ACT 320 Chapter 23

Statement of Cash
L E A R N IN G O B J E C T IV E S
23 Flows
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe the purpose of the statement of 6. Identify sources of information for a

cash flows. statement of cash flows.
2. Identify the major classifications of cash 7. Contrast the direct and indirect methods of
flows. calculating net cash flow from operating
3. Prepare a statement of cash flows. activities.
4. Differentiate between net income and net 8. Discuss special problems in preparing a
cash flow from operating activities. statement of cash flows.
5. Determine net cash flows from investing 9. Explain the use of a worksheet in preparing
and financing activities. a statement of cash flows.
23-1
Preparation of Statement of Cash Flows
Primary purpose:
To provide information about a company’s cash receipts
and cash payments during a period.
Secondary objective:
To provide cash-basis information about the company’s
operating, investing, and financing activities.
23-2 LO 1
Usefulness of the Statement of Cash Flows

Provides information to help assess:
1. Entity’s ability to generate future cash flows.
2. Entity’s ability to pay dividends and meet obligations.
3. Reasons for difference between net income and net cash

flow from operating activities.
4. Cash and noncash investing and financing transactions.
23-3 LO 1
Statement of Cash
23 Flows
LEARNING OBJECTIVES

23-4
Classification of Cash Flows
Operating Investing Financing

Activities Activities Activities
Income Changes in Changes in

Statement Items Investments and Long-Term
Long-Term Liabilities and
Asset Items Stockholders’
Equity
23-5 LO 2
Illustration 23-1
Classification of
Typical Cash Inflows
and Outflows
23-6 LO 2
Illustration 23-1
Classification of
Typical Cash Inflows
and Outflows
23-7 LO 2
The basis recommended by the FASB for the statement of

cash flows is actually “cash and cash equivalents.” Cash
equivalents are short-term, highly liquid investments that are
both:
 Readily convertible to known amounts of cash, and
 So near their maturity that they present insignificant risk of
changes in interest rates.
Generally, only investments with original maturities of three

months or less qualify under this definition.
23-8 LO 2
Company
Product Life
Cycle
23-9 LO 2
Format of the Statement of Cash Flows

Presentation:
1. Operating activities. Direct Method
2. Investing activities. Indirect Method

3. Financing activities.
Report inflows and outflows

from investing and financing
activities separately.
23-10 LO 2
Format of the Statement of Cash Flows
Illustration 23-2
23-11 LO 2
Steps in Preparation
Three Sources of Information:
1. Comparative balance sheets.
2. Current income statement data.
3. Selected transaction data.
Three Major Steps:

Step 1. Determine change in cash.
Step 2. Determine net cash flow from
operating activities.
Step 3. Determine net cash flows from
23-12 investing and financing activities. LO 2
Statement of Cash
23 Flows
LEARNING OBJECTIVES

23-13
Illustrations—Tax Consultants Inc.
Illustration: Tax Consultants Inc. started on January 1, 2013,

when it issued 60,000 shares of $1 par value common stock
for $60,000 cash. The company rented its office space,
furniture, and equipment, and performed tax consulting
services throughout the first year.
The comparative balance sheets at the beginning and end of

the year 2013 appear in Illustration 23-3. Illustration 23-4
shows the income statement and additional information for Tax
Consultants.
23-14 LO 3
Illustration 23-3 Illustration 23-3
Comparative
Balance Sheets, Tax
Consultants Inc.,
Year 1
Illustration 23-4
Income
Statement, Tax
Consultants Inc.,
Year 1
23-15
Step 1: Determine the Change in Cash

Illustration 23-3
23-16 LO 3
Statement of Cash
23 Flows
LEARNING OBJECTIVES

23-17
Step 2: Determine the Net Cash Flow from

Operating Activities
 Company must determine revenues and expenses on a
cash basis.
 Eliminate the effects of income statement transactions

that do not result in an increase or decrease in cash.
 Convert net income to net cash flow from operating

activities through either a direct method or an indirect
method.
23-18 LO 4
Step 2: Determine the Net Cash Flow from

Operating Activities Illustration 23-5
Net Income versus Net Cash
Flow from Operating Activities
23-19 LO 4
Increase in Accounts Receivable—Indirect Method

Accounts receivable increased by $36,000 (from $0 to $36,000)
during the year.
Illustration 23-6
Accounts Receivable
1/1/13 Balance 0 Receipts from customers 89,000
Revenues 125,000
12/31/13 Balance 36,000
When the Accounts Receivable balance increases, cash receipts are

lower than revenue earned under the accrual basis.
23-20 LO 4
Increase in Accounts Receivable—Indirect Method

