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Appendix 13.1: Summary of IFRS 9, Financial Instruments

Appendix 13.1: Summary of IFRS 9, Financial Instruments

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Synthesis



FACMU14

P a r t



4



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Statement of Cash Flows:

Another Look



1. Review the rationale for the statement

of cash flows, emphasizing why net

income differs from cash flows.



3. Solidify your understanding of the cash

flow effects of various transactions

presented in Chapters 8 through 15.



2. Review the T-account procedure, introduced in Chapter 6, for preparing the

statement of cash flows.



4. Develop skills in analyzing and interpreting the statement of cash flows.



Chapter



16

L E A R N I N G

OBJECTIVES



C



hapter 6 introduces the statement of cash flows, discussing its rationale and illustrating a

T-account approach for its preparation. Subsequent chapters describe the effect of various

transactions on the income statement and the balance sheet but do not consider their effect on the

statement of cash flows. This chapter discusses the effect of these transactions on the statement of

cash flows, using a comprehensive example.



REVIEW OF CONCEPTS UNDERLYING

THE STATEMENT OF CASH FLOWS

Chapter 6 discusses the following concepts underlying the statement of cash flows:

1. The statement of cash flows explains the reasons for the change in cash and cash equivalents

during a period. This statement classifies the reasons as relating to operating or investing or

financing decisions.

2. Revenues from sales of goods or services to customers during a period do not necessarily

equal cash received from customers during that period. The receipt of cash can precede, coincide with, or follow the recognition of revenue. Expenses incurred to generate revenues during

a period do not necessarily equal cash spent for the goods and services consumed in operations during that period. The expenditure of cash can precede, or coincide with, or follow the

recognition of expenses. Thus, net income for a period will likely differ from cash flow from

operations for that period.

3. Most, but not all, firms report cash flows from operations using the indirect method. The

indirect method starts with net income, adds any expense amount that does not use cash, and

subtracts any revenue amount that does not provide cash. The adjustments to convert net

income to cash flow from operations generally involve

(1) Adding the amount by which an expense exceeds the related cash expenditure for the

period (for depreciation, adding the entire amount as there was no cash expenditure in the

current period).

(2) Subtracting (or adding) the amount by which a revenue item exceeds (or is less than) the

related cash receipt for the period. An common example of an arrangement in which



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614



Chapter 16



Statement of Cash Flows: Another Look



revenue is less than the related cash receipt is a customer payment in advance, for a

good or service to be delivered in a later accounting period.

(3) Adjusting for non-cash income elements that are not revenue and expenses, including

gains and losses from dispositions of noncurrent assets; equity method earnings that

do not equal dividends received and equity method losses.

(4) Adding credit changes1 in operating non-cash working capital accounts, such as

accounts receivable, inventories, and accounts payable.

(5) Subtracting debit changes in operating working capital accounts.

4. Cash flow from investing activities includes cash purchases and cash sales of most noncurrent assets, including marketable securities that are not classified as trading securities;

property, plant, and equipment; intangibles; and investments in securities.

5. Cash flow from financing activities includes cash issues and cash redemptions of long-term

borrowings, cash sales and cash repurchases of common and preferred shares, and cash

dividends.



REVIEW OF T-ACCOUNT PROCEDURE FOR

PREPARING THE STATEMENT OF CASH FLOWS

The accountant prepares the statement of cash flows after completing the balance sheet and the

income statement. Chapter 6 describes and illustrates a procedure for preparing the statement

of cash flows using a T-account work sheet. A summary of the procedure follows:



Step 1 Obtain a balance sheet for the beginning and the end of the period for which you wish

to prepare the statement of cash flows.

