CH 23

Preparation
Preparation of
of the
the Statement
Statement of
of Cash
Cash Flows
Flows
Primary purpose:
To provide information about a companys cash receipts and
cash payments during a period.
Secondary objective:
To provide cash-basis information about the companys
operating, investing, and financing activities.
23-1
Usefulness
Usefulness of
of the
the Statement
Statement of
of Cash
Cash Flows
Flows
Provides information to help assess:
1. Entitys ability to generate future cash flows.
2. Entitys ability to pay dividends and meet obligations.
3. Reasons for difference between net income and net cash flow
from operating activities.
4. Cash and noncash investing and financing transactions.
23-2
Classification
Classification of
of Cash
Cash Flows
Flows
Operating
Activities
Investing
Activities
Financing
Activities
Income Statement
Changes in
Investments and
Long-Term Asset
Items
Changes in LongTerm Liabilities

and Stockholders
Equity
Transactions
23-3
Classification
Classification of
of Cash
Cash Flows
Flows
The basis recommended by the FASB for the statement of cash
flows is actually cash and cash equivalents. Cash equivalents are
short-term, highly liquid investments that are both:
Readily convertible to known amounts of cash, and
So near their maturity that they present insignificant risk of

changes in value (e.g., due to changes in interest rates).
Generally, only investments with original maturities of three months or

less qualify under this definition.
23-4
Format
Format of
of the
the Statement
Statement of
of Cash
Cash Flows
Flows
Presentation:
1. Operating activities.
2. Investing activities.
Direct Method
Indirect Method
3. Financing activities.
Report inflows and outflows from investing and financing
activities separately.
23-5
Steps
Steps in
in Preparation
Preparation
Three Sources of Information:
1. Comparative balance sheets.
2. Current income statement.
3. Selected transaction data.
Three Major Steps:

Step 1. Determine change in cash.
Step 2. Determine net cash flow from operating
activities.
23-6
Step 3. Determine net cash flows from investing and

financing activities.
First Example - 2015

Tax Consultants Inc. started on January 1, 2015, when
it issued 60,000 shares of $1 par value common stock
for $60,000 cash. The company rented its office
space, furniture, and equipment, and performed tax
consulting services throughout the first year.
The comparative statements of financial position at
the beginning and end of the year 2015 shows the
income statement and additional information for Tax
Consultants.
23-7

Tax Consultants, Inc.
Comparative Balance Sheets
December 31, 2015
January 1, 2015
$
49,000.00 $
36,000.00
$
85,000.00 $
-
Assets
Cash
Accounts Receivable
Total
Liabilities And Equities
Accounts Payable
$
Common Stock, 1.00 par
Retained Earnings
Total
$
Revenues
Operating expenses
Income before Taxes
Income Tax Expense
Net Income
5,000.00 $
60,000.00
20,000.00
85,000.00 $
Income Statement
For the Year ended December 31, 2015
125,000.00
85,000.00
40,000.00
6,000.00
34,000.00
Dividends of 14,000 were declared and paid in 2015.

23-8
Increase/Decrease
$49,000.00 Increase
36,000.00 Increase
$ 5,000.00 Increase
60,000.00 Increase
20,000.00 Increase

Direct Method
Deducts operating cash disbursements from operating cash receipts.
Cash Collected from Revenues
$89,000.00
(125,000 - 36,000)
Cash Payments for Expenses
80,000.00
(85,000 - 5,000)
Income before Income Taxes
9,000.00
Cash Payments for Income Taxes
6,000.00
Net Cash Provided by Operating Activities
$ 3,000.00
Net cash provided by operating activities is the equivalent of cash basis

net income.
23-9

Indirect Method
Net Income
$34,000.00
Adjustments to reconcile net income to net

cash provided by operating activities:
Increase in Accounts Receivable
Increase in Accounts Payable
(36,000.00)
5,000.00
(31,000.00)
$ 3,000.00
Common adjustments to Net Income (Loss):
23-10
Depreciation and amortization expense.
Gain or loss on disposition of long-term assets.
Change in current assets and current liabilities.

LO 4
First Example 2015

Assets
December 31, 2015
Cash
Accounts Receivable
Total
49,000.00
January 1, 2015
$
36,000.00
Increase/Decrease
-
$49,000.00 Increase
36,000.00 Increase
85,000.00
5,000.00
$ 5,000.00 Increase

Accounts Payable
60,000.00
60,000.00 Increase
Retained Earnings
20,000.00
20,000.00 Increase
Total
85,000.00
No long-term assets, thus no investing activities.

