Edmonds Managerial Chapter 14

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CHAPTER 14
Statement ofCash Flows
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Reporting Format for the Statement of Cash Flows

• The Statement of Cash Flows must include the
  following three sections, as defined in FASB
  Statement 95

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Cash Flows fromOperating Activities
Cash Flows from Operating Activities
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Cash Flows fromInvesting Activities

• Inflows
• Selling property, plant, and equipment.
• Selling investment securities.
• Collecting loans.

Cash Flows from Investing Activities
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Cash Flows fromFinancing Activities

• Inflows
• Borrowing.
• Issuing stock.

Cash Flows from Financing Activities
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Noncash Investing and Financing Transactions

• Significant noncash investing and financing
  transactions must be reported separately.
• Example Issuing common stock in exchange for
  land.

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Cash Flows fromOperating Activities
Cash flows from operating activities can be
prepared using either the direct method or the
indirect method.
Lets look at the direct method first.
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Converting from Accrual to Cash-Basis Accounting

• Accrual basis revenue includes sales that did not
  result in cash inflows.
• Cash received from customers can be computed as
  follows

Decrease in receivables


Cash received from customers
Net sales
Increase in receivables


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Converting from Accrual to Cash-Basis Accounting
We will use T-accounts toanalyze changes in
accounts. Lets look at an example.
The Accounts Receivable balance was 1,200 on
12/31/04 and 1,000 on 12/31/05. If accrual
Sales Revenue for 2005 was 20,600, what were
cash receipts from sales?
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Converting from Accrual to Cash-Basis Accounting
Accounts Receivable
12/31/04 Balance
Accrual Sales Revenue
Cash receipts
20,800
12/31/05 Balance
The Accounts Receivable balance was 1,200 on
12/31/04 and 1,000 on 12/31/05. If accrual
Sales Revenue for 2005 was 20,600, what were
cash receipts from sales?
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Converting from Accrual to Cash-Basis Accounting
Now lets use T-account analysis for a liability
account with anaccrued expense.
The Salaries Payable balance was 900 on 12/31/04
and 1,000 on 12/31/05. If accrued Salaries
Expense for 2005 was 2,700, what amount of cash
was paid for salaries?
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Converting from Accrual to Cash-Basis Accounting
Salaries Payable
12/31/04 Balance
Accrued Salaries Expense
Cash payments
2,600
12/31/05 Balance
The Salaries Payable balance was 900 on 12/31/04
and 1,000 on 12/31/05. If accrued Salaries
Expense for 2005 was 2,700, what amount of cash
was paid for salaries?
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Direct Method
Now that we have seen the T-account method of
analysis, lets use it to prepare a Direct Method
Statement of Cash Flows for New South
Corporation. We will begin with by analyzing
changes in balance sheet accounts.
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Direct Method

• Additional Information
• The corporation sold equipment for 300 cash
  during the year. The equipment had an original
  cost of 1,500 and accumulated depreciation of
  1,100 at the time of sale.
• The corporation issued a 2,500 mortgage note in
  exchange for land during the year.
• There was a 1,500 cash dividend paid during the
  year.

Lets get started analyzing the accounts. First,
we willreview the T-account analysis that we
completed earlier.Then we will analyze the
remaining balance sheet accounts starting with
the current accounts.
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Accounts Receivable
12/31/04 Balance
Cash receipts 20,800
Accrual sales revenue
12/31/05 Balance
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Inventory
12/31/04 Balance
Cost of Goods Sold
Purchases
11,200
12/31/05 Balance
11,500
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Interest Receivable
12/31/04 Balance
Cash receipts
600
Interest Revenue
12/31/05 Balance
600
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Prepaid Insurance
12/31/04 Balance
Cash payment
300
Insurance Expense
12/31/05 Balance
1,400
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Other Operating Expenses Payable
12/31/04 Balance
Cash payment
1,200
Other Operating Expenses
12/31/05 Balance
Now that we have analyzed the current accounts
and found the cash receipts and cash payments
related to operations, we are ready to prepare
the Cash Flow from Operating Activities portion
of the Statement of Cash Flows.
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Cash Flow fromOperating Activities
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Direct Method
Now, lets continue to use the T-account analysis
for the remaining noncurrent balance sheet
accounts.
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Marketable Securities
12/31/04 Balance
Cash paid
1,600
12/31/05 Balance
2,500
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Equipment
Equipment sale
12/31/04 Balance
Cash paid for equipment
2,300
12/31/05 Balance
After completing the analysis of
noncurrentassets, we are ready to prepare the
CashFlow from Investing Activities portionof
the Statement of Cash Flows.
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Cash Flow fromInvesting Activities
Next, we will analyze noncurrent liabilities and
equity so that we can prepare the Cash Flow from
Financing Activities portion of the Statement of
Cash Flows.
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Mortgage Payable
12/31/04 Balance
Mortgage issued for Land
2,500
12/31/05 Balance
3,000
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Common Stock
12/31/04 Balance
Cash received from stocksale
2,000
12/31/05 Balance
After completing the analysis of
noncurrentliabilities and equity, we are ready
to prepare the Cash Flow from Financing
Activitiesportion of the Statement of Cash Flows.
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Cash Flow fromFinancing Activities
Next, we will put the three sections together to
completethe Statement of Cash Flows.
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Notice that the Ending Cash Balance on the
Statement of Cash Flows agrees with the 12/31/05
Cash balance on the Balance Sheet.
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Indirect Method
Now lets look at the Indirect Method that is
used by over 95 of all companies.
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A Comparison of the Directand Indirect Methods

• Net cash flow is the same for both methods.
• The Direct Method provides more detail about cash
  from operating activities.
• The investing and financing sections for the two
  methods are identical.

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Indirect Method
Changes in current assets and current liabilities
as shown on the following table.
Cash Flows from Operating Activities
Net Income
Losses and - Gains
Noncash expenses such as depreciation and
amortization.
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Indirect Method
Use this table when adjusting Net Incometo Cash
Flow from Operations.
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Indirect Method
We will use the Indirect Method to prepare the
Cash Flows from Operating Activities for the New
South Corporation. First, we will review the
Balance Sheet and Income Statement for New South
Corporation.
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The Indirect Method begins with Net Income, which
is then adjusted for the non-cash items included
in net income. For New South Corporation, the
only non-cash items are depreciation and a loss.
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To complete the Cash Flow from Operating
Activities section, we must examine comparative
balance sheets to determine the changes in
current assets and current liabilities from the
beginning of the period to the end of the period.
(Remember, we showed the balance sheets a few
slides earlier.)
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Statement of Cash Flows Indirect Method Example
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Remember that when we prepared the operating
section using the Direct Method, we also arrived
at Net Cash Flow from Operating Activities of
6,600.
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Indirect Method
Because the investingand financing sectionsare
identical with eithermethod of preparation, we
will not repeatthose sections of thestatement.
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The Financial Analyst
A rapidly growingcompany might be short ofcash
in spite of largereported net income.
Because accruals anddeferrals affect operating
income,cash flow from operating activitiesmay
be stable thanoperating income.
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The Financial Analyst
The statement focusesattention on
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End of Chapter 14