2. 1 Multi-Step vs. Single-Step Income Statement
Multiple-step Single-step
Sales Revenue Net Sales a Total Revenue
Cost of Goods
Sold
Gross Profit b Total Expenses
Operating
Expenses
Income from
operations c
Non-operating
items
Net Income d
a Sales - Sales returns - Sales Discounts
b Net sales - Cost of goods sold
c Gross profit - Operating expenses
d Income from operations + Other revenue/gains - other expenses/losses
Other Revenues and Gains Other Expenses and Losses
Interest revenue from notes receivable and marketable
securities
Interest expense on notes and loans payable
Dividend revenue from investments in capital stock Casualty losses from recurring causes such as vandalism and
accidents
Rent revenue from subleasing a portion of the store Losses from the sales of abandonment of property, plant, and
equipment
Gain from sale of property, plant and equipment Loss from strikes by employees and suppliers
2
3. 2 Typical Receipts and Payments Classified by
Activity
Operating activities
Cash inflows:
From sale of goods or services.
From returns on loans (interest) and on equity securities (dividends).
Cash outflows:
To suppliers for inventory.
To employees for services.
To government for taxes.
To lenders for interest.
To others for expenses.
Investing activities
Cash inflows:
From sale of property, plant, and equipment.
From sale of debt or equity securities of other entities.
From collection of principal on loans to other entities.
Cash outflows:
To purchase property, plant, and equipment.
To purchase debt or equity securities of other entities.
To make loans to other entities.
Financing activities
Cash inflows:
From sale of equity securities (company’s own stock).
From issuance of debt (bonds and notes).
Cash outflows:
To stockholders as dividends.
To redeem long-term debt or reacquire capital stock. 3
4. 3 Information Sources for Activities
OPERATING ACTIVITIES
Analyze Income statement items
Changes in noncash current asset and current liability items
FINANCING ACTIVITIES
Analyze increases and decreases in long-term
liability and stockholders’ equity items
INVESTING ACTIVITIES
Analyze increases and decreases in investments
and long-term asset items
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Business Inside
5. 4 Format of the Statement of Cash Flows
COMPANY NAME
Statement of Cash Flows
Period Covered
Cash flows from operating activities
(List of individual items)
Net cash provided (used) by operating activities
XX
XXX
Cash flows from investing activities
(List of individual inflows and outflows)
Net cash provided (used) by investing activities
XX
XXX
Cash flows from financing activities
(List of individual inflows and outflows)
(Net cash provided (used) by financing activities
XX
XXX
Net increase (decrease) in cash XXX
Cash at beginning of period XXX
Cash at end of period XXX
Noncash investing and financing activities
(List of individual noncash transactions)
XXX
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Business Inside
6. 5 Converting Net Income to Net Cash Provided
(Used) by Operating Activities
Accrual Basis of Accounting Cash Basis of Accounting
Earned Revenue
Net
Income
Adjust Revenues to Cash
Receipts
Net Cash
Provided by
Operating
Activities
Incurred Expenses Adjust Expenses to Cash
Disbursements
INDIRECT METHOD
1. Begin with net income and adjust
for income statement items that did
not effect cash.
2. Reconcile net income to net cash
provided (used) by operating
activities.
DIRECT METHOD
1. Adjust each item on the income
statement from the accrual basis to
the cash basis.
2. Major classes of operating cash
receipts and cash payments are
reported.
OR
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Business Inside
7. 6 Operating Activities – Indirect Method
Adjustments for Noncash Items
Adjustments for
noncash charges and
credits
Noncash charges and credits
Add to (Deduct
from) Net Income
Depreciation Expense Add
Patent amortization expense Add
Depletion expense Add
Loss on sale of equipment Add
Gain on sales of equipment Deduct
Adjustments to convert net
income to net cash provided
by operating activities.
All noncash expenses are added to net income, and all noncash
revenues are subtracted from net income.
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Business Inside
8. 7 Operating Activities – Indirect Method
Adjustments For Current Assets and Liabilities
Adjustments for
Current Items
For Changes In:
Add to Net
Income
Deduct from Net
Income
Current assets Decreases Increases
Current liabilities Increases Decreases
For Changes in
Individual Accounts:
Add to Net
Income
Deduct from Net
Income
Accounts receivable Decrease Increase
Inventory Decrease Increase
Prepaid expenses Decrease Increase
Accounts payable Increase Decrease
Accrued expenses payable Increase Decrease
Adjustments to convert net income to net
cash provided by operating activities.
