CHAPTER 12
STATEMENT OF CASH FLOWS
Student Learning Objectives and Related Assignment Materials
Student Learning Objectives
Mini–
Exercises
Exercises
Coached
Problems
Problems
(Groups
A & B)
Skills
Development
Cases
Continuing
Case
LO 12-1 Identify cash
flows arising from
operating, investing,
and financing activities.
1, 2, 8,
11
1, 7, 13
1
A1, B1
1, 2, 4, 5
LO 12-2 Report cash flows
from operating
activities, using the
indirect method.
2, 3, 4, 5
1, 2*, 3*,
4*, 5*,
6*, 7*, 8,
9, 10, 11,
12, 13,
14^, 17,
18
2, 3, 4
A2, A3,
A4, B2,
B3, B4
6, 7
1†, 2^£
LO 12-3 Report cash flows
from investing
activities.
6, 9
13, 15,
16
3, 4, 6
A3, A4,
A6, B3,
B4, B6
1†
LO 12-4 Report cash flows
from financing
activities.
7, 9
13, 15,
16
3, 4, 6
A3, A4,
A6, B3,
B4, B6
1†
LO 12-5 Interpret cash
flows from operating,
investing, and financing
activities.
1, 10
6*, 7*, 9,
10, 13,
17, 19,
20
3, 4, 6
A3, A4,
A6, B3,
B4, B6
1, 2, 3, 4, 5,
9
1†
LO 12-6 Report and
interpret cash flows
from operating
activities, using the
direct method.
11, 12,
13
18, 19,
20
5, 6
A5, A6,
B5, B6
8
LO 12-S1 Report cash
flows from PPE
disposals using the
indirect method.
21, 22
7
A7
LO 12-S2 Use the T-
account approach for
preparing an indirect
method statement of
cash flows.
23
(Table footnotes on next page.)
Student Learning Objectives and Related Assignment Materials, continued
* Animated solution included in the PowerPoint Slides.
^ Particularly challenging; requires students to combine multiple concepts in order to advance to the
next level of accounting knowledge.
† Continuing Case 12-1 builds on the story of Nicole’s Getaway Spa, introduced in earlier chapters. This
case focuses on preparing a statement of cash flows using the indirect method. This case will be
extended in future chapters.
£ Continuing Case 12-2 builds on the story of Wiki Art Gallery (WAG), an instructional case in
Connect. This case focuses on the calculation of the amount of cash collected from its customers.
Overview
The difference between operating cash flows and net income has never been so apparent as when Lehman
Brothers reported $11.5 billion in net income and $94.2 billion in net operating cash outflows during
2006-08, perhaps making it the initial tipping point into a worldwide financial crisis.
Students learn how to classify cash flows, interpret both direct and indirect method statements of cash
flows, and prepare both formats of statements.
Chapter supplements illustrate two additional topics for the indirect method: the cash flow effects of fixed
asset disposals (A) and using a spreadsheet to prepare the statement (B).
Synopsis of Chapter Revisions
• Updated focus company illustrations
• Final section of chapter illustrates user analyses that are possible with direct method but not indirect
method presentation
• Deleted spreadsheet approach, previously in chapter supplement
• Revised demonstration cases to be more consistent with approaches illustrated in chapter
• Reviewed and updated all end-of-chapter material
PowerPoint Slides
Student Learning Objective
PowerPoint® Slides
LO 12-1 Identify cash flows arising from operating, investing, and financing
activities.
12-2 through 12-12
LO 12-2 Report cash flows from operating activities, using the indirect
method.
12-13 through 12-23
LO 12-3 Report cash flows from investing activities.
12-24 through 12-26
LO 12-4 Report cash flows from financing activities.
12-27 through 12-33
LO 12-5 Interpret cash flows from operating, investing, and financing
activities.
12-34 through 12-38
LO 12-6 Report and interpret cash flows from operating activities, using the
direct method.
12-39 through 12-42
LO 12-S1 Report cash flows from PPE disposals using the indirect method.
12-43 through 12-45
LO 12-S2 Use the T-account approach for preparing an indirect method
statement of cash flows.
12-46 through 12-49
Animated Builds and Animated Solutions
PowerPoint® Slides
Exercise 12-2
12-51 through 12-52
Exercise 12-3
12-53 through 12-55
Exercise 12-4
12-56 through 12-58
Exercise 12-5
12-59 through 12-61
Exercise 12-6
12-62 through 12-65
Exercise 12-7
12-66 through 12-70
Chapter Summary
LO 12-1 Identify cash flows arising from operating, investing, and financing activities.
