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CHAPTER 18
THE STATEMENT OF CASH FLOWS
After studying this chapter, you should be able to: 1 Indicate the primary purpose of the statement of cash flows. 2 Distinguish among operating, investing, and financing activities. 3 Prepare a statement of cash flows using the indirect method. 4 Prepare a statement of cash flows using the direct method. 5 Analyze the statement of cash flows.
PREVIEW OF CHAPTER 18
THE STATEMENT OF CASH FLOWS
Format
Meaning
of cash flows
Usefulness
Preparation Indirect & direct methods
Classifications Significant
noncash activities
PREVIEW OF CHAPTER 18
THE STATEMENT OF CASH FLOWS
OR
PREVIEW OF CHAPTER 18
THE STATEMENT OF CASH FLOWS
STUDY OBJECTIVE 1
STUDY OBJECTIVE 2
Operating Activities
Investing Activities
Financing Activities
ILLUSTRATION 18-2
FORMAT OF STATEMENT OF CASH FLOWS
The general format of the SCF Is the 3 activities previously discussed operating, investing, and financing plus the significant noncash investing and financing activities.
COMPANY NAME Statement of Cash Flows Period Covered Cash flows from operating activities (List of individual items) Net cash provided (used) by operating activities Cash flows from investing activities (List of individual inflows and outflows) Net cash provided (used) by investing activities Cash flows from financing activities (List of individual inflows and outflows) Net cash provided (used) by financing activities Net increase (decrease) in cash Cash at beginning of period Cash at end of period Noncash investing and financing activities (List of individual noncash transactions)
Company Kmart Corporation Wal-Mart Stores, Inc. The GAP, Inc. J. C. Penney Company, Inc. Sears, Roebuck and Co. The May Department Stores Company
Net Cash from Operations $ 1237 7580 1478 1058 3090 1505
ILLUSTRATION 18-3 THREE MAJOR STEPS IN PREPARING THE STATEMENT OF CASH FLOWS
Step 1: Determine the net increase/decrease in cash.
The difference between the beginning and ending cash balances can be easily computed from comparative balance sheets.
+ or XYZ Goods
This step involves analyzing not only the current years income statement but also comparative balance sheets and selected additional data.
This step involves analyzing comparative balance sheet data and selected additional information for their effects on cash.
For Sale
Investing
Financing
STUDY OBJECTIVE 3
ILLUSTRATION 18-4
COMPARATIVE BALANCE SHEET, 2002, WITH INCREASES AND DECREASES
The comparative balance sheets at the beginning and end of 2002 showing increases and decreases are shown below.
COMPUTER SERVICES COMPANY Comparative Balance Sheets Change Jan. 1, 2002 Increase/Decrease $ 0 $ 34,000 Increase 0 30,000 Increase 0 10,000 Increase $ 0
Assets Cash Accounts receivable Equipment Total Liabilities and Stockholders Equity Accounts payable Common stock Retained earnings Total
$ 0 0 0 $ 0
Additional information: (1) Examination of selected data indicates that a dividend of $15,000 was declared and paid during the year. (2) The equipment was purchased at the end of 2002. No depreciation was taken in 2002.
ILLUSTRATION 18-6 NET INCOME VERSUS NET CASH PROVIDED BY OPERATING ACTIVITIES
The indirect method starts with net income and converts it to net cash provided by operating activities. In other words, the indirect method adjusts net income for items that affect reported net income but do not affect cash. Noncash charges in the income statement are added back to net income. Likewise, noncash credits are deducted. The result is to calculate net cash provided by operating activities.
Accrual Basis of Accounting Earned Revenues Cash Basis of Accounting
Eliminate noncash revenues
Net Income
Incurred Expenses
ILLUSTRATION 18-7
ANALYSIS OF ACCOUNTS RECEIVABLE
When accounts receivable increase during the year, revenues on an accrual basis are higher than are revenues on a cash basis. In other words, operations of the period caused revenues to increase, but not all of these revenues resulted in an increase in cash. Some of increase in revenues had to result in an increase in accounts receivable. As shown below, Computer Services Company had $85,000 in revenues, but collected only $55,000 in cash. Therefore, to convert net income into net cash provided by operating activities, the increase of $30,000 in accounts receivable must be deducted from net income.
