Ch12 Fundamental Of Financial Accounting By Edmonds (4th Edition)
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Fundamental Financial Accounting Concepts Fourth Edition by Edmonds, McNair, Milam, Olds PowerPoint® presentation by J. Lawrence Bergin
12- 2
Chapter 12 Statement of Cash Flows
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 3
Purpose of the Statement of Cash Flows To show how the business acquired its cash during the current year ◆ To show how the business spent its cash during the current year ◆
This information is crucial for decision makers to predict future cash flows of the business. McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 4
What is considered “CASH” for the Statement of Cash Flows? ◆
Cash includes cash and cash equivalents for purpose of the statement.
◆
Cash Equivalents are
Short-term, highly liquid investments, with – Maturity dates of 3 months or less from the date acquired by the holder, and are – Easily convertible into known amounts of cash. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin –
12- 5
Categories of Cash Flows They are based on activities related to cash flows: ➊ Operating the business. ➋ Investing in productive assets. ➌ Financing the business. These are the sections of the Statement of Cash Flows. McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 6
Operating Activities ◆
◆
◆
Cash inflows and outflows that are directly related to income from normal operations. Technically, FASB defines operating activities as those that are not investing or financing activities. There are two ways to compute net cash flow from operating activities: – Direct method – Indirect method
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 7
Cash Flows from Operating Activities Cash inflows and outflows that are directly related to income from normal operations. ◆ Inflows include: ◆
– Receipts from customers. – Interest on receivables. – Dividends received.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 8
Cash Flows from Operating Activities Cash inflows and outflows that are directly related to income from normal operations. ◆ Outflows include: ◆
he ot – Payments to suppliers. t y Pa – Interest paid on liabilities. – Income taxes paid. – Salary and wages payments to employees.
McGraw-Hill/Irwin
er ord
of
© The McGraw-Hill Companies, Inc., 2003
12- 9
Cash Flows from Investing Activities Cash inflows and outflows that are related to the purchase and sale of productive assets. ◆ Inflows include proceeds from: ◆
– Sales of property, plant, and equipment. – Sales of investments in securities. – Collection of principal on loans made to others. McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 10
Cash Flows from Investing Activities Cash inflows and outflows that are related to the purchase and sale of productive assets. ◆ Outflows include payments for: ◆
– The purchase of property, plant and equipment. – The purchase of long-term investments. – Loans to others. McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 11
Cash Flows from Financing Activities Cash inflows and outflows that are related to how cash was obtained to finance the enterprise. ◆ Inflows include: ◆
– Proceeds from sale of stock. – Proceeds from sale of bonds and from borrowings.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 12
Cash Flows from Financing Activities Cash inflows and outflows that are related to how cash was obtained to finance the enterprise. ◆ Outflows include: ◆
– Payments to purchase treasury stock. – Principal payments to retire bonds and loans. – Dividends paid to owners. (Remember, INTEREST paid is NOT a financing activity; it is an Operating Activity.) McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 13
Cash Flows from Noncash Activities ◆
Investing and financing activities that do not involve cash, e.g., – Retirement of bonds by issuing stock. – Settlement of debt by transferring assets other than cash. cash
◆
Noncash activities must be disclosed separately in the financial statements.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 14
Preparing the Statement of Cash Flows The face of the statement includes: Net Cash Flows from Operating Activities +Net Cash Flows from Investing Activities +Net Cash Flows from Financing Activities =Net change in Cash Flows for the period + Beginning Cash Balance =End of period Cash Balance
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 15
Two Alternative Approaches ◆
Indirect Method – Shows net cash inflow (outflow) from operations as an adjustment of net income. – Used by 97% of companies.
