21

The Statement of Cash Flows

Revisited

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
 CASH INFLOWS
Operating Activities Investing Activities Financing Activities
Sale of operational assets Issuance of stock
Cash received Sale of investments Issuance of bonds
from revenues Collections of loans and notes

Business

Cash paid for Purchase of operational Payment of dividends

expenses assets
Repurchase of stock
Purchase of investments
Repayment of debt
Loans to others

CASH OUTFLOWS
21 - 2
 Role of the Statement of Cash Flows

Helps
Helps users
users assess
assess .. .. ..
 aa firm’s
firm’s ability
ability to
to generate
generate cash.
cash.
 aa firm’s
firm’s ability
ability to
to meet
meet its
its
obligations.
obligations.
 the
the reasons
reasons forfor differences
differences
between
between income
income and and associated
associated
cash
cash flows.
flows.
 the
the effect
effect of
of cash
cash andand noncash
noncash
investing
investing andand financing
financing activities
activities
on
on aa firm’s
firm’s financial
financial position.
position.
21 - 3
 Role of the Statement of Cash Flows
Lists all cash inflows and
all cash outflows by
category: Operating,
Investing, and Financing

Explains the change in

cash during the period
Cash is King!
Required by GAAP Especially during
an economic
downturn
21 - 4
 Cash and Cash Equivalents

• Short-term, highly liquid

Resources investments.
immediately • Readily converted into cash,
available to pay with little or no risk of loss.
obligations. • Examples: money market
funds Treasury bills
• Maturity date must not be
longer than 3 months from
date of purchase.

21 - 5
 Primary Elements of the Statement of
Cash Flows

Operating Activities
Reconciliation of the Net
Investing Activities Increase or Decrease in
Cash with the Change in
the Balance of the Cash
Financing Activities Account

Noncash Investing
and Financing
Activities
21 - 6
 Primary Elements of the Statement of
Cash Flows
Operating Reports the cash effects of the
Activities elements of net income.

Reports the cash effects of the

Investing acquisition and disposition of assets
(other than inventory and cash
Activities equivalents).

Reports the cash effects of the sale

Financing or repurchase of shares, the
issuance or repayment of debt
Activities securities, and the payment of cash
dividends.
21 - 7
 Cash Flows from Operating Activities

Inflows from:
 customers.
 interest and dividends.
+ Cash
Flows
from
Outflows to: Operating
 suppliers of goods. _ Activities
 salaries and wages.
 interest on debt.
 income taxes.
21 - 8
 Direct Method or Indirect Method of Reporting
Cash Flows from Operating Activities
Two Formats for Reporting Operating
Activities

Direct Method Indirect Method

Reports the Starts with

cash effects of accrual net
each operating income and
activity converts to
cash basis
Note that no matter which format is used, the same amount
of net cash flows operating activities is generated.
21 - 9
 Direct Method
Under the direct method, the cash effect of each
operating activity is reported directly in the
statement.

21 - 10
 Indirect Method
By the indirect method, we arrive at net cash flow from
operating activities indirectly by starting with reported net
income and working backwards to convert that amount to a
cash basis.

21 - 11
 Cash Flows from Investing Activities
Inflows from:
 Sale of long-term assets used in
the business.
 Sale of investment securities
(stocks and bonds). + Cash
 Collection of nontrade
receivables.
Flows
from
Outflows to: Investing
 Purchase of long-term assets
used in the business. _ Activities
 Purchase of investment
securities (stocks and bonds).
 Create nontrade receivables.
21 - 12
 Cash Flows from Financing Activities
Inflows from:
 Sale of shares to owners.
 Borrowing from creditors
through notes, loans, + Cash
mortgages, and bonds.
Flows
from
Outflows to:

Financing
Owners in the form of dividends
or other distributions. _ Activities
 Owners for the reacquisition of
shares previously sold.
 Creditors as repayment of the
principal amounts of debt.
21 - 13
 Reconciliation with Change in Cash Balance
The net amount of cash inflows and
outflows reconciles the change in the
company’s beginning and ending cash
balances.

