The Statement of Cash Flows Revisited, Part 2

The Statement of Cash Flows Revisited Part 2 Chapter 21 Preparation of the Statement of Cash Flows Reconstructing the events and transactions that occurred during the period helps identify the operating, investing, and financing activities to be reported. A spreadsheet can be used to ensure that no reportable activities are inadvertently overlooked. 21-19 21-20 Comparative Balance Sheets UNITED BRANDS CORPORATION Spreadsheet for the Statement of Cash Flows Changes Dec. 31, Dec. 31, 2012 Debits Credits 2013 Balance Sheet Assets: Cash Accounts receivable Short-term investments Inventory Prepaid insurance Land Buildings and equipment Less: Accumulated depreciation 20 30 50 6 60 75 (20) 221 29 32 12 46 3 80 81 (16) 267 Liabilities: Accounts payable Salaries payable Income tax payable Notes payable Bonds payable Less: Discount on bonds payable 20 1 8 50 (3) 26 3 6 20 35 (1) Shareholders' Equity: Common stock 100 Paid-in capital 20 Retained earnings 25 221 130 29 19 267 We begin by entering the beginning and ending balances for each account on the spreadsheet. The changes columns will be used later to explain the increase or decrease in each account balance. 21-21 Comparative Income Statements Income Statement Revenues: Sales revenue Investment revenue Gain on sale of land Dec. 31, 2012 Changes Debits Dec. 31, Credits 2013 Expenses: Cost of good sold Salaries expense Depreciation expense Bond interest expense Insurance expense Loss on sale of equipment Income tax expense Net income The beginning balances for income statement accounts always are zero. 100 3 8 (60) (13) (3) (5) (7) (2) (9) 12 21-22 Statement of Cash Flows Statement of Cash Flows Operating Activities: Investing Activities: Financing Activities: Dec. 31, 2012 Changes Debits Dec. 31, 2013 Credits Spreadsheet entries duplicate the actual journal entries used to record the transactions as they occurred during the year. They are entered on the spreadsheet only and are not recorded in the accounting records. UNITED BRANDS CORPORATION Spreadsheet for the Statement of Cash Flows Changes Dec. 31, Dec. 31, Debits Credits 2012 2013 Balance Sheet Assets: Cash Accounts receivable Short-term investments Inventory Prepaid insurance Land Buildings and equipment Less: Accumulated depreciation 20 30 50 6 60 75 (20) Dec. 221 31, 2012 29 32 12 46 3 80 81 Changes (16) Dec. 267 31, Debits Credits 2013 Liabilities: Income Statement Accounts payable 20 Revenues: Salaries payable 1 Sales revenue Income tax revenue payable 8 Investment Accounts Noteson payable - Receivable Gain sale of land Bonds payable Beg. bal. 3050 Less: Discount on bonds payable Expenses: Credit sales 100(3) ? Cash Cost of good sold End. bal. Shareholders' Equity: Salaries expense Common stock Depreciation expense Bond interest expense Insurance expense Paid-in capital Loss on sale of equipment Income expense Retainedtax earnings Net income 32 100 20 25 221 received 26 3 100 36 20 8 35 (1) (60) (13) (3) 130 (5) (7) (2) 29 (9) 12 19 267 Let’s start by analyzing sales revenue and its related account accounts receivable by looking at the relationship in a Taccount format. UNITED BRANDS CORPORATION Spreadsheet for the Statement of Cash Flows Changes Dec. 31, Dec. 31, Debits Credits 2012 2013 Balance Sheet Assets: Cash Accounts receivable Short-term investments Inventory Prepaid insurance Land Buildings and equipment Less: Accumulated depreciation 20 30 50 6 60 75 (20) Dec. 221 31, 2012 29 32 12 46 3 80 81 Changes (16) Dec. 267 31, Debits Credits 2013 Liabilities: Income Statement Accounts payable 20 Revenues: Salaries payable 1 Sales revenue Income tax revenue payable 8 Investment Accounts Noteson payable - Receivable Gain sale of land Bonds payable Beg. bal. 3050 Less: Discount on bonds payable Expenses: Credit sales 100(3) 98 Cash Cost of good sold End. bal. Shareholders' Equity: Salaries expense Common stock Depreciation expense Bond interest expense Insurance expense Paid-in capital Loss on sale of equipment Income expense Retainedtax earnings Net income 32 100 20 25 221 received 26 3 100 36 20 8 35 (1) (60) (13) (3) 130 (5) (7) (2) 29 (9) 12 19 267 We can see from this analysis that cash received from customers must have been $98 million. Let’s see how to post this entry to the spreadsheet. UNITED BRANDS CORPORATION Spreadsheet for the Statement of Cash Flows Changes Dec. 31, Dec. 31, Debits 2012 Credits 2013 Balance Sheet Assets: Cash Accounts receivable Short-term investments Inventory Prepaid insurance Land Buildings and equipment Less: Accumulated depreciation 20 29 30 (1) 2 32 12 50 46 6 3 60 80 75 81 (20) (16) Changes 221 267 Dec. 31, Dec. 31, Liabilities: Debits Credits 2012 2013 26 Accounts payable 20 Income Statement Salaries payable 1 3 Revenues: Income tax payable 8 6 Sales revenue (1) 100 