University:
California State University, Northridge
Course:
ACCT 350 | Intermediate Financial Accounting I
Academic year:

2024
Views:

414

Pages:

32
Author:

Chace Holden

Statement of Cash Flows Re-visited Learning Objectives 1. Prepare a complete statement of cash flows, and provide the required supplemental disclosures. 2. Understand the differences among cash flow statements prepared according to U.S. GAAP, U.K. GAAP, and IASB standards. 3. Incorporate material from the entire text into the preparation of a statement of cash flows. 4. Perform a detailed case analysis of a company’s operations and performance using cash flow data. Preparing a Complete Statement of Cash Flows You will need to refer to pages 1222 and Exhibit 21-3 in your text for this chapter’s presentation. Absence of Transaction Data • Sometimes, detailed cash flow information, we can create the statement by analyzing the income statement and balance sheet. • We must infer the cash flow effects of the various transactions during the business period. A 6-Step Process 1. Compute how much the cash balance changed during the year. 2. Convert the income statement from an accrual-basis to a cash-basis summary of operations. a. Eliminate expenses that do not involve the outflow of cash, such as depreciation expense. b. Eliminate gains and losses associated with investing or financing activities to avoid counting these items twice. c. Adjust for changes in the balances of current operating assets and operating liabilities- these are cases where cash flow does not match revenue or expenses reported. A 6-Step Process 3. 4. 5. 6. Analyze the long-term assets to identify the cash flow effects of investing activities. Also examine investment securities accounts. Analyze the long-term debt and stockholders’ equity accounts to determine the cash flow effects of any financing transactions. Also analyze the short-term loan accounts. Make sure that the total net cash flow is equal to the net increase or decrease in cash as computed in step 1. Prepare the formal statement of cash flows by classifying all cash inflows and outflows by their activity class. Prepare supplemental disclosure, including the disclosure of any significant investing or financing transactions. Illustration of the 6-Step Process will use the Western Step 1:We Compute howinformation much the of cash balance Resources to illustrate changed duringthe the6-step year:process. Beginning Cash Balance $55,000 - Ending Cash Balance (50,600) Decrease in cash ($4,400) The purpose of our cash flows statement is to explain how the decrease in cash occurred. Illustration of the 6-Step Process Step 2: Convert the income statement from an accrual to a cash-basis summary of operations: Add: Depreciation Expense Amortization Expense $20,900 5,000 1. Add the amount of depreciation and amortization expense back to net income because no cash flow was associated with these expenses in the current period. (Adjustments A1 and A2) Illustration of the 6-Step Process Step 2: Convert the income statement from an accrual to a cash-basis summary of operations: Add: Loss on Sale of Building Less: Gain on Sale of LongTerm investment $4,000 ($6,500) 2. Subtract the amount of gains and add the amount of losses because they are included in the computation of net income, failing to adjust for them here would result in their being double counted. (Adjustments B1 and B2) Illustration of the 6-Step Process Step 2: Convert the income statement from an accrual to a cash-basis summary of operations: Add: Decrease in accounts receivable $3,500 3. Add the decrease in Accounts Receivable. The accounts receivable account decreases when customers pay for more than they purchased this year. Thus, Western Resources has more cash than it would have had if customers had not paid down their accounts. (Adjustment C1) Illustration of the 6-Step Process Step 2: Convert the income statement from an accrual to a cash-basis summary of operations: Add: Increase in Unearned Sales Revenue $7,000 4. Add the increase in Unearned Sales Revenue. Unearned Sales Revenue goes up when customers pay for goods or services in advance. Thus, an increase in Unearned Sales Revenue represents cash collected over and above the sales amount. (Adjustment C2) Illustration of the 6-Step Process Step 2: Convert the income statement from an accrual to a cash-basis summary of operations: Add: Decrease in Inventory $1,500 5. Add the decrease in Inventory. By allowing the Inventory amount to decrease, Western Resources has conserved cash that otherwise would have been used to purchase inventory. (Adjustment C3) Illustration of the 6-Step Process Step 2: Convert the income statement from an accrual to a cash-basis summary of operations: Subtract: Decrease in Accounts Payable ($6,700) 6. Subtract the decrease in Accounts Payable. Western Resources paid extra cash to reduce the balance in Accounts Payable. (Adjustment C4) Illustration of the 6-Step Process Step 2: Convert the income statement from an accrual to a cash-basis summary of operations: Subtract: Increase in Prepaid Operating Expenses ($4,500) 7. Subtract the increase in Prepaid Operating Expenses. Western Resources paid extra cash by prepaying for services that it won’t use until a future period. (Adjustment C5) Illustration of the 6-Step Process Step 2: Convert the income statement from an accrual to a cash-basis summary of operations: Add: Increase in Obligation for Employee Severance 11,700 8. Add the increase in Obligation for Employee Severance. A restructuring charge does not involve an immediate outlay of cash. Western has not yet paid any cash associated with the restructuring. (Adjustment C6) Illustration of