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D. Example of Statement of Cash Flows

D. Example of Statement of Cash Flows

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Module 17: Statement of Cash Flows



Other expenses and losses



(2,560)



693



2,440



Income before

extraordinary item and

income taxes



15,440



Income tax expense:

Current portion



5,000



Deferred portion



3,360



Net income



8,360

$ 7,080



Additional information includes





















Treasury bills have a maturity of less than three months from date of purchase.

Fixed assets costing $5,000 with a book value of $2,000 were sold for $4,000.

Three-year insurance policy was purchased in year 1.

At 12/31/Y2, available-for-sale investments with a book value of $6,600 at 12/31/Y1 and $5,100

at 12/31/Y2 sold for $5,100.

Additional bonds were issued on 12/31/Y2 for $4,000. There was no premium or discount.

Bonds with a book value of $9,000 were retired on 12/31/Y2.

Other revenue and gains include a $3,000 unrealized gain recognized for trading securities.

Other expenses and losses consist of $1,060 interest paid and $1,500 realized loss on available-for-sale securities.

Changes in investments:

• No changes in fair value of the investments occurred prior to year 2.

• There were no sales or purchases of trading securities during year 2.

• The tax rate is 40%.



1.  Procedural Steps





a. The first step is to calculate the change in cash and cash equivalents.

Cash

Treasury bills



Year 2



Year 1



Change



$9,000



$8,000



+$1,000



4,000



3,000







+ 1,000

+$2,000



Net change in cash and cash equivalents

b. Calculate net cash flows from operating activities

(1)  Indirect approach

Net income

Decrease in accounts receivable



1,000



(a)



Decrease in inventory



1,000



(b)



Decrease in prepaid insurance



1,000



(c)



Decrease in accounts payable



(3,000)



(d)



Increase in income tax payable



2,000



(e)



Increase in deferred tax liability



3,360



(f)



(3,000)



(g)



Unrealized gain on trading securities

Realized loss on available-for-sale

securities

Gain on sale of fixed assets

Depreciation expense

Net cash flows from operating

activities



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$ 7,080



(h)

1,500

(2,000)



(i)



4,000



(j)

$12,940



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Module 17: Statement of Cash Flows



Reconstructing journal entries may serve to explain the effect on net income of an increase or decrease of a

particular account.

(a)

Accounts receivable. For accounts receivable to decrease, the journal entry must have been

Cash

Accounts receivable



xx

xx



Cash increased as a result of the collection of accounts receivable. The $1,000 decrease in accounts

receivable should be added to net income.

(b)

Inventory. For inventory to decrease, the entry must have been

Cost of goods sold

Inventory



xx

xx



Expenses (CGS) increased without an additional cash outlay for inventory, so the $1,000 decrease is added

back to net income.

(c)

Prepaid insurance. For prepaid insurance to decrease, the entry must have been

Insurance expense

Prepaid insurance



xx

xx



Because expenses increased without a corresponding cash outlay, the $1,000 decrease in prepaid insurance

should be added to net income.

(d)

Accounts payable. For accounts payable to decrease, the entry must have been

Accounts payable

Cash



xx

xx



The entry involves a cash outlay, so the $3,000 decrease in accounts payable is deducted from net income.

(e)

Income tax payable. For income tax payable to increase, the entry must have been

Income tax expense

Income tax payable



xx

xx



Expenses increased without an actual cash outlay; therefore the $2,000 increase in the liability is added

back to net income.

(f)

Deferred tax liability. For deferred tax liability to increase, the entry must have been

Income tax expense

Deferred tax liability



xx

xx



Expenses increased without an actual cash outlay; therefore the $3,360 increase in the liability, which is a

noncash expense, is added back to net income.

(g)

Unrealized gain on trading securities. The entry to record the unrealized gain on trading securities would

have been

Investment in Simba Co.—held-for-trading

Unrealized holding gain



3,000

3,000



Since unrealized gains on trading securities are recognized as income but do not involve a cash inflow, such

gains must be subtracted from net income.

