Financial Accounting
IFRS 4th Edition
Weygandt ● Kimmel ● Kieso
Chapter 14
Statement of Cash Flows
Chapter Outline
Learning Objectives
LO 1 Discuss the usefulness and format of the statement
of cash flows.
LO 2 Prepare a statement of cash flows using the
indirect method.
LO 3 Analyze the statement of cash flows.
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Learning Objective 1
Discuss the Usefulness and Format of
the Statement of Cash Flows
LO 1
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Usefulness and Format
Statement of Cash Flows provides information to help
assess:
1. Entity’s ability to generate future cash flows.
2. Entity’s ability to pay dividends and meet
obligations.
3. Reasons for difference between net income and
net cash provided (used) by operating activities.
4. Cash investing and financing transactions during
the period.
LO 1
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Classification of Cash Flows (1 of 4)
Operating
Activities
Income
Statement
Activities
LO 1
Investing
Activities
Financing
Activities
Changes in
Investments
and Noncurrent
Assets
Changes in
Non-current
Liabilities
and 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.
LO 1
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Classification of Cash Flows (3 of 4)
Investing activities—Changes in investments and noncurrent 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.
LO 1
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Classification of Cash Flows (4 of 4)
Financing activities—Changes in non-current liabilities
and equity
Cash inflows:
From sale of ordinary shares.
From issuance of long-debt (bonds and notes).
Cash outflows:
To shareholders as dividends.
To redeem long-term debt or reacquire
ordinary shares (treasury shares).
LO 1
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Significant Non-Cash Activities
1.
2.
3.
4.
Direct issuance of ordinary shares to purchase assets.
Conversion of bonds into ordinary shares.
Direct issuance of debt to purchase assets.
Exchanges of plant assets.
Companies report significant financing and investing activities that
do not affect cash in either a
• Supplementary schedule (bottom on the statement) or
• Separate note to the financial statements.
LO 1
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Format of the Statement of Cash Flows
Order of Presentation:
1. Operating activities.
2. Investing activities.
3. Financing activities.
LO 1
Direct Method
Indirect Method
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Format of the Statement of Cash Flows
COMPANY NAME
Statement of Cash Flows
For the Period Covered
Cash flows from operating activities
(List of individual items)
XX
Net cash provided (used) by operating activities
XXX
Cash flows from investing activities
(List of individual inflows and outflows)
XX
Net cash provided (used) by investing activities
XXX
Cash flows from financing activities
(List of individual inflows and outflows)
Net cash provided (used) by financing activities
XX
XXX
Net increase (decrease) in cash
XXX
Cash at beginning of period
XXX
Cash at end of period
XXX
Note xx
Non-cash investing and financing activities
XXX
(List of individual non-cash transactions)
LO 1
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DO IT! 1: Usefulness and Format
Classify each of these transactions by type of cash flow activity.
Hu Na Ltd. had these transactions:
1.
Issued 100,000 HK$50 par value ordinary shares
for HK$8,000,000 cash.
2.
Borrowed HK$2,000,000 from Castle Bank, signing
a 5-year note bearing 8% interest.
3.
Purchased two semi-trailer trucks for
HK$1,700,000 cash.
4.
Paid employees HK$120,000 for salaries and
wages.
5.
Collected HK$200,000 cash for services performed.
LO 1
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Learning Objective 2
Prepare a Statement of Cash Flows
Using the Indirect Method
LO 2
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Preparing the Statement of Cash Flows
Three sources of information:
1. Comparative statements of financial position
2. Current income statement
3. Additional information
LO 2
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Preparing the Statement of Cash Flows
Three Major Steps:
LO 2
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Preparing the Statement of Cash Flows
Three Major Steps:
LO 2
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Preparing the Statement of Cash Flows
Three Major Steps:
LO 2
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Indirect and Direct Methods
Companies must convert net income from an accrual
basis to a cash basis using either of two methods.
1. Indirect method adjusts net income for items that
do not affect cash.
2. Direct method shows operating cash receipts and
payments.
