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Introduction to Cash Flow Statement

The official name for the cash flow statement is the statement of cash flows. We will use both names throughout AccountingCoach.com. The statement of cash flows is one of the main financial statements. (The other financial statements are the balance sheet, income statement, and statement of stockholders' equity.) The cash flow statement reports the cash generated and used during the time interval specified in its heading. The period of time that the statement covers is chosen by the company. For example, the heading may state "For the Three Months Ended December 31, 2010" or "The Fiscal Year Ended September 30, 2010". The cash flow statement organizes and reports the cash generated and used in the following categories: 1. Operating activities – converts the items reported on the income statement from the accrual basis of accounting to cash. 2. Investing activities – reports the purchase and sale of long-term investments and property, plant and equipment.

3. Financing activities – reports the issuance and repurchase of the company's own bonds and stock and the payment of dividends. 4. Supplemental information – reports the exchange of significant items that did not involve cash and reports the amount of income taxes paid and interest paid.

What Can The Statement of Cash Flows Tell Us?
Because the income statement is prepared under the accrual basis of accounting, the revenues reported may not have been collected. Similarly, the expenses reported on the income statement might not have been paid. You could review the balance sheet changes to determine the facts, but the cash flow statement already has integrated all that information. As a result, savvy business people and investors utilize this important financial statement. Here are a few ways the statement of cash flows is used. 1. The cash from operating activities is compared to the company's net income. If the cash from operating activities is consistently greater than the net income, the company's net income or earnings are said to be of a "high quality". If the cash from operating activities is less than net income, a red flag is raised as to why the reported net income is not turning into cash. 2. Some investors believe that "cash is king". The cash flow statement identifies the cash that is flowing in and out of the company. If a company is consistently generating more cash than it is using, the company will be able to increase its dividend, buy back some of its stock, reduce debt, or acquire another company. All of these are perceived to be good for stockholder value. 3. Some financial models are based upon cash flow.

Understanding The Changes In Cash
We often enhance our comprehension of a topic when we have to think through solutions to problems, so to help you really understand the cash flow statement, we've put together some questions for you to answer. As you formulate your response you will be learning to think about cash flows the way an accountant does. 1. When Mary Smith invests her personal money into her new company, what will happen to her company's Cash account? The Cash account increases, and because of double entry system, the owner’s equity Mary Smith, capital also increase.

2. When a company purchases inventory (merchandise purchased in order to be resold) what will
happen to its Cash account? The Cash account decreases, and because of double entry system, the assetst account inventory increases. 3. What happens to the company's Cash account if it borrows money from the bank by signing a note payable?

The cash account increases, and because of double entry system, the liability account Notes payable increase. 4. What happens to a company's Cash account if it declares a dividend on its shares of stock? It is assumed that the company pays the dividend and therefore the cash account decreases, because of double entry system, the Stockholders’ equity account Retained Earnings also decreases. 5. What is the effect on its Cash account when a company pays some of itsAccounts Payable? The cash account decreases, and because of double entry system, the liability account Accounts Payable is decreased. 6. What is the effect on its Cash account when a company prepays a 6-month insurance
premium? The Cash account decreases, and because of double entry system, the assets account Prepaid Insurance increases. 7. What is the effect on its Cash account when a company sells merchandise, but allows the customer to pay in 30 days? There is no effect on cash account. The transaction does, however, result in a debit to asset account Accounts Receivable and a credit to income statement account Sales, which has the effect of increasing sales and net income on the income statement. The transaction changes nothing on the statement of cash flow since there is no cash involved at this time ( the cash will be received in 30 days ).

8. What is the effect on its Cash account when a company receives payment from one of its customers 30 days after the sale was recorded?

When owner's equity increases. the Cash account increases.On the day the cash is received. . Consider the General journal entry for this transaction. what is the likely effect on Cash? If the assets account Prepaid Insurance increased. Much of what you learned in the practice questions above is common sense. When an asset (other than cash) decreases. Consider the General journal entry for this transaction. If the liability account Bonds Payable decreases. we assume that the company paid an insurance premium that covered more than the current month. Therefore. If the liability account Bonds Payable increases. the Cash account decreases. and because of double entry system. you now own the book (you've increased your "assets") but you also have less money (you've decreased your cash). ) 9. what is the likely effect this will have on Cash? If Accounts Payable decreased. When owner's equity decreases. we assume that the company paid some of its bills. the Cash account increases. ( Be aware that this transaction has no effect on income statement – there is no increase on sales and no increase on income. If a company's Accounts Payable account decreased. Consider the general journal entry for this transaction. therefore assume that the cash account will also decreased. what's the likely effect on Cash? The cash account increase because we assume that the company receives cash from the sale of any and all assets. what's the likely effect on Cash? If the asset account Land increased. the Cash account decreases. what is the likely effect on Cash? The cash account increased because we assume that the company receives cash when they issue bonds. we assume that the cash account decreased. When a liability decreases. If the asset account Land increased. you can make the following general assumptions:       When an asset (other than cash) increases. we assume that the company paid cash to purchase the land. If the asset account Land decreased. For example. the cash account increases. If the asset account Prepaid Insurance increased. what is the likely effect on Cash? The cash account decreases because we assume that the company used cash or paid cash to repurchase/redeem/reduce its bonds that are outstanding. Cash xxxx Land xxxx Gain on sale of Land xxxx 13. 14. the assets account Accounts Receivable decreases. when you use cash to buy a book. the Cash account decreases. Prepaid Insurance xxxx Cash xxxx 11. When a liability increases. the Cash account increases. the cash account decreased. therefore. 10. Based on what you learned. Land xxxx Cash xxxx 12.

