Chapter

The Statement of Cash Flows

Section 2: Cash Flows from Operating Activities
Section Objectives
2. Compute cash flows from operating activities.

25

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

QUESTION:

What is the schedule of operating expenses?

ANSWER:

The schedule of operating expenses is a schedule that supplements the income statement.
It shows the selling and general and administrative expenses in greater detail.

Objective 2.

Compute Cash Flows From Operating Activities.

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.

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.

Indirect Method
Cash Flows from Operating Activities
+ or + + = Net income 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

Adjustments for Noncash Items on the Income Statement

Depreciation expense. of premium on bonds payable.

Amortization

Gain or loss on sale of equipment.

Depreciation Expense

On the income statement.

Not a cash outflow.

back to net income on the statement of cash flows.

Added

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.

Gain on Sale of Equipment

Equipment was sold for a greater amount than its book value so the company recorded a gain on the disposal.
On the statement of cash flows, the gain must be subtracted from net income because it did not provide cash.

QUESTION:

What are operating assets and liabilities?

ANSWER:

Operating assets and liabilities are current assets and current liabilities.
Changes are usually related to routine business operations and are reflected in net income.

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.

Decreases in Prepaid Expenses

Less 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 decrease in prepaid expenses is added to net income.

Increase in Supplies

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.

Decrease in Noncash Current Assets

Decreases

in noncash current assets are added to net income to arrive at cash flows from operating activities. is an example of a noncash current asset.

Inventory

Decrease in Merchandise Inventory

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.

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

Increase in Sales Tax Payable

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.

Increase in Payroll Taxes Payable

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.

Increase in Interest Payable

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.

Decrease in Current Liabilities

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.

Decrease in Accounts Payable

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.

Summary of Effects of Changes in Current Assets and Current Liabilities.

Add to Net Income

Increase in current asset Decrease in current asset Increase in current liability Decrease in current liability x x

Deduct from Net Income

x

Effect of Net Loss on Cash Flows from Operations

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.

California Products, Inc. Statement of Cash Flows (Partial) Year Ended December 31, 2008 Cash Flows from Operating Activities Net income after taxes (per income statement) Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense Amortization of premium on bonds payable Gain on sale of equipment Changes in noncash current assets and current liabilities: Increase in accounts receivable Decrease in merchandise inventory Decrease in prepaid expenses Increase in supplies Decrease in accounts payable Increase in sales tax payable Increase in payroll taxes payable Increase in interest payable Total adjustments Net cash provided by operating activities

56,578.00

7,680.00 ( 500.00) (4,000.00)

(32,150.00) 20,000.00 300.00 (250.00) (21,769.00) 1,000.00 120.00 645.00 (28,924.00) 27,654.00

SECTION

R
E V I

Complete the following sentences:

The two ways to prepare the statement of direct method and the cash flows are the ____________ indirect method ______________.

net income as The indirect method treats __________ the primary source of cash from operating activities.

E
W

Depreciation expense does not reflect a ___________ back to cash outlay so it must be added __________ net income.

SECTION

R
E V I

Complete the following sentences:

current assets and liabilities Changes in _______ Operating Activities are shown in the _________________ section of the statement of cash flows.

Increases in current assets are subtracted from net income to calculate ______________ net cash from operating activities.

E
W

added to Increases in current liabilities are ________ net income to calculate net cash from __________ operating activities.

Thank You
for using

College Accounting, 11th Edition

Price Haddock Brock