ACC 313 Chapter 22

Knight, Creighton University

the statement of cash flows is a _______ statement

period

what entities are required to preparer a statement of cash flows?

ones that present both a balance sheet and income statement

what basis is the statement of cash flows prepared on?

cash, cash equivalents, and restricted cash or cash equivalents

cash equivalents

short-term, highly liquid investments

criteria for classifying an item as a cash equivalent:

• readily convertible into known amounts of cash

• so near maturity that they present no significant risk because of changes in values caused by changes in interest rates

what are the only type of investments that generally qualify as cash equivalents?

debt-type investments with original maturities of 3 months or less

examples:

• treasury bills

• commercial paper

• money market funds

what are the reporting requirements concerning cash equivalents?

• all entities must disclose their policies concerning what is classified as a “cash equivalent”

• “cash equivalents” and “cash” must be shown on the same line on the balance sheet

• purchases and sales of “cash equivalents” are not shown on a statement of cash flows → this is because they are part of cash management

how are restricted cash and cash equivalents reported?

sometimes in “current assets”, sometimes in “other assets”

what does the statement of cash flows show?

• where cash came from during a period

• what cash was used for during a period

• the change in the balance of “cash and cash equivalents” and “restricted cash and cash equivalents” for the period

what is the primary purpose of the statement of cash flows?

provide information about cash receipts and payments of an entity during a period so users can assess:

• entity’s ability to generate positive future cash flows

• entity’s ability to meet future cash obligations

• reason for differences between “net income” and “net cash provided by operating activities”

• cash and non-cash investing and financing activities

• entity’s ability to pay cash dividends

the statement of cash flows provides a direct basis for assessing an entity’s…

liquidity

operating cash flows-to-sales ratio

net cash inflows from operating activities / net sales (revenues)

capital expenditures ratio

net cash inflows from operating activities / net annual capital expenditures

current cash debt coverage ratio

net cash inflows from operating activities / average current liabilities

cash debt coverage ratio

net cash inflows from operating activities / average total liabilities

operating cash flows-to-total assets ratio

net cash inflows from operating activities / average total assets

cash flow yield ratio

net cash inflows from operating activities / net income

“cash” times interest earned ratio

net cash inflows from operating activities + cash paid for interest + cash paid for income taxes / cash paid for interest

what are the limitations of the statement of cash flows?

• statement is historically-based, but users are really interest in future cash flows

• subject to manipulation, just like NI is, if it’s computed on a cash basis instead of an accrual basis

what are the three classifications of cash flows?

operating activities, investing activities, and financing activities

operating activities

include all transactions and events that are not investing and financing activities; involve cash effects that enter directly into the determination of net income (they impact cash and net income the same)

investing actvities

include lending/collecting cash on loans; acquiring/disposing of investments and productive long-lived assets (PP&E)

financing activities

include obtaining cash from creditors and repaying amounts borrowed; obtaining capital from owners, providing them with a return on their investment, and returning their investments through retiring stock

operating cash inflows examples

• cash received from sale of goods and services

• cash received from returns on loans (interest receivable), debt investments (interest receivable), and equity investments (dividends receivable)

operating cash outflows examples

• cash paid to suppliers for inventory

• cash paid to employees for their services

• cash paid to the government for taxes

• cash paid to lenders for interest

• cash paid to others for expenses

investing cash inflows examples

• cash received from sale of PP&E

• cash received from sale of debt/equity securities of another entity

• cash received from collection of principal on a loan

investing cash outflows examples

• cash paid to purchase PP&E

• cash paid to purchase debt/equity securities of another entity

• cash paid to make a loan to others

financing cash inflows examples

• cash received from sale of entity’s own equity securities

• cash received from issuance of debt (bonds and notes)

• cash received as a result of any other forms of borrowing

financing cash outflows examples

• cash paid to shareholders as dividends

• cash paid to redeem (retire) debt

• cash paid to reacquire equity as treasury stock or retire it

when handling changes in accounts, the ______ method is required to be used

gross

*example: an entity may report two separate purchases of equipment as a single activity on the statement of CFs, but they may not report a purchase of equipment and a sale of equipment as a single activity

how are non-cash investing and financing activities reported on the statement of cash flows?