Illustration 23-6
Accounts Receivable
1/1/13 Balance 0 Receipts from customers 89,000
Revenues 125,000
12/31/13 Balance 36,000
The increase in accounts receivable is subtracted from net income to

arrive at net cash provided by operating activities.
Illustration 23-7
23-21 LO 4
Increase in Accounts Payable—Indirect Method

Accounts payable increased by $5,000 during the year.
When accounts payable increase during the year, expenses on an

accrual basis exceed those on a cash basis.
Illustration 23-7
23-22 LO 4
Statement of Cash
23 Flows
LEARNING OBJECTIVES

23-23
Tax Illustration 23-3
Consultants
Inc.
Step 3:
Determine Net
Cash Flows Illustration 23-8
from Investing
and Financing
Activities
23-24
Consultants
Inc.
Step 3:
Determine Net
from Investing
and Financing
Activities
23-25
Consultants
Inc.
Step 3:
Determine Net
from Investing
and Financing
Activities
23-26
Consultants
Inc.
Step 3:
Determine Net
from Investing
and Financing
Activities
23-27
Consultants
Inc.
Step 3:
Determine Net
from Investing
and Financing
Activities
23-28
Statement of Cash Flows—2013 Illustration 23-8
23-29 LO 5
Operating Activities — Indirect Method
Illustration: Norman Company’s financial statements for the year
ended December 31, 2014, contained the following condensed
information.
2014 2013 Change
Service revenue $ 840,000
Operating expenses 624,000
Depreciation expense 60,000
Loss on sale of equipment 26,000
Income before income tax 130,000
Income tax 40,000
Net income $ 90,000
Accounts receivable $ 37,000 $ 59,000 $ (22,000)

Accounts payable 46,000 31,000 15,000
Income taxes payable 4,000 8,500 (4,500)
23-30 LO 5
Operating Activities — Indirect Method
Prepare the operating activities section of the statement of cash flows
using the indirect method (Step 2).
Cash flows from operating activities

Net income $ 90,000
Adjustment to reconcile net income
to net cash provided by operating activities:
Loss on sale of equipment 26,000
Decrease in accounts receivable 22,000
Increase in accounts payable 15,000
Decrease in income taxes payable (4,500)
Net cash provided by operating activities 208,500
23-31 Advance slide to uncover solution LO 5

Operating Activities — Direct Method
Norman Company’s financial statements for the year ended December
31, 2014, contained the following condensed information.
2014 2013 Change

Service revenue $ 840,000
Operating expenses 624,000
Depreciation expense 60,000 Assume accounts
Loss on sale of equipment 26,000 payable relates to
operating
Income before income tax 130,000 expenses.
Income tax 40,000
Net income $ 90,000
Accounts receivable $ 37,000 $ 59,000 $ (22,000)

Accounts payable 46,000 31,000 15,000
Income taxes payable 4,000 8,500 (4,500)
23-32 LO 5

using the Direct method (Step 2).
Illustration 23-22
Accounts Receivable
1/1/14 Balance 59,000 Receipts from customers 862,000
Revenues 840,000
12/31/14 Balance 37,000
23-33 LO 5

Illustration 23-24
Accounts Payable
1/1/14 Balance 31,000
Payments to suppliers 609,000 Operating expenses 624,000
12/31/14 Balance 46,000
23-34 LO 5

Illustration 23-24
Income Tax Payable

1/1/14 Balance 8,500
Payments for income tax 44,500 Income tax expense 40,000
12/31/14 Balance 4,000
23-35 LO 5

Cash flows from operating activities
Cash receipts from customers $ 862,000
Cash paid for operating expenses (609,000)
Cash paid for income taxes (44,500)
Net cash provided by operating activities $ 208,500
23-36 LO 5
Step 3: Determine Net Cash Flow from
Investing and Financing Activities
Illustration: (a) Plant assets that had cost $25,000 6 years before
and were being depreciated on a straight-line basis over 10 years
with no estimated scrap value were sold for $5,300.
Plant assets (cost) $ 25,000

