ACC 213 Cash Flows - Lecture notes 1 PDF

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lecture notes on cash flows ...

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The Statement of Cash Flows Purposeofast at ementofcashflows: To provide information about the cash inflows and outflows of an entity during a period. To summarize the operating, investing, and financing activities of the business.

The cash flow statement helps users to assess a company’s liquidity, financial flexibility, operating capabilities, and risk. The statement of cash flows is useful because it provides answers to the following important questions: Where did cash come from? What was cash used for? What was the change in the cash balance?

Specifically, the information in a statement of cash flows, if used with information in the other financial statements, helps external users to assess: 1.

A company’s ability to generate positive future net cash flows,

2.

A company’s ability to meet its obligations and pay dividends,

3.

A company’s need for external financing,

4.

The reasons for differences between a company’s net income and associated cash receipts and payments, and

5.

Both the cash and noncash aspects of a company’s financing and investing transactions.

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Whatcanwel earnf rom SCFt hati snotal readyavai l abl ei n t heot herfinanci alst at ement s ?

It provides answers to important questions like: Where did cash come from? What was cash used for? What was the change in the cash balance? Couldn’t we just look the balance sheet? The change in cash could be determined, but the statement of cash flows provides detailed information about a company’s cash receipts and cash payments during the period. Many things you want to know about a company is summarized in this one statement Operating, financing and investing cash flows

Net income does not always tell the whole story about operating performance. A statement of cash flows is an excellent forecasting tool.

Revi ew oft erms Cash and cash equivalents It is a short-term, highly liquid investment. It must be readily convertible to cash and it must be so near to maturity that there is insignificant risks of changes in value due to changes in interest rate.

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Noncashrevenuesandexpenses Net income includes items that were neither cash inflow nor cash outflows: Depreciation expense Accretion expense on asset retirement obligation Amortization of intangibles Impairment loss on goodwill and intangibles Earnings of affiliated companies accounted for using the equity method Impairment losses on other noncurrent assets Compensation expense related to stock options Net income also includes gains and losses from investing and financing activities Gain ≠ cash received (unless carrying value was zero) Even when there is a loss, cash might have been received Net income must be adjusted for these items to get the cash provided by operations – part of the reconciling schedule or “indirect method” For other items, there are revenues/expenses as well as cash flows but the amounts are different: Bond interest expense ≠ bond interest paid (if bonds were sold at premium or discount) Sales were not all collected in cash (bad debts, other changes in Accounts Receivable) Purchases were not necessarily paid for during period (change in Accounts Payable) Income tax expense ≠ income taxes paid due to deferred tax assets/liabilities as well as income taxes refunds receivable or unpaid taxes owed

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Company, Inc. Statement of Cash Flows For the year ended December 31, 199X Cash Flows from Operating Activities Cash received from customers Cash received as interest income * Cash received as dividend income Cash paid for cost of goods sold * Cash paid for selling expenses Cash paid for general & administrative expenses Cash paid for interest (including interest on capital leases) Cash paid for income taxes Cash that would have been paid for taxes except for “excess tax deduction” related to stock based compensation Net cash provided by (or used by) operating activities Cash Flows from Investing Activities Cash received from sale of property, plant, & equipment Cash received from sale of investments Cash received from repayment of note receivables Cash paid to acquire property, plant, and equipment Cash paid to acquire investments Cash paid out as a loan Net cash provided by (or used by) investing activities Cash Flows from Financing Activities Cash received as proceeds from issuance of debt Cash received as proceeds from issuance of stock Cash received as proceeds from reissuance of treasury stock Cash paid to repay debt (principal payment) Cash paid on principal related to capital leases Cash paid to reacquire stock (purchase treasury stock) Cash paid as dividends Cash retained due to “excess tax deduction” related to stock options Net cash provided by (or used by) financing activities Net increase (decrease) in cash Beginning cash and cash equivalents balance =Ending cash and cash equivalents balance Schedule of Noncash Investing and Financing Activities Assets for Liabilities &/or Equity Liabilities &/or Equity for Assets Liabilities for Equity and Equity for Liabilities Capital lease (acquisition of asset and obligation for lessee) A reconciliation of net income to cash provided by operations *Brackets indicate items that are normally combined

