9,000
Inventories 172,000 180,000 8,000*
Accounts payable (merchandise
creditors) 43,500 46,700 3,200*
Accrued expenses payable (operating
expenses) 26,500 24,300 2,200
Income taxes payable 7,900 8,400 500*
Dividends payable 14,000 10,000 4,000

64
109
(Continued)
 110

Rundell Inc. 16-

Click to edit Master title style
Income Statement
For the Year Ended December 31, 2008 3
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
(Concluded) 65
110
Other expense:
Interest expense 8,000 4,000
 111

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Cash Received from Customers
3

The $1,180,000 of sales for

Rundell Inc. is reported using
the accrual method. An
adjustment is necessary to
convert the sales reported on
the income statement to the
cash method.

111
 112

Determining the Cash Received

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from Customers

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16-
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Cash Received from Customers
Rundell Inc.
style 3
Income Statement
For the Year Ended December 31, 2008
Sales $1,180,000

Cost of merchandiseCash
sold received 790,000
from customers Changes
Gross profit $ 390,000
Operating expenses:
Sales $1,180,000
Depreciation expense $ 7,000
Increase in accounts rec. (9,000)
Other operatingCash
expenses
received 196,000
from customers $1,171,000
Total operating expenses 203,000
Income from operations $ 187,000
Other income:
Gain on sale of land $ 12,000 67
113

Other expense:
Interest expense 8,000 4,000
 114

16-
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Cash Received from Customers
Rundell Inc.
style
CASH
3
Income Statement
For the Year Ended December 31, 2008 BASIS
Sales $1,180,000 $1,171,000

Cost of merchandiseCash
sold received 790,000
from customers Changes
Gross profit $ 390,000
Operating expenses:
Sales $1,180,000
Depreciation expense $ 7,000
Increase in accounts rec. (9,000)
Other operatingCash
expenses
received 196,000
from customers $1,171,000
Total operating expenses 203,000
Income from operations $ 187,000
Other income:
Gain on sale of land $ 12,000 68
114

Other expense:
Interest expense 8,000 4,000
 115

16-
3
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Example Exercise 16-6

Sales reported on the income statement were

$350,000. The accounts receivable balance
declined $8,000 over the year. Determine the
amount of cash received from customers.
Follow My Example 16-6

Sales $350,000
Add decrease in accounts receivable 8,000
Cash received from customer $358,000
69
115
For Practice: PE 16-6A, PE 16-6B
 116

16-
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Cash Payments for Merchandise
Rundell Inc.
style
CASH
3
Income Statement
For the Year Ended December 31, 2008 BASIS
Sales $1,180,000 $1,171,000

Cost of merchandise sold 790,000

Cash payments for
Gross profit merchandise $ 390,000
Changes
Operating expenses:
Depreciation expense
Cost $ 7,000$790,000
of merchandise sold

Other operating expenses 196,000

Total operating expenses 203,000

Income from operations $ 187,000
Other income:
Gain on sale of land $ 12,000 70
116

Other expense:
Interest expense 8,000 4,000
 117

Determining the Cash Payments

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for Merchandise style

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16-
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Rundell Inc.
title style
CASH
3
Income Statement
For the Year Ended December 31, 2008 BASIS
Sales $1,180,000 $1,171,000

Cost of merchandise sold 790,000

Cash payments for
Gross profit merchandise $ 390,000
Changes
Operating expenses:
Depreciation expense
Cost $ 7,000$790,000
of merchandise sold
Decrease in inventories (8,000)
Other operating expenses 196,000
Decrease in accounts payable 3,200
Cash payments
Total operating expensesfor 203,000
merchandise
Income from operations $785,200
$ 187,000
Other income:
Gain on sale of land $ 12,000 71
118

Other expense:
Interest expense 8,000 4,000
 119

16-
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Rundell Inc.
title style
CASH
3
Income Statement
For the Year Ended December 31, 2008 BASIS
Sales $1,180,000 $1,171,000
(785,200)
Cost of merchandise sold 790,000
Cash payments for
Gross profit merchandise $ 390,000
Changes
Operating expenses:
Depreciation expense
Cost $ 7,000$790,000
of merchandise sold
Decrease in inventories (8,000)
Other operating expenses 196,000
Decrease in accounts payable 3,200
Cash payments
Total operating expensesfor 203,000
merchandise
Income from operations $785,200
$ 187,000
Other income:
Gain on sale of land $ 12,000 72
119

Other expense:
Interest expense 8,000 4,000
 120

16-
3
Click to edit Master title style
Example Exercise 16-7
Cost of merchandise sold reported on the income
statement was $145,000. The accounts payable balance
increased $4,000, and the inventory balance increased
by $9,000 over the year. Determine the amount of cash
paid for merchandise.
Follow My Example 16-7
Cost of merchandise sold $145,000
Add increase in inventories 9,000
Deduct increase in accounts payable (4,000)
Cash payments for merchandise $150,000
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For Practice: PE 16-7A, PE 16-7B
 121

16-
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Cash Payments for Operating Expenses
Rundell Inc. CASH
3
Income Statement
For the Year Ended December 31, 2008 BASIS
Sales $1,180,000 $1,171,000
(785,200)
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 74
121