the operating activities section has adjustments for depreciation expense and for the gains and losses on the sale of long-term assets. the balance sheet accounts at December 31. Cash involving investing activities 3. The changes—or differences—in these account balances will likely be entered in one of the sections of the statement of cash flows. Assuming that the cash flow statement is being prepared using the indirect method (the method used by most companies) the differences in a company's balance sheet accounts will provide much of the needed information.For a change in assets (other than cash)—the change in the Cash account is in the opposite direction. such as: Accounts Receivable Inventory Supplies Prepaid Insurance Other Current Assets Notes Payable (generally due within one year) Accounts Payable Wages Payable Payroll Taxes Payable Interest Payable Income Taxes Payable Unearned Revenues Other Current Liabilities In addition to using the changes in current assets and current liabilities. Cash Provided From or Used By Operating Activities This section of the cash flow statement reports the company's net income and then converts it from the accrual basis to the cash basis by using the changes in the balances of current asset and current liabilityaccounts. 2. Cash involving operating activities 2. 2010 will be compared to the balance sheet accounts at December 31. Cash Provided From or Used By Investing Activities . For example. followed by a list of those balance sheet accounts which affect it. 1. 2009. Supplemental information. Cash involving financing activities 4. For a change in liabilities and owner's equity—the change in the Cash account is in the same direction Format of the Statement of Cash Flows The statement of cash flows has four distinct sections: 1. if the statement of cash flows is for the year 2010. Shown below is each of the four sections of the statement of cash flows.

For example. and equipment. such as: Notes Payable (generally due after one year) Bonds Payable Deferred Income Taxes Preferred Stock Paid-in Capital in Excess of Par-Preferred Stock Common Stock Paid-in Capital in Excess of Par-Common Stock Paid-in Capital from Treasury Stock Retained Earnings Treasury Stock In short. plant. Also reported are significant exchanges not involving cash.is reported in this section of the cash flow statement Operating Activities Operating Activities Investing Activities Financing Activities Financing Activities *This refers to current assets other than Cash. Cash Provided From or Used By Financing Activities This section of the cash flow statement reports changes in balances of the long-term liability andstockholders' equity accounts.This section of the cash flow statement reports changes in the balances of long-term asset accounts.. Supplemental Information This section of the cash flow statement discloses the amount of interest and income taxes paid. investing activities involve the purchase and/or sale of long-term investments and property. such as: Long-term Investments Land Buildings Equipment Furniture & Fixtures Vehicles In short. 4. the exchange of company stock for company bonds would be reported in this section. Where To Enter The Balance Sheet Changes Take a look at the summary below—it shows where the changes in balance sheet accounts should be entered on your statement of cash flows: A change in this balance sheet category Current Assets* Current Liabilities Long-term Assets Long-term Liabilities Stockholders' Equity . Adjustments Within The Operating Activities Section .. financing activities involve the issuance and/or the repurchase of a company's own bonds or stock. Dividend payments are also reported in this section. 3.

On January 20. The total cost to Good Deal for all 14 calculators is $700. Statement of Cash Flows For the Month Ended January 31. and if the company paid out cash for all of its expenses. Matt prepares financial statements for his new business as of January 31. Income Statement For the Month Ended January 31. Good Deal buys 14 graphing calculators for $50 per calculator—this is about 50% less than the selling price Matt has observed at the retail stores. 2010. Good Deal Co.When we use the indirect method to prepare a statement of cash flows we begin with the net income figure from the company's income statement as our starting point. However. & Owner's Equity $1. We then make adjustments to that figure to arrive at the cash amount. then net income would equal the cash from operating activities. Balance Sheet January 31. and the changes in current assets and current liabilities. January Transactions and Financial Statements On January 2. gain or losses on sales of assets.300 700 $2.000 Good Deal Co. 2010: Good Deal Co. 2010 Revenues Expenses Net Income $0 0 $0 Good Deal Co.000 of his personal money into his sole proprietorship. 2010 Operating Activities . he decides to turn his hobby into a business called "Good Deal Co. balance sheet. 2010 Assets Cash Inventory Total Assets Liabilities & Owner's Equity Liabilities Owner's Equity Matt Jones. 2010 Matt invests $2. The purpose is to show how these transactions are reported on the cash flow statement.000 $2. and a statement of cash flows for the current month and for the year-to-date period. Capital Total Liab. If all of a company's revenues were cash sales (no credit sales). Story To Illustrate Matt is a college student who enjoys buying and selling merchandise using the Internet. On January 2. since some of the revenues and expenses on the income statement were not cash transactions." Each month the Good Deal Co. At the end of each month we will prepare an income statement. we must include depreciation. Good Deal has no other transactions during January. These adjustments will be illustrated in the hypothetical story presented in Part 3.000 $ 0 2. will have one or two transactions.

