Statement of Cash Flows: Understanding Operating, Investing, and Financing Activities, Study notes of Financial Accounting

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ACC101 – CHAPTER 12

Statement of Cash Flows

Key Terms and Concepts to Know

The Statement of Cash Flows reports the sources of cash inflows and cash outflow during an accounting period. The inflows and outflows are divided into three sections or categories based on the underlying cause or nature of the cash flows:  Operating Activities  Investing Activities  Financing Activities Because the statement explains the changes in the cash balance during the period, the beginning and ending balances in Cash are not included in these three sections. The beginning cash balance is added to the total of the three sections to determine the ending balance for cash in what could be considered a fourth section of the statement.

At times, companies enter into investing and financing transactions that do not involve cash, such as issuing common stock to purchase land. These transactions are not reported on the statement of cash flows because they do not provide or use cash. Instead, they are reported in a separate section or note which is presented after the ending cash balance.

used, that a reconciliation of net income to net cash provided or used by operating activities be provided in the footnotes or as part of the statement. This reconciliation frequently looks quite similar the cashflow from operating activities section prepared using the indirect method.

Cash received from customers:  Sales (+decrease in A/R OR -increase in A/R) Less: payments to creditors and for expenses  Cost of Merchandise Sold +increase in inventories OR -decrease in inventories +decrease in A/P OR -increase in A/P  Operating Expenses +decrease in accrued expenses OR -increase in accrued expenses  Interest Expense +decrease in interest payable OR -increase in interest payable  Income Tax Expense +decrease in income tax payable OR -increase in income tax payable =Net Cash Flows from Operating Activities

Investing Activities

Operating Activities include events and transactions that affect long-term assets. For example, the journal entry to record the sale of land with a cost of $100,000 for $120,000 would be:

Cash 120, Land 100, Gain on sale of land 20,

The effect of this transaction is to reduce long-term assets by $100,000. On the statement of cash flows, the cash proceeds are reported as an inflow in the investing activities section and the gain is deducted from net income in the operating activities section as noted above.

If equipment is purchased for $75,000, the journal entry would be:

Equipment 75, Cash 75,

The $75,000 would be reported as a use of cash in the investing section.

Cash inflows from: Sale of Long-term Assets o Property, Plant or Equipment o Intangible assets o Investments Less: Cash outflows from: Purchase of Long-term Assets o Property, Plant or Equipment o Intangible assets o Investments =Net Cash Flows from Investing Activities

Financing Activities

Financing Activities include events and transactions that affect long-term liabilities and equity. For example, the journal entry to record the issuance of bonds with a face value of $100,000 would be:

Cash 100, Bonds Payable 100,

The effect of this transaction is to increase long-term liabilities by $100,000. On the statement of cash flows, the cash proceeds are reported as an inflow in the financing activities section.

If the bonds are subsequently retired at 101, the journal entry would be

Loss 1, Bonds Payable 100, Cash 101,

The effect of this transaction is to reduce long-term liabilities by $100,000. On the statement of cash flows, the cash spent is reported as an outflow in the financing activities section and the loss is added to net income in the operating activities section as noted above.

Dividends paid are also included in the financing activities section. Dividends paid are not part of the operating activities section because dividends do not appear in the income statement. They are reported in the financing activities section because they relate to the equity section of the balance sheet and cash flows from changes in equity are reported in this section.

Practice Problem # For each of the following situations indicate the items to be reported on the statement of cash flows. Be sure to include the section of the statement the item would appear in and the amount.

a. The board of directors declared cash dividends totaling $240,000 during the current year. The comparative balance sheet indicates dividends payable of $50,000 at the beginning of the year and $60,000 at the end of the year.

b. An analysis of the general ledger accounts indicates that office equipment, which had cost $245,000 and on which accumulated depreciation totaled $95,000 on the date of sale, was sold for $130,000 during the year.

c. An analysis of the general ledger accounts indicates that delivery equipment, which had cost $39,000 and on which accumulated depreciation totaled $23,000 on the date of sale, was sold for $20,000 during the year.

d. During the year the company issued 5,000 shares of $10 par Common Stock for $50 per share.

e. During the year the company purchased land with a mortgage note payable.

f. Depreciation reported on the income statement was $55,000.

g. Bonds Payable of $60,000 were retired.

