Principles of Accounting- Preparing the Statement of Cash Flows

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Nguyen Tan Binh 1 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4a 7/17/2006 Nguyễn Tấn Bình 1 Principles of Accounting Fulbright Economics Teaching Program Ho Chi Minh City, Vietnam Academic Year: 2005-2006 7/17/2006 Nguyễn Tấn Bình 2 Lecture Notes 4a Preparing the Statement of Cash Flows Nguyen Tan Binh 2 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4a 7/17/2006 Nguyễn Tấn Bình 3 Cash Flows and Income  The income statement and the statement of cash flows meet the different demands for information  The income statement tells us how the firm has been operating to enrich the owners’ equity (looking at the results)  The matching rule is applied for revenues and expenses; the accrual basis of accounting is used to measure the results of business activities  The statement of cash flows concerns with the net cash flow generated from business activities 7/17/2006 Nguyễn Tấn Bình 4 Preparing the Statement of Cash Flows Direct Method Bo Ho Company Balance Sheet, December 31 (amounts in thousands) Current Assets 2004 2003 Current Debt 2004 2003 Cash 16 25 Payables 74 6 Receivables 45 25 Salaries Payable 25 4 Inventory 100 60 Total Current Assets 161 $110 Total Current Debt 99 10 Fixed Assets, Acc. Cost 581 330 Long-term Debt 125 5 Accumulated Depreciation(101 ) (110) Owners’ Equity 417 315 Fixed Assets, net 480 220 Total Assets 641 330 Total Debt & OE 641 330 Notes: During 2004, the firm liquidated some fixed assets for book values and received 10 in cash; it also paid dividends of 19 Nguyen Tan Binh 3 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4a 7/17/2006 Nguyễn Tấn Bình 5 Direct Method Bo Ho Company Income Statement ($1000) December 31, 2004 Revenue $200 Expenses: Cost of Goods Sold 100 Salaries Expense 36 Depreciation Expense 17 Interest Expense 4 Total Expenses 157 Earnings Before Tax 43 Corporate Income Tax 20 Net Income $ 23 7/17/2006 Nguyễn Tấn Bình 6 Direct Method Bo Ho Company Statement of Cash Flows ($1000) December 31, 2004 CASH FLOW FROM OPERATING: Receipts from Customers $ 180 Payments Suppliers $ 72 Salaries 15 Interest 4 Taxes 20 Total Payments (111) Net Cash Flow from Operating (I) $ 69 Nguyen Tan Binh 4 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4a 7/17/2006 Nguyễn Tấn Bình 7 Direct Method Bo Ho Company Statement of Cash Flows ($1000) December 31, 2004 (cont.) CASH FLOW FROM INVESTING: Payments for Purchases of Fixed Assets $(287) Collections from Liquidation of Fixed Assets 10 Net Cash Flow from Investing (II) (277) 7/17/2006 Nguyễn Tấn Bình 8 Direct Method Bo Ho Company Statement of Cash Flows ($1000) December 31, 2004 (cont.) CASH FLOW FROM FINANCING: Long term Borrowing $120 Stock Issue 98 Dividends Paid (19) Net Cash Flow from Financing (III) 199 TOTAL NET CASH FLOW = I+II+III (decrease) (9) Cash Balance, December 31, 2003 25 Cash Balance, December 31, 2004 $ 16 Nguyen Tan Binh 5 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4a 7/17/2006 Nguyễn Tấn Bình 9 Direct Method  Step 1: Look at the change in the balance from the beginning to the end of period  These numbers are often shown at the end of the cash flow statement • Total net cash flow + the beginning cash balance = the ending cash balance • Or, the ending cash balance – the beginning cash balance = total net cash flow 7/17/2006 Nguyễn Tấn Bình 10 Direct Method  In our example, cash balance reduces by $9,000  Operating activity during period provides $69,000  Investing activity uses $277,000  Financing activity generates $199,000 ($69,000 + 199,000 – 277,000 = - $9,000)  It tells us, the firm shows a profit but its cash is decreasing Nguyen Tan Binh 6 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4a 7/17/2006 Nguyễn Tấn Bình 11 Changes in Accounting Equation  The accounting equation can be rearranged: Cash = Liabilities + OE – Non-cash Assets or ∆Cash = ∆Liabilities + ∆OE – ∆Non-cash Assets Any change (∆) in non-cash items (liabilities, owners’ equity, or assets) must be accompanied by a change in cash to keep the equation balance  If a non-cash asset changes, how will it affect cash? 7/17/2006 Nguyễn Tấn Bình 12 Changes in Accounting Equation (cont.)  