Chapter 11: Statement of Cash Flows – Financial Accounting Study Notes

Statement of Cash Flows

Introduction

The Statement of Cash Flows is a key financial statement that reports a company's cash inflows and outflows over a specific period. It provides essential information about the sources and uses of cash, helping stakeholders assess the liquidity, financial flexibility, and overall financial health of an organization.

Purposes of the Statement of Cash Flows

Reporting Cash Flows

• Cash receipts: Inflows of cash from various activities.

• Cash payments: Outflows of cash for expenses, investments, and financing.

• Time span: Covers a period such as a month, quarter, or year.

Four Main Purposes

• Predicts future cash flows: Assists in forecasting the company's ability to generate cash.

• Evaluates management decisions: Shows how management's choices affect cash position.

• Determines ability to pay dividends and interest: Indicates whether the company can meet its obligations to shareholders and creditors.

• Shows relationship of net income to cash flows: Highlights differences between accrual-based net income and actual cash movements.

Timing of Financial Statements

Exhibit 11-1: Timing Overview

• Balance Sheet: Reports financial position at a specific point in time.

• Income Statement, Statement of Stockholders' Equity, Statement of Cash Flows: Report activities over a period of time.

Types of Business Activities

Operating, Investing, and Financing Activities

• Operating Activities: Transactions that create revenues, expenses, gains, and losses, resulting in net income.

• Investing Activities: Transactions that increase or decrease long-term assets, such as plant assets and investments.

• Financing Activities: Transactions related to long-term liabilities and owners' equity, such as issuing debt or stock.

Exhibit 11-2: Effects on the Balance Sheet

• Operating Cash Flows: Affect current assets and current liabilities.

• Investing Cash Flows: Affect long-term assets.

• Financing Cash Flows: Affect long-term liabilities and stockholders' equity.

Formats for Operating Activities

Indirect vs. Direct Method

• Indirect Method: Reconciles net income to net cash provided by operating activities by adjusting for non-cash items and changes in working capital.

• Direct Method: Reports all cash receipts and cash payments from operating activities directly.

Indirect Method	Direct Method
Net income: $600 Adjustments: Depreciation, etc.: $300 Net cash provided by operating activities: $900	Collections from customers: $2,000 Deductions: Payments to suppliers, etc.: ($1,100) Net cash provided by operating activities: $900

Preparing the Statement of Cash Flows (Indirect Method)

Key Components

• Transactions that make up net income (from the income statement): - Net income - Depreciation, depletion, amortization expense - Gains and losses on sale of long-term assets

• Changes from comparative balance sheets: - Increase or decrease in each current asset - Increase or decrease in each current liability

Depreciation, Depletion, and Amortization Expenses

• Added back to net income to convert net income to cash flow.

• No effect on cash, but decreases net income.

• Add-back cancels the deduction on the income statement.

• Example: TRRS reports depreciation expense of $18,000.

Gains and Losses on Sale of Long-Term Assets

• Adjust net income for gains and losses.

• Subtract gains from operating activities.

• Add losses to operating activities.

• Example: Equipment sold for $62,000, book value $54,000, gain of $8,000.

Changes in Current Assets and Liabilities (Excluding Cash)

• Increase in noncash current asset: Decreases cash. - Accounts Receivable increased by $15,000 - Prepaid Expenses increased by $1,000

• Decrease in noncash current asset: Increases cash. - Inventory decreased by $3,000

• Increase in current liability: Increases cash. - Accounts Payable increased by $34,000

• Decrease in current liability: Decreases cash. - Salary and Wages Payable decreased by $2,000 - Accrued Liabilities decreased by $2,000

Exhibit 11-6: Statement of Cash Flows—Operating Activities—Indirect Method

Item	Amount (in thousands)
Net income	53
Depreciation	18
Gain on sale of plant assets	(8)
Increase in accounts receivable	(15)
Increase in prepaid expenses	(1)
Decrease in inventory	3
Increase in accounts payable	34
Decrease in salary and wage payable	(2)
Decrease in accrued liabilities	(2)
Net cash provided by operating activities	84

Cash Flows from Investing Activities

Definition and Examples

• Affect long-term assets such as plant assets and long-term investments.

• Increase (purchase of long-term assets) decreases cash.

• Decrease (sale of long-term assets) increases cash.

Exhibit 11-8: Computing Cash Flows from Investing Activities

Activity	Cash Flow Effect
Acquisition of plant assets	Decrease cash
Proceeds from sale of plant assets	Increase cash
Loan to another company	Decrease cash

Cash Flows from Financing Activities

Definition and Examples

• Affect liabilities and stockholders' equity (e.g., Notes Payable, Bonds Payable, Long-Term Debt, Common Stock, Paid-in Capital, Retained Earnings).

• Most data are obtained from the balance sheet.

