Chapter 13 – Statement of Cash Flows
13 STATEMENT OF CASH FLOWS
Chapter Summary
The statement of cash ows was introduced in Chapter 1. This chapter
begins by reviewing the purpose of the statement. Its usefulness to creditors
and investors in evaluating solvency is emphasized from the outset. The
classification of cash transactions into operating, investing, and financing
activities is explained in full. This section includes an explanation of the
reasoning behind the classification of interest receipts, interest payments,
and dividend receipts as operating activities. We also take the opportunity at
the outset to highlight the importance of cash ows from operating activities.
The approach to preparing the statement centers on analyzing the
income statement and the associated changes in noncash balance sheet
accounts. The approach is introduced using a simple illustration based on
changes in the balance of the marketable securities account. We then apply
this methodology to an example that develops the entire statement.
The direct method is used to compute cash ows from operating
activities. Discussion of the indirect method is also presented. Either or both
methods may be chosen at the option of the instructor.
The analysis of ows from investing and financing activities is
somewhat simpler than that for operating activities and the coverage is as a
result relatively brief.
The chapter concludes with a detailed discussion of the use of the SCF
in developing strategies to manage cash ows. Emphasis here is on the use
of the accounting information by internal management rather than investors
and creditors external to the firm.
Learning Objectives
1. Explain the purposes and uses of a statement of cash ows.
2. Describe how cash transactions are classified in a statement of cash
ows.
3. Compute the major cash ows relating to operating activities.
4. Compute the cash ows relating to investing and financing activities.
5. Distinguish between the direct and indirect methods of reporting
operating cash ows.
6. Explain why net income differ from net cash ows from operating
activities.
7. Compute net cash ows from operating activities using the indirect
method.
8. Discuss the likely effect of various business strategies on cash ows.
9. Explain how a worksheet may be helpful in preparing a statement of
cash ows.
Brief topical outline
AStatement of cash flows
1Purposes of the statement
2Example of a statement of cash flows – See Exhibit 13-1 (page 567)
3Classification of cash flows
aOperating activities
bInvesting activities
cFinancing activities
dWhy are receipts and payments of interest classified as operating
activities? – see Case in Point (page 568)
eCash and cash equivalents
fCash versus accrual information
BPreparing a statement of cash flows
1Operating activities
2Investing activities
3Financing activities
4Cash and cash equivalents
5Cash flows from operating activities
aCash received from customers
bInterest and dividends received
6Cash payments for merchandise and for expenses
aCash paid for purchases of merchandise
bCash payments for expenses
cCash paid to suppliers and employees
dCash payments for interest and taxes
eA quick review
7Cash flows from investing activities
aPurchases and sales of securities
bLoans made and collected – see Your Turn (page 576)
cCash paid to acquire plant assets
dProceeds from sales of plant assets
eA quick review
8Cash flows from financing activities
aShort-term borrowing transactions
bProceeds from issuing bonds payable and capital stock
cCash dividends paid to stockholders
dA quick review
9Relationship between the statement of cash flows and the balance sheet – see
Case in Point (page 579)
10 Reporting operating cash flows by the indirect method
aReconciling net income with net cash flows
bThe indirect method: a summary
cIndirect method may be required in a supplementary schedule
dThe statement of cash flows: a second look
CFinancial analysis and decision making
1Free cash flow – see Your Turn (page 584)
DManaging cash flows
1Budgeting: the primary cash management tool
2What priority should managers give to increasing net cash flows?
aShort-term results versus long-term growth
bOne-time boosts to cash flows
3 Some strategies for permanent improvements in cash flow
a Deferring income taxes
bPeak pricing
cDevelop an effective product mix – see Ethics, Fraud & Corporate
Governance (page 587)
EA worksheet for preparing a statement of cash flows
1Data for an illustration
aAdditional information
2The worksheet
aEntries in the middle column
3Entry
FConcluding remarks
Topical coverage and suggested assignment
Homework Assignment
(To Be Completed Prior to Class)
Class
Meetings on
Chapter
Topical
Outline
Coverage
Discussion
Questions
Brief
Exercises Exercises Problems
Critical
Thinking
Cases
1 A 1, 2, 3, 1, 3 1, 5 1, 6
2 B 6, 7, 8 5, 6 2, 4 2, 3 2
3 C – F 11, 13, 15 9 8, 9, 10 7, 8
Comments and observations
Teaching objectives for Chapter 13
In presenting the statement of cash flows, our teaching objectives are to:
1Explain the content and usefulness of this financial statement.
Financial Accounting, 16e 13- 3
2Provide a brief history of this financial statement, distinguishing it from the statement of
changes in financial position and emphasizing the need for information regarding cash flows
in this era of corporate “takeovers.”
3Describe the major classifications within the statement of cash flows. Emphasize the
relative importance of the net cash flow from operating activities.
