Examples of noncash investing and financing activities

Discussion Questions

READ – Chapter One - The Cash Flow Statement

WRITE – a minimum of 200 words addressing the following questions:

What information does the cash flow statement provide that you cannot see in the other financial statements (income statement, balance sheet, owner’s equity)?

Explain the parts of the cash flow statement.

What elements of the cash flow statement do you think are most important for company management to monitor and why?

How can this document be used by investors?

DQ #2: Apple’s Cash Flow

READ – Chapter One - The Cash Flow Statement

WRITE – a minimum of 200 words addressing the following questions:

Go to www.apple.com. Scroll to the bottom of the page and under About Apple, click on investors. Click on Financial Information and then click on 10K – Annual Reports. Click on the 9/26/2015 report. Go to the section titled, Financial Statements and Supplementary Data, which contains the Cash Flow Statement. Review the cash flow statement for Apple.

How would you summarize Apple’s cash flow position and what does this statement tell you about where the money is coming from and where it’s going?

What should Apple do to improve its cash position and why?

What trends does the cash flow statement reveal?

Does the cash flow statement reveal any major cash flow changes?

How Is Cash Flow to Be Monitored?

Beyond just looking at cash on the balance sheet, how is one to assess a company's cash, cash flow, and cash flow prospects? For many years, the accounting profession only required presentation of the balance sheet, income statement, and a statement of retained earnings (or stockholders' equity). In the 1960s, following several prominent and seemingly sudden business failures due to poor cash flow, the profession determined to require a fourth financial statement reporting on funds flow. The specific content and format evolved. In the 1990s, the profession began to require the current format for a statement of cash flows. This statement has become a well-established component of required reporting for corporate entities. The objective of the statement is to provide information that is helpful in assessing the amounts, timing, and uncertainty of an organization's cash inflows and outflows. Accordingly, the statement of cash flows divides cash flow information into key categories related to operating activities, investing activities, and financing activities. The statement also provides information about other investing and financing activities that do not directly entail the generation or consumption of cash. Thus, the statement also provides a key source of insight about a company's overall investing and financing actions.

Operating Activities

In a sweeping generalization, think of the operating activities of a business as the routine transactions and events that enter into the determination of ongoing income. Thus, the operating activities section of the statement of cash flows is a bit like a cash basis income statement. But, as you will soon see from the following details, this generalization should be used as a frame of reference only. Specifically, cash inflows from operating activities consist of receipts from customers for providing goods and services, the cash amount of interest earnings, and cash dividends received. Cash outflows relate to payments for inventory purchases, salaries, wages, taxes, interest, and other such business expenses. However, another way to view "operating" cash flows is to include anything that is not an "investing" or "financing" cash flow. This means that any cash flows that do not clearly fall into the categories of investing activities or financing activities are regarded as related to operations. Because this view casts the operating activities section as a "default" grouping, it is also necessary to understand the specifics of each of the next two categories.

Investing Activities

Investing activities relate to acquiring and disposing of longer term investments in stocks and debt issued by others, as well as buying and selling items of property, plant, and equipment. Investing cash inflows result when a company receives the proceeds from selling the stock and debt of others (unless such investment was initially acquired for "trading" rather than longer term investment purposes) and when proceeds from the sale of plant assets are received. Similarly, if longer term loans have been made to others, an investing cash inflow occurs when the principal amount of debt is repaid. As noted in the discussion of operating activities, it is important to note that interest earned on loans is regarded as an operating cash inflow. Only the principal collections are reported as investing inflows. Conversely, cash outflows from investing activities result on payment to acquire land, buildings, and equipment, as well as the acquisition of long-term investments in other firms, loans to others, and similar items.

Financing Activities

Financing activities relate to obtaining and repaying capital funding needs. Cash inflows result by interactions with investors and lenders via the issuance of stock and bonds as well as borrowing from specific lenders. Conversely, repaying the principal amounts borrowed is a financing activity that results in a cash outflow. One must be very careful to differentiate between repayments of principal on debt versus the interest cost. Interest is treated as an expense in income and is also treated as an operating cash flow in the cash flow statement. One generally thinks of obtaining capital from shareholders as a cash inflow; however, a company may occasionally buy back treasury shares, and these transactions are reported as a cash outflow in the financing activities section. Likewise, dividends paid to shareholders are similarly classified as a cash outflow.