23-11

Assets
December 31, 2015
Cash
Accounts Receivable
Total
49,000.00
January 1, 2015
$
36,000.00
Increase/Decrease
-
$49,000.00 Increase
36,000.00 Increase
85,000.00
5,000.00
$ 5,000.00 Increase

Accounts Payable
60,000.00
60,000.00 Increase
Retained Earnings
20,000.00
20,000.00 Increase
Total
23-12
85,000.00
Purchase of common stock for $60,000 (Financing).

Assets
December 31, 2015
Cash
Accounts Receivable
Total
49,000.00
January 1, 2015
$
36,000.00
Increase/Decrease
-
$49,000.00 Increase
36,000.00 Increase
85,000.00
5,000.00
$ 5,000.00 Increase

Accounts Payable
60,000.00
60,000.00 Increase
Retained Earnings
20,000.00
20,000.00 Increase
Total
23-13
85,000.00
Net income of $34,000 (Operating).
Dividends paid of $(14,000) (Financing).
LO 5

Statement of Cash Flows - 2015
Statement of Cash Flows
For the Year ended December 31, 2015
Indirect Method
Net Income
cash provided by Operating Activities:
Increase in Accounts Receivable
Increase in Accounts Payable
Cash flows from Financing Activities
Issuance of Common Stock
Payment of Dividends
Net Cash provided by Financing Activites
Net Increase in Cash
Cash January 1, 2015
Cash December 31, 2015
23-14
$34,000.00
(36,000.00)
5,000.00
(31,000.00)
3,000.00
60,000.00
(14,000.00)
46,000.00
49,000.00
$49,000.00
Operating
OperatingActivities
Activities
Indirect
Indirect Method
Method
Norman Companys financial statements for the year ended December 31, 2016,
contained the following condensed information.
Service Revenue
Operating Expenses
Depreciation Expense
Loss on Sale of Equipment
Income before tax
Income tax
Net Income
Accounts Receivable
Accounts Payable
Income Taxes Payable
23-15
2016
$ 840,000.00
624,000.00
60,000.00
26,000.00
130,000.00
40,000.00
$ 90,000.00
2016
37,000.00
46,000.00
4,000.00
Assume A/P
relates to
operating expense
2015
59,000.00
31,000.00
8,500.00
Change
(22,000.00)
15,000.00
(4,500.00)
LO 4
Operating
OperatingActivities
Activities
Indirect
Indirect Method
Method
Prepare the operating activities section of the statement of cash flows using the
indirect method.
Cash flow from Operating Activities

Net Income
Decrease in AR
Increase in AP
Decrease in Income Tax Payable
23-16
$ 90,000.00
60,000.00
26,000.00
22,000.00
15,000.00
(4,500.00)
118,500.00
208,500.00
LO 4
Operating Activities Direct Method

Norman Companys financial statements for the year ended December 31,
2016, contained the following condensed information.
Service Revenue
Operating Expenses
Income before tax
Income tax
Net Income
Accounts Receivable
Accounts Payable
Income Taxes Payable
23-17
2016
$ 840,000.00
624,000.00
60,000.00
26,000.00
130,000.00
40,000.00
$ 90,000.00
2016
37,000.00
46,000.00
4,000.00
Assume accounts
payable relates to
operating expenses.
2015
59,000.00
31,000.00
8,500.00
Change
(22,000.00)
15,000.00
(4,500.00)
LO 4

Prepare the operating activities section of the statement of cash flows using
the Direct method.
Accounts Receivable
1/1/12
Balance 59,000
Revenues 840,000
12/31/12
23-18
Balance 37,000
Receipts from customers
862,000

the Direct method.
Accounts Payable
1/1/12
Payments to suppliers 609,000
Operating expenses
12/31/12
23-19
Balance 31,000
624,000
Balance 46,000

the Direct method.
Income Tax Payable

1/1/12
Payments for income tax
44,500
Income tax expense

12/31/12
23-20
Balance 8,500
40,000
Balance 4,000

the Direct method.
Direct Method
Cash Collected from Customers
Cash Payments for Operating Expenses
Cash Paid for Income Taxes
23-21
$ 862,000.00
(609,000.00)
(44,500.00)
$ 208,500.00
Determine Net Cash Flow from Investing and

