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Financial Accounting

Weygandt ● Kimmel ● Nai-Hui Su

with IFRS 5^th Edition

Chapter 14�Statement of Cash Flows

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Wiley Custom Edition

Ch 14 Statement of Cash Flows

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Chapter Outline

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Ch 14 Statement of Cash Flows

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Learning Objective 1�Discuss the Usefulness and Format of the Statement of Cash Flows.

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14.1

Statement of Cash Flows: Usefulness and Format

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Usefulness of the Statement of Cash Flows

Statement of Cash Flows provides information to help assess:

Entity’s ability to generate future cash flows.
Entity’s ability to pay dividends and meet obligations.
The reasons for the difference between net income and net cash provided (used) by operating activities.
The cash investing and financing transactions during the period.

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Classification of Cash Flows

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Operating Activities

Income Statement Activities

Investing Activities

Changes in Investments and Non-current Assets

Financing Activities

Changes in Non-current Liabilities and Equity

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Classification of Cash Flows – Operating

Operating activities—Income statement items

Cash inflows:

From sale of goods or services.
From interest received and dividends received.

Cash outflows:

To suppliers for inventory.
To employees for wages.
To government for taxes.
To lenders for interest.

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ILLUSTRATION 14.1 (Partial) Typical receipt and payment classifications

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Classification of Cash Flows – Investing

Investing activities—Changes in investments and non-current assets

Cash inflows:

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:

To purchase property, plant, and equipment.
To purchase investments in debt or equity securities of other entities.
To make loans to other entities.

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ILLUSTRATION 14.1 (Partial) Typical receipt and payment classifications

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Classification of Cash Flows – Financing

Financing activities—Changes in non-current liabilities and equity

Cash inflows:

From sale of ordinary shares.
From issuance of long-debt (bonds and notes).

Cash outflows:

To shareholders as dividends.
To redeem long-term debt or reacquire
ordinary shares (treasury shares).

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ILLUSTRATION 14.1 (Partial) Typical receipt and payment classifications

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Sample Statement of Cash Flows Note

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ILLUSTRATION 14.2 Daimler’s statement of cash flows note

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Significant Non-Cash Activities

Direct issuance of ordinary shares to purchase assets.
Conversion of bonds into ordinary shares.
Direct issuance of debt to purchase assets.
Exchanges of plant assets.

Companies report significant financing and investing activities that do not affect cash in either a

Separate note or
Supplementary schedule

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Format of the Statement of Cash Flows

Order of Presentation:

Operating activities.
Investing activities.
Financing activities.

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Direct Method.

Indirect Method.

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Statement of Cash Flow – Example

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ILLUSTRATION 14.3 Format of statement of cash flows

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DO IT! 1 Cash Flow Activities

Classify each of these transactions by type of cash flow activity. Hu Na Ltd. had these transactions:

Issued 100,000 HK$50 par value ordinary shares for HK$8,000,000 cash.
Borrowed HK$2,000,000 from Castle Bank, signing a 5-year note bearing 8% interest.
Purchased two semi-trailer trucks for HK$1,700,000 cash.
Paid employees HK$120,000 for salaries and wages.
Collected HK$200,000 cash for services performed.

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Financing

Investing

Operating

– Solution

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Learning Objective 2�Prepare a Statement of Cash Flows Using the Indirect Method.

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14.2

Preparing the Statement of Cash Flows—Indirect

Method

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Preparing the Statement of Cash Flows

Three sources of information:

Comparative statements of financial position
Current income statement
Additional information

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Preparation – Step 1

Three sources of information:

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ILLUSTRATION 14.4 (Partial) Three major steps in preparing the statement of cash flows

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Preparation – Step 2

Three sources of information:

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ILLUSTRATION 14.4 (Partial) Three major steps in preparing the statement of cash flows

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Preparation – Step 3

Three sources of information:

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ILLUSTRATION 14.4 (Partial) Three major steps in preparing the statement of cash flows

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Indirect and Direct Methods

Companies must convert net income from an accrual basis to a cash basis using either of two methods.

Indirect method adjusts net income for items that do not affect cash.
Direct method shows operating cash receipts and payments.

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Methods Adopted by Companies

Companies favor the indirect method for two reasons:

It is easier and less costly to prepare.
It focuses on differences between net income and net cash flow from operating activities.