The classification of dividends and interest is potentially confusing and bears clarification. Accounting rules require that dividends paid be reported as a financing cash outflow. Dividends received, interest received, and interest paid are all reported as operating cash flows. Because the classification of these amounts is subject to conceptual debate, the accounting rules have explicitly adopted this specific classification model.

The preceding discussion was intended to build your general understanding of the classification scheme for various cash flow items. At times, accounting can become somewhat detailed, and Table 1.1 dives deeper into this subject by providing a more detailed listing of appropriate schemes to use for classifying most cash flow items.

Table 1.1: Summary table of investing/financing/operating activities

Inflows

Outflows

Investing activities

Receipts from collections or sales of loans made by the enterprise and of other entities' debt instruments

Disbursements for loans made by the enterprise and payments to acquire debt instruments of other entities

Receipts from sales of equity instruments of other enterprises and from returns on investment in those instruments

Payments to acquire equity instruments of other enterprises

Receipts from sales of property, plant, and equipment and other productive assets

Payments at the time of purchase or soon before or after purchase to acquire property, plant, and equipment and other productive assets

Financing activities

Proceeds from issuing equity instruments

Payments of dividends or other distributions to owners, including outlays to reacquire the enterprise's equity instruments

Proceeds from issuing bonds, mortgages, and notes and from other short- or long-term borrowing

Repayments of amounts borrowed

Receipts from contributions and investment income that by donor stipulation are restricted for the purposes of acquiring, constructing, or improving property, plant, equipment, or other long-lived assets

Other principal payments to creditors who have extended long-term credit

Proceeds received from derivative instruments that include financing elements at inception

Distributions to counterparties of derivative instruments that include financing elements at inception

Cash retained as a result of the tax deductibility of increases in the value of certain equity instruments issued under share-based payment arrangements

Operating activities

Cash receipts from sales of goods or services, including receipts from collection or sale of accounts and both short- and long-term notes receivable from customers arising from those sales

Cash payments to acquire materials for manufacture or goods for resale, including principal payments on accounts and both short- and long-term notes payable to suppliers for those materials or goods

Cash receipts from returns on loans, other debt instruments of other entities, and equity securities—interest and dividends

Cash payments to other suppliers and employees for other goods or services

All other cash receipts that do not stem from transactions defined as investing or financing activities, such as amounts received to settle lawsuits; proceeds of insurance settlements except for those that are directly related to investing or financing activities, such as from destruction of a building; and refunds from suppliers

Cash payments to governments for taxes, duties, fines, and other fees or penalties and the cash that would have been paid for income taxes if increases in the value of certain equity instruments issued under share-based payment arrangements

Cash payments to lenders and other creditors for interest

All other cash payments that do not stem from transactions defined as investing or financing activities, such as payments to settle lawsuits, cash contributions to charities, and cash refunds to customers

Table 1.1 was adapted from the scheme set forth by the Financial Accounting Standards Board (Statement of Financial Accounting Standard No. 95, Statement of Cash Flows, FASB, 1997) and provides a useful decision table for most transactions that are apt to arise in the ordinary course of business. As you can see, the classification scheme can become rather detailed; at this point in your studies, you should not be overly concerned about understanding the nuances of unfamiliar-sounding transactions.

Noncash Investing and Financing Activities

The statement of cash flows represents a compilation of all operating, investing, and financing activities that cause a change in cash. The net change represents the increase or decrease to cash during a period and should serve to reconcile the change from the beginning- of-period to end-of-period cash balances. This reconciliation within the statement of cash flows could be viewed as complete fulfillment of the objectives for a cash flow statement. However, the statement has an enhanced purpose. It is expanded to reveal other noncash investing and financingactivities. For example, a company may exchange common stock for land. Such transactions do not trigger a direct inflow or outflow of cash, but they are nonetheless highly significant investing/financing events. Other examples include acquiring a building for a note payable, retiring debt with stock, and so forth. The statement of cash flows includes a separate section reporting noncash investing and financing activities.