Step 2 Prepare a T-account work sheet. A master T-account for cash appears at the top of

the work sheet. This master T-account has three sections labeled, respectively, Operations,

Investing, and Financing. Enter the beginning and the ending balances in cash and cash equivalents in the master T-account. Cash equivalents represent short-term, highly liquid investments

in which a firm has temporarily placed excess cash. Generally, only investments with maturities of three months or less qualify as cash equivalents. We use the term cash flows to refer

to changes in cash and cash equivalents. Complete the T-account work sheet by preparing a

T-account for each balance sheet account other than cash and cash equivalents, and enter the

beginning and the ending balances.

Step 3 Explain the change in the master Cash account between the beginning and the end of

the period by accounting for, the changes in the other balance sheet accounts. Do this by reconstructing the entries originally made in the accounts during the period and entering them in

appropriate T-accounts on the work sheet. By explaining the changes in balance sheet accounts

other than cash and cash equivalents, this process also explains the change in cash and cash

equivalents. We make such extensive use of the Cash Change Equation in this chapter that we

abbreviate words into symbols, as follows:

Cash Change Equation

Change in

Change in

Change in

Change

Shareholders’ − Non-cash

+

=

Liabilities

in Cash

Assets

Equity



∆Cash =

∆L

+

∆SE

∆N$A



Step 4 Prepare a statement of cash flows using information in the T-account work sheet.

1



With respect to a single account, the term credit change means a decrease in an asset account or an increase in a

liability (or shareholders’ equity) account. So, “credit changes in operating working capital accounts” means “a

decrease in a current operating asset account or an increase in a current operating liability account.” In parallel,

with respect to a single account, the term debit change means an increase in an asset account or a decrease in a

liability (or shareholders’ equity) account.



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Comprehensive Illustration of the Statement of Cash Flows



COMPREHENSIVE ILLUSTRATION OF

THE STATEMENT OF CASH FLOWS

The comprehensive illustration that follows uses data for Ellwood Corporation for 2013.

Exhibit 16.1 presents an income statement for 2013; Exhibit 16.2 presents a comparative balance sheet for December 31, 2013 and 2012; and Exhibit 16.3 presents a statement of cash

flows. The calculation of cash flow from operations first presents the indirect method. The

sections that follow explain each of the line items in Exhibit 16.3. Exhibit 16.4 shows the

T-account work sheet. Cash and cash equivalents decreased by $790 during the year, from

$2,670 (= $1,150 + $1,520) to $1,880 (= $1,090 + $790).



LINE 1: NET INCOME

The income statement indicates net income of $760 for the period. The work sheet entry presumes that cash provisionally increases by the amount of net income.

(1a) Cash (Operations—Net Income) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .



760

760



The effect of net income on the Cash Change Equation is as follows:

=

Operations + $760 (1a) =

∆Cash



∆L

$0



+

+



∆SE

$760 (1a)









∆N$A

$0



Throughout this chapter, entries with a number followed by the letter a indicate entries on

the statement of cash flows work sheet. Entries with a number and not followed with the letter

a indicate entries made during the year in the accounting records of Ellwood Corporation.



© Cengage Learning 2014



EXHIB IT 16.1



Ellwood Corporation

Consolidated Income Statement

For the Year 2013



REVENUES AND OTHER INCOME

Sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Interest and Dividends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Equity in Earnings of Affiliate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Gain on Disposal of Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .



$10,500

320

480

40

$11,340



EXPENSES

Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Selling and Administrative Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Compensation Expense (Employee Stock Options). . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Impairment Loss on Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Loss on Sale of Marketable Equity Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Interest Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Income Tax Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total Expenses and Losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .



$ 6,000

3,550

170

80

30

450

300

$10,580

$ 760



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616



Chapter 16



Statement of Cash Flows: Another Look



EXHIBIT 16.2



Ellwood Corporation

Consolidated Balance Sheet

December 31



ASSETS

Current Assets

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Certificate of Deposit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .



© Cengage Learning 2014



Marketable Equity Securities Available for Sale . . . . . . . . . . . . . . . . . . . . . .

Accounts Receivable (Net) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Prepayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total Current Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Investments

Investment in Company A (15%—Available for Sale) . . . . . . . . . . . . . . . . . .