but at January 31.300 is verified at the bottom of the cash flow statement and on the balance sheet.Net Income Increase in Inventory Cash Provided (Used) in Operating Activities Investing Activities Financing Activities Investment by Owner Net Increase in Cash Cash at the beginning of the month Cash at the end of the month $ 0 (700) (700) 0 2. Capital (Matt's investment in the business). Matt receives $800 from the school on March 8. Matt prepared financial statements for his new business as of February 28.000 1. Recall that when Inventoryincreased by $700. However. 28. For a change in liabilities and owner's equity—the change in the Cash account is in the same direction. the Cash balance is $1. Matt delivers the calculators on February 25 and gives the school an $800 invoice due by March 10.300 Good Deal's income statement for January showed no profit or loss. 2010: Good Deal Co. 2010. There was a $0 cash at January 1.300. For a change in assets (other than cash)—the change in the Cashaccount is in the opposite direction. The decrease in cash occurred because the company increased its inventory by $700 during January. Recall that when the owner invested cash in the company Cash increased and Owner's Equity increased. The net change in the Cash account from the owner's investment and the cash outflow for inventory is a positive $1.300. the cash flow statement reports that Good Deal's operating activities resulted in a decrease in cash of $700.300 0 $1.000 which corresponds to the increase in Matt Jones. since it did not have any sales or expenses. February Transactions and Financial Statements On February 25. Income Statement For the Month Ended Feb. This net change of a positive $1. Good Deal sells 10 calculators to a nearby high school for $80 each. The financing activities section shows an increase in cash of $2. 2010 . Cash decreased by $700.

300 As you can see above. not when the expenses or goods are paid for. Under the accrual basis of accounting—revenue is recognized when title passes (at the time of shipment or time of delivery).) As a result of the accrual basis of accounting. 2010 Revenues Expenses Net Income $800 500 $300 .300 on January 31 and will show $1. Expenses (such as the cost of goods sold for $500) appear on the income statement when they best match up with revenues.Revenues Expenses Net Income $800 500 $300 The income statement for the month of February shows revenues (or sales) of $800. That agrees with the company's balance sheet that reported Cash of $1. the income statement reports $300 of net income even though there was no cash inflow or cash outflow during February. notwhen the money is received. Good Deal Co. the cash flow statement for the month of February reports no change in cash. 2010 Operating Activities Net Income Increase in Accounts Receivable Decrease in Inventory Cash Provided (Used) in Operating Activities Investing Activities Financing Activities Investment by Owner Net Increase in Cash Cash at the beginning of the month Cash at the end of the month $ 300 (800) 500 0 0 0 0 1. Good Deal Co.300 on February 28. not when they are paid for. Statement of Cash Flows For the Month Ended February 28.300 $1. Income Statement For the Two Months Ended February 28. (Other expenses will also appear on the income statement when they are used.

2010 Assets Cash Accounts Receivable Inventory Liabilities & Owner's Equity Liabilities Owner's Equity Matt Jones. Good Deal Co. Net Income Total Owner's Equity Total Liabilities & Owner's Equity $1.000 1. Balance Sheet February 28. the fact that the company's Accounts Receivable increased by $800 means the company did not collect the cash from its sales. Recall that Good Deal has not received any money yet from its operations (buying and selling merchandise) and it paid out $700 for the 14 calculators it purchased. Matt Jones. As a result.300 2. However. 2010 Operating Activities Net Income Increase in Accounts Receivable Increase in Inventory Cash Provided (Used) in Operating Activities Investing Activities Financing Activities Investment by Owner Net Increase in Cash Cash at the beginning of the year Cash at February 28. the cash flows for the two-month period shows that Good Deal's cash from operating activities is a negative $700.300 $2.300 800 200 $ 0 Total Assets $2.000 of financing by the owner.The year-to-date net income of $300 increases the owner's equity on the balance sheet.300. Capital (excl. Statement of Cash Flows For the Two Months Ended February 28.300 Good Deal Co. Capital has increased from $2. Capital on the balance sheet. March Transactions and Financial Statements .) Matt Jones. the net change in cash for the first two months is a positive $1.000 300 2. And because Inventory increased by $200. Curr Yr.300 0 $1.300 Good Deal's income statement for the first two months shows a positive net income of $300. the company's Cash had also decreased in order to pay for the Inventory increase. 2010 $ 300 (800) (200) (700) 0 $2. This agrees to the change in cash on the balance sheet—none on January 1 but $1. Please note the connection between the bottom line of the year-to-date income statement and the change in Matt Jones.300. net inc. When this is combined with the negative $700 from operating activities.300 on February 28. The cash flow statement also shows $2.000 to $2.

