Chapter 13 Notes Statement of Cash Flows The Statement of Cash Flows Usefulness and Format 1 Statement of cash flows A basic financial statement that provides information about the cash receipts cash payments and net change in cash during a period resulting from operating investing and financing activities Information in a statement of cash flows should help investors creditors and others assess 2 a The entity s ability to generate future cash flows b The entity s ability to pay dividends and meet obligations c The reasons for the difference between net income and net cash provided used by operating activities i Allows them to assess the reliability of the net income number d The cash investing and financing transactions during the period 3 The statement of cash flows classifies cash receipts and cash payments as operating investing and financing activities 4 Operating activities Cash flow activities that include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income 5 Investing activities Cash flow activities that include a purchasing and disposing of investments and property plant and equipment using cash and b lending money and collecting the loans 6 Financing activities Cash flow activities that include a obtaining cash from issuing debt and repaying the amounts borrowed and b obtaining cash from stockholders repurchasing shares and paying dividends 7 Operating activities category is the most important this source of cash is considered to be the best measure of a company s ability to generate sufficient cash to continue as a going concern 8 Operating activities involve income statement items 9 Investing activities involve cash flows resulting from changes in investments and long term asset items 10 Financing activities involve cash flows resulting from changes in long term liability and stockholders equity items 11 Companies classify some cash flows related to investing or financing as operating activities because companies report these items in the income statement where results of operations are shown 12 Not all of a company s significant activities involve cash examples of this include a Direct issuance of common stock to purchase assets b Conversion of bonds into common stock c Direct issuance of debt to purchase assets d Exchanges of plant assets 13 Companies do not report in the body of the statement of cash flows significant financing and investing activities that do not affect cash 14 Instead they report these activities in either a separate schedule at the bottom of the statement of cash flows or in a separate note or supplementary schedule to the financial statements 15 The reporting of these noncash activities in separate schedule satisfies the full disclosure principle 16 In homework present significant noncash investing and financing activities in a separate schedule at the bottom of the statement of cash flows 17 In the presentation of the statement of cash flows the operations activities section always appears first followed by the investing activities and then the financing activities section 18 The statement of cash flows is not prepared from an adjusted trial balance 19 The statement of cash flows deals with cash receipts and payments a The company must adjust the effects of the use of accrual accounting to determine cash flows 20 In information to prepare the statement comes from 3 sources a Comparative Balance Sheets indicates the amount of changes in assets liabilities and stockholders equity from the beginning to end of the period b Current Income Statement helps determine the amount of cash provided or used by operations during the period c Additional Information includes transaction data that are needed to determine how cash was provided or used during the period 21 In order to perform Step 1 the company must convert net income from an accrual basis to a cash basis a Can use either the indirect method or the direct method b Both methods arrive at the same total amount for Net cash provided by operating activities but differ in how they arrive at the amount 22 Indirect method A method of preparing a statement of cash flows in which net income is adjusted for items that do not affect cash to determine net cash provided by operating activities a Most companies use this method 23 Reasons why the indirect method is preferred a b It is easier and less costly to prepare It focuses on the differences between net income and net cash flow from operating activities 24 Direct method A method of determining net cash provided by operating activities by adjusting each item in the income statement from the accrual basis to the cash basis and which shows operating cash receipts and payments Preparing The Statement of Cash Flows Indirect Method 1 STEP 1 OPERATING ACTIVITES 2 Determine net cash provided used by operating activities by converting net income from an accrual basis to a cash basis 3 Company adjust net income in numerous ways 4 Under the accrual basis of accounting companies record revenue when earned and record expenses when incurred 5 Earned revenues may include credit sales for which the company has not yet 6 Expenses incurred may include some items that it has not yet paid in cash 7 Thus under the accrual basis net income is not the same as net cash provided by collected cash operating activities 8 Under the indirect method companies must adjust net income to convert certain items to the cash basis 9 Depreciation Expense cash a Although depreciation expense reduces net income it does not reduce b Depreciation expense is a noncash charge c The company must add it back to net income to arrive at net cash provided by operating activities d As the first adjustment to net income in the statement of cash flows companies frequently list depreciation and similar noncash charges such as amortization of intangible assets depletion expense and bad debt expense 10 Loss On Sale of Equipment a Investing activities section should report cash received from the sale of plant assets b Because of this companies must eliminate from net income all gains and losses related to the disposal of plant assets to arrive at cash provided by operating activities c A loss is eliminate by adding the amount of the loss back to net income to d arrive at net cash provided by operating activities If a gain on sale occurs the company deducts the gain from its net income in order to determine net cash provided by operating
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