Chapter 8Chapter 8The Statement of The Statement of

Cash FlowsCash Flows

8-1 Multi-Step vs. Single-Step Income 8-1 Multi-Step vs. Single-Step Income StatementStatement

Multiple-stepMultiple-step Single-stepSingle-step

Sales Sales RevenueRevenue

Net SalesNet Sales a a Total Total RevenueRevenue

Cost of Cost of Goods SoldGoods Sold

Gross ProfitGross Profit b b Total Total ExpensesExpenses

Operating Operating ExpensesExpenses

Income from Income from operations operations cc

Non-Non-operating operating itemsitems

Net IncomeNet Income d d

aa Sales - Sales returns - Sales Discounts Sales - Sales returns - Sales Discounts

bb Net sales - Cost of goods sold Net sales - Cost of goods sold

cc Gross profit - Operating expenses Gross profit - Operating expenses

dd Income from operations + Other revenue/gains - other expenses/losses Income from operations + Other revenue/gains - other expenses/losses

Other Revenues and GainsOther Revenues and Gains Other Expenses and LossesOther Expenses and Losses

Interest revenue from notes receivable and Interest revenue from notes receivable and marketable securitiesmarketable securities

Interest expense on notes and loans payableInterest expense on notes and loans payable

Dividend revenue from investments in capital stockDividend revenue from investments in capital stock Casualty losses from recurring causes such as Casualty losses from recurring causes such as vandalism and accidentsvandalism and accidents

Rent revenue from subleasing a portion of the storeRent revenue from subleasing a portion of the store Losses from the sales of abandonment of property, Losses from the sales of abandonment of property, plant, and equipmentplant, and equipment

Gain from sale of property, plant and equipmentGain from sale of property, plant and equipment Loss from strikes by employees and suppliersLoss from strikes by employees and suppliers

8-2 Typical Receipts and Payments 8-2 Typical Receipts and Payments Classified by ActivityClassified by Activity

Operating activitiesOperating activities Cash inflows:Cash inflows: From sale of goods or services.From sale of goods or services. From returns on loans (interest) and on equity securities (dividends).From returns on loans (interest) and on equity securities (dividends). Cash outflows:Cash outflows: To suppliers for inventory.To suppliers for inventory. To employees for services.To employees for services. To government for taxes.To government for taxes. To lenders for interest.To lenders for interest. To others for expenses.To others for expenses.

Investing activitiesInvesting activities Cash inflows:Cash inflows: From sale of property, plant, and equipment.From sale of property, plant, and equipment. From sale of debt or equity securities of other entities.From sale of debt or equity securities of other entities. From collection of principal on loans to other entities.From collection of principal on loans to other entities. Cash outflows:Cash outflows: To purchase property, plant, and equipment.To purchase property, plant, and equipment. To purchase debt or equity securities of other entities.To purchase debt or equity securities of other entities. To make loans to other entities.To make loans to other entities.

Financing activitiesFinancing activities Cash inflows:Cash inflows: From sale of equity securities (company’s own stock).From sale of equity securities (company’s own stock). From issuance of debt (bonds and notes).From issuance of debt (bonds and notes). Cash outflows:Cash outflows: To stockholders as dividends.To stockholders as dividends. To redeem long-term debt or reacquire capital stock.To redeem long-term debt or reacquire capital stock.

8-3 Information Sources for Activities8-3 Information Sources for Activities

OPERATING ACTIVITIESOPERATING ACTIVITIES

Analyze Income statement itemsAnalyze Income statement items

Changes in noncash current asset and current liability Changes in noncash current asset and current liability itemsitems

FINANCING ACTIVITIESFINANCING ACTIVITIES

Analyze increases and decreases in long-term Analyze increases and decreases in long-term

liability and stockholders’ equity itemsliability and stockholders’ equity items

INVESTING ACTIVITIESINVESTING ACTIVITIES

Analyze increases and decreases in investments Analyze increases and decreases in investments

and long-term asset itemsand long-term asset items

8-4 Format of the Statement of Cash Flows8-4 Format of the Statement of Cash Flows

