CASH FLOW STATEMENTS

The official name for the cash flow statement is the statement of cash flows. We will use both names throughout AccountingCoach.com.

The statement of cash flows is one of the main financial statements. (The other financial statements are the balance sheet, income statement, and statement of stockholders' equity.)

The cash flow statement reports the cash generated and used during the time interval specified in its heading. The period of time that the statement covers is chosen by the company. For example, the heading may state "For the Three Months Ended December 31, 2010" or "The Fiscal Year Ended September 30, 2010".

The cash flow statement organizes and reports the cash generated and used in the following categories: 1. Operating activities converts the items reported on the income statement from the accrual basis of accounting to cash. 2. Investing activities reports the purchase and sale of long-term investments and property, plant and equipment.

3. Financing activities reports the issuance and repurchase of the company's own bonds and stock and the payment of dividends. 4. Supplemental information reports the exchange of significant items that did not involve cash and reports the amount of income taxes paid and interest paid.

What Can The Statement of Cash Flows Tell Us?

Because the income statement is prepared under the accrual basis of accounting, the revenues reported may not have been collected. Similarly, the expenses reported on the income statement might not have been paid. You could review the balance sheet changes to determine the facts, but the cash flow statement already has integrated all that information. As a result, savvy business people and investors utilize this important financial statement. Here are a few ways the statement of cash flows is used. 1. The cash from operating activities is compared to the company's net income. If the cash from operating activities is consistently greater than the net income, the company's net income or earnings are said to be of a "high quality". If the cash from operating activities is less than net income, a red flag is raised as to why the reported net income is not turning into cash. 2. Some investors believe that "cash is king". The cash flow statement identifies the cash that is flowing in and out of the company. If a company is consistently generating more cash than it is using, the company will be able to increase its dividend, buy back some of its stock, reduce debt, or acquire another company. All of these are perceived to be good for stockholder value. 3. Some financial models are based upon cash flow.

We often enhance our comprehension of a topic when we have to think through solutions to problems, so to help you really understand the cash flow statement, we've put together some questions for you to answer. As you formulate your response you will be learning to think about cash flows the way an accountant does.

1. 2. 3. 4. 5. 6. 7. 8. 9.

When Mary Smith invests her personal money into her new company, what will happen to Answer her company's Cash account? When a company purchases inventory (merchandise purchased in order to be resold) what will happen to its Cash account? What happens to the company's Cash account if it borrows money from the bank by signing a note payable? What happens to a company's Cash account if it declares a dividend on its shares of stock? What is the effect on its Cash account when a company pays some of its Accounts Payable? What is the effect on its Cash account when a company prepays a 6-month insurance premium? Answer Answer Answer Answer Answer

What is the effect on its Cash account when a company sells merchandise, but allows the Answer customer to pay in 30 days? What is the effect on its Cash account when a company receives payment from one of its Answer customers 30 days after the sale was recorded? If a company's Accounts Payable account decreased, what is the likely effect this will have on Cash? Answer Answer Answer Answer Answer Answer

10. If the asset account Prepaid Insurance increased, what is the likely effect on Cash? 11. If the asset account Land increased, what's the likely effect on Cash? 12. If the asset account Land decreased, what's the likely effect on Cash? 13. If the liability account Bonds Payable increases, what is the likely effect on Cash? 14. If the liability account Bonds Payable decreases, what is the likely effect on Cash?

Much of what you learned in the practice questions above is common sense. For example, when you use cash to buy a book, you now own the book (you've increased your "assets") but you also have less money (you've decreased your cash). Based on what you learned, you can make the following general assumptions: When an asset (other than cash) increases, the Cash account decreases. When an asset (other than cash) decreases, the Cash account increases. When a liability increases, the Cash account increases. When a liability decreases, the Cash account decreases. When owner's equity increases, the Cash account increases. When owner's equity decreases, the Cash account decreases.

For a change in assets (other than cash)the change in the Cash account is in the opposite direction.

For a change in liabilities and owner's equitythe change in the Cash account is in the same direction.

Story To Illustrate
Matt is a college student who enjoys buying and selling merchandise using the Internet. On January 2, 2010, he decides to turn his hobby into a business called "Good Deal Co." Each month the Good Deal Co. will have one or two transactions. At the end of each month we will prepare an income statement, balance sheet, and a statement of cash flows for the current month and for the year-todate period. The purpose is to show how these transactions are reported on the cash flow statement.

