Question

Download Pfizer’s 2015 annual report (search Pfizer Investor Relations). Locate the firm’s consolidated statement of cash flows and answer the following:

Does the firm employ the direct or indirect method of accounting for operating cash flows?

Why does the firm account for the changes in balances in operating accounts (e.g., accounts receivable, inventory, accounts payable) in determining operating cash flows as net of acquisitions and divestitures?

Describe the accounting for cash paid for business acquisitions in the statement of cash flows.

Describe the accounting for any noncontrolling subsidiary interest and any other business combination–related items in the consolidated statement of cash flows.

Answer 1

Following is the firm's consolidated statement of cash flows:-

All the answers are provided as per the information available in Pfizer's 2015 annual report.

a. The firm employs the indirect method of accounting for operating cash flows.

The cash flow statement can be prepared using either the direct method or indirect method. The cash flow from financing and investing activities’ sections will be identical under both the indirect and direct method.

The indirect method for calculating cash flow from operations uses accrual accounting information, and always begins with the net income value. The net income is then adjusted for changes in the assets and liabilities account of the balance sheet by adding to or subtracting from net income to derive the operating cash flow.

Under the direct method, the only section of the cash flow statement that will differ in presentation is the cash flow from operations section. The direct method lists the cash receipts and payments made during a period for a business’ operations. The cash outflows are subtracted from the cash inflows to calculate the net cash flow from operating activities, before the cash from investing and financing activities are included to get the net cash increase or decrease in the company.

Most reporting entities use the indirect method to report cash flows from operating activities that begins with net income and then eliminates any noncash items (such as depreciation expense) as well as nonoperating gains and losses.

b. In 2015 and 2014, the line item Other changes in assets and liabilities, net of acquisitions and divestitures, primarily reflects changes, in the normal course of business, in accounts receivable, inventories, other current assets, other noncurrent assets, accounts payable, accrued compensation and other current and non-current liabilities.

For 2015, this line item also includes the adjustments necessary to reflect the payments of certain liabilities associated with legal matters accrued in prior periods, including Neurontin-related matters, partially offset by the deferral of an upfront payment received as part of our tanezumab collaborative arrangement.

The premise of the indirect method is to start with net income and then adjust for non-cash expenditures to arrive at cash flow from operating activities.

Changes in working capital must be adjusted in order to identify the flow of cash. For example, an increase in accounts receivable increases net income and shareholder’s equity since a sale has been made and the company can reasonably expect payment in the future. However, cash has yet to be received for accounts receivable. In order to adjust net income to cash flow, the increase in accounts receivable for the period must be subtracted from net income. Conversely, accounts payable measures payment owed to suppliers. An increase in accounts payable decreases net income, but increases the cash balance when adjusting net income in the cash flow statement. An easy way to see this increase is to recognize that a company taking longer to pay its bills will see a rise in its cash balance as well as its accounts payable.

Several other non-cash items appear often on the cash flow statement, including prepaid expenses and unearned revenues. Prepaid expenses are assets on the balance sheet that do not reduce net income or shareholder’s equity. However, prepaid expenses do reduce cash. Adjusting for an increase in prepaid expense is similar to adjusting for an increase in accounts receivable: they both decrease cash flow. Unearned revenues is a liability, so it works in the same way as accounts payable. An increase in unearned revenues does not affect net income or shareholder’s equity, but it does increase cash since payment has been received for future delivery of products or services. Again, the key is when cash was actually received or spent.

c. The accounting for cash paid for business acquisitions can be known from the Investing activities.

Investing Activities

2015 v. 2014

Net cash used in investing activities was $3.0 billion in 2015, compared to $5.7 billion in 2014.

The decrease in net cash used in investing activities was primarily attributable to:

• net redemptions of investments of $14.6 billion in 2015, compared to net purchases of investments of $4.2 billion in 2014, partially offset by:

• cash paid of $15.7 billion, net of cash acquired, in 2015 for the acquisition of Hospira

• cash paid of $763 million, net of cash acquired, in 2015 primarily for the acquisition of Baxter’s portfolio of marketed vaccines

2014 v. 2013

Net cash used in investing activities was $5.7 billion in 2014, compared to $10.5 billion in 2013.

The decrease in net cash used in investing activities was primarily attributable to:

• net purchases of investments of $4.2 billion in 2014, compared to $9.4 billion in 2013, partially offset by:

• cash paid of $195 million, net of cash acquired, for the acquisition of InnoPharma in 2014.

d. Accounting for any non controlling subsidiary interest and any other business combination related items deals with the financing activities of business.

Financing Activities

2015 v. 2014

Net cash used in financing activities was $10.2 billion in 2015, compared to $10.0 billion in 2014.

The increase in net cash used in financing activities was primarily attributable to:

• net principal payments on long-term debt of $3.0 billion in 2015, compared to net proceeds from issuance of long-term debt of $2.4 billion in 2014; and

• purchases of common stock of $6.2 billion in 2015, compared to $5.0 billion in 2014, partially offset by:

• net proceeds from short-term borrowings of $4.3 billion in 2015, compared to net payments on short-term borrowings of $1.8 billion in 2014.

2014 v. 2013

Net cash used in financing activities was $10.0 billion in 2014, compared to $15.0 billion in 2013.

The decrease in net cash used in financing activities was primarily attributable to:

• purchases of common stock of $5.0 billion in 2014, compared to $16.3 billion in 2013, partially offset by:

• net proceeds from borrowings of $548 million in 2014, compared to net proceeds from borrowings of $6.0 billion in 2013; and

• proceeds from the exercise of stock options of $1.0 billion in 2014, compared to $1.8 billion in 2013.