Business & Finance Case Study: Statement of Cash Flows Assignment
Serenity3203
Chapter20-StatementofCashFlows.pptxStatement of Cash Flows
Revsine/Collins/Johnson/Mittelstaedt/Soffer: Chapter 20
© 2021 McGraw Hill. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw Hill.
© McGraw Hill
1
Learning Objectives 1 After studying this chapter, you will understand:
The major sources and uses of cash reported in the operating, investing, and financing sections of the statement of cash flows.
Why accrual net income and operating cash flow differ and the factors that explain this difference.
The difference between the direct and indirect methods of determining cash flow from operations.
How to prepare a statement of cash flows from comparative balance sheet data, an income statement, and other financial information.
Why changes in balance sheet accounts over a year may not reconcile to the corresponding account changes included in the statement of cash flows.
20-‹#›
© McGraw Hill
Learning Objectives 2 After studying this chapter, you will understand:
How operating cash flows can be distorted.
Differences between reporting interest and dividends received and interest and dividends paid on the statement of cash flows under I F R S rules vs. U.S. G A A P.
20-‹#›
© McGraw Hill
Why Cash Flows are Important
Accrual earnings may not always provide a complete measure of enterprise’s performance and health.
Accrual accounting relies on subjective judgments that may introduce measurement error and uncertainty into reported earnings.
One-time write-offs and restructuring charges require subjective judgments that an adversely affect the quality of reported earnings.
Management can readily manipulate accrual income by postponing discretionary expenditures for research and development or advertising or by purposeful last-in, first-out (L I F O) dipping.
For these reasons, analysts also scrutinize a firm’s cash flows to evaluate its performance and creditworthiness.
A significant difference between accrual earnings and operating cash flow is a “red flag.”
20-‹#›
© McGraw Hill
Review of Cash Flow Statement Formats and Content
Net cash flows from operating activities
Arise from events or transactions that enter into the determination of net income – that is, transactions related to the production and delivery of goods and services to customers.
Net cash flows from investing activities
Result from the purchase or sale of productive assets such as plant and equipment, from the purchase or sale of marketable securities, and from the acquisition of other companies or divestitures.
Net cash flows from financing activities
Result when a company sells its own stock or bonds, pays dividends, buys back its own shares (treasury stock), or issues or repays debt.
Net increase (decrease) in cash and cash equivalents
20-‹#›
© McGraw Hill
Approaches to Determine Net Cash Flows from Operating Activities
Cash flow from operating activities may be presented in two ways.
Although the components of the operating section of the cash flow statement differ between the two methods, the amount of cash flow from operating activities is the same under both methods.
Direct method
Cash transactions related to the determination of net income are reported in the operating section.
Indirect method
Begins with net income and then adjustments are made for the differences between the amount of net income recognized during the period and the related operating cash flow amount.
The overwhelming majority of public companies use the indirect method.
20-‹#›
© McGraw Hill
Cash Flows from Operating Activities: The Direct Method 1
Exhibit 20.1 Golden Enterprises, Inc., and Subsidiary Consolidated Statements of Cash Flows
For the Fiscal Years Ended June 3, 2016, and May 29, 2015
| 2016 | 2015 | |
| Cash flows from Operating Activities | ||
| Cash received from customers | $136,289,283 | $131,980,056 |
| Miscellaneous income | 97,108 | 88,918 |
| Cash paid to suppliers and employees for cost of goods sold | (66,550,001) | (63,720,473) |
| Cash paid for suppliers and employees for selling, general and administrative | (61,224,782) | (61,947,388) |
| Income taxes | (1,140,191) | (1,839,759) |
| Interest expense | (335,562) | (458,184) |
| Net cash provided by operating activities | 7,135,855 | 4,103,170 |
| CASH MOWS FROM INVESTING ACTIVITIES |
20-‹#›
© McGraw Hill
Cash Flows from Operating Activities: The Direct Method 2
| 2016 | 2015 | |
| Purchases of property, plant and equipment | (1,182,854) | (2,725,450) |
| Proceeds from sale of property, plant and equipment | 56,446 | 284,806 |
| Net cash used in investing activities | (1,126,408) | (2,440,644) |
| CASH FLOWS FROM FINANCING ACTIVITIES | ||
| Change in line of credit | (2,823,477) | 294,966 |
| Debt (repayments) proceeds | (824,435) | 1,698,505 |
| Principal payments under capital lease obligation | (30,970) | – |
| Purchases of treasury shares | – | (2,204,375) |
| Cash dividends paid | (1,496,160) | (1,452,803) |
| Net cash used in financing activities | (5,175,042) | (1,663,707) |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | 834,405 | (1,181) |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR | 1,159,449 | 1,160,630 |
| CASH AND CASH EQUIVALENTS AT END Of YEAR | $ 1,993,854 | $ 1,159,449 |
Source: Golden Enterprises Form 10-K for the year ended June 3, 2016.
20-‹#›
© McGraw Hill
Cash Flows from Operating Activities: The Direct Method 3
The minimum specific categories of cash inflows and cash outflows that are required to be reported under the direct method are:
Cash collected from.
Interest and dividends received.
Other operating cash receipts.
Cash paid to employees and other suppliers of goods and services.
Interest paid.
Income taxes paid.
Other operating cash payments.
Note that Interest income and Interest expense are shown as components of cash flows from operating activities.
20-‹#›
© McGraw Hill
Cash Flows from Operating Activities: The Direct Method 4
A supplemental reconciliation of net income to net operating cash flow is required when the direct method is used.