LO 2
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Indirect and Direct Methods
Companies favor the indirect method for two
reasons:
1. Easier and less costly to prepare.
2. Focuses on differences between net income and
net cash flow from operating activities
LO 2
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Indirect Method Illustrated
Computer Services International
Comparative Statements of Financial Position
December 31
Assets
Property, plant, and equipment
Land
2020
Change in
Account Balance
Increase/Decrease
2019
€ 130,000
€ 20,000
€110,000
Increase
Buildings
160,000
40,000
120,000
Increase
Accumulated depreciation—buildings
(11,000)
(5,000)
6,000
Increase
Equipment
27,000
10,000
17,000
Increase
Accumulated depreciation—equipment
(3,000)
(1,000)
2,000
Increase
5,000
1,000
4,000
Increase
Inventory
15,000
10,000
5,000
Increase
Accounts receivable
20,000
30,000
10,000
Decrease
Cash
55,000
33,000
22,000
Increase
€398,000
€138,000
Current assets
Prepaid expenses
Total assets
LO 2
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Indirect Method Illustrated
Computer Services International
Comparative Statements of Financial Position
December 31
Equity and Liabilities
2020
2019
Change in
Account Balance
Increase/Decrease
€ 70,000
€ 50,000
€ 20,000 Increase
164,000
48,000
116,000 Increase
130,000
20,000
110,000 Increase
28,000
12,000
16,000 Increase
6,000
8,000
€398,000
€138,000
Equity
Share capital—ordinary
Retained earnings
Non-current liabilities
Bonds payable
Current liabilities
Accounts payable
Income taxes payable
Total equity and liabilities
LO 2
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2,000 Decrease
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Indirect Method Illustrated
Computer Services International
Income Statement
For the Year Ended December 31, 2020
€507,000
Sales revenue
Cost of goods sold
€150,000
Operating expenses (excluding depreciation)
111,000
Depreciation expense
9,000
Loss on disposal of plant assets
3,000
Interest expense
42,000
Income before income tax
192,000
Income tax expense
47,000
Net income
LO 2
315,000
€145,000
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Indirect Method Illustrated
Additional information for 2020:
1. Depreciation expense was comprised of €6,000 for building and
€3,000 for equipment.
2. The company sold equipment with a book value of €7,000 (cost
€8,000, less accumulated depreciation €1,000) for €4,000 cash.
3. Issued €110,000 of long-term bonds in direct exchange for land.
4. A building costing €120,000 was purchased for cash. Equipment
costing €25,000 was also purchased for cash.
5. Issued ordinary shares for €20,000 cash.
6. The company declared and paid a €29,000 cash dividend.
LO 2
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Step 1: Operating Activities
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 non-cash expenses (depreciation and amortization
expense).
• Deduct gains and add losses that resulted from investing and
financing activities.
• Analyze changes to non-cash current asset and current liability
accounts.
LO 2
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Step 1: Operating Activities (1 of 2)
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 issuance of ordinary
shares.
c. Payment of cash dividends to the company’s
shareholders.
d. None of the above.
LO 2
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Step 1: Operating Activities (2 of 2)
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 issuance of ordinary
shares.
c. Payment of cash dividends to the company’s
shareholders.
d. None of the above.
LO 2
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Step 1: 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:
Net income
€ 145,000
Adjustments to reconcile net income to net cash provided by
operating activities:
9,000
Depreciation expense
Net cash provided by operating activities
LO 2
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€ 154,000
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Step 1: Loss on Disposal of Plant Assets
(1 of 2)
Companies should report cash received from the sale
(disposal) of plant assets in the investing activities
section. Therefore,
• any loss on sale is added to net income in the
operating section.
• any gain on sale is deducted from net income in the
operating section.
LO 2
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Step 1: Loss on Disposal of Plant Assets
(2 of 2)
Cash flows from operating activities:
Net income
€ 145,000
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense
€9,000
Loss on disposal of plant assets
Net cash provided by operating activities
LO 2
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3,000
12,000
€ 157,000
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Step 1: Changes to Non-Cash Current
Asset Accounts (1 of 4)
To arrive at net cash provided by operating activities
• Deduct from net income increases in current asset
accounts.
• Add to net income decreases in current asset
accounts.
LO 2
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Step 1: Changes to Non-Cash Current
Asset Accounts (2 of 4)
When the Accounts Receivable balance decreases, cash receipts
are higher than sales revenue.