Capital (excl. The Good Deal financial statements dated March 31 are: Good Deal Co. No other transactions occurred in March. Good Deal Co.) Matt Jones.300. 2010 Revenues Expenses Net Income $800 500 $300 Note that the year-to-date net income causes the amount in the owner's capital account (on the balance sheet) to increase from $2.300 2.000 300 2. net inc. Income Statement For the Month Ended March 31.300 $2.100 0 200 $ 0 Total Assets $2.On March 8 Good Deal receives $800 for the calculators sold to the school on February 25. .000 to $2.300 Good Deal Co. Balance Sheet March 31. 2010 Revenues Expenses Net Income $0 0 $0 Good Deal Co. 2010 Assets Cash Accounts Receivable Inventory Liabilities & Owner's Equity Liabilities Owner's Equity Matt Jones. Curr Yr. Net Income Total Owner's Equity Total Liabilities & Owner's Equity $2. Income Statement For the Three Months Ended March 31.

investing. 2010. but then shows that $200 of cash was used to increase inventory.300 2-28-10 $1. 2010 Assets Cash Accounts Receivable Inventory Total Assets 3-31-10 $2. and financing activities for the three months ended March 31.Statement of Cash Flows For the Three Months Ended March 31.000 was received from the owner's investment in the company. Balance Sheets March 31 and February 28. The statement of cash flows also shows that $2. Since much of the information for the cash flow statement comes from changes in balance sheet accounts.300 800 200 $2. only $100 of cash was provided from operating activities. The operating activities section of the statement of cash flows begins with the $300 in net income. The net cash inflow from the company's operating.300 Change $ 800 (800) -0$ -0- .100. we need to have the balance sheet amounts for both February 28.100 in the Cash account on March 31 and there was $0 on January 1.100 represents the change in cash from the beginning of the accounting year through March 31. If you look at the March 31 balance sheet. you will find that it confirms this— there is $2.000 2. The statement of cash flows presented above was for the three months ended March 31. 2010 was $2. 2010 Operating Activities Net Income Increase in Accounts Receivable Increase in Inventory Cash Provided (Used) in Operating Activities Investing Activities Financing Activities Investment by Owner Net Increase in Cash Cash at the beginning of the year Cash at March 31. As a result. 2010.100 The income statement for the first three months of the business shows a net income of $300. 2010 and March 31.100 0 $2. Good Deal Co. 2010 $ 300 0 (200) 100 0 $2.100 -0200 $2. Let's look at how the statement of cash flows would be prepared for just one month—March 2010. Thedifferences in these account balances from February 28 to March 31 will provide us with information we need on the activities in March. The figure of $2.

2010 Operating Activities Net Income Decrease in Accounts Receivable Change in Inventory Cash Provided (Used) in Operating Activities Investing Activities Financing Activities Net Increase in Cash Cash at the beginning of the month Cash at the end of the month $ 0 800 0 800 0 0 800 1. The changes in the balance sheet accounts from February 28 to March 31 provided the other information needed for the month of March: Good Deal Co.) Matt Jones. the cash flow statement for March must end up explaining this $800 increase in the Cash account. Capital (excl.300 (If you are wondering why March 31 is shown before February 28. it is because accountants usually place the most current amounts closest to the account names. This $0 of net income is the first amount reported on the statement of cash flows. since there were no revenues.300 $2.300 $2. will serve as a "check figure" for the bottom line of the cash flow statement for the month of March.000 300 2.300 $2.) Focus on the "Change" column above. . In other words. Curr Yr. The other amounts in the "Change" column will be used on the statement of cash flows to identify the reasons for the $800 increase in cash. or losses.300 2. Statement of Cash Flows For the Month Ended March 31. The first amount. gains. Since there were no sales and no expenses in March. Cash increased by $800 because $800 of accounts receivable were collected during March.000 300 2. net inc. a positive $800 change in the Cash account. This is a courtesy to the reader in that these are assumed to be the more important amounts and will be easier to read if placed closest to the words. the income statement for the one month of March (see above) reported no net income.Liabilities & Owner's Equity Liabilities Owner's Equity Matt Jones. Net Income Total Owner's Equity Total Liabilities & Owner's Equity $ -0- $ -0- $ -0-0-0-0$ -0- 2. expenses.100 Let's review the cash flow statement for the month of March 2010:   Net income for March is $0.

Balance Sheet April 30.) Matt Jones. .300 on February 28 to $2. Income Statement For the Four Months Ended April 30.    Inventory did not change. There were no changes in long-term liabilities or owner's equity. nothing is reported in the financing activities section. This was the only transaction during April.450 Total Assets $2. so Cash was not affected.100 on March 31. The $150 is reported on the balance sheet in the asset account Supplies. there is no change to the Supplies Expense account. (We could omit this line since it had no effect on cash. Matt prepared the following financial statements for Good Deal Co. April Transactions and Financial Statements On April 28 Good Deal orders $150 of supplies on account.300 $2. Income Statement For the Month Ended April 30. Good Deal Co. The summation of the amounts on the statement of cash flows is a positive $800. Net Income Total Owner's Equity Total Liabilities & Owner's Equity $2. 2010 Revenues Expenses Net Income $0 0 $0 Since no supplies were used in April.100 0 200 150 $ 150 2. The supplies arrive on April 30 along with an invoice showing that the full $150 is due by May 30. None of the supplies were used in April.000 300 2. hence.) There were no changes in long-term assets during March. This amount agrees to the increase in the Cash account balance from $1. so nothing is reported in the investing activities section. net inc. Capital (excl.450 As you can see from the balance sheet the company added assets of $150 (Supplies) and added its first liability of $150 (Accounts Payable). 2010 Revenues Expenses Net Income $800 500 $300 Good Deal Co. Curr Yr. as of April 30: Good Deal Co. 2010 Assets Cash Accounts Receivable Inventory Supplies Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones.

