Financial Accounting and Accounting Standards

Report
Chapter 10
Financial Statements
1. Understand the purposes of the balance sheet.
2. Define the elements of a balance sheet.
3. Explain how to measure the elements of a balance
sheet.
4. Classify the assets of a balance sheet.
5. Classify the liabilities of a balance sheet.
6. Report the stockholders’ equity of a balance sheet.
7. Understand the concepts of income.
8. Explain the conceptual guidelines for reporting
income.
9. Define the elements of an income statement.
10. Describe the major components of an income
statement.
11. Compute income from continuing operations.
12. Compute results from discontinued operations.
13. Identify extraordinary items.
14. Prepare a statement of retained earnings.
15. Report comprehensive income.
Balance Sheet
Claims against
resources (Liabilities)
Resources
(Assets)
Remaining claims
accruing to owners
(Owner’s Equity)
Balance Sheet
Basic Accounting Identity
A = L + OE
Balance Sheet
Basic Definitions - SFAC No. 6
Assets
Probable future economic benefits
obtained or controlled by a
particular entity as a result of past
transactions or events.
Balance Sheet
Basic Definitions - SFAC No. 6
Liabilities
Probable future sacrifices of
economic benefits arising from
present obligations of a particular
entity to transfer assets or provide
services to other entities as a result
of past transactions or events.
Balance Sheet
Basic Definitions - SFAC No. 6
Owners’ Equity
The residual interest in the assets
of an entity that remains after its
liabilities are deducted.
Balance Sheet Format
Asset Classifications
Cash
Inventories
Current
Assets
Receivables
Prepayments
Balance Sheet Format
Asset Classifications
Investments
and funds
Intangibles
Noncurrent
Assets
Property, Plant,
& Equipment
Deferred
Charges
Balance Sheet Format
Liability Classifications
Accounts
Payable
Short-term
Notes Payable
Current
Liabilities
Collections in
advance of unearned
revenue
Accrued
Expenses
Working Capital
Less:
Equals:
Current assets
Current liabilities
Working Capital
Current assets
Current liabilities
= Working Capital Ratio
Balance Sheet Format
Liability Classifications
Capital
Leases
Long-term
Notes Payable
Noncurrent
Liabilities
Bonds
Payable
Pension
Liabilities
Balance Sheet Format
Equity Classifications
Capital
Stock
Other Contributed
Capital
Owners’
Equity
Retained
Earnings
Treasury
Stock
Statement of Changes in Stockholders’ Equity
statement
should
showthe
AThis
corporation
must
disclose
investments
by and
changes
in its stockholders’
distributions
to owners
during
equity account
when issuing
the period,
among
other items.
financial
statements.
Statement of Changes in Stockholders’ Equity
FASB Statement of Concepts No. 6 defined investments
by owners and distributions to owners, as follows:
 Investments by owners are increases in the equity of a
company resulting from transfers of something valuable
to the company from other entities in order to obtain or
increase ownership interests.
 Distributions to owners are decreases in the equity of a
company caused by transferring assets, rendering
services, or incurring liabilities to owners.
Statement of Changes in Stockholders’ Equity
SCHEDULE A
CARON MANUFACTURING COMPANY
Statement of Changes in Stockholders’ Equity
For Year Ended December 31, 2007
Accumulated
Common Additional
Other
Stock
Paid-in
Retained Comprehensive
$5 par
Capital
Earnings
Income
Total
Balance, Jan. 1, 2007 $65,000
Unrealized increase in
value of availablefor-sale securities
Net income
Cash dividends paid
Common stock issued
6,500
Balance, Dec. 31, 2007 $71,500
$143,400
$ 64,900
$10,000
$283,300
2,000
2,000
62,500
(11,200)
37,000
$373,600
62,500
(11,200)
30,500
$173,900
$116,200
$12,000
Additional Reporting Issues

Offsetting assets and liabilities

Loss and gain contingencies

Valuations reported in the Balance Sheet

Terminology

Comparative Statements
Contingent Liabilities and Assets
Loss
No
Probable (?)
or
No
Disclosure
Yes
and
Reasonably
estimated (?)
Reasonably possible
Report amount
in financial
statements
Yes
Disclose in notes
to the financial
statements
Limitations of Balance Sheet



Current value amounts generally are not
shown on the Balance Sheet.
Contains many estimates.
Certain assets and liabilities are not shown on
the Balance Sheet, e.g., human resources.
Income Statement
Economic
Income
vs.
Accounting
Income
Concepts of Income
Capital Maintenance Concept
Under this concept, corporate income for a
period of time is the amount that may be paid to
stockholders during that period and still enable
the corporation to be as well off at the end of the
period as it was at the beginning.
Concepts of Income
Capital Maintenance Concept
Assume a corporation has net assets of $45,000 at the
beginning and $80,000 at the end of the year, and that no
additional investments or withdrawals were made.
Ending net assets
The corporation could pay
Less: Additional investment
out $35,000 to
Ending net assets excluding investment
stockholders and still be
Less: Beginning net assets
as well off at year-end.
Total income for the year
$80,000
0
$80,000
(45,000 )
$35,000
Concepts of Income
Capital Maintenance Concept
Assume a corporation has net assets of $45,000 at the
beginning and $80,000 at the end of the year. Stockholders
made additional capital investments of $10,000.
Ending net assets
Less: Additional investment
Ending net assets excluding investment
Less: Beginning net assets
Total income for the year
$80,000
(10,000 )
$70,000
(45,000 )
$25,000
Concepts of Income
Transactional Approach
The transactional approach to
income measurement is used in
accounting today.
Concepts of Income
Transactional Approach
Under this concept, a company records its net
assets at their historical cost, and it does not
record changes in the asset and liabilities unless
a transaction, event, or circumstance has
occurred that provides reliable evidence of a
change in value.
Concepts of Income
Transactional Approach
A corporation’s net income for an accounting
period currently is measured as follows:
Net income = Revenues – Expenses + Gains - Losses
Revenues
Revenues are inflows (or increases) of
assets of a company or settlement of
its liabilities during a period from
delivering or producing goods,
rendering services, or other activities
that are the company’s ongoing
major or central operations.
Revenues Recognition
Recognition is the process of
formally recording and reporting
an item in a company’s financial
statements when they are earned.
Revenues
A company usually recognizes
revenue at the time goods are
sold or services are rendered.
Expenses
Expenses are outflows of assets of a
company or incurrences of liabilities
during a period from delivering or
producing goods, rendering services, or
carrying out other activities that are
the company’s ongoing major or
central operations.
Expense Recognition
Expenses should be matched or recognized in
the same period as the revenues they help
generate.
1.
2.
3.
Cause and effect
(cost of goods sold and commissions)
Systematic and rational (depreciation)
Immediate recognition (period costs)
Gains and Losses
Gains and losses are
reported net (not net of tax)
in contrast to revenues and
expenses, which are reported
gross. They appear in the
Other section of a multiple
step income statement.
Income Statement Content
1. Income from continuing operations