Exhibit 20.3 Golden Enterprises, Inc., and Subsidiary Consolidated Statements of Cash Flows
For the Fiscal Years Ended June 3, 2016, and May 29, 2015
Reconciliation of Net Income to Net Cash Provided by Operating Activities
| 2016 | 2015 | |
| Net income | $3,184,803 | $1,773,841 |
| Adjustment to reconcile net income to net cash provided by operating activities: | ||
| 1) Depreciation | 3,876,111 | 3,906,766 |
| 2) Deferred income taxes | (84,598) | 307,643 |
| 3) Stock-based compensation | 253,011 | 55,019 |
| 4) Gain on sale of property and equipment | (56,446) | (283,256) |
| 5) Change in receivables—net | 418,703 | 255,335 |
| 6) Change in inventories | (492,913) | 417,442 |
20-‹#›
© McGraw Hill
Cash Flows from Operating Activities: The Direct Method 5
This reconciliation is the same as the operating section of the statement of cash flows prepared using the indirect method.
Firms using the indirect method are also required to separately disclose:
Interest paid.
Income taxes paid.
Source: Golden Enterprises Form 10-K for the year ended June 3, 2016.
| 2016 | 2015 | |
| 7) Change in prepaid expenses | 74,283 | (72,340) |
| 8) Change in cash surrender value of insurance | 191,830 | (27,906) |
| 9) Change in other assets—other | 55,662 | 234,548 |
| 10) Change in accounts payable | (882,590) | (572,100) |
| 11) Change in accrued expenses | 136,950 | (931,885) |
| 12) Change in salary continuation plan | 7,368 | (105,124) |
| 13) Change in income tax receivable | 453,681 | (854,813) |
| Net cash provided by operating activities | $7,135,855 | $4,103,170 |
20-‹#›
© McGraw Hill
Overview of the Indirect Method
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Depreciation 1
During 2016, Golden Enterprises made the following entry for depreciation:
| D R Depreciation expense | $3,876,111 | |
| C R Accumulated depreciation on fixed assets | $3,876,111 |
Exhibit 20.3 Golden Enterprises, Inc., and Subsidiary Consolidated Statements of Cash Flows
For the Fiscal Years Ended June 3, 2016, and May 29, 2015
Reconciliation of Net Income to Net Cash Provided by Operating Activities
| 2016 | 2015 | |
| Net income | $3,184,803 | $1,773,841 |
| Adjustment to reconcile net income to net cash provided by operating activities: | ||
| 1) Depreciation | 3,876,111 | 3,906,766 |
| 2) Deferred income taxes | (84,598) | 307,643 |
| 3) Stock-based compensation | 253,011 | 55,019 |
| 4) Gain on sale of property and equipment | (56,446) | (283,256) |
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Depreciation 2
| 2016 | 2015 | |
| 5) Change in receivables—net | 418,703 | 255,335 |
| 6) Change in inventories | (492,913) | 417,442 |
| 7) Change in prepaid expenses | 74,283 | (72,340) |
| 8) Change in cash surrender value of insurance | 191,830 | (27,906) |
| 9) Change in other assets—other | 55,662 | 234,548 |
| 10) Change in accounts payable | (882,590) | (572,100) |
| 11) Change in accrued expenses | 136,950 | (931,885) |
| 12) Change in salary continuation plan | 7,368 | (105,124) |
| 13) Change in income tax receivable | 453,681 | (854,813) |
| Net cash provided by operating activities | $7,135,855 | $4,103,170 |
Source: Golden Enterprises Form 10-K for the year ended June 3, 2016.
Although the debit to Depreciation expense reduced net income, there was no cash outflow.
Depreciation expense must be added back to net income as a reconciling item under the indirect method.
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Deferred Income Taxes 1
During 2016, Golden showed a decrease in its deferred tax liabilities net of deferred tax assets of $84,598.
Exhibit 20.3 Golden Enterprises, Inc., and Subsidiary Consolidated Statements of Cash Flows
For the Fiscal Years Ended June 3, 2016, and May 29, 2015
Reconciliation of Net Income to Net Cash Provided by Operating Activities
| 2016 | 2015 | |
| Net income | $3,184,803 | $1,773,841 |
| Adjustment to reconcile net income to net cash provided by operating activities: | ||
| 1) Depreciation | 3,876,111 | 3,906,766 |
| 2) Deferred income taxes | (84,598) | 307,643 |
| 3) Stock-based compensation | 253,011 | 55,019 |
| 4) Gain on sale of property and equipment | (56,446) | (283,256) |
| 5) Change in receivables—net | 418,703 | 255,335 |
| 6) Change in inventories | (492,913) | 417,442 |
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Deferred Income Taxes 2
| 2016 | 2015 | |
| 7) Change in prepaid expenses | 74,283 | (72,340) |
| 8) Change in cash surrender value of insurance | 191,830 | (27,906) |
| 9) Change in other assets—other | 55,662 | 234,548 |
| 10) Change in accounts payable | (882,590) | (572,100) |
| 11) Change in accrued expenses | 136,950 | (931,885) |
| 12) Change in salary continuation plan | 7,368 | (105,124) |
| 13) Change in income tax receivable | 453,681 | (854,813) |
| Net cash provided by operating activities | $7,135,855 | $4,103,170 |
Source: Golden Enterprises Form 10-K for the year ended June 3, 2016.
When this happens, the debit to income tax expense exceeds the taxes due in the current period.
This decrease in net deferred tax liabilities must be subtracted from net income because the tax expense understates the cash outflow for taxes in 2016.
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Stock-Based Compensation 1
Golden recorded $253,011 of stock-based compensation expense in 2016.
This amount represents the recognition of compensation expense of a portion of previously issued stock-based awards as those awards moved through the vesting period.