Example Statement

The following example presents a statement of cash flows. For now, do not be too concerned with details. Instead, just take note of the overall structure. Notice that this is an operating statement covering a defined period of time, much like the income statement and statement of retained earnings. Thus, the date calls attention to the period of time covered by the report. The statement contains a major section for each category of cash flow activities and culminates with a reconciliation of the change in cash balance over the span of the period. Finally, it concludes with details on the noncash investing/financing actions.

Exhibit 1.1

A cash flow statement from an example corporation showing the cash flows from operation activities, investing activities and financing activities. The totals show the net increase in cash, the cash balance at January 1 and Dec 31, and then the noncash investing/financing activities.

Exhibit 1.1 prepared the operating activities section under a direct approach. That is, each cash flow component was directly presented (e.g., cash received from customers). An alternative indirect approach is also permitted. Later sections of this chapter make this distinction much clearer, and you will be exposed to both techniques by chapter's end.

1.2

A Deeper Focus on Operating Cash Flows

It is now time to focus on the details within the operating activities section of the statement of cash flows for Example Corporation. Therein, it is revealed that $167,000 of cash was generated from operations. This is noted by the total for the operating activities section. The first line within the operating activities section shows that customers paid the company $1,500,000. But much of that cash flow was spent on inventory, salaries, rent, interest, other operating expenses, and taxes. These data are relatively easy to identify by looking at the operating activities section of the cash flow statement. Also, they tend to be self-explanatory as to their meaning. But, how are the data derived? Some companies have very strong information systems that allow accountants to mine their databases for specific cash payments. At other times, a company must use analytical procedures and assumptions to estimate the specific cash flow amounts. Let's think about how this would occur, beginning with the calculation of cash received from customers.

Cash Received From Customers

The operating activities section revealed cash collections from customers of $1,500,000. If all sales were for cash, then this amount would correspond to total sales in the income statement. However, companies typically make some sales on account. Thus, cash collected is not exactly the same as total sales. The difference between cash collections and total sales is reflected as an increase or decrease in accounts receivable. In other words, increasing accounts receivable balances signal that more sales occurred on account than were collections on account. The opposite is of course true. Thus, one can adjust total sales found on an accrual basis income statement by the change in accounts receivable to estimate cash collections from customers. This assumes uncollectible accounts are not material; if they were, additional adjustments would be necessary.

Students generally understand this concept, but an additional example may prove helpful. Suppose you started a new business. During your first year of operations, total sales were $100,000. If you ended the year with $20,000 in accounts receivable, how much of the sales did you collect? Hopefully, it is apparent that the answer to this question is $80,000. In other words, cash collected from customers was $80,000. If you discontinued the business and made no additional sales in the second year, but did collect the $20,000 owed to you from the prior year sales, then your cash collections would be $20,000. In the first year, accounts receivable increased (and you subtracted that from sales to find cash collections); in the second year, accounts receivable decreased (and you added that to sales to find cash collections). This gives rise to the general model that you can use to calculate cash collected from customers:

Total Sales Minus the Increase in Receivables (or, plus a decrease in receivables)

Next, let's apply this model to Example Corporation. Assume total sales were $1,750,000, and accounts receivable increased from $300,000 to $550,000. The $250,000 increase in receivables (i.e., uncollected sales) would be subtracted from total sales to arrive at cash collections of $1,500,000. Applying the standard formula produces the correct calculation, as shown:

