Indirect Method vs. Direct Method and Horizontal vs. Vertical Analysis
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Chapter12PPT.pptxFinancial Accounting: Tools for Business Decision Making
Eighth Edition
Kimmel ● Weygandt ● Kieso
Chapter 12
Statement of Cash Flows
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Financial Accounting: Tools for Business Decision Making
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Copyright ©2017 John Wiley & Sons, Inc.
Chapter Outline:
Learning Objectives
Discuss the usefulness and format of the statement of cash flows.
Prepare a statement of cash flows using the indirect method.
Use the statement of cash flows to evaluate a company.
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L O 1: Discuss the Usefulness and Format of the Statement of Cash Flows
Usefulness of the Statement of Cash Flows
Provides information to help assess:
Entity’s ability to generate future cash flows.
Entity’s ability to pay dividends and meet obligations.
Reasons for difference between net income and net cash provided (used) by operating activities.
Cash investing and financing transactions during the period.
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Classification of Cash Flows (1 of 4)
Operating Activities
Income Statement Items
Investing Activities
Changes in Investments and Long-Term Assets
Financing Activities
Changes in Long-Term Liabilities and Stockholders’ Equity
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Classification of Cash Flows (2 of 4)
Operating activities—Income statement items
Cash inflows:
From sale of goods or services.
From interest received and dividends received.
Cash outflows:
To suppliers for inventory.
To employees for wages.
To government for taxes.
To lenders for interest.
To others for expenses.
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Classification of Cash Flows (3 of 4)
Investing activities—Changes in investments and long-term assets
Cash inflows:
From sale of property, plant, and equipment.
From sale of investments in debt or equity securities of other entities.
From collection of principal on loans to other entities.
Cash outflows:
To purchase property, plant, and equipment.
To purchase investments in debt or equity securities of other entities.
To make loans to other entities.
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Classification of Cash Flows (4 of 4)
Financing activities—Changes in long-term liabilities and stockholders’ equity
Cash inflows:
From sale of common stock.
From issuance of debt (bonds and notes).
Cash outflows:
To stockholders as dividends.
To redeem long-term debt or reacquire capital stock (treasury stock).
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Significant Noncash Activities
Direct issuance of common stock to purchase assets.
Conversion of bonds into common stock.
Issuance of debt to purchase assets.
Exchanges of plant assets.
Companies report noncash activities in either a
separate schedule (bottom of the statement) or
separate note to the financial statements.
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Accounting Across the Organization (1 of 2)
Net What?
Net income is not the same as net cash provided by operating activities. Below are some results from recent annual reports (dollars in millions), including Target Corporation. Note how the numbers differ greatly across the list even though all these companies engage in retail merchandising.
| Company | Net Income | Net Cash Provided by Operating Activities |
| Kohl's Corporation | $ 889 | $ 1,884 |
| Wal-Mart Stores, Inc. | 16,669 | 25,591 |
| J. C. Penney Company, Inc. | (1,388) | (1,814) |
| Costco Wholesale Corp. | 20,391 | 3,437 |
| Target Corporation | 1,971 | 6,520 |
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Format of the Statement of Cash Flows (1 of 2)
Order of Presentation:
Operating activities.
Direct Method
Indirect Method
Investing activities.
Financing activities.
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Format of the Statement of Cash Flows (2 of 2)
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Do It 1: Cash Flow Activities
Illustration: Classify each of these transactions by type of cash flow activity.
Issued 100,000 shares of $5 par value common stock for $800,000 cash.
Financing
Borrowed $200,000 from Castle Bank, signing a 5-year note bearing 8% interest.
Financing
Purchased two semi-trailer trucks for $170,000 cash.
Investing
Paid employees $12,000 for salaries and wages.
Operating
Collected $20,000 cash for services performed.
Operating
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L O 2: Prepare a Statement of Cash Flows Using the Indirect Method
Three sources of information:
Comparative balance sheets
Current income statement
Additional information
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Preparing the Statement of Cash Flows (1 of 3)
Three Major Steps:
Step 1: Determine net cash provided/used by operating activities by converting net income from an accrual basis to a cash basis.