ACCOUNTS RECEIVABLE 0 Receipts from customers 85,000 30,000
1/1/02 12/31/02
55,000
ILLUSTRATION 18-8
ANALYSIS OF ACCOUNTS PAYABLE
When accounts payable increase during the year, operating expenses on an accrual basis are higher than they are on a cash basis. For Computer Services Company, operating expenses reported in the income statement were $40,000. Since Accounts Payable increased $4,000, only $36,000 ($40,000 $4,000) of the expenses were paid in cash. To adjust net income to net cash provided by operating activities, the increase of $4,000 must be added to net income.
Payments to creditors ACCOUNTS PAYABLE 36,000 1/1/02 Balance Operating expenses 12/31/02 Balance 0 40,000 4,000
ILLUSTRATION 18-9
PRESENTATION OF NET CASH PROVIDED BY OPERATING ACTIVITIES, 2002 INDIRECT METHOD
The changes in accounts receivable and accounts payable were the only changes in current assets and current liabilities during the year for Computer Services Company. Therefore, any other revenues or expenses reported in the income statement were received or paid in cash. The operating activities section of the SCF for Computer Services Company is shown below.
COMPUTER SERVICES COMPANY Partial Statement of Cash Flows Indirect Method For the Year Ended December 31, 2002 Cash flows from operating activities Net income $ 35,000 Adjustments to reconcile net income to net cash provided by operating activities: Increase in accounts receivable $ ( 30,000) Increase in accounts payable 4,000 ( 26,000) Net cash provided by operating activities $ 9,000
ILLUSTRATION 18-10
ANALYSIS OF RETAINED EARNINGS
The reasons for the net increase of $20,000 in Retained Earnings are determined by analysis. 1 Net income increased Retained Earnings by $35,000. 2 The additional information below the income statement in Illustration 18-5 indicates that a cash dividend of $15,000 was declared and paid. The increase due to net income is reported in the operating activities section while the cash dividend paid is reported in the financing activities section. This analysis can also be made directly from the Retained Earnings account as shown below.
RETAINED EARNINGS 15,000 1/1/02 Balance 12/31/02 Net income 12/31/02 Balance
12/31/02
Cash dividend
0 35,000 20,000
ILLUSTRATION 18-12
COMPARATIVE BALANCE SHEET, 2003, WITH INCREASES AND DECREASES
The comparative balance sheets at the beginning and end of 2003 showing increases and decreases are shown to the right.
COMPUTER SERVICES COMPANY Comparative Balance Sheets December 31 Assets Cash Accounts receivable Prepaid expenses Land Building Accumulated depreciation building Equipment Accumulated depreciation equipment Total Liabilities and Stockholders Equity Accounts payable Bonds payable Common stock Retained earnings Total 2003 $ 56,000 20,000 4,000 130,000 160,000 ( 11,000) 27,000 ( 3,000) $ 383,000 2002 $ 34,000 30,000 0 0 0 0 10,000 0 $ 74,000 Change Increase/Decrease $ 22,000 Increase 10,000 Decrease 4,000 Increase 130,000 Increase 160,000 Increase 11,000 Increase 17,000 Increase 3,000 Increase
The income statement and additional information for 2003 for Computer Services Company are shown to the right.
Additional information: (1) In 2003, the company declared and paid a $15,000 cash dividend. (2) The company obtained land through the issuance of $130,000 of long-term bonds. (3) A building costing $160,000 was purchased for cash; equipment costing $25,000 was also purchased for cash. (4) During 2003, the company sold equipment with a book value of $7,000 (cost $8,000, less accumulated depreciation of $1,000) for $4,000 cash.
ILLUSTRATION 18-14
ANALYSIS OF ACCUMULATED DEPRECIATION EQUIPMENT
The increase in Accumulated Depreciation Equipment was $3,000, which does not represent depreciation expense for the year since the account was debited $1,000 as a result a sale of some equipment. Depreciation expense for 2003 was $4,000 ($3,000 + $1,000). This amount is added to net income to determine net cash provided by operating activities. The T-account below provides information about the changes that occurred in this account in 2003.
