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Statement Statement of Cash of Cash FlowsFlows

The statement of cash flows reports a firm’s major cash inflows and outflows

for a period. It provides useful information about a firm’s ability to

generate cash from operations, maintain and expand its operating

capacity, meet its financial obligations, and pay dividends.

Reporting Cash Flows 16-1

The statement of cash flows reports cash flows from three types of activities:

1. Cash flows from operating activities are cash flows from transactions that affect net income.

2. Cash flows from investing activities are cash flows from transactions that affect the investments in noncurrent assets.

3. Cash flows from financing activities are cash flows from transactions that affect the equity and debt of the business.

Statement of Cash Flows—NetSolutions

(payments for treasury stock, dividends, and redemption of debt securities)

Financing Financing

(payments for expenses)

Operating Operating

Sources (increases) of Cash Uses (decreases) of Cash

(receipts from sales of noncurrent assets)

Investing Investing

(receipts from issuing equity and debt

securities)

Financing Financing

(payments for acquiring noncurrent

assets)

Investing Investing

(receipts from revenues)

Operating Operating

Exhibit 2 Cash Flows 16-1

Cash Flows from Operating Activities 16-1

The direct method reports the sources of operating cash and

the uses of operating cash.8

The indirect method reports the operating cash flows by beginning with net income and

adjusting it for revenues and expenses that do not involve the receipt or payment of cash.

Cash inflows from operating activities normally arise when cash is received from customers.

Cash outflows from operating activities normally arise when cash is paid to suppliers for merchandise, supplies, services and to employees for salaries and wages.

A primary advantage of the direct method is that it reports the sources and uses of operating cash flows in

the statement of cash flow.

A primary disadvantage of the direct method is that the necessary data

may not be readily available and may be costly to gather.

A primary advantage of the indirect method is that it focuses on the

differences between net income and cash flows from operations.

Because the data are readily available, another advantage of the indirect

method is that it is normally less costly to use than the direct method.

Cash Flows from Operations: Direct and Indirect Methods—NetSolutions

same amount

Cash Flows from Investing Activities 16-1

Cash inflows from investing activities normally arise from selling fixed assets, investments, and intangible assets.

Cash outflows from investing activities normally include payments to acquire fixed assets, investments, and intangible assets.

Cash Flows from Financing Activities 16-1

Cash inflows from financing activities normally arise from issuing debt or equity securities.

Cash outflows from financing activities normally include paying cash dividends, repaying debt, and acquiring treasury stock.

Noncash Investing and Financing Activities

Noncash investing and financing activities are transactions that do not

involve cash. The effect of such transactions is recorded in a separate schedule that appears at the bottom of

the statement of cash flows.

Example Exercise 16-1

For each of the following, identify whether it would be disclosed as an operating, financing, or investing activity on the statement of cash flows under the indirect method.

a. Purchase patent

b. Pay cash dividend

c. Disposal of equipment

d. Net income

e. Purchase treasury stock

f. Depreciation expense

An efficient approach to preparing the statement of cash flows is to analyze the

changes in the noncash balance sheet accounts. The logic of this approach is that a

change in any balance sheet account (including Cash) can be analyzed in terms of changes in the other balance sheet accounts.

Comparative Balance Sheet

(Continued)

Comparative Balance Sheet

(Concluded)

Retained Earnings

The Retained Earnings account for Rundell Inc. reveals that the balance increased $80,000 during the year.

ACCOUNT Retained Earnings ACCOUNT NO. 32

Balance Date Item Debit Credit Debit Credit2008Jan. 1 Balance 202,300.00Dec. 31 Net income 108,000.00 310,300.00

31 Cash dividends 28,000.00 282,300.00

ACCOUNT Retained Earnings ACCOUNT NO. 32

Balance Date Item Debit Credit Debit Credit2008Jan. 1 Balance 202,300.00Dec. 31 Net income 108,000.00 310,300.00

31 Cash dividends 28,000.00 282,300.00

The net income of $108,000 is entered on the statement (or working papers).

To statementTo statementTo statementTo statement

Operating Activities— Rundell Inc.

Cash flows from operating activities:Net income $108,000Adjustments to reconcile net income

to net cash flow from operating activities:

This phrase is added to indicate This phrase is added to indicate that accrual basis net income is that accrual basis net income is being adjusted to arrive at cash being adjusted to arrive at cash

flows from operations.flows from operations.

This phrase is added to indicate This phrase is added to indicate that accrual basis net income is that accrual basis net income is being adjusted to arrive at cash being adjusted to arrive at cash

flows from operations.flows from operations.

ACCOUNT Accumulated Depreciation—Building ACCT. NO.

