CHAPTER 4
CHAPTER 4: : FINANCIAL STATEMENTS AND ADDITIONAL DISCLOSURE
Chapter Objectives: Upon completion of this chapter the student will be able to:
Identify the basic types of financial statements
Prepare income statements, statement of retained earnings, and balance sheet
Enumerate the importance of each financial statement and enumerate the limitations and strengths
Understand the need to have financial data about cash flows of a business entity. Understand the purposes and uses of the statement of cash flows.
Describe the major disclosure requirements and provisions of the current accounting standard on the statement of cash flows.
Identify the three major classifications of cash flows.
Describe the procedure of reporting cash flows from operations.
Prepare the statement of cash flows using either the direct or indirect methods. Identify additional disclosures beyond the financial statements
4.1 INTRODUCTION 4.1 INTRODUCTION
In the previous chapters we have stressed that the measurement of the resource and obligations In the previous chapters we have stressed that the measurement of the resource and obligations of a business enterprise is fundamental to the accounting process. The on-going recording of of a business enterprise is fundamental to the accounting process. The on-going recording of transactions and events and the preparation of end-of-period adjusting entries may be described transactions and events and the preparation of end-of-period adjusting entries may be described as a process measuring assets and liabilities. The result of this process is summarized in as a process measuring assets and liabilities. The result of this process is summarized in general-purpose financial statements that provide decision makers with useful information. To purpose financial statements that provide decision makers with useful information. To supplement the basic financial statements, additional disclosures may be included in notes to the supplement the basic financial statements, additional disclosures may be included in notes to the financial statements and in other sections of the annual report to share holders.
financial statements and in other sections of the annual report to share holders. 4.2 INCOME STATEMENT
4.2 INCOME STATEMENT
The income statement presents revenues, gains, expense and losses recognized by the firm for a The income statement presents revenues, gains, expense and losses recognized by the firm for a specified period of time. The income statement is an important financial statement because it specified period of time. The income statement is an important financial statement because it provides investors and creditors with information that helps them predict the amount, timing, and provides investors and creditors with information that helps them predict the amount, timing, and uncertainly of future cash flows. Through use of the income statement, investors and creditors uncertainly of future cash flows. Through use of the income statement, investors and creditors are able to evaluate the past performance of an enterprise and determine the risk of achieving are able to evaluate the past performance of an enterprise and determine the risk of achieving particular cash flows.
particular cash flows.
4.2.1 Alternative Forms of Income Statement 4.2.1 Alternative Forms of Income Statement
The manner in which accounting information is displayed in an income statement can influence The manner in which accounting information is displayed in an income statement can influence the reader’s interpretation of the information. Except for three specific items (extra ordinary the reader’s interpretation of the information. Except for three specific items (extra ordinary items, discontinued operations, and effects of changes in accounting principles), GAAP does not items, discontinued operations, and effects of changes in accounting principles), GAAP does not require a standard format for organizing and presenting the firms revenues, expenses, gains, and require a standard format for organizing and presenting the firms revenues, expenses, gains, and losses. These income statement elements are organized in one of two general ways: a single-step losses. These income statement elements are organized in one of two general ways: a single-step format and a multiple-step format.
format and a multiple-step format.
Single-Step Format:
Single-Step Format: The single-step format uses only two broad section classifications: (1) aThe single-step format uses only two broad section classifications: (1) a revenue and gains section, and (2) an expenses and losses section. It is a single step statement revenue and gains section, and (2) an expenses and losses section. It is a single step statement because only one step is involved in computing and displaying operating income.
The single-step form of income statement is presented below: The single-step form of income statement is presented below:
NICE
NICE CorporationCorporation Income Statement Income Statement
For the Year ended Dec. 31, 1990. For the Year ended Dec. 31, 1990. Revenue:
Revenue:
Net sales ---Br. 18,108 Net sales ---Br. 18,108
Investment income ---420
Investment income ---420
Gain on disposal of equipment --- Gain on disposal of equipment --- 5050 Total revenue ---18,578 Total revenue ---18,578 Costs and Expenses: Costs and Expenses: Cost of goods sold ---Br. 11,988 Cost of goods sold ---Br. 11,988 Selling Expenses ---2640
Selling Expenses ---2640
General and administrative Expense ---1620
General and administrative Expense ---1620
Interest Expense ---230
Interest Expense ---230
Income taxes expense ---Income taxes expense ---1,0431,043 Total costs and expenses Total costs and expenses ---17,52117,521 Net income ---Br. Net income ---Br. 1,0571,057 Multiple-Step Format: Multiple-Step Format: The multiple-step format provides for several classifications andThe multiple-step format provides for several classifications and intermediate subtotal measures of income. It typically distinguishes among various operations intermediate subtotal measures of income. It typically distinguishes among various operations and activities that affect income. The multiple-step form is more likely to be found in more and activities that affect income. The multiple-step form is more likely to be found in more detailed income statements prepared for the use of management bankers and other creditors. detailed income statements prepared for the use of management bankers and other creditors. The multiple-step form of income statement is presented below: The multiple-step form of income statement is presented below: NICE Corporation NICE Corporation Income Statement Income Statement For the year ended December 31, 1990 (In thousands of birrs) For the year ended December 31, 1990 (In thousands of birrs) Sales (net of discounts, returns, and allowances) ---Br. 18,108 Sales (net of discounts, returns, and allowances) ---Br. 18,108 Cost of goods sold: Cost of goods sold: Inventories Jan 1, 1990 ---Br. 1,000 Inventories Jan 1, 1990 ---Br. 1,000 Purchases (net of discounts, returns, and allowances) 10,302 Purchases (net of discounts, returns, and allowances) 10,302 Freight-in ---Freight-in ---1,2661,266 11,568 11,568 Cost of goods available for sale ---Cost of goods available for sale ---12,56812,568 Less: Inventories Dec. 31, 1990 ---580
Less: Inventories Dec. 31, 1990 ---580
Cost of goods sold ---Cost of goods sold ---11,98811,988 Gross profit on sales ---6,120 Gross profit on sales ---6,120 Operating expenses: Operating expenses: Selling expenses: Selling expenses: Sales salaries ---Br. 1260 Sales salaries ---Br. 1260 Advertising and promotion ---880
Advertising and promotion ---880
Depreciation on building ---420
Depreciation on building ---420
Other ---Other ---8080 Br. (2,640)Br. (2,640) General and administrative expenses: General and administrative expenses: Salaries ---1,160 Salaries ---1,160 Property tax ---308
Property tax ---308
Depreciation on equipment ---80
Depreciation on equipment ---80 Other
Total operating expenses ---Br. ( Total operating expenses ---Br. (4260)4260) Income from operation ---Br. 1,860 Income from operation ---Br. 1,860 Other revenue (Expenses):
Other revenue (Expenses):
Investment income---Br. 420 Investment income---Br. 420 Gain on disposal of equipment ---50 Gain on disposal of equipment ---50 Interest expense --- (
Interest expense --- (230)230) 240240 Income before income taxes ---Br. 2,100 Income before income taxes ---Br. 2,100 Income taxes expense (including Br. 20 differed) ---Income taxes expense (including Br. 20 differed) ---1,0431,043 Net income ---Br. Net income ---Br. 10571057 Earnings per share of common stock ---Br. Earnings per share of common stock ---Br. 1.251.25
4.2.2 Classification of Revenue 4.2.2 Classification of Revenue
The major source of revenue for most business enterprises is the production and sale of goods The major source of revenue for most business enterprises is the production and sale of goods and services. Examples of secondary sources are dividends, loyalties, interest, rents, investment and services. Examples of secondary sources are dividends, loyalties, interest, rents, investment income from affiliated companies, and gains on the disposal of assets.