This step involves analyzing not only the current year's income statement but also comparative balance sheets and selected additional data.
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Preparing the Statement of Cash Flows (2 of 3)
Three Major Steps:
Step 2: Analyze changes in noncurrent asset and liability accounts and record as investing and financing activities, or disclose as noncash transactions.
This step involves analyzing comparative balance sheet data and selected additional information for their effects on cash.
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Preparing the Statement of Cash Flows (3 of 3)
Three Major Steps:
Step 3: Compare the net change in cash on the statement of cash flows with the change in the Cash account reported on the balance sheet to make sure the amounts agree.
The difference between the beginning and ending cash balances can be easily computed from comparative balance sheets.
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Indirect and Direct Methods
Companies favor the indirect method for two reasons:
Easier and less costly to prepare.
Focuses on differences between net income and net cash flow from operating activities.
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Indirect Method (1 of 4)
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Indirect Method (2 of 4)
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Indirect Method (3 of 4)
| Liabilities and Stockholders' Equity | 2017 | 2016 | Change in Account Balance |
| Current liabilities | Blank | Blank | Blank |
| Accounts payable | $ 28,000 | $ 12,000 | $ 16,000 Increase |
| Income taxes payable | 6,000 | 8,000 | 2,000 Decrease |
| Long-term liabilities | Blank | Blank | Blank |
| Bonds payable | 130,000 | 20,000 | 110,000 Increase |
| Stockholders' equity | Blank | Blank | Blank |
| Common stock | 70,000 | 50,000 | 20,000 Increase |
| Retained earnings | 164,000 | 48,000 | 116,000 Increase |
| Total liabilities and stockholders' equity | $398,000 double underline | $138,000 double underline | Blank |
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Indirect Method (4 of 4)
Additional information for 2017:
Depreciation expense was comprised of $6,000 for building and $3,000 for equipment.
The company sold equipment with a book value of $7,000 (cost $8,000, less accumulated depreciation $1,000) for $4,000 cash.
Issued $110,000 of long-term bonds in direct exchange for land.
A building costing $120,000 was purchased for cash. Equipment costing $25,000 was also purchased for cash.
Issued common stock for $20,000 cash.
The company declared and paid a $29,000 cash dividend.
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Step 1: Operating Activities (1 of 15)
Determine Net Cash Provided/used by Operating Activities by Converting Net Income from Accrual Basis to Cash Basis.
Common adjustments to Net Income (Loss):
Add back noncash expenses (depreciation, amortization, or depletion expense).
Deduct gains and add losses.
Analyze changes to noncash current asset and current liability accounts.
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Step 1: Operating Activities (2 of 15)
Review Question
Which is an example of a cash flow from an operating activity?
a. Payment of cash to lenders for interest.
b. Receipt of cash from the sale of capital stock.
c. Payment of cash dividends to the company’s stockholders.
d. None of the above.
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Step 1: Operating Activities (3 of 15)
Review Question
Which is an example of a cash flow from an operating activity?
a. Payment of cash to lenders for interest.
b. Receipt of cash from the sale of capital stock.
c. Payment of cash dividends to the company’s stockholders.
d. None of the above.
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Step 1: Operating Activities (4 of 15)
Depreciation Expense
Although depreciation expense reduces net income, it does not reduce cash. The company must add it back to net income.
| Cash flows from operating activities: | Blank |
| Net income | $ 145,000 |
| Adjustments to reconcile net income to net cash provided by operating activities: | Blank |
| Depreciation expense | 9,000 |
| Net cash provided by operating activities | $ 154,000 |
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Step 1: Operating Activities (5 of 15)
Loss on Disposal of Plant Assets
Companies report as a source of cash in the investing activities section the actual amount of cash received from the sale.
Any loss on disposal is added to net income in the operating section.
Any gain on disposal is deducted from net income in the operating section.
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Step 1: Operating Activities (6 of 15)
Loss on Disposal of Plant Assets
| Cash flows from operating activities: | Blank |
| Net income | $ 145,000 |
| Adjustments to reconcile net income to net cash provided by operating activities: | Blank |
| Depreciation expense | 9,000 |
| Loss on disposal of plant assets | 3,000 |
| Net cash provided by operating activities | $ 157,000 |
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Step 1: Operating Activities (7 of 15)
Changes to Noncash current Asset
When the Accounts Receivable balance decreases, cash receipts are higher than revenue earned under the accrual basis.