COMPANY NAMECOMPANY NAMEStatement of Cash FlowsStatement of Cash Flows

Period CoveredPeriod Covered

Cash flows from operating activitiesCash flows from operating activities (List of individual items)(List of individual items) Net cash provided (used) by operating activitiesNet cash provided (used) by operating activities

XXXXXXXXXX

Cash flows from investing activitiesCash flows from investing activities (List of individual inflows and outflows)(List of individual inflows and outflows) Net cash provided (used) by investing activitiesNet cash provided (used) by investing activities

XXXXXXXXXX

Cash flows from financing activitiesCash flows from financing activities (List of individual inflows and outflows)(List of individual inflows and outflows) (Net cash provided (used) by financing activities(Net cash provided (used) by financing activities

XXXXXXXXXX

Net increase (decrease) in cashNet increase (decrease) in cash XXXXXX

Cash at beginning of periodCash at beginning of period XXXXXX

Cash at end of periodCash at end of period XXXXXX

Noncash investing and financing activitiesNoncash investing and financing activities (List of individual noncash transactions)(List of individual noncash transactions)

XXXXXX

8-5 Converting Net Income to Net Cash 8-5 Converting Net Income to Net Cash Provided (Used) by Operating ActivitiesProvided (Used) by Operating Activities

Accrual Basis of Accrual Basis of AccountingAccounting

Cash Basis of AccountingCash Basis of Accounting

Earned RevenueEarned Revenue

Net Net

IncomeIncome

Adjust Revenues to Adjust Revenues to Cash ReceiptsCash Receipts Net Cash Net Cash

Provided by Provided by

Operating Operating

ActivitiesActivitiesIncurred Incurred ExpensesExpenses

Adjust Expenses to Adjust Expenses to Cash DisbursementsCash Disbursements

INDIRECT METHODINDIRECT METHOD

1.1. Begin with net income and Begin with net income and adjust for income statement adjust for income statement items that did not effect cash.items that did not effect cash.

2.2. Reconcile net income to net Reconcile net income to net cash provided (used) by cash provided (used) by operating activities.operating activities.

DIRECT METHODDIRECT METHOD

1.1. Adjust each item on the income Adjust each item on the income statement from the accrual statement from the accrual basis to the cash basis.basis to the cash basis.

2.2. Major classes of operating cash Major classes of operating cash receipts and cash payments are receipts and cash payments are reported.reported.

OROR

8-6 Operating Activities – Indirect Method 8-6 Operating Activities – Indirect Method Adjustments for Noncash ItemsAdjustments for Noncash Items

Adjustments for Adjustments for noncash charges noncash charges and creditsand credits

Noncash charges and Noncash charges and creditscredits

Add to (Deduct Add to (Deduct from) Net Incomefrom) Net Income

Depreciation ExpenseDepreciation Expense AddAdd

Patent amortization expensePatent amortization expense AddAdd

Depletion expenseDepletion expense AddAdd

Loss on sale of equipmentLoss on sale of equipment AddAdd

Gain on sales of equipmentGain on sales of equipment DeductDeduct

Adjustments to convert net Adjustments to convert net income to net cash income to net cash provided by operating provided by operating activities.activities.

All noncash expenses are added to net income, and all noncash All noncash expenses are added to net income, and all noncash revenues are subtracted from net income.revenues are subtracted from net income.

8-7 Operating Activities – Indirect Method 8-7 Operating Activities – Indirect Method Adjustments For Current Assets and Adjustments For Current Assets and LiabilitiesLiabilities

Adjustments Adjustments for Current for Current ItemsItems

For Changes In:For Changes In:Add to Net Add to Net IncomeIncome

Deduct from Deduct from Net IncomeNet Income

Current assetsCurrent assets DecreasesDecreases IncreasesIncreases

Current liabilitiesCurrent liabilities IncreasesIncreases DecreasesDecreases

For Changes in For Changes in Individual Accounts:Individual Accounts:

Add to Net Add to Net IncomeIncome

Deduct from Deduct from Net IncomeNet Income

Accounts receivableAccounts receivable DecreaseDecrease IncreaseIncrease

InventoryInventory DecreaseDecrease IncreaseIncrease

Prepaid expensesPrepaid expenses DecreaseDecrease IncreaseIncrease

Accounts payableAccounts payable IncreaseIncrease DecreaseDecrease

Accrued expenses Accrued expenses payablepayable

IncreaseIncrease DecreaseDecrease

Adjustments to convert net income Adjustments to convert net income to net cash provided by operating to net cash provided by operating

activities.activities.