The statement of cash flow concerns with changes in non-cash accounts as a means to explain why and how the cash balance changes during the accounting period Changes in Cash = Changes in all Non-cash Accounts or What happens to Cash? = Why does it happen? Nguyen Tan Binh 7 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4a 7/17/2006 Nguyễn Tấn Bình 13 Cash Equation Assets = Liabilities + Owners’ Equity Î Current Assets + Fixed Assets = Liabilities + Owners’ Equity Î Cash + Receivables + Inventory = Liabilities + Owners’ Equity – Fixed Assets Î Cash = Liabilities + OE – FA – Receivables – Inventory ) A change in Liabilities or Owners’ Equity leads to a positive change in Cash ) A change in Assets leads to a negative change in Cash 7/17/2006 Nguyễn Tấn Bình 14 Calculating Cash Flow from Operating Activity  Receipts from customers are the largest inflow from operating activity  Disbursements for merchandise purchases and operating expenses are the largest outflow to operating activity  Inflows minus (-) outflows equal the net cash flow generated from (or used by) operating activity Nguyen Tan Binh 8 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4a 7/17/2006 Nguyễn Tấn Bình 15 From Amounts on the Income Statement to Items on the Statement of Cash Flows  Accountants often calculate cash flows from income statement items  Some accountants use the balance sheet with their experiences and additional information to determine changes in the balance sheet and calculate cash flow items  However, most of corporate accounting systems cannot provide detailed information to follow this way 7/17/2006 Nguyễn Tấn Bình 16 From Amounts on the Income Statement to Items on the Statement of Cash Flows (cont.)  In our example, $180,000 is collected from customers. This amount is determined as follows: Revenue $200,000 (+) Beginning Receivables 25,000 (=) Total Receivables $225,000 (-) Ending Receivables 45,000 (=) Collections during Period $180,000 ======= Or Revenue $200,000 Decrease (Increase) in Receivables (20,000 ) Collections during Period $180,000 =======  Remember that an increase in receivables means collections < revenue Nguyen Tan Binh 9 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4a 7/17/2006 Nguyễn Tấn Bình 17 From Amounts on the Income Statement to Items on the Statement of Cash Flows (cont.)  The difference between the cost of goods sold and the amount paid to suppliers can be determined by looking at inventory and payables Ending Inventory $100,000 (+) Cost of Goods Sold 100,000 (=) Merchandise during Period $200,000 (-) Beginning Inventory (60,000) (=) Merchandise Purchased during Period $140,000 ======= Beginning Payables $ 6,000 (+) Merchandise Purchased during Period 140,000 (=) Total Payables $146,000 (-) Ending Payables (74,000) (=) Amount Paid to Suppliers $ 72,000 ======= 7/17/2006 Nguyễn Tấn Bình 18 From Amounts on the Income Statement to Items on the Statement of Cash Flows (cont.)  Calculations on the previous slide for the amount paid to suppliers can be summarized as follows: Cost of Goods Sold $100,000 Increase (Decrease) in Inventory 40,000 Decrease (Increase) in Payables (68,000 ) Amount Paid to Suppliers $72,000 Nguyen Tan Binh 10 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4a 7/17/2006 Nguyễn Tấn Bình 19 From Amounts on the Income Statement to Items on the Statement of Cash Flows (cont.)  The salaries paid can be determined by salaries expense and salaries payable Beginning Salaries Payable $ 4,000 (+) Salaries Expense during Period 36,000 (=) Total Salaries Payable $ 40,000 (-) Ending Salaries Payable (25,000) (=) Salaries Paid $ 15,000 Or, Salaries Expense during Period $ 36,000 Decrease (Increase) in Salaries Payable (21,000) Salaries Paid $ 15,000 7/17/2006 Nguyễn Tấn Bình 20 From Amounts on the Income Statement to Items on the Statement of Cash Flows (cont.)  Note that in our example, both interest payable and corporate tax payable have a zero balance at the beginning and the ending of period  It means the total interest expense and tax have been accrued and paid off, so the cash flow equals the expenses, namely, $4,000 interest paid, and $20,000 tax paid [...].. .Principles of accounting Fulbright Economics Teaching Program 2005-2006 Lecture 4a Comparing the Income Statement and the Statement of Cash Flows Since revenues and expenses are recognized on the accrual basis of accounting, they are inevitably related to the balance sheet accounts The cash impacts on income statement accounts are balanced by the related balance sheet accounts The balance... 