$1,750,000 − ($550,000 − $300,000) = $1,500,000

Cash Paid for Inventory

The operating activities section revealed that $800,000 in cash was paid for the purchase of inventory. This calculation is a bit trickier because it must take into consideration both changes in inventory and changes in accounts payable related to the purchase of inventory. The starting point to calculate cash paid for inventory is to determine total purchases of inventory. If inventory levels were unchanged during the period, then cost of goods sold would equal total purchases. However, if inventory on the balance sheet increased, then total purchases would exceed cost of goods sold (and vice versa). The following formula shows the general frame of reference for converting cost of goods sold to total purchases:

Cost of Goods Sold Plus the Increase in Inventory (or, minus a decrease in inventory)

Once total purchases are determined, it is next necessary to assess how much of the purchases were for cash. In other words, total inventory purchased must be adjusted for the portion that was purchased on credit. This is similar logic to that which was used for calculating cash collected on sales. The following formula shows the general frame of reference for converting purchases of inventory to cash paid for inventory:

Inventory Purchased Minus the Increase in Payables (or, plus a decrease in payables)

To be clear, the preceding formula only takes into consideration payables related to the purchase of inventory. Payables related to utilities, rent, and other operating expenses should not be commingled with this particular calculation.

Assume that Example Corporation had $750,000 in cost of goods sold during the period. Furthermore, inventory on the balance sheet increased by $100,000, and accounts payable related to inventory increased by $50,000. Logically, total purchases were $850,000, but the increase in payables means that only $800,000 of total purchases were funded.

Cash Paid for Operating Expenses

Example Corporation incurred operating expenses for salaries, rent, interest, other costs, and taxes. Any or all of these could have been paid in cash, in which case the reported amount of expense and cash flow effects would be identical. However, to the extent there were/remain unpaid obligations, an adjustment would be needed. Assume that the company reported salaries expense of $250,000. The beginning balance sheet included $35,000 of salaries payable and the ending balance sheet included $10,000 of salaries payable. The $275,000 cash paid for salaries would reflect the total expense plus the additional $25,000 paid to bring about a reduction in the payable balance. Similar considerations would be needed for each expense category, as reflected by the following formulation:

Expense Plus the Decrease in Related Payable (or, minus an increase in related payable)

For Example Corporation, assume that all other expenses were equal to their respective cash payment amounts.

Noncash Expenses and Gains/Losses

Some expenses do not impact operating cash flows. One of the most prominent examples is depreciation. Consider the journal entry that is used to record depreciation:

12-31-X3

Depreciation Expense

80,000

Accumulated Depreciation

80,000

To record annual depreciation expense

Notice that this expense is not accompanied by a credit to cash. There is no impact on cash from this entry, even though an expense is recorded. Thus, it is not reported as an operating cash flow item, despite its negative impact on income. You can extend the logic applicable to depreciation to other noncash expenses. They should not be reported within cash flows from operating activities. Of course, it may occur to you that cash was expended to buy the depreciable asset. Thus, there is a cash flow effect at the time the asset is purchased for cash. As will be demonstrated subsequently, the cash paid to purchase a depreciable item is shown as an investing activity at the time the asset is acquired.

Another element that you might find in an income statement is a gain or loss on the sale of an item of property, plant, and equipment. Here, it is important to note that the full proceeds from the asset sale are reported as a cash inflow within the investing activities section of the cash flow statement. This is true, whether the asset sale is at a gain or loss. Thus, nothing additional needs to be reported in the operating activities section. In other words, the gain or loss you will observe in the income statement does not have a corollary impact on the operating activities section of the cash flow statement.

1.3

Alternative View of Operating Activities

Previously, it was mentioned that the operating activities section of the cash flow statement was akin to a cash basis income statement. The illustrated approach was the direct approach to presenting the operating activities of the business. In other words, each line item shows the direct amount of cash flow attributable to the described object. However, current accounting rules permit an alternative format called the indirect approach. The indirect approach starts with a company's reported income number and reconciles that number to the amount of cash provided by operating activities. Thus, the method is a roundabout, or "indirect," technique to come up with operating cash flows. Importantly, the amount of cash provided by operating activities is the same under both approaches. They are simply alternative ways to demonstrate how cash from operations is reported: (a) by measuring each direct contribution to a company's cash or (b) by starting with reported income and reconciling for differences between income and operating cash flow.

