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Principles of Accounting- Preparing the Statement of Cash Flows

Nguyen Tan Binh
1
Fulbright Economics Teaching Program
2005-2006
Principles of accounting Lecture 4a
7/17/2006
Nguyễn Tấn Bình
1
Principles of Accounting
Fulbright Economics Teaching Program
Ho Chi Minh City, Vietnam
Academic Year: 2005-2006
7/17/2006
Nguyễn Tấn Bình
2
Lecture Notes 4a
Preparing the Statement
of Cash Flows
Nguyen Tan Binh
2
Fulbright Economics Teaching Program

2005-2006
Principles of accounting Lecture 4a
7/17/2006
Nguyễn Tấn Bình
3
Cash Flows and Income

The income statement and the statement of
cash flows meet the different demands for
information

The income statement tells us how the firm has
been operating to enrich the owners’ equity
(looking at the results)

The matching rule is applied for revenues and expenses; the
accrual basis of accounting is used to measure the results of
business activities

The statement of cash flows concerns with the net
cash flow generated from business activities
7/17/2006
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4
Preparing the Statement of Cash Flows
Direct Method
Bo Ho Company
Balance Sheet, December 31 (amounts in thousands)
Current Assets 2004 2003 Current Debt 2004 2003
Cash 16 25 Payables 74 6
Receivables 45 25 Salaries Payable 25
4
Inventory 100 60
Total Current Assets 161 $110 Total Current Debt 99 10
Fixed Assets, Acc. Cost 581 330 Long-term Debt 125 5
Accumulated Depreciation(101
) (110) Owners’ Equity 417 315
Fixed Assets, net 480 220
Total Assets 641 330 Total Debt & OE 641 330
Notes: During 2004, the firm liquidated some fixed assets for book values and received 10
in cash; it also paid dividends of 19
Nguyen Tan Binh
3
Fulbright Economics Teaching Program
2005-2006
Principles of accounting Lecture 4a
7/17/2006
Nguyễn Tấn Bình
5
Direct Method
Bo Ho Company
Income Statement ($1000)
December 31, 2004
Revenue $200
Expenses:
Cost of Goods Sold 100
Salaries Expense 36
Depreciation Expense 17
Interest Expense 4
Total Expenses 157
Earnings Before Tax 43
Corporate Income Tax 20
Net Income $ 23
7/17/2006
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6
Direct Method
Bo Ho Company
Statement of Cash Flows ($1000)
December 31, 2004
CASH FLOW FROM OPERATING:
Receipts from Customers $ 180
Payments
Suppliers $ 72
Salaries 15
Interest 4
Taxes 20
Total Payments (111)
Net Cash Flow from Operating (I) $ 69
Nguyen Tan Binh
4
Fulbright Economics Teaching Program
2005-2006
Principles of accounting Lecture 4a
7/17/2006
Nguyễn Tấn Bình
7
Direct Method
Bo Ho Company
Statement of Cash Flows ($1000)
December 31, 2004 (cont.)
CASH FLOW FROM INVESTING:
Payments for Purchases of Fixed Assets $(287)
Collections from Liquidation of Fixed Assets 10
Net Cash Flow from Investing (II) (277)
7/17/2006
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8
Direct Method
Bo Ho Company
Statement of Cash Flows ($1000)
December 31, 2004 (cont.)
CASH FLOW FROM FINANCING:
Long term Borrowing $120
Stock Issue 98
Dividends Paid (19)
Net Cash Flow from Financing (III) 199
TOTAL NET CASH FLOW = I+II+III (decrease) (9)
Cash Balance, December 31, 2003 25
Cash Balance, December 31, 2004 $ 16
Nguyen Tan Binh
5
Fulbright Economics Teaching Program
2005-2006
Principles of accounting Lecture 4a
7/17/2006
Nguyễn Tấn Bình
9
Direct Method

Step 1: Look at the change in the balance
from the beginning to the end of period

These numbers are often shown at the end of
the cash flow statement

Total net cash flow + the beginning cash
balance = the ending cash balance

Or, the ending cash balance – the beginning
cash balance = total net cash flow
7/17/2006
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10
Direct Method

In our example, cash balance reduces by
$9,000

Operating activity during period provides $69,000

Investing activity uses $277,000

Financing activity generates $199,000
($69,000 + 199,000 – 277,000 = - $9,000)

It tells us, the firm shows a profit but its cash is
decreasing
Nguyen Tan Binh
6
Fulbright Economics Teaching Program
2005-2006
Principles of accounting Lecture 4a
7/17/2006
Nguyễn Tấn Bình
11
Changes in Accounting Equation

The accounting equation can be rearranged:
Cash = Liabilities + OE – Non-cash Assets
or
∆Cash = ∆Liabilities + ∆OE – ∆Non-cash Assets
Any change (∆) in non-cash items (liabilities, owners’
equity, or assets) must be accompanied by a change
in cash to keep the equation balance

If a non-cash asset changes, how will it affect cash?
7/17/2006
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Changes in Accounting Equation
(cont.)