Exhibit 20.3 Golden Enterprises, Inc., and Subsidiary Consolidated Statements of Cash Flows
For the Fiscal Years Ended June 3, 2016, and May 29, 2015
Reconciliation of Net Income to Net Cash Provided by Operating Activities
| 2016 | 2015 | |
| Net income | $3,184,803 | $1,773,841 |
| Adjustment to reconcile net income to net cash provided by operating activities: | ||
| 1) Depreciation | 3,876,111 | 3,906,766 |
| 2) Deferred income taxes | (84,598) | 307,643 |
| 3) Stock-based compensation | 253,011 | 55,019 |
| 4) Gain on sale of property and equipment | (56,446) | (283,256) |
| 5) Change in receivables—net | 418,703 | 255,335 |
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Stock-Based Compensation 2
| 2016 | 2015 | |
| 6) Change in inventories | (492,913) | 417,442 |
| 7) Change in prepaid expenses | 74,283 | (72,340) |
| 8) Change in cash surrender value of insurance | 191,830 | (27,906) |
| 9) Change in other assets—other | 55,662 | 234,548 |
| 10) Change in accounts payable | (882,590) | (572,100) |
| 11) Change in accrued expenses | 136,950 | (931,885) |
| 12) Change in salary continuation plan | 7,368 | (105,124) |
| 13) Change in income tax receivable | 453,681 | (854,813) |
| Net cash provided by operating activities | $7,135,855 | $4,103,170 |
Source: Golden Enterprises Form 10-K for the year ended June 3, 2016.
There is no corresponding cash flow associated with this expense.
This stock-based compensation expense must be added back to net income as a reconciling item under the indirect method.
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Gain on Sale of Property 1
Golden sold assets for a gain of $56,446 during 2016.
This amount represents the excess of the selling price over book value of assets sold during the period.
Exhibit 20.3 Golden Enterprises, Inc., and Subsidiary Consolidated Statements of Cash Flows
For the Fiscal Years Ended June 3, 2016, and May 29, 2015
Reconciliation of Net Income to Net Cash Provided by Operating Activities
| 2016 | 2015 | |
| Net income | $3,184,803 | $1,773,841 |
| Adjustment to reconcile net income to net cash provided by operating activities: | ||
| 1) Depreciation | 3,876,111 | 3,906,766 |
| 2) Deferred income taxes | (84,598) | 307,643 |
| 3) Stock-based compensation | 253,011 | 55,019 |
| 4) Gain on sale of property and equipment | (56,446) | (283,256) |
| 5) Change in receivables—net | 418,703 | 255,335 |
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Gain on Sale of Property 2
| 2016 | 2015 | |
| 6) Change in inventories | (492,913) | 417,442 |
| 7) Change in prepaid expenses | 74,283 | (72,340) |
| 8) Change in cash surrender value of insurance | 191,830 | (27,906) |
| 9) Change in other assets—other | 55,662 | 234,548 |
| 10) Change in accounts payable | (882,590) | (572,100) |
| 11) Change in accrued expenses | 136,950 | (931,885) |
| 12) Change in salary continuation plan | 7,368 | (105,124) |
| 13) Change in income tax receivable | 453,681 | (854,813) |
| Net cash provided by operating activities | $7,135,855 | $4,103,170 |
Source: Golden Enterprises Form 10-K for the year ended June 3, 2016.
The gain increased net income, but it did not reflect the increase in cash flow from operations related to this transaction.
The Gain on sale of property must be subtracted from net income to arrive at cash flows from operations.
The cash received from the transaction is reported in the investing activities section.
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Change in Receivables––Net 1
During 2016, the amount in Golden’s Accounts receivable (net of Allowance for uncollectibles) account decreased by $418,703.
Exhibit 20.3 Golden Enterprises, Inc., and Subsidiary Consolidated Statements of Cash Flows
For the Fiscal Years Ended June 3, 2016, and May 29, 2015
Reconciliation of Net Income to Net Cash Provided by Operating Activities
| 2016 | 2015 | |
| Net income | $3,184,803 | $1,773,841 |
| Adjustment to reconcile net income to net cash provided by operating activities: | ||
| 1) Depreciation | 3,876,111 | 3,906,766 |
| 2) Deferred income taxes | (84,598) | 307,643 |
| 3) Stock-based compensation | 253,011 | 55,019 |
| 4) Gain on sale of property and equipment | (56,446) | (283,256) |
| 5) Change in receivables—net | 418,703 | 255,335 |
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Change in Receivables––Net 2
| 2016 | 2015 | |
| 6) Change in inventories | (492,913) | 417,442 |
| 7) Change in prepaid expenses | 74,283 | (72,340) |
| 8) Change in cash surrender value of insurance | 191,830 | (27,906) |
| 9) Change in other assets—other | 55,662 | 234,548 |
| 10) Change in accounts payable | (882,590) | (572,100) |
| 11) Change in accrued expenses | 136,950 | (931,885) |
| 12) Change in salary continuation plan | 7,368 | (105,124) |
| 13) Change in income tax receivable | 453,681 | (854,813) |
| Net cash provided by operating activities | $7,135,855 | $4,103,170 |
Source: Golden Enterprises Form 10-K for the year ended June 3, 2016.
This means that sales on account (accrual-basis revenue) were less than cash collections on account in 2016.
The increase in Receivables–net must be added back to net income as a reconciling item under the indirect method.
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Change in Inventories 1
During 2016, the amounts in Golden’s inventory accounts increased by $492,913.
For now, we assume that all inventory purchases were paid for in cash.
