Act 211, Chapter 11

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Chapter 11:

Chapter 11 Statement of Cash Flows McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Part A:

Part A Formatting the Statement of Cash Flows 11- 2

LO1 Classification of Transactions:

LO1 Classification of Transactions Categories of Cash Flows Operating activities Investing activities Financing activities Include cash receipts and cash payments for transactions relating to revenue and expense activities Include cash transactions involving the purchase and sale of long-term assets and current investments Inflows and outflows of cash resulting from the external financing of a business 11- 3

Reporting Cash Flow Activities:

Reporting Cash Flow Activities Cash Flows from Operating Activities Cash Inflows Sale of goods or services Receipt of interest and dividends Cash Outflows Purchase of inventory For operating expenses For interest For income taxes Cash Flows from Investing Activities Cash Inflows Sale of investments Sale of property, plant and equipment or intangibles Collection of notes receivable Cash Outflows Purchase of investments Purchase of property, plant and equipment or intangibles Acceptance of notes receivable Cash Flows from Financing Activities Cash Inflows Issuance of bonds or notes payable Issuance of stock Cash Outflows Repayment of bonds or notes payable Reacquisition of stock (treasury stock) Payment of dividends 11- 4

Sources of Information:

Sources of Information Information Sources Explanation 1. Income statement The income statement provides important information in the determination cash flows from operating activities. 2. Balance sheets We look at the change in asset, liability, and stockholders’ equity accounts from the end of last period to the end of this period to find cash flows from operating, investing, and financing activities. 3. Detailed accounting records Sometimes we need additional information from the accounting records to determine specific cash inflows or cash outflows for the period. 11- 5

Relationship between Financial Statements:

Relationship between Financial Statements 11- 6

Sectioning “Cheat Sheet” (with a few exceptions):

Radford University - M. Chatham - Financial Accounting 211 7 Sectioning “Cheat Sheet” (with a few exceptions) Assets Liabilities Current Current * Long-Term Long-Term * Note payable principal = Financing Note payable interest = Operating Stockholder’s Equity Operating Investing Financing * Receipt of dividends on an investment = Operating

Statement of Cash Flows:

Statement of Cash Flows Provides a summary of cash inflows and cash outflows during the reporting period E-GAMES, INC. Statement of Cash Flows For the Year Ended December 31, 2012 Cash Flows from Operating Activities Net income $42,000 Adjustments for noncash effects: Depreciation expense 9,000 Loss on sale of land 4,000 Increase in accounts receivable (7,000) Decrease in inventory 10,000 Increase in prepaid rent (2,000) Decrease in accounts payable (5,000) Increase in interest payable 1,000 Decrease in income tax payable (2,000) Net cash flows from operating activities $50,000 11- 8

Statement of Cash Flows (continued):

Statement of Cash Flows (continued) Cash Flows from Investing Activities Purchase of investment (35,000) Sale of land 6,000 Net cash flows from investing activities (29,000) Cash Flows from Financing Activities Issuance of common stock 5,000 Payment of cash dividends (12,000) Net cash flows from financing activities (7,000) Net increase (decrease) in cash 14,000 Cash at the beginning of the period 48,000 Cash at the end of the period $62,000 Note: Noncash Activities Purchased equipment by issuing a note payable $20,000 11- 9

Reporting Noncash Activities:

Reporting Noncash Activities Transactions that don’t increase or decrease cash Excluded from the statement of cash flows Reported in a separate note to the financial statements as noncash activities Purchase of long-term assets by issuing debt Purchase of long-term assets by issuing stock Conversion of bonds payable into common stock Exchange of long-term assets Examples: 11- 10

Operating Activities – Indirect and Direct Methods:

Operating Activities – Indirect and Direct Methods Begin with net income and then list adjustments to net income in order to arrive at operating cash flows. More popular method. Easier and less costly. Adjust the items on the income statement to directly show the cash inflows and outflows from operations. Conceptually better method. More difficult and more costly. Differ only in the presentation format for operating activities. We report investing, financing, and noncash activities identically under both methods. Indirect Method Direct Method 11- 11

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Part B:

Part B Preparing the Statement of Cash Flows 11- 13

Steps in Preparing the Statement of Cash Flows:

Steps in Preparing the Statement of Cash Flows Step 1. Calculate net cash flows from operating activities, using information from the income statement and changes in current assets (other than cash) and current liabilities from the comparative balance sheets. Step 2. Determine the net cash flows from investing activities, by analyzing changes in long-term asset accounts from the comparative balance sheets. Step 3. Determine the net cash flows from financing activities, by analyzing changes in long-term liabilities and stockholders’ equity accounts from the comparative balance sheets. Step 4. Combine the operating, investing, and financing activities, and make sure the total agrees with the net increase (decrease) in cash. 11- 14

Reconciliation (Operating Section):

Radford University - M. Chatham - Financial Accounting 211 15 Reconciliation ( Operating Section ) We reconcile to ACCRUAL BASIS Net Income CASH BASIS Net Income (which is, by definition, NET CASH FLOWS for operating activities) INDIRECT METHOD!