Accounts Receivable
| 1/1/017 | Balance | 30,000 | Receipts from customer | 517,000 |
| Blank | Sale Revenue | 507,000 | Blank | Blank |
| 12/31/17 | Balance | 20,000 | Blank | Blank |
Company adds to net income the amount of the decrease in accounts receivable.
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Step 1: Operating Activities (8 of 15)
Changes to Noncash current Asset
| Cash flows from operating activities: | Blank |
| Net income | $ 145,000 |
| Adjustments to reconcile net income to net cash provided by operating activities: | Blank |
| Depreciation expense | 9,000 |
| Loss on disposal of plant assets | 3,000 |
| Decrease in accounts receivable | 10,000 |
| Net cash provided by operating activities | $ 167,000 |
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Step 1: Operating Activities (9 of 15)
Changes to Noncash current Asset
When the Inventory balance increases, the cost of merchandise purchased exceeds the cost of goods sold.
Inventory
| 1/1/17 | Balance | 10,000 | Cost of goods sold | 150,000 |
| Blank | Purchase | 155,000 | Blank | Blank |
| 12/31/17 | Balance | 15,000 | Blank | Blank |
Cost of goods sold does not reflect cash payments made for merchandise. The company deducts from net income this inventory increase.
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Step 1: Operating Activities (10 of 15)
Changes to Noncash current Asset
| Cash flows from operating activities: | Blank |
| Net income | $ 145,000 |
| Adjustments to reconcile net income to net cash provided by operating activities: | Blank |
| Depreciation expense | 9,000 |
| Loss on disposal of plant assets | 3,000 |
| Decrease in accounts receivable | 10,000 |
| Increase in inventory | (5,000) |
| Net cash provided by operating activities | $ 162,000 |
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Step 1: Operating Activities (11 of 15)
Changes to Noncash current Asset
When the Prepaid Expense balance increases, cash paid for expenses is higher than expenses reported on an accrual basis. The company deducts the increase from net income to arrive at net cash provided by operating activities.
If prepaid expenses decrease, reported expenses are higher than the expenses paid.
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Step 1: Operating Activities (12 of 15)
Changes to Noncash current Asset
| Cash flows from operating activities: | Blank |
| Net income | $ 145,000 |
| Adjustments to reconcile net income to net cash provided by operating activities: | Blank |
| Depreciation expense | 9,000 |
| Loss on disposal of plant assets | 3,000 |
| Decrease in accounts receivable | 10,000 |
| Increase in inventory | (5,000) |
| Increase in prepaid expenses | (4,000) |
| Net cash provided by operating activities | $ 158,000 |
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Step 1: Operating Activities (13 of 15)
Changes in Current Liabilities
When Accounts Payable increases, the company received more in goods than it actually paid for. The increase is added to net income to determine net cash provided by operating activities.
When Income Taxes Payable decreases, the income tax expense reported on the income statement was less than the amount of taxes paid during the period. The decrease is subtracted from net income to determine net cash provided by operating activities.
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Step 1: Operating Activities (14 of 15)
Changes in Current Liabilities
| Cash flows from operating activities: | Blank |
| Net income | $ 145,000 |
| Adjustments to reconcile net income to net cash provided by operating activities: | Blank |
| Depreciation expense | 9,000 |
| Loss on disposal of plant assets | 3,000 |
| Decrease in accounts receivable | 10,000 |
| Increase in inventory | (5,000) |
| Increase in prepaid expenses | (4,000) |
| Increase in accounts payable | 16,000 |
| Decrease in income taxes payable | (2,000) |
| Net cash provided by operating activities | $ 172,000 |
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Step 1: Operating Activities (15 of 15)
Summary of Conversion to Net Cash Provided by Operating Activities—Indirect Method
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Anatomy of a Fraud (1 of 2)
For more than a decade, the top executives at the Italian dairy products company Parmalat engaged in multiple frauds that overstated cash and other assets by more than $1 billion while understating liabilities by between $8 and $12 billion. Much of the fraud involved creating fictitious sources and uses of cash. Some of these activities incorporated sophisticated financial transactions with subsidiaries created with the help of large international financial institutions. However, much of the fraud employed very basic, even sloppy, forgery of documents. For example, when outside auditors requested confirmation of bank accounts (such as a fake $4.8 billion account in the Cayman Islands), documents were created on scanners, with signatures that were cut and pasted from other documents. These were then passed through a fax machine numerous times to make them look real (if difficult to read). Similarly, fictitious bills were created in order to divert funds to other businesses owned by the Tanzi family (who controlled Parmalat).
