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FINANCIAL ACCOUNTING
Fourth Canadian Edition
LIBBY, LIBBY, SHORT, KANAAN, GOWING

Reporting and Interpreting Cash Flows Chapter 5

PowerPoint Author:

Robert G. Ducharme, MAcc, CA University of Waterloo, School of Accounting and Finance

Copyright 2011 McGraw-Hill Ryerson Limited

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Understanding the Business Positive cash flows permit a company to . . .

Pay dividends to owners. Take advantage of market opportunities. Expand its operations. Replace needed assets.

Financial analysts consider cash flow an important indicator of a companys financial health.
Copyright 2011 McGraw-Hill Ryerson Limited LO 1

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Classifications of the Statement of Cash Flows

Cash Equivalents

Cash

Currency

Short-term, highly liquid investments. Readily convertible into cash. So near maturity that market value is unaffected by interest rate changes (i.e., original maturities of less than 3 months).
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Classifications of the Statement of Cash Flows

Cash inflows and outflows directly related to earnings from normal operations.
Cash inflows and outflows related to the acquisition or sale of productive facilities and investments in the securities of other companies. Cash inflows and outflows related to external sources of financing (owners and creditors) for the enterprise.
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Operating Activities Investing Activities Financing Activities

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CASH INFLOWS
Operating Activities Cash received from revenues Investing Activities Sale of operational assets Sale of investments Collections of loans Financing Activities Issuance of shares Issuance of bonds and notes

Business
Cash paid for expenses Purchase of operational assets Purchase of investments Loans to others Payment of dividends Repurchase of shares Repayment of debt

CASH OUTFLOWS
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ANDREW PELLER LIMITED Consolidated Statement of Cash Flows Three Months Ended September 30, 2008 Cash provided by (used in) operating activities: Net earnings / Profit $ Items not affecting cash: Depreciation of plant equipment Deferred income taxes Changes in non-cash operating working capital items: Increase in trade receivable Increase in inventories Increase in prepayments Increase in trade payables Decrease in accrued liabilities Cash provided by (used in) investing activities: Purchases of property, plant and equipment Proceeds from long-term investments Cash provided by (used in) financing activities: Repayment of long-term debt Increase in bank borrowings Payment of dividends Net increase (decrease) in cash & cash equivalents Cash & cash equivalents at beginning of period Cash & cash equivalents at end of period
Copyright 2011 McGraw-Hill Ryerson Limited

3,517 2,126 (1,562) (5,509) (1,382) (1,006) 5,708 (1,165) 727 (3,006) 58 (2,948) (464) 3,882 (1,197) 2,221 -

Andrew Peller Limited uses the indirect method. The indirect method is used by 99.5% of companies. This ending cash balance should agree with the statement of financial position.

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Cash Flows from Operating Activities

The Direct Method of presenting the Operating Activities section of the statement of cash flows reports components of cash flows from operating activities as gross receipts and gross payments. The Indirect Method of presenting the Operating Activities section of the statement of cash flows adjusts profit to compute cash flows from operating activities.
Copyright 2011 McGraw-Hill Ryerson Limited LO 1

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Direct Method vs. Indirect Method

Two Formats for Reporting Operating Activities

Direct Method Reports the cash effects of each operating activity

Indirect Method Starts with accrual profit and converts to cash basis

Note that no matter which format is used, the same amount of net cash flows from operating activities is generated.
Copyright 2011 McGraw-Hill Ryerson Limited LO 1

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Cash Flows from Operating Activities Although IAS 7: Statement of Cash Flows encourages companies to report cash flows from operating activities using the direct method, it is rarely seen in practice. Many financial executives have reported that they do not use it because it is more expensive to implement than the indirect method.
Copyright 2011 McGraw-Hill Ryerson Limited LO 1

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Cash Flows from Operating Activities

Inflows Cash received from: Customers Dividends and interest on investments Outflows Cash paid for: Purchase of goods for resale and services (electricity, etc.) Salaries and wages Income taxes Interest on liabilities
Copyright 2011 McGraw-Hill Ryerson Limited