• The statement has three main sections: Cash flows from operating activities, which are related to
earning income from normal operations; Cash flows from investing activities, which are related to
the acquisition and sale of productive assets; and Cash flows from financing activities, which are
related to external financing of the enterprise.
• The net cash inflow or outflow for the period is the same amount as the increase or decrease in
cash and cash equivalents for the period on the balance sheet. Cash equivalents are highly liquid
investments purchased within three months of maturity.
LO 12-2 Report cash flows from operating activities, using the indirect method.
• The indirect method for reporting cash flows from operating activities reports a conversion of net
income to net cash flow from operating activities.
• The conversion involves additions and subtractions for (1) noncash expenses (such as
depreciation expense) and revenues that do not affect current assets or current liabilities, and (2)
changes in each of the individual current assets (other than cash) and current liabilities (other than
debt to financial institutions, which relates to financing).
LO 12-3 Report cash flows from investing activities.
• Investing activities reported on the cash flow statement include cash payments to acquire fixed
assets and investments and cash proceeds from the sale of fixed assets and investments.
LO 12-4 Report cash flows from financing activities.
• Cash inflows from financing activities include cash proceeds from issuance of debt and common
stock. Cash outflows include cash principal payments on debt, cash paid for the repurchase of the
company’s stock, and cash dividend payments. Cash payments associated with interest are a cash
flow from operating activities.
LO 12-5 Interpret cash flows from operating, investing, and financing activities.
• A healthy company will generate positive cash flows from operations, some of which will be used
to pay for purchases of property, plant, and equipment. Any additional cash (called free cash
flow) can be used to further expand the business, pay down some of the company’s debt, or
simply build up the cash balance. A company is in trouble if it is unable to generate positive cash
flows from operations in the long-run because eventually creditors will stop lending to the
company and stockholders will stop investing in it.
LO 12-6 Report and interpret cash flows from operating activities, using the direct method.
• The direct method for reporting cash flows from operating activities accumulates all of the
operating transactions that result in either a debit or a credit to cash into categories. The most
common inflows are cash received from customers and dividends and interest on investments.
The most common outflows are cash paid for purchase of services and goods for resale, salaries
and wages, income taxes, and interest on liabilities. It is prepared by adjusting each item on the
income statement from an accrual basis to a cash basis.
Chapter Outline
Teaching Notes
LO 12-1 Identify cash flows arising from operating, investing, and financing activities.
I. Understand the Business
A. Business Activities and Cash Flows
1. Business activities have financial effects even when they
don’t involve cash. That’s why accrual accounting exists.
a. Accrual-based net income is the best measure of
profitability during the period.
b. Financial statement users need information about cash
and changes in its cash; the balance sheet and income
statement do not provide this information.
i. The balance sheet shows a company’s cash balance
at a point in time, but it doesn’t explain the
activities that caused changes in its cash.
ii. The income statement doesn’t explain changes in
cash because it focuses on just the operating results
of the business; also, the timing of cash receipts
and payments may differ from the accrual-based
income statement, which reports revenues when
they are earned and expenses when they are
incurred.
c. The purpose of the statement of cash flows is to show
how each major type of business activity caused a
company’s cash to increase or decrease during the
accounting period.
The “Spotlight on Ethics”
2. On statement of cash flows, cash is defined to include
cash and cash equivalents –short-term, highly liquid
investments purchased within three months of maturity;
considered equivalent to cash because they are both:
feature addresses the
usefulness of the statement of
cash flows in predicting
business failures.
a. Readily convertible to known amounts of cash, and
b. So near to maturity that there is little risk their value
will change.
✓ Supplemental Enrichment
B. Classifying Cash Flows
Activity (Activity) #1
1. Cash Flows from Operating Activities (Cash Flows
from Operations)—Cash inflows and outflows related to
components of net income.
Condensed statement
illustrated in Exhibit 12.1
a. Inflows––Cash provided by:
i. Collecting from customers
ii. Receiving dividends
iii. Receiving interest
b. Outflows––Cash used for:
i. Purchase of services (electricity, etc.) and goods
for resale
ii. Paying salaries and wages
iii. Paying income taxes
iv. Paying interest
Chapter Outline
Teaching Notes
c. Difference between these cash inflows and outflows is
reported as a subtotal, Net Cash Provided by (Used
for) Operating Activities.