they are not shown in the body of the statement, but must be disclosed either in a footnote to the fin. stmt.s or in a supporting schedule at the bottom of the statement of CFs

format of the statement of cash flows - indirect method

(heading - for the xxx ended…)

operating activities

net income

± non-cash exp.s, rev.s, losses, and gains included in net income

= net cash inflows (outflows) from operating activities

investing activities

• list of individual inflows and outflows

net cash inflows (outflows) from investing activities

financing activities

• list of individual inflows and outflows

net cash inflows (outflows) from financing activities

net increase (decrease) in cash and cash equivalents

+ beg. bal. of cash and cash equivalents

= end. bal. of cash and cash equivalents

non-cash investing and financing activities

• list of individual non-cash investing and financing transactions

why does the operating activities section begin with net income when using the indirect method?

the assumption is that whenever a journal entry is made, the effect on net income also happened to cash

format of the statement of cash flows - direct method

(heading - for the xxx ended…)

operating activities

• list of individual inflows and outflows

net cash inflows (outflows) from operating activities

investing activities

• list of individual inflows and outflows

net cash inflows (outflows) from investing activities

financing activities

• list of individual inflows and outflows

net cash inflows (outflows) from financing activities

net increase (decrease) in cash and cash equivalents

+ beg. bal. of cash and cash equivalents

= end. bal. of cash and cash equivalents

non-cash investing and financing activities

• list of individual non-cash investing and financing transactions

the investing activities and financing activities section of both types of statements of cash flows are prepared how?

in exactly the same manner

which cash flows statement method is encouraged by FASB?

the direct method

how is the operating section of the statement of CFs prepared using the direct method?

straightforward descriptions are made; amounts shown are adjusted for changes in any related balance sheet accounts

what items must be reported separately when using the direct method?

• cash collected from customers

• interest and dividends received

• any other operating cash receipts

• cash paid to employees and suppliers of goods/services

• interest paid

• income taxes paid

• any other operating cash payments

when must the indirect method for statement of CFs preparation be shown?

always

if the direct method is used in the body of the statement of CFs, where is the indirect method shown?

as a supporting schedule as a reconciliation of the direct method

what is the objective of the indirect method?

to begin with net income and adjust this amount for all items that affected net income and cash in different manners

under the indirect method, can entities net the changes in all of the same types of accounts?

yes, but breakdown of each change into individual accounts is encouraged

(ex. entities can report a net trade receivables account)

what information is needed to prepare the statement of cash flows?

• comparative balance sheets

• the current income statement

• selected transaction data

what are the four steps in preparing a statement of cash flows?

1. set up the statement with a heading and the last four lines of the statement

2. fill in the bottom portion of the statement, this information is known before the full statement is prepared

3. go through any provided additional information (make journal entries, use T-accounts)

4. go through all “non-cash and non-cash equivalent” accounts (make journal entries, use T-accounts)

at what point should the statement of cash flows be properly prepared?

once the changes in every balance sheet account have been properly explained

what are the two questions to ask when prepare a statement of cash flows using the direct method?

1. did the transaction affect cash and net income the same?

2. is the transaction a non-cash investing and financing activity?

what are the three questions to ask when prepare a statement of cash flows using the indirect method?

1. did the transaction affect cash?

2. did the transaction affect net income?

3. is the transaction a non-cash investing and financing activity?

how are depreciation and amortization reported on the statement of cash flows?

direct method: nothing is done

indirect method: added/deducted from net income

how are gains and losses reported on the statement of cash flows?

direct method: nothing is done

indirect method: gains are subtracted from net income; losses are added to net income

how are declarations of dividends, stock dividends, and stock splits reported on the statement of cash flows?

both methods: nothing is done

how are allowances for uncollectibles and bad debts reported on the statement of cash flows? (when using allowance method)

write-off: nothing is done for both methods

period-ending adjusting entry:

direct method: nothing is done

indirect method: added/deducted from net income