All changes in current assets are handled in a similar manner and all
changes in current liabilities are handled in a similar manner, but the
adjustments are exactly the opposite.
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Business Inside
9. 8 Cash Flows from Operating Activities – Indirect
Method
Problem Data
DEMONSTRATION COMPANY
Comparative Balance Sheet Accounts
December 31
Current Assets 2003 2002 Change
Accounts receivable $30,000 $39,000 $9,000 Decrease
Prepaid rent 15,000 10,000 5,000 Increase
Inventory 20,000 18,000 2,000 Increase
Current Liabilities
Accounts payable 18,000 12,000 6,000 Increase
Interest payable 6,000 2,000 4,000 Increase
Taxes payable 3,000 5,000 2,000 Decrease
DEMONSTRATION COMPANY
Income Statement
For the Year Ended December 31, 2005
Revenues
Sales revenue
Gain on sale of land
Total revenues
$400,000
20,000
$420,000
Expenses
Cost of goods sold
Operating expenses
Depreciation expense
Interest expense
Income tax expense
Total expenses
280,000
75,000
15,000
8,000
7,000
385,000
Net Income $35,000
Using the data
provided, prepare
the cash flows
from operating
activities section of
the statement of
cash flows using
the indirect
method.
9
10. 8 Cash Flows from Operating Activities – Indirect
Method (continued)
DEMONSTRATION COMPANY
Statement of Cash Flows (Indirect Method)
For the Year Ended December 31, 2004
Cash flows from operating activities
Net Income
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation expense
Gain on sale of land
Decrease in accounts receivable
Increase in prepaid rent
Increase in inventory
Increase in accounts payable
Increase in interest payable
Decrease in taxes payable
Net cash provided by operating activities
$15,000
(20,000)
9,000
(5,000)
(2,000)
6,000
4,000
(2,000)
$35,000
5,000
$40,000
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Business Inside
11. 9 Cash Flows from Operating Activities – Direct
Method
Problem Data
DEMONSTRATION COMPANY
Comparative Balance Sheet Accounts
December 31, 2005
2005 2004 Change
Current assets
Accounts receivable
Prepaid rent
Inventory
$30,000
15,000
20,000
$39,000
10,000
18,000
$9,000 Decrease
5,000 Increase
2,000 Increase
Current liabilities
Accounts payable
Interest payable
Taxes payable
18,000
6,000
3,000
12,000
2,000
5,000
6,000 Increase
4,000 Increase
2,000 Decrease
DEMONSTRATION COMPANY
Income Statement
For the Year Ended December 31, 2005
Revenues
Sales revenue
Gain on sale of land
Total revenues
$400,000
20,000
$420,000
Expenses
Cost of goods sold
Operating expenses
Depreciation expense
Interest expense
Income tax expense
Total expenses
280,000
75,000
15,000
8,000
7,000
385,000
Net Income $35,000
Using the
provided data,
prepare the cash
flows from
operating
activities section
of the statement
of cash flows
using the direct
method.
11
12. 9 Cash Flows from Operating Activities – Direct
Method (continued)
Accrual Basis Add Deduct Cash Flows
Sales $400,000 9,000 A/R $409,000 (+)
Gain on sale of land 20,000 20,000 Gain -0-
Cost of goods sold 280,000 2,000 Inv. 6,000 A/P 276,000 (-)
Operating expenses 75,000 5,000 P. Rent 80,000 (-)
Depreciation expense 15,000 15,000 Depre. -0-
Interest expense 8,000 4,000 Int. Pay. 4,000 (-)
Income tax expense 7,000 2,000 Tax. Pay. 9,000 (-)
Net Income $35,000 Cash from operating activities $40,000
DEMONSTRATION COMPANY
Statement of Cash Flows (Direct Method)
For the Year Ended December 31, 2005
Cash flows from operating activities
Cash receipts from customers
Cash payments
To suppliers
For operating expenses
For interest
For income taxes
Net cash provided by operating activities
$276,000
80,000
4,000
9,000
$409,000
$369,000
$40,000 12