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Operat i ngAct i vi t i es (Usually associated with working capital accounts like Accounts receivable, inventory, salaries payable, etc.) Inflows: From sale of goods and services From receiving dividends investments From receiving interest from investments or loans From sale of trading securities From reduced income taxes due to “excess tax deduction” related to stock options

Outflows: To suppliers for inventory and other materials To employees for services To other entities for services (insurance, etc.) To government for taxes To lenders for interest To purchase trading securities Interest expense is an operating item! Investment earnings (dividends & interest) is an operating item! Buying and selling trading securities are operating activities! These things may not make sense to you – so “memorize.”

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I nvest i ngAct i vi t i es (Usually associated with long-term assets) Inflows:

From sale of property, plant and equipment From sale of debt or equity investments of other entities* From collections of principal on loans to other entities Outflows:

To purchase property, plant and equipment To purchase debt or equity securities of other entities To make loans to other entities

*except investments classified as trading securities which are included in operating activities

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Fi nanci ngAct i vi t i es (Usually associated with long-term liability and equity items) Inflows:

From issuance of debt (bonds and notes) From issuance of equity securities Common stock Preferred stock Re-issuance of treasury stock Outflows:

To stockholders as dividends To repay or retire long-term debt, including capital leases for lessee (interest on leases is classified as operating) To reacquire capital stock (treasury stock)

An“anomal y”onSCF Dividends are paid to stockholders and interest is paid to bondholders. Dividends paid are shown as outflows under financing activities However, FASB defined interest expense to be an operating activity Interest & dividend revenue are defined to be operating activities, too.

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Di rectversusI ndi rectPresent at i ons FASB Statement No. 95 allows two ways to calculate and report a company’s net cash flow from operating activities on its statement of cash flows.

TheDi rectMet hod Under the direct method, operating cash outflows are deducted from operating cash inflows to determine the net cash flow from operating activities. If you choose the direct method, a reconciliation of cash provided by operations to net income is a required disclosure. This is the same schedule that appears in a statement prepared using the indirect method The required information items on a direct method statement of cash flow (per FASB) Operating Inflows Cash collected from customers (including lessees, tenants, licensees, and the like) Interest and dividends received Other operating cash receipts, if any Operating outflows Cash paid to employees and other suppliers of goods or services (including insurance, advertising and the like) Interest paid Income taxes paid Other operating cash payments, if any

TheI ndi rectMet hod Under the indirect method, net income is adjusted for noncash items related to operations to compute the net cash flow from operating activities. If you choose to use the indirect method, you must also disclose interest paid and income taxes paid during the year.

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Ot herdi scl osures Under both methods (direct & indirect), you must disclose noncash financing and investing activities This can be on face of the statement or in the notes to the financial statements. Examples: Trade common stock for land Convertible bonds converted to common stock

NoncashI t ems Some financing and investing activities do not affect an entity’s cash flow. Examples: Trade common stock for land Issue bonds in exchange for a building Convertible bonds converted to common stock

Significant transactions should be disclosed separately. The disclosure of significant noncash financing and investing activities are required under both methods (direct & indirect) The disclosure can be on face of the statement or in the notes to the financial statements. The o r e t i c alCo ns i de r at i o ns The direct method has the advantage of reporting operating cash inflows separately from operating cash outflows, which may be useful in estimating future cash flows. The direct method is more meaningful to most financial statement users and the “tie in” to net income is also provided in a separate schedule which is the same as the indirect method presentation. Under the indirect method, adjustments are made to net income to arrive at cash flow from operating activities. Thus, cash from operating activities is “tied” to net income. An advantage of the indirect method is that income flows are converted from an accrual basis to a cash flow basis. In this manner, the indirect method shows the “quality of earnings” by providing information about intervals of leads and lags between income flows and operating cash flows.

