Principles of Accounting- Statement of Cash Flows

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Principles of Accounting- Statement of Cash Flows

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Only one method to prepare cash flows from investing and financing: the direct method

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Nội dung Text: Principles of Accounting- Statement of Cash Flows

  1. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 Fulbright Economics Teaching Program Ho Chi Minh City, Vietnam Academic Year: 2005-2006 Principles of Accounting 7/17/2006 Nguyễn Tấn Bình 1 Lecture Notes 4 Statement of Cash Flows 7/17/2006 Nguyễn Tấn Bình 2 Nguyen Tan Binh 1
  2. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 The main objective of the statement of cash flows • Shows the relationship between the Net Income and Net Cash Flow • Explains how cash is generated and used during a business period • Evaluates the ability to pay debt in time • This information is very useful to decision makers (managers, lenders, shareholders…) in forecasting the future cash flows 7/17/2006 Nguyễn Tấn Bình 3 The necessity of the statement of cash flows Additionally provides a lot of important information that the balance sheet and the income statement cannot to provide: • The balance sheet only reflects the values and the sources of assets at a certain date (a point of time) How to know how much the firm has disbursed for purchases (or collected from liquidations) of fixed assets during a business period? How to know how much the firm has borrowed (or paid back) during a business period? 7/17/2006 Nguyễn Tấn Bình 4 Nguyen Tan Binh 2
  3. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 The necessity of the statement of cash flows Additionally provides a lot of important information that the balance sheet and the income statement fail to provide: • The income statement is made on the accrual, not the cash, basis of accounting Why does a firm show profit but have no cash, and vice versa? How to explain changes (increases or decreases) in cash balance from the beginning to the end of the business period? 7/17/2006 Nguyễn Tấn Bình 5 What is called “cash” in the statement of cash flows • Cash, bank deposits, floats, and cash equivalent securities • Cash equivalent securities include – Marketable securities with high liquidity – Easy to be transferred into cash 7/17/2006 Nguyễn Tấn Bình 6 Nguyen Tan Binh 3
  4. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 Classification of cash flows A firm of any form or any size has 3 types of activities: 1. Operating 2. Investing 3. Financing The statement of cash flows reflects three cash flows from the three above activities 7/17/2006 Nguyễn Tấn Bình 7 Cash flow from operating • Disbursement flows into and receipt flows from the main operating activity of the firm • There are two methods to calculate the cash flow from operating activity: – Direct method – Indirect method 7/17/2006 Nguyễn Tấn Bình 8 Nguyen Tan Binh 4
  5. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 Cash flow from operating Receipt flows (inflows) include: – Collections from customers – Interest receipt, receipt from other operations – Dividend receipt (from investments in other companies) 7/17/2006 Nguyễn Tấn Bình 9 Cash flow from operating Disbursement flows (outflows) include – Payment to suppliers – Interest, tax payments – Salary payment of er ord he ot yt Pa – Payment to other operations 7/17/2006 Nguyễn Tấn Bình 10 Nguyen Tan Binh 5
  6. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 Cash flows from investing and financing • Only one method to prepare cash flows from investing and financing: the direct method • Shows the actual disbursement and receipt flows 7/17/2006 Nguyễn Tấn Bình 11 Cash flow from investing • Disbursement and receipt flows for purchases and sales of fixed assets, investments, and investment recovery 7/17/2006 Nguyễn Tấn Bình 12 Nguyen Tan Binh 6
  7. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 Cash flow from investing • Receipt flows (inflows) include – Liquidations of fixed assets – Sales of marketable securities – Recovery of investment or lending 7/17/2006 Nguyễn Tấn Bình 13 Cash flow from investing • Disbursement flows (outflows) include – Purchases of fixed assets – Purchases of marketable securities – Lending or capital contribution to other companies 7/17/2006 Nguyễn Tấn Bình 14 Nguyen Tan Binh 7
  8. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 Cash flow from financing • Disbursement flows into and receipt flows from financing activity (capital mobilization) for the firm’s operations • Funds raised from owners and lenders 7/17/2006 Nguyễn Tấn Bình 15 Cash flow from financing • Receipt flows (inflows) include – Stock issue – Corporate bond issue – Bank loans 7/17/2006 Nguyễn Tấn Bình 16 Nguyen Tan Binh 8