Example # Given the following information and using the indirect method prepare the Cash Flows from Operating Activities section of the statement of cash flows.

End of Year Beginning of Year Change Cash $ 23,500 $ 37,400 (13,900) Accounts receivable (net) 84,500 80,350 4, Inventories 100,200 94,300 5, Prepaid expenses 4,970 5,300 (330) Accounts payable (creditors) 71,400 68,900 2, Salaries Payable 5,320 6,450 (1,130)

Net Income reported on the income statement for the current year was $134,800. Depreciation recorded on buildings and equipment was $27,400 for the year.

Solution #

Cash Flows from Operating Activities Net Income $134, Add: Decrease in prepaid expenses $ 330 Increase in Accounts Payable 2, Depreciation Expense 27,400 + 30, 165, Deduct: Increase in Accounts Receivable $ 4, Increase in Inventories 5, Decrease in Salaries Payable 1,130 - 11, Net Cash Flows from Operating Activities $153,

Practice Problem # Given the following information and using the indirect method prepare the Cash Flows from Operating Activities section of the statement of cash flows.

End of Year Beginning of Year Change Cash $345,000 $386, Accounts Receivable 554,300 567, Merchandise Inventory 693,000 672, Prepaid Expenses 27,000 24, Accounts Payable (creditors) 510,000 527, Wages Payable 39,500 36,

The net income reported on the income statement for the current year was $465,000, which included a gain on sale of investments of $3,000. Depreciation recorded on store equipment for the year amounted to $99,800.

T-Account Method of Analyzing Accounts

By analyzing each transaction and each change in a ledger account for the year in terms of how it has affected cash, all of the data necessary to prepare the Statement of Cash Flows can be prepared.

Analyzing the following comparative balance sheet and additional information will illustrate this method.

(increases) (decreases) (inflows) (outflows) (inflows) (outflows) a) 98,500 N.I. c) 11,000 gain c) 60,000 sold g) 115,000 to f) 40,000 issue 70,670 div. Pd b) 23,500 Depr. 7,300 Invent investments const. Bldg mortgage d) 7,000 Amort. 380 Prep. Exp. e) 15,000 sold 7,000 A/R 3,200 A/P land 1,500 Accr. Exp. 500 Inc. Tx Pay

Cash - Operating Cash - Investing Cash - Financing

i) 74,670 div. a) 98,500 N.I. b) 13,000 b) 10,

23830

c ) 49,000 d) 7,000 e) 15,

f) 40,000 g) 115,000 70,670 pd i) 74,670 dec l.

4,

h) 75,000 h) 25000 h) 100,

Co m m o n S to ck P IC-e x ce ss o f p a r-CS Bo n d s P a ya b le

In ve stm e n ts P a te n ts L a n d

M o rtg a g e N o te P a ya b le Bu ild in g Divid e n d s P a ya b le

Re ta in e d Ea rn in g s Accu m. De p r.-Bld g Accu m. D e p r.-M /E

a) Net Income increases Cash-Operating and increases Retained Earnings. b) Depreciation Expense is added back to Cash-Operating (noncash expense) and it increases Accumulated Depreciation on the Building and Machinery & Equipment. c) Selling investments increases Cash-Investing for the selling price of $60,000, decreases Investments for the cost of $49,000, and the gain of $11,000 is deducted from Cash-Operating. d) Patent amortization is added back to Cash-Operating (noncash expense) and it decreases the Patent account. e) Selling land increases Cash-Investing for the selling price of $15,000, and decreases land for the cost of $15,000. No gain or loss. f) Issuing a mortgage note increases Cash-Financing and increases Mortgage Note Payable. g) Constructing a building increases the Building account and decreases Cash- Investing.

h) Issuing stock to retire bonds is a noncash financing/investing activity that will be listed at the end of the Statement of Cash Flows. This transaction increased Common Stock and PIC-excess of par-CS and decreased Bonds Payable. i) Dividends declared increase Dividends Payable and decrease Retained Earnings. j) The remaining items listed in the Cash-Operating account above are the changes in the current asset and current liability accounts. k) The Dividends Payable account needs to be analyzed to determine the dividends actually paid. The credit from (i) indicates an increase in the account of $74,670. The change in the account taken from the balance sheet indicates the account increased by only $4,000 for the year; therefore $70,670 must have been paid. This is shown in Cash-Financing as an outflow.

C a sh F l o w s fr o m O p e r a ti n g A c ti v i ti e s

N e t In c o m e 9 8 , 5 0 0 A d d : D e p re c ia t io n E x p e n s e 2 3 , 5 0 0 A m o rt iz a t io n E x p e n s e 7 , 0 0 0 D e c re a s e in A / R 7 , 0 0 0 In c re a s e in A c c ru e d E x p e n s e s 1 , 5 0 0 3 9 , 0 0 0 1 3 7 , 5 0 0 D e d u c t : G a in o n S a le 1 1 , 0 0 0 In c re a s e in In ve n t o ry 7 , 3 0 0 In c re a s e in P re p a id E x p e n s e 3 8 0 D e c re a s e in A / P 3 , 2 0 0 D e c re a s e in In c o m e Ta x P a y a b le 5 0 0 2 2 , 3 8 0 N e t C a sh F l o w s fr o m O p e r a ti n g A c ti v i ti e s 1 1 5 , 1 2 0

C a sh F l o w s fr o m I n v e sti n g A c ti v i ti e s

C a s h re c e ive d fro m s e llin g in ve s t m e n t s 6 0 , 0 0 0 C a s h re c e ive d fro m s a le o f la n d 1 5 , 0 0 0 7 5 , 0 0 0 L e s s : C a s h p a id t o c o n s t ru c t a b u ild in g (1 1 5 , 0 0 0 ) N e t C a sh F l o w s u se d fo r I n v e sti n g A c ti v i ti e s (4 0 , 0 0 0 )

C a sh F l o w s fr o m F i n a n c i n g A c ti v i ti e s

C a s h re c e ive d fro m is s u in g a m o rt g a g e 4 0 , 0 0 0 L e s s : C a s h p a id fo r d ivid e n d s (7 0 , 6 7 0 ) N e t C a sh F l o w s u se d fo r F i n a n c i n g A c ti v i ti e s (3 0 , 6 7 0 )

I n c r e a se i n C a sh 4 4 , 4 5 0 C a sh a t th e b e g i n n i n g o f th e y e a r 9 5 , 9 0 0 C a sh a t th e e n d o f th e y e a r 1 4 0 , 3 5 0

S c h e d u l e o f N o n c a sh F i n a n c i n g / I n v e sti n g A c ti v i ti e s C o m m o n S t o c k w a s is s u e d t o re t ire B o n d s P a y a b le 1 0 0 , 0 0 0

D o w l i n g C o m p a n y S ta te m e n t o f C a sh F l o w s F o r th e y e a r e n d e d D e c e m b e r 3 1 , 2 0 0 2

6. Depreciation on factory equipment would be reported in the statement of cash flows prepared by the indirect method in: a. The cash flows from financing activities section b. The cash flows from investing activities section c. The cash flows from operating activities section d. A separate schedule
7. The statement of cash flows classifies cash receipts and payments into four activity categories. a. True b. False
8. Under the indirect method, noncash expenses are added to net income. a. True b. False
9. Which of the following would be classified as an operating activity? a. Payment of a cash dividend b. Sale of equipment c. Making a loan to another entity d. Payment of interest
10. Which of the following is not an operating activity? a. Payment of taxes b. Dividends received c. Payment of a cash dividend d. Payment to suppliers
11. The indirect method of preparing the statement of cash flows begins with a. Collections from customers b. Cash sales c. Net income d. Beginning Cash Balance
12. Under the indirect method of preparing the statement of cash flows, an increase in accounts receivable is: a. Added to net sales b. Deducted from net sales c. Added to net income d. Deducted from net income

13. Under the indirect method of preparing the statement of cash flows, which of the following is added to net income in the operating activities section? a. Gain on sale of equipment b. Depreciation expense c. Increase in accounts receivable d. Decrease in accounts payable
14. Under the indirect method of preparing the statement of cash flows, which of the following is deducted from net income in the operating activities section? a. Gain on sale of land b. Amortization expense c. Decrease in inventory d. Increase in wages payable
15. Assume a company sold a piece of equipment for $3,000. The original cost was $15,000 and the accumulated depreciation prior to the sale was $10,000. What amount, if any, would appear in the operating activities section of the statement of cash flows using the indirect method? a. $ b. $2, c. $3, d. $15,
16. Which of the following would be classified as a financing activity? a. Purchase of treasury stock b. Receipt of dividends c. Sale of an investment in bonds d. Purchase of a Patent
17. Which of the following would be classified as an investing activity? a. Purchasing an investment in bonds b. Payment of a dividend c. Issuing Common Stock d. Payment of interest
18. According to the comparative balance sheet, the balance of the Dividends Payable account at the beginning and end of the year was $54,000 and $52,500 respectively. The Retained Earnings Statement indicates that $80, in dividends was declared during the year. What amount of dividends was paid out during the year? a. $80, b. $54, c. $78, d. $81,

Practice Problem # a. Dividends Payable 50,000 50,000 + 240,000 – X = 60, X 240,000 290,000 – X = 60, X = 230,000 dividends paid = Financing Outflow 60,

b. Investing Inflow of $130, Book Value: 245,000 – 95,000 = $150, Loss of $20,000 is reported in the Operating Activity Section and is added back to net income c. Investing Inflow of $20, Book Value: 39,000 – 23,000 = $16, Gain of $4,000 is reported in the Operating Activity Section and is deducted from net income d. Financing Inflow of $250, e. Separate Schedule f. $55,000 is reported in the Operating Activity section and is added back to net income g. Financing Outflow of $60,

Practice Problem # Cash Flows from Operating Activities Net Income 465, Add: Depreciation Expense 99, Decrease in A/R 13, Increase in Wages Payable 3,500 116, 581, Deduct: Gain on Investments 3, Increase in Mdse Inv. 20, Increase in Prepaid Exp. 3, Decrease in A/P 17,400 44, Net Cash Flows from Operating Activities 537,

SOLUTIONS TO MULTIPLE CHOICE QUESTIONS

1. C: 50,000 BV - 15,000 loss = 35,000 selling price
2. C: Selling Price $100,000 is reported as an investing activity
3. A
4. D
5. C
6. C
7. B: Three Categories; Operating, Investing and Financing
8. A
9. D
10. C
11. C
12. D
13. B
14. A
15. B: Selling Price of $3,000 less Book Value (15,000 – 10,000) of $5,000 = $2,000 loss
16. A
17. A
18. D: Beg. Bal. 54,000 + Dividends Declared 80,000 – End. Bal. 52,500 = 81,500 paid
19. D: Net Income 115, Add: Loss 8, Depr. 48, Decr. Prepaid 2, Incr. Sal. Pay 500 58, Deduct: Incr. A/R 10, Incr. Invent. 9, Decr. A/P 7,800 (27,800) Net Cash Flows from Operating Activities 145,
20. C: 2,000,000 * 1.08 = 2,160,000 inflow from financing