Exhibit 20.3 Golden Enterprises, Inc., and Subsidiary Consolidated Statements of Cash Flows
For the Fiscal Years Ended June 3, 2016, and May 29, 2015
Reconciliation of Net Income to Net Cash Provided by Operating Activities
| 2016 | 2015 | |
| Net income | $3,184,803 | $1,773,841 |
| Adjustment to reconcile net income to net cash provided by operating activities: | ||
| 1) Depreciation | 3,876,111 | 3,906,766 |
| 2) Deferred income taxes | (84,598) | 307,643 |
| 3) Stock-based compensation | 253,011 | 55,019 |
| 4) Gain on sale of property and equipment | (56,446) | (283,256) |
| 5) Change in receivables—net | 418,703 | 255,335 |
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Change in Inventories 2
| 2016 | 2015 | |
| 6) Change in inventories | (492,913) | 417,442 |
| 7) Change in prepaid expenses | 74,283 | (72,340) |
| 8) Change in cash surrender value of insurance | 191,830 | (27,906) |
| 9) Change in other assets—other | 55,662 | 234,548 |
| 10) Change in accounts payable | (882,590) | (572,100) |
| 11) Change in accrued expenses | 136,950 | (931,885) |
| 12) Change in salary continuation plan | 7,368 | (105,124) |
| 13) Change in income tax receivable | 453,681 | (854,813) |
| Net cash provided by operating activities | $7,135,855 | $4,103,170 |
Source: Golden Enterprises Form 10-K for the year ended June 3, 2016.
The increase in inventory means that cash outflow for inventory purchases was greater than the cost of inventory sold during the year.
The increase in inventory must be subtracted from net income as a reconciling item under the indirect method.
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Change in Prepaid Expenses 1
During 2016, the balance in Golden’s Prepaid expenses account decreased by $74,283.
Exhibit 20.3 Golden Enterprises, Inc., and Subsidiary Consolidated Statements of Cash Flows
For the Fiscal Years Ended June 3, 2016, and May 29, 2015
Reconciliation of Net Income to Net Cash Provided by Operating Activities
| 2016 | 2015 | |
| Net income | $3,184,803 | $1,773,841 |
| Adjustment to reconcile net income to net cash provided by operating activities: | ||
| 1) Depreciation | 3,876,111 | 3,906,766 |
| 2) Deferred income taxes | (84,598) | 307,643 |
| 3) Stock-based compensation | 253,011 | 55,019 |
| 4) Gain on sale of property and equipment | (56,446) | (283,256) |
| 5) Change in receivables—net | 418,703 | 255,335 |
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Change in Prepaid Expenses 2
| 2016 | 2015 | |
| 6) Change in inventories | (492,913) | 417,442 |
| 7) Change in prepaid expenses | 74,283 | (72,340) |
| 8) Change in cash surrender value of insurance | 191,830 | (27,906) |
| 9) Change in other assets—other | 55,662 | 234,548 |
| 10) Change in accounts payable | (882,590) | (572,100) |
| 11) Change in accrued expenses | 136,950 | (931,885) |
| 12) Change in salary continuation plan | 7,368 | (105,124) |
| 13) Change in income tax receivable | 453,681 | (854,813) |
| Net cash provided by operating activities | $7,135,855 | $4,103,170 |
Source: Golden Enterprises Form 10-K for the year ended June 3, 2016.
This decrease represents cash payments for items such as insurance and rent that were less than the related accrual-basis expenses on the income statement.
The decrease in prepaid expenses must be added to net income as a reconciling item under the indirect method.
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Cash Surrender Value of Insurance 1
During 2016, the balance in Golden’s Cash surrender value of life insurance (C S V) account decreased by $191,830. Golden treats this as an operating source of cash.
Exhibit 20.3 Golden Enterprises, Inc., and Subsidiary Consolidated Statements of Cash Flows
For the Fiscal Years Ended June 3, 2016, and May 29, 2015
Reconciliation of Net Income to Net Cash Provided by Operating Activities
| 2016 | 2015 | |
| Net income | $3,184,803 | $1,773,841 |
| Adjustment to reconcile net income to net cash provided by operating activities: | ||
| 1) Depreciation | 3,876,111 | 3,906,766 |
| 2) Deferred income taxes | (84,598) | 307,643 |
| 3) Stock-based compensation | 253,011 | 55,019 |
| 4) Gain on sale of property and equipment | (56,446) | (283,256) |
| 5) Change in receivables—net | 418,703 | 255,335 |
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Cash Surrender Value of Insurance 2
| 2016 | 2015 | |
| 6) Change in inventories | (492,913) | 417,442 |
| 7) Change in prepaid expenses | 74,283 | (72,340) |
| 8) Change in cash surrender value of insurance | 191,830 | (27,906) |
| 9) Change in other assets—other | 55,662 | 234,548 |
| 10) Change in accounts payable | (882,590) | (572,100) |
| 11) Change in accrued expenses | 136,950 | (931,885) |
| 12) Change in salary continuation plan | 7,368 | (105,124) |
| 13) Change in income tax receivable | 453,681 | (854,813) |
| Net cash provided by operating activities | $7,135,855 | $4,103,170 |
Source: Golden Enterprises Form 10-K for the year ended June 3, 2016.
When the company pays the premiums on life insurance policies, the payment increases the cash surrender value of those policies.
When policies are terminated, the company receives cash from the insurance company.
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Change in Other Assets 1
During 2016, the balance in Golden’s Other assets account decreased by $55,662.
