Type
Solution Manual
Book Title
Financial Accounting Fundamentals 5th Edition
ISBN 13
978-0078025754

978-0078025754 Chapter 12 Lecture Note Part 1

March 26, 2020
CHAPTER 12
REPORTING CASH FLOWS
Related Assignment Materials
Student Learning Objectives
Questions
Quick
Studies*
Exercises*
Problems*
Beyond the
Numbers
Conceptual objectives:
C1. Distinguish between operating,
investing, and financing
activities, and describe how
noncash investing and financing
activities are disclosed
1, 2, 3, 5, 7,
8, 9,14
12-1, 12-20
12-1, 12-14
12-3, 12-8,
12-7, 12-8,
12-9, 12-10
Analytical objectives:
A1. Analyze the statement
of cash flows and apply the
cash flow on total assets ratio.
1, 9, 12, 13
12-17
12-10, 12-11
12-3
12-1, 12-2,
12-3, 12-4,
12-5, 12-6,
12-7, 12-8
Procedural objectives:
P1. Prepare a statement of cash
flows.
12-2, 13-3,
12-9
12-9, 12-11,
12-12, 12-17,
12-18
12-3, 12-4,
12-5, 12-6,
12-7, 12-8
P2. Compute cash flows from
operating activities using
the indirect method.
6, 10, 11
12-4, 12-5,
12-6, 12-11,
12-19
12-2, 12-3,
12-4, 12-5,
12-6, 12-11
12-1, 12-3,
12-4, 12-6,
12-7
12-6
P3. Determine cash flows from
both investing and financing
activities.
2, 3, 7, 8, 9,
15
12-7, 12-8,
12-9, 12-10,
12-12, 12-13,
12-19
12-7, 12-8,
12-11, 12-12,
12-17, 12-18
12-3, 12-4,
12-5, 12-6,
12-7, 12-8
P4A.Illustrate use of a spreadsheet to
prepare a statement of
cash flows (Appendix 12A)
12-18
12-13
12-4, 12-7
P5B.Compute cash flows from
operating activities using
the direct method.(Appendix
12B)
4, 5
12-14, 12-15,
12-16
12-12, 12-14,
12-15, 12-16,
12-17, 12-18
12-2, 12-5,
12-8
12-6
*See additional information on next page that pertains to these quick studies, exercises and problems.
Additional Information on Related Assignment Material
Synopsis of Chapter Revisions
Dave’s Killer Bread: NEW opener with new entrepreneurial assignment
New infographics for operating, investing and financing activities
New linkage of cash flow classifications to balance sheet
Simplified discussion of noncash investing and financing
New, simplified preparation steps for statement of cash flows
New, overall summary T-account for preparing statement of cash flows
New reconstruction entries to help determine cash
Updated cash flow analysis using Nike
Numerous new assignments
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?
4. How much is paid in cash dividends?
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 informationgenerally 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 ReportingTwo ways of reporting
that apply only to the operating activities section.
1. Direct Methodseparately 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 Methodreports 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 types of adjustments are:
a. to income statement items involving operating activities
that do not affect
i. Revenues and gains are deducted from net income.
ii. Expenses and losses are added back to net income.
b. for changes in current assets (other than cash) and current
liabilities
i.Decreases in noncash current assets are added to net
income.
ii.Increases in noncash current assets are subtracted
from net income.
iii.Increases in current liabilities are added to net income.
iv.Decreases in current liabilities are subtracted from net
income
C. Summary of Adjustments for the Indirect methodsee
Exhibit 12-12 in text.
Chapter Outline
Notes
III. Cash Flows from Investingidentical 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 securitiesexcluding trading securities).
B. Explain these changes to identify their cash flows effects using
reconstruction analysis (reconstructed entriesnot 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
liabilitiesincluding 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 entriesnot the actual
entries by the preparer).
C. Report their cash flow effects.
V. Proving Cash Balances
Last step in preparing the statement is to report the beginning and
ending cash balances and provide that the net change in cash is
explained by operating, investing and financing cash flows. Exhibit
12.13 in text.
VI. Global ViewCompares 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.
Chapter Outline
Notes
VII. Decision AnalysisCash 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.
VIII. 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.
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.
Chapter Outline
Notes
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.
IX. Direct Method of Reporting Operating Cash Flows (Appendix
12B)
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 12B.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.
VISUAL #12-1
CLASSIFYING ACTIVITIES IN THE STATEMENT OF CASH FLOWS
OPERATING ACTIVITIES
Cash inflows from
Cash outflows to
Customers for cash sales
Collections on credit sales
Borrowers for interest
Dividends received
Lawsuit settlements
Salaries and wages
Lenders for interest
Charities
Suppliers of goods and services
Government for taxes and fines
INVESTING ACTIVITIES
Cash inflows from
Cash outflows to
Selling investments in securities
Selling (discounting) notes
Collecting principal on notes
Selling long-term productive assets
Make loans to others
Purchase long-term productive assets
Purchase investments in securities
FINANCING ACTIVITIES
Cash inflows from
Cash outflows to
Contributions by owners
Issuing notes and bonds
Issuing its own equity stock
Issuing short-term and long-term
debt
Repay cash loans
Pay withdrawals by owners
Pay dividends to shareholders
Purchase treasury stock
NONCASH INVESTING AND FINANCING ACTIVITIES
Retirement of debt by issuing equity stock
Conversion of preferred stock to common stock
Leasing of assets in a capital lease transaction
Purchase of a long-term asset by issuing a note or a bond
Exchange of noncash assets for other noncash assets
Purchase of noncash assets by issuing equity or debt
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