Total take: Billions of dollars
The Missing Control
Independent internal verification. Internal auditors at the company should have independently verified bank accounts and major transfers of cash to outside companies that were controlled by the Tanzi family.
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Do It 2a: Net Cash Provided by Operating Activities (1 of 2)
Josh’s PhotoPlus reported net income of $73,000 for 2017. Included in the income statement were depreciation expense of $7,000 and a gain on disposal of plant assets of $2,500. Josh’s comparative balance sheets show the following balances.
| Blank | 12/31/17 | 12/31/16 |
| Accounts receivable | $21,000 | $17,000 |
| Accounts payable | 2,200 | 6,000 |
Calculate net cash provided by operating activities for Josh’s PhotoPlus.
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Do It 2a: Net Cash Provided by Operating Activities (2 of 2)
Josh’s PhotoPlus reported net income of $73,000 for 2017, which included depreciation expense of $7,000 and a gain on disposal of plant assets of $2,500. Accounts receivable increased $4,000 and accounts payable decreased by $3,800. Calculate net cash provided by operating activities.
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Step 2: Investing and Financing Activities (1 of 10)
Company purchased land of $110,000 by issuing long-term bonds. This is a significant noncash investing and financing activity that merits disclosure in a separate schedule.
Land
| 1/1/17 | Balance | 20,000 | Blank |
| Blank | Issued bonds | 110,000 | Blank |
| 12/31/17 | Balance | 130,000 | Blank |
Bonds Payable
| Blank | 1/1/17 | Balance | 20,000 |
| Blank | Blank | For land | 110,000 |
| Blank | 12/31/17 | Balance | 130,000 |
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Step 2: Investing and Financing Activities (2 of 10)
Partial statement
| Net cash provided by operating activities | 172,000 |
| Cash flows from investing activities: | Blank |
| Purchase of building | (120,000) |
| Purchase of equipment | (25,000) |
| Sale of equipment | 4,000 |
| Net cash used by investing activities | (141,000) |
| Cash flows from financing activities: | Blank |
| Issuance of common stock | 20,000 |
| Payment of cash dividends | (29,000) |
| Net cash used by financing activities | (9,000) |
| Net increase in cash | 22,000 |
| Cash at beginning of period | 33,000 |
| Cash at end of period | $ 55,000 double underline |
| Disclosure: Issuance of bonds to purchase land | $ 110,000 double underline |
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Step 2: Investing and Financing Activities (3 of 10)
From the additional information, the company acquired an office building for $120,000 cash. This is a cash outflow reported in the investing section.
Building
| 1/1/17 | Balance | 40,000 | Blank |
| Blank | Office building | 120,000 | Blank |
| 12/31/17 | Balance | 160,000 | Blank |
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Step 2: Investing and Financing Activities (4 of 10)
Partial statement
| Net cash provided by operating activities | 172,000 |
| Cash flows from investing activities: | Blank |
| Purchase of building | (120,000) |
| Purchase of equipment | (25,000) |
| Sale of equipment | 4,000 |
| Net cash used by investing activities | (141,000) |
| Cash flows from financing activities: | Blank |
| Issuance of common stock | 20,000 |
| Payment of cash dividends | (29,000) |
| Net cash used by financing activities | (9,000) |
| Net increase in cash | 22,000 |
| Cash at beginning of period | 33,000 |
| Cash at end of period | $ 55,000 double underline |
| Disclosure: Issuance of bonds to purchase land | $ 110,000 double underline |
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Step 2: Investing and Financing Activities (5 of 10)
The additional information explains that the equipment increase resulted from two transactions: (1) a purchase of equipment of $25,000, and (2) the sale for $4,000 of equipment costing $8,000.