(h)

Realized loss on available-for-sale securities. When $5,100 stock in ABC Co. was sold, the previously

unrealized loss of $1,500 ($5,100 FV at 12/31/Y2 – $6,600 FV at 12/31/Y1) which arose in year 2 became

realized. The entry to record the sale would have been

Cash

Realized loss

Available for sale



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5,100

1,500

6,600



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Module 17: Statement of Cash Flows



695



Because the realized loss does not involve any cash outflow, it must be added back to net income. Note that

a $1,500 unrealized loss would have been recognized in financial statements prepared during year 2. The

entry to remove this amount from the other comprehensive income account entitled “Unrealized loss on

available-for-sale securities account” and the tax effect is

Adjustment to market (available-for-sale securities)

Deferred tax benefit—unrealized loss

Unrealized loss on available-for-sale securities

Deferred tax asset



1,500

600

1,500

600



Since an unrealized loss on AFS securities of $3,500 was recognized during year 2 (from year 1 to year

2), a $5,000 decline in FV must have occurred in year 2, as shown below. The deferred tax asset of $1,400

came from recognizing the future benefit of the unrealized loss of $3,500. The entry was

Deferred tax asset

Deferred tax expense (benefit)



1,400

1,400



Market Adjustment

(Available-for-Sale

Securities)

Sale



1,500



Available-for-Sale

Securities







Year 1 Bal.



5,000



Year 2 Unreal.

loss



3,500



Year 2 Bal.



Year 1 Bal.



6,600

Year 2 Bal.



Accumulated Other

Comprehensive

Income

Year 1 Bal.

Closing entry



15,400







3,500



During year



Year 2 Bal.



2,100



Year 2 Bal.



Closing entry

Year 2 Bal.







1,400



2,000



Realized

upon sale



3,500



Closing entry







Deferred Tax

Benefit—Unrealized

Loss

600



1,500



Unreal. Loss recog. 5,000



Closing entry



Sale



Sale



Unrealized Loss

on AFS Securities





1,400



22,000



Deferred Tax Asset

Year 2 adj.







Year 1 Bal.







Year 2 Adj.



2,000



Year 2 Bal.



1,400



600



Sale



Because unrealized gains/losses on available-for-sale securities do not affect cash flows, no adjustment for

this change is necessary on the statement of cash flows.

(i)

Gain on sale of fixed assets. The entry to record the sale would have been

Cash

Accumulated depreciation

Gain on sale

Asset



4,000

3,000

2,000

5,000



The total amount of cash received in payment for the asset, not just the amount of the gain, represents the

cash inflow. Since cash inflow from the sale (including the amount of the gain) appears in the investing

section, the gain should be subtracted from net income.



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Module 17: Statement of Cash Flows



696



(j)

Depreciation expense. The entry to record depreciation is

Depreciation expense

Accumulated depreciation



4,000

4,000



Because expenses increased without a corresponding cash outlay, the amount recorded for depreciation

expense should be added to net income. In this case, the increase in accumulated depreciation must take

into consideration the accumulated depreciation removed with the sale of the asset.

AD

AD of sold asset



3,000*



4,000



Beg. bal.



4,000



Depreciation (plug)



5,000



End. bal.



*  $5,000 Cost – $2,000 book value

(2)  Direct approach

Cash received from customers

Cash provided by operating activities

Cash paid to suppliers

Cash paid for operating expenses

Cash paid for interest

Cash paid for income taxes

Cash disbursed for operating activities

Net cash flows from operating activities



$51,000 (a)

22,000 (b)

12,000 (c)

1,060 (d)

3,000 (e)

38,060

$12,940



(a)

Cash received from customers. Net sales + Beginning AR – Ending AR = Cash received from customers

($50,000 + $5,000 – $4,000 = $51,000). Cash received from customers also may be calculated by

analyzing T-accounts.

Accounts Receivable

Beg. bal.

Sales



5,000

50,000



End. bal.



4,000



51,000



Cash collected



(b)

Cash paid to suppliers. Cost of goods sold + Beginning AP – Ending AP + Ending inventory – Beginning

inventory = Cash paid to suppliers ($20,000 + $7,000 – $4,000 + $1,000 – $2,000 = $22,000). This is a twoaccount analysis. The amount for cash paid to suppliers equals the debit to accounts payable, but to solve for that

amount, you must first determine purchases. To calculate purchases you must analyze the inventory account.

Step 1. Calculate purchases

Inventory

Beg. bal.

Purchases



2,000

19,000



End. bal.



1,000



20,000



CGS



Step 2. Calculate cash payments to suppliers

Accounts Payable

Cash paid to suppliers



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22,000



7,000

19,000



Beg. bal.

Purchases



4,000



End. bal.