It is interesting that most companies opt for the indirect approach, although accounting standard setters have long suggested that the direct approach is preferable. One reason is that compiling direct cash flow data can be more problematic than the simpler indirect approach. Companies often do not have a sufficiently robust information system to sort all cash receipts and payments in a way that enables a precise assessment of each category of direct cash flows. Actual business environments are more complex than the illustration provided within. With that having been said, let's look closer at the indirect approach. In the next few paragraphs, the logic of each amount included within the indirect approach will be explained. First, however, is a comparative view of the presentation of operating activities under each of the two methods (Exhibit 1.2). In particular, (a) take note that the indirect approach begins with net income and reconciles to operating cash flows, and (b) operating cash flows are the same under both approaches. This is just a road map to what you are about to learn. Don't allow yourself to be overwhelmed by this initial view.

Exhibit 1.2

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To begin to understand the indirect approach better, start by examining the income statement for Example Corporation in Exhibit 1.3.

Exhibit 1.3

An income statement for an example corporation, showing revenues, cost of goods sold, gross profit, operating expenses, income before income taxes, less: income taxes and the net income.

The net income of $457,000 is not equivalent to the operating cash flows or change in cash. It is the accrual basis measure of the results of operations. Some of the data points within the income statement may look familiar from the preceding narrative. For example, take notice that total sales are $1,750,000, which equals the amount noted previously in the discussion about cash collected from sales.

The indirect approach begins with the company's income and provides a listing of various adjustments that are needed to convert the results to a measure of operating cash flows. Exhibit 1.4 is the cash flow statement for Example Corporation, this time prepared under the indirect approach. This statement is identical to the one presented previously, except that the operating activities section has been significantly revised to reflect the indirect approach.

Exhibit 1.4

A cash flow statement from an example corporation showing the cash flows from operation activities, investing activities and financing activities. The totals show the net increase in cash, the cash balance at January 1 and Dec 31, and then the noncash investing/financing activities.

Perhaps additional explanation will help you follow the construction of the indirect presentation of operating cash flows. Table 1.2 provides an added explanation for each adjustment for each of Example Corporation components within the operating activities section.

Table 1.2: Explanation for each adjustment for each of Example Corporation components within the operating activities section

Depreciation expense

Added back to net income because it is a noncash expense

Increase in accounts receivable

Subtracted because it represents uncollected sales

Increase in inventory

Subtracted because it corresponds to purchases of inventory in excess of cost of goods sold

Increase in accounts payable

Added because it represents costs not yet funded

Decrease in salaries payable

Subtracted because it represents payments in excess of the amount expensed

Gain on sale of equipment

Subtracted because (a) it is not related to operating activities, and (b) the full proceeds from the land sale are shown in the investing activities section

In a full business setting, the logic evident in the preceding table would potentially be extended to a countless variety of other revenue and expense items. Table 1.3 is at times helpful in classifying the needed adjustments within the operating activities section.

Table 1.3: Needed adjustments within operating activities

Current assets

Current liabilities

Those that increased are subtracted

Examples include increases in accounts receivable, inventory, prepaid expenses

Those that decreased are subtracted

Examples include decreases in accounts payable, salaries payable, interest payable

Those that decreased are added

Examples include decreases in accounts receivable, inventory, prepaid expenses

Those that increased are added

Examples include increases in accounts payable, salaries payable, interest payable

Indeed, a following section in this chapter will show how a worksheet can be used to pinpoint the change in each balance sheet. Eventually, the change in all accounts on the balance sheet must be considered in preparing a statement of cash flows. Logical analysis and reasoning is necessary to tackle this challenge, and in some respects the ability to translate accrual basis income to operating cash flows can be viewed as a litmus test of your understanding of accounting. For Example Corporation, the conversion process distills itself to an amount equal to the $167,000 net cash provided by operating activities. This is an identical result to the direct approach. Either approach is an accepted manner of presentation. However, for companies opting to report under the direct approach, a supplemental table is required to reconcile net income to operating cash flows. Thus, as a practical matter, companies opting for the direct approach also present the indirect information. Conversely, companies opting for the indirect approach must also report supplement data about the amount of cash paid for interest and taxes.

