CHAPTER 1 6 … The Statement of Cash Flows
Objective 1: Identify the purposes of the statement of cash flows
A. The statement of cash flows reports cash flow (cash receipts and cash payments) during
the period—where the cash came from, and how it was spent.
B. The period of time covered by the statement of cash flows and the income statement is
the same. (Refer to Exhibit 1 6-1.)
C. The purposes of the statement are:
1. to predict future cash flows,
2. to evaluate management decisions, and
3. to predict the ability to make debt payments to lenders pay dividends to
D. Cash includes cash on hand, cash in the bank, and cash equivalents. Cash equivalents
are very liquid short-term investments such as money market investments and Treasury
Objective 2: Distinguish among operating, investing, and financing cash flows
A. Cash flows are classified as operating, investing, or financing activities. (Refer to
Exhibit 1 6-2.)
1. Operating activities create revenues, expenses, gains, and losses.
a. Operating activities relate to transactions that make up net income.
b. They also affect current assets and current liability accounts.
c. Operating activities are the most important of the three categories.
2. Investing activities are increases and decreases in long-term assets. Investing
activities are less critical than operating activities.
3. Financing activities involve obtaining funds to launch a business and keep it
running. Financing activities relate to long-term liabilities and owners’ equity
B. There are two formats for reporting operating activities—the direct method and the
1. The indirect method begins with net income and reconciles to cash flows from
2. The direct method lists cash receipts from specific operating activities and cash
payments for each operating activity.
3. The total for operating activities and the total change in cash is the same for both
methods. The investing activities and financing activities are exactly the same for
Objective 3: Prepare a statement of cash flows by the indirect method
A. An income statement and a balance sheet is needed to prepare the statement of cash
B. Follow these steps to prepare the statement of cash flows by the indirect method:
1. Lay out the template as show in Exhibit 16-3.
2. Use the comparative balance sheet (Exhibit 16-4) to determine the increase or
decrease in cash. This is the check figure.
3. From the income statement (Exhibit 16-5), take net income, depreciation,
depletion, and amortization expense, and any gains or losses on the sale of assets.
4. Use the data from the income statement and balance sheet to complete the
statement of cash flows. (See Exhibit 16-7).
C. Operating activities section of the cash flow statement begins with net income, taken
from the income statement (Exhibit 16-5). The following items are adjustments to
reconcile net income to net cash provided by operating activities. An operating activities
section (indirect method) is illustrated in Exhibit 16-6.
1. Add depreciation, depletion, amortization, and any other expenses that reduce
net income but not cash.
2. Add losses and subtract gains on the sale of assets because they also affect
income without affecting cash.
3. Subtract increases in a current asset other than cash, because an increase in a
current asset, such as Inventory, indicates that there is a decrease in cash.
4. Add decreases in current assets other than cash, because a decrease in a
current asset means that there is an increase in cash.
5. Subtract decreases in current liabilities, because decreases in current liabilities
indicates a decrease in cash.
6. Add increases in current liabilities, because increases in current liabilities
indicate an increase in cash.
B. Cash flow from investing activities can be identified by analyzing long-term asset
accounts (Exhibit 16-8).
1. To simplify the calculations for the plant asset sales and acquisitions, the asset
account is carried net of depreciation rather than having a separate account for
2. Computation for cash purchase or book value of plant asset sold:
Beginning Book value Ending
plant asset + Acquisitions - Depreciation - of plant = plant asset
balance (net) assets sold balance (net)
3. Sale proceeds = Book value of asset sold + Gain - Loss
4. The beginning and ending balance of the plant asset is from the balance sheet and
the gain or loss is from the income statement.
C. Cash flow from financing activities can be identified by analyzing liability and
stockholders’ equity accounts. Exhibit 16-9 summarizes these computations.