Investment in Company B (40%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Property, Plant, and Equipment

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Buildings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Less Accumulated Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total Property, Plant, and Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . .

Intangible Assets

Patent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Less Accumulated Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total Intangible Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current Liabilities

Bank Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Accounts Payable (for Inventory) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Warranty Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Advances from Customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total Current Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Noncurrent Liabilities

Bonds Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Capitalized Lease Obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Deferred Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total Noncurrent Liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Shareholders’ Equity

Preferred Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Common Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Additional Paid-In Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Accumulated Other Comprehensive Income:

Unrealized Loss on Marketable Securities . . . . . . . . . . . . . . . . . . . . . . . .

Unrealized Gain on Investments in Securities . . . . . . . . . . . . . . . . . . . . .

Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Less Cost of Treasury Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total Shareholders’ Equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total Liabilities and Shareholders’ Equity . . . . . . . . . . . . . . . . . . . . . . . .



2013



2012



$ 1,090

790



$ 1,150

1,520



190

4,300

2,350

600

$ 9,320



280

3,400

1,500

800

$ 8,650



$ 1,280

2,420

$ 3,700



$ 1,250

2,100

$ 3,350



$ 920

8,900

11,540

(6,480)

$14,880



$ 1,000

8,600

10,840

(6,240)

$14,200



$ 2,550

(750)

$ 1,800

$29,700



$ 2,550

(600)

$ 1,950

$28,150



$ 2,750

3,230

900

1,000

$ 7,880



$ 2,000

2,450

1,200

600

$ 6,250



$ 1,370

2,100

650

$ 4,120



$ 2,820

1,800

550

$ 5,170



$ 1,200

2,110

4,400



$ 1,000

2,000

4,000



(40)

80

10,330

$18,080

(380)

$17,700

$29,700



(30)

50

9,960

$16,900

(250)

$16,730

$28,150



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Comprehensive Illustration of the Statement of Cash Flows



EXHIBIT 16.3



Ellwood Corporation

Consolidated Statement of Cash Flows

For the Year 2013



OPERATIONS

(1) Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Non-cash Revenues, Expenses, Gains, and Losses Included in Income:

(2) Depreciation of Buildings and Equipment . . . . . . . . . . . . . . . . . . . . .

(3) Amortization of Patent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(4) Compensation Expense (in Form of Employee Stock Options) . . . . . . . .



$



700

150

170



(5) Loss on Impairment of Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(6) Loss on Sale of Marketable Equity Securities . . . . . . . . . . . . . . . . . . .

(7) Deferred Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(8) Excess of Coupon Payments over Interest Expense . . . . . . . . . . . . . . .

(9) Gain on Disposal of Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(10) Equity in Undistributed Earnings of Affiliate . . . . . . . . . . . . . . . . . . .

(11) Decrease in Prepayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(12) Increase in Accounts Payable (for Inventory). . . . . . . . . . . . . . . . . . .

(13) Increase in Advances from Customers . . . . . . . . . . . . . . . . . . . . . . . .

(14) Increase in Accounts Receivable (Net) . . . . . . . . . . . . . . . . . . . . . . .

(15) Increase in Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(16) Decrease in Warranty Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cash Flow from Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .



© Cengage Learning 2014



INVESTING

(17) Sale of Marketable Equity Securities . . . . . . . . . . . . . . . . . . . . . . . . .

(18) Sale of Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(19) Acquisition of Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cash Flow from Investing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

FINANCING

(20) Short-Term Bank Borrowing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(21) Long-Term Bonds Issued. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(22) Preferred Shares Issued . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(23) Retirement of Long-Term Debt at Maturity. . . . . . . . . . . . . . . . . . . . .

(24) Acquisition of Common Shares. . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(25) Dividends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

(26) Common Shares (Issued on Exercise of Employee Options) . . . . . . . . . .

Cash Flow from Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Net Change in Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cash, Beginning of 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cash, End of 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .



LINE 2: DEPRECIATION OF BUILDINGS



AND



760



80

30

100

(50)

(40)

(320)

200

780

400

(900)

(850)

(300)

$



$



910



50

180

(1,300)

(1,070)



$



750

400

200

(1,500)

(130)

(390)

40

(630)

$ (790)

2,670

$ 1,880



EQUIPMENT



Internal records indicate that depreciation on manufacturing facilities totaled $450 and on selling

and administrative facilities totaled $250 during the year. The firm included these amounts in cost

of goods sold and selling and administrative expenses, respectively, in the income statement in

Exhibit 16.1. None of this $700 of depreciation required an operating cash flow during 2013. The

firm reported cash expenditures for these assets as investing activities in the earlier periods when it

acquired them. Thus, the work sheet entry to explain the change in the Accumulated Depreciation

account adds back depreciation to net income in deriving cash flow from operations.

(2a) Cash (Operations—Depreciation Expense Addback) . . . . . . . . . . . . . . . . . .

Accumulated Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .



700

700



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Chapter 16



Statement of Cash Flows: Another Look



Ellwood Corporation

T-Account Work Sheet



EXHIBIT 16.4



Cash



Net Income

Depreciation Expense

Amortization Expense

Employee Stock Option Compensation

Impairment Loss on Land

Loss on Sale of Marketable Securities

Deferred Income Taxes

Decrease in Prepayments

Increase in Accounts Payable

Increase in Advances from Customers

Sale of Marketable Securities

Sale of Equipment

Short-Term Borrowing

Long-Term Bonds Issued

Preferred Shares Issued

Common Shares Issued



Marketable Equity Securities

Available for Sale



280

(6b)

10

80

(6a)

20 (27a)



190









Prepayments

800

200

600



(11a)



(1a)

(2a)

(3a)

(4a)

(5a)

(6a)

(7a)

(11a)

(12a)

(13a)



Operations

760

50

700

40

150

320

170

900

80

850

30

300

100

200

780

400



(6a)

(9a)



Investing

50

1,300

180



(20a)

(21a)

(22a)

(26a)





Financing

750

1,500

400

130

200

390

40

1,880



1,000







920



80



(5a)



© Cengage Learning 2014



Accumulated Depreciation

6,240



(9a)

460

700

(2a)

6,480



Bank Notes Payable

2,000



750 (20a)

2,750





(8a)

(9a)

(10a)

(14a)

(15a)

(16a)



Excess Coupon Payments

Gain on Sale of Equipment

Equity in Undistributed Earnings of Affiliate

Increase in Accounts Receivable (Net)

Increase in Inventories

Decrease in Warranty Liability



(19a)



Acquisition of Equipment



(23a)

(24a)

(25a)



Retirement of Long-Term Debt

Acquisition of Common Shares

Dividends



Accounts Receivable (Net)



3,400

(14a)

900





4,300



Investment in Company A

Available for Sale



1,250

(28a)

30



1,280



Land





2,670





(29a)





Buildings

8,600

300

8,900







Patent

2,550







2,550



Accounts Payable (for Inventory)

2,450



780 (12a)

3,230







(15a)





Inventories

1,500

850

2,350



Investment in Company B



2,100

(10a)

320



2,420





(19a)





Equipment

10,840

1,300

600

11,540



(9a)



Accumulated Amortization

600



150

(3a)

750





(16a)



Warranty Liability

1,200

300

900







(continued)



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Comprehensive Illustration of the Statement of Cash Flows



EXHIBIT 16.4



Ellwood Corporation

T-Account Work Sheet (continued)



Advances from Customers

600



400 (13a)



1,000



(8a)

(23a)

(30a)







Deferred Income Taxes

550



100

(7a)

650



© Cengage Learning 2014



Retained Earnings

9,960

390

760

10,330



Bonds Payable

2,820

50

400

1,500

300

1,370

Preferred Shares

1,000

200







Additional Paid-In Capital

4,000



170

(4a)

