The contents of this chapter include all of the following: Indicate the primary purpose of the statement of cash flows; distinguish among operating, investing, and financing activities; explain the impact of the product life cycle on a company’s cash flows;…
PART III: Decision Tools Lecture 26 Statement of Cash Flows Revisited Learning Learning Objectives Objectives Describe the purpose of the statement of cash flows Identify the major classifications of cash flows Differentiate between net income and net cash flow from operating activities Contrast the direct and indirect methods of calculating net cash flow from operating activities Determine net cash flows from investing and financing activities Prepare a statement of cash flows Identify sources of information for a statement of cash flows Discuss special problems in preparing a statement of cash flows Explain the use of a worksheet in preparing a statement of cash flows Statement Statement of of Cash Cash Flows Flows Preparation of the Statement Usefulness Classification of cash flows Format of statement Steps in preparation Examples Sources of information Indirect vs direct method Special Problems in Statement Preparation Use of a Worksheet Adjustments to net income Preparation of worksheet Accounts receivable (net) Analysis of transactions Other working capital changes Preparation of final statement Net losses Significant noncash transactions Section Section 11 Preparation Preparation of of the the Statement Statement of of Cash Cash Flows Flows Primary purpose: To provide information about a company’s cash receipts and cash payments during a period Secondary objective: To provide cash-basis information about the company’s operating, investing, and financing activities LO Describe the purpose of the statement of cash flows Usefulness Usefulness of of the the Statement Statement of of Cash Cash Flows Flows Provides information to help assess: Entity’s ability to generate future cash flows Entity’s ability to pay dividends and meet obligations Reasons for difference between net income and net cash flow from operating activities Cash and noncash investing and financing transactions LO Describe the purpose of the statement of cash flows Classification Classification of of Cash Cash Flows Flows Operating Activities Investing Activities Financing Activities Income Changes in Investments and Long-Term Asset Items Changes in Long-Term Liabilities and Stockholders’ Equity Statement Transactions LO Identify the major classifications of cash flows Classification Classification of of Cash Cash Flows Flows LO Identify the major classifications of cash flows Classification Classification of of Cash Cash Flows Flows LO Identify the major classifications of cash flows Classification Classification of of Cash Cash Flows Flows The basis recommended by the FASB for the statement of cash flows is actually “cash and cash equivalents.” Cash equivalents are short-term, highly liquid investments that are both: Readily convertible to known amounts of cash, and So near their maturity that they present insignificant risk of changes in value (e.g., due to changes in interest rates) Generally, only investments with original maturities of three months or less qualify under this definition LO Identify the major classifications of cash flows Classification Classification of of Cash Cash Flows Flows Typical Company Product Life Cycle 10 LO Identify the major classifications of cash flows Adjustments Adjustments to to Net Net Income Income Changes in Deferred Income Taxes Affect net income but have no effect on cash Equity Method of Accounting 48 Net increase in the investment account does not affect cash flows Company must deduct the net increase from net income to arrive at net cash flow from operating activities LO Discuss special problems in preparing a statement of cash flows Adjustments Adjustments to to Net Net Income Income Loss and Gains 49 A loss is added to net income to compute net cash flow from operating activities because the loss is a non-cash charge in the income statement Company reports a gain in the statement of cash flows as part of the cash proceeds from the sale of equipment under investing activities, thus it deducts the gain from net income to avoid double-counting—once as part of net income and again as part of the cash proceeds from the sale LO Discuss special problems in preparing a statement of cash flows Adjustments Adjustments to to Net Net Income Income Stock Options 50 Cash is not affected by recording the expense The company must increase net income by the amount of compensation expense from share options in computing net cash flow from operating activities LO Discuss special problems in preparing a statement of cash flows Adjustments Adjustments to to Net Net Income Income Extraordinary Items Companies should report either as investing activities or as financing activities cash flows from extraordinary transactions and other