◆
Direct Method (used in Ch. 1-11 in text.) – Reports the components of cash from operations as gross receipts and payments. – Recommended by the FASB, but rarely used.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 16
Converting Accrual Data to Cash Data Accounting records are kept on the accrual basis (GAAP). ◆ Cash data must be developed before the SCF can be prepared (especially for operating activities). ◆ The examples that follow demonstrate the direct method for converting accrual data to cash data. ◆
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 17
Three information sources are used: The income statement for the current period. ➋ Comparative beginning of period and end of period balance sheets. ➌ Additional transaction details not found in the financial statements. ➊
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 18
Direct Method SCF Converting Revenues to Cash Basis Accrual basis revenue includes sales that did not result in cash inflows. ◆ Can be computed as: ◆
Revenue, Accrual basis
McGraw-Hill/Irwin
+ decrease or = increase in A/R
Revenue, Cash basis
© The McGraw-Hill Companies, Inc., 2003
12- 19
Direct Method SCF Example: The A/R balance was $45,000 on 1/1/04 and $52,000 on 12/31/04. If accrual sales revenue for 2004 was $600,000, what was cash basis revenue?
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 20
Direct Method SCF Example:
The A/R balance was $45,000 on 1/1/04 and $52,000 on 12/31/04. If accrual sales revenue for 2004 was $600,000, what was cash basis revenue? Accounts Receivable 45,000
52,000 McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 21
Direct Method SCF Example:
The A/R balance was $45,000 on 1/1/04 and $52,000 on 12/31/04. If accrual sales revenue for 2004 was $600,000, what was cash basis revenue? Accounts Receivable 45,000 600,000
Cash collected
52,000 McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 22
Direct Method SCF Example:
The A/R balance was $45,000 on 1/1/04 and $52,000 on 12/31/04. If accrual sales revenue for 2004 was $600,000, what was cash basis revenue? Accounts Receivable 45,000 600,000 52,000 McGraw-Hill/Irwin
593,000
Cash collected
So, Accrual Sales $600,000 - Increase in A/R 7,000 = Cash collected from customers $593,000
© The McGraw-Hill Companies, Inc., 2003
12- 23
Direct Method Converting Accrued Expenses to Cash Accrual basis expenses include expenses that have not yet been paid. ◆ Can be computed as: ◆
Expense, Accrual Basis
+ decrease or - increase in “expense” payables
McGraw-Hill/Irwin
Expense, Cash Basis
© The McGraw-Hill Companies, Inc., 2003
12- 24
Direct Method SCF Example: (Accrued) Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004?
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 25
Direct Method SCF Example: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004? Salary Expense
McGraw-Hill/Irwin
Salary Payable
© The McGraw-Hill Companies, Inc., 2003
12- 26
Direct Method SCF Example: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004? Salary Expense
Salary Payable
$500,000
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 27
Direct Method SCF Example: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004? Salary Expense $500,000
Salary Payable 35,000 10,000
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 28
Direct Method SCF Example: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004? Salary Expense $500,000
Salary Payable 35,000 $500,000 10,000
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 29
Direct Method SCF Example: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004? Salary Expense $500,000
Salary Payable 35,000 525,000 $500,000 10,000
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 30
Direct Method SCF Example: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004?
Salary Expense $500,000
Salary Payable 525,000 Cash paid
35,000 $500,000 10,000
McGraw-Hill/Irwin
So, Accrual exp. $500,000 + Decr. in pay. 25,000 = Cash paid
$525,000
© The McGraw-Hill Companies, Inc., 2003
12- 31
Direct Method Converting Cost of Goods Sold to Cash Basis
Requires analysis of two balance sheet accounts: inventory and accounts payable. ◆ Can be computed as: ◆
Cost of Goods Sold Expense
+ Increase or - Decrease in
inventory and + Decrease or - Increase in accounts payable
Cash payments to suppliers McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 32
Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?
Inventory 12,000
Cost of Gds Sold 20,000
10,000 Accounts Payable 13,000
13,600
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 33
Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?
Inventory 12,000
Cost of Gds Sold 20,000
10,000 Accounts Payable 13,000
13,600
What increases and decreases each account? McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 34
Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?
Purchases on credit
Inventory Cost of Gds Sold Inv. sold 20,000 12,000 10,000 Accounts Payable Purchases 13,000 on credit 13,600
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 35
Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?