Sales revenue (net)
Cost of goods sold
Gross profit
Operating expenses
Income from operations
Other items
Income from continuing operations before tax
Income tax expense related to continued
operations
Income from continuing operations
Income Statement Content
2. Results from discontinued operations
a.
b.
Income (loss) from operations of
discontinued significant components (net
of income taxes).
Gain (loss) from disposals of
discontinued significant components (net
of income taxes).
Income Statement Content
3.
4.
5.
Extraordinary items (net of income taxes)
Net income
Earnings per share
That’s it!
Income Statement (Single-Step)
Proper Heading
{
Central Company
Income Statement
For the Year Ended 12/31/X9
Revenues and gains:
Sales, net
Interest income
Gain on sale of plant assets
Total revenues and gains
Expenses and losses:
Cost of goods sold
Selling Expenses
General and Admin. Exp.
Depreciation
Interest
Income taxes
Loss: sale of investment
Total expenses & losses
Net income
$
$
785,250
62,187
24,600
872,037
351,800
197,350
78,500
17,500
27,000
62,500
9,000
$
743,650
128,387
Income Statement (Single-Step)
{
Proper Heading
Revenues
& Gains
{
C e n tra l C o m p a n y
In c o m e S ta te m e n t
F o r th e Ye a r E n d e d 1 2 /3 1 /X 9
R e ve n u e s a n d g a in s:
S a le s, n e t
$
785,250
In te re st in co m e
62,187
G a in o n sa le o f p la n t a sse ts
24,600
T o ta l re ve n u e s a n d g a in s
872,037
Ex p e n se s a n d lo sse s:
Expenses
& Losses
{
C o st o f g o o d s so ld
S e llin g Ex p e n se s
$
351,800
197,350
G e n e ra l a n d A d m in . Ex p .
78,500
D e p re cia tio n
17,500
In te re st
27,000
In co m e ta x e s
62,500
L o ss: sa le o f in ve stm e n t
9,000
T o ta l e x p e n se s & lo sse s
N e t in co m e
743,650
$
128,387
Let’S take a
look at a
Multi-Step
Income
Statement,
next.
Income Statement (Multiple-Step)
{
Proper Heading
C e n tra l C o m p a n y
In c o m e S ta te m e n t
F o r th e Ye a r E n d e d 1 2 /3 1 /X 9
S a le s, n e t
$
785,250
C o st o f g o o d s so ld
351,800
G ro ss m a rg in
433,450
O p e ra tin g e x p e n se s:
S e llin g e x p e n se s
$
197,350
G e n e ra l & A d m in .
78,500
D e p re cia tio n
17,500
293,350
In co m e fro m O p e ra tio n s
140,100
O th e r re ve n u e s & g a in s:
In te re st in co m e
$
G a in
62,187
24,600
86,787
O th e r e x p e n se s:
In te re st
L o ss
$
27,000
9,000
(36,000)
In co m e b e fo re ta x e s
190,887
In co m e ta x e s
N e t in co m e
62,500
$
128,387
Cost of Goods Sold
BANNER CORPORATION
Schedule 1: Cost of Goods Sold
For Year Ended December 31, 2007
Inventory, January 1, 2007
Purchases
Freight-in
Cost of purchases
Less: Purchases returns
Net purchases
Cost of goods available for sale
Less: Inventory, December 31, 2007
Cost of goods sold
$ 41,000
$80,300
5,500
$85,800
(2,800)
83,000
$124,000
(38,000)
$ 86,000
Income Statement (Multiple-Step)
{
Proper Heading
Gross
Margin
{
C e n tra l C o m p a n y
In c o m e S ta te m e n t
F o r th e Ye a r E n d e d 1 2 /3 1 /X 9
S a le s, n e t
$
785,250
C o st o f g o o d s so ld
351,800
G ro ss m a rg in
433,450
O p e ra tin g e x p e n se s:
S e llin g e x p e n se s
$
197,350
G e n e ra l & A d m in .
78,500
D e p re cia tio n
17,500
293,350
In co m e fro m O p e ra tio n s
140,100
O th e r re ve n u e s & g a in s:
In te re st in co m e
$
G a in
62,187
24,600
86,787
O th e r e x p e n se s:
In te re st
L o ss
$
27,000
9,000
(36,000)
In co m e b e fo re ta x e s
190,887
In co m e ta x e s
N e t in co m e
62,500
$
128,387
Income Statement (Multiple-Step)
{
Proper Heading
Gross
Margin
Operating
Expenses
{
{
C e n tra l C o m p a n y
In c o m e S ta te m e n t
F o r th e Ye a r E n d e d 1 2 /3 1 /X 9
S a le s, n e t
$
785,250
C o st o f g o o d s so ld
351,800
G ro ss m a rg in
433,450
O p e ra tin g e x p e n se s:
S e llin g e x p e n se s
$
197,350
G e n e ra l & A d m in .
78,500
D e p re cia tio n
17,500
293,350
In co m e fro m O p e ra tio n s
140,100
O th e r re ve n u e s & g a in s:
In te re st in co m e
$
G a in
62,187
24,600
86,787
O th e r e x p e n se s:
In te re st
L o ss
$
27,000
9,000
(36,000)
In co m e b e fo re ta x e s
190,887
In co m e ta x e s
N e t in co m e
62,500
$
128,387
Operating Expenses
Operating expenses are
those primary recurring
costs (other than cost of
goods sold) incurred to
generate sales revenue.
Income Statement (Multiple-Step)
{
Proper Heading
Gross
Margin
Operating
Expenses
{
{
C e n tra l C o m p a n y
In c o m e S ta te m e n t
F o r th e Ye a r E n d e d 1 2 /3 1 /X 9
S a le s, n e t
$
C o st o f g o o d s so ld
351,800
G ro ss m a rg in
433,450
O p e ra tin g e x p e n se s:
S e llin g e x p e n se s
$
197,350
G e n e ra l & A d m in .
78,500
D e p re cia tio n
17,500
293,350
In co m e fro m O p e ra tio n s
Nonoperating
Items
{
785,250
140,100
O th e r re ve n u e s & g a in s:
In te re st in co m e
$
G a in
62,187
24,600
86,787
O th e r e x p e n se s:
In te re st
L o ss
$
27,000
9,000
(36,000)
In co m e b e fo re ta x e s
190,887
In co m e ta x e s
N e t in co m e
62,500
$
128,387
Income Statement (Multiple-Step)
{
Proper Heading
Gross
Margin
Operating
Expenses
{
{
C e n tra l C o m p a n y
In c o m e S ta te m e n t
F o r th e Ye a r E n d e d 1 2 /3 1 /X 9
S a le s, n e t
$
C o st o f g o o d s so ld
351,800
G ro ss m a rg in
433,450
O p e ra tin g e x p e n se s:
S e llin g e x p e n se s
$
197,350
G e n e ra l & A d m in .
78,500
D e p re cia tio n
17,500
293,350
In co m e fro m O p e ra tio n s
Nonoperating
Items
{
{
140,100
O th e r re ve n u e s & g a in s:
In te re st in co m e
$
G a in
62,187
24,600
86,787
O th e r e x p e n se s:
In te re st
L o ss
Taxes
785,250
$
27,000
9,000
(36,000)
In co m e b e fo re ta x e s
190,887
In co m e ta x e s
N e t in co m e
62,500
$
128,387
Other Items
Extraordinary gains and losses and discontinued
operations are . . .
Reported separately on the income
statement.
2. Shown net of any related taxes.
1.
Income Tax Expense
Income tax expense is matched against the following:
1.
2.
3.
Income from continuing operations
Income (loss) from the operations of a
discontinued component
Gain (loss) from the disposal of a discontinued
component
4.
Extraordinary items
5.
Any prior period adjustments
6.
Any items of other comprehensive income
Income Tax Expense
Interperiod tax allocation involves
allocating a corporation’s income tax
obligation as an expense to various
accounting periods because of temporary
(timing) differences between its taxable
income and pretax financial income.
Income Tax Expense
Intraperiod tax allocation involves
allocating a corporation’s total income
tax expense for a period to the various
components of its net income, retained
earnings, and other comprehensive
income.
Extraordinary Items
An extraordinary
item is an event or
transaction that is
both unusual in
nature and
infrequent in
occurrence.
Unusual nature--the
underlying event or
transaction possesses a high
degree of abnormality and is
of a type clearly unrelated
to, or only incidentally
related to, the ordinary and
typical activities of the
company.
Infrequency of
occurrence--the underlying
event or transaction is of a
type that is not reasonably
expected to recur in the
foreseeable future.
Extraordinary Items
Event
No
Report Gain (Loss) As
Unusual?
or
No
Infrequent?
Income from Continuing
Operation (Other Items
section)
Extraordinary Items
Event
No
Unusual?
Yes
and
Infrequent?
Yes
or
No
Report Gain (Loss) As
Extraordinary
Item
Extraordinary Items

Specific extraordinary items identified in
the pronouncement
◦ The direct result of a major casualty (such as
an earthquake).
◦ An expropriation.
◦ A prohibition under a newly enacted law or
regulation that clearly meets both criteria.
Extraordinary Items
Events that the APB Opinion No. 30 identified as not
qualifying as extraordinary:
1.
The write-down or write-off of receivables,
inventories, equipment leased to others, or
intangible assets.
2.
Gains or losses from exchanges or transactions of
foreign currency.
3.
Gains or losses from the disposals of a business
component.
Continued
Extraordinary Items
Events that the APB Opinion No. 30 identified as not
qualifying as extraordinary:
4.
Other gains or losses from the sale or
abandonment of property, plant, or equipment.
5.
The effects of a strike.
6.
The adjustment of accruals on long-term contracts.
7.
The effect of a terrorist attack.
Extraordinary Items
One other item is required to be reported as
an extraordinary item. As prescribed by
FASB Statement No. 141, when a company
purchases another company and pays less
than the fair value of the other company, it
reports the difference as an extraordinary
gain.
Extraordinary Items Example
During 19X8, Apex Co. experienced a loss of $75,000
due to an earthquake at one of its manufacturing plants
in Nashville. This was considered an extraordinary
item. The company reported income from continuing
operations of $128,387. All gains and losses are
subject to a 30% tax rate.
How would this item appear on the 19X8 income
statement?
Extraordinary Items Example
Extraordinary Loss $ (75,000)
Less: Tax Benefits
($75,000 × 30%)
22,500
Net Loss
$ (52,500)
Extraordinary Items Example
Extraordinary Loss
Less: Tax Benefits
($75,000 × 30%)
Net Loss
$ (75,000)
22,500
$ (52,500)
Income Statement Presentation:
In co m e b e fo re e x tra o rd in a ry ite m
$ 128,387
Ex tra o rd in a ry L o ss:
Ea rth q u a ke lo ss
(n e t o f ta x b e n e fit o f $22,500)
N e t in co m e
(52,500)
$ 75,887
Reporting Unusual or Infrequent Items

Some events are unusual or infrequent, but
not both.
For example:
 restructuring charges.
 gain or loss from the sale of assets.
I wonder how I
should report
these items.
Reporting Unusual or Infrequent Items
Psst! Why don’t you try
reporting them in Income
from Operations?
I wonder how I
should report
these items.
Discontinued Operations
What is a
component?
A company may decide to
“discontinue” some of its
operations and sell a component
of these operations.
Discontinued Operations
A component may
be a subsidiary, an
operating segment
or an asset group.
A component of a company
involves operations and cash
flows that can be clearly
distinguished, operationally
and for financial purposes,
from the rest of the company.
If a component of an entity has either been disposed of
or classified as held for sale,we report the results of its
operations separately in discontinued operations if two
conditions are met:
1. The operations and cash flows of the component have
been(or will be) eliminated from the ongoing operation.
2. The entity will not have any significant continuing
involvement in the operations of the component after the
disposal transaction..
FASB Statement No. 144 requires that all of the
following criteria be met to qualify for “held for sale”:
1. Management has committed to a plan to sell the component.
2. The component is available for immediate sale in its present
condition.
3. Management has begun an active program to locate a buyer.
4. The sale is probable within one year.
5. The component is being marketed for sale at a price that is
reasonable in relation to component’s fair market value.
6. It is unlikely that management will make significant changes
to the plan.
Held for Sale
Discontinued Operations

Two components are
accounted for:
◦ Results of operations for the
discontinued operations before the
disposal decision.
◦ Gain or loss from disposal of a
segment.
Income Statement: Results from Discontinued
Operations
Income from continuing operations
Results from discontinued operations:
Income from operations of
discontinued Division X (net
of $2,880 income taxes)
Loss on disposal of Division X
(net of $6,000 income tax credit)
Income before extraordinary items
$93,000
Reported net of taxes
$ 6,720
(14,000 )
(7,280 )
$85,720
Reported net of taxes
Income Statement: Results from Discontinued
Operations
Note that discontinued
operations are reported on the
income statement after the
continuing operations, but
before extraordinary items.
Income Statement: Results from Discontinued
Operations
Income from continuing operations
Results from discontinued operations:
Income from operations of
discontinued Division X (net
of $2,880 income taxes)
$93,000
$ 6,720
Income before extraordinary items
Element 1: operating income (loss)
$85,720
Income Statement: Results from Discontinued
Operations
Income from continuing operations
Results from discontinued operations:
Income from operations of
discontinued Division X (net
of $2,880 income taxes)
Loss on disposal of Division X
(net of $6,000 income tax credit)
Income before extraordinary items
$93,000
$ 6,720
(14,000 )
Element 2: gain or loss on disposal
(7,280 )
$85,720
Income Statement: Results from Discontinued
Operations
Sale Illustration
On September 30, 2007, Duvall Company sells
Division C (a component of its operations) for
$102,000 and incurs $2,000 of legal fees and closing
costs. At the time of the sale, the book values of
Division C’s assets and liabilities are $150,000 and
$80,000, respectively. Duvall Company is subject to a
30% income tax rate.
Continued
Sale Illustration
Net cash received ($102,000 – $2,000)
$100,000
Book value of net assets of Division C:
Assets
$150,000
Liabilities
Net book value
Pretax gain
Income tax (30%)
After-tax gain
(80,000 )
(70,000 )
$ 30,000
(9,000 )
$ 21,000
Sale in a Later Accounting Period
When a company classifies a significant
component as held for sale, it records and reports
the component at the lower of (1) its book value
(book value of assets minus book value of
liabilities) or (2) its fair value (the amount at which
the assets and liabilities as a whole could be sold in
a current single transaction) less any cost to sell.
Sale in a Later Accounting Period
Elmo Company classifies Division M (a significant component
of its operations) as “held for sale” at the end of 2007. Elmo
Company expects to sell Division M in 2008 at its fair value of
$200,0000 (consisting of assets with a fair value of $300,000
and liabilities with a fair value of $100,000). At the end of
2007, the book value of Division M is $240,000 (assets book
value, $330,000; liabilities book value, $90,000). The
company is subject to a 30% income tax rate.
Continued
Fair value of Division M
$200,000
Book value of net assets of Division M:
Assets
$330,000
Liabilities
(90,000 )
Net book value
(240,000 )
Pretax loss
$ (40,000 )
End of 2007
Loss on Write-Down of Held-For-Sale
Division M (pretax)
Liabilities of Division M
Assets of Division M
40,000
10,000
30,000
Income Statement: Results from Discontinued
Operations
Disclosures Required by FASB Statement No. 144
 A description of the facts and circumstances
leading up to the sale, and, if held-for-sale, the
expected manner and timing of the sale.
 The revenues and pretax income (loss) of the
component included in its operating income (loss)
reported in the results of discontinued operations
section of the company’s income statement.
Continued
Income Statement: Results from Discontinued
Operations
Disclosures Required by FASB Statement No. 144
 If not reported separately on its income statement,
the gain (loss) on the sale and the caption on the
income statement that includes the gain (loss).
 If not separately reported on its balance sheet, the
book value of the major classes of assets and
liabilities.
Reporting Accounting Changesc