4Briefly explain why it is that accounting records maintained on the accrual basis of
accounting do not show cash flows as balances of specific ledger accounts.
5Explain how cash flows may be determined by examining income statement accounts and
the changes in related balance sheet accounts.
6Illustrate the computation of the basic cash flows (direct method) relating to operating
activities. Emphasize the rationale underlying each computation.
7Explain the basic reasons why net cash flow from operating activities may differ from the
amount of net income.
8Illustrate the computation of cash flows relating to investing and financing activities. Again,
emphasize the rationale underlying each computation.
9Briefly compare and contrast the direct and indirect methods of reporting net cash flows
from operating activities.
10 Discuss the critical importance of managing cash flows and introduce strategic options for
management to improve cash flows from existing operations.
General comments
When the FASB acted to replace the statement of changes in financial position with a new
financial statement¾a statement of cash flows¾we believe the Board significantly improved the
quality of financial reporting and accounting education. The old statement of financial position
was difficult to read, to understand, and to teach. It could be prepared on any of several
bases¾including cash, working capital, and net quick assets. The “funds statements” included in
the annual reports of major companies were difficult to interpret and seldom comparable, and
they usually bore little resemblance to the textbook illustrations. And teaching “funds flow” was
not easy, especially at the introductory level. Typical teaching approaches usually involved
complicated working papers, mythical T accounts, and numerous confusing adjustments to the
net income figure.
We find the new statement of cash flows intuitively logical. Therefore, it should be more
meaningful to readers of financial statements and easier to explain in the classroom. The
phenomenon of cash flows from operations is now explained by such easy-to-understand
captions as “Cash collected from customers” and “Cash paid to suppliers and employees.”
Chapter 13 – Statement of Cash Flows
Compare this to the old approach of “Net income, plus depreciation, minus nonoperative gains,
plus nonoperative losses, etc., etc.”
The direct and indirect methods One area of controversy in presenting cash flows is whether
to use the direct or indirect method of determining the cash flow from operating activities. The
FASB recommends use of the direct method, but at present, the indirect method is far more
widely used in practice.
Without question, we opt for the direct method. Introductory students are able to
understand the direct method, as it explains in straightforward terms the nature of the cash flows
comprising “operating activities.” The indirect method is an abstraction, meaningful only to
someone who already understands clearly the differences between the accrual and cash basis of
accounting. Thus, we consider the direct method a “gift from heaven” to the introductory
accounting instructor.
Of course, not everyone sees it our way. Therefore we also present the indirect approach.
A Supplemental Topic presents a worksheet approach to the indirect method.
Supplemental Exercises
Group Exercise
Two methods of preparing the operating activities section of the cash
ow statement are discussed in the text: the indirect method and the direct
method.
Go to http://www.fasb.org/st/summary/stsum95.shtml and review
the FASB Statement No. 95 to see if the FASB has a preference on which
method to use in preparing the operating activities section.
Internet Exercise
Obtain the latest annual report for ExxonMobil at www.exxonmobil.com.
Examine the balance sheet. What amount of current liabilities is the
company reporting as of the end of the current accounting period? Now
obtain the statement of cash ows. How much cash did ExxonMobil
generate from operating activities during this accounting period? Was this
net cash ow from operating activities suffcient to pay the company’s
current liabilities? If not, how did the company obtain the necessary cash to
remain solvent?
10-MINUTE QUIZ A SECTION
In order to prepare the statement of cash flows for Rag Dolls Corporation for 2010, the
accountant has compiled the following data regarding cash flows:
Cash paid to acquire marketable securities……..……..……………………..….….... $ 370,000
Chapter 13 – Statement of Cash Flows
Proceeds from issuance of capital stock..……………..…………………..…..…….... 280,000
Proceeds from issuance of bonds payable….……..…………………..…..………..… 55,000
Payments to settle short-term debt.……………………………..…….……..……..…… 32,500
Interest and dividends received……………………………………………………..…….. 10,000
Cash received from customers………………………………………………….…….…... ?
Dividends paid……………………………………………………………….…….….….…... 130,000
Cash paid to suppliers and employees……..……………………..………………..…… 1,030,000
Interest paid…………………………………………………………………………………..…. 25,000
Income taxes paid………………………………………………………………………..….… 70,000
Cash and cash equivalents, January 1, 2010……….……………..…………...……... 43,000
Cash and cash equivalents, December 31, 2010………..…………….……..…….... 58,000
Using the above information, indicate the best answer for each question in the space provided.
1Rag Dolls’ cash flow from investing activities during 2010 is:
a$390,000 net cash used by investing activities.
b$322,500 net cash provided by investing activities.
c$352,500 net cash used by investing activities.
d$360,000 net cash used by investing activities.
