Cash Flow Statement

Practice As You Learn

Practice As You Learn

Format of the Indirect Method:

Net Income

+ – Adjustments for Noncash Items   
add expenses and losses
subtract revenues and gains

+ – Change in Current Assets and Liabilities

Current Assets:   
subtract increases from prior year   
add decrease from prior year

Current Liabilities:  
add increases from prior year 
subtract decreases from prior year
_________________________
= Cash from operating activities

Preparing the Cash Flow Statement using the Direct Method:

Collected from customers:

Sales or other revenue
+ beginning receivable
–  ending receivable
= Cash collected from customers 

Collected from investments – dividend and interest income:

Dividend/Interest Income
+ beginning receivable
–  ending receivable
= Cash collected from dividends/interest

Paid to suppliers:

Cost of Goods Sold
–  Beginning Inventory
+ Ending Inventory
+ Beginning A/P
–  Ending A/P 
= Cash Paid to Suppliers

Paid for all other expenses:

Expense
+ Beginning matching payable
–  Ending matching payable
= Cash Paid for expense

Expense 
– Beginning matching asset
+ ending matching asset
= Cash paid for expense

Always: + Beginning – Ending, 
Except when matching an asset with an expense


Other key things to remember:

Investing Activities:
Report only the cash paid or received related to the change in long-term assets

Only use the change in the account when you have no other information

Financing Activities:
Report only the cash received or paid related to long-term liabilities or shareholders

Only use the change in the account when you have no other information

Non-Cash transactions are listed at the bottom of the cash flow statement

Cash Flow Statement – Practice Problem 1- Direct Method
Cash Flow Statement – Practice Problem 2 – Indirect Method

Use the following information for both practice problems:

A corporation reported the following information:

Current Year Prior Year
Cash 5,000 7,000
Accounts receivable 12,000 18,000
Inventory 35,000 28,000
Property & Equipment 40,000 30,000
Accumulated Depreciation (17,000) (10,000)
Total Assets 75,000 73,000
Accounts Payable 25,000 21,000
Income Taxes Payable 4,000 1,000
Long Term Liabilities 10,000 12,000
Common Stock 14,000 12,000
Retained Earnings 22,000 27,000
Total Liabilities & S/E 75,000 73,000
Sales 120,000
Cost of Goods Sold 80,000
Gross Profit 40,000
Selling Expense 25,000
Depreciation Expense 7,000
Income Before Tax 8,000
Tax Expense 3,000
Net Income 5,000
Dividends Paid – $10,000

Prepare a statement of cash flows using the direct method and the indirect method.

Check Your Answer Problem 1

Answers to Cash Flow Statement – Practice Problem 1- Direct Method 

1st Set up the format for calculating the operating activities section using the direct method and put in the numbers from the given financial statements

Start with the income statement and go down from the top.  Make sure that you use all revenues and expenses that will be paid in cash.

Current year is ending.    Prior year is beginning.    

Collected from customers:  Sales

Sales or other revenue 120,000
+ Beginning receivable 18,000
–  Ending receivable (12,000)
= Cash collected from customers 126,000

Paid to suppliers: CGS

Cost of Goods Sold 80,000
– Beginning Inventory (28,000)
+ Ending Inventory 35,000
+ Beginning A/P 21,000
–  Ending A/P (25,000)
= Cash Paid to Suppliers 83,000

Paid for all other expenses:  Selling      

Selling Expense 25,000
+ Beginning matching payable 0
–  Ending matching payable        0
= Cash Paid for expense 25,000

There is no selling payable to match with selling expense.
No payable means that all expenses are paid as incurred and cash paid = expense

Depreciation is not used since it is a non cash (not paid) expense

Paid for all other expenses:  Taxes    

Expense 3,000
+ Beginning matching asset 1,000
– ending matching asset (4,000)
= Cash paid for expense      0

Important: Make sure that you have used all current assets (except cash) and all current liabilities in the above calculations. All must be used and matched with an account on the income statement

2nd    Using the calculated amounts, prepare the operating section using the direct method

Cash received from:
customers – selling goods and services 126,000
Cash paid for:
purchases from suppliers (83,000)
selling expenses (25,000)
income taxes to the government             0
Total Cash paid: (108,000)
=Cash flow from operating activities 18,000

3rd   Get the information to use for the investing section:

Go back to the balance sheet and identify all long-term asset accounts.
Cash related to the changes in these accounts will be reported in this section.

CY PY
Property & Equipment 40,000 30,000
Accumulated Depreciation (17,000) (10,000)

Property increases with a purchase, difference of 10,000.
Assume that the change was all in cash ONLY when you have NO other information.

Accumulated depreciation has no impact to cash and this account is ignored when preparing the financing section.

4th   Get the information to use for the financing section:

Go back to the balance sheet and identify all long-term liability and equity accounts.  Cash related to these accounts will be reported in this section.

CY PY
Long Term Liabilities 10,000 12,000
Common Stock 14,000 12,000
Retained Earnings 22,000 27,000

A decrease of $2,000 indicates that long term liabilities have been repaid
An increase of $2,000 indicates that common stock has been issued

When you have no other information for the account, you assume the change was all cash.

Retained earnings changes with income $15,000 and dividends paid $10,000

Only dividends paid to shareholders is shown in the financing section

Net Income/Loss is not reported on the direct statement.