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Module 17: Statement of Cash Flows



697



 Note that the $2,000 difference between the $20,000 CGS (accrual-basis amount) and the

$22,000 cash payments made to suppliers (cash-basis amount) equals the difference between the $1,000

decrease in inventory and the $3,000 decrease in accounts payable when the indirect method is used.

However, under the indirect method the difference is deducted from net income. This is because when the

direct method is used, expenses such as CGS are examined as outflows of cash, whereas when the indirect

method is used, net income (revenue-expenses, including CGS) is treated as a net cash inflow.





(c)  Cash paid for operating expenses. Operating expenses + Ending prepaid expenses – Beginning

prepaid expenses – Depreciation expense (and other noncash operating expenses) = Cash paid for

operating expenses ($17,000 + $2,000 – $3,000 – $4,000 = $12,000). The two accounts in this problem

that relate to operating expenses are accumulated depreciation and prepaid insurance.

Prepaid

Insurance

Beg. bal.



Accumulated

Depreciation



3,000

Insurance

expense



End. bal.



AD of

sold asset



3,000



2,000



4,000



Beg. bal.



4,000



Depreciation

expense



5,000



End. bal.



 Since neither the expiration of prepaid insurance nor depreciation expense required a cash outlay, cash

basis operating expenses are accrual expenses of $17,000 less depreciation ($4,000) and insurance

expense ($1,000), or $12,000.





(d)  Cash paid for interest. No analysis needed; amount was given in problem



(e)  Cash paid for income taxes. Current portion of income tax expense + Beginning income tax

payable – Ending income tax payable = Cash paid for income taxes ($5,000 + $1,000 – $3,000

= $3,000). The journal entry for income tax expense is

Income tax expense—current

Income tax expense—deferred

Income tax payable (current portion)

Deferred tax liability



5,000

1,360

5,000

1,360





Therefore, taxes paid are $3,000, as shown in the T-account below.

Income Tax Payable

Income taxes paid



3,000



1,000



Beg. bal.



5,000



Current portion



3,000



End. bal.



c.  Analyze other accounts and determine whether the change is a cash inflow or outflow and whether it is a

financing, an investing, or a noncash investing and financing activity.





(1) Investments in ABC Co. decreased by $5,100 when this portion was sold (cash inflow, investing activity).

The entry to record the sale was

Cash

Investment in ABC Co.— available-for-sale







5,100

5,100



(2) Fixed assets increased by $5,000 after $5,000 of assets were sold for $4,000 (cash inflow, investing

activity). Thus, $10,000 of fixed assets were purchased (cash outflow, investing activity).

Fixed Assets

Beg. bal.

Purchase of new assets

End. bal.







c14.indd 697



$17,000

10,000



5,000



Sold asset



22,000



(3) Bonds payable increased by $4,000 when additional bonds were issued (cash inflow, financing activity).



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Module 17: Statement of Cash Flows



698







(4) Bonds payable decreased by $9,000 when they were retired (cash outflow, financing activity). The entry to

record the retirement of debt was

Bonds payable

Cash



9,000

9,000







(5) Common stock had no change.







(6) Retained earnings increased $2,040 after net income of $7,080, indicating a dividend of $5,040 (cash

outflow, financing activity).

Retained Earnings

30,000

Cash dividend



5,050



7,080

32,040







Beg. bal.

Net income

End. bal.



d.  Prepare formal statement

Haner Company

STATEMENT OF CASH FLOWS

For the Year Ended December 31, Year 2

Cash flows from operating activities:

Cash received from customers

Cash provided by operating activities

Cash paid to suppliers

Cash paid for operating expenses

Cash paid for income taxes

Cash paid for interest expense

Cash disbursed for operating activities

Net cash flows from operating activities

Cash flows from investing activities:

Proceeds from sale of investments

Proceeds from sale of fixed assets

Acquisition of fixed assets

Net cash used by investing activities

Cash flows from financing activities:

Proceeds from sale of bonds

Repayment of long-term debt

Dividends paid

Net cash used by financing activities

Net increase in cash and cash equivalents

Cash and cash equivalents at beginning of year

Cash and cash equivalents at end of year



c14.indd 698



$51,000

$ 51,000

22,000

12,000

3,000

1,060

38,060

$ 12,940

$ 5,100

4,000

(10,000)

(900)

$ 4,000

(9,000)

(5,040)

(10,040)

$ 2,000

11,000

$ 13,000



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Module 17: Statement of Cash Flows



699



Reconciliation of net income to cash provided by operating activities:

[This schedule would include the amounts from D.1.b.(1) (near the beginning of this example) starting with N and

ending with Net cash flows from operating activities of $13,040.]