January Transactions and Financial Statements

On January 2, 2010 Matt invests $2,000 of his personal money into his sole proprietorship, Good Deal Co. On January 20, Good Deal buys 14 graphing calculators for $50 per calculatorthis is about 50% less than the selling price Matt has observed at the retail stores. The total cost to Good Deal for all 14 calculators is $700. Good Deal has no other transactions during January.

Matt prepares financial statements for his new business as of January 31, 2010:

Good Deal Co. Income Statement For the Month Ended January 31, 2010 Revenues Expenses Net Income $0 0 $0

Good Deal Co. Balance Sheet January 31, 2010 Assets Cash Inventory $1,300 700 Liabilities & Owner's Equity Liabilities Owner's Equity Matt Jones, Capital 2,000 $ 0

Total Assets

$2,000

Total Liab. & Owner's Equity

$2,000

Good Deal Co. Statement of Cash Flows For the Month Ended January 31, 2010 Operating Activities Net Income Increase in Inventory Cash Provided (Used) in Operating Activities Investing Activities Financing Activities Investment by Owner Net Increase in Cash Cash at the beginning of the month Cash at the end of the month 2,000 1,300 0 $1,300 $ 0 (700) (700) 0

Good Deal's income statement for January showed no profit or loss, since it did not have any sales or expenses. However, the cash flow statement reports that Good Deal's operating activities resulted in a decrease in cash of $700. The decrease in cash occurred because the company increased its inventory by $700 during January. The financing activities section shows an increase in cash of $2,000 which corresponds to the increase in Matt Jones, Capital (Matt's investment in the business). The net change in the Cash account from the owner's investment and the cash outflow for inventory is a positive $1,300.

This net change of a positive $1,300 is verified at the bottom of the cash flow statement and on the balance sheet. There was a $0 cash at January 1, but at January 31, the Cash balance is $1,300.

For a change in assets (other than cash)the change in the Cashaccount is in the opposite direction. Recall that when Inventoryincreased by $700, Cash decreased by $700.

For a change in liabilities and owner's equitythe change in the Cash account is in the same direction. Recall that when the owner invested cash in the company Cash increased and Owner's Equity increased.

February Transactions and Financial Statements

On February 25, 2010, Good Deal sells 10 calculators to a nearby high school for $80 each. Matt delivers the calculators on February 25 and gives the school an $800 invoice due by March 10. Matt receives $800 from the school on March 8.

Matt prepared financial statements for his new business as of February 28, 2010:

Good Deal Co. Income Statement For the Month Ended Feb. 28, 2010 Revenues Expenses Net Income $800 500 $300

The income statement for the month of February shows revenues (or sales) of $800. Under the accrual basis of accountingrevenue is recognized when title passes (at the time of shipment or time of delivery), notwhen the money is received. Expenses (such as the cost of goods sold for $500) appear on the income statement when they best match up with revenues, not when the expenses or goods are paid for. (Other expenses will also appear on the income statement when they are used, not when they are paid for.) As a result of the accrual basis of accounting, the income statement reports $300 of net income even though there was no cash inflow or cash outflow during February.

Good Deal Co. Statement of Cash Flows For the Month Ended February 28, 2010 Operating Activities Net Income Increase in Accounts Receivable Decrease in Inventory $ 300 (800) 500

Cash Provided (Used) in Operating Activities Investing Activities Financing Activities Investment by Owner Net Increase in Cash Cash at the beginning of the month Cash at the end of the month

0 0

0 0 1,300 $1,300

As you can see above, the cash flow statement for the month of February reports no change in cash. That agrees with the company's balance sheet that reported Cash of $1,300 on January 31 and will show $1,300 on February 28.

Good Deal Co. Income Statement For the Two Months Ended February 28, 2010 Revenues Expenses Net Income $800 500 $300

The year-to-date net income of $300 increases the owner's equity on the balance sheet. Please note the connection between the bottom line of the year-to-date income statement and the change in Matt Jones, Capital on the balance sheet. Matt Jones, Capital has increased from $2,000 to $2,300.