Cash Flows from Operating Activities

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Cash Flows from Investing Activities

Inflows Cash received from: Sale or disposal of property, plant and equipment Sale or maturity of investments in securities
Outflows Cash paid for: Purchase of property, plant and equipment Purchase of investments in securities
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Cash Flows from Investing Activities

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Cash Flows from Financing Activities

Inflows Cash received from: Borrowings on notes, mortgages, bonds, etc. from creditors Issuing shares to owners
Outflows Cash paid for: Repayment of principal to creditors (excluding interest, if it is classified an operating activity) Repurchasing shares from owners Dividends to owners
Copyright 2011 McGraw-Hill Ryerson Limited

Cash Flows from Financing Activities

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Relationships to the Statement of Financial Position and the Income Statement

Information needed to prepare a statement of cash flows: Comparative Statements of Financial Position. Income Statement. Additional details concerning selected accounts, transactions and events.

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Relationships to the Statement of Financial Position and the Income Statement

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Cash = Liabilities Shareholders Equity Non-cash Assets

Derives from . . .

Assets = Liabilities Shareholders Equity

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Relationships to the Statement of Financial Position and the Income Statement

Selected Cash Transactions and Their Effect on Other Statement of Financial Position Accounts

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Category Transactions Cash Effect Other Account Affected +Cash -Accounts Receivable (A) Operating Collect trade receivables Pay trade payables -Cash -Accounts Payable (L) Prepay rent -Cash +Prepaid Rent (A) Pay interest -Cash -Retained Earnings (SE) Sell for cash +Cash +Retained Earnings (SE) -Cash +Equipment (A) Investing Purchase equipment for cash Sell investment securities for cash +Cash -Investments (A) -Cash -Notes Payable-Bank (L) Financing Pay back debt to bank +Share Capital (SE) Issue shares for cash +Cash

Copyright 2011 McGraw-Hill Ryerson Limited

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Reporting and Interpreting Cash Flows from Operating Indirect Method

The indirect method adjusts profit by eliminating non-cash items.
+/- Changes in current assets and current liabilities.

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Profit

Cash Flows from Operating Activities: Indirect Method

+ Losses and - Gains

+ Non-cash expenses such as depreciation and amortization.

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Copyright 2011 McGraw-Hill Ryerson Limited

Reporting and Interpreting Cash Flows from Operating Activities Indirect Method
Change in Account Balance During Year Increase Decrease Subtract from profit. Add to profit. Add to profit. Subtract from profit.

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Current Assets Current Liabilities

Use this table when adjusting Profit to Operating Cash Flows using the indirect method.
Copyright 2011 McGraw-Hill Ryerson Limited LO 2

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ANDREW PELLER LIMITED Consolidated Statement of Financial Position

Dollars in Thousands

Sept. 30, 2008 June 30, 2008

Changes

ASSETS Trade receivables Inventories Prepayments Total current assets Property, plant, and equipment (net) Long-term investments Goodwill Total assets LIABILITIES & SHAREHOLDERS' EQUITY Bank borrowings Trade payables Accrued liabilities Dividends payable Current portion of long-term borrowings Total current liabilities Long-term borrowings Deferred income taxes Total liabilities Shareholders' Equity Share capital Retained earnings Total shareholders' equity Total liabilities & shareholders' equity
Copyright 2011 McGraw-Hill Ryerson Limited

$ $

29,721 94,715 7,849 132,285 101,354 7,399 44,499 285,537 51,046 24,423 9,875 1,197 6,158 92,699 74,767 12,682 180,148 7,375 98,014 105,389 285,537

$ $

24,212 93,333 6,843 124,388 100,474 7,457 44,499 276,818 47,164 18,715 11,040 1,197 6,184 84,300 75,205 14,244 173,749 7,375 95,694 103,069 276,818

