Accounting Chapter 16 Notes
Reconciliation of net income
Adjust net income of $320,000 for changes in operating assets and liabilities to arrive at net cash flow from operating activities.
16-2c Dividends and Dividends Payable
Cash dividends paid during the year can also be computed by adjusting the dividends declared during the year for the change in the dividends payable account as follows:
16-1a Cash Flows from Operating Activities
Cash flows from operating activities reports the cash inflows and outflows from a company's day-to-day operations. Companies may select one of two alternative methods for reporting cash flows from operating activities in the statement of cash flows: The direct method The indirect method
Classifying Cash Flows
Identify the type of cash flow activity for each of the following events (operating, investing, or financing):
16-2b Adjustments to Net Income—Indirect Method
Omni Corporation's accumulated depreciation increased by $12,000, while $3,400 of patent amortization was recognized between balance sheet dates. There were no purchases or sales of depreciable or intangible assets during the year. In addition, the income statement showed a gain of $4,100 from the sale of land. Reconcile Omni's net income of $50,000 to net cash flow from operating activities.
Free cash flow
The amount of operating cash flow remaining after replacing current productive capacity
16-2 Preparing the Statement of Cash Flows—The Indirect Method
To illustrate, the accounting equation can be solved for cash as follows: Assests (A ), Liabilities (L), Stockholders' Equity (SE), Cash (C), Cash Asset (CA), Noncash Assets (NA) A = L + SE C + NA = L + SE C = L + SE - NA Therefore, any change in the cash account can be determined by analyzing changes in the liability, stockholders' equity, and noncash asset accounts as follows: Change in cash = Change in Liabilities + Change in SE - Change in NA Under the indirect method, there is no order in which the balance sheet accounts must be analyzed. However, net income (or net loss) is the first amount reported on the statement of cash flows. Because net income (or net loss) is a component of any change in Retained Earnings, the first account normally analyzed is Retained Earnings.
16-2b Net Cash Flow from Operating Activities—Indirect Method example 16-3
Victor Corporation's current operating assets and liabilities from the company's comparative balance sheet were as follows: Adjust Victor's net income of $70,000 for changes in current operating assets and liabilities to arrive at net cash flow from operating activities.
Cash Flows
for example h subtract treasury stock from shares
Cash outflows (payments) from operating activities include:
- Cash payments to suppliers of goods and services - Cash payments to employees for services including benefits - Cash payments for grants considered to be operating activities of the grantor - Cash payments for quasi-external operating transactions (including payments in lieu of taxes) - Cash payments for program loans - Cash payments for pensions or OPEB regardless of whether the defined benefit pension plan or defined benefit OPEB plan is administered through a trust that meets the specified criteria of either GASB 68, paragraph 4, or GASB 75, paragraph 4, respectively. - Other cash payments not classified in the other categories
16-1b Cash Flows from (Used for) Investing Activities
Cash flows from (used for) investing activities show the cash inflows and outflows related to changes in a company's long-term assets. Cash inflows from investing activities normally arise when cash is received from selling fixed assets, investments, and intangible assets. Cash outflows normally include payments to purchase fixed assets, investments, and intangible assets.
Cash Flows from Operating Activities—Indirect Method
Indicate whether each of the following would be added to or deducted from net income in determining net cash flow from operating activities by the indirect method:
Statement of Cash Flows from Operating Activities
Prepare the Cash Flows from Operating Activities section of the statement of cash flows, using the indirect method.
16-2b Cash Flow from Operating Activities—Indirect Method example 16-4
Prepare the Cash flows from operating activities section of the statement of cash flows, using the indirect method. Net income: 120,000 Depreciation Expense: 12,000 Loss on disposal of equipment: 15,000 Increase in accounts receivable 5,000 Decrease in accounts payable: 2,000
16-1e Format of the Statement of Cash Flows
The statement of cash flows presents the cash flows generated by, or used for, the three activities previously discussed: operating, investing, and financing. These three activities are always reported in the same order, following the format illustrated in Exhibit 3.
Statement of cashflow
operating , investing , financial activities https://www.alamo.edu/contentassets/9106779f02f84dc9afdebd1faf464d98/accounting/cash-flows.pdf
The Indirect Method
reports cash flows from operating activities by beginning with net income and adjusting it for revenues and expenses that do not involve the receipt or payment of cash The adjustments to reconcile net income to net cash flow from operating activities include such items as depreciation and gains or losses on fixed assets. Changes in current operating assets and liabilities such as accounts receivable or accounts payable are also added or deducted, depending on their effect on cash flows. In effect, these additions and deductions adjust net income, which is reported on an accrual accounting basis, to cash flows from operating activities, which is a cash basis. A primary advantage of the indirect method is that it reconciles the differences between net income and net cash flows from operations. In doing so, it shows how net income is related to the ending cash balance that is reported on the balance sheet.
16-1d Noncash Investing and Financing Activities
A company may enter into transactions involving investing and financing activities that do not directly affect cash. For example, a company may issue common stock to retire long-term debt. Although this transaction does not directly affect cash, it does eliminate future cash payments for interest and for paying the bonds when they mature. Because such transactions indirectly affect cash flows, they are reported in a separate section of the statement of cash flows. This section usually appears at the bottom of the statement of cash flows.