Financing Activities
Plant assets that had cost $25,000 6 years before and were being
depreciated on a straight-line basis over 10 years with no estimated
scrap value were sold for $5,300.
Plant Assets (cost)

Acc. Depreciation (25K/10)*6
15,000.00
Book Value at date of Sale
10,000.00
Sale Proceeds
23-22
$ 25,000.00
Loss on Sale
5,300.00
$ 4,700.00
Financing and Investing, Continued

During the year, 10,000 shares of common stock with a stated
value of $10 a share were issued for $33 a share.
The company sustained a net loss for the year of $50,000.
Depreciation amounted to $22,000, and a gain of $9,000
was realized on the sale of land for $39,000 cash.
During the year, treasury stock costing $47,000 was
purchased.
23-23
Statement of Cash Flows

Cash Flows from Operating Activities
Net Income
Loss on Sale (Plant Asset)
Gain on Sale (Land)
Cash Flows from Investing Activities
Sale of Plant Assets
Sale of Land
Cash from Investing Activities
Cash flows from Financing Activities
Issuance of Common Stock
Purchase of Company Stock
Net Cash provided by Financing Activities
Net Change in Cash
23-24
$(50,000.00)
4,700.00
22,000.00
(9,000.00)
17,700.00
(32,300.00)
5,300.00
39,000.00
44,300.00
330,000.00
(47,000.00)
283,000.00
295,000.00
Sources
Sources of
of Information
Information for
for the
the Statement
Statement of
of Cash
Cash Flows
Flows
1. Comparative balance sheets.

2. An analysis of the Retained Earnings account.
3. Write downs, amortization charges, and similar book
entries, such as depreciation, because they have no effect on

cash.
23-25
Net
Net Cash
Cash Flow
Flow from
from Operating
OperatingActivitiesIndirect
ActivitiesIndirect
Versus
Versus Direct
Direct Method
Method
Indirect Method
23-26
Adjustments Needed to Determine Net Cash Flow from

Operating Activities.
LO 7
Net
Net Cash
Cash Flow
Flow from
from Operating
ActivitiesIndirect
Versus
Versus Direct
Direct Method
Method
Direct Method
23-27
Companies adjust each item in the income statement

from the accrual basis to the cash basis.
LO 7
Net
Net Cash
Cash Flow
Flow from
from Operating
ActivitiesIndirect
Versus
Versus Direct
Direct Method
Method
Direct Versus Indirect Considerations
In Favor of the Direct Method
23-28
Shows operating cash receipts and payments.
Information about cash receipts and payments is more revealing of

a companys ability
1.
to generate sufficient cash from operating activities to pay its

debts,
2.
to reinvest in its operations, and
3.
to make distributions to its owners.
Net
Net Cash
Cash Flow
Flow from
from Operating
ActivitiesIndirect
Versus
Versus Direct
Direct Method
Method
Direct Versus Indirect Considerations
In Favor of the Indirect Method
23-29
Focuses on the differences between net income and net cash flow
from operating activities.
Provides link between the statement of cash flows and the income
statement and statement of financial position.
Adjustments
Adjustments to
to Net
Net Income
Income
Depreciation and Amortization
Amortization of limited-life intangible assets.
Amortization of bond discount or premium.
Postretirement Benefit Costs
23-30
Company must adjust net income by the difference between

cash paid and the expense reported.
Adjustments
Adjustments to
to Net
Net Income
Income
Loss and Gains
23-31
A loss is added to net income to compute net cash flow from

operating activities because the loss is a non-cash charge in the
income statement.
Company reports a gain in the statement of cash flows as part