29 Non -cash Investing and Financing Activities Non -cash activities have no impact on cash, and hence, do not appear on the statement of cash flows Remember, cash flows from investing and financing activities are prepared under the direct method; that is, they are actually received and paid Readers still want to know this information These items will be shown as endnotes to the statement of cash flows, ... recording on the statement of cash flow 7/17/2006 Nguyễn Tấn Bình 41 More Discussion on the Statement of Cash Flows Two items usually shown on the statement of cash flow in the indirect method: Profits or losses from sales of fixed assets (investing) Profits or losses from debt payment before due (financing) 7/17/2006 Nguyen Tan Binh Nguyễn Tấn Bình 42 21 Fulbright Economics Teaching Program 2005-2006 Principles. .. on a separate statement 7/17/2006 Nguyen Tan Binh Nguyễn Tấn Bình 30 15 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4a Preparing the Statement of Cash Flows Indirect Method In addition to the direct method of calculating cash flows from operations, the indirect method is also used The indirect method proves to be better in valuation of income quality The indirect... reflected in the other activities (investing or financing), so they should be adjusted to avoid from being double recorded on the same statement of cash flows 7/17/2006 Nguyễn Tấn Bình 39 Adjustments (cont.) Ben Thanh Company sells a piece of land for 50 million in cash; its acquisition cost is 75 million; the firm has a loss of 25 million How does this loss affect the cash flow from operating on the statement. .. but the profits (losses) from debt payment before due have been shown in the net income These profits (losses) should be adjusted as same as those from sales of fixed assets 7/17/2006 Nguyen Tan Binh Nguyễn Tấn Bình 44 22 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4a Statement of Cash Sources and Uses Bo Ho Company The statement of cash sources and uses is the precursor... 2005-2006 Principles of accounting Lecture 4a Adjustments (cont.) Profits (losses) from non -cash operating do not belong to the firm’s main operating activity, but are shown on the income statement, and hence, affect the net income These profits (losses) should be subtracted from (added to) net income, because they have been recorded in the other activity (investing and financing) These profits (losses)... Cash = ∆Liabilities + ∆Owners’ Equity – ∆Non -cash Assets 7/17/2006 23 Nguyễn Tấn Bình Comparing the Income Statement and the Statement of Cash Flows (cont.) The common adjustments to transfer the amounts on the income statement into cash flow items: Income Statement Non -cash Assets Liabilities Revenue Cost of Goods Sold Salaries Expense Rental Expense Insurance Expense Depreciation Expense Amortization... operating on the statement of cash flow? 7/17/2006 Nguyen Tan Binh Nguyễn Tấn Bình 40 20 Fulbright Economics Teaching Program 2005-2006 Principles of accounting Lecture 4a Adjustments (cont.) The firm’s net income has included the 25 million loss, but this is not an operating activity The cash flow of 50 million (with the loss imbedded) is shown in the category of cash flow from investing The 25 million loss... Teaching Program 2005-2006 Principles of accounting Lecture 4a Comparing the Income Statement and the Statement of Cash Flows (cont.) Remember, regardless plus or minus an increase or a decrease, any change in non -cash assets, liabilities, or owners’ equity is always accompanied by a change in cash to keep the accounting equation balance Cash = ∆Liabilities + ∆Owners’ Equity – ∆Non -cash Assets 7/17/2006 . at the change in the balance from the beginning to the end of period  These numbers are often shown at the end of the cash flow statement • Total net cash. Tấn Bình 3 Cash Flows and Income  The income statement and the statement of cash flows meet the different demands for information  The income statement
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