For example, assume that UBC’s net increase in cash

is $9 million and the Cash beginning balance is $20
million. The cash reconciliation would be as follows:

21 - 14
21 - 15
 Noncash Investing and Financing Activities
Significant investing and financing transactions not involving
cash also are reported (usually in a disclosure note).
1. Acquiring an asset by incurring a debt payable to
the seller.
2. Acquiring an asset by entering into a capital lease.
3. Converting debt into common stock or other equity
securities.
4. Exchanging noncash assets or liabilities for other
noncash assets or liabilities.

21 - 16
 U.S. GAAP and IFRS
The FASB and IASB are working together on a project,
Financial Statement Presentation, to establish a common
standard for presenting information in the financial statements.

21 - 17
 U.S. GAAP and IFRS
Based on the joint FASB and IASB Financial Statement
Presentation project, the statement of cash flows is
slated to change in several ways.

• Operating and Investing cash flows will be categorized as

“Business” activities and some cash flows may switch
categories.
• The statement will have three additional groupings: income
taxes, discontinued operations, and equity (if needed).
• Direct method will be required.
• Eliminate the concept of “cash equivalents” in favor of cash
only.
21 - 18
 Preparation of the Statement of Cash Flows

Reconstructing the events and transactions that

occurred during the period helps identify the
operating, investing and financing activities to be
reported.

A spreadsheet can be used to ensure that

no reportable activities are inadvertently
overlooked.

Let’s see how to use a spreadsheet to prepare a

Statement of Cash Flows on the next few slides.
21 - 19
 UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes We begin by
Dec. 31,
2010 Debits Credits
Dec. 31,
2011
entering the
Balance Sheet
Assets:
beginning and
Cash
Accounts receivable
20
30
29
32
ending balances
Short-term investments
Inventory
-
50
12
46
for each account
Prepaid insurance 6 3 on the
Land 60 80
Buildings and equipment 75 81 comparative
Less: Accumulated depreciation (20) (16)
221 267 balance sheet and
Liabilities:
Accounts payable 20 26 income statement.
Salaries payable 1 3
Income tax payable 8 6
Notes payable - 20 The changes
Bonds payable 50 35
Less: Discount on bonds payable (3) (1) columns will be
Shareholders' Equity: used later to
Common stock 100
130 explain the
Paid-in capital 20
29 increase or
Retained earnings 25
19
decrease in each
221 267
account balance.
21 - 20
 Changes
Dec. 31, Dec. 31,
2010 Debits Credits 2011
Income Statement
Revenues:
Sales revenue 100
Investment revenue 3
Gain on sale of land 8

Expenses:
Cost of good sold (60)
Salaries expense (13)
Depreciation expense (3)
Bond interest expense (5)
Insurance expense (7)
Loss on sale of equipment (2)
Income tax expense (9)
Net income 12

The beginning balances for income

statement accounts are always zero.

21 - 21
 Changes
Dec. 31, Dec. 31,
2010 Debits Credits 2011
Statement of Cash Flows
Operating Activities:

Next we
allocate space
on the
Investing Activities:
spreadsheet
for the
statement of
Financing Activities:
cash flows.

Spreadsheet entries duplicate the actual journal entries

used to record the transactions as they occurred during
the year.
They are only entered on the spreadsheet and are not
recorded in the accounting records.
21 - 22
 UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows

Dec. 31,
Changes
Dec. 31,
Let’s start by
Balance Sheet
2010 Debits Credits 2011
analyzing
Assets:
Cash 20 29
Sales
Accounts receivable 30 32 Revenue and
Short-term investments - 12
Inventory 50 46 its related
Prepaid insurance 6 3
Land 60 80 account
Buildings and equipment
Less: Accumulated depreciation
75
(20) Changes
81
(16) Accounts
Liabilities:
Dec. 221
2010
31,
Debits Credits
Dec. 31,
2011
267
Receivable by
Income Statement
Accounts
Revenues:
Salaries
payable
payable
20
1
26
3
looking at the
Sales revenue
Income tax payable
Investment revenue
8 1006
3
relationship in
Notes payable - 20
Gain onpayable
Bonds sale of land Accounts
50
Receivable 8
35 a T-account
Less: Discount Beg. bal. payable
on bonds 30(3) (1)
Expenses: Credit sales 100 ? Cash received format.
Cost of good sold
Shareholders' Equity: (60)
Salaries expense
Common stock
End. bal. 32
100 (13)
Depreciation expense (3)
130
Paid-in capitalexpense
Bond interest 20 (5)
Insurance expense 29
(7)
Retained earnings
Loss on sale of equipment 25 (2)
Income tax expense 19
(9)
Net income 221 267
12

