Financial Accounting

Eleventh Edition
Global Edition

Chapter 11
Cash Flows

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Learning Objectives
11.1 Identify the purposes of the statement of cash flows
11.2 Distinguish among operating, investing, and financing
cash flow activities
11.3 Prepare cash flows from operating activities using the
indirect method
11.4 Prepare cash flows from investing activities
11.5 Prepare cash flows from financing activities
11.6 Prepare cash flows from operating activities using the
direct method
11.7 Evaluate a company’s ability to generate cash flows

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Learning Objective 11.1
Identify the purposes of the statement of cash flows

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Identify the Purposes of the
Statement of Cash Flows (1 of 2)
• Reports cash flows:
– Cash receipts
– Cash payments
– Covers a span of time (month, quarter, year)
– Typically the same time period as the Income
Statement

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Identify the Purposes of the
Statement of Cash Flows (2 of 2)
• Three purposes:
– Shows the relationship of net income to cash flows
– Evaluates management decisions
– Based on past performance
– Predicts future cash flows
– Past cash flows predict future cash flows

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Learning Objective 11.2
Distinguish among operating, investing, and financing
cash flow activities

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Distinguish Among Operating, Investing, and
Financing Cash Flow Activities (1 of 2)
Three Types of Business Activities
• Operating
– Create revenues, expenses, gains, and losses – net
income
• Investing
– Increase and decrease medium- and long-term
assets
• Financing
– Related to long-term liabilities and shareholders’
equity
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Exhibit 11-1 Major Classes of Cash Receipts and
Cash Payments on the Statement of Cash Flows

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Exhibit 11-2 How Operating, Investing, and
Financing Activities Affect the Balance Sheet

*Note that IFRS gives some flexibility on where to report certain items:
Interest payment – Operating or Financing
Interest received – Operating or Investing
Dividend payment – Operating or Financing
Dividend received – Operating or Investing

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Distinguish Among Operating, Investing, and
Financing Cash Flow Activities (2 of 2)
• Two Formats for Operating Activities
– Indirect Method → reconciles from net income to net cash
provided by operating activities (simpler, used by more companies)
– Direct Method → Reports all cash receipts and cash payments
from operating activities (more complicated, preferred by the IASB)

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Learning Objective 11.3
Prepare cash flows from operating activities using the
indirect method

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Exhibit 11-3: The Roadster Factory’s
Income Statement

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Prepare Cash Flows from Operating
Activities Using the Indirect Method (1 of 6)
To illustrate the statement of cash flows, we use The
Roadster Factory, Inc. (TRF), a dealer in auto parts for
sports cars. Using the comparative balance sheets for
20X6 and 20X7 and the income statement for 20X7,
prepare the statement of cash flows using the indirect
method.

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Exhibit 11-4 TRF’s Balance Sheet

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Exhibit 11-5 Template for Cash Flows from
Operating Activities: Indirect Method

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Prepare Cash Flows from Operating
Activities Using the Indirect Method (2 of 6)
Cash Flows from Operating Activities
• Step 1: Start with the net income from the income statement
(Exhibit 11-3)
• Step 2: Add depreciation, depletion, amortization expense;
deduct gains and losses on sale of long-term assets
• Step 3: Identify the changes in current assets and current
liabilities from the balance sheet (Exhibit 11-4)
• Step 4: Deduct increase or decrease in each current asset
(other than cash)
• Step 5: Deduct increase or decrease in each current liabilities

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Prepare Cash Flows from Operating
Activities Using the Indirect Method (3 of 6)
• Depreciation, Depletion, and Amortization
Expenses
– Added back to net income to convert net income to
cash flow
– Noeffect on cash, decreases net income
– Add-back cancels the deduction on the income
statement
The Roadster Factory, Inc. reports depreciation expense
on their income statement of $18,000 (Exhibit 11-6).

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Exhibit 11-6 Statement of Cash Flows: Operating
Activities by the Indirect Method (1 of 3)

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Prepare Cash Flows from Operating
Activities Using the Indirect Method (4 of 6)
• Gains and Losses on the Sale of Long-Term
Assets
– An adjustment to net income
– Subtract gains from operating activities
– Add losses from operating activities
The Roadster Factory sold equipment for $62,000. The
book value was $54,000, so there was a gain of
$8,000.

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Exhibit 11-6 Statement of Cash Flows: Operating
Activities by the Indirect Method (2 of 3)

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Prepare Cash Flows from Operating
Activities Using the Indirect Method (5 of 6)
Changes in Current Assets and Current Liabilities
• Increase in a noncash current asset decreases cash
– Accounts Receivable increased by $15,000
– Prepaid Expenses increased by $1,000
• Decrease in noncash current assets increases cash
– Inventory decreased by $3,000

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Prepare Cash Flows from Operating
Activities Using the Indirect Method (6 of 6)
Changes in Current Assets and Current Liabilities
• Increase in a current liability increases cash
– Accounts Payable increased by $34,000
• Decrease in current liabilities decreases cash
– Salary and Wages Payable decreased by $2,000
– Accrued Liabilities decreased by $2,000

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Exhibit 11-6 Statement of Cash Flows: Operating
Activities by the Indirect Method (3 of 3)

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Learning Objective 11.4
Prepare cash flows from investing activities

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Prepare Cash Flows from Investing
Activities (1 of 5)
Cash Flow from Investing Activities
• Affect long-term assets
– Plant assets, long-term Investments
• Increase represents purchase of long-term assets
– Decreases cash
• Decrease represents sale of long-term assets
– Increases cash

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Prepare Cash Flows from Investing
Activities (2 of 5)
• Computing Purchases and Sales of PPE
‒ Combine all plant assets into a single account
(PPE) to compute cash flows.