Purchases on credit
Inventory Cost of Gds Sold Inv. sold 20,000 12,000 10,000
Cash paid Accounts Payable Purchases 13,000 to suppliers on credit
13,600
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 36
Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?
Purchases on credit
Inventory Cost of Gds Sold Inv. sold 20,000 12,000 20,000 10,000
Cash paid Accounts Payable Purchases 13,000 to suppliers on credit
13,600
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 37
Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?
Purchases on credit
Inventory Cost of Gds Sold Inv. sold 20,000 12,000 20,000 18,000 10,000
Cash paid Accounts Payable Purchases 13,000 to suppliers on credit
18,000
13,600
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 38
Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?
Purchases on credit
Inventory Cost of Gds Sold Inv. sold 20,000 12,000 20,000 18,000 10,000
Cash paid Accounts Payable Purchases 13,000 to suppliers on credit
17,400
18,000
13,600
McGraw-Hill/Irwin
Cash paid
© The McGraw-Hill Companies, Inc., 2003
12- 39
Direct Method Converting Deferrals to Cash Basis ◆
Accounts like unearned revenue and prepaid insurance may cause the cash received or disbursed to be different from the revenue or expense shown on the income statement.
◆
Cash for a deferred expense can be computed as:
Expense Accrual Basis
McGraw-Hill/Irwin
+ Increase or - Decrease in related PREPAID =
Expense, Cash Basis
© The McGraw-Hill Companies, Inc., 2003
12- 40
Direct Method Converting Deferrals to Cash Basis ◆
Accounts like unearned revenue and prepaid insurance may cause the cash received or disbursed to be different from the revenue or expense shown on the income statement.
◆
Cash from an unearned revenue (deferred revenue) can be computed as:
Revenue, Accrual Basis
McGraw-Hill/Irwin
+ Increase or - Decrease in Unearned rev. =
Revenue, Cash Basis © The McGraw-Hill Companies, Inc., 2003
12- 41
Direct Method Example: Suppose the Unearned Revenue account showed a beginning balance of $200 and an ending balance of $900. The income statement indicates that $1,200 is the amount of Revenue (earned) for the period. How much cash was collected for revenue (assuming A/R did not change)? Unearned Revenue
McGraw-Hill/Irwin
Revenue
© The McGraw-Hill Companies, Inc., 2003
12- 42
Calculate the CASH! Unearned Revenue 200 900 So,
Revenue 1200 1200
McGraw-Hill/Irwin
Accrual based Revenue
$1,200
Increase in Unearn.Rev. = Cash collected from customers
$
© The McGraw-Hill Companies, Inc., 2003
12- 43
Direct Method Example: Unearned Revenue 200
What is cash-basis revenue??
900 Revenue 1,200 1,200
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 44
Determine what causes increases and decreases to each account, and find the CASH!
Unearned Revenue 200 1200
CASH
900 Revenue 1200 1200
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 45
Calculate the CASH! Unearned Revenue 200 1200 1900
CASH
900 Revenue 1200 1200
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 46
Calculate the CASH! Unearned Revenue 200 1200 1900
CASH
900 So,
Revenue 1200 1200
McGraw-Hill/Irwin
Accrual based Revenue + Increase in Unearn.Rev. = Cash collected from customers
$1,200 700 $1,900
© The McGraw-Hill Companies, Inc., 2003
12- 47
To summarize: ◆
What kinds of accounts need to be examined to see if there is a difference between our accrual accounting records and actual cash?
versus General Ledger McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 48
To summarize: ◆ ◆ ◆ ◆ ◆
Accounts Receivable Prepaids Inventory Accounts Payable Other Payables All current assets (except cash) and current liabilities, related to operations, need to be examined in conjunction with related revenue and expense accounts.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 49
Indirect Method ◆
Net cash flows from operating activities are determined by . . . ◆Starting with net income, then . . . ◆Adding and subtracting items that reconcile net income to operating cash flows.
