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McGraw-Hill/Irwin
15-2
Why is there a difference between net income and net cash flow?
McGraw-Hill/Irwin
15-3
Learning Objective 1
McGraw-Hill/Irwin
15-4
Cash
The term cash on the statement of cash flows refers broadly to both currency and cash equivalents.
T-bills
Cash
Money Market Funds
McGraw-Hill/Irwin
Commercial Paper
Copyright 2008, The McGraw-Hill Companies, Inc.
15-5
Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts
Changes in Liabilities
Net Income
McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.
15-6
Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts
15-7
Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts
15-8
Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts
15-9
Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts
15-10
Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts
McGraw-Hill/Irwin
15-11
Cash Accounts Receivable Inventory Land Equipment Accumulated Depr. Accounts Payable Salaries Payable Note Payable - Joe Doe Common Stock Retained Earnings
McGraw-Hill/Irwin
15-12
Additional Information:
There was a net loss for the year of $27,000. Depreciation charges for the year were $6,000. During the year, Ed sold land originally costing $32,000 for $32,000. During the year, Ed paid dividends of $3,000 to the stockholders. Ed issued $50,000 of common stock to settle the note due to Joe Doe.
McGraw-Hill/Irwin
15-13
A Simplified Statement of Cash Flows: An Example Here is a summary of the sources of cash for Eds Pizza Hut.
Ed's Pizza Hut Sources of Cash Decrease in A/R $ Decrease in Land Increase in A/P Depreciation charges Total sources of cash $
McGraw-Hill/Irwin
15-14
A Simplified Statement of Cash Flows: An Example Here is a summary of the uses of cash for Eds Pizza Hut.
Ed's Pizza Hut Uses of Cash Net loss Increase in Inventory Increase in Salaries Payable Dividends paid Total uses of cash $ 27,000 50,000 5,000 3,000 85,000
The net cash flow for Eds Pizza Hut is ($19,000): $66,000 in sources minus $85,000 in uses.
McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.
15-15
Ed's Pizza Hut Uses of Cash Net loss Increase in Inventory Increase in Salaries Payable Dividends paid Total uses of cash
McGraw-Hill/Irwin
This simplified approach does not follow the format required for external reporting purposes. It is for illustrative purposes only.
Copyright 2008, The McGraw-Hill Companies, Inc.
15-16
Learning Objective 2
McGraw-Hill/Irwin
15-17
Operating activities are those activities that enter into the determination of net income.
Transactions affecting current assets Transactions affecting current liabilities Changes in noncurrent balance sheet accounts that directly affect net income
McGraw-Hill/Irwin
15-18
Investing activities relate to transactions involving the acquiring or disposing of noncurrent assets.
Acquiring or selling property, plant and equipment Acquiring or selling securities Lending money to another entity and subsequently collecting on the loan
McGraw-Hill/Irwin
15-19
McGraw-Hill/Irwin
15-20
Operating Activities: Net income Changes in current assets Changes in noncurrent assets that affect net income (e.g., depreciation) Changes in current liabilities (except for debts to lenders and dividends payable) Changes in noncurrent liabilities that affect net income Investing Activities: Changes in noncurrent assets that are not included in net income Financing Activities: Changes in the current liabilities that are debts to lenders rather than obligations to suppliers, employees, or the government Changes in noncurrent liabilities that are not included in net income Changes in capital stock accounts Dividends
McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.
15-21
15-22
Operating Activities
Net Income (Loss) Add: Decr. in Current Noncash Assets Incr. in Current Liabilities Depreciation Charges Losses Less: Incr. in Current Noncash Assets Decr. in Current Liabilities Gains Net Cash Flows from Operating Activities $ XXX XXX XXX XXX XXX (XXX) (XXX) (XXX) $ XXX
Includes those activities that enter into the determination of net income.
McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.
15-23
Operating Activities
Sources of cash are added to net income and uses of cash are subtracted from net income.
Impact on Net Income Sources Uses Current Noncash Assets Current Liabilities Decreases Increases Increases Decreases
McGraw-Hill/Irwin
15-24
Operating Activities
Net Income (Loss) Add: Decr. in Current Noncash Assets Incr. in Current Liabilities Depreciation Charges Losses Less: Incr. in Current Noncash Assets Decr. in Current Liabilities Gains Net Cash Flows from Operating Activities
Impact on Net Income Sources Uses Current Noncash Assets Current Liabilities
McGraw-Hill/Irwin
Decreases Increases
Increases Decreases
Copyright 2008, The McGraw-Hill Companies, Inc.