21 - 23
 UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows

Dec. 31,
Changes
Dec. 31,
We can see from
Balance Sheet
2010 Debits Credits 2011
this analysis that
Assets:
Cash 20 29
cash received
Accounts receivable
Short-term investments -
30 32
12
from customers
Inventory
Prepaid insurance
50
6
46
3
must have been
Land 60 80 $98 million.
Buildings and equipment 75 81
Less: Accumulated depreciation (20) (16)
221 Changes 267
Liabilities: Dec. 31, Dec. 31,
Accounts payable 201020 Debits Credits 201126
Income Statement
Salaries payable 1 3
Revenues:
Income tax payable 8 6 Let’s see how
Sales payable
Notes revenue
Investment
Bonds revenue
payable
-
50
100
20
3
35 to post this
Accounts Receivable
Gain on Discount
Less: sale of land
on bonds payable
Beg. bal. 30
(3) 8
(1)
entry to the
Expenses: Credit
Shareholders'
Cost of good
Common
Equity:sales
sold
stock
100
100
98 Cash received
(60)
spreadsheet.
End.
Salaries expense
bal. 32 (13)
130
Depreciation
Paid-in capitalexpense 20 (3)
Bond interest expense (5)
29
Insuranceearnings
Retained expense 25 (7)
Loss on sale of equipment (2)
19
Income tax expense 221 (9)
267
Net income 12

21 - 24
 UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes
First, $2 million
Dec. 31, Dec. 31, is debited to
2010 Debits Credits 2011
Balance Sheet Accounts
Assets:
Cash 20 29
Receivable to
Accounts receivable
Short-term investments -
30 (1) 2 32
12
account for the
Inventory 50 46 total change in
Prepaid insurance 6 3
Land 60 80 the account.
Buildings and equipment 75 81
Less: Accumulated depreciation (20) (16)
221 Changes 267
Liabilities: Dec. 31, Dec. 31,
Accounts payable 201020 Debits Credits 201126
Income payable
Salaries Statement 1 3 Then, $100
Revenues:
Income tax payable
Sales revenue
Notes payable -
8
(1) 100
6
100
20
million is credited
Investment
Gain on
revenue
Bonds payable
sale of land
Accounts Receivable
50 353
8
to Sales Revenue
Less: Discount
Beg.on bonds payable
bal. 30 (3) (1)

Expenses: Credit sales 100 98 Cash received

to account for the
Shareholders' Equity:
Cost of good sold
End. bal.
Common stock 32 100 (60) total change in
Salaries expense (13)
Depreciation expense
Paid-in capital 20
130
(3) the account.
Bond interest expense (5)
29
Insurance expense (7)
Retained earnings 25
Loss on sale of equipment (2)
19
Income tax expense (9)
221 267
Net income 12

21 - 25
 Changes
Dec. 31, Dec. 31,
2010 Debits Credits 2011
Statement of Cash Flows The final
Operating Activities:
Cash Inflows: part of this
From customers (1) 98
entry is a
$98 million
entry on
the
Statement
Investing Activities: of Cash
Flows
Accounts Receivable under Cash
Beg. bal.
FinancingCredit
Activities:
30 Inflows
sales 100 98 Cash received
End. bal. 32 from
Customers.

21 - 26
 UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes The $12 million
Dec. 31, Dec. 31,
2010 Debits Credits 2011 increase in the
Balance Sheet
Assets: Short-term
Cash 20 29
Accounts receivable 30 (1) 2 32 Investments
Short-term investments
Inventory
-
50
(12) 12 12
46
account is due
Prepaid insurance
Land
6
60
3
80
to the purchase
Buildings and equipment 75 81 of short-term
Less: Accumulated depreciation (20) (16)
221 267 investments
Liabilities:
Accounts payable 20 26 during the year.
Salaries payable 1 3
Income tax payable 8 6
Notes payable - 20
Bonds payable 50 35
Less: Discount on bonds payable (3) (1)
Note that in the
Shareholders' Equity:
Common stock Short-term 100
Investments textbook, entry
Beg. bal. 0 130 number 12
Paid-in capital 20
Purchases 12 29
illustrates the
End. bal.
Retained earnings 12 25 analysis of the
19
221 267
Short-term
Investment account.
21 - 27
 Changes
Dec. 31, Dec. 31,
2010 Debits Credits 2011
Statement of Cash Flows The final
Operating Activities:
Cash Inflows:
part of this
From customers (1) 98 entry is a
$12 million
entry on
the
Statement
Investing Activities: of Cash
Flows
Purchase of S-T investment (12) 12 under
Investing
Short-term Investments
Financing Activities:
Beg. bal. 0
Activities.
Purchases 12
End. bal. 12