The statement of cash flow concerns with
changes in non-cash accounts as a means to
explain why and how the cash balance
changes during the accounting period
Changes in Cash = Changes in all Non-cash
Accounts
or
What happens to Cash? = Why does it happen?
Nguyen Tan Binh
7
Fulbright Economics Teaching Program
2005-2006
Principles of accounting Lecture 4a
7/17/2006
Nguyễn Tấn Bình
13
Cash Equation
Assets = Liabilities + Owners’ Equity
Î Current Assets + Fixed Assets = Liabilities +
Owners’ Equity
Î Cash + Receivables + Inventory = Liabilities +
Owners’ Equity – Fixed Assets
Î Cash = Liabilities + OE – FA – Receivables –
Inventory
)
A change in Liabilities or Owners’ Equity leads to a positive
change in Cash
)
A change in Assets leads to a negative change in Cash
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14
Calculating Cash Flow from
Operating Activity

Receipts from customers are the largest
inflow from operating activity

Disbursements for merchandise purchases
and operating expenses are the largest
outflow to operating activity

Inflows minus (-) outflows equal the net
cash flow generated from (or used by)
operating activity
Nguyen Tan Binh
8
Fulbright Economics Teaching Program
2005-2006
Principles of accounting Lecture 4a
7/17/2006
Nguyễn Tấn Bình
15
From Amounts on the Income Statement to
Items on the Statement of Cash Flows

Accountants often calculate cash flows from
income statement items

Some accountants use the balance sheet with their
experiences and additional information to
determine changes in the balance sheet and
calculate cash flow items

However, most of corporate accounting systems
cannot provide detailed information to follow this
way
7/17/2006
Nguyễn Tấn Bình
16
From Amounts on the Income Statement to
Items on the Statement of Cash Flows (cont.)

In our example, $180,000 is collected from customers.
This amount is determined as follows:
Revenue $200,000
(+) Beginning Receivables 25,000
(=) Total Receivables $225,000
(-) Ending Receivables 45,000
(=) Collections during Period $180,000
=======
Or
Revenue $200,000
Decrease (Increase) in Receivables (20,000
)
Collections during Period $180,000
=======

Remember that an increase in receivables means collections < revenue
Nguyen Tan Binh
9
Fulbright Economics Teaching Program
2005-2006
Principles of accounting Lecture 4a
7/17/2006
Nguyễn Tấn Bình
17
From Amounts on the Income Statement to
Items on the Statement of Cash Flows (cont.)

The difference between the cost of goods sold and the amount
paid to suppliers can be determined by looking at inventory and
payables
Ending Inventory $100,000
(+) Cost of Goods Sold 100,000
(=) Merchandise during Period $200,000
(-) Beginning Inventory (60,000)
(=) Merchandise Purchased during Period $140,000
=======
Beginning Payables $ 6,000
(+)
Merchandise Purchased during Period
140,000
(=) Total Payables $146,000
(-) Ending Payables (74,000)
(=) Amount Paid to Suppliers $ 72,000
=======
7/17/2006
Nguyễn Tấn Bình
18
From Amounts on the Income Statement to
Items on the Statement of Cash Flows (cont.)

Calculations on the previous slide for the
amount paid to suppliers can be summarized as
follows:
Cost of Goods Sold $100,000
Increase (Decrease) in Inventory 40,000
Decrease (Increase) in Payables (68,000
)
Amount Paid to Suppliers $72,000
Nguyen Tan Binh
10
Fulbright Economics Teaching Program
2005-2006
Principles of accounting Lecture 4a
7/17/2006
Nguyễn Tấn Bình
19
From Amounts on the Income Statement to
Items on the Statement of Cash Flows (cont.)

The salaries paid can be determined by salaries expense and
salaries payable
Beginning Salaries Payable $ 4,000
(+) Salaries Expense during Period 36,000
(=) Total Salaries Payable $ 40,000
(-) Ending Salaries Payable (25,000)
(=) Salaries Paid $ 15,000
Or,
Salaries Expense during Period $ 36,000
Decrease (Increase) in Salaries Payable (21,000)
Salaries Paid $ 15,000
7/17/2006
Nguyễn Tấn Bình
20
From Amounts on the Income Statement to
Items on the Statement of Cash Flows (cont.)

Note that in our example, both interest payable
and corporate tax payable have a zero balance at
the beginning and the ending of period

It means the total interest expense and
tax have been accrued and paid off, so
the cash flow equals the expenses,
namely, $4,000 interest paid, and
$20,000 tax paid

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