◆
Requires an analysis of changes in all current asset and current liability accounts [related to operations], except cash.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 50
Indirect Method: Conversion from Net Income to Net Cashflow from Operating Activities ◆
Additions to net income: ✚ Depreciation, depletion, and amortization. ✚ All losses. ✚ Decreases in current assets (other than cash). ✚ Increases in current liabilities.
◆
Deductions from net income: - All gains. - Increases in current assets (other than cash). - Decreases in current liabilities.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 51
T-account approach ◆
Set up a t-account for every balance sheet account – Put beginning and ending balances in the accounts, using comparative balance sheets
◆
Make the CASH T-account a BIG one, with room for the three sections of the Statement of Cash Flows
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 52
T-account approach: ◆
◆
McGraw-Hill/Irwin
Make every balance sheet account balance, using the income statement accounts to calculate increases and decreases to the accounts. When the cash number is calculated for various increases or decreases in balance sheet accounts, put the appropriate debit or credit in the big cash T-account. © The McGraw-Hill Companies, Inc., 2003
12- 53
T-account approach: ◆
Problem 12-16A (Pacific Company) is a good demonstration problem of using the T-account approach to prepare a Statement of Cash Flows using the direct method.
Let’s do 12-16A
But first, there are just a few more slides to summarize things. McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 54
Summary of Differences Between Direct and Indirect Methods
◆
◆ ◆ ◆
The direct method provides more detail about cash from operating activities. – Shows individual operating cash flows. – Shows reconciliation of operating cash flows to net income in a supplemental schedule. The investing and financing sections for the two methods are identical. Net cash flow from Operating Activities and total net cash flow are the same for both methods. The schedule of Noncash Investing/Financing Activities is identical for both methods.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 55
How important is the Statement of Cash Flows? ◆
◆
◆
McGraw-Hill/Irwin
It is crucial to the presentation of a complete picture of the financial status of a business. Many businesses with great ideas and potential have failed due to their failure to manage their cash flows. Remember, the statement is REQUIRED by GAAP.
© The McGraw-Hill Companies, Inc., 2003
12- 56
Chapter 12
This course is FINISHED!! McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 2
Chapter 12 Statement of Cash Flows
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 3
Purpose of the Statement of Cash Flows To show how the business acquired its cash during the current year ◆ To show how the business spent its cash during the current year ◆
This information is crucial for decision makers to predict future cash flows of the business. McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 4
What is considered “CASH” for the Statement of Cash Flows? ◆
Cash includes cash and cash equivalents for purpose of the statement.
◆
Cash Equivalents are
Short-term, highly liquid investments, with – Maturity dates of 3 months or less from the date acquired by the holder, and are – Easily convertible into known amounts of cash. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin –
12- 5
Categories of Cash Flows They are based on activities related to cash flows: ➊ Operating the business. ➋ Investing in productive assets. ➌ Financing the business. These are the sections of the Statement of Cash Flows. McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 6
Operating Activities ◆
◆
◆
Cash inflows and outflows that are directly related to income from normal operations. Technically, FASB defines operating activities as those that are not investing or financing activities. There are two ways to compute net cash flow from operating activities: – Direct method – Indirect method
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 7
Cash Flows from Operating Activities Cash inflows and outflows that are directly related to income from normal operations. ◆ Inflows include: ◆
– Receipts from customers. – Interest on receivables. – Dividends received.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 8
Cash Flows from Operating Activities Cash inflows and outflows that are directly related to income from normal operations. ◆ Outflows include: ◆
he ot – Payments to suppliers. t y Pa – Interest paid on liabilities. – Income taxes paid. – Salary and wages payments to employees.
