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# A201 Lesson Plan Chapter 12: Statement of Cash Flows

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### A201 Lesson Plan Chapter 12: Statement of Cash Flows

1. 1. A201 Lesson Plan Chapter 12: Statement of Cash Flows Overview: The statement of cash flows has been prepared throughout the semester by classifying the transaction data in the cash account as to operating, investing, and financing activities under the direct method. The chapter reviews the direct method and also introduces the indirect method for statement presentation. I. Explain accrual to cash conversions. A. Relationship No. 1. The land account had a beginning balance of \$20,000 and an ending balance of \$30,000. Based on this information alone, determine the amount and type (i.e., operating, investing, or financing activity) of cash flow associated with the change in the land account. Beginning Balance 20,000 Ending Balance 30,000 B. Relationship No. 2. Accounts receivable has a beginning and ending balance of \$34,000 and \$32,000, respectively. Assume that all sales are made on account and that the company had \$385,000 of sales during the accounting period. Determine the implications regarding cash flow. Beginning Balance 34,000 Sales Ending Balance 32,000 C. Relationship No. 3. Given the following information determine the amount of cash spent for inventory: Account Title Beginning Ending Inventory \$60,000 \$50,000 Accounts Payable 25,000 23,000 Assume that all purchases of inventory are on account and that cost of goods sold for the period amounted to \$220,000. Cash Inventory Accounts Equity Payable Beginning Balance \$ XXXX 60,000 25,000 Cost of Goods Sold (220,000) (220,000) Ending Balance 50,000 23,000 1
2. 2. II. Financial Statement Data as Source Data for the Preparation of the Statement of Cash Flows - Direct Method. A. Remember that the ending balances on last year’s balance sheet constitute the beginning balances for the current period. B. The current period’s ending balances are shown on the current balance sheet. C. Accordingly, the beginning and ending account balances can be determined by examining two balance sheets from consecutive accounting periods. D. Revenue, gain, expense, and loss data can be found on the income statement. Steps to Prepare a Statement of Cash Flow - Direct Method: 1. Set-up columns for all balance sheet accounts. 2. Assume that all revenue and expense transactions are on account. 3. Proceed with the reconstruction of the cash entries via an item-by-item analysis of the financial statements using summary entries. 4. Begin with the items shown on the income statement checking them off as they are recorded in the spreadsheet model. III. Cash Flow Prepared under the Indirect Method. A. The difference rests solely in the method of presentation of the operating section of the statement of cash flows. The section starts with the amount of reported net income and makes the appropriate accrual to cash conversions so as to determine the amount of cash flow from operating activities. B. Apply the three rules for converting net income to cash flow from operating activities: 1. Increases in current assets should be deducted from net income and decreases in current assets should be added to net income. 2. Increases in current liabilities should be added to net income and decreases in current liabilities should be deducted from net income. 3. All noncash expenses and losses must be added to net income and all noncash revenue and gains must be subtracted from net income. C. Compare this result with the cash flow from operating activities that was determined under the direct method. The fact that the results are identical reinforces the point that the two approaches represent different presentations of the same economic consequences. The presentation of the investing and financing activities does not differ between the direct and indirect reporting approaches. IV. Practical Examples. A. Example 1. B. Example 2. 2
3. 3. Example 1: Statement of Cash Flows Cash + Accts. Equip- Accum. Retained Revenues Expenses Net Cash Rec. + ment + Deprec. = Earnings - = Income Flow 1 1,500 500 2,000 (1,200) 2,800 2 200 200 200 200 3 350 (350) 350 OA 4 100 (500) 425 25 25 25 100 IA 5 (175) (175) 175 (175) Total 1,950 350 1,500 (950) 2,850 225 175 50 450 NC 1. Beginning balances. 2. Revenue on account. 3. Collect cash from accounts receivable. 4. Sell some equipment. 5. Recognize depreciation. Statement of Cash Flows Worksheet Direct Method Indirect Method Operating Activities: Operating Activities: Net cash from Operations \$ Investing Activities: Investing Activities: Net Change to Cash Net Change to Cash 3