The Direct Method
reports operating cash inflows (receipts) and cash outflows (payments) The primary operating cash inflow is cash received from customers. The primary operating cash outflows are cash payments for merchandise, operating expenses, interest, and income tax payments. The cash received from operating activities less the cash payments for operating activities is the net cash flow from operating activities. The primary advantage of the direct method is that it directly reports cash receipts and cash payments in the statement of cash flows. Its primary disadvantage is that these data may not be readily available in the accounting records. Thus, the direct method is normally more costly to prepare and, as a result, is used infrequently in practice.
Cash inflows (proceeds) from operating activities include:
- Cash receipts from sales of goods and services including receipts from collection of accounts receivable and both short/long-term notes receivable from customers and students arising from those sales - Cash receipts from quasi-external operating transactions with other funds - Grant receipts for activities considered as operating activities of the grantor government - Cash receipts for reimbursement of operating transactions - Cash receipts from collection of program loans - Cash contributions to a defined benefit pension plan administered through a trust that meets the criteria in GASB 68, paragraph 4, or to a defined benefit OPEB plan administered through a trust that meets the criteria in GASB 75, paragraph 4. - Other cash receipts not classified in the other categories.
16-1f No Cash Flow per Share
Cash flow per share is sometimes reported in the financial press. As reported, cash flow per share is normally computed as cash flow from operations divided by the number of common shares outstanding. However, such reporting may be misleading because of the following: Users may misinterpret cash flow per share as the per-share amount available for dividends. This would not be the case if the cash generated by operations is required for repaying loans or for reinvesting in the business. Users may misinterpret cash flow per share as equivalent to (or better than) earnings per share. For these reasons, the financial statements, including the statement of cash flows, should not report cash flow per share.
16-1c Cash Flows from (Used for) Financing Activities
Cash flows from (Used for) financing activities show the cash inflows and outflows related to changes in a company's long-term liabilities and stockholders' equity. Cash flows from (used for) financing activities are reported on the statement of cash flows as follows: Cash inflows from financing activities normally arise when cash is received from issuing long-term debt or equity securities. For example, issuing bonds, notes payable, preferred stock, and common stock creates cash inflows from financing activities. Cash outflows from financing activities include paying cash dividends, repaying long-term debt, and acquiring treasury stock.
16-1 Reporting Cash Flows
The statement of cash flows reports a company's cash inflows and outflows for a period. The statement of cash flows provides useful information about a company's ability to do the following: - Generate cash from operations - Maintain and expand its operating capacity - Meet its financial obligations - Pay dividends The statement of cash flows reports three types of cash flow activities, as follows: Cash flows from operating activities are the cash flows from transactions that affect the net income of the company. Example: Purchase and sale of merchandise by a retailer. Cash flows from (used for) investing activities are the cash flows received from or used for transactions that affect investments in the noncurrent assets of the company. Example: Purchase and sale of fixed assets, such as equipment and buildings. Cash flows from (used for) financing activities are the cash flows received from or used for transactions that affect the debt and equity of the company. Example: Issuing or retiring equity and debt securities.
16-2b Adjustments to Net Income
Under the accrual method of accounting, revenues and expenses are recorded at different times from when cash is received or paid. For example, merchandise may be sold on account and the cash received at a later date. Likewise, insurance premiums may be paid in the current period but expensed in a following period. Thus, under the indirect method, adjustments to net income must be made to determine cash flows from operating activities. Step 1. Expenses that do not affect cash are added. Such expenses decrease net income but do not involve cash payments and, thus, are added to net income. Example: Depreciation of fixed assets and amortization of intangible assets are non-cash expenses that are added to net income. Step 2. Losses on the disposal of assets are added and gains on the disposal of assets are deducted. The disposal (sale) of assets is an investing activity rather than an operating activity. However, the losses and gains are reported as part of net income. As a result, any losses on disposal of assets are added back to net income. Likewise, any gains on disposal of assets are deducted from net income. Example: Land costing $100,000 is sold for $90,000. The loss of $10,000 is added back to net income. Step 3. Changes in current operating assets and liabilities are added or deducted as follows: Increases in noncash current operating assets are deducted. Decreases in noncash current operating assets are added. Increases in current operating liabilities are added. Decreases in current operating liabilities are deducted. Example: A sale of $10,000 on account increases sales, accounts receivable, and net income by $10,000. However, no cash is received or paid. Thus, the $10,000 increase in accounts receivable is deducted from net income. Similar adjustments are required for the changes in the other current asset and liability accounts, such as inventory, prepaid expenses, accounts payable, accrued expenses payable, and income taxes payable, as shown in Exhibit 5.
16-2b Net Cash Flow from Operating Activities—Indirect Method
Step 1. Add depreciation of $7,000. Analysis: The comparative balance sheet in Exhibit 4 indicates that Accumulated Depreciation—Building increased by $7,000. Given that there was no other activity in this account, as shown on the following page, depreciation expense for the year was $7,000 on the building: Step 2. Deduct the gain on the sale of land of $12,000. Analysis: The income statement in Exhibit 4 reports a gain of $12,000 from the sale of land. The proceeds, which include the gain, are reported in the Investing section of the statement of cash flows. Thus, the gain of $12,000 is deducted from net income in determining cash flows from operating activities. Step 3. Add and deduct changes in current operating assets and liabilities excluding cash. Analysis: The increases and decreases in the current operating asset and current liability accounts excluding cash are as follows: