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Chapter 13 Review
Terms in this set (62)
The fourth basic financial statement
is the statement of cash flows
The primary purpose of the statement is to provide information about
an entity's cash receipts and cash payments during a period
The information in the statement of cash flows should help investors to assess the
a. entity's ability to generate future cash flows.
b. entity's ability to pay dividends and meet obligations.
c. reasons for the difference between net income and net cash provided (used) by operating activities.
d. cash investing and financing transactions during the period.
The statement of cash flows classifies cash receipts and cash payments by
Operating, Investing, and Financing activities
Investing activities which include
(1) acquiring and disposing of investments and (2) lending money and collecting the loans
Financing activities which involve liability and stockholders' equity items and include
(1) obtaining cash from issuing debt and repaying the amounts borrowed, and (2) obtaining cash from stockholders, repurchasing shares, and paying dividends.
Significant non cash transactions will include
the conversion of bonds into common stock and the acquisition of assets through the issuance of debt or capital stock
Significant non cash transactions are reported in a
separate schedule at the bottom of the statement of cash flows or they may appear in a separate note or supplementary schedule to the financial statements
The three classes of activities constitute the general format of the statement with the operating activities section appearing first, followed by
the investing activities and financing activities sections
The net cash provided or used by each activity is totaled to show the
the net increase (decrease) in cash for the period
The net change in cash for the period is then
added to or subtracted from the beginning-of-the-period cash balance to arrive at the ending cash balance
Finally, any significant non cash investing and financing activities are reported in a
separate schedule at the bottom of the statement
The information to prepare the cash flow statement usually comes from three sources
(a) comparative balance sheets (b) the current income statement, and (c) additional information
Preparing Step 1 for cash flow statement
Determine net cash provided/used by operating activities. This step involves analyzing not only the current year's income statement, but also comparative balance sheets and selected additional data.
Preparing Step 2 for cash flow statement
Analyze changes in non current asset and liability accounts and record as investing and financing activities, or disclose as non cash transactions. This step involves analyzing comparative balance sheet data and selected additional information for their effects on cash.
Preparing step 3 for cash flow statements
Compare the net change in cash on the statement of cash flows with the change in the cash account reported on the balance sheet to make sure the amounts agree
In performing step 1, the operating activities section must be converted from an
accrual basis to a cash basis. This may be done by either the indirect method or the direct method.
Both methods arrive at the same total amount for "net cash provided by operations" but they differ in how
they arrive at the total amount
The indirect method is used extensively
The FASB has expressed a preference for
the direct method
The first step- Indirect
determine net cash provided/used by operating activities
Under generally accepted accounting principles the accrual basis of accounting is used which results in
recognizing revenues when earned and expenses when incurred
In order to determine cash provided from operations it is necessary to
report revenues and expenses on a cash basis. This is determined by adjusting net income for items that did not affect cash.
The operating section of the statement of cash flows should begin with
(a) net income, (b) add
(or deduct) items not affecting cash, and (c) show net cash provided by operating activities.
In determining net cash provided by operating activities,
a. increases in specific current assets other than cash are deducted from net income, and decreases are added to net income.
b. increases in specific current liabilities are added to net income, and decreases are deducted from net income.
c. expenses for depreciation, amortization, and depletion and a loss on a sale of equipment are added to net income, and a gain on a sale of equipment is deducted from net income.
The Second Step—Indirect
net cash provided/used by investing and financing activities is generally determined from changes in non current accounts reported in the comparative balance sheets and selected additional data.
a. If the account, Land, increases $50,000 and the transaction data indicates that land was purchased for cash,
a cash outflow from an investment activity has occurred.
b. If the account, Common Stock, increases $100,000 and the transaction data indicates that additional capital stock was issued for cash,
a cash inflow from a financing activity has resulted.
The redemption of debt and the retirement or reacquisition of capital stock are
cash outflows from financing activities
The Third Step—Indirect
is to determine the net change in cash on the statement of cash flows with the change in the cash account reported on the balance sheet to make sure the amounts agree.
Free cash flow describes the
cash remaining from operations after adjustment for capital expenditures and dividends
Free cash flow equation
Net cash provided by operating activities - Capital Expenditures - Cash Dividends
Examples of significant non cash activities are as follows.
1) Direct issuance of common stock to purchase assets.
2)Conversion of bonds into common stock.
3) Direct issuance of debt to purchase assets.
4) Exchanges of plant assets
Issued 100,000 shares of $5 par value common stock for $800,000 cash
Borrowed $200,000 from Castle Bank, signing a 5-year note bearing 8% interest
Purchased two semi-trailer trucks for $170,000 cash
Paid employees $12,000 for salaries and wages
Collected $20,000 cash for services performed
The statement of cash flows
reports the cash receipts, cash payments, and net change in cash resulting from operating, investing, and financing activities during a period
The information in a statement of cash flows should helps investors, creditors, and others assess the following
1) The entity's ability to generate future cash flows.
2) The entity's ability to pay dividends and meet obligations
3) The reasons for the difference between net income and net cash provided (used) by operating activities
4)The cash investing and financing transactions during the period
Operating activities include
the cash effects of transactions that create revenues and expenses. They thus enter into the determination of net income.
Operating activities include
the cash effects of transactions that create revenues and expenses. They thus enter into the determination of net income
The operating activities category is the
The operating activities shows
the cash provided by company operations.
The operating activities source of cash is generally considered to be the best measure of
a company's ability to generate sufficient cash to continue as a going concern.
Cash inflows from Operating activities
-From sale of goods or services
-From interest received and dividends received
Cash outflows from Operating activities
-To suppliers for inventory
-To employees for wages
-To government for taxes
-To lenders for interest
-To others for expenses
Cash inflows from investing activities- changes in investments and long-term assets
-From sale of property, plant, and equipment
-From sale of investments in debt or equity securities of other entities
-From collection of principal on loans to other entities
Cash outflows from investing activities
-To purchase property, plant, and equipment
-To purchase investments in debt or equity
-To make loans to other entities
Cash inflows from financing activities- changes in long-term liabilities and stockholders' equity
-From sale of common stock
-From issuance of debt (bonds and notes).
Cash outflows from financing activities
-To stockholders as dividends
-To redeem long-term debt or reacquire capital stock (treasury stock)
Operating activities involve
income statement items
Investing activities involve cash flows resulting from changes in
investments and long-term asset items
Financing activities involve cash flows resulting from changes in
long-term liability and stockholders' equity items
Companies classify as operating activities some cash flows related to investing or financing activities. For example, receipts of investment revenue (interest and dividends) are classified as operating activities. So are payments of interest to lenders. Why are these considered operating activities?
Because companies report these items in the income statement, where results of operations are shown.
Companies do not report in the body of the statement of cash flows significant financing and investing activities that
do not affect cash
to prepare cash flow statement usually comes from three sources
-Comparative balance sheets
-Current income statement
Comparative balance sheets
Information in the comparative balance sheets indicates the amount of the changes in assets, liabilities, and stockholders' equities from the beginning to the end of the period.
Current income statement
Information in this statement helps determine the amount of net cash provided or used by operating activities during the period
Such information includes transaction data that are needed to determine how cash was provided or used during the period
Three types of adjustments to convert net income to net cash provided by operating activities
-Add back non cash expenses, such as depreciation expense and and amortization expense
-Deduct gains and add losses, that resulted from investing and financing
-Analyze changes, to non cash asset and current liability accounts
Operating activities involve income statement items.
Investing activities involve cash flows resulting from changes in investments and long-term asset items.
Financing activities involve cash flows resulting from changes in long-term liability and stockholders' equity items.
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