Equipment
| 1/1/17 | Balance | 40,000 | Equipment sold | 8,000 |
| Blank | Purchase | 25,0000 | Blank | Blank |
| 12/31/17 | Balance | 27,000 | Blank | Blank |
Journal Entry
| Cash | 4,000 | Blank |
| Accumulated Depreciation | 1,000 | Blank |
| Loss on Disposal of Plant Assets | 3,000 | Blank |
| Equipment | Blank | 8,000 |
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Statement of Cash Flows (1 of 2)
Indirect Method
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Step 2: Investing and Financing Activities (6 of 10)
The increase in common stock resulted from the issuance of new shares.
Common Stock
| 1/1/17 | Balance | 50,000 | Blank |
| Blank | Shares sold | 20,000 | Blank |
| 12/31/17 | Balance | 70,000 | Blank |
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Step 2: Investing and Financing Activities (7 of 10)
Partial statement
| Net cash provided by operating activities | 172,000 |
| Cash flows from investing activities: | Blank |
| Purchase of building | (120,000) |
| Purchase of equipment | (25,000) |
| Sale of equipment | 4,000 |
| Net cash used by investing activities | (141,000) |
| Cash flows from financing activities: | Blank |
| Issuance of common stock | 20,000 |
| Payment of cash dividends | (29,000) |
| Net cash used by financing activities | (9,000) |
| Net increase in cash | 22,000 |
| Cash at beginning of period | 33,000 |
| Cash at end of period | $ 55,000 double underline |
| Disclosure: Issuance of bonds to purchase land | $ 110,000 double underline |
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Step 2: Investing and Financing Activities (8 of 10)
Retained earnings increased $116,000 during the year. This increase can be explained by two factors: (1) Net income of $145,000 increased retained earnings, and (2) Dividends of $29,000 decreased retained earnings.
Retained Earnings
| Blank | Blank | Blank | 1/1/17 | Balance | 48,000 |
| Blank | Dividends | 29,000 | Blank | Net income | 145,000 |
| Blank | Blank | Blank | 12/31/17 | Balance | 164,000 |
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Statement of Cash Flows (2 of 2)
Indirect Method
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Step 2: Investing and Financing Activities (9 of 10)
Review Question
Which is an example of a cash flow from an investing activity?
a. Receipt of cash from the issuance of bonds payable.
b. Payment of cash to repurchase outstanding capital stock.
c. Receipt of cash from the sale of equipment.
d. Payment of cash to suppliers for inventory.
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Step 2: Investing and Financing Activities (10 of 10)
Review Question
Which is an example of a cash flow from an investing activity?
a. Receipt of cash from the issuance of bonds payable.
b. Payment of cash to repurchase outstanding capital stock.
c. Receipt of cash from the sale of equipment.
d. Payment of cash to suppliers for inventory.
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Step 3: Net Change in Cash (1 of 2)
Compare the net change in cash on the Statement of Cash Flows with the change in the cash account reported on the Balance Sheet to make sure the amounts agree.
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Accounting Across the Organization (2 of 2)
Burning Through Our Cash
Box (cloud storage), Cyan (game creator), Fireeye (cyber security), and Mobile Iron (mobile security of data) are a few of the tech companies that recently have issued or are about to issue stock to the public. Investors now have to determine whether these tech companies have viable products and high chances for success. An important consideration in evaluating a tech company is determining its financial flexibility—its ability to withstand adversity if an economic setback occurs. One way to measure financial flexibility is to assess a company’s cash burn rate, which determines how long its cash will hold out if the company is expending more cash than it is receiving. Fireeye, for example, burned cash in excess of $50 million in 2013. But the company also had over $150 million as a cash cushion, so it would take over 30 months before it runs out of cash. And even though Box has a much lower cash burn rate than Fireeye, it still has over a year’s cushion. Compare that to the tech companies in 2000, when over one-quarter of them were on track to run out of cash within a year. And many did. Fortunately, the tech companies of today seem to be better equipped to withstand an economic setback.
