Financial accounting 9th jamie pratt chapter 14
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Chapter 14
Statement of Cash Flows
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The Statement of Cash Flows
Summary of company’s transactions that involve cash over a period of time. Transactions are classified as:
Operations
Investments
Financing
Figure 14-1 Sample statement of cash flows
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Required for financial statements by SFAS 95 (1987).
Statement of Cash Flows
Primary purpose is to provide relevant information about cash receipts and cash
disbursements of the company during the period.
Serves to complement the other financial statements.
Focus is on cash flows, not income.
Reconciles the balance sheet and the income statement.
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Definition of Cash
Cash consists of coin, currency, and available funds on deposit at the bank.
Negotiable instruments such as money orders, certified checks, cashier’s checks,
personal checks, and bank drafts are also considered cash.
Also certain cash equivalents, which include commercial paper and other debt
investments with maturities of less than three months are included in the statement of
cash flows.
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Content of Statement of Cash Flows
Explains change in cash and cash equivalents.
Cash equivalents are defined as short-term, highly liquid investments near to maturity.
Examples of cash equivalents are Treasury bills and money market funds.
Format of SCF includes the following three sections:
cash flow from operating activities.
cash flow from investing activities.
cash flow from financing activities.
Like US GAAP, IFRS requires the presentation of a SCF, and the format is largely the same.
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General Description of the Statement of Cash Flows
Figure 14-2
Standard
statement
of cash
flows
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Cash Provided (Used) by Operating Activities
Cash Flows from operating activities is based on the income statement, and converts
income activity to a cash basis.
There are two formats for the presentation of CF from operating activity:
Direct Method: this technique shows cash received from customers and cash paid to
various entities for operating activities.
Indirect Method: this technique starts with net income and makes adjustments to net
income to convert it to a cash basis.
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Cash Provided (Used) by Operating Activities
If the direct method is used, the indirect method must be presented in a supplementary
schedule.
FASB recommends companies use the direct method including the supplementary schedule.
The direct method is more straight-forward and provides more information with the
supplementary disclosure, but the vast majority of companies present only the indirect
method.
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Cash Provided (Used) by Investing Activities
Cash Flows from investing activities explain the changes in cash from the purchase or sale
of the company’s (primarily) long-term assets.
Examples of investing activity includes:
Cash paid for purchase of equipment, land, buildings, marketable securities (available-forsale and equity), intangible assets, and most other long term assets.
Cash received from sale of equipment, land, buildings, marketable securities (availablefor-sale and equity), intangible assets, and most other long term assets.
Cash paid for issue of non-trade notes receivable (both short-term and long-term).
Cash received for repayment on non-trade notes receivable (both short-term and longterm).
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Cash Provided (Used) by Financing Activities
Cash Flows from financing activities explain the changes in cash from the issue or
retirement of the company’s (primarily) long-term liabilities and contributed capital (equity).
Examples of financing activity includes:
cash received from issue of bonds, mortgages and other long-term debt,
cash received from issue of common stock and preferred stock,
cash paid for the retirement of long-term debt,
cash paid for the repurchase of treasury stock,
cash paid for dividends,
cash received for issue of non-trade notes payable (both short-term and long-term), and
cash paid for retirement or repayment on non-trade notes payable (both short-term and
long-term).
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Cash Provided (Used) by Financing Activities
Note that cash paid for dividends is classified as a financing activity, but cash
paid for interest is classified as an operating activity.
Note that cash received for dividends and cash received for interest are both
classified as operating activities.
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The Importance of Cash from Operating Activities
Cash from Operating Activities has special importance to a business and
those outside the company:
The sale of services and/or inventory is a prerequisite for a successful
business.
Investing and Financing cash flows can vary greatly year to year
Operating cash flows should be more consistent, and, expected to reoccur
making them essential for predicting future outcomes
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The Importance of Significant Noncash Transactions
Significant non-cash transactions such as issuing stock or a note for an asset must be
disclosed in the footnotes of the financial statements
For example MCI acquired Satellite Business Systems (SBS) for common stock and a note payable and required disclosure
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Deriving Cash Flow from Accrual Financial Statements Operating – Sales and Bad Debt Expense
Cash inflow from sales can be determined by analyzing changes in accounts receivable and the allowance for
doubtful accounts.
Figure 14-6
Determining
cash inflow
from sales
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Deriving Cash Flow from Accrual Financial Statements Operating – Fees Earned
Cash inflow related to fees earned can be determined by looking at changes in the advance account
Figure 14-7
Determining
cash inflow
from fees
earned
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Deriving Cash Flow from Accrual Financial Statements Operating – Cost of Goods Sold
Cash outflow associated with goods sold can be determined with changes in inventory and accounts
payable.
Figure 14-8
Determining
cash outflow
from inventory purchases
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Deriving Cash Flow from Accrual Financial Statements Operating – Miscellaneous Expenses
Cash outflow related to miscellaneous expense can be determined by analyzing changes in
accrued payables
Figure 14-8
Determining
cash outflow
from miscellaneous expenses
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Deriving Cash Flow from Accrual Financial Statements Operating – Insurance Expense
Cash outflow related to insurance expense can be determined by looking at changes to the prepaid
insurance account
Figure 14-10
Determining
cash outflow
related to insurance expense
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Deriving Cash Flow from Accrual Financial Statements Operating – Depreciation, Amortization, and
Losses on Sales
There is no operating cash effect with these items
Note : They are a part of net income and therefore the operating section of the
statements of cash flows must be adjusted for these items under the indirect
method of preparing the statements of cash flows.
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Deriving Cash Flow from Accrual Financial Statements Operating – Interest Expense
Cash outflow related to interest expense can be determined by looking at changes in the discounts
on note payable account
Figure 14-11
Determining
cash outflow
related to interest expense
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Deriving Cash Flow from Accrual Financial Statements Operating – Income Tax Expense
Cash outflow related to income tax expense can be determined by looking at changes in the income
tax payable account
Figure 14-12
Determining
cash outflow
related to income taxes
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Deriving Cash Flow from Accrual Financial Statements Investing
Cash inflows and outflows associated with investing activities are analyzed by looking at changes in
the long-lived asset accounts.
Outflows occur when assets are acquired.
Figure 14-13
Determining
cash outflow
for land purchases
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Deriving Cash Flow from Accrual Financial Statements Investing (cont’d)
Cash inflows and outflows associated with investing activities are analyzed by looking at changes in the long-lived asset accounts.
Inflows occur when assets are sold.
Figure 14-14
Determining
cash inflow
from sale of machinery
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Deriving Cash Flow from Accrual Financial Statements Financing – Payment on Notes Payable
A pay down on a note payable would be do to the payment of cash unless another transaction is
indicated.
Figure 14-15 Determining
cash outflow
from payments on notes
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