Chapter 6 Financial Statements

6-1 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

6-2 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 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. To purchase property, plant, and equipment. To purchase debt or equity securities of other entities. To make loans to other entities. Financing activities From sale of equity securities (company’s own stock). From issuance of debt (bonds and notes). To stockholders as dividends. To redeem long-term debt or reacquire capital stock.

6-3 Information Sources for Activities OPERATING ACTIVITIES Analyze Income statement items Changes in noncash current asset and current liability items INVESTING ACTIVITIES Analyze increases and decreases in investments and long-term asset items FINANCING ACTIVITIES Analyze increases and decreases in long-term liability and stockholders’ equity items

6-4 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 Cash flows from financing activities (Net cash provided (used) by financing activities Net increase (decrease) in cash Cash at beginning of period Cash at end of period Noncash investing and financing activities (List of individual noncash transactions)

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 Begin with net income and adjust for income statement items that did not effect cash. Reconcile net income to net cash provided (used) by operating activities. DIRECT METHOD Adjust each item on the income statement from the accrual basis to the cash basis. Major classes of operating cash receipts and cash payments are reported. OR

Noncash charges and credits Add to (Deduct from) Net Income 6-6 Operating Activities – Indirect Method Adjustments for Noncash Items Adjustments to convert net income to net cash provided by operating activities. Adjustments for noncash charges and credits Noncash charges and credits Add to (Deduct from) Net Income Depreciation Expense Add Patent amortization expense Depletion expense Loss on sale of equipment Gain on sales of equipment Deduct All noncash expenses are added to net income, and all noncash revenues are subtracted from net income.

6-7 Operating Activities – Indirect Method Adjustments For Current Assets and Liabilities Adjustments to convert net income to net cash provided by operating activities. Adjustments for Current Items For Changes In: Add to Net Income Deduct from Net Income Current assets Decreases Increases Current liabilities For Changes in Individual Accounts: Accounts receivable Decrease Increase Inventory Prepaid expenses Accounts payable Accrued expenses payable 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.

6-8 Cash Flows from Operating Activities – Indirect Method 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 12,000 6,000 Increase Interest payable 6,000 2,000 4,000 Increase Taxes payable 3,000 5,000 2,000 Decrease Problem Data DEMONSTRATION COMPANY Income Statement For the Year Ended December 31, 2008 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.

6-8 Cash Flows from Operating Activities – Indirect Method (continued) DEMONSTRATION COMPANY Statement of Cash Flows (Indirect Method) For the Year Ended December 31, 2008 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 $35,000 5,000 $40,000