McGraw-Hill/Irwin
er ord
of
© The McGraw-Hill Companies, Inc., 2003
12- 9
Cash Flows from Investing Activities Cash inflows and outflows that are related to the purchase and sale of productive assets. ◆ Inflows include proceeds from: ◆
– Sales of property, plant, and equipment. – Sales of investments in securities. – Collection of principal on loans made to others. McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 10
Cash Flows from Investing Activities Cash inflows and outflows that are related to the purchase and sale of productive assets. ◆ Outflows include payments for: ◆
– The purchase of property, plant and equipment. – The purchase of long-term investments. – Loans to others. McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 11
Cash Flows from Financing Activities Cash inflows and outflows that are related to how cash was obtained to finance the enterprise. ◆ Inflows include: ◆
– Proceeds from sale of stock. – Proceeds from sale of bonds and from borrowings.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 12
Cash Flows from Financing Activities Cash inflows and outflows that are related to how cash was obtained to finance the enterprise. ◆ Outflows include: ◆
– Payments to purchase treasury stock. – Principal payments to retire bonds and loans. – Dividends paid to owners. (Remember, INTEREST paid is NOT a financing activity; it is an Operating Activity.) McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 13
Cash Flows from Noncash Activities ◆
Investing and financing activities that do not involve cash, e.g., – Retirement of bonds by issuing stock. – Settlement of debt by transferring assets other than cash. cash
◆
Noncash activities must be disclosed separately in the financial statements.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 14
Preparing the Statement of Cash Flows The face of the statement includes: Net Cash Flows from Operating Activities +Net Cash Flows from Investing Activities +Net Cash Flows from Financing Activities =Net change in Cash Flows for the period + Beginning Cash Balance =End of period Cash Balance
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 15
Two Alternative Approaches ◆
Indirect Method – Shows net cash inflow (outflow) from operations as an adjustment of net income. – Used by 97% of companies.
◆
Direct Method (used in Ch. 1-11 in text.) – Reports the components of cash from operations as gross receipts and payments. – Recommended by the FASB, but rarely used.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 16
Converting Accrual Data to Cash Data Accounting records are kept on the accrual basis (GAAP). ◆ Cash data must be developed before the SCF can be prepared (especially for operating activities). ◆ The examples that follow demonstrate the direct method for converting accrual data to cash data. ◆
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 17
Three information sources are used: The income statement for the current period. ➋ Comparative beginning of period and end of period balance sheets. ➌ Additional transaction details not found in the financial statements. ➊
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 18
Direct Method SCF Converting Revenues to Cash Basis Accrual basis revenue includes sales that did not result in cash inflows. ◆ Can be computed as: ◆
Revenue, Accrual basis
McGraw-Hill/Irwin
+ decrease or = increase in A/R
Revenue, Cash basis
© The McGraw-Hill Companies, Inc., 2003
12- 19
Direct Method SCF Example: The A/R balance was $45,000 on 1/1/04 and $52,000 on 12/31/04. If accrual sales revenue for 2004 was $600,000, what was cash basis revenue?
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 20
Direct Method SCF Example:
The A/R balance was $45,000 on 1/1/04 and $52,000 on 12/31/04. If accrual sales revenue for 2004 was $600,000, what was cash basis revenue? Accounts Receivable 45,000
52,000 McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 21
Direct Method SCF Example:
The A/R balance was $45,000 on 1/1/04 and $52,000 on 12/31/04. If accrual sales revenue for 2004 was $600,000, what was cash basis revenue? Accounts Receivable 45,000 600,000
Cash collected
52,000 McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 22
Direct Method SCF Example:
The A/R balance was $45,000 on 1/1/04 and $52,000 on 12/31/04. If accrual sales revenue for 2004 was $600,000, what was cash basis revenue? Accounts Receivable 45,000 600,000 52,000 McGraw-Hill/Irwin
593,000
Cash collected
So, Accrual Sales $600,000 - Increase in A/R 7,000 = Cash collected from customers $593,000
© The McGraw-Hill Companies, Inc., 2003
12- 23
Direct Method Converting Accrued Expenses to Cash Accrual basis expenses include expenses that have not yet been paid. ◆ Can be computed as: ◆
Expense, Accrual Basis
+ decrease or - increase in “expense” payables
McGraw-Hill/Irwin
Expense, Cash Basis
© The McGraw-Hill Companies, Inc., 2003
12- 24
Direct Method SCF Example: (Accrued) Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004?