5,509 1,382 1,006 880 (58) 0

3,882 5,708 (1,165) 0 (26) (438) (1,562)

0 2,320

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ANDREW PELLER LIMITED

Consolidated Statement of Income For the Three Months Ended September 30, 2008
(in thousands of dollars)

Net sales Cost of sales Gross margin Selling, general and administrative Depreciation of plant and equipment Operating profit Interest expense Profit before income taxes Provision for income taxes Profit

69,356 40,254 29,102 20,808 2,126 6,168 1,505 4,663 1,146 $3,517

The Statement of Cash Flows will begin with profit from the Income Statement.
Copyright 2011 McGraw-Hill Ryerson Limited LO 2

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ANDREW PELLER LIMITED Consolidated Statement of Cash Flows Three Months Ended September 30, 2008 Cash provided by (used in) operating activities Profit $ Items not affecting cash: Depreciation of plant and equipment Deferred income taxes Changes in non-cash operating working capital items: Increase in trade receivables Increase in inventories Increase in prepayments Increase in trade payables Decrease in accrued liabilities Net cash provided by (used in) operating activities

3,517 2,126 (1,562) 4,081

Step 1 Adjust profit for depreciation and amortization expense and other items not affecting cash.
Copyright 2011 McGraw-Hill Ryerson Limited LO 2

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ANDREW PELLER LIMITED Consolidated Statement of Cash Flows Three Months Ended September 30, 2008 Cash provided by (used in) operating activities Profit $ Items not affecting cash: Depreciation of plant and equipment Deferred income taxes Changes in non-cash operating working capital items: Increase in trade receivables Increase in inventories Increase in prepayments Increase in trade payables Decrease in accrued liabilities

3,517 2,126 (1,562) 4,081 (5,509) (1,382) (1,006) 5,708 (1,165) 727

Step 2 Adjust profit for changes in non-cash operating working capital items.
Copyright 2011 McGraw-Hill Ryerson Limited LO 2

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ANDREW LIMITED activities section, you To complete the cash flowsPELLER from operating Consolidated Statement of Cash Flows must examine a comparative statement of financial position to Three Months Ended September 30, 2008 determine the changes in non-cash operating working capital Cash provided by (used in) operating activities items from the beginning of the period to the end period. Profit $ of the 3,517 Items not affecting cash: of plant and for equipment 2,126 Now, Depreciation make adjustments changes in current assets Deferred income taxesusing the decision table below. (1,562) current liabilities 4,081 Changes in non-cash operating working capital items: Increase in trade receivables (5,509) Increase in inventories (1,382) Increase in prepayments (1,006) Increase in trade payables 5,708 Decrease in accrued liabilities (1,165) 727

and

Change in Account Balance During Year Increase Decrease Current Assets Subtract from profit. Add to profit. Current Liabilities Add to profit. Subtract from profit.
Copyright 2011 McGraw-Hill Ryerson Limited LO 2

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ANDREW PELLER LIMITED Consolidated Statement of Cash Flows Three Months Ended September 30, 2008 Cash provided by (used in) operating activities Profit $ Items not affecting cash: Depreciation of plant and equipment Deferred income taxes

3,517

2,126 (1,562) Subtract the $5,509 increase in Trade Receivables. 4,081 Changes in non-cash operating working capital items: Increase in trade receivables (5,509) Increase in inventories (1,382) Increase in prepayments (1,006) Increase in trade payables 5,708 Decrease in accrued liabilities (1,165) 727

Change in Account Balance During Year Increase Decrease Current Assets Subtract from profit. Add to profit. Current Liabilities Add to profit. Subtract from profit.
Copyright 2011 McGraw-Hill Ryerson Limited LO 2

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ANDREW PELLER LIMITED Consolidated Statement of Cash Flows Three Months Ended September 30, 2008 Cash provided by (used in) operating activities Profit $ Items not affecting cash: Depreciation of plant and equipment Deferred income taxes

