Financial Accounting - Module 14: Introduction to the Statement of Cash Flows

Cash flows related to Stockholders' Equity accounts:

1) Cash flows related to equity accounts are generally either an operating or financing activity for an manufacturer or merchandising company: a) Contributed capital - all stock-related accounts are financing activity accounts e.g common stock, preferred stock, additional paid-in capital and treasury stock b) Retained earnings: - the change in the retained earnings account due to dividends paid is a financing activity. The change due to cash flows related to net income is most likely an operating activity

What is a Summary Entry?

1) a journal entry that sums up many entries. * shows the overall account balance changes for a period of time

What is Reconciliation in the indirect method?

1) explains how we got from point A to point B: a) where point A is the accrual-based net income amount from the income statement, b) and point b is net cash flows from operating activities * reconciliation converts or reconciles the accrual-basis net income to cash-basis income from operating activities using a series of steps

Cash flows related to Liability accounts:

1) generally either an operating or financing activity for a manufacturer or merchandising company a) Notes payable and bonds payable are usually financing activity accounts b) Dividends payable is a financing activity account c) All other liabilities are usually operating activity accounts e.g accounts payable, salaries payable, interest payable, deferred revenue and taxes payable

Cash flows related to Asset accounts:

1) generally either an operating or investing activity for a manufacturer or merchandising company a) Notes receivable (related to cash loans) and most investment accounts are INVESTING activity accounts b) PP&E and intangible asset accounts are INVESTING activity accounts c) All other assets are usually OPERATING activity accounts e.g accounts receivable, interest receivable, inventory, supplies, and prepaid expenses

What are the 2 steps in creating a summary entry?

1) using relevant accounts for the question at hand, determine how each account balance changed from the beginning to the end of the year. * Special note: always measure from the beginning of the year to the end of the year and not vice versa 2) prepare a summary entry explaining the change. Solve for "Cash" in this entry

Glenwood Corp. reported net sales of $400,000 on its income statement for 20X6. Question: If its accounts receivable balance increased by $25,000 from the beginning to the end of 20X6, how much cash did Glenwood collect from customers in 20X6?

375,000 * cash 375,000 dr A/R 25,000 dr Sales revenue 400,000 cr When accounts receivable is increasing from the beginning to the end of the year, more sales than cash collections occurred during the year. To solve for the cash received in this circumstance, subtract the increase in receivables from sales revenue. Alternatively, set up a summary journal that has the effects mentioned above and solve for cash

Glenwood Corp. reported insurance expense of $40,000 on its income statement for 20X6. The following balance sheet information is available for 12/31/X6 and 12/31/X5, respectively: Prepaid insurance 12/31/X6 = 8,000 12/31/X5 = 5,000 How much cash did Glenwood pay for insurance in 20X6?

43,000 * Prepaid insurance 3,000 dr Insurance expense 40,000 dr cash 43,000 cr * The "Prepaid Insurance" account balance increased by $3,000 from the beginning to the end of the year. Therefore, debit this account in the summary entry. ** The "Insurance Expense" account balance increased by $40,000 from the beginning to the end of the year. Therefore, debit this account in the summary entry.

On the indirect method reconciliation, how should a company present an increase in an liability account related to operating activities?

An increase in a liability should be added on the reconciliation.

On the indirect method reconciliation, how should a company present an increase in an asset account related to operating activities?

An increase in an asset should be subtracted on the reconciliation.

When preparing the indirect reconciliation, which of the following account balances changes should NOT be included? a. An increase or decrease in the salaries payable balance b. An increase or decrease in the deferred revenue balance c. An increase or decrease in the machinery balance d. An increase or decrease in the prepaid insurance balance e. An increase or decrease in the supplies balance

An increase or decrease in the machinery balance

What is the effect on cash when a company records depreciation expense for the year? a. Cash increases b. Cash decreases c. Cash does not change

Cash does NOT change * Depreciation is a noncash activity. The journal entry to record depreciation involves a debit to "Depreciation Expense" and a credit to "Accumulated Depreciation". Cash is not affected.