Exhibit 20.3 Golden Enterprises, Inc., and Subsidiary Consolidated Statements of Cash Flows
For the Fiscal Years Ended June 3, 2016, and May 29, 2015
Reconciliation of Net Income to Net Cash Provided by Operating Activities
| 2016 | 2015 | |
| Net income | $3,184,803 | $1,773,841 |
| Adjustment to reconcile net income to net cash provided by operating activities: | ||
| 1) Depreciation | 3,876,111 | 3,906,766 |
| 2) Deferred income taxes | (84,598) | 307,643 |
| 3) Stock-based compensation | 253,011 | 55,019 |
| 4) Gain on sale of property and equipment | (56,446) | (283,256) |
| 5) Change in receivables—net | 418,703 | 255,335 |
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Change in Other Assets 2
| 2016 | 2015 | |
| 6) Change in inventories | (492,913) | 417,442 |
| 7) Change in prepaid expenses | 74,283 | (72,340) |
| 8) Change in cash surrender value of insurance | 191,830 | (27,906) |
| 9) Change in other assets—other | 55,662 | 234,548 |
| 10) Change in accounts payable | (882,590) | (572,100) |
| 11) Change in accrued expenses | 136,950 | (931,885) |
| 12) Change in salary continuation plan | 7,368 | (105,124) |
| 13) Change in income tax receivable | 453,681 | (854,813) |
| Net cash provided by operating activities | $7,135,855 | $4,103,170 |
Source: Golden Enterprises Form 10-K for the year ended June 3, 2016.
This decrease means that cash payments for various items were less than the related accrual-basis expenses on the income statement.
The decrease in Other assets must be added to net income as a reconciling item under the indirect method.
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Change in Accounts Payable 1
During 2016, the balance in Golden’s Accounts payable account decreased by $882,590.
Thus, cash payments on account were greater than credit purchases on account by this amount.
Exhibit 20.3 Golden Enterprises, Inc., and Subsidiary Consolidated Statements of Cash Flows
For the Fiscal Years Ended June 3, 2016, and May 29, 2015
Reconciliation of Net Income to Net Cash Provided by Operating Activities
| 2016 | 2015 | |
| Net income | $3,184,803 | $1,773,841 |
| Adjustment to reconcile net income to net cash provided by operating activities: | ||
| 1) Depreciation | 3,876,111 | 3,906,766 |
| 2) Deferred income taxes | (84,598) | 307,643 |
| 3) Stock-based compensation | 253,011 | 55,019 |
| 4) Gain on sale of property and equipment | (56,446) | (283,256) |
| 5) Change in receivables—net | 418,703 | 255,335 |
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Change in Accounts Payable 2
| 2016 | 2015 | |
| 6) Change in inventories | (492,913) | 417,442 |
| 7) Change in prepaid expenses | 74,283 | (72,340) |
| 8) Change in cash surrender value of insurance | 191,830 | (27,906) |
| 9) Change in other assets—other | 55,662 | 234,548 |
| 10) Change in accounts payable | (882,590) | (572,100) |
| 11) Change in accrued expenses | 136,950 | (931,885) |
| 12) Change in salary continuation plan | 7,368 | (105,124) |
| 13) Change in income tax receivable | 453,681 | (854,813) |
| Net cash provided by operating activities | $7,135,855 | $4,103,170 |
Source: Golden Enterprises Form 10-K for the year ended June 3, 2016.
Because credit purchases are included as part of the Cost of goods sold on the income statement, this decrease in accounts payable represents the excess of cash outflows for inventory over the expense reported on the income statement.
The decrease in Accounts payable must be subtracted from net income as a reconciling item under the indirect method.
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Change in Accrued Expenses 1
During 2016, the balance in Golden’s Accrued expenses increased by $136,950.
Accrued expenses represent expenses for items such as salaries, wages, and interest incurred in the current period but not paid.
Exhibit 20.3 Golden Enterprises, Inc., and Subsidiary Consolidated Statements of Cash Flows
For the Fiscal Years Ended June 3, 2016, and May 29, 2015
Reconciliation of Net Income to Net Cash Provided by Operating Activities
| 2016 | 2015 | |
| Net income | $3,184,803 | $1,773,841 |
| Adjustment to reconcile net income to net cash provided by operating activities: | ||
| 1) Depreciation | 3,876,111 | 3,906,766 |
| 2) Deferred income taxes | (84,598) | 307,643 |
| 3) Stock-based compensation | 253,011 | 55,019 |
| 4) Gain on sale of property and equipment | (56,446) | (283,256) |
| 5) Change in receivables—net | 418,703 | 255,335 |
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Change in Accrued Expenses 2
| 2016 | 2015 | |
| 6) Change in inventories | (492,913) | 417,442 |
| 7) Change in prepaid expenses | 74,283 | (72,340) |
| 8) Change in cash surrender value of insurance | 191,830 | (27,906) |
| 9) Change in other assets—other | 55,662 | 234,548 |
| 10) Change in accounts payable | (882,590) | (572,100) |
| 11) Change in accrued expenses | 136,950 | (931,885) |
| 12) Change in salary continuation plan | 7,368 | (105,124) |
| 13) Change in income tax receivable | 453,681 | (854,813) |
| Net cash provided by operating activities | $7,135,855 | $4,103,170 |
Source: Golden Enterprises Form 10-K for the year ended June 3, 2016.
The outflow of cash was less than the expense reported on the income statement.
The increase in accrued expenses must be added to net income as a reconciling item under the indirect method.
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Change in Accrued Expenses 3
Golden’s balance sheet shows a net increase in current and noncurrent salary continuation liabilities of $7,368 for fiscal 2016.
These liability accounts increase each year for the present value of increased retirement benefits earned by key executives during the year and decrease when the cash payments made to retired executives during the year.