of the cash proceeds from the sale of equipment under
investing activities, thus it deducts the gain from net income to
avoid double-countingonce as part of net income and again
as part of the cash proceeds from the sale.
Adjustments
Adjustments to
to Net
Net Income
Income
Extraordinary Items
Companies should report either as investing activities or as
financing activities cash flows from extraordinary transactions
and other events whose effects are included in net income, but
which are not related to operations.
23-32
Accounts
Accounts Receivable
Receivable (Net)
(Net)
Indirect Method
Because an increase in Allowance for Doubtful Accounts results from
a charge to bad debt expense, a company should add back an increase
in Allowance for Doubtful Accounts to net income to arrive at net cash
flow from operating activities.
23-33
Accounts
Accounts Receivable
Receivable (Net)
(Net)
Indirect Method
One method of presenting this information in the statement of cash
flows:
23-34
Accounts
Accounts Receivable
Receivable (Net)
(Net)
Indirect Method
Alternate method (net approach) of presenting this information in
the statement of cash flows:
23-35
Accounts
Accounts Receivable
Receivable (Net)
(Net)
Direct Method
Company should not net Allowance for Doubtful Accounts against
Accounts Receivable.
23-36
Accounts
Accounts Receivable
Receivable (Net)
(Net)
Direct Method
Company should not net Allowance
for Doubtful Accounts against
Accounts Receivable.
Cash sales should be reported at $85,000 ($100,000 - 9,000 - 6,000).

23-37
LO 8
Other
Other Working
Working Capital
Capital Changes
Changes
Some changes in working capital, although they affect cash, do
not affect net income.
23-38
Purchase of short-term non-trading equity investments.
Issuance of a short-term non-trade note payable for cash.
Cash dividend payable.
Net
Net Loss
Loss
If the net loss is $50,000 and the total amount of charges to add back
is $60,000, then net cash provided by operating activities is $10,000.
23-39
Significant
Significant Non-Cash
Non-Cash Transactions
Transactions
Common non-cash transactions that a company should disclose:
23-40
1.
Acquisition of assets by assuming liabilities (including finance lease

obligations) or by issuing equity securities.
2.
Exchanges of non-monetary assets.
3.
Refinancing of long-term debt.
4.
Conversion of debt or preference shares to ordinary shares.
5.
Issuance of equity securities to retire debt.
Use
Use of
of aa Worksheet
Worksheet
A worksheet involves the following steps.
Step 1. Enter the balance sheet accounts and their beginning and ending
balances in the balance sheet accounts section.
Step 2. Enter the data that explain the changes in the balance sheet
accounts and their effects on the statement of cash flows in the
reconciling columns of the worksheet.
Step 3. Enter the increase or decrease in cash on the cash line and at the
bottom of the worksheet. This entry should enable the totals of the
reconciling columns to be in agreement.
23-41

CH 23

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CH 23

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Preparation

Changes in LongTerm Liabilities

Readily convertible to known amounts of cash, and

So near their maturity that they present insignificant risk of

Generally, only investments with original maturities of three months or

Three Major Steps:

Step 3. Determine net cash flows from investing and

First Example - 2015

First Example - 2015

Dividends of 14,000 were declared and paid in 2015.

First Example - 2015

Cash Payments for Expenses

Income before Income Taxes

Cash Payments for Income Taxes

Net Cash Provided by Operating Activities

Net cash provided by operating activities is the equivalent of cash basis

First Example - 2015

Adjustments to reconcile net income to net

Common adjustments to Net Income (Loss):

Depreciation and amortization expense.

Gain or loss on disposition of long-term assets.

Change in current assets and current liabilities.

First Example 2015

December 31, 2015

Liabilities And Equities

No long-term assets, thus no investing activities.

First Example - 2015

December 31, 2015

Liabilities And Equities

Purchase of common stock for $60,000 (Financing).

First Example - 2011

December 31, 2015

Liabilities And Equities

Net income of $34,000 (Operating).

Dividends paid of $(14,000) (Financing).

First Example - 2015

Cash flow from Operating Activities

Operating Activities Direct Method

Operating Activities Direct Method

Receipts from customers

Operating Activities Direct Method

Operating Activities Direct Method

Income Tax Payable

Income tax expense

Operating Activities Direct Method

Determine Net Cash Flow from Investing and

Plant Assets (cost)

Book Value at date of Sale

Financing and Investing, Continued

Statement of Cash Flows

1. Comparative balance sheets.

entries, such as depreciation, because they have no effect on

Adjustments Needed to Determine Net Cash Flow from

Companies adjust each item in the income statement

Shows operating cash receipts and payments.

Information about cash receipts and payments is more revealing of

to generate sufficient cash from operating activities to pay its

to reinvest in its operations, and

to make distributions to its owners.

Amortization of limited-life intangible assets.

Amortization of bond discount or premium.

Postretirement Benefit Costs

Company must adjust net income by the difference between