Chapter 12 – Reporting and Analyzing Cash Flows
Chapter 12
Reporting and Analyzing Cash Flows
Student Learning Objectives and Related Assignment Materials*
Student Learning Objectives
Discussion
Questions
Quick
Studies
Exercises
Problems
(A &B set)**
Beyond the
Numbers
Conceptual objectives:
C1. Distinguish among operating,
investing, and financing
activities and describe how
noncash investing and financing
activities are disclosed.
2, 3, 5, 6, 7,
8, 10, 11, 14
12-1, 12-2,
12-18
12-1, 12-2
EC, CIP,
TIA, ED,
HTR, GD
Analytical objectives:
A1. Analyze the statement
of cash flows and apply the
cash flow on total assets ratio.
12-12
12-17
12-1
RIA, CA,
EC, TTN,
TIA, ED
Procedural objectives:
P1. Prepare a statement of cash
flows.
1, 8, 9, 10,
11, 14
12-17
12-10, 12-11,
12-15, 12-16,
12-18
12-1 12-2,
12-3, 12-4,
12-5, 12-6
P2. Compute cash flows from
operating activities using
the indirect method.
4, 6, 12
12-3, 12-6,
12-9, 12-14
12-4, 12-6,
12-12, 12-13
12-1, 12-2,
12-4, 12-5,
12-7
TIA
P3. Determine cash flows from
both investing and financing
activities.
13, 14
12-4, 12-5,
12-7, 12-8,
12-15, 12-16
12-8, 12-9
12-1, 12-2,
12-3, 12-4,
12-5, 12-6
P4. Illustrate spreadsheet use to
prepare a statement of
cash flows.
(Appendix 12A)
12-13
12-14
12-2, 12-5
P5. Compute cash flows from
operating activities using
the direct method.
(Appendix 12B)
2, 5
12-9, 12-10,
12-11, 12-13,
12-14
12-2, 12-5,
12-7
12-3, 12-6,
12-8
TIA
Notes appear on next page.
Chapter 12 – Reporting and Analyzing Cash Flows
* Assignment materials that can be completed by students using:
Sage 50 and QuickBooks Pro 2013 templates– none
Excel templates – Problems 12-4A, 12-5A and 12-6A.
Synopsis of Chapter Revisions
• TOMS: NEW opener with new entrepreneurial assignment
• Revised graphics to better illustrate cash inflows and outflows for operating, investing, and
financing activities
• Revised graphic to better reflect cash and cash equivalents
• Added discussion on the use of T-accounts for reconstructing transactions impacting cash
• New margin clarification for computing free cash flow
• New discussion on the potential for IASB and FASB to issue guidance for the statement of
cash flow that would require the direct method… stay tuned
PowerPoint® Slides
Chapter Learning Objective
C1
P2
P3
A1
P5
Chapter 12 – Reporting and Analyzing Cash Flows
Chapter Outline
Notes
I. Basics of Cash Flow Reporting
A. Purpose of the Statement of Cash Flows
To report 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 is 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. This information
helps users decide whether a company can pay its debts and other
obligations, and its ability to take advantage of new business
opportunities.
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. Classification 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, employees for wages, lenders for interest,
government for taxes, charities, and purchase of trading
securities.
2. Investing activities include transactions and events that affect
long-term assets. Specific examples:
a. Cash inflows from selling long-term assets, selling short-
term investments other than cash equivalents, and
collecting money the company has loaned to others.
b. Cash outflows from purchasing long-term assets,
purchasing short-term investments other than cash
equivalents, and lending money to others.
Chapter 12 – Reporting and Analyzing Cash Flows
Chapter Outline
Notes
3. Financing activities include transactions and events that
affect long-term liabilities and equity:
a. Cash inflows from issuing debt and obtaining cash from
owners.
b. Cash outflows from repaying amounts borrowed and
distributing cash to owners.
E. Noncash Investing and Financing Activities
Noncash investing and financing activities do not affect cash
receipts or payments; however, they are disclosed at the bottom of
the statement of cash flows or in a note to the statement because of
their importance and the full disclosure principle.
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 (increase or decrease) in cash for the
period.
3. Combines the net change in cash with the beginning cash to
prove the ending cash.
4. Contains a separate schedule at bottom (or notes) to report the
noncash financing and investing activities.
G. Preparing the Statement of Cash Flows
1. Five steps:
a. Compute the net increase or decrease in cash.
b. Compute net cash provided (used) by operating activities
(using either the direct or indirect method).
c. Compute net cash provided (used) by investing activities.
d. Compute net cash provided (used) by financing activities.
e. Compute net cash flows by combining the net cash
provided (used) by operating, investing, and financing
activities and then prove it by adding it to the beginning
cash to show that it equals the ending cash.
2. Analyzing the cash account – natural place to look for
information about cash flows; however, cash account usually
does not have an adequate description to allow assignment to
the correct activity.