net inc. but also reports the increase in Accounts Payable. 2010 Assets Cash Accounts Receivable Inventory Supplies Total Assets 4-30-10 $2.100 0 200 $ 0 $2.300 $2. 2010 Operating Activities Net Income Increase in Supplies Increase in Accounts Payable Cash Provided (Used) in Operating Activities Investing Activities Financing Activities Investment by Owner Net Increase in Cash Cash at the beginning of the month Cash at the end of the month $ 0 (150) 150 0 0 0 0 2. The operating activities section reports the increase in Supplies.450 $ 0 $150 0 0 0 $150 2. Statement of Cash Flows For the Month Ended April 30.000 300 2.100 $2. Curr Yr. This is a courtesy to the reader in that these are assumed to be the more important amounts and will be easier to read if placed closest to the words.300 $2.300 (If you are wondering why April 30 is shown before March 31.100 The cash flow statement for the month of April reports that there was no change in the Cash account from March 31 through April 30. it is because accountants usually place the most current amounts closest to the account names. .450 3-31-10 $2. Capital (excl.A balance sheet comparing April 30 to March 31 and the resulting differences or changes is shown below: Good Deal Co. Net Income Total Owner's Equity Total Liabilities & Owner's Equity $ 150 2.300 Change $ 0 0 0 $150 $150 Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones. Balance Sheets April 30 and March 31.) Matt Jones.100 0 200 150 $2.) Good Deal Co.000 300 2.

100 0 200 150 $2. Curr Yr. 2010 Operating Activities Net Income Increase in Inventory Increase in Supplies Increase in Accounts Payable Cash Provided (Used) in Operating Activities Investing Activities Financing Activities Investment by Owner $ 300 (200) (150) 150 100 0 2. think of the positive amounts (the numbers not in parentheses) as good for your cash balance. For example.300 $2. that's good for your cash balance (but bad for the liability Accounts Payable which increases). net inc. if you pay a bill.300 $2.000 300 2. if you don't pay your bills.450 Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones. Think of the negative amounts (the numbers within parentheses) asnot good for cash. Net Income Total Owner's Equity Total Liabilities & Owner's Equity $ 150 2. For example.) Matt Jones. Balance Sheets April 30.000 300 2. that's not good for your cash balance (but good for the liability Accounts Payable which decreases).100 0 200 150 $2.450 12-31-09 $ 0 0 0 0 $ 0 Change $2. Statement of Cash Flows For the Four Months Ended April 30. Good Deal Co.450 $ 0 0 0 0 $ 0 $ 150 2.000 .450 Good Deal Co. 2010 and December 31. Capital (excl.On the statement of cash flows. 2009 Assets Cash Accounts Receivable Inventory Supplies Total Assets 4-30-10 $2.

Income Statement For the Five Months Ended May 31. 2010 2. There were no changes in long-term liabilities.Net Increase in Cash Cash at the beginning of the year Cash at April 30.100 0 $2. There were no changes in long-term assets. the increase in Supplies is not good for cash and it is reported as a negative $150. the net change in cash that is explained by operating activities is a positive $100.100. This agrees with the change in the Cash account from $0 on December 31. Similarly. Combining the amounts. 2009 to $2. 2010 Revenues Expenses Net Income $800 500 $300 . The increase in Accounts Payable is good for cash (since some bills were not paid) so the increase in the liability account is a positive $150. Good Deal Co.    May Transactions and Financial Statements On May 30 Good Deal pays its accounts payable of $150. investing. as shown by the negative $200. 2010 Revenues Expenses Net Income $0 0 $0 Good Deal Co. On May 31 Good Deal purchases office equipment (a new computer and printer) that will be used exclusively in the business.100 on April 30. hence no cash was involved in investing activities. There was a change in owner's equity since December 31. The equipment is put into service on May 31. 2010. and as a result the financing activities section reports the owner's investment in Good Deal Co. Income Statement For the Month Ended May 31.100 and is paid for in cash. There were no other transactions in May. The increase in Inventory is not good for cash. and financing activities. the cash flow statement reports a change in cash of $2. Combining the operating. The cost of the office equipment is $1.100 Let's review the statement of cash flows for the four months ended April 30:  The operating activities section of the cash flow statement starts with the net income of $300 for the four-month period.