Good Deal Co. Balance Sheet February 28, 2010 Assets Cash $1,300 Liabilities & Owner's Equity Liabilities $ 0

Accounts Receivable Inventory

800 200

Owner's Equity Matt Jones, Capital (excl. net inc.) Matt Jones, Curr Yr. Net Income Total Owner's Equity 2,000 300 2,300 $2,300

Total Assets

$2,300

Total Liabilities & Owner's Equity

Good Deal Co. Statement of Cash Flows For the Two Months Ended February 28, 2010 Operating Activities Net Income Increase in Accounts Receivable Increase in Inventory Cash Provided (Used) in Operating Activities Investing Activities Financing Activities Investment by Owner Net Increase in Cash Cash at the beginning of the year Cash at February 28, 2010 $2,000 1,300 0 $1,300 $ 300 (800) (200) (700) 0

Good Deal's income statement for the first two months shows a positive net income of $300. However, the fact that the company's Accounts Receivable increased by $800 means the company did not collect the cash from its sales. And because Inventory increased by $200, the company's Cash had also decreased in order to pay for the Inventory increase. As a result, the cash flows for the two-month period shows that Good Deal's cash from operating activities is a negative $700. Recall that Good Deal has not received any money yet from its operations (buying and selling merchandise) and it paid out $700 for the 14 calculators it purchased.

The cash flow statement also shows $2,000 of financing by the owner. When this is combined with the negative $700 from operating activities, the net change in cash for the first two months is a positive $1,300. This agrees to the change in cash on the balance sheetnone on January 1 but $1,300 on February 28.

On March 8 Good Deal receives $800 for the calculators sold to the school on February 25. No other transactions occurred in March.

The Good Deal financial statements dated March 31 are:

Good Deal Co. Income Statement For the Month Ended March 31, 2010 Revenues Expenses Net Income $0 0 $0

Good Deal Co. Income Statement For the Three Months Ended March 31, 2010 Revenues Expenses Net Income $800 500 $300

Note that the year-to-date net income causes the amount in the owner's capital account (on the balance sheet) to increase from $2,000 to $2,300.

Good Deal Co. Balance Sheet March 31, 2010 Assets Cash Accounts Receivable Inventory Liabilities & Owner's Equity Liabilities Owner's Equity Matt Jones, Capital (excl. net inc.) Matt Jones, Curr Yr. Net Income

$2,100 0 200

2,000 300

Total Assets

$2,300

Total Owner's Equity Total Liabilities & Owner's Equity

2,300 $2,300

Good Deal Co. Statement of Cash Flows For the Three Months Ended March 31, 2010 Operating Activities Net Income Increase in Accounts Receivable Increase in Inventory Cash Provided (Used) in Operating Activities Investing Activities Financing Activities Investment by Owner Net Increase in Cash Cash at the beginning of the year Cash at March 31, 2010

$ 300 0 (200) 100 0 $2,000 2,100 0 $2,100

The income statement for the first three months of the business shows a net income of $300. The operating activities section of the statement of cash flows begins with the $300 in net income, but then shows that $200 of cash was used to increase inventory. As a result, only $100 of cash was provided from operating activities.

The statement of cash flows also shows that $2,000 was received from the owner's investment in the company. The net cash inflow from the company's operating, investing, and financing activities for the three months ended March 31, 2010 was $2,100.

The figure of $2,100 represents the change in cash from the beginning of the accounting year through March 31. If you look at the March 31 balance sheet, you will find that it confirms thisthere is $2,100 in the Cash account on March 31 and there was $0 on January 1.

The statement of cash flows presented above was for the three months ended March 31, 2010. Let's look at how the statement of cash flows would be prepared for just one monthMarch 2010.

Since much of the information for the cash flow statement comes from changes in balance sheet accounts, we need to have the balance sheet amounts for both February 28, 2010 and March 31, 2010. Thedifferences in these account balances from February 28 to March 31 will provide us with information we need on the activities in March.

April Transactions and Financial Statements

On April 28 Good Deal orders $150 of supplies on account. The supplies arrive on April 30 along with an invoice showing that the full $150 is due by May 30. None of the supplies were used in April. This was the only transaction during April.