Accounts Receivable
1/1/20 Balance
Sales revenue
12/31/20 Balance
30,000 Receipts from customers
517,000
507,000
20,000
The company adds to net income the amount of the decrease in
accounts receivable.
LO 2
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Step 1: Changes to Non-Cash Current
Asset Accounts (3 of 4)
When the Inventory balance increases, the cost of merchandise
purchased exceeds the cost of goods sold. Cost of goods sold does
not reflect cash payments made for merchandise.
The company deducts from net income the inventory increase.
When the Prepaid Expense balance increases, the cash paid for
expenses is higher than expenses reported on an accrual basis.
The company deducts from net income the prepaid expense
increase.
LO 2
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Step 1: Changes to Non-Cash Current
Asset Accounts (4 of 4)
Cash flows from operating activities:
Net income
€ 145,000
Adjustments to reconcile net income to net
cash provided by operating activities:
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
LO 2
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13,000
€ 158,000
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Step 1: Changes to Non-Cash Current
Liability Accounts (1 of 3)
To arrive at net cash provided by operating activities
• Deduct from net income decreases in current
liability accounts.
• Add to net income increases in current liability
accounts.
LO 2
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Step 1: Changes to Non-Cash Current
Liability Accounts (2 of 3)
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.
LO 2
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Step 1: Changes to Non-Cash Current
Liability Accounts (3 of 3)
Cash flows from operating activities:
Net income
€ 145,000
Adjustments to reconcile net income to net cash
provided by operating activities:
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
LO 2
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27,000
€ 172,000
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Summary of Conversion to Net Cash Provided by
Operating Activities—Indirect Method
Adjustments Required to Convert
Net Income to Net Cash Provided
by Operating Activities
Non-Cash Charges
Gains and Losses
Changes in Current Assets and
Current Liabilities
LO 2
Depreciation expense
Add
Patent amortization expense
Add
Loss on disposal of plant assets
Add
Gain on disposal of plant assets
Deduct
Increase in current asset account
Deduct
Decrease in current asset account
Add
Increase in current liability account
Add
Decrease in current liability
account
Deduct
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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 2020.
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 statements of financial position show the following
balances.
Accounts receivable
Accounts payable
12/31/19
12/31/20
₤17,000
₤21,000
6,000
2,200
Calculate net cash provided by operating activities for Josh’s
PhotoPlus.
LO 2
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DO IT! 2a: Net Cash Provided by
Operating Activities (2 of 2)
Cash flows from operating activities
Net income
₤73,000
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation expense
₤ 7,000
Gain on disposal of plant assets
(2,500)
Increase in accounts receivable
(4,000)
Decrease in accounts payable
(3,800)
Net cash provided by operating activities
LO 2
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(3,300)
₤69,700
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Step 2: Investing and Financing Activities
Analyze Changes in Non-Current Asset and Liability Accounts
and Record as Investing and Financing Activities, or Disclose as
Non-Cash Transactions.
• The company purchased land of €110,000 by issuing long-term
bonds. This is a significant non-cash investing and financing
activity that merits disclosure in a separate schedule.
• The additional information indicates the company acquired a
building for €120,000 cash. This is a cash outflow reported in
the investing section.
LO 2
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Step 2: Investing and Financing Activities
The additional information explains that the €17,000 net increase in equipment
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
1/1/20 Balance
10,000 Cost of equipment sold
Purchase of equipment
12/31/20 Balance
LO 2
8,000
25,000
27,000
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Step 2: Investing and Financing Activities
The following journal entry shows details of the sale of equipment transaction.
Cash
4,000
Accumulated Depreciation—Equipment
1,000
Loss on Disposal of Plant Assets
3,000
Equipment
LO 2
8,000
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Step 2: Investing and Financing Activities
• The company increased Share Capital—Ordinary by issuing
shares of stock for €20,000. This is a cash inflow reported in
the financing activities section of the Statement of Cash Flows.
• The additional information indicates that net income of
€145,000 increased retained earnings, and this is included in the
operating activities section.
• The company paid dividends of €29,000. The decrease in
retained earnings is a cash outflow that is reported in the
financing activities section.