income from affiliated companies, and gains on the disposal of assets.
Revenue offsets should be distinguished from expenses; they are deducted from gross revenue in Revenue offsets should be distinguished from expenses; they are deducted from gross revenue in the income statement. Such items as sales discounts and sales returns and allowances are not the income statement. Such items as sales discounts and sales returns and allowances are not expenses, but rather revenue that is never realized.
expenses, but rather revenue that is never realized.
4.2.3 Classification of Costs and Expenses 4.2.3 Classification of Costs and Expenses
Costs and expenses are classified in the income statement to help users understand the operating Costs and expenses are classified in the income statement to help users understand the operating cost relationships of the business enterprise. Classifications may be according to the nature of cost relationships of the business enterprise. Classifications may be according to the nature of expenses (natural classification), business functions, (functional classification), areas of expenses (natural classification), business functions, (functional classification), areas of responsibility, or any other useful basis.
responsibility, or any other useful basis.
In many income statements, costs and express are reported in single-step form, classified In many income statements, costs and express are reported in single-step form, classified according to the nature of expenses i.e. in categories that reflect the kind of resources used according to the nature of expenses i.e. in categories that reflect the kind of resources used during the accounting period. Examples are merchandise and supplies, salaries and fringe during the accounting period. Examples are merchandise and supplies, salaries and fringe benefits, purchased services, depreciation etc. Expenses may be classified on a functional basis benefits, purchased services, depreciation etc. Expenses may be classified on a functional basis as cost of goods sold, selling expenses, general and administrative expenses, income tax expense as cost of goods sold, selling expenses, general and administrative expenses, income tax expense etc.
etc.
4.3 STATEMENT OF RETAINED EARNINGS 4.3 STATEMENT OF RETAINED EARNINGS
A statement of retained earnings often presented as a supplement to the financial statements. The A statement of retained earnings often presented as a supplement to the financial statements. The purpose of statements of retained earnings is to reconcile the beginning and ending balances of purpose of statements of retained earnings is to reconcile the beginning and ending balances of retained earnings, showing all changes in retained earnings, during the accounting period, and to retained earnings, showing all changes in retained earnings, during the accounting period, and to provide connecting ink between the income statement and the balance sheet.
provide connecting ink between the income statement and the balance sheet.
The ending balance of retained earnings is reported on the balance sheet as one element of The ending balance of retained earnings is reported on the balance sheet as one element of owners’ equity. Major components of a statement of retained earnings are:
owners’ equity. Major components of a statement of retained earnings are: 1.
1. Prior period adjustmentsPrior period adjustments 2.
2. Net income or loss for the periodNet income or loss for the period 3.
3. Dividends – both stock dividends and cash dividendsDividends – both stock dividends and cash dividends 4.
Disclosure of cash dividends per share also is made in the statement of retained earnings. Disclosure of cash dividends per share also is made in the statement of retained earnings.
4.3.1 Prior Period Adjustments 4.3.1 Prior Period Adjustments
Prior period adjustments are correction of errors in the financial statements from a prior period Prior period adjustments are correction of errors in the financial statements from a prior period that affect retained earnings. Material errors in the financial statements might include that affect retained earnings. Material errors in the financial statements might include arithmetical mistakes, the misuse or omissions of information, mistakes in the application of arithmetical mistakes, the misuse or omissions of information, mistakes in the application of accounting principles and failure to interpret properly the accounting aspects of transactions. accounting principles and failure to interpret properly the accounting aspects of transactions. In the financial statements for the current accounting period, a prior period adjustment is In the financial statements for the current accounting period, a prior period adjustment is reported as a correction to the beginning balance of retained earnings. The format of the reported as a correction to the beginning balance of retained earnings. The format of the statement of retained earnings is presented below:
statement of retained earnings is presented below:
NICE Corporation NICE Corporation
Statement of Retained Earnings Statement of Retained Earnings For the year ended December 31, 1990 For the year ended December 31, 1990
Retained earnings, beginning of the year, as originally reported ---Br. 2,800 Retained earnings, beginning of the year, as originally reported ---Br. 2,800 Less:
Less: Prior period adjustment (correction of error), net of income tax effect of Prior period adjustment (correction of error), net of income tax effect of
Br. 240 --- ( Br. 240 --- (360)360) Retained Earnings, beginning of year, as restated ---Br. 2,440 Retained Earnings, beginning of year, as restated ---Br. 2,440 Add:
Add: Net income --- Net income ---1,0571,057 Subtotal ---3, 497 Subtotal ---3, 497 Less:
Less: Cash dividends on preferred stock ---Br. 57 Cash dividends on preferred stock ---Br. 57 Cash dividends on common stock
Cash dividends on common stock ---400 400 ( (457)457) Retained Earnings, end of year ---…. Retained Earnings, end of year ---….3, 0403, 040
4.4 BALANCE SHEET 4.4 BALANCE SHEET
The balance sheet provides economic information about an entity’s resources (assets), claims The balance sheet provides economic information about an entity’s resources (assets), claims against those resources (liabilities) and the remaining claim accruing to the owners (owners’ against those resources (liabilities) and the remaining claim accruing to the owners (owners’ equity).
equity).
If a balance sheet is examined carefully, users can gain a considerable amount of information If a balance sheet is examined carefully, users can gain a considerable amount of information related to enterprise liquidity and financial flexibility. Balance sheet is basically a historical related to enterprise liquidity and financial flexibility. Balance sheet is basically a historical statement, because it shows the cumulative effect of past transactions and events.
statement, because it shows the cumulative effect of past transactions and events.