Matt prepared the following financial statements for Good Deal Co. as of April 30:

Good Deal Co. Income Statement For the Month Ended April 30, 2010 Revenues Expenses Net Income $0 0 $0

Since no supplies were used in April, there is no change to the Supplies Expense account. The $150 is reported on the balance sheet in the asset account Supplies.

Good Deal Co. Income Statement For the Four Months Ended April 30, 2010 Revenues Expenses Net Income $800 500 $300

Good Deal Co. Balance Sheet April 30, 2010 Assets Liabilities & Owner's Equity

Cash Accounts Receivable Inventory Supplies

$2,100 0 200 150

Liabilities Accounts Payable Owner's Equity Matt Jones, Capital (excl. net inc.) Matt Jones, Curr Yr. Net Income Total Owner's Equity 2,000 300 2,300 $2,450 $ 150

Total Assets

$2,450

Total Liabilities & Owner's Equity

As you can see from the balance sheet the company added assets of $150 (Supplies) and added its first liability of $150 (Accounts Payable).

A balance sheet comparing April 30 to March 31 and the resulting differences or changes is shown below:

Good Deal Co. Balance Sheets April 30 and March 31, 2010

Assets Cash Accounts Receivable Inventory Supplies Total Assets

4-30-10 $2,100 0 200 150 $2,450

3-31-10 $2,100 0 200 $ 0

Change $ 0 0 0 $150 $150

$2,300

Liabilities & Owner's Equity Liabilities

Accounts Payable Owner's Equity Matt Jones, Capital (excl. net inc.) Matt Jones, Curr Yr. Net Income Total Owner's Equity Total Liabilities & Owner's Equity

$ 150

$150

2,000 300 2,300 $2,450

2,000 300 2,300 $2,300

0 0 0 $150

(If you are wondering why April 30 is shown before March 31, it is because accountants usually place the most current amounts closest to the account names. This is a courtesy to the reader in that these are assumed to be the more important amounts and will be easier to read if placed closest to the words.)

Good Deal Co. Statement of Cash Flows For the Month Ended April 30, 2010 Operating Activities Net Income Increase in Supplies Increase in Accounts Payable Cash Provided (Used) in Operating Activities Investing Activities Financing Activities Investment by Owner Net Increase in Cash Cash at the beginning of the month Cash at the end of the month 0 0 2,100 $2,100 $ 0 (150) 150 0 0

The cash flow statement for the month of April reports that there was no change in the Cash account from March 31 through April 30. The operating activities section reports the increase in Supplies, but also reports the increase in Accounts Payable.

On the statement of cash flows, think of the positive amounts (the numbers not in parentheses) as good for your cash balance. For example, if you don't pay your bills, that's good for your cash balance (but bad for the liability Accounts Payable which increases).

Think of the negative amounts (the numbers within parentheses) asnot good for cash. For example, if you pay a bill, that's not good for your cash balance (but good for the liability Accounts Payable which decreases).

Good Deal Co. Balance Sheets April 30, 2010 and December 31, 2009

Assets Cash Accounts Receivable Inventory Supplies Total Assets

4-30-10 $2,100 0 200 150 $2,450

12-31-09 $ 0 0 0 0 $ 0

Change $2,100 0 200 150 $2,450

Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones, Capital (excl. net inc.) Matt Jones, Curr Yr. Net Income 2,000 300 0 0 2,000 300 $ 150 $ 0 $ 150

Total Owner's Equity Total Liabilities & Owner's Equity

2,300 $2,450

0 $ 0

2,300 $2,450

Good Deal Co. Statement of Cash Flows For the Four Months Ended April 30, 2010 Operating Activities Net Income Increase in Inventory Increase in Supplies Increase in Accounts Payable Cash Provided (Used) in Operating Activities Investing Activities Financing Activities Investment by Owner Net Increase in Cash Cash at the beginning of the year Cash at April 30, 2010 2,000 2,100 0 $2,100 $ 300 (200) (150) 150 100 0

Let's review the statement of cash flows for the four months ended April 30: The operating activities section of the cash flow statement starts with the net income of $300 for the four-month period. The increase in Inventory is not good for cash, as shown by the negative $200. Similarly, the increase in Supplies is not good for cash and it is reported as a negative $150. The increase in Accounts Payable is good for cash (since some bills were not paid) so the increase in the liability account is a positive $150. Combining the amounts, the net change in cash that is explained by operating activities is a positive $100. There were no changes in long-term assets, hence no cash was involved in investing activities. There were no changes in long-term liabilities. There was a change in owner's equity since December 31, and as a result the financing activities section reports the owner's investment in Good Deal Co.