  9. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 Cash flow from financing • Disbursement flows (outflows) include – Repurchases of stock (treasury stock) – Recall or payment of corporate bond – Debt payment – Dividend payment 7/17/2006 Nguyễn Tấn Bình 17 Non-cash investing and financing activities Example: – Debt-equity conversion – Purchases and sales of fixed assets on credit • These activities do not generate cash flows, hence, are not shown on the statement of cash flows • However, the endnotes to the statement of cash flows or a separate statement is prepared to explain their changes on the balance sheet 7/17/2006 Nguyễn Tấn Bình 18 Nguyen Tan Binh 9
  10. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 Some common transactions and their impacts on the cash flows Operating transactions • Sales of goods/services for cash + • Sales on credit 0 • Interest receipt from investments + • Collections from accounts receivable + • Record of cost of goods sold 0 • Inventory purchases for cash - • Purchases on account 0 • Payment for accounts payable - 7/17/2006 Nguyễn Tấn Bình 19 Some common transactions and their impacts on the cash flows (cont.) Operating transactions • Expense payable 0 • Expense payment - • Taxes payable 0 • Tax payment - • Interest payable 0 • Interest payment - • Prepaid expense (for example, insurance) - • Records decreases in prepaid expense 0 • Records insurance expense 0 7/17/2006 Nguyễn Tấn Bình 20 Nguyen Tan Binh 10
  11. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 Some common transactions and their impacts on the cash flows (cont.) Financing transactions • Purchases of fixed assets for cash - • Purchases of fixed assets on account 0 • Liquidations of assets for cash + • Sales of fixed assets on credit 0 • Purchases of marketable securities - • Sales of marketable securities + • Lending - 7/17/2006 Nguyễn Tấn Bình 21 Some common transactions and their impacts on the cash flow (cont.) Financing transactions • Borrowing (long and short term) + • Debt payment (long and short term) - • Stock issue (common and preferred) + • Stock repurchase - • Interest payment - • Dividend payment - • Debt-equity conversion 0 • Long-term to short-term debt conversion 0 7/17/2006 Nguyễn Tấn Bình 22 Nguyen Tan Binh 11
  12. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 Cash flow concept Conventions on cash flows: Inflows, or receipt flows Outflows, or disbursement flows Net Cash Flows = Inflows – Outflows Total net cash flows (from three activities) equal the difference between ending and beginning cash balances 7/17/2006 Nguyễn Tấn Bình 23 Cash flow concept (cont.) Total net cash flows (from three activities) equal the difference between ending and beginning cash balances Remember Beginning balance + Receipts during period – Disbursements during period = Ending balance Receipts during period – Disbursements during period = Ending balance – Beginning balance Receipts during period – Disbursements during period = Total net cash flows 7/17/2006 Nguyễn Tấn Bình 24 Nguyen Tan Binh 12
  13. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 Preparing the statement of cash flows A statement of cash flow includes three parts Net cash flow from operating (I) Net cash flow from investing (II) Net cash flow from financing (III) Total net cash flows = I + II + III + Beginning cash balance = Ending cash balance 7/17/2006 Nguyễn Tấn Bình 25 Two methods of preparing the statement of cash flows (for net cash flows from operating) Indirect method – Net cash flow from operating is calculated by adjusting from net income – Most of companies use this method Direct method – Net cash flow from operating is calculated from actual receipt and disbursement flows – This method is comprehensible to readers, but few companies use it. Discussion 7/17/2006 Nguyễn Tấn Bình 26 Nguyen Tan Binh 13
  14. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 Sources of data used for preparing the statement of cash flows 1. Balance sheet, showing the beginning and ending balances 2. Income statement 3. Notes of financial statements 7/17/2006 Nguyễn Tấn Bình 27 Direct method • The simple direct method uses accounting books such as ledgers and cash book to pick up the receipt and disbursement flows. However, the workload is troublesome, confusing, and infeasible – Cash book is recorded in chronologic order, while the statement of cash flows classifies cash flows into various activities (operating, investing, and financing) – How can outsiders have this book? • This lecture presents the inferential direct method, which infers cash flows from the income statement and the balance sheet 7/17/2006 Nguyễn Tấn Bình 28 Nguyen Tan Binh 14
  15. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 Demonstrating the inferential direct method Revenue • Since revenues on the income statement are recognized on the accrual basis of accounting, they are not the accrual receipts • Infer as follows (Ending – Beginning) Revenues - = Receipts Accounts Receivable 7/17/2006 Nguyễn Tấn Bình 29 A numeric example of revenues BBB Company • Beginning-of-year Receivables (1/1/2004) are 4,000 • Ending-of-year Receivables (31/12/2004) are 5,000 • Revenues during 2004 are 80,000 – What are the accrual receipts? 7/17/2006 Nguyễn Tấn Bình 30 Nguyen Tan Binh 15