LO 2
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Step 2: Investing and Financing
Activities: Statement of Cash Flows
Cash flows from investing activities:
Purchase of building
(120,000)
Purchase of equipment
(25,000)
Disposal of plant assets
4,000
Net cash used by investing activities
(141,000)
Cash flows from financing activities:
Issuance of ordinary shares
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
Note 1
Non-cash investing and financing activities
Issuance of bonds payable to purchase land
LO 2
€ 110,000
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Step 3: Net Change in Cash
Compare the beginning and ending cash balances on the Statement of Financial Position
with those on the Statement of Cash Flows and be sure they agree.
Partial Comparative Statements of Financial Position
2020
Prepaid Expenses
2019
5,000
1,000
Inventory
15,000
10,000
Accounts receivable
20,000
30,000
Cash
55,000
33,000
€ 398,000
€ 398,000
Total assets
Partial Statement of Cash Flows
Net increase in cash
22,000
Cash at beginning of period
33,000
Cash at end of period
LO 2
€ 55,000
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DO IT! 2b: Indirect Method (1 of 4)
Use the following Comparative Statements of Financial Position, Income Statement, and
additional information to prepare a statement of cash flows using the indirect method.
Additional information (all amounts in thousands of NT$):
1.
Operating expenses include depreciation expense of NT$33,000.
2.
Equipment with a cost of NT$41,000 and a book value of NT$36,000 was sold for
NT$34,000 cash.
3.
Land was sold at its book value for cash.
4.
Interest expense of NT$12,000 was paid in cash.
5.
Equipment with a cost of NT$166,000 was purchased for cash.
6.
Bonds of NT$10,000 were redeemed at their face value for cash.
7.
Ordinary shares (NT$1 par) of NT$130,000 were issued for cash.
8.
Cash dividends of NT$55,000 were declared and paid in 2020.
9.
Ordinary shares of NT$30,000 were issued in exchange for land.
LO 2
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DO IT! 2b: Indirect Method (2 of 4)
Dragon Ltd.
Comparative Statements of Financial Position
December 31
(NT$ in thousands)
Assets
Change in
Account Balance
Increase/Decrease
2020
2019
NT$ 75,000
NT$ 70,000
Buildings
200,000
200,000
Accumulated depreciation—buildings
(21,000)
(11,000)
10,000
Increase
Equipment
193,000
68,000
125,000
Increase
Accumulated depreciation—equipment
(28,000)
(10,000)
18,000
Increase
4,000
6,000
2,000
Decrease
Inventory
54,000
-0-
54,000
Increase
Accounts receivable
68,000
26,000
42,000
Increase
Cash
54,000
37,000
17,000
Increase
NT$599,000
NT$386,000
Land
Prepaid expenses
Totals
LO 2
€5,000
Increase
-0-
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DO IT! 2b: Indirect Method (3 of 4)
Dragon Ltd.
Comparative Statements of Financial Position
December 31
(NT$ in thousands)
Equity and Liabilities
Share capital—ordinary (NT$1 par)
2020
2019
Change in
Account Balance
Increase/Decrease
NT$220,000
NT$ 60,000
NT$ 160,000
Increase
Retained earnings
206,000
136,000
70,000
Increase
Bonds payable
140,000
150,000
10,000
Decrease
Accounts payable
23,000
40,000
17,000
Decrease
Accrued expenses payable
10,000
10,000
Increase
Totals
LO 2
NT$599,000
-0NT$386,000
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DO IT! 2b: Indirect Method (4 of 4)
Dragon Ltd.
Income Statement
For the Year Ended December 31, 2020
(NT$ in thousands)
NT$ 890,000
Sales revenue
Cost of goods sold
Operating expenses
Interest expense
Loss on disposal of plant assets
NT$465,000
221,000
12,000
2,000
Income before income taxes
190,000
Income tax expense
65,000
Net income
LO 2
700,000
NT$125,000
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DO IT! 2b: Solution (1 of 2)
Dragon Ltd.
Statement of Cash Flows—Indirect Method
For the Year Ended December 31, 2020
(NT$ in thousands)
Cash flows from operating activities:
Net income
NT$125,000
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation expense
NT$33,000
Loss on disposal of plant assets
2,000
Increase in accounts receivable
(42,000)
Increase in inventory
(54,000)
Decrease in prepaid expenses
2,000
Decrease in accounts payable
(17,000)
Increase in accrued expenses payable
Net cash provided by operating activities
LO 2
10,000
(66,000)
59,000
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DO IT! 2b: Solution (2 of 2)
Dragon Ltd.
