STATEMENT OF CASH FLOWS

•Definition
 Summary of the cash receipts & payments & net change in cash
resulting from operating, investing, & financing activities during a
period in a format that reconciles the beginning and ending cash
balances.
 Is an itemization of all changes in cash in terms other than cash
 Provides a link between the beginning and ending balance sheets

1
PREPARATION OF STATEMENT OF CASH FLOWS

Primary purpose:
To provide information about a company’s cash receipts and
cash payments during a period.

Secondary objective:
To provide cash-basis information about the company’s
operating, investing, and financing activities.

2
PREPARATION OF STATEMENT OF CASH FLOWS

Usefulness of the Statement of Cash Flows

Provides information to help assess [internal & external]:
1. Entity’s ability to generate future cash flows.

2. Entity’s ability to pay dividends and meet obligations.

3. Reasons for the difference between net income and net cash flow
from operating activities.

4. Cash and noncash investing and financing transactions during the

period.

3
STATEMENT OF CASH FLOWS

Content [Elements] and Format

Operating Investing Financing
Activities Activities Activities
Transactions that Generally Generally
enter into the changes in changes in Equity
determination of net Investments and and Non-Current
income Non-Current Liability Items
Income Statement Asset Items
Items
CONTENT AND FORMAT
Cash Inflows and Outflows

LO 5
6
Classification of Cash Flows

7
❸ Conceptual Model for the Statement of Cash Flows

 Firms can prepare the SCF based on changes in balance sheet

accounts. Start with the accounting equation in equation .1.
Assets = Liabilities + Stockholders’ equity (1)
 Next, we disaggregate each element of the balance sheet equation
into its main components. The restated balance sheet equation is as
follows:
Cash + OCA + NCA = CL + NCL + CS + RE (2)
OCA = Other Current Assets
NCA = Noncurrent Assets
CL = Current Liabilities
NCL = Noncurrent Liabilities
CS = Capital Stock
RE = Retained Earnings
16-8
❸ Conceptual Model for the Statement of Cash Flows

 Subtracting OCA and NCA from both sides of the equation solves for
cash.
Cash = CL + NCL − OCA − NCA + CS + RE (3)
 Taking the changes in each equation component creates a model for
the statement of cash flows.
ΔCash = ΔCL + ΔNCL − ΔOCA − ΔNCA + ΔCS + ΔRE (4)
 Equation 4 indicates that the change in cash is based on the changes
in all the balance sheet accounts.
 For each account, the firm identifies whether the change relates to
operating, investing, or financing activities.

16-9
Cash and Cash Equivalents

The basis recommended by the IASB for the statement of cash

flows is actually “cash and cash equivalents.” Cash equivalents
are short-term, highly liquid investments that are both:
 Readily convertible to known amounts of cash, and
 So near their maturity that they present insignificant risk of
changes value in (e.g., due to changes in interest rates).

Generally, only investments with original maturities of three

months or less qualify under this definition.

10
Format of the Statement of Cash Flows

Presentation:
1. Operating activities. Direct Method

2. Investing activities. Indirect Method

3. Financing activities.

Report inflows and outflows from investing and financing

activities separately.

11
❹ Operating Cash Flows

 There are two acceptable formats for the operating section in the
SCF: the indirect method and the direct method. The two methods
report the same amount of net cash provided by operating
activities using different approaches. The indirect method is more
popular in practice.
The Indirect Method
 Under the indirect method (also referred to as the reconciliation
format), firms reconcile net income to net cash provided by
operating activities by making two types of adjustments:
1. Adjustments for noncash revenues, expenses, and other gains
and losses including investing gains & losses to avoid double
count.
2. Adjustments for changes in current assets and liabilities.

16-12
❹ Operating Cash Flows

 To adjust net income to net cash provided by operating activities,

firms add noncash expenses and losses back to net income.
Conversely, firms subtract any noncash revenues or gains from net
income to arrive at net cash provided by operating activities.
 Equation 4 illustrated the effects of changes in current assets and
liabilities:
1. Increases (decreases) in current liabilities cause operating cash
flows to be higher (lower) than accrual-basis income.
2. Increases (decreases) in current assets cause operating cash
flows to be lower (higher) than accrual-basis income.

