Chapter 14

The Statement of Cash Flows

Chapter Overview
The chapter begins with a discussion of the basic concepts and purposes of the Statement of Cash Flows
and what is included in cash and cash equivalents. Operating, investing, and financing activities are
defined. A brief comparison of the direct and indirect method for preparing cash flows from operating
activities is given. The Statement of Cash Flows using the indirect method is explained. A four-step
process is outlined. Cash inflows and outflows from the three types of activities are discussed in detail
and computations and illustrations are provided. Adjustments to net income, including depreciation,
gains/losses on the sale of assets, and changes in current assets and current liabilities, are explained. Rules
are presented that help students both learn and understand how to handle increases and decreases in
current assets and current liabilities when calculating net cash inflow or outflow from operating activities.
Cash flows from investing and financing activities are illustrated in detail. T-accounts and formulas aid in
the explanations. Noncash investing and financing activities are briefly mentioned. Decision Guidelines
help students learn how to use cash-flow information and evaluate investments. A summary problem
provides practice in preparing a Statement of Cash Flows (indirect method) using the four-step process.

Appendices explain the preparation of the statement of cash flows using the direct method and the use of
spreadsheets. Emphasis is placed on the computation of cash flow from operating activities; it is noted
that investing and financing activities follow the same presentation as under the direct method.
Computations are presented for cash collections from customers, payments to suppliers for inventory
purchases, and payments for operating expenses. In each section, the student is directed to the financial
statements to see the changes in the related accounts. A summary problem asks students to compute cash-
flow amounts and provides practice in preparing a Statement of Cash Flows (direct method).

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 Chapter 14: Teaching Outline

1) Identify the purposes of the statement of cash flows

a) Cash Equivalents

b) Exhibit 14-1 Timing of the Financial Statements

2) Distinguish among operating, investing, and financing cash flows

a) Two Formats for Operating Activities

b) Exhibit 14-2 Operating, Investing, and Financing Cash Flows and the Balance-Sheet Accounts

3) Prepare the statement of cash flows by the indirect method

a) Cash Flows from Operating Activities

b) Cash Flows from Investing Activities

c) Cash Flows from Financing Activities

d) Net Change in Cash and Cash Balances

e) Exhibit 14-3 Format of the Statement of Cash Flows: Indirect Method

f) Exhibit 14-4 Indirect Method Statement of Cash Flows

g) Exhibit 14-5 Comparative Balance Sheet

h) Exhibit 14-6 Income Statement

i) Exhibit 14-7 Computing Cash Flows from Investing Activities

j) Exhibit 14-8 Computing Cash Flows from Financing Activities

4) Identify noncash investing and financing activities

a) Exhibit 14-9 Noncash Investing and Financing Activities

5) Analyze cash flows

6) Prepare the statement of cash flows by the direct method, see Appendix 14A

a) Exhibit 14A-1 Format of the Statement of Cash Flows: Direct Method

b) Exhibit 14A-2 Comparative Balance Sheet

c) Exhibit 14A-3 Income Statement

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 d) Exhibit 14A-4 Statement of Cash Flows – Direct Method

e) Exhibit 14-5 Direct Method: How Changes in Account Balances Affect Cash Receipts and Cash

Payments

7) Prepare the indirect statement of cash flows using a spreadsheet, see Appendix 14B

a) Exhibit 14B-1 Spreadsheet for Statement of Cash Flows – direct Method

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 Chapter 14: Summary Handout for Students

1. Statement of cash flow reports cash receipts and cash payments and helps:

o Predict future cash flows

o Evaluate management decisions

o Predict ability to pay debts and dividends

2. Cash includes cash and cash equivalents

o The change in cash from the prior year is the “key reconciling figure” for the statement

of cash flows

3. Statement can be prepared using the indirect or direct methods which refers to how the net

cash flows provided by operating activities section is prepared

4. Three basic types of cash-flow activities –

o Operating activities (items illustrate indirect method)