events whose effects are included in net income, but which are not related to operations 51 LO Discuss special problems in preparing a statement of cash flows Accounts Accounts Receivable Receivable (Net) (Net) Indirect Method Because an increase in Allowance for Doubtful Accounts results from a charge to bad debt expense, a company should add back an increase in Allowance for Doubtful Accounts to net income to arrive at net cash flow from operating activities 52 LO Discuss special problems in preparing a statement of cash flows Accounts Accounts Receivable Receivable (Net) (Net) Indirect Method One method of presenting this information in the statement of cash flows: 53 LO Discuss special problems in preparing a statement of cash flows Accounts Accounts Receivable Receivable (Net) (Net) Indirect Method Alternate method (net approach) of presenting this information in the statement of cash flows: 54 LO Discuss special problems in preparing a statement of cash flows Accounts Accounts Receivable Receivable (Net) (Net) Direct Method Company should not net Allowance for Doubtful Accounts against Accounts Receivable 55 LO Discuss special problems in preparing a statement of cash flows Accounts Accounts Receivable Receivable (Net) (Net) Direct Method Company should not net Allowance for Doubtful Accounts against Accounts Receivable Cash sales should be reported at $85,000 ($100,000 - 9,000 - 6,000) 56 Increase in Accounts Receivable LO Other Other Working Working Capital Capital Changes Changes Some changes in working capital, although they affect cash, not affect net income 57 Purchase of short-term non-trading equity investments Issuance of a short-term non-trade note payable for cash Cash dividend payable LO Discuss special problems in preparing a statement of cash flows Net Net Loss Loss Illustration: If the net loss is $50,000 and the total amount of charges to add back is $60,000, then net cash provided by operating activities is $10,000 58 LO Discuss special problems in preparing a statement of cash flows Significant Significant Non-Cash Non-Cash Transactions Transactions Common non-cash transactions that a company should disclose: Acquisition of assets by assuming liabilities (including finance lease obligations) or by issuing equity securities Exchanges of non-monetary assets Refinancing of long-term debt Conversion of debt or preference shares to ordinary shares Issuance of equity securities to retire debt 59 LO Discuss special problems in preparing a statement of cash flows Use Use of of aa Worksheet Worksheet A worksheet involves the following steps Step Enter the balance sheet accounts and their beginning and ending balances in the balance sheet accounts section Step Enter the data that explain the changes in the balance sheet accounts and their effects on the statement of cash flows in the reconciling columns of the worksheet Step Enter the increase or decrease in cash on the cash line and at the bottom of the worksheet This entry should enable the totals of the reconciling columns to be in agreement 60 LO Explain the use of a worksheet in preparing a statement of cash flows RELEVANT FACTS 61 Companies preparing financial statements under IFRS must prepare a statement of cash flows as an integral part of the financial statements Both IFRS and GAAP require that the statement of cash flows should have three major sections—operating, investing, and financing—along with changes in cash and cash equivalents Similar to GAAP, the cash flow statement can be prepared using either the indirect or direct method under IFRS For both IFRS and GAAP, most companies use the indirect method for reporting net cash flow from operating activities RELEVANT FACTS 62 The definition of cash equivalents used in IFRS is similar to that used in GAAP A major difference is that in certain situations, bank overdrafts are considered part of cash and cash equivalents under IFRS (which is not the case in GAAP) Under GAAP, bank overdrafts are classified as financing activities One area where there can be substantive differences between IFRS and GAAP relates to the classification of interest, dividends, and taxes IFRS provides more alternatives for disclosing these items, while GAAP requires that except for dividends paid (which are classified as a financing activity), these items are all reported as operating activities ... operating, investing, and financing activities LO Describe the purpose of the statement of cash flows Usefulness Usefulness of of the the Statement Statement of of Cash Cash Flows Flows Provides information... 2,700 Determine net cash flows from investing and financing activities Statement Statement of of Cash Cash Flows Flows (a,b,d,h) (a,b,d,h) Statement of Cash Flows Cash flow from operating activities... Value of shares $ 330,000 LO Determine net cash flows from investing and financing activities Statement Statement of of Cash Cash Flows Flows (a,b,d,h) (a,b,d,h) Statement of Cash Flows Cash