4.4.1 Uses and Limitations of the Balance Sheet 4.4.1 Uses and Limitations of the Balance Sheet
A balance sheet in comparative form provides valuable information to creditors, stockholders, A balance sheet in comparative form provides valuable information to creditors, stockholders, management, prospective investor, and the public. Individuals with the ability to interpret management, prospective investor, and the public. Individuals with the ability to interpret comparative balance sheets may learn much as to the short-run solvency of a business enterprise, comparative balance sheets may learn much as to the short-run solvency of a business enterprise, favorable or unfavorable trends in liquidity, commitments that must be met in the future, and the favorable or unfavorable trends in liquidity, commitments that must be met in the future, and the relative positions of creditors and stockholders.
relative positions of creditors and stockholders.
foresee future economic events necessitates the preparation of balance sheets on a different basis. foresee future economic events necessitates the preparation of balance sheets on a different basis. Furthermore, accountants are unable to identify and provide a valuation for many factors that Furthermore, accountants are unable to identify and provide a valuation for many factors that have a material effect on the financial position of an enterprise. The quality, morale, and have a material effect on the financial position of an enterprise. The quality, morale, and character of management and other personnel, the market position of an enterprise and the character of management and other personnel, the market position of an enterprise and the regulation of its products are subjective and intangible factors of great importance in the regulation of its products are subjective and intangible factors of great importance in the evaluation of the financial position of an enterprise. None of these factors is reported directly in evaluation of the financial position of an enterprise. None of these factors is reported directly in the birr and cents framework of the accounting process that leads to a balance sheet.
the birr and cents framework of the accounting process that leads to a balance sheet.
4.4.2 Balance Sheet Classifications 4.4.2 Balance Sheet Classifications
The classifications, group headings, and number of items on a balance sheet vary considerably The classifications, group headings, and number of items on a balance sheet vary considerably depending on the size of the enterprise, the nature of its operations, and whether the financial depending on the size of the enterprise, the nature of its operations, and whether the financial statements are intended for wide distribution or for the use of a few owners and creditors.
statements are intended for wide distribution or for the use of a few owners and creditors.
As a generalization subject to many exceptions, the following classification of balance sheet As a generalization subject to many exceptions, the following classification of balance sheet items is suggested as representative:
items is suggested as representative: Asset:
Asset:
Current assets Current assets
Investment (held for control or not readily marketable) Investment (held for control or not readily marketable) Plant assets
Plant assets Intangible assets Intangible assets
Other noncurrent assets (including deferred charges) Other noncurrent assets (including deferred charges) Liabilities:
Liabilities:
Current liabilities Current liabilities
Long-term debt (including deferred income tax credits & deferred revenue) Long-term debt (including deferred income tax credits & deferred revenue) Stockholders’ equity:
Stockholders’ equity:
Capital stock (preferred and common stock) Capital stock (preferred and common stock) Additional paid-in capital
Additional paid-in capital Retained earnings
Retained earnings
Assets:
Assets: includes all economic resources divided in to current, investment, plant, intangible andincludes all economic resources divided in to current, investment, plant, intangible and other noncurrent.
other noncurrent. Current asset
Current assets: include cash and other assets that are reasonably expected to be realized in cashs: include cash and other assets that are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business or within one year from or sold or consumed during the normal operating cycle of the business or within one year from the balance sheet date.
the balance sheet date.
The normal operating cycle of a business is the average length of time from the expenditure of The normal operating cycle of a business is the average length of time from the expenditure of cash to inventory, to sale, to accounts receivable, and finally back to cash. Most companies use cash to inventory, to sale, to accounts receivable, and finally back to cash. Most companies use one year as the time period for classifying items as current or long-term because either the one year as the time period for classifying items as current or long-term because either the operating cycle is less than one year or the operating cycle may be difficult to measure reliably. operating cycle is less than one year or the operating cycle may be difficult to measure reliably.
Five general types of assets generally are included in the current assets classification: Five general types of assets generally are included in the current assets classification: 1.
1. Cash – Money in any form-cash and checks a waiting deposit, balances in checkingCash – Money in any form-cash and checks a waiting deposit, balances in checking accounts, and expendable cash funds.
accounts, and expendable cash funds. 2.
2. Secondary cash resources – Various short-term investments that are readily marketable. AnySecondary cash resources – Various short-term investments that are readily marketable. Any such resources whose availability for current use is restricted by contract are excluded
3.
3. Short-term receivables – Trade accounts receivable (including installment receivablesShort-term receivables – Trade accounts receivable (including installment receivables collected during the enterprises operating cycle) and notes receivable with short-term collected during the enterprises operating cycle) and notes receivable with short-term maturities.
maturities. 4.
4. Inventories – Material, supplies, goods in process, finished goods. This category includesInventories – Material, supplies, goods in process, finished goods. This category includes items held for sale in the ordinary course of operation, items in process of production of items held for sale in the ordinary course of operation, items in process of production of goods or services. Goods held on consignment from others are not included because title is goods or services. Goods held on consignment from others are not included because title is not held to such goods
not held to such goods 5.
5. Short-tem prepayments – The cost of various services, such as insurance, taxes, and rent,Short-tem prepayments – The cost of various services, such as insurance, taxes, and rent, which have been paid for in advance of use. Short-term prepayments sometimes are referred which have been paid for in advance of use. Short-term prepayments sometimes are referred to as prepaid expenses.
to as prepaid expenses. Current liabilities:
Current liabilities: are obligations whose liquidation is expected to require the use of current are obligations whose liquidation is expected to require the use of current assets or the creation of other current liabilities. Three main classes of current liabilities fall assets or the creation of other current liabilities. Three main classes of current liabilities fall within this definition.
within this definition.
1.
1. Obligations for the acquisition of goods and services that have entered the operating cycle.Obligations for the acquisition of goods and services that have entered the operating cycle. This includes trade payables (including notes and accounts payable to suppliers) and accrued This includes trade payables (including notes and accounts payable to suppliers) and accrued liabilities such as wages, commissions, income taxes, property taxes etc
liabilities such as wages, commissions, income taxes, property taxes etc 2.
2. Other debts that may be expected to required payment within the operating cycle or one year.Other debts that may be expected to required payment within the operating cycle or one year. This includes short-term notes payable to banks and the currently maturing portions of This includes short-term notes payable to banks and the currently maturing portions of long-term debt.
term debt. 3.
3. Collections received in advance of the delivery of goods or the performance of services.Collections received in advance of the delivery of goods or the performance of services.
These advances often are described as “deferred revenue” but it is the obligation to furnish the These advances often are described as “deferred revenue” but it is the obligation to furnish the goods or services or to refund the payment that requires them to be classified in the current goods or services or to refund the payment that requires them to be classified in the current liabilities section of the balance sheet.
liabilities section of the balance sheet.