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Example 1 - Statement of Cash Flow – DIRECT METHOD Year ending 12/31/06 Ref 15,000 X

Palouse Pottery Cash Accounts Receivable Allowance for doubtful accounts Merchandise Inventory Prepaid Expenses Plant, property & equipment Accumulated Depreciation Accounts Payable Salaries Payable Interest payable Income Taxes Payable Dividends Payable Long term liabilities Common stock, $1 par Retained Earnings

Closing entry for Sales Gain/(loss) on sale of PP&E Realized gain/(loss) - land Cost of goods sold Salaries & other operating expenses Bad debt expense Depreciation & amortization Interest expense Income taxes expense Net income (accrual basis) Statement of Cash Flows Operating Activities

Year ending 12/31/07 42,000

Target 27,000

40,000 (3,000) 25,000 3,000

37,500 (4,500) 43,000 6,000

(2,500) (1,500) 18,000 3,000

215,000 (80,000) 215,000 (23,000) (2,000) (2,000) (1,500) 0 (25,000) (100,000) (61,500) (215,000) 1997 Rev/(Exp) 93,000 (4,000) 20,000 (35,000) (37,000)

236,000 (82,000) 278,000 (31,000) (9,000) (1,500) (5,500) (8,000) (15,000) (145,000) (63,000) (278,000) 1997 Rec/(Disb)

21,000 (2,000)

Debit Ref 27,000

Credit

(8,000) (7,000) 500 (4,000) (8,000) 10,000 (45,000) (1,500) 0

(2,000) (11,000) (2,500) (7,000) 14,500 (INFLOWS)

(OUTFLOWS)

Investing Activities

Financing Activities

Noncash Financing/Investing CHANGE IN CASH

X

27,000

Totals

Additional information: a. Wrote off $500 accounts receivable as uncollectible b. Sold operational assets for $4,000 cash that had cost $17,000 and had a book value of $8,000 c. Declared a cash dividend of $13,000 585b63ac9925affa9be7003ab9449945.doc created by T. Gordon 5/1/2021

d. e. f. g.

Sold land for $30,000 that had been acquired for $10,000 Paid a $10,000 long-term note installment Purchase plant, property & equipment for $48,000 cash. Issued common stock for $45,000 cash.

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Example 1 - Statement of Cash Flow – INDIRECT METHOD Year ending 12/31/06 Ref 15,000 X

Palouse Pottery Cash Accounts Receivable Allowance for doubtful accounts Merchandise Inventory Prepaid Expenses Plant, property & equipment Accumulated Depreciation Accounts Payable Salaries Payable Interest payable Income Taxes Payable Dividends Payable Long term liabilities Common stock, $1 par Retained Earnings

Year ending 12/31/07 42,000

Target 27,000

40,000 (3,000) 25,000 3,000

37,500 (4,500) 43,000 6,000

(2,500) (1,500) 18,000 3,000

215,000 (80,000) 215,000 (23,000) (2,000) (2,000) (1,500) 0 (25,000) (100,000) (61,500) (215,000)

236,000 (82,000) 278,000 (31,000) (9,000) (1,500) (5,500) (8,000) (15,000) (145,000) (63,000) (278,000)

21,000 (2,000)

Debit Ref 27,000

(INFLOWS)

Statement of Cash Flows Operating Activities

Credit

(8,000) (7,000) 500 (4,000) (8,000) 10,000 (45,000) (1,500) 0

(OUTFLOWS)

Investing Activities

Financing Activities

Noncash Financing/Investing CHANGE IN CASH

X

27,000

Totals

Additional information: a. Wrote off $500 accounts receivable as uncollectible b. Sold operational assets for $4,000 cash that had cost $17,000 and had a book value of $8,000 585b63ac9925affa9be7003ab9449945.doc created by T. Gordon 5/1/2021

d. Sold land for $30,000 that had been acquired for $10,000 e. Paid a $10,000 long-term note installment f. Purchase plant, property & equipment for $48,000 cash.

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c. Declared a cash dividend of $13,000

g. Issued common stock for $45,000 cash.