Disclosure of accounting policy:

For purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased

with a maturity of three months or less to be cash equivalents.



NOTE: If the reconciliation approach for operating activities had been shown in the body of

the statement instead of the direct approach, an additional schedule showing interest paid and

income taxes paid would be necessary.



NOW REVIEW MULTIPLE-CHOICE QUESTIONS 30 THROUGH 37







E. Capital Leases

In the period an entity enters into a capital lease, a noncash financing and investing activity in the amount of the

present value of the minimum lease payments is reported following the cash flow statement. As payments are

made by the lessee, the principal reduction component is reported as a cash outflow under financing activities.

The interest component is reported in the operating activities section under the direct method. Under the indirect

method, interest paid must be disclosed as supplementary information.







F. Research Component—Accounting Standards Codification











1. ASC Topic 230 outlines the accounting rules for the statement of cash flows. Typical research issues may

involve determining the cash equivalents of the enterprise; classifying items as either operating, investing, or

financing activities; and identifying significant noncash transactions. Note that ASC Topic 230 specifically

prohibits reporting cash flow per share information on the statement of cash flows.

2. Below are keywords for researching issues on the statement of cash flows. Note that in some paragraphs in

FARS, the word “transaction” or “transactions” (rather than “activity”) is used to discuss whether an item is

included in the operating, investing, or financing section of the statement of cash flows.

Cash equivalents

Financing activities

Financing transactions

Investing activities

Investing transactions



Noncash activities

Noncash transactions

Operating activities

Operating transactions

Reconciliation of net income



G. International Financial Reporting Standards (IFRS)

1.

Statement of cash flows. The accounting rules for the statement of cash flows are similar to US GAAP.





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a. For IFRS, cash flows include the inflows and outflows of both cash and cash equivalents.







(1) Cash equivalents include cash on hand, bank balances for immediate use, other demand deposits, and

short-term investments with maturities of three months or less.







b. Both the direct method and indirect method are acceptable methods for preparing the statement of cash flows.









(1) However, for the indirect method, operating activities may be presented using a modified approach.

(2) This modified indirect method shows revenues and expenses in operating activities, and then reports the

changes in working capital accounts.



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Module 17: Statement of Cash Flows



700























2. As in US GAAP, the statement of cash flows is divided into three parts: operating, investing, and financing

activities. At the bottom of the statement of cash flows, a reconciliation must be made with the amounts in the

statement of cash flows and the cash and cash equivalents reported in the statement of financial position.

3. The most significant difference between IFRS and US GAAP is where certain items are presented on the

statement of cash flows.

a. For example, interest and dividends received may be reported on the statement of cash flows as operating or

investing activities.

b. Interest and dividends paid may be reported either in the operating activities or the financing activities

sections.

(1) Although the entity has discretion on where interest and dividends are reported, it must be reported on a

consistent basis.

c. Cash from the purchase and sale of trading securities are classified as operating activities.

d. Cash advances and loans (bank overdrafts) are also usually classified as operating activities.

e. Taxes paid on income must be disclosed separately in operating activities.

(1) However, cash flows from certain taxes may be classified elsewhere if they are related to investing or

financing activities.

f. In addition, the effects of noncash transactions are not reported on the statement of cash flows. Instead,

significant noncash activities must be disclosed in the notes to the financial statements.

NOW REVIEW MULTIPLE-CHOICE QUESTIONS 38 THROUGH 39



KEY TERMS

Cash equivalents. Short-term, highly liquid investments that (1) are readily convertible to known amounts of cash and

(2) are so near their maturity (original of three months or less from date of purchase by the enterprise) that they present

negligible risk of changes in value because of changes in interest rates.

Direct approach. Cash flow elements of operating activities are derived from the accrual basis components of net

income.

Indirect method. Starts with income from continuing operations and adjusts for changes in operating related accounts

(e.g., inventory and accounts payable) and noncash expenses, revenues, losses, and gains.

Statement of Cash Flow. Provides information about an entity’s cash receipts and cash payments and discloses information about the financing and investing activities of an entity.



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