Change in estimates

Change in accounting principle

Change in reporting entity
Change in Estimates



Revision of a previous accounting
estimate.
The new estimate should be used in
the current and future periods.
The prior accounting results should
not be disturbed –FASB Statement No.
154.
Change in Estimates
Example
On January 1, 19X5, we purchased equipment
costing $30,000, with a useful life of 10 years
and no salvage value. During 19X8, we
determine that the remaining useful life is 5
years (8-year total life). We use straight-line
depreciation.
◦ Calculate depreciation expense for 19X8 based upon
this new estimate.
Change in Estimates
Example
Asset cost
Accumulated depreciation
12/31/X7 - ($3,000 × 3 years)
Remaining to be depreciated
Remaining useful life
Revised annual depreciation
$
30,000
$
(9,000)
21,000
÷ 5 years
4,200
Record depreciation expense of $4,200 for
19X8 and subsequent years.
Change in Accounting Principle



Occurs when changing from one GAAP method to
another GAAP method.
Make a catch-up adjustment known as the
cumulative effect of a change in accounting
principle.
The cumulative effect is reported net of taxes and
directly after the beginning retained earnings
amount on the company’s retained earnings
statement.
Let’s
move on
to a few
final
topics.
Other Topics

Earnings Per Share.

Statement of Retained Earnings.

Prior Period Adjustments.

Comprehensive Income
Earnings Per Share
Generally computed as follows:
Net Income Available
to Common
Shareholders
÷
Average Number of
Common Share
Outstanding
Statement of Retained Earnings
Retained earnings is the
link between a
corporation’s balance sheet
and its income statement.
Statement of Retained Earnings
Beginning retained earnings
Plus (minus): Prior period adjustment
(net of $2,400 income taxes)
Adjusted beginning retained earnings
Plus (minus): Net income (loss)
Minus: Dividends (specifically identified,
including per share amounts)
Ending retained earnings
$59,200
5,600
$64,800
22,300
$87,100
(9,400)
$77,700
Prior Period Adjustments



Corrections of errors from a previous
period.
Appear on the Statement of Retained
Earnings as an adjustment to
beginning retained earnings.
Must show the adjustment net of
income taxes.
Comprehensive Income
Recall that the FASB now requires companies
to report their comprehensive income (or loss)
for the accounting period.
A company’s comprehensive income consists of
two parts: net income and other
comprehensive net income. Currently, there
are four items of a company’s other
comprehensive income:
Continued
Comprehensive Income
1.
2.
3.
4.
Any unrealized increases (gains) or decreases
(losses) in the market value of investments in
available-for-sale securities.
Any change in the excess of its additional
pension liability over unrecognized prior
service costs.
Certain gains and losses on “derivative”
financial instruments.
Any transaction adjustment from converting the
financial statements of a company’s foreign
operations into U. S. dollars.
Comprehensive Income
The FASB allows a company to report its
comprehensive income under three alternatives:
 In a separate statement of comprehensive income.
 On the face of its income statement.
 In its statement of changes in stockholders’ equity.
The company must display the statement
containing the comprehensive income as a major
financial statement in its annual report.
Whose
Idea
was
this?
OH NO!
YOURS...
The income statement reports the
results from operating the business
for a period of time, such as a year.
It is helpful to think of the income statement as
comprising 5 types of activities:
Income Statement: 5 types of
activities:





Selling the product
The cost of producing or acquiring the goods or
services sold
The expenses incurred in marketing and
distributing the product or service to the customer
along with administrative operating expenses
The financing costs of doing business: for
example, interest paid to creditors and dividend
payments to the preferred stockholders
The taxes owed based on a firm’s taxable income
Income Statement
SALES
- EXPENSES
= PROFIT
Income Statement
SALES
- EXPENSES
= PROFIT
Revenue
Income Statement
SALES
- EXPENSES
= PROFIT
•Cost of Goods Sold
•Operating Expenses
(marketing, administrative)
•Financing Costs
•Taxes
Income Statement
SALES
- Cost of Goods Sold
GROSS PROFIT
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT)
- Income Taxes
EARNINGS AFTER TAXES (EAT)
- Preferred Stock Dividends
- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS
Income Statement
SALES
- Cost of Goods Sold
GROSS PROFIT
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT)
- Income Taxes
EARNINGS AFTER TAXES (EAT)
- Preferred Stock Dividends
- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS
Income Statement
SALES
- Cost of Goods Sold
GROSS PROFIT
- Operating Expenses
OPERATING INCOME (EBIT)
- Interest Expense
EARNINGS BEFORE TAXES (EBT)
- Income Taxes
EARNINGS AFTER TAXES (EAT)
- Preferred Stock Dividends
- NET INCOME AVAILABLE
TO COMMON STOCKHOLDERS
Balance Sheet
The balance sheet provides a snapshot of the firm’s
financial position at a specific point in time,
presenting its asset holdings, liabilities, and ownersupplied capital.
The balance sheet is not intended to represent the
current market value of the company, but rather
reports the historical transactions recorded at their
costs.
Balance Sheet
Total Assets
=
Outstanding
Debt
+
Shareholders’
Equity
Assets
represent the resources owned by the firm
1.
2.
3.
Current assets - consisting primarily of cash,
marketable securities, accounts receivable,
inventories, and prepaid expenses
Fixed or long-term assets – comprising
equipment, buildings, and land
Other assets – all assets not otherwise included
in the firm’s current assets or fixed assets, such
as patents, long-term investments in securities,
and goodwill
The liabilities and owners’ equity
indicate how the assets are financed.
(1) The debt consists of such sources as credit
extended from suppliers or a loan from a bank.
(2)
The equity includes the stockholders’ investment
in the firm and the cumulative profits retained in
the business up to the date of the balance sheet.
Assets
Balance Sheet
Liabilities (Debt) & Equity
Current Assets
Cash
Marketable Securities
Accounts Receivable
Inventories
Prepaid Expenses
Fixed Assets
Machinery & Equipment
Buildings and Land
Other Assets
Investments & patents
Current Liabilities
Accounts Payable
Accrued Expenses
Short-term notes
Long-Term Liabilities
Long-term notes
Mortgages
Equity
Preferred Stock
Common Stock (Par
value)
Paid in Capital
Retained Earnings
Assets

Current Assets: assets that are relatively liquid,
and are expected to be converted to cash within a
year.
◦ Cash, marketable securities, accounts receivable,
inventories, prepaid expenses.


Fixed Assets: machinery and equipment,
buildings, and land.
Other Assets: any asset that is not a current asset
or fixed asset.
◦ Intangible assets such as patents and copyrights.
Financing


Debt Capital: financing provided by a creditor.
Short-term debt: borrowed money that must be
repaid within the next 12 months.
◦ Accounts payable, other payables such as interest or
taxes payable, accrued expenses, short-term notes.

Long-term debt: loans from banks or other
sources that lend money for longer than 12
months.
Financing



Equity Capital: shareholders’ investment in the
firm.
Preferred Stockholders: received fixed dividends,
and have higher priority than common
stockholders in event of liquidation of the firm.
Common Stockholders: residual owners of a
business. They receive whatever is left after
creditors and preferred stockholders are paid.
Computing a company’s Taxes
Types of taxpayers
1. Sole proprietors
2. Partnerships
3. Corporations
Computing a company’s Taxes
Sole proprietors


Report business income on personal tax
returns
Pay taxes at personal tax rate
Computing a company’s Taxes
Partnerships
a. The partnership reports income but does
not pay taxes
b. Each partner reports his or her portion of
income and pays the corresponding taxes.
Computing a company’s Taxes
a.
b.
c.
Corporations
Corporation reports income and pays taxes
Owners do not report these earnings except
when all or part of the profit is paid out as
dividends.
Our focus is on corporate taxes.
Computing Taxable Income
1. Taxable income is based on gross income less
tax-deductible expenses
a.
b.
Interest expense is tax deductible
Dividend payments are not tax deductible
2. Depreciation
a.
b.
Modified accelerated cost recovery system used
for computing depreciation for tax purposes
We use straight-line depreciation to reduce
complexity.
Corporate Income Tax Rates
Taxable Income
$1 - $50,000
$50,001 - $75,000
$75,001 - $100,000
$100,001 - $335,000
$335,001 - $10,000,000
$10,000,001 - $15,000,000
$15,000,001 - $18,333,333
over $18,333,333
Since 1993
Corporate Tax Rate
15%
25%
34%
39%
34%
35%
38%
35%
Computing Taxes Owed
1. Taxes paid are based on corporate tax structure.
2. Tax rates used to calculate tax liability are marginal
tax rates, or the rate applicable to the next dollar of
income.
3. Average tax rate is calculated by dividing taxes
owed by the firm’s total income
4. Marginal tax rate is used in financial decision
making
Computing Taxes Owed

Space Cow Computer has sales of $32 million,
cost of goods sold at 60% of sales, cash
operating expenses of $2.4 million, and $1.4
million in depreciation expense. The firm has
$12 million in 9.5% bonds outstanding. The firm
will pay $500,000 in dividends to its common
stock holders.