3,517

2,126 (1,562) Subtract the $1,382 increase in Inventories. 4,081 Changes in non-cash operating working capital items: Increase in trade receivables (5,509) Increase in inventories (1,382) Increase in prepayments (1,006) Increase in trade payables 5,708 Decrease in accrued liabilities (1,165) 727

Change in Account Balance During Year Increase Decrease Current Assets Subtract from profit. Add to profit. Current Liabilities Add to profit. Subtract from profit.
Copyright 2011 McGraw-Hill Ryerson Limited LO 2

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ANDREW PELLER LIMITED Consolidated Statement of Cash Flows Three Months Ended September 30, 2008 Cash provided by (used in) operating activities Profit $ Items not affecting cash: Depreciation of plant and equipment Deferred income taxes

3,517

2,126 (1,562) Subtract the $1,006 increase in Prepayments. 4,081 Changes in non-cash operating working capital items: Increase in trade receivables (5,509) Increase in inventories (1,382) Increase in prepayments (1,006) Increase in trade payables 5,708 Decrease in accrued liabilities (1,165) 727

Change in Account Balance During Year Increase Decrease Current Assets Subtract from profit. Add to profit. Current Liabilities Add to profit. Subtract from profit.
Copyright 2011 McGraw-Hill Ryerson Limited LO 2

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ANDREW PELLER LIMITED Consolidated Statement of Cash Flows Three Months Ended September 30, 2008 Cash provided by (used in) operating activities Profit $ Items not affecting cash: Depreciation of plant and equipment Deferred income taxes

3,517

2,126 (1,562) Add the $5,708 increase in Trade Payables. 4,081 Changes in non-cash operating working capital items: Increase in trade receivables (5,509) Increase in inventories (1,382) Increase in prepayments (1,006) Increase in trade payables 5,708 Decrease in accrued liabilities (1,165) 727

Change in Account Balance During Year Increase Decrease Current Assets Subtract from profit. Add to profit. Current Liabilities Add to profit. Subtract from profit.
Copyright 2011 McGraw-Hill Ryerson Limited LO 2

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ANDREW PELLER LIMITED Consolidated Statement of Cash Flows Three Months Ended September 30, 2008 Cash provided by (used in) operating activities Profit $ Items not affecting cash: Depreciation of plant and equipment Deferred income taxes

3,517 2,126 (1,562) Liabilities. 4,081 (5,509) (1,382) (1,006) 5,708 (1,165) 727

Subtract the $1,165 decrease in Accrued

Changes in non-cash operating working capital items: Increase in trade receivables Increase in inventories Increase in prepayments Increase in trade payables Decrease in accrued liabilities

Change in Account Balance During Year Increase Decrease Current Assets Subtract from profit. Add to profit. Current Liabilities Add to profit. Subtract from profit.
Copyright 2011 McGraw-Hill Ryerson Limited LO 2

Interpreting Cash Flows from Operating Activities

Accounts Receivable Changes
Managers sometimes attempt to boost declining sales by extending credit terms or by lowering credit standards. The resulting increase in accounts receivable can cause profit to outpace cash flows from operations.

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Inventory Changes
Copyright 2011 McGraw-Hill Ryerson Limited

Inventory growth can be a sign that planned sales growth did not materialize. A decline in inventory can be a sign that the company is anticipating lower sales in the next quarter.
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Interpreting Cash Flows from Operating Activities

A common rule of thumb followed by financial and credit analysts is to avoid firms with rising profit but falling cash flow from operations. Investors will not invest in a company if they do not believe that cash generated from operations will be available to pay them dividends or expand the company.

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Creditors will not lend money if they do not believe that cash generated from operations will be available to pay back the loan.
Copyright 2011 McGraw-Hill Ryerson Limited LO 2

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Quality of Earnings Ratio

Quality of = Cash Flow from Operating Activities Earnings Ratio Profit

In general, this ratio measures the portion of income that was generated in cash. All other things equal, a higher quality of income ratio indicates greater ability to finance operating and other cash needs from operating cash inflows.