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Prepare Cash Flows from Investing
Activities (3 of 5)
Computing Purchases and Sales of Investments,
and Loans and Collections

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Prepare Cash Flows from Investing
Activities (4 of 5)
Purchases and Sales of Investments, and Loans
and Collections

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Prepare Cash Flows from Investing
Activities (5 of 5)
Purchases and Sales of Investments, and Loans
and Collections

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Exhibit 12-7 Statement of Cash
Flows: Investing Activities

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Exhibit 11-8 Computing Cash Flows
from Investing Activities

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Learning Objective 11.5
Prepare cash flows from financing activities

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Prepare Cash Flows from Financing
Activities (1 of 5)
• Affect liabilities and stockholders’ equity
– Notes Payable, Bonds Payable, Long-Term Debt,
Share Capital, Paid-in Capital in Excess of Par,
and Retained Earnings
• Most data from balance sheet
• Increases are offset by increases in cash
• Decreases are offset by decreases in cash

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Prepare Cash Flows from Financing
Activities (2 of 5)
Computing Issuance and Payments of Long-Term
Debt

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Prepare Cash Flows from Financing
Activities (3 of 5)
Computing Issuances of Shares and Purchases of
Treasury Shares

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Prepare Cash Flows from Financing
Activities (4 of 5)
Computing Dividend Declarations and Payments

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Exhibit 11-9 Statement of Cash
Flows: Investing Activities

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Exhibit 11-10 Computing Cash Flows
from Financing Activities

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Exhibit 11-11 Statement of Cash
Flows: Indirect Method

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Prepare Cash Flows from Financing
Activities (5 of 5)
Noncash Investing and Financing Activities

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Exhibit 11-12 Noncash Investing and
Financing Activities (All Amounts Assumed)

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Learning Objective 11.6
Prepare cash flows from operating activities using the
direct method

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Prepare Cash Flows from Operating
Activities Using the Direct Method (1 of 9)
• IAS 7 prefers the direct method
– Provides clearer information about the sources
and uses of cash
– Very small percentage of companies actually use
direct
– Requires more computations than the indirect
method
– Investing and financing cash flows are unaffected
by the method used

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Prepare Cash Flows from Operating
Activities Using the Direct Method (2 of 9)
Compute Operating Cash Flows by the 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
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Prepare Cash Flows from Operating
Activities Using the Direct Method (3 of 9)
Cash Flows from Operating Activities
Depreciation, depletion, and amortization expenses are
not listed on the direct-method statement of cash flows
because they do not affect cash

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Exhibit 11-13 Direct Method of Computing Cash
Flows from Operating Activities

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Exhibit 11-14 TRF’s Income Statement

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Exhibit 11-15 TRF’s Balance Sheets

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Prepare Cash Flows from Operating
Activities Using the Direct Method (4 of 9)
Cash Collections from Customers

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Prepare Cash Flows from Operating
Activities Using the Direct Method (5 of 9)
Payments to Suppliers

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Prepare Cash Flows from Operating
Activities Using the Direct Method (6 of 9)
Payments for Operating Expenses

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Prepare Cash Flows from Operating
Activities Using the Direct Method (7 of 9)
Payments for Operating Expenses

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Prepare Cash Flows from Operating
Activities Using the Direct Method (8 of 9)
Payments for Operating Expenses

Payments tosuppliers=Paymentsforinventory+Paymentsforother operatingexpenses
 

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Prepare Cash Flows from Operating
Activities Using the Direct Method (9 of 9)
Payments to Employees

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Learning Objective 11.7
Evaluate a company’s ability to generate cash flows

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Evaluate a Company’s Ability to
Generate Cash Flows (1 of 3)
Free Cash Flows

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Evaluate a Company’s Ability to
Generate Cash Flows (2 of 3)
Cash Realization Ratio
– Measures amount of net profit reflected in actual cash
generated from operations
– Calculated as a ratio of CFO over net profit

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Exhibit 11-16 Cash Realization
Comparisons (1 of 2)

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Evaluate a Company’s Ability to
Generate Cash Flows (3 of 3)
Examining Cash Flow Patterns
– Examined over a period of time, not just at the end of
one fiscal year
– For simple analysis, plot the cash flow patterns over a
number of years (refer to Singtel and Vodafone’s
example)

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Exhibit 11-17 Singtel’s Cash Flow
Patterns 2012–2016 (2 of 2)

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Exhibit 11-18 Vodafone’s Cash Flow
Patterns 2012–2016

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