Calculate the firm’s tax liability.
Computing Taxes Owed
Sales
Cost of Goods Sold
Operating Expenses
Depreciation Expense
EBIT or NOI
Interest Expense
Taxable Income
$32,000,000
(19,200,000)
(2,400,000)
(1,400,000)
9,000,000
(1,140,000)
7,860,000
Computing Taxes Owed
Income
tax rate
$50,000 x .15
$25,000 x .25
$25,000 x .34
$235,000 x .39
$7,525,000 x .34
Total Tax payment
tax payment
=
=
=
=
=
$
7,500
6,250
8,500
91,650
2,558,500
$2,672,400
short cut: $7,860,000 x .34 = $2,672,400
Tax Example: 2-3A
Delaney, Inc. - Corporate Income Tax
Sales
$4,000,000
Cost of goods sold and
cash operating expenses
2,400,000
Depreciation expense
100,000
Operating profit
$1,500,000
Interest expense
150,000
Taxable Income
$1,350,000
Tax Example: 2-3A
Tax Liability:
$50,000 x 0.15
25,000 x 0.25
25,000 x 0.34
235,000 x 0.39
1,015,000 x 0.34
$1,350,000
=
=
=
=
=
$7,500
6,250
8,500
91,650
345,100
$459,000
Tax Example: 2-3A
Potts, Inc. - Corporate Income Tax
Sales
$ 6,000,000
Cost of goods sold and
cash operating expenses
Operating profit
5,600,000
$
400,000
Interest expense
30,000
Taxable Income
$ 370,000
Tax Example: 2-4A
Tax Liability:
$50,000 x 0.15
25,000 x 0.25
25,000 x 0.34
235,000 x 0.39
35,000 x 0.34
$370,000
=
=
=
=
=
$7,500
6,250
8,500
91,650
11,900
$125,800
Free Cash Flows
In measuring cash flows, we could use the
conventional accountant’s presentation called a
statement of cash flows. However, we are more
interested in considering cash flows from the
perspective of the firm’s shareholders and its
investors, rather than from an accounting view.
Free Cash Flows
We will instead measure the cash flow that is free
and available to be distributed to the firm’s
investors, both debt and equity investors, or what
we will call free cash flows.
Free Cash Flows
While an income statement measures a company’s
profits, profits are not the same as cash flows; profits
are calculated on an accrual basis rather than a
cash basis.
The cash flows that are generated through a firm’s
operations and investments in assets will always
equal its cash flows paid to – or received from – the
company’s investors (both creditors and
stockholders).
Free Cash Flows
Firm’s Operating
Free cash flows
Cash flows
generated through
the firm’s operations
and investments in
assets
=
=
Firm’s Financing
Free cash flows
Cash flows paid to or received by - the
firm’s investors
(creditors &
stockholders)
Calculating Free Cash Flows:
An Operating
Perspective
The after-tax cash flows generated from operations
less the firm's investments in assets.
It is this same amount that will be available for
distributing to the firm’s investors. That is, a firm's
free cash flows for a given period is equal to:
Calculating Free Cash Flows:
Perspective
After-tax cash flow
from operations
less
investment in net
operating working
capital
less
investments in fixed
and other assets
An Operating
Calculating Free Cash Flows:
An Operating
Perspective
After-tax cash flow
from operations
less
investment in net
operating working
capital
less
investments in fixed
and other assets
Operating income
+ depreciation
- cash tax payments
Calculating Free Cash Flows:
An Operating
Perspective
After-tax cash flow
from operations
less
investment in net
operating working
capital
less
investments in fixed
and other assets
[Change in current
assets]
-
[change in non-interest
bearing current liabilities]
Calculating Free Cash Flows:
An Operating
Perspective
After-tax cash flow
from operations
less
investment in net
operating working
capital
less
investments in fixed
and other assets
Investments in
fixed assets
includes the
change in gross
fixed assets and
any other balance
sheet assets not
already
considered.
What are the five uses of FCF?
1. Pay interest on debt.
2. Pay back principal on debt.
3. Pay dividends.
4. Buy back stock.
5. Buy nonoperating assets (e.g., marketable
securities, investments in other companies,
etc.)
Income Statement
2003
2004
Sales
3,432,000
5,834,400
COGS
2,864,000
4,980,000
340,000
720,000
18,900
116,960
3,222,900
5,816,960
209,100
17,440
62,500
176,000
146,600
(158,560)
Taxes (40%)
58,640
(63,424)
Net income
87,960
(95,136)
Other expenses
Deprec.
Tot. op. costs
EBIT
Int. expense
EBT
Income Statement




Sales increased by over $2.4 million.
Costs shot up by more than sales.
Net income was negative.
However, the firm received a tax refund since it
paid taxes of more than $63,424 during the
past two years.
Balance Sheet: Assets
2003
2004
9,000
7,282
48,600
20,000
AR
351,200
632,160
Inventories
715,200
1,287,360
Total CA
1,124,000
1,946,802
Gross FA
491,000
1,202,950
Less: Depr.
146,200
263,160
Net FA
344,800
939,790
1,468,800
2,886,592
Cash
S-T invest.
Total assets
Balance Sheet: Assets

Net fixed assets almost tripled in size.

AR and inventory almost doubled.

Cash and short-term investments fell.
Balance Sheet: Liabilities & Equity
2003
2004
Accts. payable
145,600
324,000
Notes payable
200,000
720,000
Accruals
136,000
284,960
481,600
1,328,960
Long-term debt
323,432
1,000,000
Common stock
460,000
460,000
Ret. earnings
203,768
97,632
Total equity
663,768
557,632
1,468,800
2,886,592
Total CL
Total L&E
Balance Sheet: Liabilities & Equity
NOWC =
Operating
CA
Operating
CL
NOWC04
= ($7,282 + $632,160 + $1,287,360)
- ($324,000 + $284,960)
= $1,317,842.
NOWC03
= $793,800.
Operating
capital
= NOWC + Net fixed assets.
Operating
capital04
= $1,317,842 + $939,790
= $2,257,632.
Operating
capital03
= $1,138,600.
NOPAT = EBIT(1 - Tax rate)
NOPAT04
= $17,440(1 - 0.4)
= $10,464.
NOPAT03
= $125,460.
FCF = NOPAT - Net investment in
operating capital
= $10,464 - ($2,257,632 - $1,138,600)
= $10,464 - $1,119,032
= -$1,108,568.
How do you suppose investors reacted?
ROIC = NOPAT / operating capital
ROIC04 = $10,464 / $2,257,632 = 0.5%.
ROIC03 = 11.0%.


No. The ROIC of 0.5% is less than the WACC of
10%. Investors did not get the return they
require.
Note: High growth usually causes negative FCF
(due to investment in capital), but that’s ok if
ROIC > WACC. For example, Home Depot has
high growth, negative FCF, but a high ROIC.
EVA = NOPAT- (WACC)(Capital)
EVA04 = $10,464 - (0.1)($2,257,632)
= $10,464 - $225,763
= -$215,299.
EVA03 = $125,460 - (0.10)($1,138,600)
= $125,460 - $113,860
= $11,600.
Stock price
# of shares
EPS
DPS
2003
$8.50
100,000
$0.88
$0.22
2004
$2.25
100,000
-$0.95
$0.11



MVA = Market Value of the Firm - Book Value of
the Firm
Market Value = (# shares of stock)(price per
share) + Value of debt
Book Value = Total common equity + Value of
debt
(More…)

If the market value of debt is close to the book value
of debt, then MVA is:
MVA =
Market value of equity – book value of equity

Market Value of Equity 2004:
◦ (100,000)($6.00) = $600,000.

Book Value of Equity 2004:
◦ $557,632.
MVA04 = $600,000 - $557,632 = $42,368.
MVA03 = $850,000 - $663,768 = $186,232.
Cash Flow Reporting
the Trend Toward Cash Flows

Increased Business Risk
-- Growing bankruptcy rate in the 70’s and 80’s.
-- The problem of uneven cash flows for small
companies.
-- Cash flow information helps investors avoid losses
from business failures.
Cash Flow Reporting
the Trend Toward Cash Flows

Previous Funds Statements
-- Statement of Changes in Financial Position (APB
Opinion No. 19)
 Cash Basis or Working Capital Basis

Differences between Cash and Accrual Accounting
-- GAAP is increasingly complex.
Cash flow information is important in the short run.
Cash Flow Reporting
the Usefulness of Cash Flows

Free cash flow
Operating
Cash
Receipts

-
(
Necessary Operating
and Capital
Expenditures
+
Debt
Service
Payments
Financial flexibility
-- the ability to use cash flows to meet unexpected
needs and opportunities.
)
Statement of Cash Flows
Purpose
The Statement helps users assess . . .

a firm’s ability to generate cash.

a firm’s ability to meet its obligations.


the reasons for differences between income and
associated cash flows.
the effect of cash and noncash investing and
financing activities on a firm’s financial position.
SFAS No. 95 Requirements


Requires the use of cash and cash equivalents as
the basis of reporting.
Allows two methods of reporting.
Direct Method
Shows actual net cash inflow (outflow) from
operations.
Indirect Method
Shows net cash inflow (outflow) from operations
as an adjustment of net income.
Cash and Cash Equivalents


Cash is characterized as those items immediately
available to pay obligations.
Cash Equivalents are characterized as
-- Short-term, highly liquid investments.
-- Readily convertible into known and fixed amounts of
cash.
-- So near maturity that there is insignificant risk of
market value fluctuation from interest rate changes.
Cash Flow Categories

Cash Flows from Operating
Activities
--Can be determined using either
the direct method or the indirect
method.


Cash Flows from Investing
Activities
Cash Flows from Financing
Activities
Cash From Operating Activities

Inflows

Outflows
Receipts from customers
Payments to suppliers
Interest received
Payments to employees
Dividends received
Interest payments
Refunds from suppliers
Income tax payments
Revenues received in
advance
Payments on operating
leases
Cash Flows From Investing Activities

Inflows

Outflows
Proceeds from plant assets
sales
Payments to purchase plant
assets
Proceeds from sales and
maturities of debt and
equity securities
Purchases of debt and
equity securities
Collections of loan principal
Payments to purchase real
estate
Sale of real estate
Loans to others
Cash Flows From Financing Activities

Inflows
Proceeds from debt for
specific investing
activities
Proceeds from loans from
financial institutions
Proceeds from stock or
bond issues

Outflows
Dividends paid to
stockholders
Principal payments on loans
from financial institutions
Principal payments on
capital leases
Noncash Activities


Disclosure is required for significant noncash
investing and financing activities.
Disclosure should appear in a supporting schedule
to the Statement of Cash Flows or in the Notes to
the Financial Statements.
Noncash Activities

Common noncash activities include:
- Retirement of bonds by issuing stock.
- Settlement of debt by transferring assets.
- Incurrence of capitalized lease obligations.