Balance Date Item Debit Credit Debit Credit2008Jan. 1 Balance 58,300.00Dec. 31 Depr. for year 7,000.00 65,300.00

to statementto statementto statementto statement

The comparative balance sheet (Exhibit 4: Slides 23 and 24) indicates that Accumulated Depreciation—Building increased by $7,000. By analyzing the account we can see that the increase is the result of the year-end adjusting entry.

Amortization is treated in the same manner as

depreciation.

16-2Cash flows from operating activities:

Net income $108,000Adjustments to reconcile net income to net cash flow from operating activities:

Depreciation Depreciation 7,000 7,000

Operating Activities—Rundell Inc.

Cash flows from operating activities:Net income $108,000Adjustments to reconcile net income to net cash flow from operating activities:

Depreciation 7,000Gain on sale of landGain on sale of land (12,000)(12,000)

Adjustments to Net Income (Loss) Using the Indirect Method

Changes in Current AccountsChanges in Current Accounts

Accounts

Accounts receivable (net) $ 74,000 $ 65,000

Inventories 172,000 180,000

Accounts payable (mdse.) 43,500 46,700

Accrued expenses payable 26,500 24,300

Income taxes payable 7,900 8,400

8,000*

3,200*

2008 2007

December 31 Increase

Decrease*

Note that Cash and Dividends Payable are not included in this analysis.

Cash flows from operating activities:Net income $108,000Adjustments to reconcile net income to net cash flow from operating activities:

Depreciation 7,000Gain on sale of land (12,000)

Changes in current operating assets Changes in current operating assets and liabilities:and liabilities:

Increase in accounts receivableIncrease in accounts receivable (9,000)(9,000)Decrease in inventoryDecrease in inventory 8,0008,000Decrease in accounts payableDecrease in accounts payable (3,200)(3,200)Increase in accrued expensesIncrease in accrued expenses 2,2002,200Decrease in income taxes payableDecrease in income taxes payable (500)(500)

Operating Activities—Indirect Method

39You will notice that increases actually decrease cash flows from operating activities, and decreases do just the opposite.

Statement of Cash Flows—Indirect Method for Rundell Inc. (Operating Activities Section)

Same information as Slide 39, only in final form.

Building

ACCOUNT Building ACCOUNT NO.

Balance Date Item Debit Credit Debit Credit

2008Jan. 1 Balance 200,000Dec. 27 Purchased for cash 60,000 260,000

By examining the Building account, we can determine that Rundell Inc. bought a building for $60,000 cash.

ACCOUNT Land ACCOUNT NO.

Balance Date Item Debit Credit Debit Credit

2008Jan. 1 Balance 125,000June 8 Sold for $72,000 cash 60,000 65,000Oct. 12 Purchased for $15,000

cash 15,000 80,000

The $45,000 decline in the Land account resulted from two separate transactions: a sale and a purchase.

The first transaction, the sale of land, is classified as a positive

cash flows from investing activity because land is a noncash asset.

The $12,000 gain was recorded earlier on Slide 34

as an operating activity. The purchase of land also is an

investing activity.

Click the button to view Slide 34. To return to

this slide, type “56” and press the “Enter” key.

The second transaction is the purchase of land for cash of $15,000. This transaction is

reported as an outflow of cash in the cash flows from investing activities section.

Cash Flows Used for Payment of Dividends

ACCOUNT Dividends Payable ACCOUNT NO.

Balance Date Item Debit Credit Debit Credit2008Jan. 1 Balance 10,000

10 Cash paid 10,000 —June 20 Dividends declared 14,000 14,000July 10 Cash paid 14,000 —Dec. 20 Dividends declared 14,000 14,000

Note that while $28,000 in dividends were declared, only $24,000 were paid during the year.

Because paying of dividends affects equity and is an outflow of cash, it is a

negative $24,000 cash flows from financing activities

transaction.

Common Stock

Common Stock increased by $8,000.

ACCOUNT Common Stock ACCOUNT NO.

Balance Date Item Debit Credit Debit Credit2008Jan. 1 Balance 16,000Nov. 1 4,000 shares issued/cash 8,000 24,000

ACCOUNT Paid-in Capital in Excess of Par—Common Stock Balance Date Item Debit Credit Debit Credit2008Jan. 1 Balance 80,000Nov. 1 4,000 shares issued/cash 40,000 120,000

Analyzing the two accounts together, we can determine that the 4,000 shares were sold for $48,000.

Issuing common stock affects equity; therefore, we have a

positive $48,000 cash flows from financing activities item.

Bonds Payable

Bonds Payable decreased by $50,000.

ACCOUNT Bonds Payable ACCOUNT NO.

Balance Date Item Debit Credit Debit Credit2008Jan. 1 Balance 150,000June 30 Retired by payment of

cash at face amount 50,000 100,000

Retiring bonds is a cash outflow reported as a negative item

under cash flows from financing activities.

Statement of Cash Flows—Indirect Method for Rundell Inc. (Partial Statement)

The ending balance in the Cash account should match this amount.

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