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 25
Direct Method SCF Example: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004? Salary Expense
McGraw-Hill/Irwin
Salary Payable
© The McGraw-Hill Companies, Inc., 2003
12- 26
Direct Method SCF Example: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004? Salary Expense
Salary Payable
$500,000
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 27
Direct Method SCF Example: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004? Salary Expense $500,000
Salary Payable 35,000 10,000
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 28
Direct Method SCF Example: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004? Salary Expense $500,000
Salary Payable 35,000 $500,000 10,000
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 29
Direct Method SCF Example: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004? Salary Expense $500,000
Salary Payable 35,000 525,000 $500,000 10,000
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 30
Direct Method SCF Example: Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004?
Salary Expense $500,000
Salary Payable 525,000 Cash paid
35,000 $500,000 10,000
McGraw-Hill/Irwin
So, Accrual exp. $500,000 + Decr. in pay. 25,000 = Cash paid
$525,000
© The McGraw-Hill Companies, Inc., 2003
12- 31
Direct Method Converting Cost of Goods Sold to Cash Basis
Requires analysis of two balance sheet accounts: inventory and accounts payable. ◆ Can be computed as: ◆
Cost of Goods Sold Expense
+ Increase or - Decrease in
inventory and + Decrease or - Increase in accounts payable
Cash payments to suppliers McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 32
Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?
Inventory 12,000
Cost of Gds Sold 20,000
10,000 Accounts Payable 13,000
13,600
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 33
Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?
Inventory 12,000
Cost of Gds Sold 20,000
10,000 Accounts Payable 13,000
13,600
What increases and decreases each account? McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 34
Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?
Purchases on credit
Inventory Cost of Gds Sold Inv. sold 20,000 12,000 10,000 Accounts Payable Purchases 13,000 on credit 13,600
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 35
Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?
Purchases on credit
Inventory Cost of Gds Sold Inv. sold 20,000 12,000 10,000
Cash paid Accounts Payable Purchases 13,000 to suppliers on credit
13,600
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 36
Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?
Purchases on credit
Inventory Cost of Gds Sold Inv. sold 20,000 12,000 20,000 10,000
Cash paid Accounts Payable Purchases 13,000 to suppliers on credit
13,600
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 37
Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?
Purchases on credit
Inventory Cost of Gds Sold Inv. sold 20,000 12,000 20,000 18,000 10,000
Cash paid Accounts Payable Purchases 13,000 to suppliers on credit
18,000
13,600
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 38
Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?
Purchases on credit
Inventory Cost of Gds Sold Inv. sold 20,000 12,000 20,000 18,000 10,000
Cash paid Accounts Payable Purchases 13,000 to suppliers on credit
17,400
18,000
13,600
McGraw-Hill/Irwin
Cash paid
© The McGraw-Hill Companies, Inc., 2003
12- 39
Direct Method Converting Deferrals to Cash Basis ◆
Accounts like unearned revenue and prepaid insurance may cause the cash received or disbursed to be different from the revenue or expense shown on the income statement.
◆
Cash for a deferred expense can be computed as:
Expense Accrual Basis
McGraw-Hill/Irwin
+ Increase or - Decrease in related PREPAID =
Expense, Cash Basis
© The McGraw-Hill Companies, Inc., 2003
12- 40
Direct Method Converting Deferrals to Cash Basis ◆
Accounts like unearned revenue and prepaid insurance may cause the cash received or disbursed to be different from the revenue or expense shown on the income statement.