300 . Capital (excl.250) 0 0 0 1.300 $ 0 2.) Matt Jones. 2010 Assets Cash Accounts Receivable Inventory Supplies Office Equipment Total Assets 5-31-10 $ 850 0 200 150 1.300 $2.300 $2. Net Income Total Owner's Equity Total Liabilities & Owner's Equity $ 850 0 200 150 1.000 300 2. Balance Sheets May 31 and April 30.300 A balance sheet comparing May 31 to April 30 and the resulting differences or changes is shown below: Good Deal Co. Capital (excl.000 300 2.) Matt Jones. Curr Yr.100 $2. Net Income Total Owner's Equity Total Liabilities & Owner's Equity $ 0 $ 150 2. net inc. Curr Yr.100 $2.450 Change $(1.300 4-30-10 $2.450 $ (150) 0 0 0 $ (150) 2.100 $ (150) Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones.100 0 200 150 0 $2. net inc.Good Deal Co.000 300 2. 2010 Assets Cash Accounts Receivable Inventory Supplies Office Equipment Total Assets Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones.300 $2. Balance Sheet May 31.

300 . Net Income Total Owner's Equity Total Liabilities & Owner's Equity $ 0 $ 0 0 0 0 $ 0 $ 0 2.000 300 2.100) 0 (1. Capital (excl.300 $2. 2010 Operating Activities Net Income Decrease in Accounts Payable Cash Provided (Used) in Operating Activities Investing Activities Purchase of Office Equipment Financing Activities Net Increase in Cash Cash at the beginning of the month Cash at the end of the month $ 0 (150) (150) (1. Curr Yr.250) 2.Good Deal Co. Statement of Cash Flows For the Month Ended May 31.300 $2. 2009 Assets Cash Accounts Receivable Inventory Supplies Office Equipment Total Assets 5-31-10 $ 850 0 200 150 1.300 Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones. Balance Sheets May 31.100 $ 850 Good Deal Co.300 12-31-09 $ 0 0 0 0 0 $ 0 Change $ 850 0 200 150 1. net inc. 2010 and December 31.100 $2.300 2.000 300 $2.) Matt Jones.100 $2.

Similarly. cash is not involved. Combining the amounts. 2010 $ 300 (200) (150) (50) (1. Because we begin preparing the statement of cash flows using the net income figure taken from the income statement. the statement of cash flows reports an increase in cash of $850. investing. In the operating activities section of the cash flow statement.100) 2. This agrees with the change in the Cash account as shown on the balance sheets from December 31. There was a change in owner's equity since December 31. as shown by the negative $200. depletion. and amortization expense.000 850 0 $ 850 Let's review the cash flow statement for the five months ended May 31:  The operating activities section starts with the net income of $300 for the five-month period. we add back the amount of the Depreciation Expense. add back expenses that did not require the use of cash. 2010. There were no changes in long-term liabilities. and financing activities. In other words. and as a result the financing activities section of the cash flow statement reports the owner's investment into the Good Deal Co. but it does not reduce the Cash account on the balance sheet. .    Depreciation Expens Depreciation moves the cost of an asset to Depreciation Expense during the asset's useful life. 2010 Operating Activities Net Income Increase in Inventory Increase in Supplies Cash Provided (Used) in Operating Activities Investing Activities Purchase of Office Equipment Financing Activities Investment by Owner Net Increase in Cash Cash at the beginning of the year Cash at May 31. Examples are depreciation. depreciation reduces net income on the income statement. the increase in Supplies is not good for cash and it is reported as a negative $150. The accounts involved in recording depreciation are Depreciation Expense and Accumulated Depreciation. To do this.Good Deal Co. Combining the operating. Statement of Cash Flows For the Five Months Ended May 31. we need to adjust the net income figure so that it is not reduced by Depreciation Expense. There is no cash involved. 2009 (or January 1. as all three involve allocating the cost of a long-term asset to an expense over the useful life of the asset. As you can see. The increase in Inventory is not good for cash. The increase in long-term assets is reported under investing activities. the net change in cash that is explained by operating activities is a negative $50. Depletion Expense and Amortization Expense are accounts similar to Depreciation Expense. 2010) and May 31.

net inc. Capital (excl. Let's assume that a depreciation expense of $20 per month is recorded by Good Deal. Capital Total Liabilities & Owner's Equity $ 850 0 200 150 1.) Matt Jones. Good Deal's financial statements at June 30 will be as follows: Good Deal Co.280 $ 0 2. Income Statement For the Six Months Ended June 30. 2010 Assets Cash Accounts Receivable Inventory Supplies Office Equipment Less: Accum.280 $2. As a result.100 (20) $2. 2010 Revenues Expenses Cost of Goods Sold Depreciation Expense Total Expense Net Income $800 500 20 520 $280 Good Deal Co. Balance Sheets June 30 and May 31. Balance Sheet June 30. Curr Yr. 2010 . June Transactions and Financial Statements The only transaction recorded by Good Deal during June was the depreciation on the office equipment. Recall that on May 31 Good Deal purchased the office equipment (a new computer and printer) for $1. Net Income Total Matt Jones. Depreciation Total Assets Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones.000 280 2.Let's illustrate how a depreciation expense is handled by continuing with the Good Deal Co.100 and it was put into service on the same day. 2010 Revenues Expenses Depreciation Expense Net Income $ 0 20 $(20) Good Deal Co.280 A balance sheet comparing June 30 to May 31 and the resulting differences or changes is shown below: Good Deal Co. Income Statement For the Month Ended June 30.