2. Cash flows from Investing Activities—Cash inflows
and outflows related to the sale or purchase of
investments and long-lived assets.
a. Inflows––Cash provided by:
i. Sale or disposal of property, plant, and equipment
ii. Sale or maturity of investments in securities
b. Outflows––Cash used for:
i. Purchase of property, plant, and equipment
ii. Purchase of investments in securities
c Difference between these cash inflows and outflows is
reported as a subtotal, Net Cash Provided by (Used
for) Investing Activities.
3. Cash flows from Financing Activities – Cash inflows
and outflows related to financing sources external to the
company (owners and lenders).
a. Inflows––Cash provided by:
i. Borrowing from lenders (formal debt contracts)
ii. Issuing stock to owners
b. Outflows––Cash used for:
i. Repaying principal to lenders
ii. Repurchasing stock from owners
iii. Paying cash dividends to owners
c. The difference between these cash inflows and
outflows is reported as a subtotal, Net Cash Provided
by (Used for) Financing Activities.
4. Although exceptions exist, a general rule is that
The “Spotlight on the World”
a. Operating cash flows cause changes in current assets
and current liabilities.
feature addresses the
classification of interest and
b. Investing cash flows affect noncurrent assets.
dividends under GAAP and
c. Financing cash flows affect noncurrent liabilities or
stockholders’ equity accounts.
IFRS
II. Study the Accounting Methods
A. Relationship to Other Financial Statements
1. To prepare a statement of cash flows, you need:
a. Comparative balance sheets showing beginning and
ending balances––used in calculating the cash flows
from all activities.
b. A complete income statement––used primarily in
calculating cash flows from operating activities.
c. Additional data concerning selected accounts that
increase and decrease as a result of investing and/or
financing activities.
Chapter Outline
Teaching Notes
2. The balance sheet equation can be rearranged.
a. Changes in Cash = Changes in (Liabilities +
Stockholders’ Equity – Noncash Assets).
b. That is, changes in cash must be accompanied by and
can be accounted for by changes in liabilities,
stockholders’ equity, and noncash assets.
B. Preparing the Statement of Cash Flows
1. Use the following steps to prepare the statement of cash
flows:
a. Determine the change in each balance sheet account.
From this year’s ending balance, subtract this year’s
beginning balance (i.e., last year’s ending balance).
Relationships between
classified balance sheet and
statement of cash flow
b. Identify the cash flow category or categories to which
each account relates. Exhibit 12.2 as a guide, but be
aware that some accounts may include two categories
of cash flows.
categories are illustrated in
Exhibit 12.2 – included as an
animated build in PPT slides
i. Retained Earnings can include both financing cash
flows (paying dividends) and operating cash flows
(generating net income).
ii. Accumulated Depreciation can be affected by
operating activities (depreciation for using
equipment in daily operations) as well as investing
activities (disposing of equipment).
Background information for
c. Create schedules that summarize operating, investing,
and financing cash flows.
Under Amour provided in
Exhibit 12.3
C. Direct and Indirect Reporting Operating Cash Flows
1. Two alternative methods may be used when presenting
the operating activities section of the statement.
a. Direct Method—Reports the components of cash
flows from operating activities as gross receipts and
gross payments.
b. Indirect Method—Adjusts net income to compute
cash flows from operating activities.
2. The amount of net cash flows provided by (used in)
operating activities is always the same under the direct
and indirect methods.
3. The choice between the two methods affects only the
operating activities section of the statement of cash flows,
not the investing and financing sections.
4. The indirect method in the following section is currently
the most commonly used method in the United States.
Chapter Outline
Teaching Notes
LO 12-2 Report cash flows from operating activities, using the indirect method.
D. Determining Operating Cash Flows Using the Indirect
Method
✓ Activity #2
1. When using the indirect method, the schedule of
operating activities has the following format:
Net income
Items included in net income that do not involve cash:
+ Depreciation
Changes in current assets and current liabilities:
+ Decreases in current assets
– Increases in current assets
– Decreases in current liabilities
+ Increases in current liabilities
Net cash flow provided by (used in) operating activities
Illustrated in Exhibit 12.4
2. Net income—When preparing a schedule to determine
operating cash flows using the indirect method, start with
net income as reported on the last line of the company’s
income statement.