200 (30a)

30 (26a)

4,400





(25a)



619





(1a)





1,200

Unrealized Loss on

Marketable Securities



30

10

(27a)

20







(24a)







(21a)



Capitalized Lease Obligation

1,800



300 (29a)









(22a)





(6b)



2,100

Common Shares

2,000

100

10

2,110









(30a)

(26a)





Unrealized Gain on

Investments in Securities

50



30 (28a)



40



80







Treasury Shares

250

130

380



Addback for Depreciation as a Product Cost The addback for the $450 of depreciation on manufacturing facilities requires elaboration. Chapter 9 explains that accountants treat

such depreciation charges as a product cost, not a period expense. The accountant debits Workin-Process Inventory for this $450 and credits Accumulated Depreciation. If, during the period,

the firm sells all the goods it produces, cost of goods sold includes this $450. Because cost of

goods sold includes an amount that does not use cash, the addback to net income adjusts for

the portion of depreciation charges that cost of goods sold includes.

If the firm does not sell all the goods it produces during the period, the ending inventory of

Work-in-Process Inventory or Finished Goods Inventory includes a portion of the $450 depreciation charge. Assume, for example, that the firm sold 80% of the units produced during the

period. Cost of goods sold includes $360 (= 0.80 × $450) of the depreciation, and inventory

accounts include the remaining $90. The statement of cash flows adds back to net income the

entire $450 of depreciation on manufacturing facilities for the period. The $90 of depreciation

included in the cost of units not sold caused the inventory accounts to increase by $90. Under

the indirect method of computing cash flow from operations, the accountant subtracts this

increase in inventories in computing cash flow from operations. The $450 addition for depreciation less the $90 subtraction for the increase in inventories nets to a $360 adjustment to income

on the statement of cash flows. Because cost of goods sold includes only $360 of depreciation,

the addition required to adjust for the depreciation included in cost of goods sold equals $360.

Thus, the work sheet entry 2a shows an addback for the full amount of depreciation for the

period (both as a product cost and as a period expense), not just the amount included in cost

of goods sold; then line 15 of the statement of cash flows includes a subtraction for the $90

increase in inventories caused by adding depreciation to work in process.

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620



Chapter 16



Statement of Cash Flows: Another Look



LINE 3: AMORTIZATION



OF



PATENT



The effect of patent amortization on cash flow is conceptually identical to that for depreciation

charges, both for period expenses and for product costs. Company records indicate that cost of

goods sold for 2013 includes patent amortization of $150. The work sheet entry to explain the

change in the Accumulated Amortization account is as follows:

(3a) Cash (Operations—Amortization Expense Addback) . . . . . . . . . . . . . . . . . .

Accumulated Amortization. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .



150

150



LINE 4: STOCK OPTION COMPENSATION E XPENSE

Notes to the financial statements of Ellwood Corporation indicate that part of the compensation to executives took the form of options to buy shares of Ellwood Corporation. Chapter 15

discusses that firms use an option pricing model to calculate a fair-value-related measure of

stock options granted during a period; this measure is the amount of compensation cost to be

recognized during the expected period of benefit, typically, the vesting period. Ellwood Corporation amortized $170 as compensation expense during 2013. Following is the entry in the

accounting records to record the expense:

(4)



Compensation Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Additional Paid-In Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Assets



=



Liabilities



+



Shareholders’

Equity



(Class.)



−170



IncSt → RE



+170



ContriCap



170

170



The $170 of compensation reduced net income but did not require a cash outflow during

2013. The entry explains part of the change in the Additional Paid-In Capital account. The

work sheet entry for the recognition of compensation cost related to employee stock options is

as follows:

(4a) Cash (Operations—Compensation Expense Addback) . . . . . . . . . . . . . . . . .

Additional Paid-In Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .



170

170



Income Tax Effects of Employee Stock Option Tax laws in certain jurisdictions

permit firms to claim an income tax deduction for stock options. For example, the income tax

law in the United States currently permits firms to deduct the intrinsic value (= market price on

the date of exercise – exercise price) of a nonqualified stock option in the year employees exercise stock options. The issues raised by the income tax benefits and their effects on the statement of cash flows are too advanced to include in the example for Ellwood Corporation in

Exhibit 16.3.



LINE 5: IMPAIRMENT LOSS ON L AND

Notes to the financial statements of Ellwood Corporation indicate that the sum of the expected

rentals on land that the company rents to others plus the amounts it expects to receive on the

eventual sale of the land has dropped so much that the land has become impaired. The difference between the carrying value of the land and its fair value at the end of 2013 is $80. The following entry is made in the accounting records to record the loss:

(5)



Loss on Impairment of Land. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .



80

80



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Comprehensive Illustration of the Statement of Cash Flows



The $80 of impairment loss reduced net income and the carrying value of land, but did

not require a cash outflow during 2013. The work sheet entry to reflect the change in the Land

account is as follows:

(5a) Cash (Operations—Asset Impairment Loss Addback) . . . . . . . . . . . . . . . . .



80



Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .



80



LINE 6: LOSS ON SALE OF MARKETABLE EQUITY SECURITIES

The accounting records indicate that Ellwood Corporation sold marketable equity securities held

as securities available for sale during 2013. Ellwood Corporation acquired these securities for $80

during 2012, wrote them down to their fair value of $70 at the end of 2012, and sold them during 2013 for $50. The firm made the following entry in the accounting records to record this sale:

(6)



Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Realized Loss on Sale of Marketable Equity Securities (IncSt) . . . . . . . . . . .

Marketable Equity Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Unrealized Loss on Securities Available for Sale

(Other Comprehensive Income) . . . . . . . . . . . . . . . . . . . . . . . . .

Assets

+50

−70



=



Liabilities



+



∆Cash



=



∆L



+



+50

(Invst.)



Shareholders’

Equity

−30

+10



0



∆SE

−20







50

30

70

10



(Class.)

IncSt → RE

OCI → AOCI



∆N$A

−70



Recall that journal entry numbers without letters, such as this one numbered (6), refer to

actual entries Ellwood recorded in its books. For some such entries, we give the effect on the

Cash Change Equation, derived from the balance sheet equation. For some complex transactions, such as this one, we give the Balance Sheet Equation. For some, we give both.

The work sheet entries to reflect this transaction are as follows:

(6a) Cash (Investing—Sale of Marketable Equity Securities) . . . . . . . . . . . . . . .

Cash (Operations—Loss on Sale of Marketable Equity

Securities Addback). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Marketable Equity Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Unrealized Loss on Securities Available for Sale

(Other Comprehensive Income) . . . . . . . . . . . . . . . . . . . . . . . . .



50

30

70

10



The statement of cash flows classifies the $50 cash proceeds as an investing activity on line

17. Net income on line 1 in Exhibit 16.3 includes a subtraction for the loss on the sale of marketable equity securities. To avoid understating the amount of cash flow from operations, the

accountant adds back the loss to net income. This addback offsets the loss included in the calculation of net income and eliminates its effect on cash flow from operations. Line 17 shows

the entire cash proceeds from the sale as an investing activity. The analyst might reasonably

view purchases and sales of marketable equity securities as operating activities because these

transactions involve the use of temporarily excess cash. Most, but not all, firms consider these

transactions sufficiently peripheral to the firms’ principal operating activity—selling goods and

services to customers—that they classify such purchases and sales as investing activities.



LINE 7: DEFERRED INCOME TAXES

Notes to the financial statements of Ellwood Corporation indicate that income tax expense of

$300 comprises $200 currently payable taxes and $100 deferred to future periods. Ellwood Corporation made the following entry during the year to recognize income tax expense.

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621



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Appendix 13.1: Summary of IFRS 9, Financial Instruments

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