15-25
Operating Activities
Net Income (Loss) Add: Decr. in Current Noncash Assets Incr. in Current Liabilities Depreciation Charges Losses Less: Incr. in Current Noncash Assets Decr. in Current Liabilities Gains Net Cash Flows from Operating Activities
Impact on Net Income Sources Uses Current Noncash Assets Current Liabilities
McGraw-Hill/Irwin
Decreases Increases
Increases Decreases
Copyright 2008, The McGraw-Hill Companies, Inc.
15-26
Operating Activities
Net Income (Loss) Add: Decr. in Current Noncash Assets Incr. in Current Liabilities Depreciation Charges Losses Less: Incr. in Current Noncash Assets Decr. in Current Liabilities Gains Net Cash Flows from Operating Activities $ XXX XXX XXX XXX XXX (XXX) (XXX) (XXX) $ XXX
Depreciation and Amortization charges are added back to net income because they are decreases in noncash assets.
McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.
15-27
Operating Activities
Net Income (Loss) Add: Decr. in Current Noncash Assets Incr. in Current Liabilities Depreciation Charges Losses Less: Incr. in Current Noncash Assets Decr. in Current Liabilities Gains Net Cash Flows from Operating Activities
Gains are subtracted from net income.
McGraw-Hill/Irwin
15-28
Investing Activities
Add: Proceeds from sale of land, buildings, equipment, or other noncurrent assets Receipt of principal from investments Less: Payments to acquire land, buildings, equipment, or other noncurrent assets Payments to acquire investments Net Cash Flows from Investing Activities
$ XXX XXX
15-29
Financing Activities
Add: Proceeds from borrowings Proceeds from issuing capital stock Proceeds from sale of bonds Less: Principal payments on borrowed funds Payments related to bond maturities Dividend payments Net Cash Flows from Financing Activities $ XXX XXX XXX (XXX) (XXX) (XXX) $ XXX
15-30
For investing and financing activities, items on the statement of cash flows should be presented in gross amounts rather than in net amounts.
McGraw-Hill/Irwin
Assume Macys purchases $50 million in property during the year and sells other property for $30 million. Instead of showing the net change of $20 million, the company must report the gross amounts of both transactions.
Copyright 2008, The McGraw-Hill Companies, Inc.
15-31
Other Issues: Direct Method or Indirect Method? Two Formats for Reporting Operating Activities
Direct Method
Indirect Method Starts with accrual net income and converts to cash basis
No matter which format is used, the same amount of net cash flows from operating activities is generated.
McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.
15-32
Learning Objective 3
Prepare a statement of cash flows using the indirect method to determine the net cash provided by operating activities.
McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.
15-33
Cash Accounts Receivable Inventory Land Equipment Accumulated Depr. Accounts Payable Salaries Payable Note Payable - Joe Doe Common Stock Retained Earnings
Lets revisit the comparative balance sheet account balances for Eds Pizza Hut.
McGraw-Hill/Irwin
15-34
A Full-Fledged Statement of Cash Flows: An Example Lets also refresh our memory regarding the following additional information.
Additional Information:
There was a net loss for the year of $27,000. Depreciation charges for the year were $6,000. During the year, Ed sold land originally costing $32,000 for $32,000. During the year, Ed paid dividends of $3,000 to the stockholders. Ed issued $50,000 of common stock to settle the note due to Joe Doe.
McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.
15-35
Adjusted Effect
Classification
List each account appearing on the comparative balance sheets except for cash and cash equivalents and retained earnings.
15-36
Adjusted Effect
Classification
Compute the change from the beginning balance to the ending balance for each account.
15-37
Adjusted Effect
Classification
6,000
Source
11,000 Source (5,000) Use (50,000) 50,000 (27,000) 3,000 Use Source Use Use
Recall that the transaction involving the Notes Payable and Common Stock was noncash.
15-38
Adjusted Effect
Classification
6,000
Source
11,000 Source (5,000) Use (50,000) 50,000 (27,000) 3,000 Use Source Use Use $
Code sources of cash as positive numbers and uses of cash as negative numbers.
15-39
on
6,000
Source
50,000
{
-
6,000
adjustments, including adjustments for gains and losses. The net effect of these should equal zero.
We need to make an adjustment 11,000 the noncash transaction for relating to Notes Payable and (5,000) Common Stock.