4. 4. Example 2: Statement of Cash Flows Example for Cost of Goods Sold: Required: 1. Record the following entries: a. Purchase inventory on credit for \$10,000. Assume a periodic system. b. Sell merchandise for cash, \$75,000. c. Pay \$15,000 on the accounts payable (no discounts). d. Inventory count at end of year is \$12,000. 2. Prepare a Statement of Cash Flows. Assets Liab. Owners' Equity Cash Accts. Rec. Inventory Accts. Pay. Cont. Cap. Ret. Earn. Inc. Stmt. Beg. bal. 10,000 5,000 50,000 7,000 45,000 13,000 Pur. inv. 10,000 (10,000) (10,000) Sell. merch. 75,000 75,000 75,000 Pay payable (15,000) (15,000) Adj. inv. (38,000) (38,000) (38,000) Ending bal. 70,000 5,000 12,000 2,000 45,000 40,000 27,000 4
5. 5. Example 2 (cont’d): Statement of Cash Flows Example for Cost of Goods Sold: Company Name Statement of Cash Flows For year Ended December 31, 2002 {Direct method} {Indirect method} Cash Flow from Operating Activities: Cash Flow from Operating Activities: Cash from Customers Net Income Cash spent on Inventory Change in Accts. Rec. Change in Inventory Change in Accts. Pay. Net Cash Flow from Operations Net Cash Flow from Operations Cash Flow from Investing Activities Cash Flow from Investing Activities Cash Flow from Financing Activities Cash Flow from Financing Activities Net Change in Cash Net Change in Cash Beginning Cash Beginning Cash Ending Cash 70,000 Ending Cash 70,000 5
6. 6. Demonstration Problem 12-1 Using T-Accounts to Prepare the Statement of Cash Flows— Direct and Indirect Methods Selected financial information for Hunt Company follows: Balance Sheets at December 31 Assets 2003 2004 Cash \$ 2,000 \$ 1,000 Accounts Receivable 8,000 9,000 Merchandise Inventory 20,000 16,000 Equipment 27,000 30,000 Accumulated Depreciation (12,000) (17,000) Land 15,000 29,000 Total Assets \$60,000 \$68,000 Liabilities Accounts Payable (for \$ 6,000 \$ 8,000 Inventory) Salaries Payable 9,000 4,000 Notes Payable 20,000 14,000 Total Liabilities 35,000 26,000 Stockholders’ Equity Common Stock, \$10 Par Value 18,000 25,000 Retained Earnings 7,000 17,000 Total Stockholders’ Equity 25,000 42,000 Total Liabilities and \$60,000 \$68,000 Stockholders’ Equity Income Statement For the Year Ended December 31, 2004 Sales \$98,000 Cost of Goods Sold 62,000 Gross Margin \$36,000 Salaries Expense (14,000) Depreciation Expense (10,000) Operating Income \$12,000 Gain on Sale of Equipment 3,000 Net Income \$15,000 Other information 1. During 2004, Hunt sold equipment that cost \$6,000 for \$4,000. Accumulated depreciation at the time of sale was \$5,000. 2. During 2004, Hunt paid cash dividends of \$5,000 to the stockholders. Required a. Analyze the financial statement data and prepare a formal statement of cash flows for 2004 using the direct method. b. Reconstruct the statement of cash flows using the indirect method. 6
7. 7. Demonstration Problem 12-1 Solution, part a. Statement of Cash Flows, Direct Method Hunt Company Statement of Cash Flows For the Year Ended December 31, 2004 Cash Flows from Operating Activities Cash Inflow from Revenue \$97,000 Cash Outflow for Inventory (56,000) Cash Outflow for Salary Expenses (19,000) ────── Net Cash Inflow from Operating \$ 22,000 Activities Cash Flows from Investing Activities Cash Inflow from Equipment Sale \$ 4,000 Cash Outflow for Equipment Purchase (9,000) Cash Outflow for Land Purchase (14,000) ────── Net Cash Outflow from Investing (19,000) Activities Cash Flows from Financing Activities Cash Inflow from Stock Issue \$ 7,000 Cash Outflow for Debt Payment (6,000) Cash Payments for Dividends (5,000) ────── Net Cash Outflow from Financing (4,000) Activities ─────── Net Decrease in Cash \$(1,000) Beginning Cash Balance 2,000 ─────── Ending Cash Balance \$ 1,000 ═══════ 7