Accumulated depreciation ([$25,000 ÷ 10] x 6) 15,000
Book value at date of sale 10,000
Sale proceeds (5,300)
Loss on sale $ 2,700
23-37 LO 5
Statement of Cash Flows
Cash flow from operating activities
Net income (loss) $ (50,000)
Adjustment to reconcile net income to cash:
O Loss on sale 2,700
Gain on sale (9,000)
Cash from operations (34,300)
Cash flow from investing activities
I Sale of plant assets 5,300
Sale of land 39,000
Cash from investing activities 44,300
Cash flow from financing activities
F Sale of common stock 330,000
Purchase of company stock (47,000)
Cash from financing activities 283,000
Net Change in Cash $ 293,000
23-38
(b): During the year, 10,000 shares of common stock with a

stated value of $10 a share were issued for $33 a share.
Shares sold 10,000

Market value per share $ 33.00
Value of shares $ 330,000
23-39 LO 5
Sale of land 39,000
23-40
(d): The company sustained a net loss for the year of

$50,000. Depreciation amounted to $22,000, and a gain of
$9,000 was realized on the sale of land for $39,000 cash.
23-41 LO 5
Sale of land 39,000
23-42
(h): During the year, treasury stock costing $47,000 was

purchased.
23-43 LO 5
Net income (loss) $ (50,000.0)
Sale of land 39,000
23-44
Statement of Cash
23 Flows
LEARNING OBJECTIVES

23-45
Sources of Information for the
1. Comparative balance sheets.

2. An analysis of the Retained Earnings account.
3. Write-downs, amortization charges, and similar “book”
entries, such as depreciation, because they have no
effect on cash.
23-46 LO 6
Statement of Cash
23 Flows
LEARNING OBJECTIVES

23-47
Net Cash Flow from Operating Activities
—Indirect Versus Direct Method
Adjustments Needed to Determine Net Cash Flow
Indirect Method from Operating Activities.
Illustration 23-18
23-48 LO 7
Companies adjust each item in the income
Direct Method statement from the accrual basis to the cash basis.
Illustration 23-21
23-49
LO 7
Special Rules Applying to Direct and Indirect

Methods
Companies that use the direct method are required, at a minimum, to
report separately:
Receipts
1. Cash collected from customers (including lessees, licensees,
etc.).
2. Interest and dividends received.
3. Other operating cash receipts, if any.
23-50 LO 7
Special Rules Applying to Direct and Indirect

Methods
Companies that use the direct method are required, at a minimum, to
report separately:
Payments
1. Cash paid to employees and suppliers of goods or services
(including suppliers of insurance, advertising, etc.).
2. Interest paid.
3. Income taxes paid.
4. Other operating cash payments, if any.
23-51 LO 7
Statement of Cash
23 Flows
LEARNING OBJECTIVES

23-52
Special Problems in Statement
Preparation
Adjustments to Net Income

Depreciation and Amortization
 Amortization of limited-life intangible assets.
 Amortization of bond discount or premium.
Postretirement Benefit Costs

 Company must adjust net income by the difference
between cash paid and the expense reported.
23-53 LO 8
Changes in Deferred Income Taxes

 Affect net income but have no effect on cash.
Equity Method of Accounting

 Net increase in the investment account does not affect
cash flows.
 Company must deduct the net increase from net income
to arrive at net cash flow from operating activities.
23-54 LO 8
Loss and Gains

 A loss is added to net income to compute net cash flow
from operating activities because the loss is a noncash
charge in the income statement.
 Company reports a gain in the statement of cash flows as
part of the cash proceeds from the sale of equipment
under investing activities, thus it deducts the gain from
net income to avoid double-counting—once as part of net
income and again as part of the cash proceeds from the
sale.
23-55 LO 8
Stock Options
 Cash is not affected by recording the expense.
 The company must increase net income by the amount of
compensation expense from share options in computing
net cash flow from operating activities.
23-56 LO 8
Extraordinary Items
 Companies should report either as investing activities or
as financing activities cash flows from extraordinary
transactions and other events whose effects are included
in net income, but which are not related to operations.
23-57 LO 8
Special Problems
Accounts Receivable (Net)

Indirect Method
Because an increase in Allowance for Doubtful Accounts results from
a charge to bad debt expense, a company should add back an
increase in Allowance for Doubtful Accounts to net income to arrive at
net cash flow from operating activities. Illustration 23-28
Accounts Receivable
Balances, Redmark Co.
23-58 LO 8
Indirect Method
One method of presenting this information in the statement of
cash flows:
Illustration 23-29
REDMARK CO.
Statement of Cash Flows (Partial)
For The Year 2014
23-59 LO 8
Indirect Method
Alternate method (net approach) of presenting this
information in the statement of cash flows:
Illustration 23-30
REDMARK CO.
For The Year 2014
23-60 LO 8
Direct Method
Company should not net Allowance for Doubtful Accounts
against Accounts Receivable.
Illustration 23-31
REDMARK CO.
Income Statement
For The Year 2014
23-61 LO 8
REDMARK CO.
Direct Method Illustration 23-31
Income Statement
For The Year 2014
Company should not net Allowance

for Doubtful Accounts against
Accounts Receivable.
REDMARK CO. Illustration 23-32

For The Year 2014
Cash sales should be reported at $85,000 ($100,000 - 9,000 - 6,000).

