Chapter 13 – Statement of Cash Flows
Financial and Managerial Accounting, 17e 13-1
13 STATEMENT OF CASH FLOWS
Chapter Summary
The statement of cash flows 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 flows 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 flows 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 flows 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 flows. 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 flows.
2. Describe how cash transactions are classified in a statement of cash flows.
3. Compute the major cash flows relating to operating activities.
4. Compute the cash flows relating to investing and financing activities.
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.
7. Compute net cash flows from operating activities using the indirect method.
8. Discuss the likely effects of various business strategies on cash flows.
9. Explain how a worksheet may be helpful in preparing a statement of cash flows.
Chapter 13 – Statement of Cash Flows
Brief topical outline
A Statement of cash flows
1 Purposes of the statement
2 Example of a statement of cash flows – See Exhibit 13-1 (page 567)
3 Classification of cash flows
a Operating activities
b Investing activities
c Financing activities
d Why are receipts and payments of interest classified as operating
activities? – see Case in Point (page 568)
e Cash and cash equivalents
f Cash versus accrual information
B Preparing a statement of cash flows
1 Operating activities
2 Investing activities
3 Financing activities
4 Cash and cash equivalents
5 Cash flows from operating activities
a Cash received from customers
b Interest and dividends received
6 Cash payments for merchandise and for expenses
a Cash paid for purchases of merchandise
b Cash payments for expenses
c Cash paid to suppliers and employees
d Cash payments for interest and taxes
e A quick review
7 Cash flows from investing activities
a Purchases and sales of securities
b Loans made and collected – see Your Turn (page 576)
c Cash paid to acquire plant assets
d Proceeds from sales of plant assets
e A quick review
8 Cash flows from financing activities
a Short-term borrowing transactions
b Proceeds from issuing bonds payable and capital stock
c Cash dividends paid to stockholders
d A quick review
9 Relationship 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
a Reconciling net income with net cash flows
b The indirect method: a summary
c Indirect method may be required in a supplementary schedule
d The statement of cash flows: a second look
C Financial analysis and decision making
Chapter 13 – Statement of Cash Flows
Financial and Managerial Accounting, 17e 13-3
1 Free cash flow – see Your Turn (page 584)
D Managing cash flows
1 Budgeting: the primary cash management tool
2 What priority should managers give to increasing net cash flows?
a Short-term results versus long-term growth
b One-time boosts to cash flows
3 Some strategies for permanent improvements in cash flow
a Deferring income taxes
b Peak pricing
c Develop an effective product mix – see Ethics, Fraud & Corporate
Governance (page 587)
E A worksheet for preparing a statement of cash flows
1 Data for an illustration
a Additional information
2 The worksheet
a Entries in the middle column
3 Entry
F Concluding 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
1
A
1, 2, 3,
1, 3
1, 5
1, 6
2
B
6, 7, 8
5, 6
2, 4
2, 3
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:
1 Explain the content and usefulness of this financial statement.
2 Provide 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.”
3 Describe the major classifications within the statement of cash flows. Emphasize the
relative importance of the net cash flow from operating activities.
Chapter 13 – Statement of Cash Flows
4 Briefly 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.
5 Explain how cash flows may be determined by examining income statement accounts and
the changes in related balance sheet accounts.
6 Illustrate the computation of the basic cash flows (direct method) relating to operating
activities. Emphasize the rationale underlying each computation.
7 Explain the basic reasons why net cash flow from operating activities may differ from the
amount of net income.
8 Illustrate the computation of cash flows relating to investing and financing activities. Again,
emphasize the rationale underlying each computation.
9 Briefly 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 statement
a statement of cash flowswe 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 bases
including 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.”
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
Chapter 13 – Statement of Cash Flows
Financial and Managerial Accounting, 17e 13-5
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 flow 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 flows. How much cash did
ExxonMobil generate from operating activities during this accounting period? Was this net cash
flow from operating activities sufficient to pay the company’s current liabilities? If not, how did
the company obtain the necessary cash to remain solvent?
Chapter 13 – Statement of Cash Flows
CHAPTER 13 NAME #
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
Proceeds from sale of marketable securities ……………………………………………… 17,500
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.
1 Rag 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.
2 Rag 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.
3 Rag 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.
4 In 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.