3. Analyzing noncash accounts – when a company records cash
inflows (debits) and outflows (credits) to the cash account, it
Chapter 12 – Reporting and Analyzing Cash Flows
Chapter Outline
Notes
4. Information to Prepare the Statement
a. Comparative balance sheets.
b. The current income statement.
c. Other information—generally derived from analyzing
noncash balance sheet accounts.
II. Cash Flows from Operating – cash flows from operating activities are
reported in one of two ways—the direct method or the indirect method.
Amount is identical under both methods.
A. Indirect and Direct Methods of Reporting
1. The direct method separately lists each major item of operating
cash receipts and each major item of operating cash payments.
(See illustration in Exhibit 12.7.)
2. The indirect method reports net income and then adjusts it for
items necessary to obtain net cash provided (used) by operating
activities. Reports the necessary adjustments to reconcile net
income to net cash provided (used) by operating activities. (See
illustration in Exhibit 12.9). This method is the most widely
used.
B. Application of the Indirect Method of Reporting
a. Add, as adjustments to net income: noncash expenses (e.g.,
depreciation), decreases in current assets, increases in
current liabilities, and losses.
b. Subtract, as adjustments to net income: increases in current
assets, decreases in current liabilities, and gains.
c. Does not report individual items of cash inflows and cash
outflows from operating activities.
d. Exhibit 12-12 summarizes the adjustments for the indirect
method.
III. Cash Flows from Investing
Three-stage process is used to determine cash provided (used) by
investing activities: (1) Identify changes in investing-related accounts,
(2) explain these changes using reconstruction method, and (3) report
their cash flow effects.
A. Analysis of Noncurrent Assets
1. Plant Asset Transactions: determine changes in all noncurrent
asset accounts (plant assets, intangible assets, investments)
2. Analyze changes in these accounts using available information
to determine their effect, if any, on cash.
Chapter 12 – Reporting and Analyzing Cash Flows
Chapter Outline
Notes
B. Analysis of Other Assets
1. Certain other asset transactions such as those involving current
notes receivable and investments in debt and equity securities
(excluding trading) are considered investing activities.
2. Analyze using same process used for noncurrent asset accounts.
IV. Cash Flows from Financing
Three-stage process is used to determine cash provided (used) by
investing activities: (1) Identify changes in financing-related accounts,
(2) explain these changes using reconstruction method, and (3) report
their cash flow effects.
A. Analysis of Noncurrent Liabilities
1. Determine changes in noncurrent liability accounts (e.g., long-
term debt, notes payable, bonds payable).
2. Analyze changes in these accounts using available information
to determine their effect, if any, on cash.
B. Analysis of Equity
1. Common Stock Transactions: determine changes in equity
accounts (e.g., owner’s capital, all stock accounts, and retained
earnings).
2. Retained Earnings Transactions: analyze changes in these
accounts using available information to determine their effect, if
any, on cash.
C. Proving Cash Balances – the last step in preparing the statement is to
report the beginning and ending cash balances and prove that the net
change in cash is explained by operating, investing, and financing
V. Global View
A. Reporting of Cash Flows from Operating – Both GAAP and IFRS
permit the reporting of cash flows from operating activities using
either the direct or the indirect method and the basic requirements
are fairly consistent across the two systems.
1. There are some differences in reporting operating cash flows.
GAAP requires cash inflows from interest and dividend revenue
be classified as operating, but IFRS permits classification under
operating, investing or financing provided that it is consistently
applied across periods.
2. GAAP requires cash outflows for interest expense be classified
as operating, but IFRS permits classification under operating,
investing or financing provided it is consistent across periods.
B. Reporting of Cash Flows from Investing and Financing – GAAP
and IFRS are similar in computing and classifying cash flows from
Chapter 12 – Reporting and Analyzing Cash Flows
Chapter Outline
GAAP requires cash outflows for income tax be classified as
operating, but IFRS permits splitting of those cash flows among
operating, investing, and financing depending on the sources of
that tax.
Notes
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. The cash flow on total assets ratio is similar to return on total
assets except the return is analyzed based on operating cash
flows rather than net income.
2. Calculated by dividing cash flow from operations by average
total assets.
VII. Spreadsheet Preparation of the Statement of Cash Flows (Appendix
12A)
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.
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.
Chapter 12 – Reporting and Analyzing Cash Flows
Chapter Outline
Notes
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.
4. By entering any remaining items, such as dividend payments,
which are necessary to reconcile the changes in all balance
sheet accounts.
VIII. Direct Method of Reporting Operating Cash Flows (Appendix
12B)
The direct method adjusts accrual-based income statement items to the
cash basis. Usual approach is to adjust income statement accounts
related to operating activities for changes in their related balance sheet
accounts. Separately list each major item or class of operating cash
receipts and cash payments.
A. Operating Cash Receipts—include cash received from sales, rent,
interest, and dividends.
B. Operating Cash Payments—include cash paid suppliers, for wages
and other operating expense, interest, and income taxes.
C. Summary of Adjustments for the Direct Method
Exhibit 12B.6 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.
D. Direct Method Format of Operating Activities
operating activities.
4. This is the method recommended (but not required) by the
FASB.
5. When the direct method is used, the FASB requires a
using the indirect method.