Exhibit 20.3 Golden Enterprises, Inc., and Subsidiary Consolidated Statements of Cash Flows
For the Fiscal Years Ended June 3, 2016, and May 29, 2015
Reconciliation of Net Income to Net Cash Provided by Operating Activities
| 2016 | 2015 | |
| Net income | $3,184,803 | $1,773,841 |
| Adjustment to reconcile net income to net cash provided by operating activities: | ||
| 1) Depreciation | 3,876,111 | 3,906,766 |
| 2) Deferred income taxes | (84,598) | 307,643 |
| 3) Stock-based compensation | 253,011 | 55,019 |
| 4) Gain on sale of property and equipment | (56,446) | (283,256) |
| 5) Change in receivables—net | 418,703 | 255,335 |
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Change in Accrued Expenses 4
| 2016 | 2015 | |
| 6) Change in inventories | (492,913) | 417,442 |
| 7) Change in prepaid expenses | 74,283 | (72,340) |
| 8) Change in cash surrender value of insurance | 191,830 | (27,906) |
| 9) Change in other assets—other | 55,662 | 234,548 |
| 10) Change in accounts payable | (882,590) | (572,100) |
| 11) Change in accrued expenses | 136,950 | (931,885) |
| 12) Change in salary continuation plan | 7,368 | (105,124) |
| 13) Change in income tax receivable | 453,681 | (854,813) |
| Net cash provided by operating activities | $7,135,855 | $4,103,170 |
Source: Golden Enterprises Form 10-K for the year ended June 3, 2016.
The net increase in these liability accounts implies that the cash payments for retirement benefits were less than the amount recognized as expense on the accrual-basis income statement.
The increase in Salary continuation plan must be added to net income as a reconciling item under the indirect method.
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Change in Accrued Income Taxes 1
During 2016, the balance in Golden’s Accrued income taxes payable account decreased by $453,681.
Exhibit 20.3 Golden Enterprises, Inc., and Subsidiary Consolidated Statements of Cash Flows
For the Fiscal Years Ended June 3, 2016, and May 29, 2015
Reconciliation of Net Income to Net Cash Provided by Operating Activities
| 2016 | 2015 | |
| Net income | $3,184,803 | $1,773,841 |
| Adjustment to reconcile net income to net cash provided by operating activities: | ||
| 1) Depreciation | 3,876,111 | 3,906,766 |
| 2) Deferred income taxes | (84,598) | 307,643 |
| 3) Stock-based compensation | 253,011 | 55,019 |
| 4) Gain on sale of property and equipment | (56,446) | (283,256) |
| 5) Change in receivables—net | 418,703 | 255,335 |
20-‹#›
© McGraw Hill
Indirect Method: Adjustment for Change in Accrued Income Taxes 2
| 2016 | 2015 | |
| 6) Change in inventories | (492,913) | 417,442 |
| 7) Change in prepaid expenses | 74,283 | (72,340) |
| 8) Change in cash surrender value of insurance | 191,830 | (27,906) |
| 9) Change in other assets—other | 55,662 | 234,548 |
| 10) Change in accounts payable | (882,590) | (572,100) |
| 11) Change in accrued expenses | 136,950 | (931,885) |
| 12) Change in salary continuation plan | 7,368 | (105,124) |
| 13) Change in income tax receivable | 453,681 | (854,813) |
| Net cash provided by operating activities | $7,135,855 | $4,103,170 |
Source: Golden Enterprises Form 10-K for the year ended June 3, 2016.
The decrease in Accrued income taxes liability accounts implies that Golden’s cash outflow for income taxes was less than its tax expense on the accrual-basis income statement.
The decrease in Accrued income taxes must be added to net income as a reconciling item under the indirect method.
20-‹#›
© McGraw Hill
Preparing the Cash Flow Statement
Information required to prepare the cash flow statement is gathered from:
An income statement (for the current year).
A comparative balance sheet (as of end of current and preceding year).
An analysis of the changes in balance sheet accounts.
T-accounts
Discussed in Chapter 4
Spreadsheet
Illustrated in Chapter 4 appendix
20-‹#›
© McGraw Hill
Cash Flow Statement Worksheet
Exhibit 20.5 Cash Flow Statement Worksheet
Burris Products Corporation
20-‹#›
© McGraw Hill
Cash Flow Statement: Indirect Method 1
Exhibit 20.6 20X1 Statement of Cash Flows
Burris Products Corporation
| Operating activities | ||
| Net income | $255,000 | |
| Adjustments to reconcile net income to net cash provided by operating activities | ||
| Depreciation | $158,000 | |
| Gain on equipment sale | (17,000) | |
| Amortization of bond discount | 4,000 | |
| Deferred income taxes increase | 6,000 | |
| Accounts receivable decrease | 9,000 | |
| Customer advance deposits decrease | (11,000) | |
| Inventory increase | (12,000) | |
| Accounts payable increase | 3,000 | |
| 140,000 | ||
| Net cash provided by operating activities | 365,000 |
20-‹#›
© McGraw Hill
Cash Flow Statement: Indirect Method 2
| Investing activities | ||
| Equipment sale | 57,000 | |
| Land purchase | (86,000) | |
| Buildings and equipment purchase | (261,000) | |
| Net cash used for investing activities | (290,000) | |
| Financing activities | ||
| Common stock issued | 50,000 | |
| Dividend paid | (90,000) | |
| Net cash used for financing activities | (40,000) | |
| Net increase in cash | $ 35,000 |
20-‹#›
© McGraw Hill
Investing & Financing Activities Section of Cash Flow Statement
Exhibit 20.9 Amazon.com, Inc., Consolidated Statements of Cash Flows
| INVESTING ACTIVITIES: | |||
| Purchases of property and equipment, including internal-use software and website development | (5,387) | (7,804) | (11,955) |
| Proceeds from property and equipment incentives | 798 | 1,067 | 1,897 |
| Acquisitions, net of cash acquired, and other | (795) | (116) | (13,972) |
| Sales and maturities of marketable securities | 3,025 | 4,733 | 9,988 |
| Purchases of marketable securities | (4,091) | (7,756) | (13,777) |
| Net cash provided by (used in) investing activities | (6,450) | (9,876) | (27,819) |
| FINANCING ACTIVITIES: | |||
| Proceeds from long-term debt and other | 353 | 621 | 16,231 |
| Repayments of long-term debt and other | (1,652) | (354) | (1,372) |
| Principal repayments of capital lease obligations | (2,462) | (3,860) | (4,799) |
| Principal repayments of finance lease obligations | (121) | (147) | (200) |
| Net cash provided by (used in) financing activities | (3,882) | (3,740) | 9,860 |
| Foreign currency effect on cash and cash equivalents | (374) | (212) | 713 |
| Net increase (decrease) in cash and cash equivalents | 1,333 | 3,444 | 1,188 |
| CASH AND CASH EQUIVALENTS, END OF PERIOD | $15,890 | $19,334 | $ 20,522 |
20-‹#›
© McGraw Hill
Reconciliation Between Statements: Some Complexities
Changes in balance sheet accounts from one year to the next often do not correspond directly into the corresponding account changes reported in the statement of cash flows.
