GLENCOE / McGraw-Hill

1. GLENCOE / McGraw-Hill

2. The Statement of Cash Flows

3. Cash Flows from Operating Activities Section Objective • Compute cash flows from operating activities.

4. Page 914 Statement of Cash Flows To prepare the statement of cash flows, you need four items. • Income statement • Schedule of operating expenses • Statement of retained earnings • Comparative balance sheet

5. QUESTION: What is the schedule of operatingexpenses? ANSWER: The schedule of operating expenses is a schedule that supplements the income statement. Page 914 It shows the selling and general and administrative expenses in greater detail.

6. Page 917 Statement of Cash Flows • Reconciles the beginning and ending cash balances • Ties together • income statement • changes in the noncash items on the balance sheet • changes in the noncash items on the statement of retained earnings • Can be prepared in two different ways: • direct method • indirect method This chapter illustrates the indirect method.

7. QUESTION: What is the indirect method of preparing the statement of cash flows? ANSWER: The indirect method of preparing the statement of cash flows treats net income as the primary source of cash from operating activities and adjusts net income for changes in noncash items. Page 925

8. Page 925 Indirect Method Cash Flows from Operating Activities Net income + or – Adjustments for noncash items on income statement + Decreases in current assets – Increases in current assets + Increases in current liabilities – Decreases in current liabilities = Net cash provided by operating activities

9. Page 917 Adjustments for Noncash Items on the Income Statement • Depreciation expense • Amortization of premium on bonds payable • Gain or loss on sale of equipment

10. Page 917 Depreciation Expense • On the income statement • Not a cash outflow • Added back to net income on the statement of cash flows

11. Page 919 Amortization of Premium on Bonds Payable • The amount of interest expense on the income statement is less than the actual cash outflow. • On the statement of cash flows, the difference is subtracted from net income.

12. QUESTION: What are operating assets and liabilities? ANSWER: Operating assets and liabilities are current assets and current liabilities. Page 919 Changes are usually related to routine business operations and are reflected in net income.

13. Page 919 Increase in Accounts Receivable • More sales on account were recorded than were collected. • Sales were included in net income but cash has not been received. • To obtain cash flows from operating activities, the increase in accounts receivable is subtracted from net income.

14. Page 920 Increase in Prepaid Expenses • More was paid for prepaid expenses than was charged to expense in arriving at net income. • Net income does not reflect cash paid for prepaid expenses. • To obtain cash flows from operating activities, the increase in prepaid expenses is subtracted from net income.

15. More supplies were paid for than were used. Net income does not reflect all cash paid for supplies. To obtain cash flows from operating activities, the increase in supplies is deducted from net income. Page 920 Increase in Supplies

16. Decreases in noncash current assets are added to net income to arrive at cash flows from operating activities. Inventory is an example of a noncash current asset. Page 920 Decreases in Current Assets

17. More inventory was sold than was purchased. Sale of inventory was reflected in net income as cost of goods sold, but cash was not paid to replace the inventory. Net income reflects higher costs than actual cash outflows. To obtain cash flows from operating activities, a decrease in inventory is added to net income. Page 920 Decrease in Merchandise Inventory

18. Page 920 Increases in Current Liabilities Increases in current liabilities are added to net income to obtain the cash flows from operating activities. • Increase in sales tax payable • Increase in payroll taxes payable • Increase in interest payable

19. More sales tax was owed than was paid to the state taxing authority. To obtain cash flows from operating activities, the increase in sales tax payable is added to net income. Page 920 Increase in Sales Tax Payable

20. More payroll taxes were owed than were paid to the government. To obtain cash flows from operating activities, the increase in payroll taxes payable is added to net income. Page 920 Increase in Payroll Taxes Payable

21. More interest was recorded as expense than was paid in cash. To obtain cash flows from operating activities, the increase in interest payable is added to net income. Page 920 Increase in Interest Payable

22. Decreases in current liabilities are subtracted from net income. If current liabilities decrease as a result of operations, some of the net income reported was not a cash flow. Page 921 Decrease in Current Liabilities

23. More cash was paid on account than purchases were recorded on account. To obtain cash flows from operating activities, the decrease in accounts payable is subtracted from net income. Page 921 Decrease in Accounts Payable

24. Page 921 Summary of Effects of Changes in Current Assets and Current Liabilities. Add to Deduct from Net Income Net Income Increase in current asset x Decrease in current asset x Increase in current liability x Decrease in current liability x

25. If the income statement reflects a net loss, the first line of the statement of cash flows is the net loss. All adjustments for noncash income and expense, current assets, and current liabilities are made to the net loss figure. Page 921 Effect of Net Loss on Cash Flows from Operations

26. CAROLINA CREATIONS, Inc. Statement of Cash Flows (Partial) Year Ended December 31, 2005 Cash Flows from Operating Activities Net income after taxes (per income statement) 128,739.00 Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense 8,280.00 Amortization of premium on bonds payable (92.00) Gain on sale of equipment (4,000.00) Changes in noncash current assets and current liabilities: Increase in accounts receivable (18,800.00) Decrease in merchandise inventory 32,500.00 Increase in prepaid expenses (150.00) Increase in supplies (145.00) Decrease in accounts payable (58,459.00) Increase in sales tax payable 1,000.00 Increase in payroll taxes payable 120.00 Increase in interest payable 645.00 Total adjustments (39,101.00) Net cash provided by operating activities 89,638.00 Page 918

27. R E V I E W Complete the following sentences: The two ways to prepare the statement of cash flows are the ____________ and the ______________. direct method indirect method net income The indirect method treats __________ as the primary source of cash from operating activities. Depreciation ___________ expense does not reflect a cash outlay so it must be __________ to net income. added back

28. R E V I E W Complete the following sentences: current Changes in _______ assets and liabilities are shown in the _________________ section of the statement of cash flows. Operating Activities Increases in current assets are ______________ net income to calculate net cash from operating activities. subtracted from added to Increases in current liabilities are ________ __________ to calculate net cash from operating activities. net income

29. Thank You for using College Accounting, Tenth Edition Price • Haddock • Brock