Statement of Cash Flows—Indirect Method
For the Year Ended December 31, 2020
(NT$ in thousands)
Cash flows from investing activities:
Sale of land
25,000
Disposal of plant assets
34,000
Purchase of equipment
(166,000)
Net cash used by investing activities
(107,000)
Cash flows from financing activities:
Redemption of bonds
(10,000)
Sale of ordinary shares
130,000
Payment of dividends
(55,000)
Net cash provided by financing activities
65,000
Net increase in cash
17,000
Cash at beginning of period
37,000
Cash at end of period
NT$54,000
Note 1
Non-cash investing and financing activities
Issued ordinary shares in exchange for land
LO 2
NT$30,000
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Learning Objective 3
Analyze the Statement of Cash Flows
LO 3
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Using Cash Flows to Evaluate a Company
Free cash flow describes the net cash provided by operating
activities after adjustment for capital expenditures and dividends.
Free Cash
=
Flow
LO 3
Net Cash Provided by
Operating Activities
–
Capital
Expenditures
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–
Cash Dividends
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Using Cash Flows to Evaluate a Company
Illustration (1 of 2)
Anheuser-Busch InBev
Statement of Cash Flows (partial)
Cash provided by operating activities
$17,451
Cash flows from investing activities
Additions to property and equipment and intangibles
$ (3,869)
Purchases of non-controlling interests
Sale of property, plant, and equipment
Acquisitions of companies
4,002
(17,439)
Other
7,124
Cash used by investing activities
(10,281)
Cash paid for dividends
LO 3
(99)
(6,253)
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Using Cash Flows to Evaluate a Company
Illustration (2 of 2)
The company generated a significant amount of cash from its
operations, but it spent most of it to buy property, plant, and
equipment, and to pay dividends.
LO 3
Cash provided by operating activities
$ 17,451
Less: Expenditures on property and equipment
Dividends paid
Free cash flow
3,869
6,253
$ 7,329
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DO IT! 3: Free Cash Flow
Luó Ltd. issued the following statement of cash flows for 2020. (a) Compute
free cash flow for Luó. (b) Explain why free cash flow often provides better
information than “Net cash provided by operating activities.”
Luó Ltd.
Statement of Cash Flows—Indirect Method
For the Year Ended December 31, 2020
(¥ in thousands)
Cash flows from operating activities:
Net income
¥19,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense
¥8,100
Loss on disposal of plant assets
1,300
Decrease in accounts receivable
6,900
Increase in inventory
(4,000)
Decrease in accounts payable
(2,000)
Net cash provided by operating activities
LO 3
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10,300
29,300
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DO IT! 3: Free Cash Flow Solution (1 of 2)
Luó Ltd.
Statement of Cash Flows—Indirect Method
For the Year Ended December 31, 2020
(¥ in thousands)
Cash flows from investing activities:
Sale of investments
Purchase of equipment
1,100
(19,000)
Net cash used by investing activities
(17,900)
Cash flows from financing activities:
Issuance of ordinary shares
10,000
Payment on long-term note payable
(5,000)
Payment of dividends
(9,000)
Net cash used by financing activities
(4,000)
Net increase in cash
7,400
Cash at beginning of year
Cash at end of year
LO 3
10,000
¥ 17,400
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DO IT! 3: Free Cash Flow Solution (2 of 2)
a. Free cash flow (¥ in thousands) = ¥29,300 - ¥19,000 - ¥9,000 =
¥1,300.
b. Net cash provided by operating activities fails to take into
account that a company must invest in new plant assets just to
maintain the current level of operations. Companies must also
maintain dividends at current levels to satisfy investors. The
measurement of free cash flow provides additional insight
regarding a company’s cash-generating ability.
LO 3
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Learning Objective 4
Prepare a Statement of Cash Flows
Using the Direct Method
LO 4
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Statement of Cash Flows – Direct
Method
1. Compute net cash provided by operating activities
by adjusting each item in the income statement
from the accrual basis to the cash basis.