Combining the operating, investing, and financing activities, the cash flow statement reports a change in cash of $2,100. This agrees with the change in the Cash account from $0 on December 31, 2009 to $2,100 on April 30, 2010

On May 30 Good Deal pays its accounts payable of $150. On May 31 Good Deal purchases office equipment (a new computer and printer) that will be used exclusively in the business. The cost of the office equipment is $1,100 and is paid for in cash. The equipment is put into service on May 31. There were no other transactions in May.

Good Deal Co. Income Statement For the Month Ended May 31, 2010 Revenues Expenses Net Income $0 0 $0

Good Deal Co. Income Statement For the Five Months Ended May 31, 2010 Revenues Expenses Net Income $800 500 $300

Good Deal Co. Balance Sheet May 31, 2010 Assets Cash Accounts Receivable Inventory Supplies Office Equipment Total Assets Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones, Capital (excl. net inc.) Matt Jones, Curr Yr. Net Income Total Owner's Equity Total Liabilities & Owner's Equity

$ 850 0 200 150 1,100 $2,300

2,000 300 2,300 $2,300

A balance sheet comparing May 31 to April 30 and the resulting differences or changes is shown below:

Good Deal Co. Balance Sheets May 31 and April 30, 2010

Assets Cash Accounts Receivable Inventory Supplies Office Equipment Total Assets

5-31-10 $ 850 0 200 150 1,100 $2,300

4-30-10 $2,100 0 200 150 0 $2,450

Change $(1,250) 0 0 0 1,100 $ (150)

Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones, Capital (excl. net inc.) Matt Jones, Curr Yr. Net Income Total Owner's Equity Total Liabilities & Owner's Equity

$ 150 2,000 300 2,300 $2,450

$ (150) 0 0 0 $ (150)

2,000 300 2,300 $2,300

Good Deal Co. Statement of Cash Flows For the Month Ended May 31, 2010 Operating Activities Net Income Decrease in Accounts Payable Cash Provided (Used) in Operating Activities Investing Activities Purchase of Office Equipment Financing Activities Net Increase in Cash Cash at the beginning of the month Cash at the end of the month

0 (150) (150)

(1,100) 0 (1,250) 2,100 $ 850

Good Deal Co. Balance Sheets

May 31, 2010 and December 31, 2009

Assets Cash Accounts Receivable Inventory Supplies Office Equipment Total Assets

5-31-10 $ 850 0 200 150 1,100 $2,300

12-31-09 $ 0 0 0 0 0 $ 0

Change $ 850 0 200 150 1,100 $2,300

Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones, Capital (excl. net inc.) Matt Jones, Curr Yr. Net Income Total Owner's Equity Total Liabilities & Owner's Equity

$ 0 0 0 0 $ 0

2,000 300 2,300 $2,300

2,000 300 $2,300 $2,300

Good Deal Co. Statement of Cash Flows For the Five Months Ended May 31, 2010 Operating Activities Net Income Increase in Inventory Increase in Supplies Cash Provided (Used) in Operating Activities Investing Activities Purchase of Office Equipment Financing Activities Investment by Owner Net Increase in Cash Cash at the beginning of the year Cash at May 31, 2010

$ 300 (200) (150) (50) (1,100) 2,000 850 0 $ 850

Let's review the cash flow statement for the five months ended May 31: The operating activities section starts with the net income of $300 for the five-month period. The increase in Inventory is not good for cash, as shown by the negative $200. Similarly, the

increase in Supplies is not good for cash and it is reported as a negative $150. Combining the amounts, the net change in cash that is explained by operating activities is a negative $50. The increase in long-term assets is reported under investing activities. There were no changes in long-term liabilities. There was a change in owner's equity since December 31, and as a result the financing activities section of the cash flow statement reports the owner's investment into the Good Deal Co. Combining the operating, investing, and financing activities, the statement of cash flows reports an increase in cash of $850. This agrees with the change in the Cash account as shown on the balance sheets from December 31, 2009 (or January 1, 2010) and May 31, 2010.