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Indirect Method Illustrated

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ILLUSTRATION 14.5 (Partial)

Comparative statements of

financial position, income

statement, and additional

information for Computer

Services International

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Indirect Method Illustrated

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ILLUSTRATION 14.5 (Partial)

Comparative statements of

financial position, income

statement, and additional

information for Computer

Services International

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Indirect Method Illustrated

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ILLUSTRATION 14.5 (Partial)

Comparative statements of

financial position, income

statement, and additional

information for Computer

Services International

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Indirect Method Illustrated – Further Information

Additional information for 2025:

Depreciation expense was comprised of €6,000 for building and €3,000 for equipment.
The company sold equipment with a book value of €7,000 (cost €8,000, less accumulated depreciation €1,000) for €4,000 cash.
Issued €110,000 of long-term bonds in direct exchange for land.
A building costing €120,000 was purchased for cash. Equipment costing €25,000 was also purchased for cash.
Issued ordinary shares for €20,000 cash.
The company declared and paid a €29,000 cash dividend.

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Starting Point for the Indirect Method

Companies must separately disclose cash flows arising from income taxes and cash flows from interest and dividends received and paid.
Basically, cash flows arising from income taxes are classified as operating activities.
Using the indirect method, companies may start with income before income tax and then disclose interest and taxes paid as well as interest and dividends received as separate line items on the face of the statement.

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Step 1: Operating Activities

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ILLUSTRATION 14.6 Six types of adjustments to convert income before income tax to net cash provided by operating activities

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Step 1 Review Question

Which is an example of a cash flow from an operating activity?

Payment of cash to lenders for interest.
Receipt of cash from the issuance of ordinary shares.
Payment of cash dividends to the company’s shareholders.
None of the above.

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Step 1 Review Question – Solution

Which is an example of a cash flow from an operating activity?

Payment of cash to lenders for interest.
Receipt of cash from the issuance of ordinary shares.
Payment of cash dividends to the company’s shareholders.
None of the above.

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Step 1: Depreciation Expense

Although depreciation expense reduces net income, it does not reduce cash. The company must add it back to net income.

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ILLUSTRATION 14.7 Adjustment for depreciation

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Step 1: Interest Expense

To separately disclose interest paid, companies first add back interest expense and then subtract interest paid in the operating section.

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ILLUSTRATION 14.8 Adjustment for interest

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Step 1: Loss on Disposal of Plant Assets

Companies should report cash received from the sale (disposal) of plant assets in the investing activities section. Therefore,

any loss on sale is added to income before income tax in the operating section.
any gain on sale is deducted from income before income tax in the operating section.

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Step 1: Loss Example

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ILLUSTRATION 14.9 Adjustment for loss on disposal of plant assets

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Step 1: Changes to Non-Cash Current Asset Accounts

To arrive at net cash provided by operating activities

Deduct from income before income tax increases in current asset accounts.
Add to income before income tax decreases in current asset accounts.

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Step 1: Changes in Accounts Receivable

When the Accounts Receivable balance decreases, cash receipts are higher than sales revenue.
The company adds to income before income tax the amount of the decrease in accounts receivable.

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ILLUSTRATION 14.10 Analysis of accounts receivable

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Step 1: Changes to Inventory

When the Inventory balance increases, the cost of merchandise purchased exceeds the cost of goods sold. Cost of goods sold does not reflect cash payments made for merchandise.

The company deducts from income before income tax the inventory increase.

When the Prepaid Expense balance increases, the cash paid for expenses is higher than expenses reported on an accrual basis.

The company deducts from income before income tax the prepaid expense increase.

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Step 1: Adjustments in Operating Activities

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ILLUSTRATION 14.11 Adjustments for changes in current asset accounts

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Step 1: Changes to Non-Cash Current Liability Accounts

To arrive at net cash provided by operating activities

Deduct from income before income tax decreases in current liability accounts.
Add to income before income tax increases in current liability accounts.

When Accounts Payable increases, the company received more in goods than it actually paid for. The increase is added to income before income tax to determine net cash provided by operating activities.

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Step 1: Current Liability Changes Illustrated

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ILLUSTRATION 14.12 Adjustments for changes in current liability accounts

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Step 1: Interest and Income Taxes Paid

Companies often provide a separate section on the face of the statement to disclose interest and income taxes paid.
When the statement of financial position did not include an accrual for interest payable, the amount reported as expense is the same as the amount of interest paid.
When Income Taxes Payable decreases, the income tax expense reported on the income statement was less than the amount of taxes paid during the period.
The company must reduce income before income tax by the amount of income taxes paid to determine net cash provided by operating activities.