5th  Use the information to put the entire cash flow statement together:

Cash received from:
customers – selling goods and services 126,000
Cash paid for:
purchases from suppliers (83,000)
selling expenses (25,000)
income taxes to the government              0
Total cash paid: (108,000)
Cash flow from operating activities 18,000
Investing:
Purchase of Property/Equipment (10,000)
Total cash used for investing activities (10,000)
Financing:
Repayment of Long-term Debt (2,000)
Issue of Common Stock 2,000
Paid dividends to shareholders (10,000)
Total cash used for financing activities: (10,000)
                
Total Change in Cash (2,000)

The change in cash should agree with the change in cash on the balance sheet.
Current year is $5,000 and prior year was $7,000, a decrease of $2,000.

For investing and financing sections you must give a description of what happened.
You cannot just write the name of the account.

When there is no additional information provided for long-term assets, liabilities and owner’s equity, assume the change to the account is all cash.

Check Your Answer Problem 2

Complete the operating section of the indirect statement:

1st Start with net income and identify any non-cash revenues or expenses

Net Income                           $5,000

+ Depreciation Expense     $  7,000

2nd Identify the current assets and current liabilities and compute the change:

CY PY Change
Accounts receivable 12,000 18,000 (6,000)
Inventory 35,000 28,000 7,000
Accounts Payable 25,000 21,000 4,000
Income taxes Payable 4,000 1,000 3,000

3rd List the current assets and current liability accounts and the change

Current assets – add decreases and subtract increases
Current liabilities – add increases and subtract decreases

(Assets and Liabilities work opposite)

Do not list the change in “cash” (this is what you are reconciling)

Net Income $5,000
+ Depreciation Expense 7,000
Changes in current assets & current liabilities
Accounts Receivable 6,000
Inventory (7,000)
Accounts Payable 4,000
Income Tax Payable 3,000
Cash from operating activities: 18,000

4th  Add Investing and Financing Sections:
(Same as the direct method)

Investing:
Purchased of Property/Equipment (10,000)
Total cash used for investing activities (10,000)
Financing:
Repayment of Long-term Debt (2,000)
Issue of Common Stock 2,000
Paid dividends to shareholders (10,000)
Total cash used for financing activities (10,000)
Total Change in Cash (2,000)

 Investing and Financing sections are the same for the direct and the indirect method.

The only difference in the two methods is the format of the operating section.

Total cash from operating activities must be the same for both methods.

Cash Flow Statement – Practice Problem 3-   Prepare a cash flow statement using the indirect method

Company XYZ had the following transactions during the current year:

1) Purchased equipment costing $10,000 for cash of $4,000 and signed a long-term note payable for $6,000

2) Accounts receivable increased $28,000

3) Repurchased treasury stock at a cost of $50,000, paid cash

4) Sold long term investments for $3,000 cash that cost $5,000

5) Inventory decreased by $22,000

6) Retained earnings increased by $15,000 and the company earned income of $17,000 for the year.

7) Sold a building with a cost of $150,000 and accumulated depreciation of $78,000 for cash in the amount of $175,000

8) Paid interest expense in the amount of $3,400

Prepare a cash flow statement using the indirect method.

Check Your Answer

1st   Identify the section of the cash flow statement where the transaction will be reported

Operating section:

2)  Accounts receivable is a current asset

5)  Inventory is a current asset

6)  Income is reported first on the indirect statement

4)  Loss on sale of long-term investments:
$3,000 – $5,000 = $2,000 loss

7)  Gain on sale of building of $103,000

Cash                                            $175,000
Accumulated Depreciation     $78,000
       Building                                       $150,000
       Gain on sale                                $103,000

Investing section: Long-term asset cash amounts 

1)  Equipment purchased for cash $4,000

4)  Cash received from sale of long-term investments of $3,000

 7)  Cash received from sale of building of $175,000

 

Financing section:  L/T Debt and Equity cash amounts

3)  Repurchase of treasury stock for the cash amount $50,000

6)  Dividend paid of $2,000       

(Net Income of 17,000 less the increase in retained earnings of 15,000)

Not included non-cash transactions:

1)  the $6,000 cost of equipment that was acquired by signing the note 

Not separately reported: 

8) interest expense is part of net income in the operating section of the indirect statement.
Revenues and expenses are not separately reported on the cash flow statement (unless they are not paid or received in cash).

 

2nd   Write the format of the indirect method cash flow statement 

For the investing and financing sections:
You must write a description of what occurred
Do not just write the account name

Net Income                                                      $17,000
– Gain on sale of building                           (103,000)
+ Loss on sale of investments                          2,000
Changes in current assets & current liabilities 

Accounts Receivable (28,000)
Inventory 22,000
Cash used for operating activites: ($90,000)

Investing:

Purchase of Equipment (4,000)
Proceeds from sale of LT investments 3,000
Proceeds from sale of building 175,000
Total cash from investing activities: 174,000

 Financing: 

Repurchase of treasury stock (50,000)
Paid dividends to shareholders (2,000)
Total cash used for financing activities: (52,000)
              
Total Change in Cash 32,000

 

Non- cash transactions: 

The company acquired equipment costing $10,000 with a long-term note in the amount of $6,000.                
Key things to notice: 

When you have a sale of an asset you must determine the gain or loss and put that in the operating section.  The cash received goes in the investing section.

Only the cash related to the long-term asset or long-term liability is reported in the investing and financing section.   Do not just write the account name and the change in the account.