23-62 Increase in Accounts Receivable LO 8
Special Problems
Other Working Capital Changes

Some changes in working capital, although they affect cash,
do not affect net income.
 Purchase of short-term available-for-sale securities.
 Issuance of a short-term nontrade note payable for cash.
 Cash dividend payable.
23-63 LO 8
Special Problems
Net Losses
Illustration: If the net loss is $50,000 and the total amount of
charges to add back is $60,000, then net cash provided by
operating activities is $10,000.
Illustration 23-33
Computation of Net Cash
Flow from Operating
Activities—Cash Inflow
23-64 LO 8
Special Problems
Significant Noncash Transactions

Common noncash transactions that a company should report
or disclose:
1. Acquisition of assets by assuming liabilities (including capital
lease obligations) or by issuing equity securities.
2. Exchanges of nonmonetary assets.
3. Refinancing of long-term debt.
4. Conversion of debt or preferred stock to common stock.
5. Issuance of equity securities to retire debt.
23-65 LO 8
Statement of Cash
23 Flows
LEARNING OBJECTIVES

23-66
Use of a Worksheet
A worksheet involves the following steps.

Step 1. Enter the balance sheet accounts and their beginning and
ending balances in the balance sheet accounts section.
Step 2. Enter the data that explain the changes in the balance
sheet accounts and their effects on the statement of cash flows in
the reconciling columns of the worksheet.
Step 3. Enter the increase or decrease in cash on the cash line

and at the bottom of the worksheet. This entry should enable the
totals of the reconciling columns to be in agreement.
23-67 LO 9

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Statement of Cash

1. Describe the purpose of the statement of 6. Identify sources of information for a

Usefulness of the Statement of Cash Flows

2. Entity’s ability to pay dividends and meet obligations.

3. Reasons for difference between net income and net cash

4. Cash and noncash investing and financing transactions.

1. Describe the purpose of the statement of 6. Identify sources of information for a

Classification of Cash Flows

Operating Investing Financing

Income Changes in Changes in

The basis recommended by the FASB for the statement of

Generally, only investments with original maturities of three

Format of the Statement of Cash Flows

2. Investing activities. Indirect Method

Report inflows and outflows

Three Major Steps:

1. Describe the purpose of the statement of 6. Identify sources of information for a

Illustration: Tax Consultants Inc. started on January 1, 2013,

The comparative balance sheets at the beginning and end of

Step 1: Determine the Change in Cash

1. Describe the purpose of the statement of 6. Identify sources of information for a

Step 2: Determine the Net Cash Flow from

 Eliminate the effects of income statement transactions

 Convert net income to net cash flow from operating

Step 2: Determine the Net Cash Flow from

Increase in Accounts Receivable—Indirect Method

12/31/13 Balance 36,000

When the Accounts Receivable balance increases, cash receipts are

Increase in Accounts Receivable—Indirect Method

12/31/13 Balance 36,000

The increase in accounts receivable is subtracted from net income to

Increase in Accounts Payable—Indirect Method

When accounts payable increase during the year, expenses on an

1. Describe the purpose of the statement of 6. Identify sources of information for a

Statement of Cash Flows—2013 Illustration 23-8

Accounts receivable $ 37,000 $ 59,000 $ (22,000)

Cash flows from operating activities

23-31 Advance slide to uncover solution LO 5

2014 2013 Change

Accounts receivable $ 37,000 $ 59,000 $ (22,000)

Prepare the operating activities section of the statement of cash flows

12/31/14 Balance 37,000

Prepare the operating activities section of the statement of cash flows

12/31/14 Balance 46,000

Prepare the operating activities section of the statement of cash flows

Income Tax Payable

12/31/14 Balance 4,000

Prepare the operating activities section of the statement of cash flows

Cash flows from operating activities

Cash receipts from customers $ 862,000

Cash paid for operating expenses (609,000)

Cash paid for income taxes (44,500)

Net cash provided by operating activities $ 208,500

Plant assets (cost) $ 25,000

(b): During the year, 10,000 shares of common stock with a

Shares sold 10,000

(d): The company sustained a net loss for the year of

(h): During the year, treasury stock costing $47,000 was

1. Describe the purpose of the statement of 6. Identify sources of information for a