16-13
❹ The Direct Method

 The direct method (also referred to as the income statement

format) prepares the SCF by disaggregating the income statement
and adjusting each line item to convert from accrual basis to cash
basis.
 In substance, the firm prepares a cash-basis income statement.
The firm applies similar adjustments as under the indirect method,
except that the adjustments apply to individual items of revenue
and expense, rather than against aggregate net income.

16-14
Format of the Statement of Cash Flows
INDIRECT METHOD

15
 Format of the Statement of Cash Flows
DIRECT METHOD
Company Name
Statement of Cash Flows
Period Covered
Cash flows from operating activities
(List of individual inflows and outflows) 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) XX
Net cash provided (used) by financing activities XXX
Net increase (decrease) in cash XXX
Cash at beginning of period XXX
Cash at end of period XXX
16
Steps in Preparation

Three Sources of Information:

1. Comparative statements of financial position.
2. Current income statement data.
3. Selected transaction data.

Three Major Steps:

Step 1. Determine change in cash.
Step 2. Determine net cash flow from operating
activities.
Step 3. Determine net cash flows from investing and
financing activities.
17
Illustration

18
Illustration

19
Step 1: Determine the Change in Cash

20
Step 2: Determine Net Cash Flow from
Operating Activities—Indirect Method
Step 2: Determine the Net Cash Flow from
Operating Activities
 Company must determine revenues and expenses on a cash
basis.

 Eliminate the effects of income statement transactions that do

not result in an increase or decrease in cash.

 Convert net income to net cash flow from operating activities

through either a direct method or an indirect method.
Step 2: Determine Net Cash Flow from
Operating Activities—Indirect Method
Step 2: Determine the Net Cash Flow from
Operating Activities
Step 2: Determine Net Cash Flow from
Operating Activities—Indirect Method

Accounts receivable decreased during the period because cash

receipts (cash-basis revenues) are higher than revenues reported on
an accrual basis. 23
Step 2: Determine Net Cash Flow from
Operating Activities—Indirect Method
To convert net income to net cash flow from operating activities, the
decrease of $10,000 in accounts receivable must be added to net
income.

24
Step 2: Determine Net Cash Flow from
Operating Activities—Indirect Method

When prepaid expenses (assets) increase during a period, expenses

on an accrual-basis income statement are lower than they are on a
cash-basis income statement. 25
Step 2: Determine Net Cash Flow from
Operating Activities—Indirect Method
To convert net income to net cash flow from operating activities, the
increase of $6,000 must be deduct from net income.

26
Step 2: Determine Net Cash Flow from
Operating Activities—Indirect Method

When accounts payable increase, the company incurred a greater amount

of expense than the amount of cash it disbursed.

27
Step 2: Determine Net Cash Flow from
Operating Activities—Indirect Method
Tax Consultants must add the 2016 increase of $35,000 in accounts
payable to net income, to convert to net cash flow from operating
activities.

28
Step 2: Determine Net Cash Flow from
Operating Activities—Indirect Method
ILLUSTRATION 23-9

Depreciation expense of $21,000 (also represented by the increase in

accumulated depreciation) is a non-cash charge.

29
Step 2: Determine Net Cash Flow from
Operating Activities—Indirect Method
Tax Consultants adds depreciation expense back to net income, to
arrive at net cash flow from operating activities.

30
Step 3: Determine Net Cash Flow from Investing
and Financing Activities

The company purchased land of $70,000 during the period.

31
Step 3: Determine Net Cash Flow from Investing
and Financing Activities
The purchase of land for cash is an investing activity, reported as a use
of cash.

32
Step 3: Determine Net Cash Flow from Investing
and Financing Activities

Tax Consultants acquired an office building using $200,000 cash.

33
Step 3: Determine Net Cash Flow from Investing
and Financing Activities
The purchase of a building for cash is an investing activity, reported as
a use of cash.

34
Step 3: Determine Net Cash Flow from Investing
and Financing Activities

Tax Consultants acquired equipment using $68,000 cash.

35
Step 3: Determine Net Cash Flow from Investing
and Financing Activities
The purchase of equipment for cash is an investing activity, reported as
a use of cash.