As you have already noted, following the operating activities section you will find the investing and financing activities. These are presented in the same manner, regardless of the method used to report operating activities.

Investing Activities

The next section of the cash flow statement relates to investing activities and is much simpler. Both inflows and outflows related to investment-related transactions are reported within this category. During the year, Example Corporation had the following unique investing transactions:

1. Sold land costing $130,000 for a total of $175,000 (producing a $45,000 gain)

2. Purchased equipment for $96,000

3. Acquired $70,000 of land in exchange for a note payable

Reviewing the statement, you should notice that Example Corporation reported a cash inflow from the sale of land and a cash outflow for the purchase of equipment. The $70,000 note-for-land transaction is a noncash transaction and is reported in the separate section reserved for such activities.

Recall that the sale of land produced a gain of $45,000, as reflected in the income statement (and operating activities section of the cash flow statement using the indirect approach). Regardless of whether a gain or loss resulted on the sale of land, what is reported in the investing activities section is the gross sales proceeds of $175,000. Because the gain was either (a) not reported under the direct approach or (b) subtracted from income under the indirect approach, the result is that the operating activities section is void of any effect from this transaction. Thus, the investing activity section need only report an addition for the sales price. Conversely, the cash paid to purchase equipment is subtracted. Noncash acquisitions are not reported in this section but are instead reserved for the noncash investing/financing activities section.

Financing Activities

The next major section of the cash flow statement relates to financing activities. This section reveals the inflows and outflows related to securing and repayment of corporate funding. You will notice that Example Corporation issued stock for a total consideration of $200,000. Assume that the par value of the newly issued shares was $100,000, thus the balance sheet will include an increase to Common Stock for $100,000 and an increase to Paid-in-Capital in Excess of Par for $100,000. Nevertheless, the only line item in the cash flow statement pertains to the gross cash received upon issuance of the shares. Dividends paid on common stock are shown as a cash outflow within this section. As long as the amounts declared and paid were identical, the dividends from the statement of retained earnings would equal the amount on the cash flow statement.

Had the company borrowed cash or repaid amounts borrowed, the financing activities section would also show these amounts. Recall, however, that interest paid on debt is instead shown in the operating activities section.

Net Change in Cash

The net amount of cash generated or consumed by the operating, investing, and financing sections should equal the change in cash for the period. Usually, a company will show the change in cash and reconcile it to the beginning and end cash positions on the balance sheet, as was done for Example Corporation. Example Corporation had a $421,000 increase in cash; when added to the beginning cash amount of $251,000, the ending balance of $672,000 results.

Noncash Investing/Financing Activities

As previously noted, the noncash investing and financing section reports on investing and financing actions that do not directly entail the use of cash. It is quite common for a company to purchase property, plant, and equipment in exchange for a promissory note. Likewise, a company may exchange stock for assets or even issue stock to retire debt. There are many such transactions and events where assets/debt/equity increase/decrease without triggering cash flow. Example Corporation's event related to the acquisition of land in exchange for a note payable. It is assumed that this is the only debt incurred by the company; the interest during the period of $3,000 was paid in cash and is reported in the operating activities section.

1.4

Using a Worksheet to Prepare the Statement

You may be wondering how to go about preparing a statement of cash flows. One approach is to set up the shell structure for the statement and gradually fill in known information about specific cash flow events. This is like solving a puzzle. You know the change in cash by reference to the balance sheet. Once you have assembled all the known information so that it fully explains the change in cash, you probably will have successfully completed the task. But, this approach can prove very frustrating, as there may be elusive components that escape your attention. A far better approach is to employ a systematic worksheet.

The worksheet forces one to compare the change in every balance sheet account during the period and squeeze out the corresponding cash flow consequences. Following is the beginning- and end-of-period balance sheets for Example Corporation. To the right of the balance sheet is an additional table showing the change in each balance sheet account. This will prove helpful in visually connecting the worksheet in Exhibit 1.5.