SFAS No. 95 provides no guidance with regard to
stock dividends or stock splits.
Direct Method
Under the direct method, a
company deducts its operating
cash outflows from its
operating cash inflows to
determine its net cash flow
from operating activities.
Operating Cash Flows
Direct Method


Information regarding cash flows must
come from several sources.
The order for the information search is:
- The income statement.
- Additional statements or schedules.
- The comparative balance sheets.
Direct Method
Inflows (3)
1. Cash from customers (A/R)
2. Cash from interest revenue (Interest Receivable)
3. Cash from dividend revenue (Dividends Rec.)
Outflows (5)
1. Cash paid to suppliers (A/P)
2. Cash paid for wages (Wages Payable)
3. Other cash expenses (Prepaid/Accrued)
4. Cash paid for interest expense (Interest Payable)
5. Cash paid for taxes (T/P and Deferred Tax)
Direct Method
Use T accounts to examine the 3
inflows and 5 outflows in the
direct method.
Cash From Customers
Sales Revenue
Accounts Receivable
30,000
42,000
Bal.
Bal.
0
42,000
37,000
5,000
Smith Company made cash sales of $30,000 and credit
sales of $42,000. How much cash was collected from
customers?
$67,000
Cash From Customers
Analyzing Sales


The key information is cash collected from
customers.
Can be computed two ways:
Obtained from cash receipts journal
Obtained from accrual sales information:
Collections
on Account
Accrual-basis
= Revenues
{
+ Decrease in net A/R
- Increase in net A/R
Analyzing Sales
Question
The balance in A/R was $40,000 on 1/1/X8 and
the balance was $52,000 on 12/31/X8. If total
sales revenue for 19X8 was $800,000, then how
much cash was received from customers?
a. $800,000
b. $760,000
c. $812,000
d. $788,000
Analyzing Sales
Question
The balance in A/R was $40,000 on 1/1/X8 and
the balance was $52,000 on 12/31/X8. If total
sales revenue for 19X8 was $800,000, then how
much cash was received from customers?
A/R increased $12,000 during
a. $800,000
the year.
b. $760,000
Subtract increases in A/R during
c. $812,000
the year from total revenues to
d. $788,000
arrive at cash collected from
customers.
$800,000 - $12,000 = $788,000
Cash From Customers
Deferred Revenue

Receipts can be found in the cash receipts journal.

Receipts can also be inferred:
Cash
Collections
=
Accrual-basis
Revenue
{
+ Increase in Deferred
Revenues
- Decrease in Deferred
Revenues
Dividends and Interest Collected
Interest Receivable
Bal.
30,000
Revenue 42,000
Bal.
12,000
Dividends Receivable
Bal.
0
Revenue 4,000
Bal.
1,000
Ives Company earned interest revenue of $42,000 & dividend
revenue of $4,000. Interest Receivable had a beginning balance of
$30,000 and an ending balance of $12,000. Dividends receivable had
a beginning balance of $0 and an ending balance of $1,000. How
much cash from interest and dividends was collected?
Dividends and Interest Collected
=72,000 Interest Receivable
Bal.
30,000
Revenue 42,000
Bal.
12,000
60,000
=4,000 Dividends Receivable
Bal.
0
3,000
Revenue 4,000
Bal.
1,000 =4,000
=72,000
Ives Company earned interest revenue of $42,000 and
dividend revenue of $4,000. During the year $60,000
of interest and $3,000 of dividends was collected.
Cash Paid to Suppliers

Payments can be found in the purchases journal.
-- assuming accounts payable is used to purchase
inventory.
Cash Paid to Suppliers
62,000
Accounts Payable
Cash paid
$47,700
59,800
62,000 Inventory
10,300 59,800 Bal.
12,500 51,000 Cost of
goods sold
49,500
Purchases
49,500
12,100
Bal.
11,000
Copeland Company had beginning and ending balances in
Accounts Payable of $10,300 and $12,100, respectively. The
beginning and ending balances in inventory were $12,500 and
$11,000 respectively. The cost of goods sold was $51,000. How
much cash was paid to suppliers?
Cash Paid to Suppliers

Payments can be inferred:
Cash
paid for
Inventory
Purchases
=
Cost
of
Goods
Sold
{
+ Inventory Increase
- Inventory Decrease
+ A/P Decrease
- A/P Increase
Cash Paid to Suppliers
Question
Examine the following information and determine
how much was paid for inventory in X7.
Inventory, 1/1/X7
Inventory, 12/31/X7
COGS, 12/31/X7
a. $900,000
b. $923,000
c. $947,000
d. $877,000
$ 130,000
$ 165,000
$ 900,000
A/P, 1/1/X7
A/P, 12/31/X7
$ 23,000
$ 35,000
Cash Paid to Suppliers
Question
Examine the following information and determine
how much was paid for inventory in X7.
In v e n to ry , 1 /1 /X 7
$ 1 3 Inventory
0 ,0 0 0
Aincreased
/P , 1 /1 /X 7
In v e n to ry , 1 2 /3 1 /X 7
$ 1 6 X7.
5 ,0 0 0
C O G S , 1 2 /3 1 /X 7
$ 9 0 0 ,0 0 0
a. $900,000
b. $923,000
c. $947,000
d. $877,000
$35,000
$ 2 3 ,0in
00
A /P , 1 2 /3 1 /X 7
$ 3 5 ,0 0 0
Accounts Payable increased
$12,000 in X7.
+ Inventory Increases
- Accounts Payable Increases
$900,000 +$35,000 - $12,000 =
$923,000
Cash Paid to Employees

Payments can be pulled from the payroll
journal.
Cash Paid to Employees
Salaries Payable
0 Bal.
Cash paid 13,000
14,000 Salaries expense
1,000 Bal.
Smith Company had beginning and balances in Salaries
Payable of $0 and $1,000. respectively. Salary expense for the
year was $14,000. How much cash was paid to employees?
Cash Paid to Employees

Cash paid to employees can be computed
from the accrual-basis expense.
Cash paid to
Employees
Accrual-basis
= Expense
{
+ Decrease in Payable
- Increase in Payable
Cash Paid to Employees
Question
Salary Expense for X7 was $700,000. The balance
in Salary Payable was $35,000 on 12/31/X6 and
the balance was $10,000 on 12/31/X7. How much
cash was paid to employees in X7?
a.
$700,000
b.
$735,000
c. $725,000
d.
$675,000
Cash Paid to Employees
Question
Salary Expense for X7 was $700,000. The balance
in Salary Payable was $35,000 on 12/31/X6 and
the balance was $10,000 on 12/31/X7. How much
cash was paid to employees in X7?
Salary Payable decreased
a. $700,000
$25,000 during the year.
b.
$735,000
Add the decrease in Salary
c. $725,000
Payable to Salary Expense to
d. $675,000
arrive at cash paid to
employees.
$700,000 + $25,000 = $725,000
Cash Expenses

Payments can be found in the cash
disbursements journal.
Cash Expenses
Prepaid/Accrued Expenses
Prepaid Bal.
20,000
Cash paid 320,000
Prepaid Bal.
12,000
60,000 Accrued Bal.
300,000 Cash operating expenses
32,000 Accrued Bal.
Wolverine Company paid $320,000 for expenses.
Cash Expenses

Payments can be inferred:
Cash
Payments
=
Accrual-basis
Expense
{
+ Decrease in Payable
- Increase in Payable
Direct Method
Prepaid Expenses


Payments can be found in the cash
disbursements journal.
Payments can be inferred:
Cash
Payments
=
Accrual-basis
Expense
{
+ Increase in Prepaid
Expenses
- Decrease in Prepaid
Expenses
Direct Method
Estimated Expenses

Depreciation, Amortization,
and Depletion Expenses
-- Operating cash flows are
not involved.
-- They are not disclosed in
the operating cash flows
section of the direct method
statement.
Direct Method
Ryan Corporation’s Income
Statement
Sales revenue (cash and A/R)
Less:
Cost of goods sold (cash and A/P)
Salaries expense (cash and S/P)
Depreciation expense
Income before income taxes
Income tax expense (cash)
Net income
$70,000
$(29,000)
(13,000)
(8,000)
(50,000)
$20,000
(6,000)
$14,000
Cash From CustomersRyan Company
Sales Revenue
Accounts Receivable
70,000
Bal.
22,600
70,000
Bal.
20,000
Accounts receivable decreased by $2,600 for Ryan
Company. How much cash was collected from
customers?
$72,600
72,600
Cash Paid to SuppliersRyan Company
Accounts Payable
Cash paid
$38,000
Inventory
10,300
Bal.
9,000
31,000
Purchases
31,000
3,300
Bal.
11,000
29,000 Cost of
goods sold
Ryan Company had beginning and ending balances in
Accounts Payable of $10,300 and $3,300, respectively. The
beginning and ending balances in inventory were $9,000 and
$11,000 respectively. The cost of goods sold was $29,000.
How much cash was paid to suppliers?
Cash Paid to EmployeesRyan Company
Ryan Company had beginning and balances in Salaries
Payable of $200 and $1,000. respectively. Salary expense for
the year was $13,000. How much cash was paid to
employees?
Salaries Payable
200 Bal.
Cash paid 12,200
13,000 Salaries expense
1,000 Bal.
Ryan Company had no change in the Taxes Payable and Deferred
Taxes accounts.
Direct Method-Ryan Company
Cash flows From Operating Activities:
Cash Inflows:
Cash received from customers
$72,600
Cash inflows from operating
activities
Cash Outflows:
Cash paid to suppliers
$(38,000)
Cash paid to employees
(12,200)
Cash paid for income taxes
(6,000)
Cash outflows for operating
activities
Net cash provided by operating activities
$72,600
(56,200)
$16,400
Direct Method
Remember to check for these cash flows.
Inflows (3)
1. Cash from customers (A/R)
2. Cash from interest revenue (Interest Receivable)
3. Cash from dividend revenue (Dividends Rec.)
Outflows (5)
1. Cash paid to suppliers (A/P)
2. Cash paid for wages (Wages Payable)
3. Other cash expenses (Prepaid/Accrued)
4. Cash paid for interest expense (Interest Payable)
5. Cash paid for taxes (T/P and Deferred Tax)
Operating Cash Flows
Indirect Method

Determines net cash flows from operating activities
by
- starting with net income.
- disclosing items that reconcile net income to
operating cash flows.