Some liabilities that will be paid shortly after the balance sheet date are excluded from current Some liabilities that will be paid shortly after the balance sheet date are excluded from current liabilities, because of the requirements that a current liability must involve the use of current liabilities, because of the requirements that a current liability must involve the use of current assets or the issuance of new short-term debt for its extinction.
assets or the issuance of new short-term debt for its extinction.
Examples are (1) obligations due at an early date that will be retired by the issuance of Examples are (1) obligations due at an early date that will be retired by the issuance of new-long-term debts, for example, bonds that will be refunded or a loan secured by the cash surrender term debts, for example, bonds that will be refunded or a loan secured by the cash surrender value of life insurance policies (the amount of cash that would be received if the policies were value of life insurance policies (the amount of cash that would be received if the policies were canceled) that will be renewed, and (2) obligations that will be paid from a fund included among canceled) that will be renewed, and (2) obligations that will be paid from a fund included among noncurrent assets, for example, a life insurance policy loan that will be liquidated by offset noncurrent assets, for example, a life insurance policy loan that will be liquidated by offset against the cash surrender value of the policy, or by deduction from the proceeds of the life against the cash surrender value of the policy, or by deduction from the proceeds of the life insurance policy at maturity.
insurance policy at maturity.
4.2.2 Noncurrent Resources and Obligations 4.2.2 Noncurrent Resources and Obligations The definition of
The definition of noncurrent assetsnoncurrent assets determines by exclusion those assets that are reported as determines by exclusion those assets that are reported as non-current. There are four categories of noncurrent assets:
non-current. There are four categories of noncurrent assets:
1. Long-term funds, investments, and receivables:
insurance policies, and funds established for such purposes as the payment of pensions, insurance policies, and funds established for such purposes as the payment of pensions, retirement of preferred stock, or repayment of long-term debt. Assets, such as land held for retirement of preferred stock, or repayment of long-term debt. Assets, such as land held for speculative purposes and future plant sites also are included in this category.
speculative purposes and future plant sites also are included in this category.
2. Long-tem tangible resources used in operations:
2. Long-tem tangible resources used in operations: These are tangible (have physicalThese are tangible (have physical substance) and are held for productive use in business operations. Land, natural resources subject substance) and are held for productive use in business operations. Land, natural resources subject to depletion, buildings, equipment, machines, tools, leased assets under capital leases, leasehold to depletion, buildings, equipment, machines, tools, leased assets under capital leases, leasehold improvements, and plant assets under construction are included. Long-term prepayments for the improvements, and plant assets under construction are included. Long-term prepayments for the use of physical assets, such as leaseholds, easements, or rights of way, also may be included in use of physical assets, such as leaseholds, easements, or rights of way, also may be included in this category, though some accountants group these in the next category.
this category, though some accountants group these in the next category.
3. Long-term intangible resources:
3. Long-term intangible resources: Long-term property rights of an intangible nature may be ofLong-term property rights of an intangible nature may be of greater importance to a business enterprise than its tangible assets. Examples of such assert are greater importance to a business enterprise than its tangible assets. Examples of such assert are patents, goodwill, trademarks, copyrights, organization costs, and franchise.
patents, goodwill, trademarks, copyrights, organization costs, and franchise.
4. Other non-current assets /Deferred charges/:
4. Other non-current assets /Deferred charges/: Included in this category are items such asIncluded in this category are items such as plant assets no longer used in operations and held for disposal costs incurred in the issuance of plant assets no longer used in operations and held for disposal costs incurred in the issuance of long-term debts, deferred start-up and moving costs, and any other noncurrent assets that is not long-term debts, deferred start-up and moving costs, and any other noncurrent assets that is not included in one of the first three categories.
included in one of the first three categories.
A
A non-current liabilitynon-current liability is an obligation that will not require the use of current assets or the is an obligation that will not require the use of current assets or the issuance of short-term debt within the next year or operating cycle, whichever is longer.
issuance of short-term debt within the next year or operating cycle, whichever is longer. They may be classified into the following
They may be classified into the following
1. Long-term debt based on security issues or related contractual arrangements:
1. Long-term debt based on security issues or related contractual arrangements: Included inIncluded in this category are notes and bonds, reported net of unamortized discount and including any this category are notes and bonds, reported net of unamortized discount and including any unamortized premium. The distinguishing characteristic is that there is a borrowing transaction unamortized premium. The distinguishing characteristic is that there is a borrowing transaction supported by a contractual obligation to pay principal and interest.
supported by a contractual obligation to pay principal and interest.
2. Other non-current liabilities:
2. Other non-current liabilities: This includes all long-term liabilities that do not belong in theThis includes all long-term liabilities that do not belong in the first category. An amount received in advance on a long-term commitment to furnish goods or first category. An amount received in advance on a long-term commitment to furnish goods or services deferred revenue, differed income tax credits, liabilities under capital leases and services deferred revenue, differed income tax credits, liabilities under capital leases and noncurrent amount payable under pension plans are examples.
noncurrent amount payable under pension plans are examples.
4.2.3 Owner’s Equity 4.2.3 Owner’s Equity
The owners’ equity in a business enterprise is the residual interest in assets, after liabilities have The owners’ equity in a business enterprise is the residual interest in assets, after liabilities have been deducted. The amount of owners’ equity thus is directly dependent on the values assigned been deducted. The amount of owners’ equity thus is directly dependent on the values assigned to assets and liabilities.
to assets and liabilities.
Owners’ equity for a corporation is called stockholders’ equity, that for a partnership, partners’ Owners’ equity for a corporation is called stockholders’ equity, that for a partnership, partners’ equity, and that for a sole proprietorship, proprietors’ equity. Owners’ equity includes equity, and that for a sole proprietorship, proprietors’ equity. Owners’ equity includes contributed (or paid-in) capital and retained earnings.
contributed (or paid-in) capital and retained earnings.
Because of legal requirements, owners’ equity is sub classified to reflect detailed sources. For Because of legal requirements, owners’ equity is sub classified to reflect detailed sources. For corporations, the most commonly reported sources are:
Capital Stock: Capital Stock: It is the firm’s stated or legal capital. It is the par value of the issued orIt is the firm’s stated or legal capital. It is the par value of the issued or outstanding preferred and common stock of the corporation and represents the amount that is outstanding preferred and common stock of the corporation and represents the amount that is not available for dividend declarations. Legal capital is specified by state law and the articles not available for dividend declarations. Legal capital is specified by state law and the articles of incorporation (the charter) of the corporation.
of incorporation (the charter) of the corporation.