Exhibit 1.5

A balance sheet from an example corporation comparing two separate years of assets, liabilities and stockholders' equity.

This balance sheet information is incorporated into the leftmost and rightmost numerical data columns of Exhibit 1.6.

Exhibit 1.6

A chart comparing the various debits, credits, cash flows from operating activities, investing activities, financing activities, and investing/non financing activities from two different years.

The middle two columns of the top half of the worksheet capture the change for each row (i.e., balance sheet accounts). For instance, Example Corporation's beginning accounts receivable was $300,000, and the ending balance was $550,000. This is a net debit to accounts receivable, as shown in the middle column. Importantly, one is not actually debiting or crediting these accounts at this time. The worksheet is merely used to demonstrate the net change for each account. The change for every row of the balance sheet must be explained. On occasion (such as with the Land account in the example), there can be both increases and decreases that must be taken into consideration as part of the full explanation of all balance changes.

For each element of change to a balance sheet account, the lower half of the worksheet shows the corresponding (offsetting debit or credit) effect of the change on a company's cash flow. For example, the increase in accounts receivable (debit) is subtracted from net income as part of the calculation of operating cash flow. In other words, cash was not generated for uncollected sales, and this is shown in the credit column in the lower portion of the worksheet. Similar effects are noted for each item, and the small letters key the changes in the top half of the worksheet to the bottom half of the worksheet. Table 1.4 provides a fuller explanation of each keyed item for Example Corporation.

Table 1.4: Example Corporation

Upper portion

Lower portion

Comment

(a)

Increase to Cash via Debit

Remaining Net Positive Cash Flow as Credit

This is the net change in cash

(b)

Increase to Accounts Receivable via Debit

Negative Cash Flow Effect via Credit

Reflects uncollected sales

(c)

Increase to Inventory via Debit

Negative Cash Flow Effect via Credit

Reflects buying inventory in excess of what was sold

(d)

Increase to Land via Debit and Increase to Note Payable via Credit

Debit and Credit as NoncashInvesting/Financing

Reflects increase in land from purchase (via note)

(e)

Decrease to Land via Credit

Positive Cash Flow Effect via Debit for Sales Proceeds, and Offsetting Credit for Gain Portion to be Excluded From Operating Activities

Reflects decrease to land from sale and inflows from investing activity

(f)

Increase to Buildings and Equipment viaDebit

Negative Cash Flow Effect via Credit

This is the purchase price of new equipment bought for cash

(g)

Increase to Accumulated Depreciation viaCredit

Offsetting Debit for Expense Portion to be Excluded From Operating Activities

Reflects the amount of depreciationexpense

(h)

Increase to Accounts Payable via Credit

Positive Cash Flow Effect via Debit

Reflects unpaid inventory purchases

(i)

Decrease to Salaries Payable via Debit

Negative Cash Flow Effect via Credit

Reflects payments for salaries previouslyexpensed

(j)

Increase to Common Stock and Paid-in Capital in Excess of Par via Credit

Positive Cash Flow Effect via Debit

Reflects issuance of stock for cash

(k)

Decrease to Retained Earnings for Dividends via Debit

Negative Cash Flow Effect via Credit

Reflects cash paid for dividends

(l)

Increase to Retained Earnings for Net Income via Credit

Positive Cash Flow Effect (before considering all other operating adjustments as per above) via Debit

The amount of net income during the period (starting point for calculating cash flows from operations under the indirect approach)

Finally, you should take time to compare the lower portion of the worksheet to the indirect statement of cash flows presented previously. It is important for you to note how the information from the worksheet is transferred to a cash flow statement. Although the worksheet can at first appear daunting, it is actually a simplifying procedural tool that will ease the frustration that can accompany the process of preparing a cash flow statement. Without this thoughtful approach of taking into consideration all the accounts on the balance sheet, one can easily overlook a few data points that are needed to complete a correct statement of cash flows.

1.5

Comprehensive Example

Many accounting educators agree that the statement of cash flows is the most challenging topic for new accounting students. It is often seen as a capstone topic for financial accounting and a litmus test for your depth of accounting knowledge. To assist you in gaining comprehension, this chapter closes with an additional comprehensive example of a statement of cash flows prepared under the indirect approach. The following example does not introduce new knowledge. Instead, it is designed to reinforce the concepts of this chapter and provide a framework for garnering a deeper appreciation of the approach you can use to master your ability to prepare a statement of cash flows. Take sufficient time to review the facts and exhibits carefully, and try to reconcile each number reported in the statement of cash flows.

Corporation presented the comparative balance sheet shown in Exhibit 1.7.

Exhibit 1.7

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Additional information about transactions and events occurring in 20X9 follows:

· Net income was $160,000, and dividends of $10,000 were declared and paid.

· Accounts payable and accounts receivable relate only to purchases and sales of inventory.

· The decrease in land resulted from the sale of a parcel of land that cost $100,000 but was sold for $125,000, producing a $25,000 gain.

· A building valued at $50,000 was acquired in exchange for 10,000 shares of $1 par value stock.

· A new piece of equipment was acquired in exchange for cash of $25,000.

· $75,000 cash was borrowed via issuing an additional note payable.

· Total interest expense was $100,000, of which $75,000 was paid in cash.

· Total taxes were $46,000, all paid in cash.

Exhibit 1.8 shows the worksheet for Graham Corporation. Be sure to observe how the beginning and ending balances for each balance sheet account are compared and the differences noted. Each difference identifies a cash flow statement impact, as further explained in Table 1.5.

Exhibit 1.8

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Table 1.5: Cash flow statement impact

Upper portion

Lower portion

Comment

(a)

Increase to Cash via Debit

Remaining Net Positive Cash Flow asCredit

This is the net change in cash

(b)

Increase to Accounts Receivable viaDebit

Negative Cash Flow Effect via Credit

Reflects uncollected sales

(c)

Increase to Inventory via Debit

Negative Cash Flow Effect via Credit

Reflects buying inventory in excess of what was sold

(d)

Increase to Prepaid Rent via Debit

Negative Cash Flow Effect via Credit

Reflects paying rent in advance

(e)

Decrease to Land via Credit

Positive Cash Flow Effect via Debit for Sales Proceeds, and Offsetting Credit for Gain Portion to be Excluded From Operating Activities

Reflects decrease to land from sale and inflow from investing activity

(f)

Increase to Building via Debit and Increase to Common Stock and Paid-in Capital via Credit

Debit and Credit as NoncashInvesting/Financing

Reflects increase in building from purchase (via stock)

(g)

Increase to Equipment via Debit

Negative Cash Flow Effect via Credit

This is the purchase price of new equipment bought for cash

(h)

Increase to Accumulated Depreciation viaCredit

Offsetting Debit for Expense Portion to be Excluded From Operating Activities

Reflects the amount of depreciationexpense

(i)

Increase to Accounts Payable via Credit

Positive Cash Flow Effect via Debit

Reflects unpaid inventory purchases

(j)

Increase to Interest Payable via Credit

Positive Cash Flow Effect via Debit

Reflects unpaid interest

(k)

Decrease to Retained Earnings for Dividends via Debit

Negative Cash Flow Effect via Credit

Reflects cash paid for dividends

(l)

Increase to Retained Earnings for Net Income via Credit

Positive Cash Flow Effect (before considering all other operating adjustments as per above) via Debit

The amount of net income during the period (starting point for calculating cash flows from operations under the indirectapproach)

The lower portion of the worksheet is readily assembled into the following proper format for presentation of the statement of cash flows in Exhibit 1.9.

Exhibit 1.9

https://media.thuze.com/MediaService/MediaService.svc/constellation/book/AUACC206.12.2/%7Bfigures%7Dfig_1.9.jpg

In summary review of the statement, it appears that the bulk of Graham's $175,000 increase in cash was due to the sale o