2Rag Dolls’ cash flow from financing activities during 2010 is:
a$322,500 net cash provided by financing activities.
b$172,500 net cash provided by financing activities.
c$127,500 net cash provided by financing activities.
d$375,000 net cash provided by financing activities.
3Rag Dolls’ cash flow from operating activities during 2010 is:
a$45,000 net cash provided by operating activities.
b$1,155,000 net cash used by operating activities.
c$240,000 net cash provided by operating activities.
d$195,000 net cash provided by operating activities.
4In the 2010 statement of cash flows for Rag Dolls Corporation, the amount of cash
received from customers is:
a$1,310,000.
b$1,103,000.
c$1,233,000.
d$1,293,000.
CHAPTER 13 NAME …………………………………….….….
#
10-MINUTE QUIZ B SECTION
Use the following information for questions 1 through 4.
Lester Corporation’s statement of cash flows for 2009 shows the following investing activities:
Proceeds from sale of marketable securities……….……………………..…..…….... $ 160,000
Purchase of land……………………………………………………………………….….…... (250,000)
Proceeds from sale of land……………………………………………………………….…. 125,000
Net cash provided by investing activities………………………..…..……..…….... $ 35,000
Chapter 13 – Statement of Cash Flows
Lester’s income statement for 2009 includes the following:
Loss on sale of marketable securities……..……………..………………..……..…….. $47,000
Gain on disposal of land……………………………………………………..….…….….… 65,000
1Refer to the above data. The cost of the land sold during 2009 was:
a$65,000. b$125,000. c$190,000. d$60,000.
2Refer to the above data. The cost (book value) of the marketable securities sold during
2009 was:
a$207,000. b$113,000. c$160,000. dSome other amount.
3Refer to the above data. Lester’s balance sheet at the end of 2008 showed Land of
$100,000. On the basis of the data presented above, compute the amount to be reported for
Land in Lester Corporation’s balance sheet at December 31, 2009.
a$250,000. b$350,000. c$290,000. dSome other amount.
4Refer to the above data. Lester’s balance sheet at the end of 2008 showed Investment in
Marketable Securities at $250,000. On the basis of the data presented above, compute the
amount to be reported for Investment in Marketable Securities in Lester Corporation’s
balance sheet at December 31, 2009.
a$43,000. b$110,000. c$137,000. d$253,000.
5Which of the following correctly describes a difference between the direct method and the
indirect method of computing operating cash flow?
aThe direct method is used when accounting records are kept on a cash basis; the
indirect method is used when accounting records are maintained on an accrual basis.
bThe direct method may be used only when a company maintains special journals for
cash receipts and cash disbursements; the indirect method is used in all other
situations.
cBoth the direct and the indirect methods result in the same net cash flow from
operating activities, but the format of this section of the statement of cash flows is
different under the alternative methods.
dThe direct method is used when all accounting records and bank statements are
available; the indirect method is used when some accounting records or documents
are missing or have been destroyed.
CHAPTER 13 NAME #
10-MINUTE QUIZ C SECTION
Using the following information, complete the statement of cash flows for Nutritional Foods for the year
ended December 31, 2010. Place parentheses around those figures in the statement representing cash outlays.
Payments for purchase of land……………………………………………………………..….….….….… $ 416,000
Proceeds from sale of land…………………………………………………………………………….….…. $58,000
Proceeds from issuance of capital stock..……………..……………………..…….……..……..…….. $347,000
Proceeds from issuance of bonds payable……………………………………………………………….. $99,000
Payments to settle short-term debt……………………………………………………………………….... $74,000
Interest and dividends received……………………………………………………………….…….….….. $49,500
Cash received from customers………………………………………………………………….….….…... $1,502,000
Dividends paid…………………………………………………………………………………………………... $182,000
Cash paid to suppliers and employees……..……………………..…………………………...……..…. $1,172,000
Interest paid …………………………………………………………………………………..….….….….… $66,000
Income taxes paid………………………………………………………………………………….….….….… $115,500
Financial Accounting, 16e 13- 7
Chapter 13 – Statement of Cash Flows
Cash and cash equivalents, January 1, 2010……….……………..…………………..…..……..……. $86,000
Cash and cash equivalents, December 31, 2010………..……………………..………..……..…….. ?
