Noncash Investing and Financing Activities
A select set of important investing and financing activities occur without generating or consuming any cash. For example, a company may exchange common stock for land, or acquire a building in exchange for a note payable. While these transactions do not entail a direct inflow or outflow of cash, they do pertain to significant investing and/or financing events. When the FASB designed the statement of cash flows, they decided to require a separate section reporting these noncash items. Thus, the statement of cash flows is actually enhanced beyond its "title;" revealing the totality of investing and financing activities, whether or not cash is actually involved.
Direct Approach to the Statement of Cash Flows
Earlier in this chapter, you studied the income statement, statement of retained earnings, and balance sheet for Emerson Corporation. Before proceeding, spend just a few moments reviewing those financial statements. Then, examine the following statement of cash flows for Emerson Corporation. Everything within this cash flow statement is derived from the data and additional comments presented earlier for Emerson. At first, some of the cash flow statement will seem a bit mysterious, but a "line by line" explanation will follow. The tan bar at the left is not part of the statement; it is to facilitate the "line by line" discussion" (e.g. line F4 will refer to the 4th line in the financing activities section).
EMERSON CORPORATION Statement of Cash Flows (Direct Approach) For the Year Ending December 31, 20X5
Methods to Prepare a Statement of Cash Flows
There are several ways to go about preparing a statement of cash flows. You may hear about a "T" account approach or a "worksheet" approach for organizing data to present the statement. But, trying to learn the statement of cash flows by focusing on the specific method for its preparation can
actually obscure your understanding of the statement. Let's first focus on our "line by line" understanding of how the content for Emerson's statement is derived. As you proceed, try to focus on understanding not memorization. The statement of cash flows draws on your complete understanding of accounting, and it is quite common for students to initially struggle with the statement; do not despair, and do not give up!
LINE 01 ~ CASH FLOWS FROM OPERATING ACTIVITIES: This line merely identifies the section:
01 | Cash flows from operating activities:
LINE 02 ~ CASH RECEIVED FROM CUSTOMERS: Emerson's customers paid $3,000,000 in cash:
02 | Cash received from customers $ 3,000,000 |
How do we know this? Emerson's information system could be sufficiently robust that a "database query" could produce this number for us. On the other hand, we can also infer this by reference to sales and receivables data found within the income statement and balance sheet:
Cash Received From Customers
Total Sales Minus the Increase in Net Receivables (or, plus a decrease in net receivables) Cash Received From Customers
$3,250,000 - ($850,000 - $600,000) Cash Received From Customers = $3,000,000
Thinking about this calculation, we note that accounts receivable increased by $250,000 during the year ($850,000 - $600,000). This means that of the total sales of$3,250,000, a net $250,000 went uncollected during the year. Thus, cash received from customers only came to $3,000,000. If net receivables had decreased instead, cash collected would have actually exceeded sales.
LINE 03 ~ CASH PAID FOR: This line identifies the items relating to operating cash outflows:
03 Less cash paid for:
LINE 04 ~ CASH PAID FOR INVENTORY: Emerson's paid $1,050,000 of cash for inventory:
04 Merchandise inventory $ 1^50^00
Determining the cash paid for inventory is perhaps one of the trickier calculations. Bear in mind that cost of goods sold is the dollar amount of inventory sold during the year. But, the amount of inventory actually purchased will be less than this amount if inventory on the balance sheet decreased during the year. This would mean that some of the cost of goods sold came from existing stock on hand rather than having all been purchased during the year. On the other hand, purchases would be greater than cost of goods sold if inventory increased:
Cost of Goods Sold Minus the Decrease in Inventory (or, plus an increase in inventory) Inventory Purchased
$1,160,000 - ($220,000 - $180,000) Inventory Purchased = $1,120,000
Now, the inventory purchased is only the starting point for determining cash paid for inventory. Inventory purchased must be adjusted for the portion that was purchased on credit. Notice that Emerson's accounts payable increased by $70,000 ($270,000 - $200,000). This means that cash paid for inventory purchases was $70,000 less than total inventory purchased:
Cash Paid for Inventory
Inventory Purchases Minus the Increase in Accounts Payable (or, plus a decrease in accounts payable) Cash Paid for Inventory = $1,120,000 - ($270,000 - $200,000) Cash Paid for Inventory = $1,050,000
LINE 05 ~ CASH PAID FORWAGES: Emerson's paid $480,000 of cash for wages during the year:
O5 Wages 480,000
Emerson's payroll records would indicate the amount of cash paid for wages, but this number can also be determined by reference to wages expense in the income statement and wages payable on the balance sheet:
Cash Paid for Wages
Wages Expense Plus the Decrease in Wages Payable (or, minus an increase in wages payable) Cash Paid for Wages
$450,000 + ($50,000 - $20,000) Cash Paid for Wages = $480,000
Emerson not only paid out enough cash to cover wages expense, but an additional $30,000 as reflected by the overall decrease in wages payable. If wages payable had increased, the cash paid would have been less than wages expense.
LINE 06, 07, 08 - CASH PAID FOR INTEREST, OTHER OPERATING EXPENSES AND INCOME TAXES:
Other operating expenses
Emerson's cash payments for these items equaled the amount of expense in the income statement. Had there been related balance sheet accounts (e.g., interest payable, taxes payable, etc.), then the expense amounts would need to be adjusted in a manner similar to that illustrated for wages.
LINE 09 - NET CASH PROVIDED BY OPERATING ACTIVITIES: This line merely provides a recap of the net effect of all operating activities. Overall, operations generated net positive cash flows of$800,000:
09 Net cash provided by operating activities $ 800,000
You may have noticed that two items within the income statement were not listed in the operating activities section of the cash flow statement. Specifically:
• Depreciation expense is in the income statement, but it is not an operating cash flow item. The reason is very simple; it is a noncash expense. Remember that depreciation is recorded via a debit to Deprecation Expense and a credit to Accumulated Depreciation. No cash is impacted by this expense entry (the "investing" cash outflow occurred when the asset was purchased), and
• The gain on sale of land in the income statement does not appear in the operating cash flows section. While the land sale may have produced cash, the entire proceeds will be listed in the investing activities section; it is a "nonoperating" item, and its full cash effect is listed elsewhere.