Reasons for these apparent differences between amounts on the balance sheet and in the cash flow statement:
Asset write-offs and impairments.
Asset retirements and reclassifications to assets held for sale.
Foreign currency translation adjustments.
Acquisitions of other companies.
Simultaneous noncash financing and investing activities.
20-‹#›
© McGraw Hill
Asset Write-Offs and Impairments
A write-down will occur when inventory become obsolete, which causes a reduction in inventory balances other than from sales.
The Inventory account must be analyzed.
Net Cash Flows from Operating Activities (Indirect Method)
Adjustment for write-down in inventory adds back this non-cash expense to net income.
Adjustment for change in inventory account converts accrual-basis Cost of goods sold on the income statement to cash payments for inventory.
20-‹#›
© McGraw Hill
Asset Retirements and Reclassifications to Assets Held for Sale 1
The P P&E and Accumulated depreciation accounts must be analyzed.
A company might sell or retire fixed asses that were not fully depreciated at a gain or loss.
A write-down may occur when property, plant, and equipment (P P&E) is impaired.
A reclassification may occur when P P&E are reclassified to assets held for sale.
Net Cash Flows from Operating Activities (Indirect Method)
Adjustment for impairment adds back this non-cash expense to net income.
Adjustment for gains subtracts this non-cash addition from net income (because the gain is reflected as part of the cash proceeds from the sale in the investing activities section).
Adjustment for loss adds this non-cash subtraction back to net income (because the loss is reflected as part of the cash proceeds from the sale in the investing activities section).
20-‹#›
© McGraw Hill
Asset Retirements and Reclassifications to Assets Held for Sale 2
Investing Activities
Cash outflows for purchases of P P&E.
Cash inflows resulting from sales of P P&E.
20-‹#›
© McGraw Hill
Simultaneous Noncash Financing and Investing Activities 1
Occasionally firms engage in investing and financing activities that cause changes in balance sheet asset and liability accounts even though they do not affect cash receipts or cash payments.
The amounts are not included in the investing and financing sections of the cash flow statement because the transactions.
Examples:
Purchasing a building by incurring a mortgage loan to the seller.
Acquiring an asset by entering into a capital lease.
Issuing stock for noncash assets in connection with a business acquisition.
G A A P requires firms to disclose these noncash simultaneous financing and investing activities in a narrative or in a schedule.
20-‹#›
© McGraw Hill
Simultaneous Noncash Financing and Investing Activities 2
| Supplemental Cash Flow Information: | |||
| Cash paid for interest on long-term debt | $ 325 | $290 | $ 328 |
| Cash paid for interest on capital and finance lease obligations | 153 | 206 | 319 |
| Cash paid for income taxes, net of refunds | 273 | 412 | 957 |
| Property and equipment acquired under capital leases | 4,717 | 5,704 | 9,637 |
| Property and equipment acquired under build-to-suit leases | 544 | 1,209 | 3,541 |
Source: Amazon.com, Inc., Form 10-K for the fiscal year ended December 31, 2017.
20-‹#›
© McGraw Hill
Analytical Insights: Ways Operating Cash Flows Can Be Distorted or Manipulated 1
Operating cash flows may be distorted or “legitimately” managed.
Changes in working capital account.
Accelerate the collection of receivables in the current period or delay the payment of accrued expenses and accounts payable until after period-end.
Accounts receivable sale versus collateralized borrowing.
Classifying receivables sales as operating cash inflows may provide a potentially misleading picture of sustainable cash flows from current operations because the outright sale or securitization of accounts receivable transfers what would be future operating cash flows into the current period.
Capitalizing versus expensing.
Costs that should be expensed might be capitalized, which permanently boosts operating cash flow.
Amounts capitalized are later expensed as depreciation or amortization, which are noncash income statement deductions that do not reduce cash flow from operations.
20-‹#›
© McGraw Hill
Analytical Insights: Ways Operating Cash Flows Can Be Distorted or Manipulated 2
Other examples of ways that operating cash flows may be distorted or “legitimately” managed.
Software development costs.
Computer software companies must expense all software development costs as incurred until the software reaches “technological feasibility.”
By selecting a low threshold for technological feasibility, firms can move software development cash outflows out of the operating section and into the investing section.
Finance versus operating leases.
Even under the new standard (generally effective in 2019), the reporting of lease payments on the cash flows statement differs:
Operating leases – Lease payment is classified as an operating cash flow.