◆
Cash from an unearned revenue (deferred revenue) can be computed as:
Revenue, Accrual Basis
McGraw-Hill/Irwin
+ Increase or - Decrease in Unearned rev. =
Revenue, Cash Basis © The McGraw-Hill Companies, Inc., 2003
12- 41
Direct Method Example: Suppose the Unearned Revenue account showed a beginning balance of $200 and an ending balance of $900. The income statement indicates that $1,200 is the amount of Revenue (earned) for the period. How much cash was collected for revenue (assuming A/R did not change)? Unearned Revenue
McGraw-Hill/Irwin
Revenue
© The McGraw-Hill Companies, Inc., 2003
12- 42
Calculate the CASH! Unearned Revenue 200 900 So,
Revenue 1200 1200
McGraw-Hill/Irwin
Accrual based Revenue
$1,200
Increase in Unearn.Rev. = Cash collected from customers
$
© The McGraw-Hill Companies, Inc., 2003
12- 43
Direct Method Example: Unearned Revenue 200
What is cash-basis revenue??
900 Revenue 1,200 1,200
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 44
Determine what causes increases and decreases to each account, and find the CASH!
Unearned Revenue 200 1200
CASH
900 Revenue 1200 1200
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 45
Calculate the CASH! Unearned Revenue 200 1200 1900
CASH
900 Revenue 1200 1200
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 46
Calculate the CASH! Unearned Revenue 200 1200 1900
CASH
900 So,
Revenue 1200 1200
McGraw-Hill/Irwin
Accrual based Revenue + Increase in Unearn.Rev. = Cash collected from customers
$1,200 700 $1,900
© The McGraw-Hill Companies, Inc., 2003
12- 47
To summarize: ◆
What kinds of accounts need to be examined to see if there is a difference between our accrual accounting records and actual cash?
versus General Ledger McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 48
To summarize: ◆ ◆ ◆ ◆ ◆
Accounts Receivable Prepaids Inventory Accounts Payable Other Payables All current assets (except cash) and current liabilities, related to operations, need to be examined in conjunction with related revenue and expense accounts.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 49
Indirect Method ◆
Net cash flows from operating activities are determined by . . . ◆Starting with net income, then . . . ◆Adding and subtracting items that reconcile net income to operating cash flows.
◆
Requires an analysis of changes in all current asset and current liability accounts [related to operations], except cash.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 50
Indirect Method: Conversion from Net Income to Net Cashflow from Operating Activities ◆
Additions to net income: ✚ Depreciation, depletion, and amortization. ✚ All losses. ✚ Decreases in current assets (other than cash). ✚ Increases in current liabilities.
◆
Deductions from net income: - All gains. - Increases in current assets (other than cash). - Decreases in current liabilities.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 51
T-account approach ◆
Set up a t-account for every balance sheet account – Put beginning and ending balances in the accounts, using comparative balance sheets
◆
Make the CASH T-account a BIG one, with room for the three sections of the Statement of Cash Flows
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 52
T-account approach: ◆
◆
McGraw-Hill/Irwin
Make every balance sheet account balance, using the income statement accounts to calculate increases and decreases to the accounts. When the cash number is calculated for various increases or decreases in balance sheet accounts, put the appropriate debit or credit in the big cash T-account. © The McGraw-Hill Companies, Inc., 2003
12- 53
T-account approach: ◆
Problem 12-16A (Pacific Company) is a good demonstration problem of using the T-account approach to prepare a Statement of Cash Flows using the direct method.
Let’s do 12-16A
But first, there are just a few more slides to summarize things. McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 54
Summary of Differences Between Direct and Indirect Methods
◆
◆ ◆ ◆
The direct method provides more detail about cash from operating activities. – Shows individual operating cash flows. – Shows reconciliation of operating cash flows to net income in a supplemental schedule. The investing and financing sections for the two methods are identical. Net cash flow from Operating Activities and total net cash flow are the same for both methods. The schedule of Noncash Investing/Financing Activities is identical for both methods.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
12- 55
How important is the Statement of Cash Flows? ◆
◆
◆
McGraw-Hill/Irwin
It is crucial to the presentation of a complete picture of the financial status of a business. Many businesses with great ideas and potential have failed due to their failure to manage their cash flows. Remember, the statement is REQUIRED by GAAP.
© The McGraw-Hill Companies, Inc., 2003
12- 56
Chapter 12
This course is FINISHED!! McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
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