F
Chapter 4 -- Statement of Cash
A
C Flows: Effects of Operating,
M Investing, & Financing Activities
U on Cash Flows
FINANCIAL ACCOUNTING
AN INTRODUCTION TO CONCEPTS,
METHODS, AND USES
11th Edition
Clyde P. Stickney and Roman L. Weil
F Learning Objectives
A
C
M 1. Understand why using the accrual basis of
U accounting to prepare the balance sheet
and income statement creates the need for
a statement of cash flows.
2. Understand the types of transactions that
result in cash flows from operating,
investing, and financing activities.
3. Distinguish between the direct and indirect
methods of reporting and analyzing cash
flows from operations.
F
A Learning Objectives
C
M 4. Develop an ability to analyze the
U statement of cash flows, including
the relation among cash flows
from operating , investing, and
financing activities for businesses
in various stages of their growth.
F
A Chapter Outline
C 1. Overview of cash flows.
M
♦ Classification of cash flows
U
2. Preparing the statement of cash
flows.
♦ Direct and indirect methods.
♦ Columnar and t-account approaches.
3. Effects of a sale of a long-term
asset.
4. An international perspective.
Chapter Summary
F Overview of the
A Statement of Cash Flows
C
M The statement of cash flows …
U (a) explains the reasons for a
change in cash.
(b) classifies the reasons for the
change as an operating, investing
or financing activity.
(c) reconciles net income with cash
flow from operations.
F
Define the Three
A Classifications of Cash Flows
C
M 1. Operations –
U cash flows related to selling goods and
services; that is, the principle business
of the firm.
2. Investing –
cash flows related to the acquisition or
sale of noncurrent assets.
3. Financing –
long term and short term cash flows
related to liabilities and owners’ equity;
dividends are a financing cash outflow.
Example of
a
Statement
of Cash
Flows
Exhibit 4.1
Components of the Statement
of Cash Flows
Cash received from Cash paid for
cash flow
Operations sale of goods - operating goods = from operations
and services and services
+-
Cash received from Cash paid for ac-
cash flow
Investing sales of investments - quisition of invest- = from investing
and PP&E ments and PP&E
Cash paid for
+-
Cash received from
dividends and cash flow
Financing issue of debt or - reacquisition of = from financing
capital stock
debt or capital stock
=
Figure 4.1 Net change in cash
for the period
F Preparing the Statement of Cash
A Flows
C
M Firms could prepare the cash flow statement
directly from the cash account. Most,
U
however, find it more efficient to prepare
the cash flow statement from the balance
sheet and income statement.
(a) Direct and indirect methods.
(b) Algebraic formulation will present the
underlying concept of the cash flow
statement.
(c) Two approaches to producing the cash
flow statement: columnar worksheet and t-
account worksheet.
F Define the Direct and Indirect
A Methods
C ♦ The Direct Method
M
U of presentation calculates cash flow from
operations by subtracting cash
disbursements to supplies, employees, and
others from cash receipts from customers.
♦ The Indirect Method
calculates cash flow from operations by
adjusting net income for noncash revenues
and expenses.
♦ Most firms present their cash flows using
the indirect method.
F
A
Algebraic Formulation
C
Recall the basic accounting equation:
M
Assets = Liabilities + Shareholders’ Equity
U
or A = L + SE
Assets are either cash (C) or not (N$A), so
C + N$A = L + SE
C + N$A = L + SE
Where means the change in the balance,
Rearranging gives the basic equation for
the statement of cash flows:
C = L + SE - N$A
F
A
Algebraic Formulation (Cont.)
C C = L + SE - N$A
M ♦ The change in cash, C, is the increase or
U decrease in the cash account.
♦ This amount must equal changes in
liabilities plus changes in shareholders’
equity minus changes in assets other than
cash.
♦ Thus, we can identify the causes in the
change in the cash account by studying
the changes in non-cash accounts.
F Two Approaches to Producing
A the Cash Flow Statement
C
M The basic formula can be
U implemented using either of two
approaches:
1. Columnar worksheet-- changes in
balance sheet accounts are
classified by definition using a
multicolumn worksheet.
2. T-Account worksheet -- changes are
classified by analysis of the t-
accounts.
F
A
Columnar Worksheet
C
M ♦ Works well for relatively simple
U
situations involving few
transactions.
♦ Enhances understanding of the
cash flow statement.
♦ Does not work as well as the T-
account method when the
number and complexity of
transactions increases.