ACCUMULATED DEPRECIATION EQUIPMENT Accumulated depreciation on 1/1/03 Balance equipment sold 1,000 Depreciation expense 12/31/03 Balance
0 4,000 3,000
ILLUSTRATION 18-15
PRESENTATION OF NET CASH PROVIDED BY OPERATING ACTIVITIES, 2003 INDIRECT METHOD
Net cash provided by operating activities for 2003 is $218,000 as calculated below.
COMPUTER SERVICES COMPANY Partial Statement of Cash Flows Indirect Method For the Year Ended December 31, 2003 Cash flows from operating activities Net income $ 139,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense $ 15,000 Loss on sale of equipment 3,000 Decrease in accounts receivable 10,000 Increase in prepaid expenses ( 4,000) Increase in accounts payable 55,000 79,000 Net cash provided by operating activities $ 218,000
ILLUSTRATION 18-16
ANALYSIS OF EQUIPMENT
Equipment increased $17,000, which was a net increase that resulted from 2 transactions: 1) a purchase of equipment of $25,000 and 2) the sale of equipment costing $8,000 for $4,000. These transactions are classified as investing activities and each should be reported separately. The purchase of equipment should therefore be reported as an outflow of cash for $25,000 and the sale should be reported as an inflow of cash for $4,000. The T-account below shows the reasons for the change in this account during the year.
EQUIPMENT 10,000 Cost of old equipment 25,000 27,000
1/1/03 12/31/03
8,000
Cash flows from investing activities Purchase of building Purchase of equipment Sale of equipment Net cash used by investing activities Cash flows from financing activities Payment of cash dividends Net cash used by financing activities Net increase in cash Cash at beginning of period Cash at end of period Noncash investing and financing activities Issuance of bonds payable to purchase land
$ 130,000
Current Assets and Current Liabilities Accounts receivable Inventory Prepaid expenses Accounts payable Accrued expenses payable
Adjustments for the noncash charges reported in the income statement are made as shown in Illustration 18-19.
Noncash Charges Depreciation expense Patent amortization expense Depletion expense Loss on sale of asset Adjustments to Convert Net Income to Net Cash Provided by Operating Activities Add Add Add Add
STUDY OBJECTIVE 4
ILLUSTRATION 18-20
COMPARATIVE BALANCE SHEET, 2002, WITH INCREASES AND DECREASES
The comparative balance sheets at the beginning and end of 2002 showing increases and decreases are shown to the right.
JUAREZ COMPANY Comparative Balance Sheet Change Increase/Decrease $ 159,000 Increase 15,000 Increase 160,000 Increase 8,000 Increase 80,000 Increase
Assets Cash Accounts receivable Inventory Prepaid expenses Land Total Liabilities and Stockholders Equity Accounts payable Accrued expenses payable Common stock Retained earnings Total
Jan. 1, 2002 $ 0 0 0 0 0 $ 0
Additional information: (1) Dividends of $70,000 were declared and paid in cash. (2) The accounts payable increase resulted from the purchase of merchandise.
To employees
For interest and dividends From receipts of interest and dividends on loans and investments
For taxes
For Juarez Company, accounts receivable increased $15,000, so that cash receipts from customers were $765,000, calculated as shown Illustration 18-24 in Illustration 18-23.
Revenues from sales Deduct: Increase in accounts receivable Cash receipts from customers
Cash receipts from customers may also be determined from an analysis of Accounts Receivable as shown in Illustration 18-24.
Illustration 18-25 Analysis of Accounts Receivable ACCOUNTS RECEIVABLE Balance 0 Receipts from customers Revenues from sales 780,000 Balance 15,000
1/1/02 12/31/02
765,000
ILLUSTRATION 18-25
FORMULA TO COMPUTE CASH RECEIPTS FROM CUSTOMERS DIRECT METHOD
The relationships among cash receipts from customers, revenues from sales, and changes in accounts receivable are shown in Illustration 18-25.