Depreciation moves the cost of an asset to Depreciation Expense during the asset's useful life. The accounts involved in recording depreciation are Depreciation Expense and Accumulated Depreciation. As you can see, cash is not involved. In other words, depreciation reduces net income on the income statement, but it does not reduce the Cash account on the balance sheet.

Because we begin preparing the statement of cash flows using the net income figure taken from the income statement, we need to adjust the net income figure so that it is not reduced by Depreciation Expense. To do this, we add back the amount of the Depreciation Expense.

Depletion Expense and Amortization Expense are accounts similar to Depreciation Expense, as all three involve allocating the cost of a long-term asset to an expense over the useful life of the asset. There is no cash involved.

In the operating activities section of the cash flow statement, add back expenses that did not require the use of cash. Examples are depreciation, depletion, and amortization expense.

Let's illustrate how a depreciation expense is handled by continuing with the Good Deal Co.

June Transactions and Financial Statements

The only transaction recorded by Good Deal during June was the depreciation on the office equipment. Recall that on May 31 Good Deal purchased the office equipment (a new computer and printer) for $1,100 and it was put into service on the same day. Let's assume that a depreciation expense of $20 per month is recorded by Good Deal. As a result, Good Deal's financial statements at June 30 will be as follows:

Good Deal Co. Income Statement For the Month Ended June 30, 2010 Revenues Expenses $ 0

Depreciation Expense Net Income

20 $(20)

Good Deal Co. Income Statement For the Six Months Ended June 30, 2010 Revenues Expenses Cost of Goods Sold Depreciation Expense Total Expense Net Income 500 20 520 $280 $800

Good Deal Co. Balance Sheet June 30, 2010 Assets Cash Accounts Receivable Inventory Supplies Office Equipment Less: Accum. Depreciation Total Assets $ 850 0 200 150 1,100 (20) $2,280 Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones, Capital (excl. net inc.) Matt Jones, Curr Yr. Net Income Total Matt Jones, Capital Total Liabilities & Owner's Equity 2,000 280 2,280 $2,280 $ 0

A balance sheet comparing June 30 to May 31 and the resulting differences or changes is shown below:

Good Deal Co. Balance Sheets June 30 and May 31, 2010

Assets Cash Accounts Receivable Inventory Supplies Office Equipment Less: Accumulated Depreciation Total Assets

6-30-10 $ 850 0 200 150 1,100 (20) $2,280

5-31-10 $ 850 0 200 150 1,100 0 $2,300

Change $ 0 0 0 0 0 (20) $(20)

Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones, Capital (excl. net inc.) Matt Jones, Curr Yr. Net Income Total Matt Jones, Capital Total Liabilities & Owner's Equity 2,000 280 2,280 $2,280 2,000 300 2,300 $2,300 0 (20) (20) $(20) $ 0 $ 0 $ 0

(If you are wondering why June 30 is shown before May 31, it is because accountants usually place the most current amounts closest to the account names. This is a courtesy to the reader in that these are assumed to be the more important amounts and will be easier to read if placed closest to the words.)

Good Deal Co. Statement of Cash Flows For the Month Ended June 30, 2010 Operating Activities Net Income Add: Depreciation Expense Cash Provided (Used) in Operating Activities Investing Activities Financing Activities Net Increase in Cash Cash at the beginning of the month Cash at the end of the month $ (20) 20 0 0 0 0 850 $850

The cash flow statement for the month of June illustrates why depreciation expense needs to be added back to net income. Good Deal did not spend any cash in June, however, the entry in the Depreciation Expense account resulted in a net loss on the income statement. To convert the bottom line of the income statement (a loss of $20) to the amount of cash provided or used in operating activities ($0) we need to add back or remove the depreciation expense amount.

