Financial accounting in an economic context 8e chapter 014

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1 Chapter 14 Statement of Cash Flows Figure 14-1 Definition of Cash Cash consists of coin, currency, and available funds on deposit at the bank Negotiable instruments such as money orders, certified checks, cashier’s checks, personal checks, and bank drafts are also considered cash Also certain cash equivalents, which include commercial paper and other debt investments with maturities of less than three months are included in the statement of cash flows Standard Statement of Cash Flows Statement of Cash Flows      Required for financial statements by SFAS 95 (1987) Primary purpose is to provide relevant information about cash receipts and cash disbursements of the company during the period Serves to complement the other financial statements Focus is on cash flows, not income Reconciles the balance sheet and the income statement Content of Statement of Cash Flows      Explains change in cash and cash equivalents Cash equivalents are defined as short-term, highly liquid investments near to maturity Examples of cash equivalents are Treasury bills and money market funds Format of SCF includes the following three sections: - cash flow from operating activities - cash flow from investing activities - cash flow from financing activities Like US GAAP, IFRS requires the presentation of a SCF, and the format is largely the same Cash Flows from Operating Activities   CF from operating activities is based on the income statement, and converts income activity to a cash basis There are two formats for the presentation of CF from operating activity: – direct method: this technique shows cash received from customers and cash paid to various entities for operating activities – indirect method: this technique starts with net income and makes adjustments to net income to convert it to a cash basis Cash Flows from Operating Activities  If the direct method is used, the indirect method must be presented in a supplementary schedule  The direct method is more informative, but the vast majority of companies present only the indirect method  FASB is considering a change to require the direct method Cash Flows from Investing Activities CF from investing activities explain the changes in cash from the purchase or sale of the company’s (primarily) long-term assets  Examples of investing activity includes: – cash paid for purchase of equipment, land, buildings, marketable securities (available-for-sale and equity), intangible assets, and most other long term assets – cash received from sale of equipment, land, buildings, marketable securities (available-for-sale and equity), intangible assets, and most other long term assets – cash paid for issue of non-trade notes receivable (both short-term and long-term) – cash received for repayment on non-trade notes receivable (both short-term and long-term)  10 Figure 14-6 32 Figure 14-7 33 Figure 14-8 34 Figure 14-9 35 Figure 14-10 36 Figure 14-11 37 Figure 14-12 38 Figure 14-13 39 Figure 14-14 40 Figure 14-15 41 Figure 14-16 42 Figure 14-17 43 Direct Method 44 Indirect Method 45 Copyright Copyright © 2011 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein 46 [...]... Method Change in Related Assets and Liabilities Accounts Receivable Beginning Balance Sales Ending Balance Cash Collection on A/R First assume that all sales are on account Now note that the relationship can be expressed in a formula involving A/R and Sales: A/RBeginning + Sales - Cash Collections = A/REnding Or: A/RBeginning + Sales - A/REnding = Cash Collections 23 Indirect Method Change in Related... activities 13 Cash Flows from Financing Activities General rule for financing activity: – cash flows for issue and retirement of long-term liabilities and equity  Exceptions to the rule: – Short term notes payable (non-trade) are included in the financing section (Short term bank notes are very common examples.) – Long term notes payable (trade) are not included in the financing section Because they relate... land is sold for $10,000 cash, and the original cost was $9,000: Cash 10,000 Land 9,000 Gain on Sale of Land 1,000 In this case, the $10,000 cash received would be shown in Investing However, if the gain is not adjusted out of net income, we would be “double counting” that effect 19 Indirect Method - Double Counted Items  Therefore, any gains or losses from sale of investing assets (equipment, land,... The change in equity method investments is classified in the operating section of SCF, because the change deals with income (Purchase and sale of equity investments are classified in investing.) Note: Trade receivables are created when inventory is sold on account Non-trade receivables are created when a company loans cash to employees or others (no sale is involved) 11 Cash Flows from Financing Activities... gain from net income 20 Indirect Method Change in Related Assets and Liabilities   The third category examines the change in the assets and liabilities that relate to the remaining income statement items, after the items in (1) and (2) have been removed The adjustment for the effect of these changes is to effectively “squeeze” the income statement item from the accrual basis of accounting to the cash... look at each asset and its related income statement component Also, remember that we are looking at the remaining assets and liabilities (after the eliminations in part 1) Since we have already eliminated depreciation expense and amortization expense, etc., we would not include the changes in these related assets (Accum Depr., Patents, etc.) 25 Indirect Method Change in Related Assets and Liabilities... dividend income) Trade Notes Receivable (short and long term) Inventories Prepaid Expenses Deferred Tax Assets (because this relates to income tax expense) Trading Investments (because they relate to unrealized gains and losses on the income statement as well as gains and losses on sale) Equity Investments (because this relates to “Income from Investment”) 26 Indirect Method Change in Related Assets and... from Investing Activities    General rule for investing activity: – cash flows for purchase and sale of long-term assets Exceptions to the rule: – Short term notes receivable (non-trade) are included in the investing section – Long term notes receivable (trade) are not included in the investing section Because they relate to trade, they are treated just like accounts receivable in the operating section... and long-term), and – cash paid for retirement or repayment on nontrade notes payable (both short-term and longterm)  12 Cash Flows from Financing Activities  Note that cash paid for dividends is classified as a financing activity, but cash paid for interest is classified as an operating activity  Note that cash received for dividends and cash received for interest are both classified as operating... basis of accounting 21 Indirect Method Change in Related Assets and Liabilities    For example, assume that total sales revenue recognized for the year is $100,000 At the beginning of the year, A/R were $2,000; at the end of the year, A/R were $3,000 What amount of cash was collected from customers? To analyze this effect, we must analyze the A/R account, and how it is increased and decreased 22 Indirect
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