3. + Depreciation—When initially recording depreciation in
the accounting system, we increase Depreciation Expense
(with a debit) and increase Accumulated Depreciation
(with a credit).
a. Depreciation does not involve cash
b. To eliminate the effect of having deducted
Depreciation Expense in the income statement, we add
it back in the statement of cash flows.
4. + Decreases in current assets – Adding decreases in
current assets serves two purposes.
a. First, it eliminates the effects of some transactions that
decreased net income but did not affect cash in the
current period.
b. Second, adding decreases in current assets allows us to
include the cash effects of other transactions that did
not affect net income in the current period but did
increase cash.
5. – Increases in current assets—Subtracting increases in
current assets similarly serves two purposes.
a. First, it eliminates the effects of transactions that
increased net income but did not affect cash in the
current period.
b. Second, subtracting increases in current assets allows
us to include the cash effects of other transactions that
did not affect net income in the current period but did
decrease cash.
Chapter Outline
Teaching Notes
6. – Decreases in current liabilities—Subtracting decreases
in current liabilities serves two purposes.
a. First, it eliminates the effects of transactions that
increased net income but did not affect cash.
b. Second, subtracting decreases in current liabilities
allows us to include the cash effects of other
transactions that did not affect net income in the
current period but did decrease cash.
7. + Increases in current liabilities—Adding increases in
current liabilities serves two purposes.
a. First, it eliminates the effects of transactions that
decreased net income but did not affect cash.
b. Second, adding increases in current liabilities allows
us to include the cash effects of other transactions that
did not affect net income in the current period but did
increase cash.
LO 12-3 Report cash flows from investing activities.
E. Under Amour’s Investing Cash Flow Calculations
Illustrated in Exhibit 12.5
1. To prepare this section of the statement of cash flows,
you must analyze accounts related to long-lived tangible
and intangible assets.
2. Unlike the analysis of operating activities, where you
were concerned only with the net change in selected
balance sheet accounts, an analysis of investing (and
financing) activities requires that you identify and
separately report the causes of both increases and
decreases in account balances.
3. The following relationships are encountered most
frequently:
a. Purchase of property, plant, and equipment for cash––
Outflow
b. Sale of property, plant, and equipment for––Inflow
c. Purchase of intangible assets––Outflow
d. Sale of intangible assets––Inflow
4. Equipment—To determine the cause of the change in the
Equipment account, accountants would examine the
detailed accounting records for equipment.
a. Purchases of equipment increase the account.
b. Disposals of equipment decrease it.
Covered in Supplement 12A
5. Intangible and Other Assets—A similar approach is used
to determine cash flows associated with intangible asset.
Chapter Outline
Teaching Notes
LO 12-4 Report cash flows from financing activities.
F. Under Amour’s Financing Cash Flow Calculations
Illustrated in Exhibit 12.6
1. This section includes changes in liabilities owed to
owners (dividends payable) and financial institutions
notes payable and other types of debt) as well as changes
in stockholders’ equity accounts.
2. The following relationships are encountered most
frequently:
a. Borrowing cash from bank or other financial
institutions––Inflow
b. Repayment of loan principal––Outflow
c. Issuance of bonds for cash––Inflow
d. Repayment of bond face value––Outflow
e. Issuance of stock for cash––Inflow
f. Repurchase of stock with cash––Outflow
g. Payment of cash dividends––Outflow
3. To compute cash flows from financing activities, you
should review changes in all debt and stockholders’
equity accounts. Increases and decreases must be
identified and reported separately.
4. Long-term Debt—Analysis of the related account(s) will
indicated if it is affected by both cash inflows
(borrowings) and outflows (repayments).
5. Contributed Capital—Analysis of the related account(s)
will indicated if it is affected by both cash inflows (stock
issuance) and outflows (purchase of treasury stock).
6. Retained Earnings—Net income increases Retained
Earnings and any dividends decrease Retained Earnings.
a. Net income has already been accounted for as an
operating cash flow.
b. Dividends, if any, would have decreased Retained
Earnings, had they been declared; their payment
would have been reported as a cash outflow in the
financing section of the statement of cash flows.
G. Under Amour’s Statement of Cash Flows
Illustrated in Exhibit 12.7
1. Under either method, the statement of cash flows
combines cash flows from operating, investing, and
financing activities to produce an overall net increase (or
decrease) in cash.
2. The net increase (decrease) subtotal combines cash flows
from operating, investing, and financing activities to
produce an overall net change in cash.
3. This net change is added to the beginning cash balance to
arrive at the ending cash balance, which is the same cash
balance as reported on the balance sheet.