Assets Cash Accounts Receivable Inventory Supplies Office Equipment Less: Accumulated Depreciation Total Assets 6-30-10 $ 850 0 200 150 1. Statement of Cash Flows For the Month Ended June 30. Net Income Total Matt Jones. Capital Total Liabilities & Owner's Equity $ 0 $ 0 $ 0 0 (20) (20) $(20) 2. This is a courtesy to the reader in that these are assumed to be the more important amounts and will be easier to read if placed closest to the words.000 300 2.300 $2. it is because accountants usually place the most current amounts closest to the account names.) Good Deal Co.280 2. however. Good Deal did not spend any cash in June.000 280 2.280 $2.) Matt Jones. net inc. 2010 Operating Activities Net Income Add: Depreciation Expense Cash Provided (Used) in Operating Activities Investing Activities Financing Activities Net Increase in Cash Cash at the beginning of the month Cash at the end of the month $ (20) 20 0 0 0 0 850 $850 The cash flow statement for the month of June illustrates why depreciation expense needs to be added back to net income.100 0 $2.280 5-31-10 $ 850 0 200 150 1. the entry in the Depreciation Expense account resulted in a net loss on the income statement. .300 Change $ 0 0 0 0 0 (20) $(20) Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones. Capital (excl.300 (If you are wondering why June 30 is shown before May 31. Curr Yr.100 (20) $2. To convert the bottom line of the income statement (a loss of $20) to the amount of cash provided or used in operating activities ($0) we need to add back or remove the depreciation expense amount.

280 Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones. Balance Sheets June 30.100 (20) $2.280 $2. net inc.Good Deal Co. Capital (excl.000 280 2. Net Income Total Matt Jones.000 280 2. 2010 Operating Activities Net Income Add back: Depreciation Expense Increase in Inventory Increase in Supplies Cash Provided (Used) in Operating Activities Investing Activities $ 280 20 (200) (150) (50) .280 12-31-09 $ 0 0 0 0 0 0 $ 0 Change $ 850 0 200 150 1.280 $2. Curr Yr.100 (20) $2. Statement of Cash Flows For the Six Months Ended June 30. Capital Total Liabilities & Owner's Equity $ 0 $ 0 0 0 0 $ 0 $ 0 2.280 2. 2010 and December 31.) Matt Jones. 2009 Assets Cash Accounts Receivable Inventory Supplies Office Equipment Less: Accumulated Depreciation Total Assets 6-30-10 $ 850 0 200 150 1.280 Good Deal Co.

100 which is reported in the investing activities section. 2010 (1. the difference of $500 would be reported in the account Loss on Sale of Truck and would reduce the company's net income.000 ($20.000 .000 the difference of $1. and financing activities.$18. One of the rules in preparing a statement of cash flows is that the entire proceeds received from the sale of a long-term asset must be reported in the second section of the statement.000 is recorded in the account Gain on Sale of Truck—an income statement account. Combining the amounts. Similarly. The transaction has the effect of increasing the company's net income.000. investing. 2009 and June 30. let's say a company sells one of its delivery trucks for $3.Increase in Office Equipment Financing Activities Investment by Owner Net Increase in Cash Cash at the beginning of the year Cash at June 30. as shown by the negative $200. The increase in long-term assets caused a cash outflow of $1. the book value of the truck is $2. the statement of cash flows reports an increase in cash of $850. That truck is shown on the company records at its original cost of $20.'s activities. There was a change in owner's equity since December 31.000 investment into the Good Deal Co. When these two amounts are combined ("netted together") the net amount is known as the book value (or the carrying value) of the asset. but there was no cash spent on depreciation). This agrees with the change in the Cash account as shown on the balance sheets from December 31. 2010. Depreciation expense is added back to net income because it was a noncash transaction (net income was reduced. This presents a problem because any gain or loss on the sale of an asset is also included in the company's net income which is reported in the first section— operating activities.000 850 0 $ 850 Let's review the cash flow statement for the six months ended June 30:  The operating activities section starts with the net income of $280 for the six-month period. For example.500 ($500 less than its $2. In the example. There were no changes in long-term liabilities.000 book value). Because the proceeds from the sale of the truck are $3. the increase in Supplies is not good for cash and it is reported as a negative $150.000.000 less accumulated depreciation of $18.000). If the truck had sold for $1.    Disposal of Assets If a company disposes of (sells) a long-term asset for an amount different from its recorded amount in the company's accounting records (its book value). each gain isdeducted from net income and each loss is added to net income in the operating activities section of the cash flow statement. the investing activities section. To avoid double counting.000 and the book value is $2.100) 2. the net change in cash that is explained by operating activities is a negative $50. The increase in the Inventory account is not good for cash. Let's illustrate this by returning to Good Deal Co. . and as a result the financing activities section reports the owner's $2. an adjustment must be made to net income on the cash flow statement. Combining the operating.