Copyright 2011 McGraw-Hill Ryerson Limited

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ANDREW PELLER LIMITED Consolidated Statement of Financial Position

Dollars in Thousands

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Sept. 30, 2008 June 30, 2008

Changes

ASSETS Trade receivables Inventories Prepayments Total current assets Property, plant, and equipment (net) Long-term investments Goodwill Total assets LIABILITIES & SHAREHOLDERS' EQUITY Bank borrowings Trade payables Accrued liabilities Dividends payable Current portion of long-term borrowings Total current liabilities Long-term borrowings Deferred income taxes Total liabilities Shareholders' Equity Share capital Retained earnings Total shareholders' equity Total liabilities & shareholders' equity Copyright 2011 McGraw-Hill Ryerson Limited

$ $

29,721 $ 94,715 7,849 132,285 101,354 7,399 44,499 285,537 $ 51,046 $ 24,423 9,875 1,197 6,158 92,699 74,767 12,682 180,148 7,375 98,014 105,389 285,537 $

24,212 93,333 6,843 124,388 100,474 7,457 44,499 276,818 47,164 18,715 11,040 1,197 6,184 84,300 75,205 14,244 173,749 7,375 95,694 103,069 276,818

5,509 1,382 1,006 880 (58) 0

3,882 5,708 (1,165) 0 (26)

Lets focus (438) (1,562) on the investing 0 accounts.

2,320
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ANDREW PELLER LIMITED Consolidated Statement of Cash Flows Three Months Ended September 30, 2008 Cash provided by (used in) operating activities: Net earnings / Profit $ Items not affecting cash: Depreciation of plant equipment Deferred income taxes Changes in non-cash operating working capital items: Increase in trade receivable Increase in inventories Increase in prepayments Increase in trade payables Decrease in accrued liabilities Cash provided by (used in) investing activities: Purchases of property, plant and equipment Proceeds from long-term investments Cash provided by (used in) financing activities: Repayment of long-term debt Increase in bank borrowings Payment of dividends

3,517 2,126 (1,562) (5,509) (1,382) (1,006) 5,708 (1,165) 727 (3,006) 58 (2,948) (464) 3,882 (1,197) 2,221 -

We must report individually the cash used to purchase equipment and the cash proceeds received from the sale of equipment.

The statement of financial position indicates that Property, Plant, and Equipment (net) increased by $880 Net increase (decrease) in cash & cash equivalents during theat quarter. This is made up of $3,006 of new Cash & cash equivalents beginning of period Cash & cash equivalents at end of period $ additions and a reduction for depreciation of $2,126.
Copyright 2011 McGraw-Hill Ryerson Limited LO 4

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ANDREW PELLER LIMITED Consolidated Statement of Cash Flows Three Months Ended September 30, 2008 Cash provided by (used in) operating activities: Net earnings / Profit $ Items not affecting cash: Depreciation of plant equipment Deferred income taxes Changes in non-cash operating working capital items: Increase in trade receivable Increase in inventories Increase in prepayments Increase in trade payables Decrease in accrued liabilities Cash provided by (used in) investing activities: Purchases of property, plant and equipment Proceeds from long-term investments Cash provided by (used in) financing activities: Repayment of long-term debt Increase in bank borrowings Payment of dividends Net increase (decrease) in cash & cash equivalents Cash & cash equivalents at beginning of period Cash & cash equivalents at end of period
Copyright 2011 McGraw-Hill Ryerson Limited

3,517 2,126 (1,562) (5,509) (1,382) (1,006) 5,708 (1,165) 727 (3,006) 58 (2,948) (464) 3,882 (1,197) 2,221 -

Long-term investments decreased by a net $58 during the $ quarter.

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Capital Acquisitions Ratio

Capital Acquisitions = Cash Flow from Operating Activities Cash Paid for Property, Plant, Ratio and Equipment

In general, this ratio reflects the portion of purchases of property, plant and equipment financed from operating activities. A high ratio indicates less need for outside financing for current and future expansions.