Individual operating cash flows are not disclosed.
Steps in Visual Inspection Method-Indirect
Method
1.
Prepare the statement’s heading and list the
three major sections.
2.
Determine the net income and list it as the
first item in the net cash flow from operating
activities section.
3.
Add back any non-cash expenses.
4.
Adjust net income for gains and losses not
related to operations.
Continued
Steps in Visual Inspection Method-Indirect
Method
5.
Adjust net income for the change in deferred taxes
6.
Adjust net income for income and losses on
investments carried under the equity method.
Continued
Indirect Method
Reconciling Items

Add to net income
-- Depreciation, depletion and amoritzation expense.
-- Losses.
-- Noncash expenses.

Subtract from net income
-- Gains.
-- Bond premium amortization.
-- Noncash Revenues.
Steps in Visual Inspection Method-Indirect
Method
7.
Examine all working capital accounts, except cash,
short-term non-trade notes payable and dividends
payable.
A Debit to a noncash account is a Decrease in
cash. (If the account had net debits during the
year).
A Credit to a noncash account is an increase in
cash. (if the account had net credits during the
year).
Continued
Indirect Method
Working Capital Accounts
Change in Account Balance during Year
Increase
Decrease
Current
Assets
Subtract from net
income
Add to net income
Current
Liabilities
Add to net income
Subtract from net
income
Note: Cash and cash equivalents, short-term investments in securities
available for sale, dividends payable, and short-term payables to financial
institutions are excluded from this category.
Steps in Visual Inspection Method-Indirect
Method
8.
Calculate the cash provided or cash used by
operating activities.
9.
Examine comparative balance sheets for changes
in non-current assets.
10. Calculate the cash provided or cash used by
investing activities.
11. Examine long-term liabilities and equity accounts.
Continued
Steps in Visual Inspection Method-Indirect
Method
12. Calculate the cash provided or cash used by
13.
14.
15.
16.
17.
financing activities.
Calculate the net change in cash that occurred
during the accounting period.
Add the beginning cash
The total should equal the ending cash on the
balance sheet
List interest and taxes paid.
List significant noncash investing and financing
activities.
Simple Statement of
Cash Flows
RYAN COMPANY
Statement of Cash Flows
For Year Ended December 31, 2007
The statement’s
heading
Adjustments to Net Income
Remember the adjustments
to net income are:
• Noncash expenses
• Gains/losses on
investments
• Deferred taxes
• Equity income
• Working capital changes
Indirect MethodRyan Corporation
Added back
since
depreciation
is not an
$14,000
outflow of
cash.
Net Cash flows From Operating Activities:
Net income
Adjustments for differences
between income flows and cash
flows for operating activities:
Add: Depreciation expense
8,000
Credits to
Decrease in accounts receivable
2,600
noncash
accounts
Increase in salaries payable
800
Debits to
Less: Increase in inventory
(2,000)
noncash
Decrease in accounts payable
(7,000)
accounts
Net cash provided by operating
Same number as
activities
$16,400
direct method
Leyton Company Information
Simple Statement of Cash Flows-Leyton
Company
Net Cash Flow From Operating Activities
Net income
$ 7,000
Adjustments for differences between income
and cash flows from operating activities:
Add: Depreciation expense
2,300
Increase in accounts payable
1,500
Less: Increase in accounts receivable
(2,700) 1,100
Net cash provided by operating activities
$8,100
Cash Flows From Investing Activities
Payment for purchase of building
$(12,000)
Proceeds from sale of land, at cost
3,000
Net cash used for investing activities
(9,000)
Continued
Simple Statement of Cash Flows
Net cash provided by operating activities
$8,100
Net cash used for investing activities
(9,000)
Cash Flows From Financing Activities
Proceeds from issuance of bonds
Payment of dividends
Net cash provided by financing activities
Net increase in Cash
Cash, January 1, 2007
Cash, December 31, 2007
$ 7,000
(3,500)
This amount should match the balance of
the Cash account in the ledger.
3,500
$2,600
4,000
$6,600
Sale of Equipment
Gains and losses from investing
activities should be eliminated from
operating activities by adding losses
and deducting gains from net income.
Dack Company sold equipment
with a cost of $2,200 and
accumulated depreciation of $700
for $2,100.
Sale of Equipment
Historical cost
Less: Accumulated depreciation
Book value
Gain (not operating)
Cash proceeds
2,200
700
$1,500
?
$2,100
Deduct $600 from net income to
reconcile net income to operating
cash.
Interest Paid and
Income Taxes Paid
FASB Statement Number 95
requires that a company using the
indirect method also disclose its
interest paid and income taxes paid.
Interest Paid
Interest Expense
1,100
$100 discount
amortization
will not require
cash
Interest Payable
Cash Paid 500
Bal.
= $1,000
0
1,000
= $1,000
Bal.
500
Jones Company had $1,100 of interest expense, including $100
amortization of bond discount. The beginning balance in Interest
Payable was $0 and the ending balance was $500. How much
cash was paid for interest?
Taxes Paid
Taxes Payable and Deferred Taxes can be combined to find taxes paid.
Taxes Payable/Deferred Taxes
= $7,050
1,500 Bal.--Taxes Payable
Cash Paid 2,820
1,920 Bal.--Deferred Taxes
3,630 Taxes Expense
= $7,050
2,130 Bal.--Taxes Payable
2,100 Bal.--Deferred Taxes
The beginning and ending balances in Taxes Payable were
$1,500 and $2,130 and the beginning and ending balances in
Deferred Taxes were $1,920 and $2,100. Tax Expense was
$3,630. How much cash was paid?
Indirect and Direct Methods
FASB No. 95 allows two
ways for a company to
calculate and report its net
cash flow from operating
activities on its statement
of cash flows.
Indirect and Direct Methods
Even though the FASB The first is called the direct
method and the second is
recommends the direct
the indirect method.
method, more than 98% of
companies use the indirect
method.
Reconciliation of Net Income to Cash Provided
by OperationsDirect Method
When the direct method is
used, a schedule to
reconcile net income to
cash provided by
operations is required.
Yes.
In other words, the
indirect method is
required even when using
the direct method.
Worksheet
Worksheet
Complex Situations

Purchases and sales of securities available for sale
are investing cash flows.

Dividends received from Investee are shown as an
operating inflow by the direct method.

Trading Securities
Unrealized gains and losses must be shown as a
reconciliation adjustment in the indirect method.
Complex Situations


Principal payments on notes payable
to banks are financing activities.
Interest expense on notes payable
to banks is treated as an operating
activitiy.
Complex Situations
Bad Debts and Write-Offs


Not disclosed by the direct method.
Two approaches are available with the indirect
method.
-- Changes in net A/R are treated as reconciling
items.
-- Changes in gross A/R are treated as reconciling
items and Bad Debt Expense is added to income.
Let’s do an
Indirect
Method
Statement
of Cash
Flows.
Statement of Cash Flows
Indirect Method Example
Using the indirect method, prepare a
Statement of Cash Flows for 19X8.
Refer to the following information . . .
Statement of Cash Flows
Indirect Method Example
Grate Big Company
Comparative Balance Sheets - Assets
December 31,
19X7
19X8
Cash
Accounts Receivable, net
Inventory
Trading Securities
Equipment, net
Investment in Tiny Co.
$
60,000
27,000
230,000
500,000
100,000
$ 70,370
35,000
200,000
25,000
425,000
130,000
Total Assets
$ 917,000
$ 885,370
Statement of Cash Flows
Indirect Method Example
G r a te B ig C o m p a n y
C o m p a r a tiv e B a la n c e S h e e ts - L ia b ilitie s a n d E q u ity
Decem ber 31,
19X7
A c c o u n ts P a y a b le
S a la r ie s P a y a b le
$
1 5 ,0 0 0
19X8
$
1 2 ,0 0 0
7 ,0 0 0
5 ,0 0 0
In te r e s t P a y a b le
1 1 ,9 5 0
7 ,3 5 0
In c o m e T a x P a y a b le
2 0 ,0 0 0
1 7 ,0 0 0
N o te s P a y a b le , B o b ' s B a n k
7 0 ,0 0 0
6 0 ,0 0 0
2 5 0 ,0 0 0
1 5 0 ,0 0 0
5 ,0 0 0
4 ,0 0 0
4 5 0 ,0 0 0
5 0 0 ,0 0 0
8 8 ,0 5 0
1 3 0 ,0 2 0
$ 9 1 7 ,0 0 0
$ 8 8 5 ,3 7 0
B o n d s P a y a b le
P r e m iu m o n B o n d s P a y a b le
C o m m o n S to c k
R e ta in e d E a r n in g s
T o ta l L ia b ilitie s a n d E q u ity
Statement of Cash Flows
Indirect Method Example
G r a te B ig C o m p a n y
In c o m e S ta te m e n t A m o u n ts
F o r th e Y e a r E n d in g D e c e m b e r 3 1 , 1 9 X 8
S a le s R e v e n u e s
$
C o s t o f G o o d s S o ld
8 0 0 ,0 0 0
5 6 0 ,0 0 0
D e p r e c ia tio n E x p e n s e
5 ,0 0 0
In te r e s t E x p e n s e
2 8 ,0 5 0
In c o m e T a x E x p e n s e
2 7 ,9 8 0
S a la r y E x p e n s e
8 0 ,0 0 0
O th e r E x p e n s e s
7 0 ,0 0 0
G a in o n S a le o f E q u ip m e n t
3 ,0 0 0
E x tr a o r d in a r y L o s s
3 0 ,0 0 0
E q u ity in In v e s te e In c o m e
4 0 ,0 0 0
N e t In c o m e
$
4 1 ,9 7 0
Statement of Cash Flows
Indirect Method Example

Additional Information
-- Trading Securities were purchased during 19X8 at
a cost of $25,000.
-- Equipment with a book value of $40,000 was sold
during the year for $43,000.
-- Equipment with a book value of $30,000 was
destroyed during a freak flood in 19X8. There was
no insurance.
-- Bond premium amortization was $1,000 for 19X8.
Statement of Cash Flows
Indirect Method Example