Cash receipts from customers
ILLUSTRATION 18-26
COMPUTATION OF PURCHASES
Juarez Company reported cost of goods sold on its income statement of $450,000. To determine purchases, cost of goods sold must be adjusted for the change in inventory. An increase (decrease) in inventory is added to (deducted from) cost of goods sold to arrive at purchases. In 2002, Juarez Illustration 18-27 Companys inventory increased $160,000. Computation of Illustration Purchases 18-26. Purchases are calculated in
Cost of goods sold Add: Increase in inventory Purchases $ 450,000 160,000 $ 610,000
ILLUSTRATION 18-27 COMPUTATION OF CASH PAYMENTS TO SUPPLIERS Cash payments to suppliers are then determined by adjusting purchases for the change in accounts payable. An accounts payable increase (decrease) is deducted from (added to) purchases. Cash payments to Illustrationin 18-28 suppliers are calculated Illustration 18-27.
Computation of Cash Payments to Suppliers Purchases Deduct: Increase in accounts payable Cash payments to suppliers $ 610,000 60,000 $ 550,000
ILLUSTRATION 18-28
Cash payments to suppliers may also be determined from an analysis of Accounts Payable as shown in Illustration 18-28.
Illustration 18-29 Analysis of Accounts Payable ACCOUNTS PAYABLE 550,000 1/1/02 Balance Purchases 12/31/02 Balance Payments to creditors 0 610,000 60,000
ILLUSTRATION 18-29
FORMULA TO COMPUTE CASH PAYMENTS TO SUPPLIERS DIRECT METHOD
The relationship among cash payments to suppliers, cost of goods sold, changes in inventory, and changes in accounts payable is shown in Illustration 18-29.
Cash payments to suppliers
=
Cost of goods sold
+ Increase in inventory + Decrease in accounts payable or or Decrease in inventory Increase in accounts payable
ILLUSTRATION 18-31
FORMULA TO COMPUTE CASH PAYMENTS FOR OPERATING EXPENSES DIRECT METHOD
Operating expenses
756,000 $ 9,000
ILLUSTRATION 18-33
ANALYSIS OF RETAINED EARNINGS
The reasons for the net increase of $42,000 in Retained Earnings are determined by analysis. 1 Net income increased Retained Earnings by $112,000. 2 The additional information below the income statement in Illustration 18-21 indicates that a cash dividend of $70,000 was declared and paid. The increase due to net income is reported in the operating activities section while the cash dividend paid is reported in the financing activities section. This analysis can also be made directly from the Retained Earnings account as shown below.
RETAINED EARNINGS 70,000 1/1/02 Balance 12/31/02 Net income 12/31/02 Balance
12/31/02
Cash dividend
0 112,000 42,000
The SCF for 2002 for Juarez Company shows that operating activities provided $9,000 cash, investing activities used $80,000 cash, while financing activities provided $230,000 cash.
(756,000) 9,000
ILLUSTRATION 18-35
COMPARATIVE BALANCE SHEET, 2003, WITH INCREASES AND DECREASES
The comparative balance sheets at the beginning and end of 2003 showing increases and decreases are shown below.
JUAREZ COMPANY Comparative Balance Sheet December 31 Assets Cash Accounts receivable Inventory Prepaid expenses Land Equipment Accumulated depreciation equipment Total 2003 $ 191,000 12,000 130,000 6,000 180,000 160,000 ( 16,000) $ 663,000 2002 $ 159,000 15,000 160,000 8,0000 80,000 0 0 $ 422,000 Change Increase/Decrease $ 32,000 Increase 3,000 Decrease 30,000 Decrease 2,000 Decrease 100,000 Increase 160,000 Increase 16,000 Increase
ILLUSTRATION 18-35
COMPARATIVE BALANCE SHEET, 2003, Change WITH INCREASES AND DECREASES Assets 2000 1999 Increase/Decrease
Cash Accounts receivable Inventory Prepaid expenses Land Equipment Accumulated depreciation equipment Total Liabilities and Stockholders Equity Accounts payable Accrued expenses payable Income taxes payable Bonds payable Common stock Retained earnings Total $ 191,000 12,000 130,000 6,000 180,000 160,000 ( 16,000) $ 663,000 $ 159,000 15,000 160,000 8,0000 80,000 0 0 $ 422,000 $ 32,000 Increase 3,000 Decrease 30,000 Decrease 2,000 Decrease 100,000 Increase 160,000 Increase 16,000 Increase
60,000 $ 8,000 Decrease 20,000 5,000 Decrease 0 12,000 Increase 0 90,000 Increase 300,000 100,000 Increase 52,000 Increase 42,000 $ 422,000
Revenues from sales Add: Decrease in accounts receivable Cash receipts from customers
Cost of goods sold Deduct: Decrease in inventory Purchases Add: Decrease in accounts payable Cash payments to suppliers
ILLUSTRATION 18-39
COMPUTATION OF CASH PAYMENTS FOR OPERATING EXPENSES
Operating expenses (exclusive of depreciation expense) was $176,000 for 2000. The $2,000 decrease in prepaid expenses is deducted and the $5,000 decrease in accrued expenses payable is added in determining cash payments for operating expenses, as shown in Illustration 18-39.