NUTRITIONAL FOODS
Statement of Cash Flows
For the Year Ended December 31, 2010
Cash flows from operating activities (direct method):
Cash received from customers………..…………………………….….. $
_________
Cash provided by operating activities……………………………..… $
$
_________
Cash disbursed for operating activities………..……...……..…….. (_______)
Net cash flows from operating activities……………………..…. $
Cash flows from investing activities:
$
_________
Net cash used by investing activities….………..……..……..….. ( )
Cash flows from financing activities:
$
_________
Net cash provided by financing activities ....………..……..….. _______
Net increase (decrease) in cash…..……………………………..……..……... $
Cash and cash equivalents, beginning of year….……..……..……..……. _______
Cash and cash equivalents, end of year.……………..……...……..…….... $______
CHAPTER 13 NAME #
10-MINUTE QUIZ D SECTION____________________________________
The following balance sheets are provided for Socrates Foods:
End of Beginning
Year of Year
Cash and cash equivalents………………………………………………………….. $170,000 $120,000
Accounts receivable………………………………………………………………….. 80,000 65,000
Inventory…………………………………………………………………….….….…... 140,000 130,000
Plant and equipment (net)…..……………..……………………..……..………... 130,000 80,000
Total assets……………………………………………………………………………. $520,000 $395,000
Accounts payable (for merchandise)………..…………………...……..……… $ 65,000 $ 35,000
Wages payable…………………………………………………………………….…... 120,000 110,000
Long-term liabilities…………………..……………………....………..……..…… 95,000 70,000
Common stock…………………………………………………………………………. 100,000 100,000
Retained earnings……..……………………..……………………..……..……..…. 140,000 80,000
Total liabilities and owners’ equity…………..………………..……..…….... $520,000 $395,000
Chapter 13 – Statement of Cash Flows
Selected information from Socrates Foods’ current year income statement:
Sales ……………………………………………………………………………………………….….….…. $1,650,000
Cost of goods sold…………………………………………………………………………………..….… 840,000
Wages expense………………………………………………………………………………….….….….. 260,000
a Compute the following:
(1) Cash received from customers during the year….………………..……..……... $__________
(2) Cash payments for merchandise during the year…….………………………….. $__________
(3) Wages paid to employees during the year….……………………..…………….... $__________
(4) In Socrates Foods’ statement of cash flows, what amount would be reported as the net change in
cash and cash equivalents?
$__________ (increase/decrease)
b Socrates Foods recorded the sale of equipment as follows:
Cash………………………………………………………………………………. 25,000
Accumulated Depreciation: Equipment….……………...……..…….. 20,000
Loss on Disposal of Equipment………..……………………....……….. 15,000
Equipment…………………………………………………………………... 60,000
How would this transaction be reported in Socrates Foods’ statement of cash flows? (Assume the direct
method is being used.)
SOLUTIONS TO CHAPTER 13 10-MINUTE QUIZZES
QUIZ A QUIZ B
5C
QUIZ C
NUTRITIONAL FOODS
Statement of Cash Flows
For the Year Ended December 31, 2010
Cash flows from operating activities:
Cash received from customers…….……………..………..……..……..… $ 1,502,000
Interest and dividends received..……..…………………….……..……..… 49,500
Financial Accounting, 16e 13- 9
Chapter 13 – Statement of Cash Flows
Cash disbursed for operating activities..……………..………..……..… (1,353,500)
Net cash flows from operating activities……….…………………………. $ 198,000
Cash flows from investing activities:
Dividends paid………………………………………………………………….… (182,000)
Net cash provided by financing activities……..…………...……..…… 190,000
Net increase (decrease) in cash…..……………………………..……..……... $ 30,000
Cash and cash equivalents, beginning of year….……..……..……..……. 86,000
Cash and cash equivalents, end of year.……………..……...……..…….... $ 116,000
QUIZ D
a
(1) $1,650,000 (sales) – $15,000 (increase in accounts receivable) = $1,635,000
b$25,000 proceeds from disposal of equipment, classified as an investing activity or
Chapter 13 – Statement of Cash Flows
Assignment Guide to Chapter 13
Brief
Exercises Exercises Problems Cases Net
1 – 10 1 – 15 1 2 3 4 5 6 7 8 1 2 3 4 5 6
Time estimate (in minutes) < 15 < 15 40 40 25 30 60 25 25 50 25 15 45 15 20 30
Difficulty rating E E M M S M S E M S S E M E M M
Learning Objectives:
1, 2, 15 √
1. Explain the purposes and uses
of a statement of cash flows.
2. Describe how cash transactions
are classified in a statement of
cash flows. 8, 10
1, 2, 7, 11,
12, 15
3. Compute the major cash flows
relating to operating activities. 1, 3, 7 4, 5, 6
4. Compute the cash flows relating
to investing and financing
activities. 5, 6
3, 13, 14, 15
5. Distinguish between the direct
and indirect methods of
reporting operating cash flows.
6. Explain why net income differs
from net cash flows from
operating activities. 9 2, 4, 6, 9
7. Compute net cash flows from
operating activities using the
indirect method.2, 4 9, 10
8. Discuss the likely effects of
various business strategies on
cash flows. 8
9. Explain how a worksheet may
be helpful in preparing a
statement of cash flows.
13-11 Instructor’s Resource Manual