Source: Shira Ovide, “Tech Firms’ Cash Hoards Cool Fears of a Meltdown,” Wall Street Journal (May 14, 2014).
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L O 3: Use the Statement of Cash Flows to Evaluate a Company
The Corporate Life Cycle
Impact of product life cycle on cash flows.
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Investor Insight Operating with Negative Cash
Listed here are amounts (in millions) of net income and net cash provided (used) by operating, investing, and financing activities for a variety of companies at one time. The final column suggests the companies’ likely phases in the life cycle based on these figures.
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Free Cash Flow (1 of 3)
Free cash flow describes the cash remaining from operations after adjustment for capital expenditures and dividends.
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Free Cash Flow (2 of 3)
Required: Calculate Microsoft’s free cash flow.
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Free Cash Flow (3 of 3)
| Cash provided by operating activities | $59,713 |
| Less: Expenditures on property, plant, and equipment | 9,571 |
| Dividends paid | 11,126 |
| Free cash flow | $39,016 double underline |
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L O 4: Appendix 12A: Prepare a Statement of Cash Flows Using the Direct Method
Compute net cash provided by operating activities by adjusting each item in the income statement from the accrual basis to the cash basis.
Companies report only major classes of operating cash receipts and cash payments.
For these major classes, the difference between cash receipts and cash payments is the net cash provided by operating activities.
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Step 1: Operating Activities
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Direct Method (1 of 4)
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Direct Method (2 of 4)
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Direct Method (3 of 4)
| Liabilities and Stockholders' Equity | 2017 | 2016 | Change in Account Balance |
| Current liabilities | Blank | Blank | Blank |
| Accounts payable | $ 28,000 | $ 12,000 | $ 16,000 Increase |
| Income taxes payable | 6,000 | 8,000 | 2,000 Decrease |
| Long-term liabilities | Blank | Blank | Blank |
| Bonds payable | 130,000 | 20,000 | 110,000 Increase |
| Stockholders' equity | Blank | Blank | Blank |
| Common stock | 70,000 | 50,000 | 20,000 Increase |
| Retained earnings | 164,000 | 48,000 | 116,000 Increase |
| Total liabilities and stockholders' equity | $398,000 double underline | $138,000 double underline | Blank |
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Direct Method (4 of 4)
Additional information for 2017:
Depreciation expense was comprised of $6,000 for building and $3,000 for equipment.
The company sold equipment with a book value of $7,000 (cost $8,000, less accumulated depreciation $1,000) for $4,000 cash.
Issued $110,000 of long-term bonds in direct exchange for land.
A building costing $120,000 was purchased for cash. Equipment costing $25,000 was also purchased for cash.
Issued common stock for $20,000 cash.
The company declared and paid a $29,000 cash dividend.
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Step 1: Operating Activities (1 of 7)
Cash Receipts from Customers
For Computer Services, accounts receivable decreased $10,000.
Accounts Receivable
| 1/1/017 | Balance | 30,000 | Receipts from customers | 517,000 |
| Blank | Sales revenue | 507,000 | Blank | Blank |
| 12/31/17 | Balance | 20,000 | Blank | Blank |
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Step 1: Operating Activities (2 of 7)
Cash Payments to Suppliers
In 2017, Computer Services Company’s inventory increased $5,000 and cash payments to suppliers were $139,000.
Inventory
| 1/1/17 | Balance | 10,000 | Cost of goods sold | 150,000 |
| Blank | Purchases | 155,000 | Blank | Blank |
| 12/31/17 | Balance | 15,000 | Blank | Blank |
Accounts Payable
| Payment to suppliers | 139,000 | 1/1/17 | Balance | 12,000 |
| Blank | Blank | Blank | Purchases | 155,000 |
| Blank | Blank | 12/31/17 | Balance | 28,000 |
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Step 1: Operating Activities (3 of 7)
Cash Payments to Suppliers
In 2017, Computer Services Company’s inventory increased $5,000 and cash payments to suppliers were $139,000.