Contributed capital in excess of par (or stated value): Contributed capital in excess of par (or stated value): If reports the value of assetsIf reports the value of assets received by the corporation above the par (or stated value) of the capital stock given in received by the corporation above the par (or stated value) of the capital stock given in exchange. These amounts usually arise when the corporation sells its stock above par (or the exchange. These amounts usually arise when the corporation sells its stock above par (or the stated amount per share) or issues stock dividends. Sometimes called additional paid-in stated amount per share) or issues stock dividends. Sometimes called additional paid-in capital or premium on stock, it is considered legal capital in most instances.
capital or premium on stock, it is considered legal capital in most instances.
Other contributed capital:Other contributed capital: It arises from such transactions as the sale of treasury stock It arises from such transactions as the sale of treasury stock above its acquisition cost and capital arising from recapitalizations. For balance sheet above its acquisition cost and capital arising from recapitalizations. For balance sheet presentation, there is generally only one additional contributed capital account, which presentation, there is generally only one additional contributed capital account, which includes contributed capital in excess of par. The specific underlying sub accounts are includes contributed capital in excess of par. The specific underlying sub accounts are maintained in a subsidiary ledger.
maintained in a subsidiary ledger.
Retained Earnings: Retained Earnings: It is essentially corporation’s accumulated net earnings, less dividendsIt is essentially corporation’s accumulated net earnings, less dividends paid out, since the company’s inception. In many corporations, retained earnings are the paid out, since the company’s inception. In many corporations, retained earnings are the largest amount in the owners’ equity section. A negative balance in retained earnings is largest amount in the owners’ equity section. A negative balance in retained earnings is called a deficit and usually arises when a company experiences operating losses.
called a deficit and usually arises when a company experiences operating losses.
Treasury Stock: Treasury Stock: Shares that have been issued and then required by the company, but notShares that have been issued and then required by the company, but not retired, are called treasury stock. Treasury stock is not an asset of the issuing firm.
retired, are called treasury stock. Treasury stock is not an asset of the issuing firm.
Companies repurchase their own stock for several reasons: Companies repurchase their own stock for several reasons:
1.
1. To meet employee stock purchase or option plan needsTo meet employee stock purchase or option plan needs 2.
2. To increase reported earnings per shareTo increase reported earnings per share 3.
3. To stabilize the stock’s priceTo stabilize the stock’s price 4.
4. To reduce the outstanding shares, perhaps to discourage a hostile takeover attemptTo reduce the outstanding shares, perhaps to discourage a hostile takeover attempt 5.
5. To contract the firms operationsTo contract the firms operations 6.
6. To indicate that management believes the stock is under valuedTo indicate that management believes the stock is under valued
4.5 STATEMENT OF STOCKHOLDERS’ EQUITY 4.5 STATEMENT OF STOCKHOLDERS’ EQUITY
A financial statement that lists the beginning and ending balances of each equity account and A financial statement that lists the beginning and ending balances of each equity account and describes all the changes that occurred during the year.
MODEL CORPORATION MODEL CORPORATION Statement of Stockholders’ Equity Statement of Stockholders’ Equity For the year ended Dec. 31, 1990 and 1991 For the year ended Dec. 31, 1990 and 1991
Common stock at Br. 10 par Additional Retained Total Common stock at Br. 10 par Additional Retained Total
No. of sharesNo. of shares Amount Amount Paid-in capital Paid-in capital EarningsEarnings
Balances, Jan, 1, 1990 ---1,250 Br. 12,500 Br. 137,858 Br. 306,535 Br. 456,893 Balances, Jan, 1, 1990 ---1,250 Br. 12,500 Br. 137,858 Br. 306,535 Br. 456,893 Net income in 1990 68,066 68,066 Net income in 1990 68,066 68,066 Cash dividend (Br. 11 a share) _____ _______ _______
Cash dividend (Br. 11 a share) _____ _______ _______ (13,750)(13,750) (13,750)(13,750) Balance, Dec. 31, 1990 --- 1250 Br. 12,500 Br. 137,858 Br. 360,851 Br. 511,209 Balance, Dec. 31, 1990 --- 1250 Br. 12,500 Br. 137,858 Br. 360,851 Br. 511,209 Net income, 1991 79,685 79,685 Net income, 1991 79,685 79,685 Cash dividends (Br. 16 a share) (31,200) (31,200) Cash dividends (Br. 16 a share) (31,200) (31,200) Issuance of common stock ---283 2,830 24,332 27,162 Issuance of common stock ---283 2,830 24,332 27,162 Conversion of Bonds
Conversion of Bonds
Payable to common stock ---417 4,170 30,315 34,485 Payable to common stock ---417 4,170 30,315 34,485 50% stock dividend distributed
--50% stock dividend distributed --975 975 9.7509.750 (9750)(9750) Balances, Dec. 31, 1991
Balances, Dec. 31, 1991 29252925 Br. Br. 29,25029,250 Br. Br. 192,505192,505 Br. Br. 399,586399,586 Br. Br. 621,341621,341
4.6 STATEMENT OF CASH FLOWS 4.6 STATEMENT OF CASH FLOWS
Financial reporting should also provide information to users regarding cash flows. Based on Financial reporting should also provide information to users regarding cash flows. Based on cash flows data on the operating, investing, and financing activities, management, investors, cash flows data on the operating, investing, and financing activities, management, investors, creditors, and other users of the financial reports of a firm can assess its solvency, liquidity, and creditors, and other users of the financial reports of a firm can assess its solvency, liquidity, and ability to meet its long-term financial obligations.
ability to meet its long-term financial obligations.
To address the foregoing information requirements of internal and external users of financial To address the foregoing information requirements of internal and external users of financial reports the accounting profession has given a due attention to providing information on cash reports the accounting profession has given a due attention to providing information on cash flows. Even though business activities are generally reported under the accrual-basis of flows. Even though business activities are generally reported under the accrual-basis of accounting, the statements of cash flows is an integral part of financial reporting of a business accounting, the statements of cash flows is an integral part of financial reporting of a business enterprise.
enterprise.
Following the issuance of Statement of Financial Accounting Standards No. 95 by FASB in Following the issuance of Statement of Financial Accounting Standards No. 95 by FASB in 1987, the statement of changes in financial position was replaced by the statement of cash flows. 1987, the statement of changes in financial position was replaced by the statement of cash flows. Provisions of FASB Statement No. 95 include:
Provisions of FASB Statement No. 95 include: 1.
1. The reporting basis of the statement of cash flows: - that a statement of cash flows explainsThe reporting basis of the statement of cash flows: - that a statement of cash flows explains the changes in cash and cash equivalents.
the changes in cash and cash equivalents. 2.