True or False: If a company reports net income on its income statement, it should always report net cash inflows instead of net cash outflows from operating activities on its statement of cash flows.

False * It is possible that a company has net income but net outflows from operating activities. For example, if a majority of a company's sales were on account and those sales remain uncollected at year-end, the company may experience this pattern.

Paying for a dividend falls into what cash flow activity?

Financing activities

issuance of stock falls into what cash flow activity?

Financing activities

Payment of a building falls into what cash flow activity?

Investing activity

Hillsborough Enterprises Inc.'s cash account balance went from $20,000 to $30,000 from the beginning to the end of its calendar year, respectively. Question: If it had net cash inflows from operating activities of $200,000 and net cash outflows from investing activities of $260,000, what were its net cash flows from financing activities?

It had net cash INFLOWS from Financing activities of $70,000 Beginning cash=($30,000) Ending cash=$20,000 net cash inflows from operating activities = $200,000 net cash outflows from investing activities = ($260,000) net cash inflows from financing activities=$70,000.

FASB states that interest expense and interest revenue fall into what category of the cash flow activities?

Operating activities

Question: If Durham's "Accounts Receivable" balances on 1/1/X6 and 12/31/X6 were $40,000 and $48,000, respectively, what can we determine about the dollar amount of sales on account relative to the dollar amount of cash collections on account for the year?

Sales on account were higher than cash collections on account. * When the Accounts Receivable (AR) balance increases from the beginning to the end of the year, there were more sales on account than cash collections on account for the year. Example: We were told the beginning and ending AR balance was $40,000 and $48,000, respectively. If we assume sales on account were $500,000 for the year, then cash collections must have been $492,000 in order to reconcile the AR general ledger account balance. The difference in the AR beginning and ending balance is the difference between the cash collection and sales on account. $40,000 + $500,000 - ? = $48,000. ? = $492,000 in cash collections

During 20X1, a company recorded a gain on the sale of land for $50,000. Question: How should this gain be treated on the indirect reconciliation?

The amount of the gain should be subtracted from net income. * The amount of the gain should be subtracted from net income.

On the indirect method reconciliation, how should a company present a loss?

The loss amount should be added back to net income.

From the beginning to the end of the current year, a company's "Insurance Expense" account increased by $20,000, and its "Prepaid Insurance" account decreased by $4,000. How much cash was paid for insurance during the year?

The summary entry would show a debit to "Insurance Expense" for $20,000, a credit to "Prepaid Insurance" for $4,000, and a credit to "Cash" for $16,000.

The direct and indirect methods are two acceptable methods a company can choose from when presenting the operating activity section of its statement of cash flows. Which of the following statements is correct for the net cash flows from operating activities amount computed using these methods?

The two methods should produce the same amount for net cash flows from operating activities.

Which of the following statements best describes the purpose of the statement of cash flows? a. To summarize the changes in the company's stockholders' equity account balances for the year. b. To summarize the company's cash inflows and cash outflows for the year. c. To summarize the company's revenues and expenses for the year. d. To report the company's total assets, total liabilities, and total stockholders' equity at the end of the year.

To summarize the company's cash inflows and cash outflows for the year.

True or False: Significant noncash activities should be disclosed at either the bottom of the statement of cash flows or in a note to the financial statements.

True

True or False: The statement of cash flows is generally prepared after the income statement, statement of stockholders' equity, and balance sheet have been prepared.

True

True or False: When the cash account is paired with an income statement account, the cash activity is most likely to be an operating activity.

True

True or False: The indirect method reconciliation must ALWAYS be prepared when a company presents a statement of cash flows.

True *If the company uses the direct method for the operating activity section, they must still disclose the indirect reconciliation in the supporting notes to the financial statements.