8. 8. Demonstration Problem 12-1 Solution, part b. Statement of Cash Flows, Indirect Method Hunt Company Statement of Cash Flows For the Year Ended December 31, 2004 Net Income \$15,000 Add Depreciation Expense (Noncash) 10,000 Decrease in Inventory 4,000 Increase in Accounts Payable 2,000 Deduct Increase in Accounts Receivable (1,000) Decrease in Salaries Payable (5,000) Gain on Sale of Equipment (Noncash) (3,000) ────── Net Cash Inflow from Operating \$ 22,000 Activities Cash Flows from Investing Activities Cash Inflow from Equipment Sale \$ 4,000 Cash Outflow for Equipment Purchase (9,000) Cash Outflow for Land Purchase (14,000) ────── Net Cash Outflow from Investing (19,000) Activities Cash Flows from Financing Activities Cash Inflow from Stock Issue \$ 7,000 Cash Outflow for Debt Payment (6,000) Cash Payments for Dividends (5,000) ────── Net Cash Outflow from Financing (4,000) Activities ─────── Net Decrease in Cash \$(1,000) Beginning Cash Balance 2,000 ─────── Ending Cash Balance \$ 1,000 ═══════ 8
9. 9. EXERCISE 12-1B a. b. c. d. e. f. g. h. i. j. EXERCISE 12-2B 9
10. 10. PROBLEM 12-11A No. Type of Activity a b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s. 10
11. 11. ACT 12-1 Part 1. Part 2. 11
12. 12. Quiz Questions for Chapter 12 Use the following information to answer the next three questions. Comparative Balance Sheets, December 31 2003 2004 Cash \$ 500 \$ 200 Accounts Receivable 4,000 2,200 Prepaid Rent 1,000 3,000 Inventory 5,000 8,000 Land 13,000 19,000 Total Assets \$23,500 \$32,400 Accounts Payable \$ 6,500 \$12,000 Note Payable 10,000 7,000 Common Stock 1,500 6,400 Retained Earnings 5,500 7,000 Total Equity \$23,500 \$32,400 Income Statement for 2004 Sales Revenue \$ 20,000 Cost of Goods Sold (15,200) Gross Margin 4,800 Rent Expense (1,000) Net Income \$ 3,800 1. The amount of net cash flow from operating activities for 2004 was a. \$9,100. b. \$6,100. c. \$ 600. d. \$18,800. 2. The amount of net cash flow from investing activities for 2004 was a. \$(9,000). b. \$(1,000). c. \$(6,000). d. \$(4,000). 3. The amount of net cash flow from financing activities for 2004 was a. \$(5,300). b. \$(4,900). c. \$(400). d. \$2,300. 12
13. 13. 4. Which of the following statements is true regarding preparing the statement of cash flows using the direct method and the T-account approach? a. The information needed to prepare the statement of cash flows can be obtained from last year’s balance sheet and comparative income statements. b. Revenue and expense accounts are most important in determining cash flows from financing activities. c. Long-term asset accounts are used to determine cash flows from investing activities. d. Cash paid for inventory is classified as an investing activities cash outflow. 5. Which of the following cash transactions is classified as an investing activity on the statement of cash flows? a. Cash borrowed. b. Cash received from issuing stock. c. Cash received from revenue. d. Cash collected on a loan. 6. Jackson Hole, Inc., owns equipment that cost \$25,000. The equipment has a four-year useful life and a \$5,000 salvage value. Assuming the company uses straight-line depreciation, the amount of depreciation expense that would appear each year on the statement of cash flows presented using the direct method would be a. a \$5,000 cash outflow under operating activities. b. a \$6,250 cash outflow under operating activities. c. a \$5,000 cash outflow under investing activities. d. zero. 7. A building costing \$55,000 with \$16,500 of accumulated depreciation was sold for \$40,000. How would the cash flow from the sale appear on the statement of cash flows? a. \$1,500 in operating activities and \$38,500 in investing activities. b. \$40,000 in financing activities. c. \$38,500 noncash financing and investing activities and \$1,500 in operating activities. d. \$40,000 in investing activities. 8. The owners of X Company invested \$2,000 in the company. X Company used the cash to invest in Y Company. On X’s statement of cash flows these transactions would be classified, respectively, as a. an investing activity and an investing activity. b. a financing activity and a financing activity. c. an investing activity and a financing activity. d. a financing activity and an investing activity. 13
14. 14. 9. Issuing a note for the purchase of land is an example of a. an investing activity. b. a financing activity. c. a noncash investing and financing activity. d. a transaction that would not appear on the statement of cash flows. 10. The sum of the three major components (operating activities, investing activities, and financing activities) on a statement of cash flows will add up to a. the ending cash balance. b. the change in the Cash account balance between the beginning and ending of the period. c. the amount of cash inflow for the period. d. net income for the period. 14