  16. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 A numeric example of revenues BBB Company • Beginning-of-year Receivables (1/1/2004) are 4,000 • Ending-of-year Receivables (31/12/2004) are 5,000 • Revenues during 2004 are 80,000 – What are the accrual receipts? Interpretation Customers owe 4,000 at the beginning of the year; they owe an additional amount of 1,000 during the year; they owe 5,000 at the end of the year The difference (ending – beginning balance) is the credit amount accrued (+), or paid (-) during the period Here, (ending – beginning balance) = 5,000 – 4,000 = 1,000 7/17/2006 Nguyễn Tấn Bình 31 A numeric example of revenues BBB Company • Beginning-of-year Receivables (1/1/2004) are 4,000 • Ending-of-year Receivables (31/12/2004) are 5,000 • Revenues during 2004 are 80,000 – What are the accrual receipts? Interpretation Revenues are 80,000 during the year. The firm thus collects 79,000 because customers owe additionally 1,000 during the period. Accrual collections from customers are : Revenues– (Ending Receivables – Beginning Receivables ) 80,000 – (5,000 – 4,000) = 79,000 7/17/2006 Nguyễn Tấn Bình 32 Nguyen Tan Binh 16
  17. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 Demonstrating the inferential direct method Expenses • Since expenses on the income statement are recognized on the accrual basis of accounting, they are not the actual disbursements • Infer as follows: (Ending - Beginning) Expenses - Expenses Payable = Disbursements 7/17/2006 Nguyễn Tấn Bình 33 A numeric example of expenses BBB Company • Salaries expense accrued during 2004 is 2,000 • Salaries payable at the beginning of the year (1/1/2004) are 200 • Salaries payable at the end of the year (31/12/2004) are 100 What is the amount paid as salaries? 7/17/2006 Nguyễn Tấn Bình 34 Nguyen Tan Binh 17
  18. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 A numeric example of expenses BBB Company • Salaries expense accrued during 2004 is 2,000 • Salaries payable at the beginning of the year (1/1/2004) are 200 • Salaries payable at the end of the year (31/12/2004) are 100 What is the amount paid for salaries? Interpretation The firm owes employees 200 at the beginning of the year; it pays 100 during the year; so it still owes 100 at the end of the year The difference (ending ending– beginning balance) is the amount paid (-) during the year In our example, ending balance – beginning balance = 100 – 200 = -100 7/17/2006 Nguyễn Tấn Bình 35 A numeric example of expenses BBB Company • Salaries expense accrued during 2004 is 2,000 • Salaries payable at the beginning of the year (1/1/2004) are 200 • Salaries payable at the end of the year (31/12/2004) are 100 What is the amount paid for salaries? Interpretation Salaries expense accrued during the year is 2,000. The firm thus has not only paid all salaries of 2,000, but also paid its dues of 100 The amount actually paid to employees is Accrued salaries – (Ending balance – beginning balance) 2,000 – (100 – 200) = 2,100 7/17/2006 Nguyễn Tấn Bình 36 Nguyen Tan Binh 18
  19. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 Indirect method (*) Net cash flows from operating is calculated from net income, and adjusted as follows: • (+) Depreciation is added, because it has been deducted when we calculate net income, but there is no disbursement • (+/-) Profits (losses) from investing and financing (such as sales of assets, debt payments) are added (subtracted), because they have been directly accounted in the category of Cash Flows from Investing and Financing • (+/-) Changes in working capital (receivables, inventory, payables) are added (subtracted) (*) See Lecture Notes 4a, Preparing the Statement of Cash Flows, Song Ha Company 7/17/2006 Nguyễn Tấn Bình 37 Notes of the two methods • The direct method provides more details of the cash flows from operating – Specifically and clearly shows the disbursement and receipt flows • The indirect method shows the “quality” of income, and points out the factors that affect the cash flows from operating more clearly • In both methods, cash flows from investing and financing are prepared in the direct method • Net cash flows in the two methods must be the same 7/17/2006 Nguyễn Tấn Bình 38 Nguyen Tan Binh 19
  20. Fulbright Economics Teaching Program Principles of accounting Lecture 4 2005-2006 How important is the statement of cash flows? • Shows a more complete picture on the firm’s financial position • Many big firms fail because they are failed to manage their cash flows • And remember, the statement of cash flows is required by the international accounting standard and by many countries’ • In Vietnam? 7/17/2006 Nguyễn Tấn Bình 39 Analysis of the statement of cash flows • The statement of cash flows shows the firm’s overall business activities over various development stages 7/17/2006 Nguyễn Tấn Bình 40 Nguyen Tan Binh 20

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