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Step 1: Operating Activities (4 of 7)
Cash Payments for Operating Expenses
Cash payments for operating expenses were $115,000.
| Operating expenses | $ 111,000 |
| Add: Increase in prepaid expenses | 4,000 |
| Cash payments for operating expenses | $115,000 |
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Step 1: Operating Activities (5 of 7)
Cash Payments for Interest
In 2017, Computer Services’ had interest expense of $42,000.
Interest Payable
| Cash paid for interest | 42,000 | 1/1/17 | Balance | 0 |
| Blank | Blank | Blank | Interest expense | 42,000 |
| Blank | Blank | 12/31/17 | Balance | 0 |
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Step 1: Operating Activities (6 of 7)
Cash Payments for Income Taxes
Cash payments for income taxes were $49,000.
Income Tax Payable
| Cash paid for taxes | 49,000 | 1/1/17 | Balance | 8,000 |
| Blank | Blank | Blank | Income tax expense | 47,000 |
| Blank | Blank | 12/31/17 | Balance | 6,000 |
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Step 1: Operating Activities (7 of 7)
| Cash flows from operating activities | Blank | Blank |
| Cash receipts from customers | Blank | $517,000 |
| Less: Cash payments: | Blank | Blank |
| To suppliers | $139,000 | Blank |
| For operating expenses | 115,000 | Blank |
| For interest expense | 42,000 | Blank |
| For income taxes | 49,000 | 345,000 |
| Net cash provided by operating activities | Blank | $172,000 |
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Step 2: Investing and Financing Activities (1 of 5)
Increase in Equipment. (1) Equipment purchased for $25,000, and (2) equipment sold for $4,000, cost $8,000, book value $7,000.
Equipment
| 1/1/17 | Balance | 10,000 | Cost of goods sold | 8,000 |
| Blank | purchases | 25,000 | Blank | Blank |
| 12/31/17 | Balance | 27,000 | Blank | Blank |
Accumulated Depreciation
| Equipment sold | 1,000 | 1/1/17 | Balance | 1,000 |
| Blank | Blank | Blank | Depreciation expense | 3,000 |
| Blank | Blank | 12/31/17 | Balance | 3,000 |
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Step 2: Investing and Financing Activities (2 of 5)
Increase in Equipment. (1) Equipment purchased for $25,000, and (2) equipment sold for $4,000, cost $8,000, book value $7,000.
Cash
4,000
Accumulated Depreciation—Equipment
1,000
Loss on Disposal of Plant Assets
3,000
Equipment
8,000
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Step 2: Investing and Financing Activities (3 of 5)
Increase in Land. Land increased $110,000. The company purchased land of $110,000 by issuing bonds.
Significant noncash investing and financing transaction.
Increase in Building. Acquired building for $120,000 cash.
Investing transaction.
Increase in Bonds Payable. Bonds Payable increased $110,000. The company acquired land by exchanging bonds for land.
Significant noncash investing and financing transaction.
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Step 2: Investing and Financing Activities (4 of 5)
Increase in Common Stock. Increase in Common Stock of $20,000. Increase resulted from the issuance of new shares of stock.
Financing transaction.
Increase in Retained Earnings. The $116,000 net increase in Retained Earnings resulted from net income of $145,000 and the declaration and payment of a cash dividend of $29,000.
Financing transaction (cash dividend)
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Step 2: Investing and Financing Activities (5 of 5)
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Step 3: Net Change in Cash (2 of 2)
Compare the net change in cash on the Statement of Cash Flows with the change in the cash account reported on the Balance Sheet to make sure the amounts agree.
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L O 5: Appendix 12B: Use the T-Account Approach to Prepare a Statement of Cash Flows
The change in cash is equal to the change in all of the other balance sheet accounts.
If we analyze the changes in all of the noncash balance sheet accounts, we will explain the change in the cash account.
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Use the T-Account Approach to Prepare a Statement of Cash Flows
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A Look at I F R S- L O-6: Compare the Procedures for the Statement of Cash Flows Under G A A P and I F R S
Key Points
Similarities
Companies preparing financial statements under IFRS must prepare a statement of cash flows as an integral part of the financial statements.
Both I F R S and G A A P require that the statement of cash flows should have three major sections—operating, investing, and financing—along with changes in cash and cash equivalents.