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Step 1: Interest and Income Taxes Paid Illustrated

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ILLUSTRATION 14.13 Reporting of interest and taxes in the operating section

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Summary of Conversion to Net Cash Provided by Operating Activities—Indirect Method

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ILLUSTRATION 14.14

Adjustments required to

convert income before income

tax to net cash provided by

operating activities

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DO IT! 2a Net Cash Provided by Operating Activities

Josh’s Photo Plus reported net income of £73,000 for 2025. Included in the income statement were depreciation expense of £7,000 and a gain on disposal of plant assets of £2,500. Josh’s comparative statements of financial position show the following balances.

Calculate net cash provided by operating activities for Josh’s Photo Plus.

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	12/31/24	12/31/25
Accounts receivable	£17,000	£21,000
Accounts payable	6,000	2,200

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DO IT! 2a Net Cash Provided by Operating Activities – Solution

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Step 2: Investing and Financing Activities

Analyze Changes in Non-Current Asset and Liability Accounts and Record as Investing and Financing Activities, or Disclose as Non-Cash Transactions.

The company purchased land of €110,000 by issuing long-term bonds. �This is a significant non-cash investing and financing activity that merits disclosure in a separate schedule.
The additional information indicates the company acquired a building for €120,000 cash. This is a cash outflow reported in the investing section.

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Step 2: Purchase of Equipment

The additional information explains that the €17,000 net increase in equipment resulted from two transactions: (1) a purchase of equipment of €25,000, and (2) the sale for €4,000 of equipment costing €8,000.

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ILLUSTRATION 14.15 Analysis of equipment

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Step 2: Equipment Journal Entry

The following journal entry shows details of the sale of equipment transaction.

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Step 2: Financing Activities

The company increased Share Capital—Ordinary by issuing shares of stock for €20,000. This is a cash inflow reported in the financing activities section of the Statement of Cash Flows.
The additional information indicates that net income of €145,000 increased retained earnings, and this is included in the operating activities section.
The company paid dividends of €29,000. The decrease in retained earnings is a cash outflow that is reported in the financing activities section.

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Step 2: Partial Statement of Cash Flows

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ILLUSTRATION 14.16 (Partial) Statement of cash flows, 2025—indirect method

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Step 2: Partial Statement of Cash Flows

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ILLUSTRATION 14.16 (Partial) Statement of cash flows, 2025—indirect method

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Step 3: Net Change in Cash

Compare the beginning and ending cash balances on the Statement of Financial Position with those on the Statement of Cash Flows and be sure they agree.
Refer to Illustration 14.5 and 14.16

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DO IT! 2b Indirect Method

Use the following Comparative Statements of Financial Position, Income Statement, and additional information to prepare a statement of cash flows using the indirect method.

Additional information (all amounts in thousands of NT$):

Operating expenses include depreciation expense of NT$33,000.
Equipment with a cost of NT$41,000 and a book value of NT$36,000 was sold for NT$34,000 cash.
Land was sold at its book value for cash.
Interest expense of NT$12,000 was paid in cash.
Equipment with a cost of NT$166,000 was purchased for cash.
Bonds of NT$10,000 were redeemed at their face value for cash.
Ordinary shares (NT$1 par) of NT$130,000 were issued for cash.
Cash dividends of NT$55,000 were declared and paid in 2025.
Ordinary shares of NT$30,000 were issued in exchange for land.

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DO IT! 2b Statement of Financial Position

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DO IT! 2b Statement of Financial Position

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DO IT! 2b Statement of Financial Position

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DO IT! 2b – Solution

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DO IT! 2b – Solution

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DO IT! 2b – Solution

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Learning Objective 3�Analyze the Statement of Cash Flows.

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14.3

Using Cash Flows to Evaluate a Company

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Free Cash Flow

Free cash flow describes the net cash provided by operating activities after adjustment for capital expenditures and dividends.

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ILLUSTRATION 14.17 Free cash flow

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Using Cash Flows to Evaluate a Company

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ILLUSTRATION 14.18 Anheuser-Busch InBev cash flow information ($ in millions)

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Free Cash Flow Calculation

The company generated a significant amount of cash from its operations, but it spent most of it to buy property, plant, and equipment, and to pay dividends.

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ILLUSTRATION 14.19 Calculation of Anheuser-Busch InBev’s free cash flow ($ in millions)

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DO IT! 3 Free Cash Flow

Luó Ltd. issued the statement of cash flows for 2025 (shown on following slide).

(a) Compute free cash flow for Luó.

(b) Explain why free cash flow often provides better information than “Net cash provided by operating activities.”

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DO IT! 3 Free Cash Flow – Solution

Free cash flow (¥ in thousands) = ¥29,300 − ¥19,000 − ¥9,000 = ¥1,300.
Net cash provided by operating activities fails to take into account that a company must invest in new plant assets just to maintain the current level of operations. Companies must also maintain dividends at current levels to satisfy investors. The measurement of free cash flow provides additional insight regarding a company’s cash-generating ability.

