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16-1
CHAPTER 16
REPORTING THE STATEMENT OF CASH FLOWS
Related Assignment Materials
Student Learning Objectives
Questions
Quick
Studies*
Exercises*
Problems*
Beyond the
Numbers
Conceptual objectives:
C1. Explain the purpose and
importance of cash flow
information.
1
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C2. Distinguish between operating,
investing, and financing
activities.
2,3, 7, 8, 9,
14
C3. Identify and disclose noncash
investing and financing
activities.
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C4. Describe the format of the
statement of cash flows.
5
Analytical objectives:
A1. Analyze the statement
of cash flows.
1, 9, 12, 13
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16-3, 16-5,
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A2. Compute and apply the
cash flow on total assets ratio.
Procedural objectives:
P1. Prepare a statement of cash
flows.
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11, 16-15,
16-16, 16-18
16-1, 16-2,
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P2. Compute cash flows from
operating activities using
the indirect method.
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16-3, 16-4,
16-6, 16-12,
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16-1, 16-2,
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P3. Determine cash flows from
both investing and financing
activities.
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P4A.Illustrate use of a spreadsheet to
prepare a statement of
cash flows (Appendix 16A)
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16-14
16-2, 16-5
P5B.Compute cash flows from
operating activities using
the direct method.(Appendix
16B)
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16-3, 16-6,
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Chapter Outline
Notes
I. Basics of Cash Flow Reporting
A. Purpose of a Statement of Cash Flows
To report all major cash receipts (inflows) and cash payments
(outflows) during a period. This report classifies cash flows into
operating, investing, and financing activities. It answers important
questions such as:
1. How does a company obtain its cash?
2. Where does a company spend its cash?
3. What explains the change in the cash balance?
B. Importance of Cash Flows
Information about cash flows, and its sources and uses, can
influence decision makers in important ways.
C. Measurement of Cash Flows
The phrase, cash flows refers to both cash and cash equivalents. A
cash equivalent must satisfy two criteria:
1. Be readily convertible to a known amount of cash.
2. Be sufficiently close to its maturity date so its market value is
unaffected by interest rate changes.
D. Classifications of Cash Flows
Cash receipts and cash payments are classified and reported in one
of three categories:
1. Operating activities include transactions and events that
determine net income (with some exceptions such as unusual
gains and losses). Specific examples:
a. Cash inflows from cash sales, collections on credit sales,
receipts of dividends and interest, sale of trading
securities, and settlements of lawsuits.
b. Cash outflows for payments to suppliers for goods and
services, to employees for wages, to lenders for interest, to
government for taxes, to charities, and to purchase trading
securities.
2. Investing activities include transactions and events that affect
long-term assets, namely the purchase or sale of these assets.
Specific examples:
a. Cash inflows from selling long-term productive assets,
selling available-for-sale securities, notes and held-to-
maturity securities, and collecting principal on loans to
others.
b. Cash outflows from purchasing long-term productive
assets, purchasing available for sale securities and held-to-
maturity securities, and making loans to others.
Chapter Outline
Notes
3. Financing activities include transactions and events that affect
long-term liabilities and equity:
a. Cash inflows from owner contributions, from issuing
company’s own stock, from issuing bonds and notes and
from issuing short and long-term debt.
b. Cash outflows from repaying cash loans, owner’s
withdrawals, paying shareholder’s cash dividend and
purchasing treasury stock.
E. Noncash Investing and Financing Activities
Activities that do not affect cash receipts or payments but because
of their importance and the full disclosure principle they are
disclosed at the bottom of the statement of cash flows or in a note
to the statement.
F. Format of the Statement of Cash Flows
1. Lists cash flows by categories (operating, financing and
investing) and identifies the net cash inflow or outflow in each
category.
2. Combines the net cash flow in each of the three categories and
identifies the net change in cash for the period.
3. Combines the net change in cash with the prior period ending
cash to prove the current period ending cash.
4. Contains a separate schedule or note disclosure of any noncash
financing and investing activities.
G. Preparing the Statement of Cash Flow
1. Five steps:
a. Compute the net increase or decrease in cash (bottom line
or target number).
b. Compute and report net cash provided (used) by operating
activities (using either the direct or indirect method).
c. Compute and report net cash provided (used) by investing
activities.
d. Compute and report net cash provided (used) by financing
activities.
e. Compute net cash flow by combining net cash provided
by operating, investing, and financing activities and then
prove it by adding it to the beginning cash balance to
show that it equals the ending cash balance.
Note: Noncash investing and financing activities are disclosed
in either a note or in a separate schedule to the statement.
Chapter Outline
Notes
2. Sources of information for preparing the statement of cash
flows
a. Comparative balance sheets.
b. The current income statement.
c. Other information—generally derived from analyzing
noncash balance sheet accounts.
3. Alternative approaches to preparing the statement:
a. Analyzing the cash account.
b. Analyzing noncash accounts.
II. Cash Flows from Operating Activities
A. Indirect and Direct Methods of Reporting—Two ways of reporting
that apply only to the operating activities section.
1. Direct Method—separately lists each major item of operating
cash receipts and each major item of operating cash payments.
Cash payments are subtracted from cash receipts to determine
the net cash provided (used) by operating activities.
2. Indirect Method—reports net income and then adjusts it for
items necessary to obtain net cash provided (used) by
operating activities.
3. Note that the net cash provided (used) by operating activities
is identical under both the direct and indirect method.