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A Look at I F R S (1 of 11)
Similarities
Similar to G A A P, the cash flow statement can be prepared using either the indirect or direct method under I F R S. In both U.S. and international settings, companies choose for the most part to use the indirect method for reporting net cash flows from operating activities.
The definition of cash equivalents used in I F R S is similar to that used in G A A P. A major difference is that in certain situations, bank overdrafts are considered part of cash and cash equivalents under I F R S (which is not the case in G A A P). Under G A A P, bank overdrafts are classified as financing activities in the statement of cash flows and are reported as liabilities on the balance sheet.
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A Look at I F R S (2 of 11)
Differences
I F R S requires that noncash investing and financing activities be excluded from the statement of cash flows. Instead, these noncash activities should be reported elsewhere. This requirement is interpreted to mean that noncash investing and financing activities should be disclosed in the notes to the financial statements instead of in the financial statements. Under G A A P, companies may present this information on the face of the statement of cash flows.
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A Look at I F R S (3 of 11)
Differences
One area where there can be substantial differences between I F R S and G A A P relates to the classification of interest, dividends, and taxes. The following table indicates the differences between the two approaches.
| Item | I F R S | G A A P |
| Interest paid | Operating or financing | Operating |
| Interest received | Operating or investing | Operating |
| Dividends paid | Operating or financing | Financing |
| Dividends received | Operating or investing | Operating |
| Taxes paid | Operating—unless specific identification with financing or investing activity | Operating |
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A Look at I F R S (4 of 11)
Differences
Under I F R S, some companies present the operating section in a single line item, with a full reconciliation provided in the notes to the financial statements. This presentation is not seen under G A A P.
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A Look at I F R S (5 of 11)
Looking to the Future
Presently, the F A S B and the I A S B are involved in a joint project on the presentation and organization of information in the financial statements. One interesting approach, revealed in a published proposal from that project, is that in the future the income statement and balance sheet would adopt headings similar to those of the statement of cash flows. That is, the income statement and balance sheet would be broken into operating, investing, and financing sections.
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A Look at I F R S (6 of 11)
I F R S Practice
Under IFRS, interest paid can be reported as:
a) only a financing element.
b) a financing element or an investing element.
c) a financing element or an operating element.
d) only an operating element.
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A Look at I F R S (7 of 11)
I F R S Practice
Under IFRS, interest paid can be reported as:
a) only a financing element.
b) a financing element or an investing element.
c) a financing element or an operating element.
d) only an operating element.
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A Look at I F R S (8 of 11)
I F R S Practice
IFRS requires that noncash items:
a) be reported in the section to which they relate, that is, a noncash investing activity would be reported in the investing section.
b) be disclosed in the notes to the financial statements.
c) do not need to be reported.
d) be treated in a fashion similar to cash equivalents.
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A Look at I F R S (9 of 11)
I F R S Practice
IFRS requires that noncash items:
a) be reported in the section to which they relate, that is, a noncash investing activity would be reported in the investing section.
b) be disclosed in the notes to the financial statements.
c) do not need to be reported.
d) be treated in a fashion similar to cash equivalents.
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A Look at I F R S (10 of 11)
I F R S Practice
In the future, it appears likely that:
a) the income statement and balance sheet will have headings of operating, investing, and financing, much like the statement of cash flows.
b) cash and cash equivalents will be combined in a single line item.
c) the IASB will not allow companies to use the direct approach to the statement of cash flows.
d) None of the above.
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A Look at I F R S (11 of 11)
I F R S Practice
In the future, it appears likely that:
a) the income statement and balance sheet will have headings of operating, investing, and financing, much like the statement of cash flows.
b) cash and cash equivalents will be combined in a single line item.
c) the IASB will not allow companies to use the direct approach to the statement of cash flows.
d) None of the above.
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Copyright
Copyright © 2017 John Wiley & Sons, Inc.
All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Act without the express written permission 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.
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$398,000
$138,000
$55,000
$110,000
$110,000
Net Cash Provided by Operating Activitie
sCapital ExpendituresCash Dividends
=--
$39,016
$398,000
$138,000