2. Companies report only major classes of operating
cash receipts and cash payments.
3. For these major classes, the difference between
cash receipts and cash payments is the net cash
provided by operating activities.
LO 4
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Direct Method Illustrated
Computer Services International
Comparative Statements of Financial Position
December 31
Assets
Property, plant, and equipment
Land
2020
Change in
Account Balance
Increase/Decrease
2019
€ 130,000
€ 20,000
€110,000
Increase
Buildings
160,000
40,000
120,000
Increase
Accumulated depreciation—buildings
(11,000)
(5,000)
6,000
Increase
Equipment
27,000
10,000
17,000
Increase
Accumulated depreciation—equipment
(3,000)
(1,000)
2,000
Increase
5,000
1,000
4,000
Increase
Inventory
15,000
10,000
5,000
Increase
Accounts receivable
20,000
30,000
10,000
Decrease
Cash
55,000
33,000
22,000
Increase
€398,000
€138,000
Current assets
Prepaid expenses
Total assets
LO 4
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Direct Method Illustrated
Computer Services International
Comparative Statements of Financial Position
December 31
Equity and Liabilities
2020
2019
Change in
Account Balance
Increase/Decrease
€ 70,000
€ 50,000
€ 20,000 Increase
164,000
48,000
116,000 Increase
130,000
20,000
110,000 Increase
28,000
12,000
16,000 Increase
6,000
8,000
€398,000
€138,000
Equity
Share capital—ordinary
Retained earnings
Non-current liabilities
Bonds payable
Current liabilities
Accounts payable
Income taxes payable
Total equity and liabilities
LO 4
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2,000 Decrease
62
Direct Method Illustrated
Computer Services International
Income Statement
For the Year Ended December 31, 2020
€507,000
Sales revenue
Cost of goods sold
€150,000
Operating expenses (excluding depreciation)
111,000
Depreciation expense
9,000
Loss on disposal of plant assets
3,000
Interest expense
42,000
Income before income tax
192,000
Income tax expense
47,000
Net income
LO 4
315,000
€145,000
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Direct Method Illustrated
Additional information for 2020:
1. Depreciation expense was comprised of €6,000 for building and
€3,000 for equipment.
2. The company sold equipment with a book value of €7,000 (cost
€8,000, less accumulated depreciation €1,000) for €4,000 cash.
3. Issued €110,000 of long-term bonds in direct exchange for land.
4. A building costing €120,000 was purchased for cash. Equipment
costing €25,000 was also purchased for cash.
5. Issued ordinary shares for €20,000 cash.
6. The company declared and paid a €29,000 cash dividend.
LO 4
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Step 1: Operating Activities
Determine Net Cash Provided/Used by Operating Activities by
Converting Net Income from Accrual Basis to Cash Basis.
• Companies simplify and condense the operating activities
section of the Cash Flow Statement by reporting only major
classes of operating cash receipts and cash payments.
• Companies deduct cash payments from cash receipts to arrive at
the net cash provided by operating activities.
• An efficient way to apply the direct method is to analyze the
items reported in the income statement in the order in which
they are listed.
LO 4
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Step 1: Operating Activities
LO 4
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Step 1: Cash Receipts from Customers
(1 of 2)
A company must consider the change in accounts
receivable to determine how much of revenue was
from cash receipts.
When revenues on an accrual basis are higher than
cash receipts, accounts receivable increases. The
company deducts the increase from sales revenue.
When accounts receivable decreases, the company
adds the decrease to sales revenue.
LO 4
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Step 1: Cash Receipts from Customers
(2 of 2)
For Computer Services, accounts receivable decreased
€10,000.
Cash Receipts
from
Customers
LO 4
=
Sales Revenue
+ Decrease in Accounts Receivable
or
- Increase in Accounts Receivable
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Step 1: Cash Payments to Suppliers (1 of 3)
A company must calculate purchases for the year to
determine how much of cash was paid to suppliers.
When inventory increases, purchases have exceeded
cost of goods sold.
Cost of Goods Sold
Add: Increase in inventory
Purchases
LO 4
€150,000
5,000
€155,000
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Step 1: Cash Payments to Suppliers (2 of 3)
A company must calculate how much of cash was
paid to suppliers by adjusting purchases by the
change in accounts payable.