What is the Statement of Cash Flows (SOCF)?

a) Fourth required financial statement a company should prepare as part of its annual report b) summarizes the company's sources (inflows) and uses (outflows) of cash during the year

What are Investing Activities?

a) Generally deal with activities that relate to investigating-related assets on the balance sheet b) investing activities can also relate to investments the company makes with excess cash or loans it gives to others (e.g notes receivables)

What are Operating Activities?

a) Generally deal with cash inflows and outflows directly related to the day to day business operations of the business. b) e.g cash flows related to most revenues and expenses are classified as operating activities

What are Financing Activities?

a) Generally deal with how a company finances or pays to support its operating and investing activities b) Financing is most often obtained through either stock issuance or various types of loans c) Financing activities are more INCIDENTAL to operations rather than part of the day to day operations. d) e.g a company taking out a loan from a bank would be a financing activity

For each of the following transactions, indicate whether the transaction (1) generates a cash inflow or outflow, and (2) is an operating, investing, or financing activity for purposes of the statement of cash flows. a) Sells inventory for cash b) Makes a cash purchase of a building c) Sells land for cash d) Borrows cash by issuing a note e) Pays a cash dividend f) Pays for inventory previously g) Receives cash from a customer h) Receives cash from the issuance of its common stock i) Pays interest on a note payable j) Receives interest on a note receivable

a) OA, inflow b) IA, outflow c) IA, inflow d) FA, inflow e) FA, outflow f) OA, outflow g) OA, inflow h) FA, inflow i) OA, outflow j) OA, inflow

Which of the following is an example of a cash flow described as an OPERATING ACTIVITY? (check all that apply) The payment of a dividend The cash purchase of supplies The receipt of cash before it is earned The cash purchase of treasury stock.

a) cash purchase of supplies b) receipt of cash before it is earned

Which of the following is an example of a cash flow described as an INVESTING ACTIVITY? (check all that apply) a) cash received from selling equipment b) cash paid to purchase equipment c) cash paid to purchase inventory

a) cash received from selling equipment b) cash paid to purchase equipment

Which of the following is an example of a cash flow described as a FINANCING ACTIVITY? (check all that apply) Cash received from the issuance of a note payable Cash paid for interest Cash received from the issuance of common stock Cash paid towards the principle on a note payable

a) cash received from the issuance of a note payable b) cash received from the issuance of common stock c) cash paid towards the principle on a note payable

What is the main goal of the direct method?

a) to present in a straightforward manner the cash inflows and outflows for the year from operating, investing, and financing activities

Losses ________ net income, it should be added to remove its effect from net income

decreases

On the indirect method reconciliation, how should a company present depreciation expense?

depreciation expense should be added back to net income

Gains __________ accrual basis net income, it must be subtracted in the reconciliation area

increases

Equipment falls into what cash flow activity?

investing activities

When measuring the account balance change for a balance sheet account that is related to operating activities, the measurement should:

measure the change from the beginning of the year to the end of the year.

When cash is a part of an entry along with an income statement account, the cash activity is _______ ____ an operating activity

most likely

income tax expense falls into what cash flow activity?

operating activities

The indirect method is used for which types of activities on the statement of cash flows? Select all that apply: a) operating activities b) investing activities c) financing activities

operating activities The indirect method is used ONLY for operating activities. The investing and financing sections of the statement of cash flows are presented using the direct method.

On the statement of cash flows, cash flows are classified into the following activities: (check all that apply)

operating activities, financing activities, and investing activities

When the cash account is paired with stockholders' equity account, the cash activity is most likely to be either an:

operating activity or financing activity

When the cash account is paired with a liability account, the cash activity is most likely to be either an:

operating activity or financing activity.

When the cash account is paired with an asset account, the cash activity is most likely to be either an:

operating activity or investing activity

If an Asset account is increased $2,000 from the beginning to the end of the year, this change would be ________ on the indirect method reconciliation.

subtracted

If the salaries payable account, decreased $6,000 from the beginning to the end of the year, this change would be __________ on the indirect method reconciliation

subtracted

When preparing a summary entry for purposes of using the direct method on the statement of cash flows, an account balance change should be measured from:

the beginning of the year to the end of the year

For the operating activity section, which presentation method is more "user-friendly"?

the direct method