Use
15-40
Preparing the Statement- of$ Cash Flows: Step 6 (17,000) Source $ 17,000 17,000 Operating
50,000 Use (50,000) 32,000 (50,000) 32,000 Operating Investing (32,000) Source -
ion
6,000
Source
50,000 (50,000) -
11,000 Source (5,000) Use (50,000) 50,000 (27,000) 3,000 Use Source Use Use $
Operating Financing
McGraw-Hill/Irwin
15-41
Ed's Pizza Hut Statement of Cash Flows For the Period Ending 3/31/2008 Operating Activities Net Loss $ Add: Decrease in A/R Increase in A/P Increase in Depr. Charges Less: Increase in Inventory Decrease in Salaries Payable Net Cash Flow from Operations Investing Activities Proceeds from sale of Land Financing Activities Dividends paid Net change in cash
(27,000) 17,000 11,000 6,000 (50,000) (5,000) (48,000) 32,000 (3,000) (19,000)
Copy the data from the worksheet into the Statement of Cash Flows section by section.
McGraw-Hill/Irwin
15-42
Ed's Pizza Hut Statement of Cash Flows For the Period Ending 3/31/2008 Operating Activities Net Loss $ Add: Decrease in A/R Increase in A/P Increase in Depr. Charges Less: Increase in Inventory Decrease in Salaries Payable Net Cash Flow from Operations Investing Activities Proceeds from sale of Land Financing Activities Dividends paid Net change in cash Cash, beginning Cash, ending $
McGraw-Hill/Irwin
(27,000) 17,000 11,000 6,000 (50,000) (5,000) (48,000) 32,000 (3,000) (19,000) 90,000 71,000
15-43
(27,000) 17,000 11,000 6,000 (50,000) (5,000) (48,000) 32,000 (3,000) (19,000) 90,000 71,000
In addition, on the face of the statement or in a supplemental schedule, disclose the issuance of $50,000 of stock to a creditor, a noncash financing activity.
Copyright 2008, The McGraw-Hill Companies, Inc.
15-44
McGraw-Hill/Irwin
The Direct Method of Determining the Net Cash Provided by Operating Activities
Appendix 15A
McGraw-Hill/Irwin
15-46
Learning Objective 4
Use the direct method to determine the net cash provided by operating activities. (Appendix 15A)
McGraw-Hill/Irwin
15-47
The direct method computes net cash provided by operating activities by reconstructing the income statement on a cash basis from top to bottom.
Cash provided by operating activities under the direct method will always agree with the amount computed using the indirect method.
McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.
15-48
+ +
Adjustments for accounts that affect revenue are the same in the direct and indirect methods.
Adjustments for accounts that affect expenses are handled in opposite ways for the direct and indirect methods.
+ + -
+ +
Copyright 2008, The McGraw-Hill Companies, Inc.
15-49
Under the direct method, no adjustments for gains and losses on the sale of assets are needed.
McGraw-Hill/Irwin
15-50
Cash Accounts Receivable Inventory Land Equipment Accumulated Depr. Accounts Payable Salaries Payable Note Payable - Joe Doe Common Stock Retained Earnings
Lets revisit the comparative balance sheet account balances for Eds Pizza Hut.
McGraw-Hill/Irwin
15-51
Lets assume that Eds Pizza Hut prepared this income statement.
McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.
15-52
Sales (as reported) Add: Decrease in accounts receivable Cash collected from customers
$ $
McGraw-Hill/Irwin
15-53
Step 2: Translate cost of goods sold into cash disbursements for purchases.
Cost of goods sold (as reported) $ Add: Increase in inventory Less: Increase in accounts payable Cash paid for purchases $ 750,000 50,000 (11,000) 789,000
McGraw-Hill/Irwin
15-54
Step 3: Translate operating expenses into cash paid for operating expenses.
Operating expenses (as reported) Add: Decrease in salaries payable Less: Increase in depreciation Cash paid for operating expenses $ 277,000 5,000 (6,000) 276,000
No adjustment for income taxes is required because Eds Pizza Hut has a net loss of $27,000.
McGraw-Hill/Irwin Copyright 2008, The McGraw-Hill Companies, Inc.
15-55
Notice that the net cash provided by operating activities agrees with that computed using the indirect method.
Copyright 2008, The McGraw-Hill Companies, Inc.
15-56
End of Chapter 15
McGraw-Hill/Irwin