Copyright 2011 McGraw-Hill Ryerson Limited

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Free Cash Flow

Free Cash Flow = Cash Flow from Operating Activities Dividends Capital Expenditures

In general, this measures a firms ability to pursue long-term investment opportunities.

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ANDREW PELLER LIMITED Consolidated Statement of Financial Position

Dollars in Thousands

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Sept. 30, 2008 June 30, 2008

Changes

ASSETS Trade receivables Inventories Prepayments Total current assets Property, plant, and equipment (net) Long-term investments Goodwill Total assets LIABILITIES & SHAREHOLDERS' EQUITY Bank borrowings Trade payables Accrued liabilities Dividends payable Current portion of long-term borrowings Total current liabilities Long-term borrowings Deferred income taxes Total liabilities Shareholders' Equity Share capital Retained earnings Total shareholders' equity Total liabilities & shareholders' equity Copyright 2011 McGraw-Hill Ryerson Limited

$ $

29,721 $ 94,715 7,849 132,285 101,354 7,399 44,499 285,537 $ 51,046 $ 24,423 9,875 1,197 6,158 92,699 74,767 12,682 180,148 7,375 98,014 105,389 285,537 $

24,212 93,333 6,843 124,388 100,474 7,457 44,499 276,818 47,164 18,715 11,040 1,197 6,184 84,300 75,205 14,244 173,749 7,375 95,694 103,069 276,818

5,509 1,382 1,006 880 (58) 0

Lets focus on the 3,882 financing 5,708 (1,165) accounts.

0 (26) (438) (1,562)

0 2,320
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ANDREW PELLER LIMITED Consolidated Statement of Cash Flows Three Months Ended September 30, 2008 Cash provided by (used in) operating activities: Net earnings / Profit $ Items not affecting cash: Depreciation of plant equipment Deferred income taxes Changes in non-cash operating working capital items: Increase in trade receivable Increase in inventories Increase in prepayments Increase in trade payables Decrease in accrued liabilities Cash provided by (used in) investing activities: Purchases of property, plant and equipment Proceeds from long-term investments Cash provided by (used in) financing activities: Repayment of long-term debt Increase in bank borrowings Payment of dividends Net increase (decrease) in cash & cash equivalents Cash & cash equivalents at beginning of period Cash & cash equivalents at end of period
Copyright 2011 McGraw-Hill Ryerson Limited

3,517 2,126 (1,562)

(5,509) Long-term debt decreased by the $464 in principal (1,382) (1,006) quarter. payments made during the 5,708 (1,165) 727 (3,006) 58 (2,948) (464) 3,882 (1,197) 2,221 LO 6

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ANDREW PELLER LIMITED Consolidated Statement of Cash Flows Three Months Ended September 30, 2008 Cash provided by (used in) operating activities: Net earnings / Profit $ Items not affecting cash: Depreciation of plant equipment Deferred income taxes Changes in non-cash operating working capital items: Increase in trade receivable Increase in inventories Increase in prepayments Increase in trade payables Decrease in accrued liabilities Cash provided by (used in) investing activities: Purchases of property, plant and equipment Proceeds from long-term investments Cash provided by (used in) financing activities: Repayment of long-term debt Increase in bank borrowings Payment of dividends Net increase (decrease) in cash & cash equivalents Cash & cash equivalents at beginning of period Cash & cash equivalents at end of period
Copyright 2011 McGraw-Hill Ryerson Limited

3,517 2,126 (1,562)

(5,509) Short-term bank borrowings increased by $3,882 (1,382) (1,006) during the quarter. 5,708 (1,165) 727 (3,006) 58 (2,948) (464) 3,882 (1,197) 2,221 LO 6