Good Deal Co. Balance Sheets June 30, 2010 and December 31, 2009

Assets Cash Accounts Receivable Inventory Supplies

6-30-10 $ 850 0 200 150

12-31-09 $ 0 0 0 0

Change $ 850 0 200 150

Office Equipment Less: Accumulated Depreciation Total Assets

1,100 (20) $2,280

0 0 $ 0

1,100 (20) $2,280

Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones, Capital (excl. net inc.) Matt Jones, Curr Yr. Net Income Total Matt Jones, Capital Total Liabilities & Owner's Equity 2,000 280 2,280 $2,280 0 0 0 $ 0 2,000 280 2,280 $2,280 $ 0 $ 0 $ 0

Good Deal Co. Statement of Cash Flows For the Six Months Ended June 30, 2010 Operating Activities Net Income Add back: Depreciation Expense Increase in Inventory Increase in Supplies Cash Provided (Used) in Operating Activities Investing Activities Increase in Office Equipment Financing Activities (1,100) $ 280 20 (200) (150) (50)

Investment by Owner Net Increase in Cash Cash at the beginning of the year Cash at June 30, 2010

2,000 850 0 $ 850

Let's review the cash flow statement for the six months ended June 30: The operating activities section starts with the net income of $280 for the six-month period. Depreciation expense is added back to net income because it was a noncash transaction (net income was reduced, but there was no cash spent on depreciation). The increase in the Inventory account is not good for cash, as shown by the negative $200. Similarly, the increase in Supplies is not good for cash and it is reported as a negative $150. Combining the amounts, the net change in cash that is explained by operating activities is a negative $50. The increase in long-term assets caused a cash outflow of $1,100 which is reported in the investing activities section. There were no changes in long-term liabilities. There was a change in owner's equity since December 31, and as a result the financing activities section reports the owner's $2,000 investment into the Good Deal Co. Combining the operating, investing, and financing activities, the statement of cash flows reports an increase in cash of $850. This agrees with the change in the Cash account as shown on the balance sheets from December 31, 2009 and June 30, 2010.

a company disposes of (sells) a long-term asset for an amount different from its recorded amount in the company's accounting records (its book value), an adjustment must be made to net income on the cash flow statement. For example, let's say a company sells one of its delivery trucks for $3,000. That truck is shown on the company records at its original cost of $20,000 less accumulated depreciation of $18,000. When these two amounts are combined ("netted together") the net amount is known as the book value (or the carrying value) of the asset. In the example, the book value of the truck is $2,000 ($20,000 $18,000). Because the proceeds from the sale of the truck are $3,000 and the book value is $2,000 the difference of $1,000 is recorded in the account Gain on Sale of Truckan income statement account. The transaction has the effect of increasing the company's net income. If the truck had sold for $1,500 ($500 less than its $2,000 book value), the difference of $500 would be reported in the account Loss on Sale of Truck and would reduce the company's net income. One of the rules in preparing a statement of cash flows is that the entire proceeds received from the sale of a long-term asset must be reported in the second section of the statement, the investing activities section. This presents a problem because any gain or loss on the sale of an asset is also included in the company's net income which is reported in the first sectionoperating activities. To avoid double counting, each gain isdeducted from net income and each loss is added to net income in the operating activities section of the cash flow statement. Let's illustrate this by returning to Good Deal Co.'s activities.

July Transactions and Financial Statements

On July 1 Matt decides that his company no longer needs its office equipment. Good Deal used the equipment for one month (May 31 through June 30) and had recorded one month's depreciation of $20. This means the book value of the equipment is $1,080 (the original cost of $1,100 less the $20 of accumulated depreciation). On July 1 Good Deal sells the equipment for $900 in cash and records a loss of $180 in the account Loss on Sale of Equipment on its income statement. There were no other transactions in July. The income statement and the statement of cash flows for the month of July illustrate how the disposal of the equipment is reported:

Good Deal Co. Income Statement For the Month Ended July 31, 2010 Revenues Expenses Loss on Sale of Equipment Net Income $ 0

180 $(180)

Good Deal Co. Income Statement For the Seven Months Ended July 31, 2010 Revenues Expenses Cost of Goods Sold Depreciation Expense Loss on Sale of Equipment Total Expense Net Income $800 500 20 180 700 $100

Good Deal Co. Balance Sheets July 31, 2010 and June 30, 2010

Assets Cash Accounts Receivable

7-31-10 $1,750 0

6-30-10 $ 850 0

Change $ 900 0

Inventory Supplies Office Equipment Less: Accumulated Depreciation Total Assets

200 150 0 0 $2,100

200 150 1,100 (20) $2,280

0 0 (1,100) 20 $ (180)

Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones, Capital (excl. net inc.) Matt Jones, Curr Yr. Net Income Total Matt Jones, Capital Total Liabilities & Owner's Equity

2,000 100 2,100 $2,100

2,000 280 2,280 $2,280

0 (180) (180) $ (180)

Good Deal Co. Statement of Cash Flows For the Month Ended July 31, 2010 Operating Activities Net Income Add back: Depreciation Expense Add back: Loss on Sale of Equipment Cash Provided (Used) in Operating Activities Investing Activities Proceeds from sale of Office Equipment Financing Activities Net Increase in Cash Cash at the beginning of the month Cash at the end of the month

$ (180) 0 180 0 900 0 900 850 $1,750

Let's review the cash flow statement for the month of July 2010: Net income for July was a net loss of $180. There were no revenues, expenses, or gains, but there was an entry of $180 in the account Loss on Sale of Equipment. There was no depreciation expense in July, and current assets and current liabilities did not change in July, so cash was not affected. (We could have omitted the line "Depreciation Expense".) There was no cash provided or used by operating activities. Good Deal received $900 from the sale of its office equipment. There was no change in long-term liabilities or owner's equity during July.

The summation of the amounts on the cash flow statement is a positive cash inflow of $900. This amount agrees to our check figurethe increase in the Cash account balance from June 30 to July 31.

Good Deal Co. Balance Sheets July 31, 2010 and December 31, 2009

Assets Cash Accounts Receivable Inventory Supplies Office Equipment Less: Accumulated Depreciation Total Assets

7-31-10 $1,750 0 200 150 0 0 $2,100

12-31-09 $ 0 0 0 0 0 0 $ 0

Change $1,750 0 200 150 0 0 $2,100

Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones, Capital (excl. net inc.) Matt Jones, Curr Yr. Net Income Total Matt Jones, Capital Total Liabilities & Owner's Equity

$ 0 0 0 0 $ 0

2,000 100 2,100 $2,100

2,000 100 2,100 $2,100

Good Deal Co. Statement of Cash Flows For the Seven Months Ended July 31, 2010 Operating Activities Net Income Add back: Depreciation Expense Add back: Loss on Sale of Equipment Increase in Inventory Increase in Supplies Cash Provided (Used) in Operating Activities Investing Activities Purchase of Office Equipment Proceeds from sale of Office Equipment Cash Provided (Used) in Investing Activities Financing Activities

100 20 180 (200) (150) (50)

(1,100) 900 (200)

Investment by owner Net Increase in Cash Cash at the beginning of the year Cash at July 31, 2010

2,000 1,750 0 $1,750

Let's review the cash flow statement for the seven months of January through July 2010: Net income for the seven months is $100. This includes revenues, gains, expenses, and losses. Included in the net income for the seven months is $20 of depreciation expense. This expense reduced net income but did not reduce the Cash account; therefore we add the $20 depreciation expense to the net income. Also included in net income is the $180 entry into the Loss on Sale of Equipment account. This loss was reported on the income statement thereby reducing net income but not reducing cash. (The cash received from the sale of the equipment appears in its entirety under the investing activities section of the cash flow statement.) Inventory on July 31 is $200 (4 calculators at a cost of $50 each). Since the company began with no inventory, this increase in the Inventory account means that $200 of cash was used to increase inventory. Supplies increased from none to $150. The increase in the Supplies account is assumed to have had a negative effect of $150 on the Cash account. Combining the amounts so far, we see that the cash from operating activities is a negative $50. In other words, rather than providing cash, the operating activities used $50 of cash. There is cash outflow (or payment) of $1,100 to purchase the office equipment on May 31 and the $900 of cash inflow (or receipt) from the sale of the office equipment on July 1. Combining these two amounts results in the net outflow ("cash used in investing activities") of $200. There was an owner's investment of $2,000 made on January 2.

The statement of cash flow's bottom line amount of $1,750 results from combining the amount totals of the previous three sectionsoperating, investing, and financing activities. This $1,750 agrees to the check figurethe difference in the Cash account balance from the beginning of January to July 31.