When accounts payable increase, a company deducts
the increase from purchases.
Purchases
€ 155,000
Deduct: Increase in accounts payable
Cash payments to suppliers
LO 4
16,000
€139,000
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Step 1: Cash Payments to Suppliers (3 of 3)
In 2020, Computer Services Company’s inventory increased
€5,000 and accounts payable increased € 16,000. Cash
payments to suppliers were €139,000.
Cash
Payments to
Suppliers
LO 4
=
Cost of
Goods
Sold
+ Increase in Inventory
or
- Decrease in Inventory
+ Decrease in Accounts Payable
or
- Increase in Accounts Payable
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Step 1: Cash Payments for Operating
Expenses (1 of 2)
• A company needs to adjust operating expenses by
changes in prepaid expenses and accrued expenses
payable.
• When prepaid expenses increase, cash paid for
operating expenses is higher than operating expenses
reported on the income statement.
• To determine cash payments for operating expenses, a
company deducts an increase in accrued expenses
payable from operating expenses on the income
statement.
LO 4
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Step 1: Cash Payments for Operating
Expenses (2 of 2)
Cash payments for operating expenses were €115,000.
Operating expenses
€ 111,000
Add: Increase in prepaid expenses
Cash payments for operating expenses
Cash
Payments for
Operating
=
Operating
Expenses
Expenses
LO 4
4,000
€115,000
+ Increase in Prepaid
Expenses
or
- Decrease in Prepaid
Expenses
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+ Decrease in Accrued
Expenses Payable
or
- Increase in Accrued
Expenses Payable
73
Step 1: Cash Payments for Income Taxes
Income taxes payable decreased €2,000.
Income tax expense
€47,000
Add: Decrease in income taxes payable
Cash payments for income taxes
Cash Payments for
Income Taxes
LO 4
=
Income Tax
Expense
2,000
€49,000
+ Decrease in Income Taxes Payable
or
- Increase in Income Taxes Payable
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Step 1: Operating Activities
Operating activities section of the statement of cash flows of Computer Services.
Cash flows from operating activities
Cash receipts from customers
€ 517,000
Less: Cash payments:
To suppliers
€139,000
For operating expenses
115,000
For interest expense
42,000
For income taxes
49,000
Net cash provided by operating activities
LO 4
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345,000
€172,000
75
Step 2: Investing and Financing Activities
Analyze Changes in Non-Current Asset and Liability Accounts
and Record as Investing and Financing Activities, or Disclose as
Non-Cash Transactions
Investing and financing activities are measured and reported
the same way under both the direct and indirect methods.
LO 4
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Step 2: Investing and Financing Activities
Equipment purchased for €25,000, and (2) equipment sold for €4,000, cost
€8,000, book value €7,000.
Equipment
1/1/20 Balance
10,000 Cost of equipment sold
Purchase of equipment
12/31/20 Balance
25,000
27,000
Cash
4,000
Accumulated Depreciation—Equipment
1,000
Loss on Disposal of Plant Assets
3,000
Equipment
LO 4
8,000
8,000
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Step 2: Investing and Financing Activities
Increase in Land. Land increased €110,000. The
company purchased land of €110,000 by issuing
bonds.
Significant non-cash
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 non-cash
investing and financing
transaction.
LO 4
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Step 2: Investing and Financing Activities
Increase in Share Capital—Ordinary. Increase in Share
Capital—Ordinary of €20,000. Increase resulted from the
issuance of new shares.
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)
LO 4
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Step 2: Statement of Cash Flows – Direct Method
Computer Services International
Statement of Cash Flows—Direct Method
For the Year Ended December 31, 2020
Cash flows from operating activities
Cash receipts from customers
€ 517,000
Less: Cash payments:
To suppliers
€139,000
For operating expenses
115,000
For income taxes
49,000
For interest expense
42,000
Net cash provided by operating activities
LO 4
345,000
172,000
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Step 2: Statement of Cash Flows - Direct Method
Computer Services International
Statement of Cash Flows—Direct Method
For the Year Ended December 31, 2020
Cash flows from investing activities
Purchase of building
(120,000)
Purchase of equipment
(125,000)
Disposal of plant assets
4,000
Net cash used by investing activities
(141,000)
Cash flows from financing activities
Issuance of ordinary shares
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
Note 1
Non-cash investing and financing activities
Issuance of bonds payable to purchase land
LO 4
€110,000
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Step 3: Net Change in Cash
Compare the Net change in cash on the Statement of Cash Flows with the change in the cash
account reported on the Statement of Financial Position to make sure the amounts agree.