100 Notes payable 20 Investment revenue 3 Bonds payable 50 35 Gain on sale of land 8 Less: Discount on bonds payable (3) (1) Accounts Receivable Expenses: Beg. bal. Shareholders' Equity: Cost of goodCredit sold sales Common stock Salaries expense End. bal. Depreciation expense Paid-in capitalexpense Bond interest Insurance expense Retained earnings Loss on sale of equipment Income tax expense Net income 30 100 100 98 32 20 25 221 Cash received (60) (13) 130 (3) (5) 29 (7) (2) 19 (9) 267 12 First, $2 million is debited to accounts receivable to account for the total change in the account. Then, $100 million is credited to sales revenue to account for the total change in the account. Statement of Cash Flows Operating Activities: Cash Inflows: From customers Changes Dec. 31, 2012 Debits (1) Dec. 31, Credits 2013 98 Investing Activities: Accounts Receivable Beg. bal. 30 Credit sales 100 98 Cash received Financing Activities: End. bal. 32 The final part of this entry is a $98 million entry on the statement of cash flows under cash inflows from customers. UNITED BRANDS CORPORATION Spreadsheet for the Statement of Cash Flows Changes Dec. 31, Dec. 31, Debits 2012 Credits 2013 Balance Sheet Assets: Cash Accounts receivable Short-term investments Inventory Prepaid insurance Land Buildings and equipment Less: Accumulated depreciation 20 30 (1) (12) 50 6 60 75 (20) 221 2 12 Liabilities: Accounts payable 20 Short-term Investments Salaries payable 1 Income tax payable Beg. bal. 0 8 Notes payable Purchases 12 Bonds payable 50 End. bal. 12 Less: Discount on bonds payable (3) Shareholders' Equity: Common stock 100 Paid-in capital 20 Retained earnings 25 221 29 32 12 46 3 80 81 (16) 267 26 3 6 20 35 (1) 130 29 19 267 The $12 million increase in the short-term investments account is due to the purchase of short-term investments during the year. Note that in the textbook, entry number 12 illustrates the analysis of the short-term investment account. Statement of Cash Flows Operating Activities: Cash Inflows: From customers Changes Dec. 31, 2012 Debits (1) Dec. 31, Credits 2013 The final part of this entry is a $12 million entry on the statement of cash flows under investing activities. 98 Investing Activities: Purchase of S-T investment Financing Activities: Short-term Investments Beg. bal. 0 Purchases 12 End. bal. 12 (12) 12 UNITED BRANDS CORPORATION Spreadsheet for the Statement of Cash Flows Changes Dec. 31, Dec. 31, Debits Credits 2012 2013 Balance Sheet Assets: Cash Accounts receivable Short-term investments Inventory Prepaid insurance Land Buildings and equipment Less: Accumulated depreciation 20 30 (1) (12) 50 6 60 75 (14) (20) 221 Liabilities: Accounts payable Salaries payable Income tax payable Notes payable Bonds payable Less: Discount on bonds payable 20 1 8 50 (3) Shareholders' Equity: Common stock 100 Paid-in capital 20 Retained earnings 25 x denotes a noncash transaction 221 29 32 12 46 3 80 81 (16) 267 2 12 20x (14) 20x 26 3 6 20 35 (1) 130 29 19 267 In entry number 14, we find that a note payable was issued as payment for a building. Investing in a new building is a significant investing activity and financing the acquisition with long-term debt is a significant financing activity. UNITED BRANDS CORPORATION Spreadsheet for the Statement of Cash Flows Changes Dec. 31, Dec. 31, Debits 2012 Credits 2013 Balance Sheet Assets: Cash Accounts receivable Short-term investments Inventory Prepaid insurance Land Buildings and equipment Less: Accumulated depreciation 20 30 50 6 60 75 (20) 221 (19) (1) (12) 9 2 12 (13) (14) (9) 30 20x 7 Liabilities: Accounts payable Salaries payable Income tax payable Notes payable Bonds payable Less: Discount on bonds payable 20 1 8 (10) 50 (15) (3) Shareholders' Equity: Common stock 100 Paid-in capital Retained earnings 20 25 (16) (18) 221 2 15 (4) (8) (3) (9) (6) 4 3 10 14 3 (4) (5) 6 2 (14) 20x (7) 2 (16) (17) (16) (17) 10 20 3 6 13 5 (11) 12 29 32 12 46 3 80 81 (16) 267 26 3 6 20 35 (1) 130 29 19 267 After entering all the transactions, this is what the balance sheet portion of the spreadsheet looks like. Income Statement Revenues: Sales revenue Investment revenue Gain on sale of land Expenses: Cost of good sold Salaries expense Depreciation expense Bond interest expense Insurance expense Loss on sale of equipment Income tax expense Net income Changes Dec. 31, 2012 Debits (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) 60 13 3 5 7 2 9 12 Dec. 31, Credits 2013 100 3 8 100 3 8 (60) (13) (3) (5) (7) (2) (9) 12 After entering all the transactions, this is what the income statement portion of the spreadsheet looks like. Statement of Cash Flows Operating Activities: Cash Inflows: From customers From investment revenue Cash Outflows: To suppliers of goods To employees To bondholders For insurance expense For income taxes Net cash