All changes in current assets are handled in a similar manner All changes in current assets are handled in a similar manner and all changes in current liabilities are handled in a similar and all changes in current liabilities are handled in a similar manner, but the adjustments are exactly the opposite.manner, but the adjustments are exactly the opposite.

8-8 Cash Flows from Operating Activities – 8-8 Cash Flows from Operating Activities – Indirect MethodIndirect Method

Problem Problem DataData

DEMONSTRATION COMPANYDEMONSTRATION COMPANYComparative Balance Sheet AccountsComparative Balance Sheet Accounts

December 31December 31

Current AssetsCurrent Assets 20032003 20022002 ChangeChange

Accounts Accounts receivablereceivable

$30,000$30,000 $39,000$39,000 $9,000 Decrease$9,000 Decrease

Prepaid rentPrepaid rent 15,00015,000 10,00010,000 5,000 Increase5,000 Increase

InventoryInventory 20,00020,000 18,00018,000 2,000 Increase2,000 Increase

Current LiabilitiesCurrent Liabilities

Accounts payableAccounts payable 18,00018,000 12,00012,000 6,000 Increase6,000 Increase

Interest payableInterest payable 6,0006,000 2,0002,000 4,000 Increase4,000 Increase

Taxes payableTaxes payable 3,0003,000 5,0005,000 2,000 Decrease2,000 Decrease

DEMONSTRATION COMPANYDEMONSTRATION COMPANYIncome StatementIncome Statement

For the Year Ended December 31, 2005For the Year Ended December 31, 2005

RevenuesRevenues Sales revenueSales revenue Gain on sale of landGain on sale of land Total revenuesTotal revenues

$400,000$400,00020,00020,000

$420,000$420,000

ExpensesExpenses Cost of goods soldCost of goods sold Operating expensesOperating expenses Depreciation Depreciation expenseexpense Interest expenseInterest expense Income tax expenseIncome tax expense Total expensesTotal expenses

280,000280,00075,00075,00015,00015,000

8,0008,0007,0007,000

385,000385,000

Net IncomeNet Income $35,000$35,000

Using the data Using the data provided, provided, prepare the prepare the cash flows from cash flows from operating operating activities section activities section of the statement of the statement of cash flows of cash flows using the using the indirect method.indirect method.

8-8 Cash Flows from Operating Activities – 8-8 Cash Flows from Operating Activities – Indirect Method (continued)Indirect Method (continued)

DEMONSTRATION COMPANYDEMONSTRATION COMPANY

Statement of Cash Flows (Indirect Method)Statement of Cash Flows (Indirect Method)

For the Year Ended December 31, 2004For the Year Ended December 31, 2004

Cash flows from operating activitiesCash flows from operating activities

Net IncomeNet Income

Adjustments to reconcile net income to net cash provided by operating Adjustments to reconcile net income to net cash provided by operating activitiesactivities

Depreciation expenseDepreciation expense

Gain on sale of landGain on sale of land

Decrease in accounts receivableDecrease in accounts receivable

Increase in prepaid rentIncrease in prepaid rent

Increase in inventoryIncrease in inventory

Increase in accounts payableIncrease in accounts payable

Increase in interest payableIncrease in interest payable

Decrease in taxes payableDecrease in taxes payable

Net cash provided by operating activitiesNet cash provided by operating activities

$15,000$15,000

(20,000(20,000))

9,0009,000

(5,000)(5,000)

(2,000)(2,000)

6,0006,000

4,0004,000

(2,000)(2,000)