Partial Comparative Statements of Financial Position
2020
Prepaid Expenses
2019
5,000
1,000
Inventory
15,000
10,000
Accounts receivable
20,000
30,000
Cash
55,000
33,000
€ 398,000
€ 398,000
Total assets
Partial Statement of Cash Flows
Net increase in cash
22,000
Cash at beginning of period
33,000
Cash at end of period
LO 4
€ 55,000
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Learning Objective 5
Use the T-Account Approach to Prepare
a Statement of Cash Flows
LO 5
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83
Use the T-Account Approach
The change in cash is equal to the change
in all of the other statement of financial
position accounts.
If we analyze the changes in all of the non-cash statement
of financial position accounts, we will explain the change
in the Cash account.
LO 5
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Use the T-Account Approach
LO 5
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Use the T-Account Approach
LO 5
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A Look at US GAAP and IFRS (1 of 5)
Key Points
Similarities
• Companies preparing financial statements under both GAAP and IFRS must prepare a
statement of cash flows as an integral part of the financial statements.
• Both IFRS and GAAP require that the statement of cash flows should have three major
sections— operating, investing, and financing—along with changes in cash and cash
equivalents.
• Similar to IFRS, the statement of cash flows can be prepared using either the indirect
or direct method under GAAP. Companies choose for the most part to use the indirect
method for reporting net cash flows from operating activities.
LO 5
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A Look at US GAAP and IFRS (2 of 5)
Key Points
Differences
• The definition of cash equivalents used in GAAP is similar to that used in IFRS. A major
difference is that in certain situations, bank overdrafts are considered part of cash and
cash equivalents under IFRS (which is not the case in GAAP). Under GAAP, bank
overdrafts are classified as financing activities in the statement of cash flows and are
reported as liabilities on the statement of financial position.
• IFRS requires that non-cash investing and financing activities be excluded from the
statement of cash flows. Instead, these non-cash activities should be reported
elsewhere. This requirement is interpreted to mean that non-cash investing and
financing activities should be disclosed in the notes to the financial statements instead
of in the financial statements. Under GAAP, companies may present this information
on the face of the statement of cash flows.
LO 5
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A Look at US GAAP and IFRS (3 of 5)
Key Points
Differences
• One area where there can be substantial differences between IFRS and GAAP relates
to the classification of interest, dividends, and taxes. The following table indicates the
differences between the two approaches.
Item
IFRS
GAAP
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
LO 5
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89
A Look at US GAAP and IFRS (4 of 5)
Key Points
Differences
• Under IFRS, 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 GAAP.
• Similar to IFRS, under GAAP companies must disclose the amount of taxes and interest
paid. Under GAAP, companies disclose this in the notes to the financial statements.
Under IFRS, some companies disclose this information in the notes, but others provide
individual line items on the face of the statement. In order to provide this information
on the face of the statement, companies first add back the amount of interest expense
and tax expense (similar to adding back depreciation expense) and then further down
the statement they subtract the cash amount paid for interest and taxes.
LO 5
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A Look at US GAAP and IFRS (5 of 5)
Looking to the Future
Presently, the FASB and the IASB 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 statement of financial position (balance sheet) would adopt headings
similar to those of the statement of cash flows. That is, the income statement and
statement of financial position would be broken into operating, investing, and financing
sections.
With respect to the cash flow statement specifically, the notion of cash equivalents will
probably not be retained. That is, cash equivalents will not be combined with cash but
instead will be reported as a form of highly liquid, low-risk investment. The definition of
cash in the existing literature would be retained, and the statement of cash flows would
present information on changes in cash only. In addition, the FASB favors presentation of
operating cash flows using the direct method only. However, the majority of IASB
members express a preference for not requiring use of the direct method of reporting
operating cash flows.
LO 5
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Copyright
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or from the use of the information contained herein.
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