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ANDREW PELLER LIMITED Consolidated Statement of Cash Flows Three Months Ended September 30, 2008 Cash provided by (used in) operating activities: Net earnings / Profit $ Items not affecting cash: Depreciation of plant equipment Deferred income taxes Changes in non-cash operating working capital items: Increase in trade receivable Increase in inventories Increase in prepayments Increase in trade payables Decrease in accrued liabilities Cash provided by (used in) investing activities: Purchases of property, plant and equipment Proceeds from long-term investments Cash provided by (used in) financing activities: Repayment of long-term debt Increase in bank borrowings Payment of dividends Net increase (decrease) in cash & cash equivalents Cash & cash equivalents at beginning of period Cash & cash equivalents at end of period
Copyright 2011 McGraw-Hill Ryerson Limited

3,517 2,126 (1,562)

(5,509) Cash dividends of $1,197 were paid during the (1,382) quarter. (1,006) 5,708 (1,165) 727 (3,006) 58 (2,948) (464) 3,882 (1,197) 2,221 LO 6

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Interpreting Cash Flows from Financing Activities

The long-term growth of a company is normally financed from three sources: internally generated funds, the issuance of shares, and money borrowed on a long-term basis. The statement of cash flows shows how management has elected to fund its growth. This information is used by analysts who wish to evaluate the capital structure and growth potential of a business.
Copyright 2011 McGraw-Hill Ryerson Limited LO 6

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ANDREW PELLER LIMITED Consolidated Statement of Cash Flows Three Months Ended September 30, 2008 Cash provided by (used in) operating activities: Net earnings / Profit $ Items not affecting cash: Depreciation of plant equipment Deferred income taxes Changes in non-cash operating working capital items: Increase in trade receivable Increase in inventories Increase in prepayments Increase in trade payables Decrease in accrued liabilities Cash provided by (used in) investing activities: Purchases of property, plant and equipment Proceeds from long-term investments Cash provided by (used in) financing activities: Repayment of long-term debt Increase in bank borrowings Payment of dividends Net increase (decrease) in cash & cash equivalents Cash & cash equivalents at beginning of period Cash & cash equivalents at end of period
Copyright 2011 McGraw-Hill Ryerson Limited

3,517 2,126 (1,562)

(5,509) Now we can reconcile the change in cash to the (1,382) (1,006) ending cash balance that appears on the Statement 5,708 of Financial Position. (1,165) 727 (3,006) 58 (2,948) (464) 3,882 (1,197) 2,221 LO 6

Completing the Statement and Additional Disclosures

Required Supplemental Information 1. Reconciliation of profit to cash flow from operations. 2. Cash paid for income taxes and interest. 3. Significant non-cash investing and financing activities.

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Significant non-cash investing and financing transactions do not involve cash.

Example: Purchase of a building with a mortgage.

Companies that use the direct method for computing cash flow from operations usually present a reconciliation of profit to cash flow from operations as a supplemental schedule.
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Supplement A: Adjustment for Gains and Losses Direct Method

Transactions that cause gains and losses should be classified on the statement of cash flows as operating, investing, or financing activities, depending on their dominate characteristics. For example, if the sale of equipment produced a gain, it would be classified as an investing activity.
Gains must be subtracted from profit to avoid double counting the gain.

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Gains

Losses
Copyright 2011 McGraw-Hill Ryerson Limited

Losses must be added to profit to avoid double counting the loss.

Supplement 5A

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Supplement A: Adjustments for Gains and Losses on Sale of Long-term Assets: Indirect Method
Property, plant, and equipment with an original cost of $10,000 and accumulated depreciation of $4,000 is sold for $8,000 cash.
GENERAL JOURNAL
Date Description Debit Credit

Cash (+A) Accumulated depreciation (-XA, +A) Equipment (-A) Gain on disposal (+Gain, +SE)

8,000 4,000 10,000 2,000

Because the gain was included in the computation of income, it is necessary to remove (subtract) the $2,000 gain from the Operating Activities section of the statement to avoid double counting.
Copyright 2011 McGraw-Hill Ryerson Limited Supplement 5A