36
Step 3: Determine Net Cash Flow from Investing
and Financing Activities

Tax Consultants acquired received $150,000 from the issuance of bonds.

37
Step 3: Determine Net Cash Flow from Investing
and Financing Activities
The cash received from the issuance of these bonds represents an
inflow of cash from a financing activity.

38
Step 3: Determine Net Cash Flow from Investing
and Financing Activities
ILLUSTRATION 23-9

Two factors explain the increase in retained earnings: (1) net income of
$134,000 increased retained earnings, and (2) dividends of $18,000
decreased retained earnings.
39
Step 3: Determine Net Cash Flow from Investing
and Financing Activities
Payment of the dividends is a financing activity that involves a cash
outflow.

40
INDIRECT METHOD

41
DRECT
METHOD
TAX CONSULTANTS INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2016
Cash flows from operating activities
Cash received from customers (Note 1) 502,000.00
Cash Payments:
For operating expenses (Note 2) 240,000.00
For income taxes (Note 3) 68,000.00 308,000.00
Net cash provided by operating activities 194,000.00
Cash flows from investing activities
Purchase of land (70,000.00)
Purchase of building (200,000.00)
Purchase of equipment (68,000.00)
Net cash used by investing activities (338,000.00)
Cash flows from financing activities
Issuance of bonds 150,000.00
Payment of cash dividends (18,000.00)
Net cash provided by financing activities 132,000.00
Net decrease in cash (12,000.00)
Cash, January 1, 2016 49,000.00
Cash, December 31, 2016 37,000.00
42
Note 1
Revenue 492,000
Add: A/C Receivable, Jan. 1 36,000
Less: A/C Receivable, Dec. 31 (26,000)
Cash Received From Customers 502,000
Note 2
Operating Expenses 269,000
Add: Prepaid Expenses, Dec. 31 6,000
Accounts Payable, Jan. 1 5,000
Less: Prepaid Expenses, Jan. 1 -0-
Accounts Payable, Dec. 31 40,000
Cash Payments For Operating Expenses 240,000
Note 3:
Cash Payments For Income Taxes (+ 0) 68,000
43
Example II

ABC Company, which began business on January 1, 2015, has the

following selected statement of financial position information.
 Example II

ABC’s December 31, 2015, income statement and additional information are
as follows.

Additional Information
(a) Dividends of €70,000 were declared and paid in cash.
(b) The accounts payable increase resulted from the purchase of merchandise.
(c) Prepaid expenses and accrued expenses payable relate to operating expenses.
 Example II
ABC determines cash payments to suppliers by adjusting purchases
for the change in accounts payable.

Presentation of the direct method for reporting net cash flow from operating activities.
ABC
 Operating Activities — Direct Method

When companies use the direct method they are required to provide in a
separate schedule the reconciliation of net income to net cash provided
by operating activities.

ABC

ILLUSTRATION 23-26
Operating Activities Section—Direct Method, 2016
Preparation of Statement of Cash Flows
Significant Non-Cash Activities
 Many significant investing and financing transactions do not have
immediate cash flow consequences.
Reported in a separate note to the financial statements.

Examples include:
 Issuance of ordinary shares to purchase assets.
 Conversion of bonds into ordinary shares.
 Issuance of debt to purchase assets.
 Exchanges on long-lived assets.

LO 6
STATEMENT OF CASH FLOWS

EXERCISE 1
The comparative balance sheets for Alpha Company on
December 31, 2008, and 2007 are given below.

Alpha Company
Comparative Balance Sheets
December 31, 2008 and 2007
Assets 2008 2007
Cash Br40,000 Br60,000
Accounts Receivable (net) 120,000 100,000
Inventories 24,000 16,000
Property, Plant, and Equipment (net) 280,000 160,000
Intangible assets (net) 120,000 140,000
Total Assets Br584,000 Br476,000
Liabilities & Owners’ Equity
Current Liabilities $80,000 $20,000
Long-term liabilities 120,000 60,000
Common stock 400,000 360,000
Retained earnings (16,000) 36,000
Total liabilities and Owners’ Equity Br584,000 Br476,000
Additional data:
A.No plant asset was sold.
B.Depreciation expense was Br60,000.
C.Br60,000 of dividends were declared and paid.
D.No intangibles were purchased or sold.
Required
Prepare a statement of cash flows for the year 2008 using the
indirect method.
STATEMENT OF CASH FLOWS