• Increases in these accounts are offset by increases in cash; decreases are offset by decreases in cash.

Exhibit 11-9: Computing Cash Flows from Financing Activities

Activity	Cash Flow Effect
Proceeds from issuance of long-term debt	Increase cash
Proceeds from issuance of common stock	Increase cash
Payment of long-term debt	Decrease cash
Payment of dividends	Decrease cash

Noncash Investing and Financing Activities

Definition and Examples

• Significant investing and financing activities that do not affect cash directly but must be disclosed.

• Examples include acquisition of assets by issuing stock or notes payable.

Noncash Activity	Amount (in thousands)
Acquisition of building by issuing common stock	300
Acquisition of land by issuing note payable	70
Payment of long-term debt by issuing common stock	100
Total noncash investing and financing activities	470

Preparing the Statement of Cash Flows (Direct Method)

Overview

• Preferred by FASB and IASB for its clarity regarding sources and uses of cash.

• Rarely used in practice due to complexity and computational requirements.

• Investing and financing cash flows are unaffected by the method used.

Exhibit 11-11: Template and Cash Receipts/Payments

• Lists all cash receipts (e.g., collections from customers, interest received).

• Lists all cash payments (e.g., payments to suppliers, employees, interest, taxes).

Summary of TRRS's 2024 Transactions (Exhibit 11-12)

Operating Activities	Amount
Sales on credit	$303,000
Collections from customers	$288,000
Interest revenue and receipts	$2,000
Cost of goods sold	$150,000
Purchases of inventory on credit	$147,000
Payments to suppliers	$133,000
Salary and wage expense	$56,000
Payments of salary and wages	$59,000
Depreciation expense	$18,000
Other operating expense	$17,000
Income tax expense and payments	$15,000
Interest expense and payments	$7,000

Investing Activities	Amount
Cash payments to acquire plant assets	$196,000
Loan to another company	$21,000
Proceeds from sale of plant assets	$62,000 (including $8,000 gain)

Financing Activities	Amount
Proceeds from issuance of long-term debt	$94,000
Proceeds from issuance of common stock	$4,000
Payment of long-term debt	$11,000
Declaration and payment of cash dividends	$17,000

Cash Flows from Operating Activities (Direct Method)

• Cash Receipts (Positive): - Cash collections from customers - Cash receipts of interest and dividends - Other operating receipts

• Cash Payments (Negative): - Payments to suppliers - Payments to employees - Payments of interest and income taxes - Other operating expenses

Note: Depreciation, depletion, and amortization expenses are not listed on the direct-method statement of cash flows because they do not affect cash.

Exhibit 11-13: Statement of Cash Flows—Direct Method

Receipts	Amount (in thousands)
Collections from customers	288
Interest received	2
Total cash receipts	290
Payments	Amount (in thousands)
To suppliers	(133)
To employees	(59)
For interest	(7)
For income taxes	(15)
Other operating payments	(17)
Total cash payments	(231)
Net cash provided by operating activities	59

Exhibit 11-13: Investing and Financing Activities

Investing Activities	Amount (in thousands)
Acquisition of plant assets	(196)
Loan to another company	(21)
Proceeds from sale of plant assets	62
Net cash used for investing activities	(155)
Financing Activities	Amount (in thousands)
Proceeds from issuance of long-term debt	94
Proceeds from issuance of common stock	4
Payment of long-term debt	(11)
Payment of dividends	(17)
Net cash provided by financing activities	70

Direct Method Computations

Computing Cash Collections from Customers

• Formula: $\text{Beginning balance} + \text{Sales} - \text{Collections} = \text{Ending balance}$

• Example: $81,000 + 303,000 - X = 96,000 \implies X = 288,000$

Cash Receipts of Interest and Dividends

• Cash receipts of interest and dividends appear on the statement of cash flows.

• TRRS received $2,000 of interest revenue; no dividend revenue.

Summary Table: Noncash Investing and Financing Activities

Noncash Activity	Amount (in thousands)
Acquisition of building by issuing common stock	300
Acquisition of land by issuing note payable	70
Payment of long-term debt by issuing common stock	100
Total noncash investing and financing activities	470

Key Formulas

• Indirect Method: $\text{Net Income} + \text{Noncash Expenses} + \text{Losses} - \text{Gains} + \text{Decrease in Current Assets} - \text{Increase in Current Assets} + \text{Increase in Current Liabilities} - \text{Decrease in Current Liabilities}$

• Direct Method (Collections from Customers): $\text{Beginning Accounts Receivable} + \text{Sales} - \text{Collections} = \text{Ending Accounts Receivable}$

Conclusion

The Statement of Cash Flows is essential for understanding a company's cash position and its ability to meet obligations, invest in growth, and return value to shareholders. Mastery of both the indirect and direct methods is crucial for financial accounting students preparing for exams and real-world application.