Reconciliation cont. (Indirect Method):

Radford University - M. Chatham - Financial Accounting 211 16 Reconciliation cont. (Indirect Method) Net Income (Accrual Basis) XXX Add Back Non-Cash Expenses XXX (Depr., Depl., Amor., Bad Debt) Add Back Losses, and/or XXX Subtract Gains ( XXX ) 1) 2) Add or Subtract s (changes) in Current Assets and Current Liabilities ( XXX ) or XXX 3) Net Cash Flows (Operating Activities) XXX =

“Cheat Sheet” for CA/CL s:

Radford University - M. Chatham - Financial Accounting 211 17 “Cheat Sheet” for CA/CL s For Current Liabilities , relationship between change and effect is DIRECT Example: Salaries Payable 2,000 7,000 5,000 Increase So, ADD the $5,000 increase in Operating Activities

“Cheat Sheet” continued:

Radford University - M. Chatham - Financial Accounting 211 18 “Cheat Sheet” continued For Current Assets , relationship between change and effect is INVERSE Example: Accounts Receivable (Trade) 4,000 6,000 2,000 Increase So, SUBTRACT the $2,000 Increase in Operating Activities

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Illustration :

Illustration The income statement, balance sheets, and additional information for E-Games, Inc., are provided in the following Illustration. We will use this information in preparing the statement of cash flows following the four basic steps. 11- 20

Illustration (continued):

Illustration (continued) 11- 21

Illustration (concluded ):

Illustration (concluded ) Additional Information for 2012 Purchased stock in Intendo Corporation for $35,000. Sold land originally costing $10,000 for $6,000, resulting in a $ 4,000 loss on sale of land. Purchased $20,000 in equipment by issuing a $20,000 note payable due in three years. No cash was exchanged in the transaction . Issued common stock for $5,000 cash. Declared and paid a cash dividend of $12,000. 11- 22

Basic Format:

Basic Format 11- 23

LO2 Operating Activities – Indirect Method:

LO2 Operating Activities – Indirect Method Both net income and cash flows from operating activities represent the same operating activities. The income statement reports net income on an accrual basis. On the other hand, the statement of cash flows reports the very same activities on a cash basis. We remove the noncash components from net income so that what’s left is cash flows from operating activities. We can classify the noncash components as: revenues and expenses that don’t affect cash at all (adjustments for noncash components of net income), and revenues and expenses that do affect cash, but not by the amount reported as the revenue or expense (adjustments for changes in current assets and current liabilities). 11- 24

Adjustments For Noncash Components of Net Income:

Adjustments For Noncash Components of Net Income Depreciation Expense and Loss on Sale of Land Add back Depreciation Expense and Loss on Sale of Land which was earlier subtracted from the net income. 11- 25

Adjustments for Changes in Current Assets and Current Liabilities :

Adjustments for Changes in Current Assets and Current Liabilities Increase in Accounts Receivable (Increase in a current asset) Subtract 11- 26

Adjustments for Changes in Current Assets and Current Liabilities :

Adjustments for Changes in Current Assets and Current Liabilities Decrease in Inventory (Decrease in a Current Asset) Add Back 11- 27

Adjustments for Changes in Current Assets and Current Liabilities :

Adjustments for Changes in Current Assets and Current Liabilities Decrease in Accounts Payable / Increase in Prepaid Rent (Decrease in a Current Liability / Increase in a Current Asset) Subtract 11- 28

Adjustments for Changes in Current Assets and Current Liabilities :

Adjustments for Changes in Current Assets and Current Liabilities Increase in Interest Payable (Increase in a Current Liability) Add Back 11- 29

Cash Flows from Operating Activities:

Cash Flows from Operating Activities 11- 30

Summary of All Adjustments:

Summary of All Adjustments Cash Flows from Operating Activities Net income Adjustments for noncash effects: For noncash components of income + Depreciation expense + Loss on sale of assets – Gain on sale of assets For changes in current assets and current liabilities – Increase in a current asset + Decrease in a current asset + Increase in a current liability – Decrease in a current liability = Net cash flows from operating activities 11- 31

LO3 Investing Activities:

LO3 Investing Activities Cash Outflow Cash Inflow Noncash activity disclosed in the footnote 11- 32

LO3 Financing Activities:

LO3 Financing Activities Cash Inflow Cash Outflow Retained earnings, beg. Balance $41,000 + Net income 42,000 – Dividends (12,000) Retained earnings, ending balance $71,000 11- 33

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Cash Flow Analysis Analysis 11- 35

LO4 Cash Flow Analysis:

LO4 Cash Flow Analysis Analysis based on net cash flows from operating activities (CFFO) 11- 36

Cash Return on Assets:

Cash Return on Assets ($ in millions) CFFO ÷ Average Total Assets = Cash Return on Assets Apple $10,159 ÷ ($53,851 + $39,572)/2 = 21.8% Dell $ 1,894 ÷ ($26,500 + $27,561)/2 = 7.0% ($ in millions) Net Income ÷ Average Total Assets = Return on Assets Apple $5,704 ÷ ($53,851 + $39,572)/2 = 12.2% Dell $2,478 ÷ ($26,500 + $27,561)/2 = 9.2% Return on Assets Cash Return on Assets Cash Return on Assets is higher than the Return on Assets for Apple, but not for Dell 11- 37

Components of Cash Return on Assets:

Components of Cash Return on Assets Cash Return on Assets = Cash Flow to Sales x Asset Turnover CFFO = CFFO x Net Sales Average Total Assets Net Sales Average Total Assets ($ in millions) CFFO ÷ Net Sales = Cash Flow to Sales Apple $10,159 ÷ $36,537 = 27.8% Dell $1,894 ÷ $61,101 = 3.1% Net Sales ÷ Average Total Assets = Asset Turnover Apple $36,537 ÷ ($53,851 + $39,572)/2 = 0.8 times Dell $61,101 ÷ ($26,500 + $27,561)/2 = 2.3 times 11- 38

Appendix:

Appendix Operating Activities-Direct Method 11- 39 NOT Responsible for!!!

Operating Activities-Direct Method:

Operating Activities-Direct Method Cash Paid for Interest 11- 40

Operating Activities-Direct Method:

Operating Activities-Direct Method Cash Paid for Income Taxes 11- 41

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Good Luck on the Chapter 11 Homework!

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