B. Application of the Indirect Method of Reporting
1. Reports net income and then adjusts it for three types of items
necessary to obtain net cash provided (used) by operating
activities.
2. The three types of adjustments are:
a. to reflect changes in noncash current assets and current
liabilities.
b. to income statement items involving operating activities
that do not affect cash inflows or outflows.
c. to eliminate gains and losses resulting from investing and
financing activities (not part of operating activities).
3. Adjustments for changes in current assets and current
liabilities are made as follows:
a. Decreases in noncash current assets are added to net
income.
b. Increases in noncash current assets are subtracted from net
income.
c. Increases in current liabilities are added to net income.
d. Decreases in current liabilities are subtracted from net
Chapter Outline
Notes
4. Adjustments for operating items not providing or using cash
are made as follows:
a. Expenses with no cash outflows are added back to net
income.
b. Revenues with no cash inflows are subtracted from net
income.
5. Adjustments for nonoperating items are made as follows:
a. Nonoperating losses are added back to net income.
b. Nonoperating gains are subtracted from net income.
C. Summary of Adjustments for the Indirect method—see Exhibit 16-
12, page 644 of text.
III. Cash Flows from Investing—identical under direct and indirect
methods. Three-stage process of analysis to determine cash provided
(used) by investing activities:
A. Identify changes in investing-related accounts (all non-current
assets, and the current accounts for both notes receivable and
investments in securities—excluding trading securities).
B. Explain these changes to identify their cash flows effects using
reconstruction analysis (reconstructed entries—not the actual
entries by the preparer).
C. Report their cash flow effects.
IV. Cash Flows from Financing— identical under direct and indirect
methods. Three-stage process of analysis to determine cash provided
(used) by financing activities:
A. Identify changes in financing-related accounts (all non-current
liabilities—including current portion of any notes and bonds, and
the equity accounts).
B. Explain these changes to identify their cash flows effects using
reconstruction analysis (reconstructed entries—not the actual
entries by the preparer).
C. Report their cash flow effects.
16-7
Chapter Outline
Notes
V. Global View—Compares U.S.GAAP to IFRS
A. Both systems permit the direct or indirect approach to reporting
cash flows from operating activities and the application of both
methods are fairly consistent under both systems. Two basic
differences are:
1. U.S. GAAP requires cash inflows from interest and dividend
revenue is classified as operating activities, whereas IFRS
permits classification under operating or investing provided it
is consistent across periods.
2. U.S.GAAP requires cash outflows for interest expense to be
classified as operating activities, whereas IFRS permits
classification under operating or investing provided it is
consistent across periods.
B. Both systems are fairly similar in reporting cash flows from
investing and financing activities.
VI. Decision Analysis—Cash Flow Analysis
A. Analyzing Cash Sources and Uses
1. Managers stress understanding and predicting cash flows for
business decisions.
2. Creditor and investor decisions are also based on a company's
cash flow evaluations.
3. Operating cash flows are generally considered to be most
significant because they represent results of ongoing
operations.
B. Cash Flow on Total Assets
1. Similar to return on total assets except the return is analyzed
based on operating cash flows rather than net income.
2. Computed by dividing cash flow from operations by average
total assets.
Chapter Outline
Notes
VII. Spreadsheet Preparation of the Statement of Cash Flows
(Appendix 16A)
A spreadsheet approach may be used to organize and analyze the
information to prepare a statement of cash flows by the indirect
method, including the supplemental disclosures of noncash investing
and financing activities.
A. The spreadsheet has four columns containing dollar amounts.
1. Columns one and four contain the beginning and ending
balances of each balance sheet account.
2. Columns two and three are for reconciling the changes in
each balance sheet account.
B. Separate sections on the working paper present (a) balance
sheet items with debit balances; (b) balance sheet items with
credit balances; (c) cash flows from operating activities,
starting with net income; (d) cash flows from investing
activities; (e) cash flows from financing activities; and (f)
noncash investing and financing activities.
C. Information for sections (c) - (f) is developed in four steps in
the Analysis of Changes columns:
1. By adjusting net income for the changes in all noncash
current asset and current liability account balances. This
reconciles the changes in these accounts.
2. By eliminating from net income the effects of all noncash
revenues and expenses. This begins the reconciliation of
noncurrent assets.
3. By eliminating from net income any gains or losses from
investing and financing activities. This involves the
reconciliation of noncurrent assets and noncurrent
liabilities and perhaps the recording of disclosures in
sections (c) - (g).
4. By entering any remaining items, such as dividend
payments, which are necessary to reconcile the changes in
all balance sheet accounts.
Chapter Outline
Notes
VIII. Direct Method of Reporting Operating Cash Flows (Appendix
16B)
A. Separately list each major item or class of operating cash
receipts and cash payments.
B. Classes of operating cash receipts include cash received from
customers, renters, interest, and dividends.
C. Classes of operating cash payments include cash paid to
suppliers, to employees and other operating expense, interest,
and income taxes.
D. Subtract the cash payments from cash receipts to determine
the net cash provided (used) by operating activities.
E. The items to be listed are determined by adjusting individual
accrual basis income statement items to cash basis items. This
is done by determining the impact from changes in their
related balance sheet accounts.
F. Exhibit 16B.6 (p. 661) summarizes the common adjustments
for the items making up net income to arrive at net cash
provided (used) by operating activities under the direct
method.
G. This is the method recommended (but not required) by the
FASB.
H. When the direct method is used, the FASB requires a
reconciliation of net income to net cash provided (used) by
operating activities. This is operating cash flows computed
using the indirect method.