2. Cash flows in the statement of cash flows are classified according to three majorCash flows in the statement of cash flows are classified according to three major categories:
categories: (a)
(a) Cash flows from operating activities,Cash flows from operating activities, (b)
(b) Cash flows from investing activities, andCash flows from investing activities, and (c)
(c) Cash flows from financing activities.Cash flows from financing activities. 3.
3. Disclosure requirements of significant non-cash investing and financing transactions.Disclosure requirements of significant non-cash investing and financing transactions. 4.
4. Methods or formats of reporting cash flows permitted by the profession.Methods or formats of reporting cash flows permitted by the profession.
Major Classification of Cash Flows Major Classification of Cash Flows
(a)
(a) Cash flows from operating activities,Cash flows from operating activities, (b)
(b) Cash flows from investing activities, andCash flows from investing activities, and (c)
(c) Cash flows from financing activities.Cash flows from financing activities. (a) Cash Flows from Operating Activities:
(a) Cash Flows from Operating Activities: Operating activities include transactions and eventsOperating activities include transactions and events that affect the determination of the firm’s operating income. Cash flows from operating activities that affect the determination of the firm’s operating income. Cash flows from operating activities include cash inflows and outflows from operating activities. Below are presented some common include cash inflows and outflows from operating activities. Below are presented some common examples of such cash flows:
examples of such cash flows: Cash inflows from:
Cash inflows from:
Sale of goods and servicesSale of goods and services
Sale of trading securitiesSale of trading securities
Rent revenueRent revenue
Interest revenueInterest revenue
Dividend revenueDividend revenue
Cash outflows to: Cash outflows to:
Purchases of inventoryPurchases of inventory
Payment of wages, salaries, and other expenses for employees servicesPayment of wages, salaries, and other expenses for employees services
Payment of taxesPayment of taxes
Payment of interest expensePayment of interest expense
Payment of utilities expensesPayment of utilities expenses
Purchase of trading securitiesPurchase of trading securities (b) Cash Flows from Investing Activities:
(b) Cash Flows from Investing Activities: Investing activities include transitions and eventsInvesting activities include transitions and events that involve the purchase and sale of long-term assets such as plant assets and securities that involve the purchase and sale of long-term assets such as plant assets and securities (excluding cash equivalents). These activities are related to the central and ongoing operation of (excluding cash equivalents). These activities are related to the central and ongoing operation of a business only indirectly. Some examples of cash flows from investing activities include:
a business only indirectly. Some examples of cash flows from investing activities include: Cash receipts from:
Cash receipts from:
Sale of plant assetsSale of plant assets
Sale of business segmentSale of business segment
Sale of securities (excluding cash equivalents)Sale of securities (excluding cash equivalents)
Collection of principal on loans made to other entitiesCollection of principal on loans made to other entities Cash payments to:
Cash payments to:
Purchase of plant assetsPurchase of plant assets
Purchase of securities (excluding cash equivalents)Purchase of securities (excluding cash equivalents)
Make loans to other entitiesMake loans to other entities
(c) Cash Flows from Financing Activities:
(c) Cash Flows from Financing Activities: Financing activities include transactions and eventsFinancing activities include transactions and events involving cash receipts and payments to and from owners (equity financing) and creditors (debt involving cash receipts and payments to and from owners (equity financing) and creditors (debt financing). Examples of cash flows from financing activities include:
financing). Examples of cash flows from financing activities include: Cash receipts from:
Cash receipts from:
Sale of stocksSale of stocks
Sale of bondsSale of bonds
Bank borrowingsBank borrowings
Cash payments to: Cash payments to:
Payment of dividends to stockholdersPayment of dividends to stockholders
Repayment of principals on debtsRepayment of principals on debts
Repurchase of an entity’s own stock (treasury stock) Repurchase of an entity’s own stock (treasury stock)
4.7 PREPARING THE STATEMENT OF CASH FLOWS 4.7 PREPARING THE STATEMENT OF CASH FLOWS
As noted earlier, the statement of cash flows provides information about cash flows from three As noted earlier, the statement of cash flows provides information about cash flows from three major activities: operating, investing, and financing. There are two methods that may be used in major activities: operating, investing, and financing. There are two methods that may be used in preparing a statement of cash flow:
preparing a statement of cash flow: 1)
2)
2) The direct method.The direct method.
The two methods differ in calculating and reporting the amount of cash flow from operating The two methods differ in calculating and reporting the amount of cash flow from operating activities. The reporting of the other two major activities (investing and financing) are generally activities. The reporting of the other two major activities (investing and financing) are generally similar under both methods.
similar under both methods.
4.7.1 The Indirect Method 4.7.1 The Indirect Method
This method begins with net income as reported on the income statement and adjusts the net This method begins with net income as reported on the income statement and adjusts the net income computed on the accrual basis for any items that do not affect cash flows. The income computed on the accrual basis for any items that do not affect cash flows. The adjustments to net income required to compute cash flows from operating activities could be adjustments to net income required to compute cash flows from operating activities could be determined by analyzing some items on the income statement and balance sheet. There are three determined by analyzing some items on the income statement and balance sheet. There are three basic types of these adjustments:
basic types of these adjustments: (a)
(a) Adjustments for non-cash income statement items,Adjustments for non-cash income statement items, (b)
(b)Adjustments for gains and losses from sale of assets, andAdjustments for gains and losses from sale of assets, and (c)
(c) Adjustments for changes in current operating accounts.Adjustments for changes in current operating accounts.
The indirect method for preparing a statement of cash flows is favored and used by many firms. The indirect method for preparing a statement of cash flows is favored and used by many firms. This is because, it is relatively easy to apply and it reconciles the difference between net income This is because, it is relatively easy to apply and it reconciles the difference between net income and the net cash flow provided by operating activities.
and the net cash flow provided by operating activities.
(a) Adjustments for Non-Cash Income Statement Items:
(a) Adjustments for Non-Cash Income Statement Items: The income statement reportsThe income statement reports revenues and expense on the accrual basis. That is, revenues reported are recognized when revenues and expense on the accrual basis. That is, revenues reported are recognized when realized and expenses when incurred. Accordingly, there are some items reported on the income realized and expenses when incurred. Accordingly, there are some items reported on the income statement that do not affect cash receipts or payments. In computing the cash flows from statement that do not affect cash receipts or payments. In computing the cash flows from operating activities these items should be adjusted to the net income figure. Below are given operating activities these items should be adjusted to the net income figure. Below are given some examples of
some examples of non-cash income statement itemsnon-cash income statement items and their treatment in reconciling net and their treatment in reconciling net income to net cash flow from operating activities.