$35,00$35,0000

5,0005,000

$40,00$40,0000

8-9 Cash Flows from Operating Activities – 8-9 Cash Flows from Operating Activities – Direct MethodDirect Method

Problem DataProblem Data

DEMONSTRATION COMPANYDEMONSTRATION COMPANYComparative Balance Sheet AccountsComparative Balance Sheet Accounts

December 31, 2005December 31, 2005

20052005 20042004 ChangeChange

Current assetsCurrent assets Accounts receivableAccounts receivable Prepaid rentPrepaid rent InventoryInventory

$30,000$30,00015,00015,00020,00020,000

$39,000$39,00010,00010,00018,00018,000

$9,000 $9,000 DecreaseDecrease

5,000 Increase5,000 Increase2,000 Increase2,000 Increase

Current liabilitiesCurrent liabilities Accounts payableAccounts payable Interest payableInterest payable Taxes payableTaxes payable

18,00018,0006,0006,0003,0003,000

12,00012,0002,0002,0005,0005,000

6,000 Increase6,000 Increase4,000 Increase4,000 Increase

2,000 Decrease2,000 Decrease

DEMONSTRATION COMPANYDEMONSTRATION COMPANYIncome StatementIncome Statement

For the Year Ended December 31, 2005For the Year Ended December 31, 2005

RevenuesRevenues Sales revenueSales revenue Gain on sale of landGain on sale of land Total revenuesTotal revenues

$400,000$400,00020,00020,000

$420,000$420,000

ExpensesExpenses Cost of goods soldCost of goods sold Operating expensesOperating expenses Depreciation Depreciation expenseexpense Interest expenseInterest expense Income tax expenseIncome tax expense Total expensesTotal expenses

280,000280,00075,00075,00015,00015,000

8,0008,0007,0007,000

385,000385,000

Net IncomeNet Income $35,000$35,000

Using the Using the provided data, provided data, prepare the prepare the cash flows from cash flows from operating operating activities activities section of the section of the statement of statement of cash flows cash flows using the direct using the direct method.method.

8-9 Cash Flows from Operating Activities – 8-9 Cash Flows from Operating Activities – Direct Method (continued)Direct Method (continued)

Accrual BasisAccrual Basis AddAdd DeductDeduct Cash FlowsCash Flows

Sales Sales $400,000$400,000 9,000 A/R9,000 A/R $409,000 (+)$409,000 (+)

Gain on sale of Gain on sale of landland

20,00020,000 20,000 Gain20,000 Gain -0--0-

Cost of goods soldCost of goods sold 280,000280,000 2,000 Inv.2,000 Inv. 6,000 A/P6,000 A/P 276,000 (-)276,000 (-)

Operating Operating expensesexpenses

75,00075,000 5,000 P. Rent5,000 P. Rent 80,000 (-)80,000 (-)

Depreciation Depreciation expenseexpense

15,00015,000 15,000 Depre.15,000 Depre. -0--0-

Interest expenseInterest expense 8,0008,000 4,000 Int. Pay.4,000 Int. Pay. 4,000 (-)4,000 (-)

Income tax Income tax expenseexpense

7,0007,000 2,000 Tax. 2,000 Tax. Pay.Pay.

9,000 (-)9,000 (-)

Net IncomeNet Income $35,000$35,000 Cash from operating activitiesCash from operating activities $40,000$40,000DEMONSTRATION COMPANYDEMONSTRATION COMPANY

Statement of Cash Flows (Direct Method) Statement of Cash Flows (Direct Method)

For the Year Ended December 31, 2005For the Year Ended December 31, 2005

Cash flows from operating activitiesCash flows from operating activities

Cash receipts from customersCash receipts from customers

Cash paymentsCash payments

To suppliersTo suppliers

For operating expensesFor operating expenses

For interestFor interest

For income taxesFor income taxes

Net cash provided by operating Net cash provided by operating activitiesactivities

$276,000$276,000

80,00080,000

4,0004,000

9,0009,000

$409,000$409,000

$369,000$369,000

$40,000$40,000