EXERCISE 2
The financial statements of Robinson Company are as follows:
The Robinson Company
Comparative Balance Sheets
December 31,
Assets 1999 1998 Increase (Decrease)
Cash $130,000 $40,000 $90,000
Accounts receivable 69,000 60,000 9,000
Inventory 80,000 100,000 (20,000)
Prepaid insurance 6,000 4,000 2,000
Land 120,000 200,000 (80,000)
Building 500,000 400,000 100,000
Accumulated depreciation (105,000) (100,000) (5,000)
Total assets $800,000 $704,000 $(96,000)
Liabilities and Owners’ Equity
Accounts payable $20,000 $25,000 ($5,000)
Income tax payable 22,600 20,000 2,600
Notes payable, long-term 40,000 50,000 (10,000)
Bonds payable 120,000 100,000 20,000
Common stock 450,000 400,000 50,000
Paid-in capital 60,000 50,000 10,000
Retained earnings 87,400 59,000 28,400
Total liabilities & Owners’ Equity $800,000 $704,000 $(96,000)
 The Robinson Company
Income Statement
For the year ended December 31, 1999
Sales revenue $200,000
Expenses
Cost of goods sold $80,000
Salary expense 39,000
Depreciation expense 5,000
Interest expense 3,000
Insurance expense 1,000
Loss on sale of land 10,000
Income tax expense 18,600
Total expenses 156,600
Net income $43,400
Other information:
•Land, which originally cost $100,000, was sold for $90,000.
•Building was purchased for cash.
•Bonds were issued at par value in exchange for land.
•Common stock with a par value of $50,000 was issued for $60,000.
•Dividends of $15,000 were declared and paid during the year.
 The Robinson Company
Statement of Cash Flows (Indirect Method)
For the Year Ended December 31, 1999
Cash Flows From Operating Activities:
Net income Br.43,400
Adjustments:
Increase in accounts receivable (Br.9,000)
Decrease in inventory 20,000
Increase in prepaid expenses (2,000)
Decrease in accounts payable (5,000)
Increase in income taxes payable 2,600
Depreciation expense 5,000
Loss on sale of land 10,000 21,600
Net cash flows provided by operating activities Br.65,000
Cash Flows From Investing Activities:
Proceeds from sale of land Br.90,000
Acquisition of building (100,000)
Net cash flows used by operating activities (10,000)
Cash Flows From Financing Activities:
Proceeds from issuance of common stock Br.60,000
Payment of long-term notes payable (10,000)
Payment of dividend (15,000)
Net cash flows provided by financing activities 35,000
Net increase in Cash & Cash Equivalents 90,000
Cash & Cash Equivalents, @ Beg. of the Year 40,000
Cash & Cash Equivalents, @ End. of the Year Br.130,000
Schedule of Noncash Investing & Financing Activities
Issuance of bonds in exchange for land Br.20,000
 The Robinson Company
Statement of Cash Flows (Direct Method)
For the Year Ended December 31, 1999
Cash Flows From Operating Activities:
Cash received from customers Br.191,000
Cash paid to suppliers Br.65,000
Cash paid to employees 39,000
Cash paid for interest 3,000
Cash paid for insurance 3,000
Cash paid for taxes 16,000
Cash disbursed for operating activities 126,000
Net cash flows provided by operating activities Br.65,000
Cash Flows From Investing Activities:
Proceeds from sale of land Br.90,000
Acquisition of building (100,000)
Net cash flows used by operating activities (10,000)
Cash Flows From Financing Activities:
Proceeds from issuance of common stock Br.60,000
Repayment of notes payable (10,000)
Payment of dividend (15,000)
Net cash flows provided by financing activities 35,000
Net increase in cash & cash equivalents 90,000
Cash & cash equivalents, @ Beg. of the year 40,000
Cash & cash equivalents, @ End. of the year Br.130,000
Schedule of Noncash Investing & Financing Activities
Issuance of bonds in exchange for land Br.20,000
STATEMENT OF CASH FLOWS