Illustration 18-40 Computation of Cash Payments for Operating Expenses Operating expenses, exclusive of depreciation Deduct: Decrease in prepaid expenses Add: Decrease in accrued expenses payable Cash payments for operating expenses $ 176,000 ( 2,000) 5,000 $ 179,000
ILLUSTRATION 18-40
COMPUTATION OF CASH PAYMENTS FOR INCOME TAXES Income tax expense reported on the income statement was $36,000. The $12,000 increase in income taxes payable must be deducted from income tax expense to determine cash payments for income taxes. Cash payments for income taxes were Illustration 18-41 $24,000 as shown in Illustration 18-40.
Computation of Cash Payments for Income Taxes Income tax expense Deduct: Increase in income taxes payable Cash payments for income taxes $ 36,000 12,000 $ 24,000
ILLUSTRATION 18-41
FORMULA TO COMPUTE CASH PAYMENTS FOR INCOME TAXES DIRECT METHOD
The relationships among cash payments for income taxes, income tax expense, and changes in income taxes payable are shown in the formula in Illustration 18-41.
Cash payments for income taxes
ILLUSTRATION 18-42
ANALYSIS OF EQUIPMENT AND RELATED ACCUMULATED DEPRECIATION
The comparative balance sheet shows that Equipment increased $160,000 in 2003. The additional information in Illustration 1836 that the increase resulted from 2 investing transactions: 1) equipment costing $180,000 was purchased for cash and 2) equipment costing $20,000 was sold for $17,000 cash when its book value was $18,000. For Juarez Company, the investing activities section will show: 1) the $180,000 purchase of equipment as an outflow of cash and 2) the $17,000 sale of equipment as an inflow of cash.
1/1/03 12/31/03 Balance Cash purchase Balance EQUIPMENT 0 Cost of equipment sold 180,000 160,000 20,000
ILLUSTRATION 18-42
ANALYSIS OF EQUIPMENT AND RELATED ACCUMULATED DEPRECIATION
Sale of equipment
ACCUMULATED DEPRECIATION EQUIPMENT 2,000 1/1/03 Balance Depreciation expense 12/31/03 Balance
0 18,000 16,000
(841,000) 137,000
ILLUSTRATION 18-43 STATEMENT OF CASH FLOWS, 2003 Cash flows from operating activities Cash receipts from customers $ 978,000 DIRECT METHOD
Cash payments: To suppliers For operating expenses For income taxes Net cash provided by operating activities Cash flows from investing activities Purchase of equipment Sale of equipment Net cash used by investing activities Cash flows from financing activities Issuance of bonds payable Payment of cash dividend Net cash provided by financing activities Net increase in cash Cash at beginning of period Cash at end of period Noncash investing and financing activities Issuance of common stock to purchase land $ 638,000 179,000 24,000 (841,000) 137,000
JUAREZ COMPANY Statement of Cash Flows Direct Method For the Year Ended December 31, 2000
$ 100,000
STUDY OBJECTIVE 5
CASH
The GAP, Inc. reported the following information in its 2000 annual report:
Gap, Inc. ($ in millions) Fiscal 2000 Fiscal 1999
Current Liabilities Total Liabilities Net Sales Net Cash provided by operating activities
$1,478 2
$1,753 + $1,553
.89:1
ILLUSTRATION 18-46
Net Sales
$1,478
$11,635
13%
ILLUSTRATION 18-47
$1,478 2
$2,956 + $2,390
.55:1
COPYRIGHT
Copyright 2002 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written consent of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.
CHAPTER 18
THE STATEMENT OF CASH FLOWS