1. Computation of issuances and payments of note payable:
Beginning Payment Ending
long-term debt + Issuances of new debt - of = note payable
balance note payable balance
2. Computation of stock issuances and retirements:
stock + Issuances of new stock = stock
5. Computation of treasury stock purchases and sales:
Beginning Purchases Ending
treasury stock + of = treasury stock
balance treasury stock balance
6. Computation of dividend payments:
retained earnings + Net income - Dividends= retained earnings
D. Noncash investing and financing activities, such as acquisition of plant assets by
issuing common stock, are reported in a separate schedule that accompanies the
statement of cash flows or in a note. Exhibit 16-10 provides an example.
Appendix A : Prepare the statement of cash flows by the direct method
A. The FASB prefers the direct method; however, few companies use it because it requires
B. Preparation of the statement of cash flows involves these steps:
1. Lay out the template of the statement of cash flows by the direct method as shown
in Exhibit 1 6A-1.
2. Use the comparative balance sheet to determine the increase or decrease in cash
during the period. This is the check figure.
3. Use the available data to prepare the statement of cash flows. Exhibit 1 6A-3 is a
statement of cash flows—direct method.
C. Cash flows from operating activities are listed first because these are the most
important source of cash. These cash flows include:
1. Cash receipts:
a. Cash collections from customers
b. Cash receipts of interest and dividends
2. Cash payments:
a. Cash payments to suppliers for both inventory and operating expenses
b. Cash payments to employees
c. Cash payments for interest expense and income taxes
3. Depreciation, depletion, and amortization expense do not affect cash, and so
are not listed on the statement of cash flows (direct method).
C. Cash flows from investing activities include:
1. Cash payments: Purchases of plant assets and investments in other companies.
2. Cash receipts: Proceeds from sale of plant assets and investments.
D. Cash flows from financing activities include:
1. Cash receipts: Proceeds from the issuance of stock and issuance of note
2. Cash payments: Payment of notes payable, purchase of treasury stock, and,
payment of dividends
E. Noncash investing and financing activities, such as acquisition of plant assets by
issuing common stock, are reported in a separate schedule that accompanies the
statement of cash flows or in a note.
F. Cash flow from operating activities is computed by using the following approach
(Exhibits 1 6A-6 summarizes these computations. Exhibits 16A-4 and 16A-5 are the
income statement and balance sheet used for the example in the chapter.)
Revenue or expense Adjustment for the Amount for the
from the -
change in the related = statement of
income statement sheet account(s) cash flows
1. Collections from customers must be computed by converting sales revenue
(accrual basis) to the cash basis:
Collections Sales + Decrease in Accounts Receivable
from = Revenue - Increase in Accounts Receivable
2. Payments for inventory involve adjusting cost of goods sold from the income
statement (accrual basis) to the cash basis using inventory and accounts payable
from the balance sheet:
Payments Cost of + Increase in Inventory + Decrease in Accounts
for inventory Goods Sold - Decrease in Inventory - Increase in Accounts
3. Cash payments for operating expenses adjust operating expenses from the
income statement (accrual basis) to the cash basis using prepaids and accrued
liabilities from the balance sheet. Operating expenses excluded interest and
Payments for Other
+ Increase in prepaids + Decrease in Accrued Liabilities
operating = operating - Decrease in prepaids - Increase in Accrued Liabilities
4. Payments to suppliers = payments for inventory + payments for operating
G. Investing and financing activities are the same under both methods.
H. Decision Guidelines ask important questions about evaluating investments using the
statement of cash flows.
Appendix B: Preparing the Statement of Cash Flows using a spreadsheet
A. Transaction Analysis on a spreadsheet—Indirect Method for operating activities
1. The indirect method reconciles net income to cash provided by operating
2. Net income (a) is the first operating cash inflow and is entered as a debit to Net
Income under cash flows from operating activities, and also as a credit to
3. Examples of transactions are illustrated in full in Exhibit 1 6B-1.
3. Noncash investing and financing activities require two work-sheet entries as
illustrated in Exhibit 1 6B-2.
B. Transaction Analysis on a spreadsheet—Direct Method
1. The direct method separates operating activities into cash receipts and cash
2. Only balance sheet accounts are used on the spreadsheet;, therefore, revenue and
expense transactions are entered as debits or credits to Retained Earnings.
3. Examples of transactions are illustrated in full in Exhibit 1 6B-3.