income to net cash flow from operating activities. i)
i) Depreciation on property, plant, and equipment:Depreciation on property, plant, and equipment: - depreciation expense is a non- cash - depreciation expense is a non- cash item that does not result in cash out flows. In computing the net cash flows from item that does not result in cash out flows. In computing the net cash flows from operating activities, depreciation expense must be added to amount of net income during operating activities, depreciation expense must be added to amount of net income during the period. But, you have to notice that depreciation expense is not a source of cash the period. But, you have to notice that depreciation expense is not a source of cash inflows to a business. Rather, it simply indicates that the reported net income has inflows to a business. Rather, it simply indicates that the reported net income has included expenses that do not require cash outflows and; hence, should be added back to included expenses that do not require cash outflows and; hence, should be added back to net income to compute cash flows from operations
net income to compute cash flows from operations ii)
ii) Amortization of intangible assets;Amortization of intangible assets; - Like depreciation amortization expense does not - Like depreciation amortization expense does not involve cash out flows. As a result, amortization expense should be added back to net involve cash out flows. As a result, amortization expense should be added back to net income in determining net cash flows from operating activities.
income in determining net cash flows from operating activities. iii)
iii) Bond discount and premium amortization: - Depending on whether the market rate ofBond discount and premium amortization: - Depending on whether the market rate of interest is greater or less than bond coupon rates, bonds are issued at a discount or interest is greater or less than bond coupon rates, bonds are issued at a discount or premium. Both the discount and premium represent adjustments to periodic interest premium. Both the discount and premium represent adjustments to periodic interest expenses. Amortization of bond discount decreases accrual interest expenses. So, expenses. Amortization of bond discount decreases accrual interest expenses. So, amortization of bond discount should be added back to net income and amortization of amortization of bond discount should be added back to net income and amortization of bond premiums should be deducted from net income in computing net cash flows from bond premiums should be deducted from net income in computing net cash flows from operations.
operations.
(b) Adjustments for Gains and Losses from Sale of Assets:
investments in securities like bonds and stocks or plant assets. For a merchandising or investments in securities like bonds and stocks or plant assets. For a merchandising or manufacturing enterprise the primary sources of revenue are sale of inventory. The sale of other manufacturing enterprise the primary sources of revenue are sale of inventory. The sale of other assets is an incidental or peripheral activity and is not part of the operating income of an assets is an incidental or peripheral activity and is not part of the operating income of an enterprise. Such transactions are, therefore, properly classified as investing activities rather than enterprise. Such transactions are, therefore, properly classified as investing activities rather than operating activities. The proceeds from the sale of an asset include any gain or loss. Thus, if the operating activities. The proceeds from the sale of an asset include any gain or loss. Thus, if the cash in flows are reported in the investing section and no adjustment is made to net income in the cash in flows are reported in the investing section and no adjustment is made to net income in the operating section, a double counting of the gain or loss will occur. This is corrected by operating section, a double counting of the gain or loss will occur. This is corrected by deducting the gain or adding the loss to net income in determining the cash flow from operating deducting the gain or adding the loss to net income in determining the cash flow from operating activities.
activities.
Example
Example: Assume that ABC Company sold for Birr 150,000 equipment that cost Birr 125,000: Assume that ABC Company sold for Birr 150,000 equipment that cost Birr 125,000 and has accumulated depreciation of Birr 75,000 on the date of sale.
and has accumulated depreciation of Birr 75,000 on the date of sale. The entry for the sale of the equipment would be:
The entry for the sale of the equipment would be:
Cash
---Cash --- 150,000150,000 Accumulated Depreciation Equipment
---Accumulated Depreciation Equipment --- 75,000 75,000 Equipment
---Equipment --- 125,000125,000 Gain on sale of Equipment
---Gain on sale of Equipment --- 100,000100,000
The Birr 100,000 gain on sale of equipment included in the firm’s net income. In computing the The Birr 100,000 gain on sale of equipment included in the firm’s net income. In computing the cash flows from operating activities, therefore, this amount should be subtracted under the cash flows from operating activities, therefore, this amount should be subtracted under the indirect method. The gain of Birr 100,000 is reported on the statement of cash flows under indirect method. The gain of Birr 100,000 is reported on the statement of cash flows under investing activities as cash received from the sale of equipment.
investing activities as cash received from the sale of equipment.
(c) Adjustments for Changes in Current Operating Accounts:
(c) Adjustments for Changes in Current Operating Accounts: In the previous twoIn the previous two adjustments, we have considered non-cash income statement items and gain or loss from sale of adjustments, we have considered non-cash income statement items and gain or loss from sale of assets. These two adjustments, however, are not the only adjustments to net income. The net assets. These two adjustments, however, are not the only adjustments to net income. The net income reported on the accrual-basis of accounting also include sales, cost of goods sold, as well income reported on the accrual-basis of accounting also include sales, cost of goods sold, as well as operating expense recorded on the accrual basis. To adjust these items to a cash basis, as operating expense recorded on the accrual basis. To adjust these items to a cash basis, adjustments must be made to net income for the increases or decrease in the balances of current adjustments must be made to net income for the increases or decrease in the balances of current operating accounts.
operating accounts.
Current operating accounts are classified as: Current operating accounts are classified as:
i)
i) Current operating asset accounts andCurrent operating asset accounts and ii)
ii) Current operating liability accountsCurrent operating liability accounts
i)
i) Adjustments for Changes in Current Operating Assets Accounts Adjustments for Changes in Current Operating Assets Accounts
In preparing the statement of cash flows using the indirect method, current operating asset In preparing the statement of cash flows using the indirect method, current operating asset accounts are generally adjusted by:
accounts are generally adjusted by:
Adding decrease in current operating asset accounts andAdding decrease in current operating asset accounts and
Deducting increases in current operating asset accounts to net income.Deducting increases in current operating asset accounts to net income.
Let’s look into some common current operating asset accounts. Let’s look into some common current operating asset accounts.
collected. To determine the cash flow from operating activities the Birr 30,000 increase collected. To determine the cash flow from operating activities the Birr 30,000 increase in Accounts Receivable should be deducted from the net income figure.
in Accounts Receivable should be deducted from the net income figure.
InventoryInventory: - an increase in Inventory account implies more cash was used for purchases: - an increase in Inventory account implies more cash was used for purchases of inventory than is reflected in the cost of goods sold on the income statement. A of inventory than is reflected in the cost of goods sold on the income statement. A decrease in Inventory, on the other hand, implies the cost of goods sold was more than decrease in Inventory, on the other hand, implies the cost of goods sold was more than the cash used for purchases. Accordingly, an increase in inventory should be deducted the cash used for purchases. Accordingly, an increase in inventory should be deducted from and a decrease should be added to net income.
from and a decrease should be added to net income.