Additional Information
-- Grate Big holds a 25% investment in Tiny Co. and
accounts for it using the Equity Method.
-- Grate Big received $10,000 in dividends from Tiny
Co. in 19X8.
-- Grate Big’s tax rate is 40%.
-- The Notes Payable to Bob’s Bank carry a 12% rate.
The payments are due on the first day of each
month.
Statement of Cash Flows
Indirect Method Example
N e t In c o m e
With the indirect method,
start with Net Income and
reconcile to Cash Flows
from Operating Activities.
$ 4 1 ,9 7 0
Statement of Cash Flows
Indirect Method Example
N e t In c o m e
Ad d :
$ 4 1 ,9 7 0
Dividends received from
investees that are
accounted for using the
Equity Method are added
to Net Income as a
reconciling item.
Statement of Cash Flows
Indirect Method Example
N e t In c o m e
Ad d :
D iv id e n d s fr o m T in y C o .
$ 4 1 ,9 7 0
1 0 ,0 0 0
Statement of Cash Flows
Indirect Method Example
N e t In c o m e
Ad d :
$ 4 1 ,9 7 0
D iv id e n d s fr o m T in y C o .
1 0 ,0 0 0
C h a n g e in A cco u n t B a la n ce D u rin g Ye a r
In cre a se
D e cre a se
C u rre n t
S u b tra ct fro m n e t
A d d to n e t in co m e .
A sse ts
in co m e .
C u rre n t
A d d to n e t in co m e .
L ia b ilitie s
S u b tra ct fro m n e t
in co m e .
Statement of Cash Flows
Indirect Method Example
N e t In c o m e
$ 4 1 ,9 7 0
Ad d :
D iv id e n d s fr o m T in y C o .
1 0 ,0 0 0
Ad d :
D e c r e a s e in In v e n to r y
3 0 ,0 0 0
S u b tr a c t:
In c r e a s e in A c c o u n ts R e c e iv a b le
(8 ,0 0 0 )
In c r e a s e in T r a d in g S e c u r itie s
(2 5 ,0 0 0 )
D e c r e a s e in A c c o u n ts P a y a b le
(3 ,0 0 0 )
D e c r e a s e in S a la r ie s P a y a b le
(2 ,0 0 0 )
D e c r e a s e in In te r e s t P a y a b le
(4 ,6 0 0 )
D e c r e a s e in In c o m e T a x P a y a b le
(3 ,0 0 0 )
Statement of Cash Flows
Indirect Method Example
N e t In c o m e
$ 4 1 ,9 7 0
Ad d :
D iv id e n d s fr o m T in y C o .
1 0 ,0 0 0
Ad d :
D e c r e a s e in In v e n to r y
3 0 ,0 0 0
S u b tr a c t:
In c r e a s e in A c c o u n ts R e c e iv a b le
Ad d :
(8 ,0 0 0 )
In c r e a s e in T r a d in g S e c u r itie s
(2 5 ,0 0 0 )
D e c r e a s e in A c c o u n ts P a y a b le
(3 ,0 0 0 )
D e c r e a s e in S a la r ie s P a y a b le
(2 ,0 0 0 )
D e c r e a s e in In te r e s t P a y a b le
(4 ,6 0 0 )
D e c r e a s e in In c o m e T a x P a y a b le
(3 ,0 0 0 )
Noncash expenses and
losses
Statement of Cash Flows
Indirect Method Example
N e t In c o m e
$ 4 1 ,9 7 0
Ad d :
D iv id e n d s fr o m T in y C o .
1 0 ,0 0 0
Ad d :
D e c r e a s e in In v e n to r y
3 0 ,0 0 0
S u b tr a c t:
In c r e a s e in A c c o u n ts R e c e iv a b le
Ad d :
(8 ,0 0 0 )
In c r e a s e in T r a d in g S e c u r itie s
(2 5 ,0 0 0 )
D e c r e a s e in A c c o u n ts P a y a b le
(3 ,0 0 0 )
D e c r e a s e in S a la r ie s P a y a b le
(2 ,0 0 0 )
D e c r e a s e in In te r e s t P a y a b le
(4 ,6 0 0 )
D e c r e a s e in In c o m e T a x P a y a b le
(3 ,0 0 0 )
D e p r e c ia tio n E x p e n s e
E x tr a o r d in a r y L o s s
5 ,0 0 0
3 0 ,0 0 0
Statement of Cash Flows
Indirect Method Example
N e t In c o m e
$ 4 1 ,9 7 0
Ad d :
D iv id e n d s fr o m T in y C o .
1 0 ,0 0 0
Ad d :
D e c r e a s e in In v e n to r y
3 0 ,0 0 0
S u b tr a c t:
In c r e a s e in A c c o u n ts R e c e iv a b le
Ad d :
In c r e a s e in T r a d in g S e c u r itie s
(2 5 ,0 0 0 )
D e c r e a s e in A c c o u n ts P a y a b le
(3 ,0 0 0 )
D e c r e a s e in S a la r ie s P a y a b le
(2 ,0 0 0 )
D e c r e a s e in In te r e s t P a y a b le
(4 ,6 0 0 )
D e c r e a s e in In c o m e T a x P a y a b le
(3 ,0 0 0 )
D e p r e c ia tio n E x p e n s e
E x tr a o r d in a r y L o s s
S u b tr a c t:
(8 ,0 0 0 )
Noncash revenues and
gains
5 ,0 0 0
3 0 ,0 0 0
Statement of Cash Flows
Indirect Method Example
N e t In c o m e
$ 4 1 ,9 7 0
Ad d :
D iv id e n d s fr o m T in y C o .
1 0 ,0 0 0
Ad d :
D e c r e a s e in In v e n to r y
3 0 ,0 0 0
S u b tr a c t:
In c r e a s e in A c c o u n ts R e c e iv a b le
Ad d :
In c r e a s e in T r a d in g S e c u r itie s
(2 5 ,0 0 0 )
D e c r e a s e in A c c o u n ts P a y a b le
(3 ,0 0 0 )
D e c r e a s e in S a la r ie s P a y a b le
(2 ,0 0 0 )
D e c r e a s e in In te r e s t P a y a b le
(4 ,6 0 0 )
D e c r e a s e in In c o m e T a x P a y a b le
(3 ,0 0 0 )
D e p r e c ia tio n E x p e n s e
E x tr a o r d in a r y L o s s
S u b tr a c t:
(8 ,0 0 0 )
5 ,0 0 0
3 0 ,0 0 0
A m o r tiz a tio n o f B o n d P r e m iu m
(1 ,0 0 0 )
G a in o n S a le o f E q u ip m e n t
(3 ,0 0 0 )
E q u ity in T in y C o . In c o m e
N e t C a s h F lo w fr o m O p e r a tio n s
(4 0 ,0 0 0 )
$ 2 7 ,3 7 0
Statement of Cash Flows
Indirect Method Example
N e t In c o m e
$ 4 1 ,9 7 0
Ad d :
D iv id e n d s fr o m T in y C o .
1 0 ,0 0 0
Ad d :
D e c r e a s e in In v e n to r y
3 0 ,0 0 0
S u b tr a c t:
In c r e a s e in A c c o u n ts R e c e iv a b le
In c r e a s e in T r a d in g S e c u r itie s
Note that the net Dundistributed
e c r e a s e in A cearnings
c o u n ts P afrom
y a b le
D e c rCo.)
e a s eis
in$30,000
S a la r ie s ($40,000
P a y a b le
the subsidiary (Tiny
D e c r e a s e in In te r e s t P a y a b le
- $10,000). This is
the same amount by which
D e c r e a s e in In c o m e T a x P a y a b le
the investment account increased in 19X8.
Ad d :
D e p r e c ia tio n E x p e n s e
E x tr a o r d in a r y L o s s
S u b tr a c t:
(8 ,0 0 0 )
(2 5 ,0 0 0 )
(3 ,0 0 0 )
(2 ,0 0 0 )
(4 ,6 0 0 )
(3 ,0 0 0 )
5 ,0 0 0
3 0 ,0 0 0
A m o r tiz a tio n o f B o n d P r e m iu m
(1 ,0 0 0 )
G a in o n S a le o f E q u ip m e n t
(3 ,0 0 0 )
E q u ity in T in y C o . In c o m e
N e t C a s h F lo w fr o m O p e r a tio n s
(4 0 ,0 0 0 )
$ 2 7 ,3 7 0
I. O p e ra tin g C a s h F lo w s
$ 2 7 ,3 7 0
II. In v e s tin g C a s h F lo w s
P ro c e e d s fro m s a le o f E q u ip m e n t
4 3 ,0 0 0
III. F in a n c in g C a s h F lo w s
P ro c e e d s fro m s a le o f S to c k
$ 5 0 ,0 0 0
P rin c ip a l p a id o n B o n d s
(1 0 0 ,0 0 0 )
P rin c ip a l p a id o n N o te s
(1 0 ,0 0 0 )
(6 0 ,0 0 0 )
N e t C a s h F lo w s fo r th e P e rio d
1 0 ,3 7 0
Ad d :
6 0 ,0 0 0
B e g in n in g C a s h B a la n c e
E n d in g C a s h B a la n c e
N o te : Inte re s t p a id in 1 9 X 8 w a s $ 3 2 ,6 5 0 .
Ta xe s p a id in 1 9 X 8 w e re $ 3 0 ,9 8 0 .
$ 7 0 ,3 7 0
Let’s do an
example of a
direct method
Statement of
Cash Flows.
Statement of Cash Flows
Direct Method Example