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Learning Objective *4�Prepare a Statement of Cash Flows Using the Direct Method.

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Appendix 14A

Statement of Cash Flows—Direct Method

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Statement of Cash Flows – Direct Method

Compute net cash provided by operating activities by adjusting each item in the income statement from the accrual basis to the cash basis.
Companies report only major classes of operating cash receipts and cash payments.
For these major classes, the difference between cash receipts and cash payments is the net cash provided by operating activities.

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Direct Method Illustrated

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ILLUSTRATION 14A.1 (Partial)

Comparative statements of

financial position, income

statement, and additional

information for Computer

Services International

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Direct Method Illustrated

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ILLUSTRATION 14A.1 (Partial)

Comparative statements of

financial position, income

statement, and additional

information for Computer

Services International

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Direct Method Illustrated – Income Statement

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ILLUSTRATION 14A.1 (Partial)

Comparative statements of

financial position, income

statement, and additional

information for Computer

Services International

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Direct Method – Additional Information

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ILLUSTRATION 14A.1 (Partial)

Comparative statements of

financial position, income

statement, and additional

information for Computer

Services International

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Step 1: Operating Activities (Direct)

Determine Net Cash Provided/Used by Operating Activities by Converting Net Income from an Accrual Basis to a Cash Basis.

Companies simplify and condense the operating activities section of the Cash Flow Statement by reporting only major classes of operating cash receipts and cash payments.
Companies deduct cash payments from cash receipts to arrive at the net cash provided by operating activities.
An efficient way to apply the direct method is to analyze the items reported in the income statement in the order in which they are listed.

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Step 1: Direct Method Illustration

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ILLUSTRATION 14A.2 Major classes of cash receipts and payments

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Step 1: Cash Receipts (Direct Method)

A company must consider the change in accounts receivable to determine how much of revenue was from cash receipts.
When revenues on an accrual basis are higher than cash receipts, accounts receivable increases. The company deducts the increase from sales revenue.
When accounts receivable decreases, the company adds the decrease to sales revenue.

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Step 1: Cash Receipts Example (Direct)

For Computer Services, accounts receivable decreased €10,000.

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ILLUSTRATION 14A.3 Computation of cash receipts from customers

ILLUSTRATION 14A.4 Analysis of accounts receivable

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Step 1: Cash Receipts Example (Direct)

Illustration 14A.5 shows the relationships among cash receipts from customers, sales revenue, and changes in accounts receivable.

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ILLUSTRATION 14A.5 Formula to compute cash receipts from customers—direct method

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Step 1: Cash Payments (Direct)

A company must calculate purchases for the year to determine how much of cash was paid to suppliers.
When inventory increases, purchases have exceeded cost of goods sold.

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ILLUSTRATION 14A.6 Computation of purchases

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Step 1: Cash Payments to Suppliers

A company must calculate how much of cash was paid to suppliers by adjusting purchases by the change in accounts payable.
When accounts payable increase, a company deducts the increase from purchases.
When accounts payable decrease, a company adds the decrease to purchases.

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ILLUSTRATION 14A.7 Computation of cash payments to suppliers

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Step 1: Formula for Cash Payments

In 2025, Computer Services Company’s inventory increased €5,000 and accounts payable increased € 16,000. Cash payments to suppliers were €139,000.

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ILLUSTRATION 14A.8 Analysis of accounts payable

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Step 1: Formula for Cash Payments

Illustration 14A.9 shows the relationships among cash payments to suppliers, cost of goods sold, changes in inventory, and changes in accounts payabl

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ILLUSTRATION 14A.9 Formula to compute cash payments to suppliers—direct method

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Step 1: Cash Payments for Operating Expenses

A company needs to adjust operating expenses by changes in prepaid expenses and accrued expenses payable.
When prepaid expenses increase, cash paid for operating expenses is higher than operating expenses reported on the income statement.
To determine cash payments for operating expenses, a company deducts an increase in accrued expenses payable from operating expenses on the income statement (operating expenses on an accrual basis are higher than they are on a cash basis).

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Step 1: Cash Payments for Operating Expenses

Formula for Cash Payments for Operating Expenses

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ILLUSTRATION 14A.10 Computation of cash payments for operating expenses

ILLUSTRATION 14A.11 Formula to compute cash payments for operating expenses—direct method

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Step 1: Formula to Compute Payment for Taxes

Income taxes payable decreased €2,000.