Prepaid expensesPrepaid expenses: - an increase in prepaid expenses as prepaid rent implies that more: - an increase in prepaid expenses as prepaid rent implies that more cash was paid than is reflected in the operating expenses on the income statements. A cash was paid than is reflected in the operating expenses on the income statements. A decrease, on the contrary, implies more operating expenses were reported than was paid decrease, on the contrary, implies more operating expenses were reported than was paid in cash. Therefore, an increase in prepaid asset should be deducted from and a decrease in cash. Therefore, an increase in prepaid asset should be deducted from and a decrease should be added to net income.
should be added to net income.
ii) Adjustments for Changes in Current Operating Liability Accounts ii) Adjustments for Changes in Current Operating Liability Accounts Changes in current operating liability accounts are generally adjusted by: Changes in current operating liability accounts are generally adjusted by:
Adding increases in current operating liability accounts andAdding increases in current operating liability accounts and
Deducting decreases in current operating liability accounts to net income.Deducting decreases in current operating liability accounts to net income.
Some examples of current operating liability accounts include: Some examples of current operating liability accounts include:
Accounts payableAccounts payable: - an increase reflects less cash used than the amount of purchases or: - an increase reflects less cash used than the amount of purchases or cost of goods sold recorded on an accrual basis.
cost of goods sold recorded on an accrual basis.
Salaries and wages payableSalaries and wages payable: - an increase means less cash was paid than the amount of: - an increase means less cash was paid than the amount of salaries and wages expenses reported on the income statement.
salaries and wages expenses reported on the income statement.
Interest PayableInterest Payable: - an increase reflects less cash was used than interest expenses: - an increase reflects less cash was used than interest expenses reported on the income statement.
reported on the income statement.
Taxes payableTaxes payable: - an increase mean the amount of cash paid for taxes is less than the: - an increase mean the amount of cash paid for taxes is less than the amount of taxes reported on the accrual basis.
amount of taxes reported on the accrual basis.
Unearned RevenuesUnearned Revenues: - increases indicate more cash was received than was reported as: - increases indicate more cash was received than was reported as revenue on the income statement.
revenue on the income statement.
However, changes in some current operating liability accounts may not be adjusted to net However, changes in some current operating liability accounts may not be adjusted to net income. A very good example of such current operating liability account is Dividends Payable. income. A very good example of such current operating liability account is Dividends Payable. The increase or decrease in this account should be adjusted in the financing activities section of The increase or decrease in this account should be adjusted in the financing activities section of the statement of cash flows.
the statement of cash flows.
Steps in Preparing the Statement of Cash Flows Using the Indirect Method Steps in Preparing the Statement of Cash Flows Using the Indirect Method
Four steps are generally required in preparing the statement of cash flows using the indirect Four steps are generally required in preparing the statement of cash flows using the indirect method.
method.
1.
1. Determine the change in cash and cash equivalents. This is simply the difference betweenDetermine the change in cash and cash equivalents. This is simply the difference between the beginning and ending balances of cash and cash equivalents for the period under the beginning and ending balances of cash and cash equivalents for the period under questions. The net cash flows from operating, investing, and financing activities must be questions. The net cash flows from operating, investing, and financing activities must be exactly equal to the change in cash and cash equivalents during the period. The statement of exactly equal to the change in cash and cash equivalents during the period. The statement of cash flows explains the amount of the change in the cash flow.
cash flows explains the amount of the change in the cash flow. 2.
transactions relating to the firm’s operations. The procedures for determining net cash flow transactions relating to the firm’s operations. The procedures for determining net cash flow from operating activities using the indirect method may be summarized as follows:
from operating activities using the indirect method may be summarized as follows:
Cash
Cash flows from operating activitiesflows from operating activities::
Net income --- xx
Net income --- xx
Adjustments for non-cash items Adjustments for non-cash items:: + Depreciation --- xx
+ Depreciation --- xx
+ Amortization of intangible assets --- xx
+ Amortization of intangible assets --- xx
+/- Other non cash items included in net income --- +/- Other non cash items included in net income --- xx xx xx xx
Adjustments for gains and losses Adjustments for gains and losses:: - Gains on sales of assets --- xx
- Gains on sales of assets --- xx
+ Losses on sales of assets --- + Losses on sales of assets --- xxxx xx xx Adjustments for changes in current operating accounts: Adjustments for changes in current operating accounts: - Increases in current operating asset accounts - Increases in current operating asset accounts (Except cash and cash equivalent) ---xx
(Except cash and cash equivalent) ---xx
+ Decrease in current operating assets accounts + Decrease in current operating assets accounts (Except cash and cash equivalents) ---xx
(Except cash and cash equivalents) ---xx
+ Increases in current operating liability accounts--- xx
+ Increases in current operating liability accounts--- xx
- Decreases in current operating liability accounts --- - Decreases in current operating liability accounts --- xxxx xxxx Net cash provided by (used in) operating activities ---Net cash provided by (used in) operating activities --- xx xx
3.
3. Determine the net cash provided by (used in) investing and financing activities. This stepDetermine the net cash provided by (used in) investing and financing activities. This step requires analysis of the case flow impact of all accounts and transactions relating to investing requires analysis of the case flow impact of all accounts and transactions relating to investing and financing activities.
and financing activities. 4.
4. Prepare a formal statement of cash flows, classified according to operating, investing, andPrepare a formal statement of cash flows, classified according to operating, investing, and financing activities. The total net increase (decrease) in cash reported on the statement of financing activities. The total net increase (decrease) in cash reported on the statement of cash flows should equal the amount determined in step 1 above. Therefore, the preparation cash flows should equal the amount determined in step 1 above. Therefore, the preparation of the statement of cash flows reconciles the beginning and ending cash balance for the of the statement of cash flows reconciles the beginning and ending cash balance for the period. Any significant non cash investing or financing transactions should be reported period. Any significant non cash investing or financing transactions should be reported separately not on the statement of cash flows.
separately not on the statement of cash flows.
Illustration on the Indirect Method Illustration on the Indirect Method
Assume the following are financial statements for Berta Company. Assume the following are financial statements for Berta Company.
BERTA COMPANY BERTA COMPANY Comparative Balance Sheet Comparative Balance Sheet December 31, 2001 and 2000 December 31, 2001 and 2000 Assets
Assets 20012001 20002000
Cash
Cash BirrBirr 22,00022,000 BirrBirr 16,00016,000 Account receivable
Account receivable 200,000200,000 200,000200,000 Inventory
Inventory 125,000125,000 95,00095,000
Prepaid general expenses
Prepaid general expenses 18,00018,000 10,00010,000 Plant assets
Plant assets 1,019.0001,019.000 1,000,001,000,00 Accumulated depreciation – plant assets
Accumulated depreciation – plant assets (527,000)(527,000) 597,000597,000 Total assets