21 - 28
 UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows
Changes
Dec. 31, Dec. 31,
2010 Debits Credits 2011 In entry number 14,
Balance Sheet we find that a note
Assets:
Cash 20 29 payable was issued
Accounts receivable
Short-term investments -
30 (1)
(12)
2
12
32
12
as payment for a
Inventory 50 46 building.
Prepaid insurance 6 3
Land 60 80
Buildings and equipment 75 (14) 20 x 81
Investing in a new
Less: Accumulated depreciation (20) (16) building is a
221 267
Liabilities: significant investing
Accounts payable 20 26 activity and
Salaries payable 1 3
Income tax payable 8 6 financing the
20x
Notes payable
Bonds payable
-
50
(14) 20
35
acquisition with
Less: Discount on bonds payable (3) (1) long-term debt is a
Shareholders' Equity: significant financing
Common stock 100 activity.
130
Paid-in capital 20
29
Retained earnings 25
19
221 267

21 - 29
 UNITED BRANDS CORPORATION
Spreadsheet for the Statement of Cash Flows

Dec. 31,
Changes
Dec. 31,
After entering
2010 Debits Credits 2011 all the
Balance Sheet
Assets: transactions,
Cash 20 (19) 9 29
Accounts receivable 30 (1) 2 32 this is what the
Short-term investments - (12) 12 12
Inventory 50 (4) 4 46 balance sheet
Prepaid insurance
Land
6
60 (13) 30
(8)
(3)
3
10
3
80 portion of the
Buildings and equipment
Less: Accumulated depreciation
75
(20)
(14)
(9)
20
x
7
(9)
(6)
14
3
81
(16)
spreadsheet
Liabilities:
221 267
looks like.
Accounts payable 20 (4) 6 26
Salaries payable 1 (5) 2 3
Income tax payable 8 (10) 2 6
Notes payable - (14) 20 20
Bonds payable 50 (15) 15 x 35
Less: Discount on bonds payable (3) (7) 2 (1)

Shareholders' Equity:
Common stock 100 (16) 10
(17) 20 130
Paid-in capital 20 (16) 3
(17) 6 29
Retained earnings 25 (16) 13
(18) 5 (11) 12 19
221 267

21 - 30
 Changes
Dec. 31, Dec. 31,
2010 Debits Credits 2011
Income Statement
Revenues:
Sales revenue (1) 100 100
Investment revenue (2) 3 3
Gain on sale of land (3) 8 8

Expenses:
Cost of good sold (4) 60 (60)
Salaries expense (5) 13 (13)
Depreciation expense (6) 3 (3)
Bond interest expense (7) 5 (5)
Insurance expense (8) 7 (7)
Loss on sale of equipment (9) 2 (2)
Income tax expense (10) 9 (9)
Net income (11) 12 12

After entering all the transactions, this is

what the income statement portion of the
spreadsheet looks like.
21 - 31
 Changes
Dec. 31, Dec. 31,
2010 Debits Credits 2011
Statement of Cash Flows After entering
Operating Activities:
Cash Inflows: all the
From customers
From investment revenue
(1)
(2)
98
3
transactions,
Cash Outflows: this is what
To suppliers of goods (4) 50
To employees (5) 11 the statement
To bondholders (7) 3
For insurance expense (8) 4
of cash flows
For income taxes
Net cash flows
(10) 11
22
portion of the
Investing Activities: spreadsheet
Sale of land (3) 18
Sale of equipment (9) 5 looks like.
Purchase of S-T investment (12) 12
Purchase of land (13) 30
Net cash flows (19)
Financing Activities:
Retirement of bonds payable (15) 15
Sale of common stock (17) 26
Payment of cash dividends (18) 5
Net cash flows 6
Net increase in cash (19) 9 9
Totals 376 376