Other expense:
Interest expense 8,000 4,000
 122

16-
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Rundell Inc.
title style
CASH
3
Income Statement
For the Year Ended December 31, 2008 BASIS
Sales $1,180,000 $1,171,000
(785,200)
Cost of merchandise sold 790,000

Gross profit $ 390,000 0

Operating expenses:
Depreciation expense $ 7,000
There
Thereisisno
nocash
cashflow
flowfor
for
Other operating expenses 196,000
depreciation
depreciationexpense.
expense.
Total operating expenses 203,000
Income from operations $ 187,000
Other income:
Gain on sale of land $ 12,000 75
122

Other expense:
Interest expense 8,000 4,000
 123

Determining the Cash Payments

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for Operating Expenses

123
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16-
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Rundell Inc.
title style
CASH
3
Income Statement
For the Year Ended December 31, 2008 BASIS
Sales $1,180,000 $1,171,000
(785,200)
Cost of merchandise sold 790,000

Gross profit $ 390,000 0

Operating expenses: (193,800)
Depreciation expense $ 7,000
Cash payments for
operating
Other expenses
operating expenses 196,000
Changes
Changes
Operating expenses
Total operating (other than
expenses 203,000
Incomedepreciation)
from operations $196,000$ 187,000
Other income: in accrued expenses
Increase (2,200)
Gain onpayments
sale of landfor operating $ 12,000 76
124
Cash
Other expenses
expense: $193,800
Interest expense 8,000 4,000
 125

16-
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Gain on Sale of Land
Master
Rundell Inc.
title style
CASH
3
Income Statement
For the Year Ended December 31, 2008 BASIS
Sales $1,180,000 $1,171,000
The
Thegaingainononsale
saleof ofland
landof
of$12,000
$12,000isis (785,200)
Costincluded in
inthe
of merchandise
included the proceeds
proceedsfrom
sold fromthe
thesale
sale 790,000
of
of land,
land, which
which isisreported
reported as
aspart
part of
of $
Gross profit 390,000 0
cash flows
flowsfrom
cashexpenses:
Operating frominvesting
investingactivities.
activities. (193,800)
Depreciation expense $ 7,000

Other operating expenses 196,000

0
Total operating expenses 203,000 To avoid
Income from operations $ 187,000 confusion, page
Other income: numbers for the
Gain on sale of land $ 12,000 remaining 125
slides
77 are centered on
the slides.
Other expense:
Interest expense 8,000 4,000
 126

Determining the Cash Payments

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for Operating Expenses

126
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16-
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Gain on Sale of Land
Rundell Inc.
title style
CASH
3
Income Statement
For the Year Ended December 31, 2008 BASIS
Sales $1,180,000 $1,171,000
(785,200)
Cash paid for
Cost of merchandise sold 790,000
interest expense Changes
Gross profit
Interest expense 8,000 $ 390,000 0
Operating expenses: (193,800)
+/- decrease/increase
Depreciation expense in $ 7,000
payable 0
Other operating expenses 196,000
Cash payments for interest $8,000 0
Total operating expenses 203,000
Income from operations $ 187,000 (8,000)
Other income:
Gain on sale of land $ 12,000 127
78
Other expense:
Interest expense 8,000 4,000
 128

Determining the Cash Payments

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for Income Taxes

128
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16-
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Cash Payments for Income Taxes
Rundell Inc.
style
CASH
3
Income Statement
For the Year Ended December 31, 2008 BASIS
Sales $1,180,000 $1,171,000
(785,200)
Cost of merchandise sold 790,000

Gross profit Cash payments $ 390,000 0

for income taxes
Operating expenses: Changes (193,800)
Depreciation
Incomeexpense
tax expense $ 7,000
$83,000
Add decrease in income
Other operating expenses 196,000
taxes payable 500 0
Total
Cashoperating
payments expenses
for income tax $83,500 203,000
Income from operations $ 187,000 (8,000)
Other income:
Gain on sale of land $ 12,000 129
(83,500)
79
Other expense:
Interest expense 8,000 4,000
 130

16-
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Cash Payments for Income Taxes
Rundell Inc.
style
CASH
3
Income Statement
For the Year Ended December 31, 2008 BASIS
Sales $1,180,000 $1,171,000
(785,200)
Cost of merchandise sold 790,000

Gross profit $ 390,000 0

Operating expenses: (193,800)
Depreciation expense $ 7,000

Other operating expenses 196,000

0
Total operating expenses 203,000
Income from operations $ 187,000 (8,000)
Other income:
Gain on sale of land $ 12,000 130
(83,500)
80
$ 100,500
Other expense:
Interest expense 8,000 4,000
 131

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Statement of Cash Flows—
Direct Method (Operating 3
Activities Section)

81
131
(Continued)
 132

16-
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Statement of Cash Flows—
Direct Method (Reconciliation) 3

A reconciliation is required when 82

132
the direct method is used.
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Financial Analysis and Interpretation
3

Free cash flow is a measure of

operating cash flow available for
corporate purposes after providing
sufficient fixed asset additions to
maintain current productive
capacity and dividends.

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Free Cash Flow
3
Cash flow from operations

Less: Investments in fixed assets to

maintain current production
Free cash flow
Positive free cash flow is considered favorable.
A company that has free cash flow is able to
fund internal growth, retire debt, pay
dividends, and enjoy financial flexibility.
134