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ILLUSTRATION 14A.12 Computation of cash payments for income taxes

ILLUSTRATION 14A.13 Formula to compute cash payments for income taxes—direct method

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Step 1: Operating Activities Calculation

Operating activities section of the statement of cash flows of Computer Services.

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ILLUSTRATION 14A.14 Operating activities section of the statement of cash flows

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Step 2: Investing and Financing Activities (Direct Method)

Analyze Changes in Non-Current Asset and Liability Accounts and Record as Investing and Financing Activities, or Disclose as Non-Cash Transactions.

Investing and financing activities are measured and reported the same way under both the direct and indirect methods.

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Step 2: Specific Investing and Financing Activities

Increase in Land. Land increased €110,000. The company purchased land of €110,000 by issuing bonds.
Increase in Building. Acquired building for €120,000 cash.
Increase in Bonds Payable. Bonds Payable increased €110,000. The company acquired land by exchanging bonds for land.

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Significant non-cash investing and financing transaction

Investing transaction

Significant non-cash investing and financing transaction

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Step 2: Investing and Financing Activities – Equipment

Equipment was purchased for €25,000, and equipment was sold for €4,000; it cost €8,000 and had a book value €7,000 at the time of sale.

Journal Entry:

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ILLUSTRATION 14A.15 Analysis of equipment

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Step 2: Further Investing and Financing Activities

Increase in Share Capital—Ordinary. Increase in Share Capital—Ordinary of €20,000. Increase resulted from the issuance of new shares.
Increase in Retained Earnings. The €116,000 net increase in Retained Earnings resulted from net income of €145,000 and the declaration and payment of a cash dividend of €29,000.

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Financing transaction

Financing transaction (cash dividend)

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Illustrated Statement of Cash Flows – Direct Method

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ILLUSTRATION 14A.16

Statement of cash flows,

2025 —direct method

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Step 3: Net Change in Cash (Direct)

Compare the Net Change in Cash on the Statement of Cash Flows with the Change in the Cash Account Reported on the Statement of Financial Position to Make Sure the Amounts Agree.
Illustration 14A.16 indicates that the net change in cash during the period was an increase of €22,000. This agrees with the change in balances in the Cash account reported on the statements of financial position in Illustration 14A.1.

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Learning Objective *5�Use the T-Account Approach to Prepare a Statement of Cash Flows.

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Appendix 14B

Statement of Cash Flows—

T-Account Approach

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Use the T-Account Approach

The change in cash is equal to the change in all of the other statement of financial position accounts.
If we analyze the changes in all of the non-cash statement of financial position accounts, we will explain the change in the Cash account.

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T-Account Approach Illustration

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ILLUSTRATION 14B.1

T-account approach

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A Look at U.S. GAAP

Learning Objective 6�Compare the Procedures for the Statement of Cash Flows Under IFRS and U.S. GAAP.

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Similarities

Companies preparing financial statements under both GAAP and IFRS must prepare a statement of cash flows as an integral part of the financial statements.
Both IFRS and GAAP require that the statement of cash flows should have three major sections— operating, investing, and financing—along with changes in cash and cash equivalents.
Similar to IFRS, the statement of cash flows can be prepared using either the indirect or direct method under GAAP. Companies choose for the most part to use the indirect method for reporting net cash flows from operating activities.

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Differences

A major difference is that in certain situations, bank overdrafts are considered part of cash and cash equivalents under IFRS (which is not the case in GAAP). Under GAAP, bank overdrafts are classified as financing activities in the statement of cash flows and are reported as liabilities on the statement of financial position.
IFRS requires that non-cash investing and financing activities be excluded from the statement of cash flows. Instead, these non-cash activities should be reported elsewhere. This requirement is interpreted to mean that non-cash investing and financing activities should be disclosed in the notes to the financial statements instead of in the financial statements. Under GAAP, companies may present this information on the face of the statement of cash flows.

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Classification Differences

One area where there can be substantial differences between IFRS and GAAP relates to the classification of interest, dividends, and taxes. The following table indicates the differences between the two approaches.

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Additional Differences

Under IFRS, some companies present the operating section in a single line item, with a full reconciliation provided in the notes to the financial statements. This presentation is not seen under GAAP.
Similar to IFRS, under GAAP companies must disclose the amount of taxes and interest paid. Under GAAP, companies disclose this in the notes to the financial statements. Under IFRS, some companies disclose this information in the notes, but others provide individual line items on the face of the statement. In order to provide this information on the face of the statement, companies first add back the amount of interest expense and tax expense (similar to adding back depreciation expense) and then further down the statement they subtract the cash amount paid for interest and taxes.

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Copyright

All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States 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.

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