Supplement B: Reporting Cash Flows from Operating ActivitiesDirect Method

Sales revenue + Decrease in accounts receivable - Increase in accounts receivable = Cash collected from customers
Other expenses Increase in prepaid expenses Decrease in prepaid expenses Increase in accrued expenses Decrease in accrued expenses Cash paid for expenses

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Interest/Dividend revenue + Decrease in interest/dividends receivable - Increase in interest/dividends receivable = Collections of interest/dividends on investments

+ + =

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+ + =

Cost of goods sold Increase in inventory Decrease in inventory Increase in accounts payable Decrease in accounts payable Cash payments to suppliers

+ + =

Income tax expense Increase in prepaid income taxes Decrease in prepaid income taxes Increase in income taxes payable Decrease in income taxes payable Payments of income taxes

Supplement 5B

Supplement B: Reporting Cash Flows from Operating ActivitiesDirect Method

ANDREW PELLER LIMITED Consolidated Statement of Cash Flows For the Three Months Ended September 30, 2008
(Dollars in Thousands)

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Cash flows from operating activities: Cash collected from customers Cash payments to suppliers Cash payments for other operating expenses Cash payments for interest Cash payments for income taxes Net cash provided by operating activities

63,847 (35,928) (22,979) (1,505) (2,708) 727

Remember that when we prepared the operating section using the indirect method, we also arrived at net cash inflow of $727.
Copyright 2011 McGraw-Hill Ryerson Limited Supplement 5B

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Supplement C: Spreadsheet Approach The spreadsheet approach offers a systematic way to keep track of data. A spreadsheet is organized as follows:
1. Four columns to record dollar amounts are established (beginning balance, debit changes, credit changes, and ending balance). 2. On the far left of the top half of the spreadsheet, each account name from the statement of financial position is entered. 3. On the far left of the bottom half of the spreadsheet, the name of each item that will be reported on the statement of cash flows is entered.
Copyright 2011 McGraw-Hill Ryerson Limited Supplement 5C

NATIONAL BEVERAGE CORP. Changes 30-Apr-08 Statement of Financial Position Assets: Cash and equivalents Short-term investments Accounts receivable Inventories Prepaid expenses Equipment, net Accounts payable Accrued expenses Contributed capital Retained earnings Statement of Cash Flows Cash flows from operating activities: Net income Adj. to reconcile net income to net cash provided by operating activities: Depreciation and amortization Changes in assets and liabilities: Accounts receivable Inventory Prepaid expense Accounts payable Accrued expenses Net cash provided by operating activities Cash flows for investing activities: Proceeds from sale of equipment Purchases of property, plant and equipment Maturities (sale) of short-term investments Purchase of short-term investments Net cash provided by investing activities Cash flows from financing activities: Purchase of treasury stock Proceeds from issuance of stock Net cash used in financing activities Net increase in cash & cash equivalents Debits Credits 30-Apr-09

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51,497 3,000 49,186 38,754 12,009 81,781

(n) (k) (d) (e) (i)

32,643 109,450 4,549 858 6,658 1,798 305

(j)

112,450

(f) (b) (c) (h) (m) (a)

6,457 8,891 167 2,604 950 24,742 Outflows

84,140 53,753 39,612 5,552 79,381 48,005 44,403 9,803 160,209 Subtotals

49,803 (g) 41,799 9,158 (l) 13,467

Inflows (a) 24,742

(b)

8,891 (d) (e) 4,549 858 1,798 35,489

(f) (h)

6,457 (g) 2,604

(c) (j)

167 (i) 112,450 (k) 109,450 (3,491) (l) 305 645 (n) 312,522 32,643 312,522 32,643 6,658

After entering all the transactions illustrated in the textbook, this is what the spreadsheet looks like.

(m)

950

Copyright 2011 McGraw-Hill Ryerson Limited

Supplement 5C

5-49

End of Chapter 5

Copyright 2011 McGraw-Hill Ryerson Limited