EXERCISE 3
Assume the following information concerning the ABC Company.
• Treasury bills have an original maturity of less than 3 months.
• Fixed assets costing Br.5, 000 with a book value of Br.2, 900 were sold for Br.4, 000.
•Three-year insurance policy was purchased in 20X1. ­
• Long-term investments costing Br.5, 000 were used to retire Br.5, 000 of bonds
outstanding.
• Other expenses and losses consist, of Br.1, 000 interest paid.
Comparative balance sheets for 20X1 and 20X2 are as follows:
 20X2 20X1 Net change
Cash 9,000 8,000 1,000

Treasury bills 4,000 3,000 1,000

Accounts receivable 4,000 5,000 (1,000)
Inventory 1,000 2,000 (1,000)
Prepaid insurance 2,000 3,000 (1,000)
Long-term investment in ABC Co. 17,000 22,000 (5,000)
Fixed assets 22,000 17,000 5,000
Accumulated depreciation (5,000) (4.000) (1.000)
Total Assets Br.54.000 Br.56.000 (2.000)
Accounts payable 4,000 7,000 (3,000)
Income tax payable 3,000 1,000 2,000
Deferred tax liability 5,000 3,000 2,000
Bonds payable 5,000 10,000 (5,000)
Common stock 20,000 20,000 -0­
Retained earnings 17.000 15.000 2.000
Total L & E Br.54.000 Br.56.000 (2.000)
The income statement for 20X2 is as follows:

Net sales Br.50,000

Cost of goods sold (20.000)
Gross profit 30,000
Operating expenses (17.000)
Income from operations 13,000
Other revenue and gains 2,000
Other expenses, and losses (1.000)
Income before tax Br.14,000
Income tax expense:
Current portion 5,000
Deferred portion 2.000 7.000
Net income 7.000
 ABC Company
Statement of Cash Flows (Direct Method)
For the Year Ended December 31, 20X2
Cash flows from operating activities:
Cash received from customers Br.51.000
Cash provided by operating activities Br.51,000
Cash paid to suppliers 22,000
Cash paid for operating expenses 12,000
Cash paid for income taxes 3,000
Cash paid for interest expense 1,000
Cash disbursed for operating activities 38,000 ­
Net cash flows from operating activities Br.13,000
Cash flows from investing activities:
Proceeds from sale of fixed assets 4,000
Acquisition of fixed assets (10,000)
Net cash used by investing activities (6,000)
Cash flows from financing activities:
Dividends paid (5.000)
Net cash used by financing activities (5.000)
Net increase in cash and cash equivalents 2,000
Cash and cash equivalents at beginning of year 11.000
Cash and cash equivalents at end of year Br.13.000
Reconciliation of net income to cash provided by operating activities:
Schedule of noncash investing and financing activities:
Exchange of investments to retire bonds payable 5.000
Disclosure of accounting policy:
For purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with
a maturity of three months or less to be cash equivalents.
 ABC Company
Statement of Cash Flows (Indirect Method)
For the Year Ended December 31, 20X2
Cash flows from operating activities:
Net income 7,000
Decrease in accounts receivable 1,000
Decrease in inventory 1,000
Decrease in prepaid insurance 1,000
Decrease in accounts payable (3,000)
Increase in income tax payable 2,000
Increase in deferred tax liability 2,000
Gain on sale of fixed assets (2,000)
Depreciation expense 4.000
Net cash flows from operating activities Br.13,000
Cash flows from investing activities:
Proceeds from sale of fixed assets 4,000
Acquisition of fixed assets (10.000)
Net cash used by investing activities (6,000)
Cash flows from financing activities:
Dividends paid (5.000)
Net cash used by financing activities (5.000)
Net increase in cash and cash equivalents 2,000
Cash and cash equivalents at beginning of year 11.000
Cash and cash equivalents at end of year Br.13.000
Schedule of noncash investing and financing activities:
Exchange of investments to retire bonds payable 5.000
Disclosure of accounting policy:
For purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with
a maturity of three months or less to be cash equivalents.