F Columnar Worksheet (Cont.)
A
C
Begin with a comparative balance sheet.
M
U 1. Compute the change in each balance
sheet account.
2. Classify each change as operating,
investing or financing activity.
2. Make any needed adjustments (for
example, for a sale of a long-lived asset).
4. Recast the classified changes in the form
of a cash flow statement.
F Noncash Expenses
A
C
♦ Noncash expenses, such as
M
U depreciation expense, are added
back.
♦ Not truly sources of cash, even
though they are associated with
cash inflows; rather, a reversal of the
accrual process that required the
expenses to be recognized without
regard for the cash flow.
F Changes in Specific Accounts
A
C
M increase decrease
U If noncash assets If noncash assets
Non- are increased, are decreased,
cash then cash was spent, then they provided cash
Assets so cash is an outflow, so cash is an inflow,
so negative sign. so positive sign.
If liab. or S.E. If liab. or S.E.
Liabilities increased, then cash decreased, then cash
and was obtained, was spent,
Shareholders’ so cash is an inflow, so cash is an outflow,
Equity so positive sign. so negative sign.
F T-account Worksheet
A
C ♦ The columnar works well when the
M change in each balance sheet account
U affects only one of the three types of
activities. It becomes cumbersome for
more complex (and realistic) situations.
♦ The T-account approach is a direct
extension of T-accounts - facilitates
analysis of a transaction which involves
more than one activity.
♦ For example, the change in Retained
Earnings can be due to both net income
(operating activity) and dividends
(financing activity).
F T-account Worksheet
A
C 1. Obtain beginning and ending balance
M sheets.
U 2. Prepare a T-account worksheet with a
master account, cash, divided into
operating, investing and financing
sections.
3. Explain the change in the master cash
account by reconstructing the original
entries in a summary form.
4. Make any necessary adjustments.
5. Recast the master account in the format of
a cash flow statement.
T-account Worksheet (Cont.)
Various Balance Sheet Accounts Cash
beginning beginning
balance balance
nnnnnn 3. this
ending 2. these are Operations part of the
balance offset by an nnnnnn cash
1. adjustments are opposite entry Investing account
made to all balance in the cash becomes
sheet accounts to account. Financing the cash
bring the beginning flow
balance to the ending ending statement.
balance. balance
F Effects of a Sale of a Long-Term
A Asset on Cash Flows
C
♦ A few transactions complicate the
M
derivation of a cash flow statement from a
U
comparative balance sheet, for example,
the sale of a long-term (or fixed) asset.
♦ Recall the journal entry for the sale of an
asset:
Cash nnnn
Accumulated Depreciation nnnn
Asset nnnn
Gain (or loss) on sale nnnn
F Sale of an Asset (Cont.)
A
♦ Each of the four parts of the above journal entry
C requires an adjustment in the cash flow statement.
M
♦ The first line, cash, adds a line to the investing
U
section.
♦ The second line, a debit to accumulated
depreciation, increases the depreciation expense
above the change in the accumulated depreciation
account.
♦ The third line, a credit to the asset, increases the
amount of cash invested in long-lived assets
above the change in the fixed asset accounts.
♦ The fourth line, a gain or loss, is reversed out in
the operating sections since this is not a cash
flow.
F Comparison of Cash Flow to Net
A Income
C ♦ Net income is an accrual based concept and
M purports to show the long-term.
U ♦ Cash flows purport to show the short term.
♦ Consider the outlook for both short-term and long-
term and consider that each is either good or poor.
♦ A strong growing firm would show both good long-
term and good short-term outlooks.
♦ A failing firm would show both poor long-term and
poor short term outlooks.
♦ What about a firm with good cash flows (short-
term) but poor net income (long-term)?
♦ What about a firm with poor cash flows (short-
term) but good net income (long-term)?
F 4. An International Perspective
A
C
M
♦ The International Accounting
U Standards Board (IAS No. 7)
recommends but does not require
a statement of cash flows.
♦ An approximation to a cash flow
statement can be prepared from a
comparative balance sheet with
some additional information.
F
A
Chapter Summary
C ♦ The statement of cash flows is presented.
M It reports the effects on cash flows of a
U firm’s operating, investing and financing
activities.
♦ Information in this statement helps in
understanding:
1. How operations affect liquidity,
2. The level of capital expenditures needed to
support growth, and
3. The major changes in financing.
♦ Two methods are presented to produce a
cash flow statement from a comparative
balance sheet.