Example 2 - Statement of Cash Flow Moscow Moving & Storage Cash Accounts Receivable Allowance for doubtful accounts Merchandise Inventory Prepaid Expenses Plant, property & equipment Accumulated Depreciation Accounts Payable Salaries Payable Interest payable Long term liabilities Common stock, $1 par Retained Earnings

Year ending 12/31/06 Ref 15,000

Year ending 12/31/07 5,000

Target (10,000)

30,000 (1,500) 10,000 4,500

28,500 (2,000) 17,000 500

(1,500) (500) 7,000 (4,000)

220,100 (20,000) 258,100 (10,000) (3,000) 0 (30,000)

289,100 (16,000) 322,100 (13,000) (1,000) (1,000) (10,000)

69,000 4,000

Debit

Ref

Credit

(100,000) (115,100) (258,100) 1997 Rev/(Exp) 80,000 (2,000) (35,000) (26,000)

Closing entry for Sales Gain/(loss) on sale of PP&E Cost of goods sold Salaries & other operating expenses Bad debt expense Depreciation & amortization Interest expense Income taxes expense Net income (accrual basis)

(3,000) 2,000 (1,000) 20,000

(181,000) (81,000) (116,100) (1,000) (322,100) 0 1997 Receipt/(Disb)

(1,000) (5,000) (2,000) (3,000) 6,000 (INFLOWS)

Statement of Cash Flows Operating Activities

(OUTFLOWS)

Investing Activities

Financing Activities

Noncash Financing/Investing

CHANGE IN CASH Totals

Additional Information a. Wrote off $500 accounts receivable as uncollectible b. Sold operational assets for $4,000 cash (cost $15,000, acc'd depreciation $9,000) c. Declared and paid a cash dividend, $5,000

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d. Issued common stock for $36,000 cash e. Paid a $20,000 long-term note installment f. Purchased operational assets, $39,000 cash g. Acquired land in exchange for 1,000 shares of common stock worth $45 each

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Reconciliation of Net Income to Cash Provided by Operations or – “the Indirect Method” Example 2 Moscow Moving & Storage Statement of Cash Flow Worksheet Reconciliation Schedule (Indirect method) Net income

Ref

Cash provided by operations

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Example 3 Avery Slings & Arrows, Inc. Avery Slings & Arrows Income Statement For year ending

12/31/04

Sales Earnings of affiliates (equity method) Realized loss on sale of equipment Realized gain on sale of investments Interest and dividend revenue Total revenues

6,600,000 150,000 (65,000) 53,000 15,000 6,753,000

Cost of goods sold Salaries and wages Other operating expenses Bad debt expense Depreciation expense Amortization of intangibles Accretion expense Interest expense Income tax expense Net income

3,490,000 632,000 421,000 45,000 757,000 5,000 25,000 935,000 177,000

6,487,000 266,000

Prepare a statement of cash flows (direct method) including the required reconciling schedule and any other required disclosures for Avery Slings & Arrows, Inc. Information from the balance sheet and income statement have been entered into a worksheet for your convenience. In addition to completing the worksheet, you MUST prepare a formal statement with headings, subtotals, etc. for full credit. ADDITIONAL INFORMATION a. During the year, ASA paid $2,767,000 in cash for land, building, and equipment. b. On August 5, 2004, ASA issued 25,000 shares of common stock for $42 per share. c. ASA purchased $273,000 in marketable securities during the year. d. Equipment costing $500,000 was sold during the year for $59,000. The book value was $124,000. e. During the year, AAS declared cash dividends in the amount of $203,000. f. On April 1, 2004, the holders of $1,500,000 in convertible bonds elected to convert their bonds to common stock. The conversion ratio was 25 shares of common stock for each share $1,000 face value bond. g. The noncurrent investment represents 30% of the outstanding securities of the investee. This investment is accounted for on the equity method. During 2004, ASA received $29,000 in dividends from the investment. h. On May 1, 2004, ASA acquired equipment under a capital lease. At the inception of the lease, the present value of the minimum lease payments was $648,000. i. ASA acquired a patent on a new process for $500,000 on October 15, 2004. j. During 2004, ASA sold marketable securities which it had acquired for $222,000 for $275,000. k. In February, ASA issued 150,000 shares of common stock in a 50% stock dividend. l. ASA issued $3,000,000 in bonds at face value on August 1, 2004. m. ASA sold 500 shares of treasury stock which it had acquired for $20 per share for $46 per share on January 18, ...