the 6-Step Process Step 2: Convert the income statement from an accrual to a cash-basis summary of operations: Subtract: Decrease in Income Taxes Payable (2,200) 9. Subtract the decrease in Income Taxes Payable. Western Resources paid extra cash to reduce the balance in Income Taxes Payable. (Adjustment C7) Illustration of the 6-Step Process Step 2: Convert the income statement from an accrual to a cash-basis summary of operations: Subtract: Decrease in Income Taxes Payable (2,200) 10. Add the increase in Deferred Income Tax Liability. A portion of income tax expense relates to income taxes that will not become payable until a future year. Thus, this does not involve a current cash outlay and is added back. (Adjustment C8) Illustration of the 6-Step Process Illustration of the 6-Step Process The Direct Method Illustration of the 6-Step Process Step 3: Analyze the Long-Term Assets to Identify the Cash Flow Effects of Investing Activities Book Value of long term investment sold Plus: Gain on sale Cash proceeds $96,000 6, 500 $102,000 The long-term investments account was reduced by $96,000 ($106,000 – $10,000). To calculate the amount of cash collected from this sale, use income statement information to determine whether there was a gain or loss on the sale. Illustration of the 6-Step Process Step 3: Analyze the Long-Term Assets to Identify the Cash Flow Effects of Investing Activities Increase in land account Less: payment with common stock Cash outlay $108,500 (40, 000) $68,500 The land account increased by $108,500 ($183,500 – $75,000). Supplemental information tells us that payment for the land was a combination of $68,500 of cash and common stock valued at $40,000. Only the $68,500 cash outlay will be Illustration of the 6-Step Process Step 3: Analyze the Long-Term Assets to Identify the Cash Flow Effects of Investing Activities Beginning buildings and equipment balance $345,000 Original cost of building and equipment sold (40, 000) Ending balance without additional purchases $305,000 Buildings and equipment account increased by $77,000 ($422,000 – $345,000). Additional information shows buildings and equipment with an original cost of $40,000 were sold for $10,000. This $10,000 cash proceeds will be shown. Illustration of the 6-Step Process Step 3: Analyze the Long-Term Assets to Identify the Cash Flow Effects of Investing Activities Actual ending balance $442,000 Ending balance without additional purchases (305,000) Equipment was purchased $117,000 The actual ending balance reports buildings and equipment at $422,000. Therefore buildings and equipment were purchased for $117,000 ($422,000 – $305,000). This purchase represents cash used for investing activities. Illustration of the 6-Step Process Step 3: Analyze the Long-Term Assets to Identify the Cash Flow Effects of Investing Activities Beginning Patents -Patent amortization + New Patents purchased Ending Patents $40,000 (305,000) ??? $117,000 The patents account began the year with a $40,000 balance and ended with a $35,000 balance. The numbers indicate that no new patents were purchased during the year. Illustration of the 6-Step Process Cash flows from investing activities: Sold building $ 10,000 Sold long-term investment 102,500 Purchased available-for-sale securities (2,000) Purchased land 68,500 Purchased buildings and equipment (117,000) Net cash used by investing activities $ (75,000) Illustration of the 6-Step Process Step 4: Analyze the Long-Term Debt and Stockholders’ Equity Accounts to Identify the Cash Flow Effects of Financing Activities Cash flows from financing activities: Issued common stock Borrowed short-term debt Borrowed long-term debt Paid dividends Treasury stock purchases Net cash used by financing activities $ 10,000 7,500 20,000 20,700 (3,200) $ (13,600) Illustration of the 6-Step Process Step 5: Prepare a Formal Statement of Cash Flows Illustration of the 6-Step Process Step 6: Prepare Supplemental Disclosures Three categories of supplemental disclosure are associated with the statement of cash flows: 1.Cash paid for interest and income taxes 2.Reconciliation schedule 3.Noncash investing and financing activities International Cash Flow Statements • The primary differences in cash flow reporting around the world relate to interest and income tax payments. • International Accounting Standard 7 (IAS 7) opted to allow more company discretion in deciding how to classify items like interest and dividends paid and received. • Within the FASB there was great debate about how these items should be classified. • The final version of SFAS No. 95 says that they must be classified as operating activities. International Cash Flow Statements • Interest and dividends received: IAS 7 allows companies to classify them as either operating or investing activities. • Interest paid: IAS 7 classifies it as either an operating activity or a financing activity; but it must be applied consistently. • Dividends paid: IAS 7 allows classification as either a financing activity or as an operating activity. • Income Taxes: IAS 7 allows classification as either operating activity unless the income taxes can be identified with a financing or investing activity. Cash Flow Analysis • Analysis of cash flow data can add insight into the performance of a company, beyond what we can see from the income statement and balance sheet. • When a company has a strong incentive to favorably bias its accrual assumptions to make it look good on paper, cash flow data can provide a reality check on the performance of the company. • Make sure you go through the analysis in the case of Kamila Software to see these techniques at work.

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