Chapter 6Financial 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

aa Sales - Sales returns - Sales Discounts Sales - Sales returns - Sales Discounts

bb Net sales - Cost of goods sold Net sales - Cost of goods sold

cc Gross profit - Operating expenses Gross profit - Operating expenses

dd Income from operations + Other revenue/gains - other expenses/losses 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 activitiesOperating activities Cash inflows:Cash inflows: From sale of goods or services.From sale of goods or services. From returns on loans (interest) and on equity securities (dividends).From returns on loans (interest) and on equity securities (dividends). Cash outflows:Cash outflows: To suppliers for inventory.To suppliers for inventory. To employees for services.To employees for services. To government for taxes.To government for taxes. To lenders for interest.To lenders for interest. To others for expenses.To others for expenses.

Investing activitiesInvesting activities Cash inflows:Cash inflows: From sale of property, plant, and equipment.From sale of property, plant, and equipment. From sale of debt or equity securities of other entities.From sale of debt or equity securities of other entities. From collection of principal on loans to other entities.From collection of principal on loans to other entities. Cash outflows:Cash outflows: To purchase property, plant, and equipment.To purchase property, plant, and equipment. To purchase debt or equity securities of other entities.To purchase debt or equity securities of other entities. To make loans to other entities.To make loans to other entities.

Financing activitiesFinancing activities Cash inflows:Cash inflows: From sale of equity securities (company’s own stock).From sale of equity securities (company’s own stock). From issuance of debt (bonds and notes).From issuance of debt (bonds and notes). Cash outflows:Cash outflows: To stockholders as dividends.To stockholders as dividends. To redeem long-term debt or reacquire capital stock.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

FINANCING ACTIVITIES

Analyze increases and decreases in long-term

liability and stockholders’ equity items

INVESTING ACTIVITIES

Analyze increases and decreases in investments

and long-term asset items

6-4 Format of the Statement of Cash Flows

COMPANY NAMEStatement of Cash Flows

Period Covered

Cash flows from operating activities (List of individual items) Net cash provided (used) by operating activities

XXXXX

Cash flows from investing activities (List of individual inflows and outflows) Net cash provided (used) by investing activities

XXXXX

Cash flows from financing activities (List of individual inflows and outflows) (Net cash provided (used) by financing activities

XXXXX

Net increase (decrease) in cash XXX

Cash at beginning of period XXX

Cash at end of period XXX

Noncash investing and financing activities (List of individual noncash transactions)

XXX

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

ActivitiesIncurred Expenses Adjust Expenses to Cash Disbursements

INDIRECT METHOD

1. Begin with net income and adjust for income statement items that did not effect cash.

2. Reconcile net income to net cash provided (used) by operating activities.

DIRECT METHOD

1. Adjust each item on the income statement from the accrual basis to the cash basis.

2. Major classes of operating cash receipts and cash payments are reported.

OROR

6-6 Operating Activities – Indirect Method Adjustments for Noncash Items

Adjustments for noncash charges and credits

Noncash charges and creditsAdd to (Deduct from)

Net Income

Depreciation Expense Add

Patent amortization expense Add

Depletion expense Add

Loss on sale of equipment Add

Gain on sales of equipment Deduct

Adjustments to convert net Adjustments to convert net income to net cash income to net cash provided by operating provided by operating activities.activities.

All noncash expenses are added to net income, and all noncash All noncash expenses are added to net income, and all noncash revenues are subtracted from net income.revenues are subtracted from net income.

6-7 Operating Activities – Indirect Method Adjustments For Current Assets and Liabilities

Adjustments for Current Items

For Changes In:Add to Net Income

Deduct from Net Income

Current assets Decreases Increases

Current liabilities Increases Decreases

For Changes in Individual Accounts:

Add to Net Income

Deduct from Net Income

Accounts receivable Decrease Increase

Inventory Decrease Increase

Prepaid expenses Decrease Increase

Accounts payable Increase Decrease

Accrued expenses payable Increase Decrease

Adjustments to convert net income Adjustments to convert net income to net cash provided by operating to net cash provided by operating

activities.activities.

All changes in current assets are handled in a similar manner All changes in current assets are handled in a similar manner and all changes in current liabilities are handled in a similar and all changes in current liabilities are handled in a similar manner, but the adjustments are exactly the opposite.manner, but the adjustments are exactly the opposite.

6-8 Cash Flows from Operating Activities – Indirect Method

Problem Problem DataData

DEMONSTRATION COMPANYComparative Balance Sheet Accounts

December 31

Current Assets 2003 2002 Change

Accounts receivable $30,000 $39,000 $9,000 Decrease

Prepaid rent 15,000 10,000 5,000 Increase

Inventory 20,000 18,000 2,000 Increase

Current Liabilities

Accounts payable 18,000 12,000 6,000 Increase

Interest payable 6,000 2,000 4,000 Increase

Taxes payable 3,000 5,000 2,000 Decrease

DEMONSTRATION COMPANYIncome Statement

For the Year Ended December 31, 2008

Revenues Sales revenue Gain on sale of land Total revenues

$400,00020,000

$420,000

Expenses Cost of goods sold Operating expenses Depreciation expense Interest expense Income tax expense Total expenses

280,00075,00015,000

8,0007,000

385,000

Net Income $35,000

Using the data Using the data provided, provided, prepare the prepare the cash flows from cash flows from operating operating activities section activities section of the statement of the statement of cash flows of cash flows using the using the indirect method.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

(2,000)

$35,000

5,000

$40,000