Intermediate accounting, Kieso, Chapter 23

Statement of cash flows Purposes

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

Usefulness of the 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 flow from operating activities

4) Cash and noncash investing and financing transactions

** Investors are primarily looking at this.

Classification of cash flows

Operating Activities

- Income Statement items

** Working income and accrual

Investing Activities

- Changes in investments and long-term asset items

**Cap ex.

Financing Activities

- Changes in Long-term Liabilities and Stockholders' Equity

** paying dividends

Operating Activities - typical inflows and outflows

Cash inflows:

- From sales of goods or services

- From returns on loans (interest) and on equity securities (dividends)

Cash outflows:

- To suppliers for inventory

- To employees for services

- To government for taxes

- To lenders for interest

- To others for expenses

Investing Activities - typical inflows and outflows

Cash inflows:

- From sale of property, plant, and equipment

- From sale of 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 debt or equity securities of other entities

- To make loans to other entities

** Generally long-term asset items

Financing Activities - typical inflows and outflows

Cash inflows:

- From sale of OWN equity securities

- From issuance of debt (bonds and notes) - of own debt

Cash outflows:

- To stockholders as dividends

- to redeem long-term debt or reacquire capital stock

** generally long-term liability and equity items

Cash equivalents

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 in interest rates.

** generally, only investments with original maturities of three months or less qualify under this definition

Format of the Statement of Cash Flows part 1

Cash flows from operating activities

--Net Income

-- Adjustments to reconcile net income to net cash provided (used) by operating activities:

------ (List of individual items)

--Net cash provided (used) by operating activities

Cash flows from investing activities

------ (List of individual inflows and outflows)

-- Net cash provided (used) by investing activities

Format of the Statement of Cash Flows part 2

Cash flows from financing activities

------ (List of individual inflows and outflows)

-- Net cash provided (used) by financing activities

Net increase (decrease in cash

Cash at beginning of period

Cash at end of period

3 sources of information used for statement of cash flows

1. Comparative balance sheets

2. Current income statement data.

3. Selected transaction data.

3 major steps for statement of cash flows

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.

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

Adjustments needed to determine net cash flow from operating activities - additions

* Depreciation expense

* Amortization of intangibles and deferred charges

* Amortization of discount on bonds payable

** Increase in deferred income tax liability

*Loss on investment in C.S. using equity method

*** Loss on sale of plant assets

* Loss on impairment of assets

** Decrease in receivables

** Decrease in inventory

** Decrease in prepaid expenses

** Increase in accounts payable

** Increase in accrued liabilities

Adjustments needed to determine net cash flow from operating activities - deductions

* Amortization of premium on bonds payable

** Decrease in deferred tax liability

* Increase on investment in C.S. using equity method

*** Gain on sale of plant assets

** Increase in receivables

** Increase in inventory

** Increase in prepaid expense

** Decrease in accounts payable

** Decrease in accrued liabilities

* Non cash items ... added back

** Remove the effects of accruals

*** loss/gain is a noncash charge in the I.S.

Losses and Gains (operating)

- a loss/gain is added/deducted from net income to compute net cash flow from operating activities because the loss is a noncash charge in the income statement.

- Company reports a loss/gain in the statement of cash flows as part of the cash proceeds from the sale of equipment/land/securities under investing activities, thus it adds/deducts the loss/gain from net income to avoid double-counting - once as part of net income and again as part of the cash proceeds from the sale

** If sell something, entire amount of sale here

Unrealized losses and gains

- Unrealized holding gains/losses (trading debt and equity securities) that affect net income must be reversed to determine net cash flows from operations

** no effect on cash flow because unrealized

- Unrealized holding gains/losses (i.e. available for sale debt securities) that do not affect net income require no adjustments to determine net cash flows from operations.

** No adjustment needed

** Recall these unrealized gains and losses are held in equity (other comprehensive income). Do not effect net income.

Equity method of accounting (20% to 50% ownership). Two impacts:

1. Change in equity investment: Net increase in the investment account does not affect cash flows

2. Equity earnings: Company must deduct the net increase from net income to arrive at net cash flow from operating activities.

Unusual and infrequent items (investing and financing)

Companies should report either as investing activities or as financing activities cash flows from unusual and infrequent transactions and other events whose effects are included in net income but which are not related to operations.

*i.e. a fire destroying a building

significant noncash transactions (disclosure)

Common noncash transactions that a company should report or disclose:

1. Acquisition of assets by assuming liabilities (including capital lease obligations) or by issuing equity securities.

2. Exchanges of nonmonetary assets.

3. Refinancing of long-term debt. (not taking on more debt)

4. Conversion of debt or P.S. to C.S.

5. Issuance of equity securities to retire debt.

** Below the cash flow transactions

** Trading when in one statement