 Net Income

 Depreciation, Depletion, and Amortization Expenses

 Gains and Losses on the Sale of Assets

 Changes in Current Assets and the Current Liabilities

 an increase in a current asset (other than cash) and a decrease in a current

liability both cause a decrease in cash

 a decrease in a current asset (other than cash) and an increase in a current

liability both cause an increase in cash

o Investing activities

 Increase and decrease long-term assets

 Include purchases and sales of long-term investments

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 o Financing activities

 Increase and decrease long-term liabilities and equity

 Include issuing stock, paying dividends, and buying and selling treasury stock

 Include borrowing money and paying off loans

o Calculate the net change in cash and reconcile to the ending cash balance

o In addition, report noncash investing and financing activities

5. Use Free Cash Flow to help evaluate and manage operations

o Free cash flow = Net cash provided by operating activities minus cash payments

planned for investments in plant, equipment, and other long-term assets

6. Net cash flows from operating activities can also be determined using the direct method

o Calculate cash receipts including collections from customers, interest and dividends

received

o Calculate cash payments including payments: to suppliers, to employees, for interest, for

income tax

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 Lecture Outline Tips: Key Topics

The statement of cash flows is required for GAAP purposes. Cash is “king” and is used to pay
outstanding liabilities. This important statement indicates the sources and uses of the company’s cash
flow. Point out that a company may have a positive cash balance, but it is important to know where it
came from. Hopefully, over time a company can finance its own activities from operations.

The direct and indirect methods use different computations for operating cash flow, but arrive at the same
amount. For the direct method, follow the cash when analyzing transactions that adjust net income to
operating cash flow. For example, depreciation and losses are non-cash items, but reduce net income.
Therefore, they should be added back in arriving at cash flow. Gains have the opposite effect of losses.
Net income is from the income statement, which is based on accrual accounting. The statement of cash
flow focuses on cash transactions. It may be helpful to distribute several 10-Ks to student groups and
determine differences in operating income and operating cash flow.

Again, follow the cash when analyzing changes in current assets and current liabilities. For example, an
increase in current assets is a decrease to cash. It may be helpful to ask students to prepare theoretical
journal entries for these transactions, using cash to plug the entry. An example of an increase in current
assets would be a debit to inventory and a credit to cash. Cash decreases with a credit, so this amount
would be deducted from net income in arriving at operating cash flow.

The payment of dividends is a financing activity, whereas the receipt of dividends is an investing activity.

The ending cash balance of the statement of cash flows should agree to the cash balance on the balance
sheet.

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 Chapter 14 Assignment Grid
Learning Short Exercises Problems (Group A) Problems (Group B)
Objective Exercises Moderate Difficult Difficult
Easy
1 1 11 24 28
2 2 12 24 28
3 3, 4, 5, 6, 7, 8, 13, 14, 15, 16, 17, 18, 19, 20, 24, 25, 26, 27 28, 29, 30, 31
9 21
4 9 22 27 31
5 10 23 26 30
6 14A-1, 14A-2, 14A-5, 14A-6, 14A-7, 14A-8, 14A-12, 14A-13, 14A-16, 14A-17, 14A-18,
14A-3, 14A-4 14A-9, 14A-10, 14A-11 14A-14, 14A-15 14A-19
7 14B-1, 14B-2 14B-3, 14B-4

Other End of Chapter Materials:

Continuing Exercise E14-32
Continuing Problem P14-33
Practice Set
Decision Case 14-1
Decision Case 14-2
Ethical Issue 14-1
Fraud Case 14-1
Financial Statement Case 14-1
Team Project 14-1
Team Project 14-2
Communication Activity 14-1

End of Chapter Exercises and Problems available utilizing Accounting software:

QuickBooks 10 E14-17, E14-21, P14-24A, P14-25A, E14-32, P14-33
Peachtree 10 E14-17, E14-21, P14-24A, P14-25A
Excel in Practice E14-17, E14-21, P14-24A, P14-25A
General Ledger None