Using the direct method, determine the individual
operating cash flows for the year ended 19X8.
Prepare the Cash Flows from Operating Activities
section of the Statement of Cash Flows using the
direct method.
Examine the following information . . .
Statement of Cash Flows
Direct Method Example
G r a te B ig C o m p a n y
C o m p a r a tiv e B a la n c e S h e e ts - A s s e ts
Decem ber 31,
19X7
Cash
A c c o u n ts R e c e iv a b le , n e t
$
19X8
6 0 ,0 0 0
$
7 0 ,3 7 0
2 7 ,0 0 0
3 5 ,0 0 0
2 3 0 ,0 0 0
2 0 0 ,0 0 0
-
2 5 ,0 0 0
E q u ip m e n t, n e t
5 0 0 ,0 0 0
4 2 5 ,0 0 0
In v e s tm e n t in T in y C o .
1 0 0 ,0 0 0
1 3 0 ,0 0 0
$ 9 1 7 ,0 0 0
$ 8 8 5 ,3 7 0
In v e n to r y
T r a d in g S e c u r itie s
T o ta l A s s e ts
Statement of Cash Flows
Direct Method Example
G r a te B ig C o m p a n y
C o m p a r a tiv e B a la n c e S h e e ts - L ia b ilitie s a n d E q u ity
Decem ber 31,
19X7
A c c o u n ts P a y a b le
S a la r ie s P a y a b le
$
1 5 ,0 0 0
19X8
$
1 2 ,0 0 0
7 ,0 0 0
5 ,0 0 0
In te r e s t P a y a b le
1 1 ,9 5 0
7 ,3 5 0
In c o m e T a x P a y a b le
2 0 ,0 0 0
1 7 ,0 0 0
N o te s P a y a b le , B o b ' s B a n k
7 0 ,0 0 0
6 0 ,0 0 0
2 5 0 ,0 0 0
1 5 0 ,0 0 0
5 ,0 0 0
4 ,0 0 0
4 5 0 ,0 0 0
5 0 0 ,0 0 0
8 8 ,0 5 0
1 3 0 ,0 2 0
$ 9 1 7 ,0 0 0
$ 8 8 5 ,3 7 0
B o n d s P a y a b le
P r e m iu m o n B o n d s P a y a b le
C o m m o n S to c k
R e ta in e d E a r n in g s
T o ta l L ia b ilitie s a n d E q u ity
Statement of Cash Flows
Direct Method Example
G r a te B ig C o m p a n y
In c o m e S ta te m e n t A m o u n ts
F o r th e Y e a r E n d in g D e c e m b e r 3 1 , 1 9 X 8
S a le s R e v e n u e s
$
C o s t o f G o o d s S o ld
8 0 0 ,0 0 0
5 6 0 ,0 0 0
D e p r e c ia tio n E x p e n s e
5 ,0 0 0
In te r e s t E x p e n s e
2 8 ,0 5 0
In c o m e T a x E x p e n s e
2 7 ,9 8 0
S a la r y E x p e n s e
8 0 ,0 0 0
O th e r E x p e n s e s
7 0 ,0 0 0
G a in o n S a le o f E q u ip m e n t
3 ,0 0 0
E x tr a o r d in a r y L o s s
3 0 ,0 0 0
E q u ity in In v e s te e In c o m e
4 0 ,0 0 0
N e t In c o m e
$
4 1 ,9 7 0
Statement of Cash Flows
Direct Method Example

Additional Information
-- Trading Securities were purchased during 19X8 at
a cost of $25,000.
-- Equipment with a book value of $40,000 was sold
during the year for $43,000.
-- Equipment with a book value of $30,000 was
destroyed during a freak flood in 19X8. There was
no insurance.
-- Bond premium amortization was $1,000 for 19X8.
Statement of Cash Flows
Direct Method Example

Additional Information
-- Grate Big holds a 25% investment in Tiny Co. and
accounts for it using the Equity Method.
-- Grate Big received $10,000 in dividends from Tiny
Co. in 19X8.
-- Grate Big’s tax rate is 40%.
-- The Notes Payable to Bob’s Bank carry a 12% rate.
The payments are due on the first day of each
month.
Statement of Cash Flows
Direct Method Example

Additional Information
-- The Bonds Payable carry a 9% interest rate.
Interest is payable semiannually on July 1 and on
January 1.
-- The company sold stock during the year for
$50,000 cash.
Statement of Cash Flows
Direct Method Example

Cash Received from Customers

Cash Paid to Employees
Statement of Cash Flows
Direct Method Example

Cash Received from Customers
S a le s R e v e n u e s
$
L e s s : In c re a s e in A /R
C ash

R e c e iv e d fro m C u s to m e rs
Cash Paid to Employees
8 0 0 ,0 0 0
(8 ,0 0 0 )
$
7 9 2 ,0 0 0
Statement of Cash Flows
Direct Method Example

Cash Received from Customers
S a le s R e v e n u e s
$
8 0 0 ,0 0 0
L e s s : In c re a s e in A /R
C ash

R e c e iv e d fro m C u s to m e rs
(8 ,0 0 0 )
$
7 9 2 ,0 0 0
Cash Paid to Employees
S a la ry E x p e n s e
$
A d d : D e c re a s e in S a la ry P a y a b le
C a s h P a id to E m p lo y e e s
8 0 ,0
2 00000
2 ,0 0 0
$
8 2 ,0 0 0
Statement of Cash Flows
Direct Method Example

Cash Paid for Inventory

Cash Paid for Interest
Statement of Cash Flows
Direct Method Example

Cash Paid for Inventory
C o s t o f G o o d s S o ld
A d d : D e c re a s e in A /P
L e s s : D e c re a s e in In v e n to ry
C a s h P a id fo r In v e n to ry

Cash Paid for Interest
$ 5 6 0 ,0 0 0
3 ,0 0 0
(3 0 ,0 0 0 )
$ 5 3 3 ,0 0 0
Statement of Cash Flows
Direct Method Example

Cash Paid for Inventory
C o s t o f G o o d s S o ld
$ 5 6 0 ,0 0 0
A d d : D e c re a s e in A /P
L e s s : D e c re a s e in In v e n to ry
C a s h P a id fo r In v e n to ry

Cash Paid for Interest
3 ,0 0 0
(3 0 ,0 0 0 )
$ 5 3 3 ,0 0 0
In te re s t E x p e n s e
$
A d d : D e c re a s e in In te re s t P a y a b le
C a s h P a id fo r In te re s t
2 8 ,0
2 05000
4 ,6 0 0
$
3 2 ,6 5 0
Statement of Cash Flows
Direct Method Example

Cash Paid for Taxes

Other Operating Cash Flows
Statement of Cash Flows
Direct Method Example

Cash Paid for Taxes
In c o m e T a x E x p e n s e
$
A d d : D e c re a s e in T a x e s P a y a b le
C a s h P a id fo r T a x e s

Other Operating Cash Flows
2 7 ,9
2 08000
3 ,0 0 0
$
3 0 ,9 8 0
Statement of Cash Flows
Direct Method Example

Cash Paid for Taxes
In c o m e T a x E x p e n s e
$
A d d : D e c re a s e in T a x e s P a y a b le
3 ,0 0 0
C a s h P a id fo r T a x e s

2 7 ,9
2 08000
$
3 0 ,9 8 0
Other Operating Cash Flows
A d d : D iv id e n d s fro m T in y C o .
$
1 0 ,0 0 0
L e s s : P u rc h a s e o f T ra d in g S e c u ritie s
(2 5 ,0 0 0 )
L e s s : O th e r O p e ra tin g E x p e n s e s
(7 1 ,0 0 0 )
C a s h F lo w fro m O th e r S o u rc e s
$
(8 6 ,0 0 0 )
Statement of Cash Flows
Direct Method Example

Cash Flows From Operating Activities
C a sh R e ce ive d fro m C u sto m e rs
$
C a sh P a id to Em p lo ye e s
792,000
(82,000)
C a sh P a id fo r In ve n to ry
(533,000)
C a sh P a id fo r In te re st
(32,650)
C a sh P a id fo r T a x e s
(30,980)
C a sh P a id to O th e r S o u rce s
(86,000)
C a sh F ro m O p e ra tin g A ctivitie s
$
27,370
I. O p e ra tin g C a s h F lo w s
$ 2 7 ,3 7 0
II. In v e s tin g C a s h F lo w s
P ro c e e d s fro m s a le o f E q u ip m e n t
4 3 ,0 0 0
III. F in a n c in g C a s h F lo w s
P ro c e e d s fro m s a le o f S to c k
$ 5 0 ,0 0 0
P rin c ip a l p a id o n B o n d s
(1 0 0 ,0 0 0 )
P rin c ip a l p a id o n N o te s
(1 0 ,0 0 0 )
(6 0 ,0 0 0 )
N e t C a s h F lo w s fo r th e P e rio d
1 0 ,3 7 0
Ad d :
6 0 ,0 0 0
B e g in n in g C a s h B a la n c e
E n d in g C a s h B a la n c e
N o te : Inte re s t p a id in 1 9 X 8 w a s $ 3 2 ,6 5 0 .
Ta xe s p a id in 1 9 X 8 w e re $ 3 0 ,9 8 0 .
$ 7 0 ,3 7 0
I. O p e ra tin g C a s h F lo w s
NoticeII. that
the
Cash
In v e s
tin gEnding
C a s h F lo
ws
P ro
c e ethe
d s fro
m s a le o f E q u ip m e n t
Balance
per
Statement
III. F in a n c in g C a s h F lo w s
of Cash
Flows agrees with
P ro c e e d s fro m s a le o f S to c k
$ 5 0 ,0 0 0
the ending
Cash
balance
on
P rin c ip a l p a id o n B o n d s
(1 0 0 ,0 0 0 )
rin c ip a l p a
id o n N o te s
(1 0 ,0 0 0 )
thePBalance
Sheet.
$ 2 7 ,3 7 0
4 3 ,0 0 0
(6 0 ,0 0 0 )
N e t C a s h F lo w s fo r th e P e rio d
1 0 ,3 7 0
Ad d :
6 0 ,0 0 0
B e g in n in g C a s h B a la n c e
E n d in g C a s h B a la n c e
N o te : Inte re s t p a id in 1 9 X 8 w a s $ 3 2 ,6 5 0 .
Ta xe s p a id in 1 9 X 8 w e re $ 3 0 ,9 8 0 .
$ 7 0 ,3 7 0
Statement of Cash Flows Supplemental
Schedule
N e t In c o m e
$ 4 1 ,9 7 0
Ad d :
D iv id e n d s fr o m T in y C o .
1 0 ,0 0 0
Ad d :
D e c r e a s e in In v e n to r y
3 0 ,0 0 0
S u b tr a c t:
In c r e a s e in A c c o u n ts R e c e iv a b le
Ad d :
In c r e a s e in T r a d in g S e c u r itie s
(2 5 ,0 0 0 )
D e c r e a s e in A c c o u n ts P a y a b le
(3 ,0 0 0 )
D e c r e a s e in S a la r ie s P a y a b le
(2 ,0 0 0 )
D e c r e a s e in In te r e s t P a y a b le
(4 ,6 0 0 )
D e c r e a s e in In c o m e T a x P a y a b le
(3 ,0 0 0 )
D e p r e c ia tio n E x p e n s e
E x tr a o r d in a r y L o s s
S u b tr a c t:
(8 ,0 0 0 )
5 ,0 0 0
3 0 ,0 0 0
A m o r tiz a tio n o f B o n d P r e m iu m
(1 ,0 0 0 )
G a in o n S a le o f E q u ip m e n t
(3 ,0 0 0 )
E q u ity in T in y C o . In c o m e
N e t C a s h F lo w fr o m O p e r a tio n s
(4 0 ,0 0 0 )
$ 2 7 ,3 7 0
I hope this
suit is drip
dry!
Chapter 10
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