flows Investing Activities: Sale of land Sale of equipment Purchase of S-T investment Purchase of land Net cash flows Financing Activities: Retirement of bonds payable Sale of common stock Payment of cash dividends Net cash flows Net increase in cash Totals Changes Dec. 31, 2012 Debits (1) (2) (3) (9) (17) Dec. 31, Credits 2013 98 3 18 5 26 376 (4) (5) (7) (8) (10) 50 11 3 4 11 (12) (13) 12 30 (15) 15 (18) 5 (19) 9 376 22 (19) 6 9 After entering all the transactions, this is what the statement of cash flows portion of the spreadsheet looks like. Here is the statement of cash flows prepared using the direct method. UNITED BRANDS CORPORATION Statement of Cash Flows For the Year Ended December 31, 2013 ($ in millions) Cash Flows from Operating Activities: Cash Inflows: $ From customers 98 3 From investment revenue Cash Outflows: (50) To suppliers of goods To employees (11) To bondholders (3) For insurance expense (4) For income taxes (11) Net cash flows from operating activities $ Cash Flows from Investing Activities: Sale of land (30) Sale of equipment (12) Purchase of S-T investment 18 Purchase of land 5 Net cash flows from investing activities Cash Flows from Financing Activities: Retirement of bonds payable 26 Sale of common stock (15) Payment of cash dividends (5) Net cash flows from financing activities Net increase in cash Cash balance, January 1 Cash balance, December 31 $ 22 (19) 6 9 20 29 21-34 U.S. GAAP vs. IFRS Consistent with U.S. GAAP, cash flows are classified as operating, investing, or financing. Typical Classification of Interest and Dividends  Operating Activities      Operating Activities  Investing Activities Dividends Received Interest Received Interest Paid Investing Activities    Financing Activities  Dividends Paid  Dividends Received Interest Received Financing Activities   Dividends Paid Interest Paid Preparing an SCF: The Indirect Method Getting There through the Back Door Net Income Adjustments for noncash effects: Gain on sale of land Depreciation expense Loss on sale of equipment Changes in operating assets and liabilities: Increase in accounts receivable Decrease in inventory Increase in accounts payable Increase in salaries payable Discount on bonds payable Decrease in prepaid insurance Decrease in income tax payable Net cash flows from operating activities $ 21-35 12 (8) 3 2 $ (2) 4 6 2 2 3 (2) 22 The indirect method derives the net cash increases or decreases from operating activities indirectly by starting with reported net income and “working backwards” to convert that amount to a cash basis. Components of Net Income That Do Not Increase or Decrease Cash Depreciation Expense Loss on Sale of Equipment Gain on Sale of Land Adding these items back to net income restores net income to what it would have been had depreciation and the loss not been subtracted at all. Subtracting the gain reverses the effect of the gain having been added to net income. 21-36 Components of Net Income That Do Increase or Decrease Cash 21-37 For components of net income that increase or decrease cash, but by an amount different from that reported on the income statement, net income is adjusted for changes in the balances of related balance sheet accounts to convert the effects of those items to a cash basis. Account Type Current Assets Current Liabilities Change in Account Balance During Year Increase Decrease Subtract from net Add to net income. income. Add to net income. Subtract from net income. Note: Cash and cash equivalents, short-term investments in securities available for sale, dividends payable, and short-term payables to financial institutions are excluded from this category. 21-38 Comparison with the Direct Method Appendix 21A: Spreadsheet for the Indirect Method A spreadsheet is equally useful in preparing a statement of cash flows whether we use the direct or the indirect method of determining cash flows from operating activities. 21-39 Appendix 21B: The T-Account Method of Preparing the Statement of Cash Flows The T-Account method serves the same purpose as a spreadsheet in assisting in the preparation of a statement of cash flows. 21-40 Appendix 21B: The T-Account Method of Preparing the Statement of Cash Flows 21-41 1. Draw a T-account for each income statement and balance sheet account. 2. The T-account for cash should be drawn considerably larger. 3. Enter each account’s net change on the appropriate side (debit or credit) of the uppermost portion of each Taccount. 4. Reconstruct the transactions that caused changes in each account balance during the year and record the entries for those transactions directly in the T-accounts. 5. After all account balances have been explained by Taccount entries, prepare the statement of cash flows from the cash T-account, being careful also to report noncash investing and financing activities.