Sample Homework Questions in MyAccountingLab:

E14-11, E14-12, E14-13, E14-14, E14-16, E14-19, E14-20, E14-21, E14-22, E14-23, P14-24A, P14-27A
E14A-5, E14A-6, E14A-7, E14A-8, E14A-9, E14A-11, P14A-13A, P14A-14A, P14B-2A, P14B-3B

Pre-Test Questions in MyAccountingLab:

S14-1, S14-2, S14-3, S14-5, S14-6, S14-9, S14-10, S14A-2, S14A-3, S14A-4, P14B-1A

Post-Test Questions in MyAccountingLab:

P14-31B , P14A-18B, P14B-4B

Exercise and/or Problems used in PowerPoint slides:

S14-3, S14-5, S14-6, S14-9, S14-10

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Answer Key to Chapter 14 Quiz:

1. D 6. C
2. D 7. C
3. B 8. C
4. A 9. D
5. D 10. B

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Name Date Section

CHAPTER 14
TEN-MINUTE QUIZ

Circle the letter of the best response.

1. The purposes of the cash flow statement are

A. to evaluate management decisions.
B. to determine ability to pay liabilities and dividends.
C. to predict future cash flows.
D. all of the above.

2. The main categories of cash flow activities are

A. direct and indirect.
B. current and long-term.
C. noncash investing and financing.
D. operating, investing, and financing.

3. Operating activities are most closely related to

A. long-term assets.
B. current assets and current liabilities.
C. long-term liabilities and owners’ equity.
D. dividends and treasury stock.

4. Which item does not appear on a statement of cash flows prepared by the indirect method?
A. Collections from customers
B. Depreciation
C. Net income
D. Gain on sale of land

5. Leather Shop earned net income of $57,000 after deducting depreciation of $5,000 and all other
expenses. Current assets decreased by $4,000, and current liabilities increased by $8,000. How much
was Leather Shop’s cash provided by operating activities (indirect method)?
A. $40,000
B. $66,000
C. $48,000
D. $74,000

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6. The Plant assets account of Star Media shows the following:
Plant assets, net
Beg 80,000 Depr 34,000
Purchase 428,000 Sale 42,000

End 432,000

Star Media sold plant assets at an $11,000 loss. Where on the statement of cash flows should Star
Media report the sale of plant assets? How much should the business report for the sale?
A. Financing cash flows—cash receipt of $42,000
B. Investing cash flows—cash receipt of $53,000
C. Investing cash flows—cash receipt of $31,000
D. Investing cash flows—cash receipt of $42,000

7. Mountain Water, Corp. issued common stock of $28,000 to pay off long-term notes payable of
$28,000. In what section(s) would these transactions be recorded?
A. Financing activities payment of note ($28,000)
B. Financing activities cash receipt $28,000
C. Noncash investing and financing activities $28,000
D. Both a and b are correct

8. Holmes, Inc. expects cash flow from operating activities to be $160,000, and the company plans
purchases of equipment of $83,000 and repurchases of stock of $24,000. What is Holmes’ free cash
flow?
A. $53,000
B. $160,000
C. $77,000
D. $83,000

9. (Appendix 14A: Direct Method) Maxwell Furniture Center had accounts receivable of $20,000 at
the beginning of the year and $54,000 at year-end. Revenue for the year totaled $116,000. How
much cash did the business collect from customers?
A. $150,000
B. $62,000
C. $116,000
D. $82,000

10. (Appendix 14A: Direct Method) Magic Toys Company had operating expense of $48,000. At the
beginning of the year, Magic Toys owed $10,000 on accrued liabilities. At year-end, accrued
liabilities were $5,000. How much cash did Magic Toys pay for operating expenses?
A. $38,000
B. $53,000
C. $48,000
D. $43,000

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