Finance leases – Amount of lease payment attributable to interest is an operating cash flow whereas the amount attributable to principal reduction will be classified as a financing cash flow.
20-‹#›
© McGraw Hill
Analytical Insights: Ways Operating Cash Flows Can Be Distorted or Manipulated 3
Other examples of ways that operating cash flows may be distorted or “legitimately” managed.
Cash flow effect of stock-based compensation.
The main way in which operating cash flows can be misleading due to stock options is because the stock-based compensation expense, which can be thought of as a simultaneous operating and financing transaction, does not appear in the cash flow statement.
20-‹#›
© McGraw Hill
Global Vantage Point 1
Like U.S. G A A P, I F R S encourages, but does not require the direct method.
Unlike under U.S. G A A P, I F R S firms using the direct method are not required to provide a reconciliation of net income to cash flows from operating activities.
Restricted cash is included in cash under U.S. G A A P. Under I F R S, restricted cash must meet the definition of cash and equivalents in order to be treated as cash in the S O C F.
I F R S permits to include bank overdrafts repayable on demand as a (negative) component of cash and cash equivalents.
U.S. G A A P requires overdrafts to be considered borrowing. Changes in overdraft balances are classified as a financing activity.
20-‹#›
© McGraw Hill
Global Vantage Point 2
I F R S permits more flexibility in classification of certain cash flow items.
| U.S. G A A P | I F R S | |
| Interest and dividends received | Operating cash flow | May be classified as either operating or investing. • 36% of surveyed companies classify interest received as investing. • 40% classify dividends received as investing. |
| Interest paid | Operating cash flow | May be classified as either operating or financing. • 29% of surveyed companies classify interest paid as financing. |
| Income taxes | Operating cash flow (including tax effects of investing and financing items) | Classified as operating unless components can be specifically identified with an investing or financing item. • 100% of surveyed companies classify income taxes paid as operating. |
| Dividends paid | Financing cash flow | May be classified as either operating or financing. • 97% of surveyed companies classify dividends paid as financing. |
20-‹#›
© McGraw Hill
Summary 1
The statement of cash flows provides information for assessing a firm’s ability to generate sufficient cash to pay for operating expenses, capital improvements, and currently maturing obligations.
Firms able to generate consistently strong positive cash flows from operations are considered better credit risks and benefit from a lower cost of capital.
The two alternative methods for presenting the operating activities section of a cash flow statement are the direct and indirect methods.
Most firms use the indirect method. It begins with net income and adjusts for depreciation, amortization, noncash gains and losses, and changes in noncash working capital accounts other than short-term debt, which cause net income to differ from operating cash flows for the period.
20-‹#›
© McGraw Hill
Summary 2
You will frequently encounter situations in which the changes in noncash accounts shown on comparative balance sheets will not reconcile with the adjustments shown on the cash flow statement. These discrepancies are due to one or more of the following causes: (1) asset write-offs and impairments, (2) asset retirements and reclassifications to assets held for sale, (3) foreign currency translation adjustments, (4) acquisitions of other companies, and (5) simultaneous noncash financing and investing activities. Failure to understand how these events cause balance sheet account changes to differ from changes in account balances shown on the cash flow statement can lead to incorrect interpretation of both statements.
20-‹#›
© McGraw Hill
Summary 3
Operating cash flows can sometimes be distorted or legitimately managed. You should be aware of the ways this can occur and how to adjust reported operating cash flows to enhance the comparability of this important number across firms and over time.
I F R S rules allow firms greater flexibility relative to U.S. G A A P in how interest and dividends received and interest and dividends paid are reported on the statement of cash flows.
20-‹#›
© McGraw Hill
Accessibility Content: Text Alternatives for Images
20-‹#›
© McGraw Hill
Overview of the Indirect Method – Text Alternative
Return to parent-slide containing images.
Accrual-basis net income is at the top. This leads down to: Items included in accrual-basis net income that did not affect cash in the period. Here one subtracts any Non-cash revenues and gains and adds any Non-cash expenses and losses. Then the flowchart moves on down to: Items excluded from accrual-basis net income that did affect operating cash in the period. Here are added any Cash inflows received but not recognized as earned and subtracted any Cash outflows paid but not recognized for accrual purposes. This all tallies to Net cash flows from operating activities.
20-‹#›
© McGraw Hill
Cash Flow Statement Worksheet – Text Alternative
Return to parent-slide containing images.
Row 1 are balances on December 31, 20X0, as follows: Cash, 33; Accounts Receivable, 180, Inventory, 295; Land, 250; Buildings and Equipment, 1,430; Accumulated Depreciation, (518); Accounts Payable, (160); Customer Advance Deposits, (110); Bonds Payable, (500); Discount on Bonds Payable, 70; Deferred Tax Liability, (94); Common Stock, (800), Retained Earnings, (76).
Adjustments include accounts receivable decrease of (9), inventory increase of 12, land purchase of 86, gain on equipment sale of 17 and equipment sale of (80), depreciation of (158) and equipment sale of 23, accounts payable increase of (3), customer advance deposits increase of 11, amortization of bond discount of (4), deferred income taxes increase of (6), common stock issues (50), net income of (225), and dividends paid of 90.
Next to last row includes balances on December 31, 20X1, as follows: Cash, 68; Accounts Receivable, 171, Inventory, 307; Land, 336; Buildings and Equipment, 1,628; Accumulated Depreciation, (653); Accounts Payable, (163); Customer Advance Deposits, (99); Bonds Payable, (500); Discount on Bonds Payable, 70; Deferred Tax Liability, 66; Common Stock, (850), Retained Earnings, (211). Final row shows Reconciled, but all entries are zero.
20-‹#›
© McGraw Hill