21 - 32
 UNITED BRANDS CORPORATION
Statement of Cash Flows
For the Year Ended December 31, 2011
($ in millions)
Here is the Cash Flows from Operating Activities:
Cash Inflows:
Statement of From customers
From investment revenue
$ 98
3

Cash Flows Cash Outflows:

To suppliers of goods (50)

prepared using To employees

To bondholders
(11)
(3)
For insurance expense (4)
the direct For income taxes
Net cash flows from operating activities
(11)
$ 22
method. Cash Flows from Investing Activities:
Sale of land (30)
Sale of equipment (12)
Purchase of S-T investment 18
Purchase of land 5
Net cash flows from investing activities (19)
Cash Flows from Financing Activities:
Retirement of bonds payable 26
Sale of common stock (15)
Payment of cash dividends (5)
Net cash flows from financing activities 6
Net increase in cash 9
Cash balance, January 1 20
Cash balance, December 31 $ 29

21 - 33
 U.S. GAAP vs. IFRS
Consistent with U.S. GAAP, cash flows are classified as
operating, investing, or financing.

Typical Classification of Interest and Dividends

• Operating Activities • Operating Activities

– Dividends Received
– Interest Received
– Interest Paid
• Investing Activities
• Investing Activities
– Dividends Received
– Interest Received
• Financing Activities • Financing Activities
– Dividends Paid – Dividends Paid
– Interest Paid

21 - 34
 Preparing an SCF: The Indirect Method
Getting There through the Back Door
Net Income $ 12
Adjustments for noncash effects: The indirect method
Gain on sale of land (8) derives the net cash
Depreciation expense 3
Loss on sale of equipment 2
increases or decreases
Changes in operating assets and liabilities: from operating
Increase in accounts receivable (2) activities indirectly by
Decrease in inventory 4
Increase in accounts payable 6 starting with reported
Increase in salaries payable 2 net income and
Discount on bonds payable 2
Decrease in prepaid insurance 3
“working backwards”
Decrease in income tax payable (2) to convert that amount
Net cash flows from operating activities $ 22 to a cash basis.

21 - 35
 Components of Net Income that Do Not
Increase or Decrease Cash
Depreciation Adding these items back to net
Expense
income restores net income to
what it would have been had
depreciation and the loss not been
Loss on Sale subtracted at all.
of Equipment

Subtracting the gain reverses the

Gain on Sale
of Land
effect of the gain having been
added to net income.

21 - 36
 Components of Net Income that Do
Increase or Decrease Cash
For components of net income that increase or decrease
cash, but by an amount different from that reported on the
income statement, net income is adjusted for changes in
the balances of related balance sheet accounts to convert
the effects of those items to a cash basis.

Note: Cash and cash equivalents, short-term investments in securities

available for sale, dividends payable, and short-term payables to financial
21 - 37
institutions are excluded from this category.
 Comparison with the Direct Method

21 - 38
 Appendix 21A:
Spreadsheet for the Indirect Method
A spreadsheet is
equally useful in
preparing a
statement of cash
flows whether we use
the direct or the
indirect method of
determining cash
flows from operating
activities.

21 - 39
 Appendix 21B: The T-Account Method of
Preparing the Statement of Cash Flows

The T-Account
method serves the
same purpose as a
spreadsheet in
assisting in the
preparation of a
statement of Cash
Flows.

21 - 40
 Appendix 21B: The T-Account Method of
Preparing the Statement of Cash Flows
1. Draw a T-account for each income statement and balance
sheet account.
2. The T-account for cash should be drawn considerably
larger.
3. Enter each account’s net change on the appropriate side
(debit or credit) of the uppermost portion of each T-
account.
4. Reconstruct the transactions that caused changes in each
account balance during the year and record the entries for
those transactions directly in the T-accounts.
5. After all account balances have been explained by T-
account entries, prepare the statement of cash flows from
the cash T-account, being careful also to report noncash
investing and financing activities.

21 - 41
End of Chapter 21