100 less the $20 of accumulated depreciation). This means the book value of the equipment is $1.280 Change $ 900 0 0 0 (1. The income statement and the statement of cash flows for the month of July illustrate how the disposal of the equipment is reported: Good Deal Co.750 0 200 150 0 0 $2. 2010 Revenues Expenses Loss on Sale of Equipment Net Income $ 0 180 $(180) Good Deal Co. 2010 Revenues Expenses Cost of Goods Sold Depreciation Expense Loss on Sale of Equipment Total Expense Net Income $800 500 20 180 700 $100 Good Deal Co.100) 20 $ (180) . 2010 and June 30. Good Deal used the equipment for one month (May 31 through June 30) and had recorded one month's depreciation of $20. 2010 Assets Cash Accounts Receivable Inventory Supplies Office Equipment Less: Accumulated Depreciation Total Assets 7-31-10 $1.100 6-30-10 $ 850 0 200 150 1.100 (20) $2.080 (the original cost of $1. Balance Sheets July 31. Income Statement For the Seven Months Ended July 31. Income Statement For the Month Ended July 31. There were no other transactions in July.July Transactions and Financial Statements On July 1 Matt decides that his company no longer needs its office equipment. On July 1 Good Deal sells the equipment for $900 in cash and records a loss of $180 in the account Loss on Sale of Equipment on its income statement.

net inc. This amount agrees to our check figure—the increase in the Cash account balance from June 30 to July 31.) There was no cash provided or used by operating activities.000 280 2. Net Income Total Matt Jones. 2009 .280 0 (180) (180) $ (180) Good Deal Co. so cash was not affected.    The summation of the amounts on the cash flow statement is a positive cash inflow of $900.750 Let's review the cash flow statement for the month of July 2010:   Net income for July was a net loss of $180.280 $2. There was no depreciation expense in July. expenses. Curr Yr. Good Deal received $900 from the sale of its office equipment.Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones. or gains. and current assets and current liabilities did not change in July. Good Deal Co. There were no revenues. Capital (excl. but there was an entry of $180 in the account Loss on Sale of Equipment.100 $2.000 100 2. (We could have omitted the line "Depreciation Expense". Balance Sheets July 31. 2010 and December 31.) Matt Jones. 2010 Operating Activities Net Income Add back: Depreciation Expense Add back: Loss on Sale of Equipment Cash Provided (Used) in Operating Activities Investing Activities Proceeds from sale of Office Equipment Financing Activities Net Increase in Cash Cash at the beginning of the month Cash at the end of the month $ (180) 0 180 0 900 0 900 850 $1. Capital Total Liabilities & Owner's Equity $ 0 $ 0 $ 0 2.100 2. Statement of Cash Flows For the Month Ended July 31. There was no change in long-term liabilities or owner's equity during July.

net inc.100 Liabilities & Owner's Equity Liabilities Accounts Payable Owner's Equity Matt Jones.000 100 2.750 0 .100 Good Deal Co. Capital Total Liabilities & Owner's Equity $ 0 $ 0 0 0 0 $ 0 $ 0 2.) Matt Jones.100 12-31-09 $ 0 0 0 0 0 0 $ 0 Change $1.100 $2. Capital (excl.000 100 2.Assets Cash Accounts Receivable Inventory Supplies Office Equipment Less: Accumulated Depreciation Total Assets 7-31-10 $1.100 $2. Statement of Cash Flows For the Seven Months Ended July 31. 2010 Operating Activities Net Income Add back: Depreciation Expense Add back: Loss on Sale of Equipment Increase in Inventory Increase in Supplies Cash Provided (Used) in Operating Activities Investing Activities Purchase of Office Equipment Proceeds from sale of Office Equipment Cash Provided (Used) in Investing Activities Financing Activities Investment by owner Net Increase in Cash Cash at the beginning of the year $ 100 20 180 (200) (150) (50) (1.000 1.100 2. Net Income Total Matt Jones.100) 900 (200) 2. Curr Yr.750 0 200 150 0 0 $2.750 0 200 150 0 0 $2.

expenses. The increase in the Supplies account is assumed to have had a negative effect of $150 on the Cash account. (The cash received from the sale of the equipment appears in its entirety under the investing activities section of the cash flow statement.) Inventory on July 31 is $200 (4 calculators at a cost of $50 each). Also included in net income is the $180 entry into the Loss on Sale of Equipment account. investing. This expense reduced net income but did not reduce the Cash account.Cash at July 31. This loss was reported on the income statement thereby reducing net income but not reducing cash. Combining these two amounts results in the net outflow ("cash used in investing activities") of $200. This $1. There is cash outflow (or payment) of $1. Combining the amounts so far.com/online-accounting-course/06Xpg08. 2010 $1. rather than providing cash. therefore we add the $20 depreciation expense to the net income.750 Let's review the cash flow statement for the seven months of January through July 2010:   Net income for the seven months is $100.750 results from combining the amount totals of the previous three sections—operating.html .accountingcoach.       The statement of cash flow's bottom line amount of $1. Included in the net income for the seven months is $20 of depreciation expense.100 to purchase the office equipment on May 31 and the $900 of cash inflow (or receipt) from the sale of the office equipment on July 1. There was an owner's investment of $2. Supplies increased from none to $150. In other words. http://www. Since the company began with no inventory. gains.000 made on January 2. and losses. this increase in the Inventory account means that $200 of cash was used to increase inventory.750 agrees to the check figure—the difference in the Cash account balance from the beginning of January to July 31. the operating activities used $50 of cash. and financing activities. we see that the cash from operating activities is a negative $50. This includes revenues.