You are on page 1of 30

Accounting 301: Intermediate Accounting

Accruals vs. Cash Flows

Fall 2015

Statement of Cash Flows

Provides information about the cash receipts and cash


disbursements of an enterprise that occurred during a period

Cash refers to cash plus cash equivalents

Presented for each period

Helpful in assessing future profitability, liquidity, and long-term


solvency

Operating activities
Categories of transactions
affecting cash

Investing activities
Financing activities

Operating Activities (ASC 230-10-45)

Inflows and outflows of cash that result from activities


reported in the income statement

Operating
Activities

Cash Inflows

Cash Outflows

Sale of goods or

Purchase of inventory services


Salaries, wages, and other
Interest and dividends
operating expenses from
investments
Income taxes
Net cash flows from operating activities: Difference

between the inflows and outflows

Investing Activities (ASC 230-10-45)

Inflows and outflows of cash related to the acquisition and


disposition of long-lived assets and investment assets.

Investing Activities

Cash Inflows
The sale of long-lived assets
used in the business
The sale of investment
securities*
The collection of a nontrade
receivable (excluding the

collection of interest, which is


an operating activity)

Cash Outflows
Purchase of long-lived assets
used in the business
Purchase of investment
securities like stocks and bonds
of other entities*

Loans to other entities


* Unless classified as cash equivalents or trading securities

From creditors when cash is


borrowed through notes,
loans, mortgages, and bonds

Financing Activities (ASC 230-10-45)


Cash Outflows
To owners
in the form of
Relate to the external financing
of the company

dividends or other distributions


Financing
To owners for the reacquisition
of shares previously sold
Activities
To creditors as repayment of the
Cash Inflows
principal amounts of debt
(excluding trade payables that
From owners when shares are
sold to them
relate to operating activities)

Example: Espresso Fratelli (Cont.)


Lets go back to our Espresso Fratelli example. To prepare the cash flow statement, we must return
to the Cash T-account and examine the transactions that affected the account throughout the
period. First, classify each transaction as operating, investing, or financing and then prepare the
statement of cash flows on the next page.

1. Walter and Gustavo contribute $20,000 in cash to start-up the business.


2. The company takes out a three-year loan from the bank in the amount of $10,000.
3. The company purchases an espresso machine and cart for $27,000 in cash.
5. Total supplies purchased during the month were $1,000. All purchases were made with cash.
6. The company paid $1,200 in cash to rent a space in front of Paccar Hall for 6 months
7. During the first month of operations, cash sales totaled $4,800.
8. In addition, sale of pre-paid coffee cards totaled $400 during the month.
9. Since business was better than expected, Walt and Gus hired a part-time barista to help out.
Wages paid to the part-time barista were $320.

Example: Espresso Fratelli (Cont.)


The final statement of cash flows should look like this:
Espresso Fratelli
Statement of Cash Flows
For the month ended June 30, 2015
OPERATING ACTIVITIES:

Cash
Cash
Cash
Cash

collected from customers


paid for supplies
paid for rent
paid for wages

Cash Flows From Operating Activities


INVESTING ACTIVITIES:
Cash paid for equipment
Cash Flows From Investing Activities
FINANCING ACTIVITIES:
Cash from owner contribution
Cash from bank loan
Cash Flows From Financing Activities
Net Cash Flows

Differences between US GAAP and IFRS

Fair game for midterm

Accrual vs. Cash Flow Concepts


Cash flows from operations is a distinctly different concept from net
income (accrual accounting):
1. Cash Flow Accounting - benefits and efforts are measured in terms of
cash inflows and cash outflows.
2. Accrual Accounting - benefits and efforts are measured in terms of
revenues and expenses. Revenues are inflows of assets (or
decreases in liabilities) and Expenses are outflows of assets (or
creation of liabilities). Cash is just one type of asset!

Accrual vs. Cash Flow Concepts


Accounts receivable
Notes receivable
Deffered revenue
Unearned revenue

Accrual vs. Cash Flow Concepts

Accrual vs. Cash Flow Concepts

Note that in each case, an asset or liability holds the timing difference
between net income and cash flows from operations.

Accrual vs. Cash Flow Concepts


We can think of accruals as a parking place for expected future cash
flows
Which measure is more important?
Both measures provide important to potential investors. Cash flow
measure are important for assessing liquidity. They may also be used
to assess the quality of earnings
What do markets think?

Accrual vs. Cash Flow Concepts


Dechow, P., 1994, Accounting Earnings and

Recall that in our Espresso


Fratelli example, Net Income for
June did not equal Cash Flows
from Operations. Why?
The timing of cash inflows
and
Earnings based on
outflows
accrual accounting
did not
explains almost four
match
times more variation the
in stock returns than timing of
operating cash flows.
economic events.

Accrual vs. Cash Flow Concepts


Lets compare the Net Income and Cash Flows from Operations of Top
Dawn Espresso:
Income Statement
Revenue
4,950
Expenses:
Cost of Goods Sold
825
Supplies Expense
900
Rent Expense
200
Wage Expense
320
Interest Expense
100
Depreciation Exp
400
NET INCOME
2,205

Statement of Cash Flows


Cash collections from sales
5,200
Cash paid for inventory
Cash paid for supplies
Cash paid for rent
Cash paid for wages
Cash paid for interest
Cash paid for depreciation
Cash flows from operations

1) Revenues do not equal Cash Collections from Sales. Why?

0
1,000
1,200
320
0
0
2,680

Accrual vs. Cash Flow Concepts


Espresso Fratelli received cash from customers from the sale of gift
cards and had not yet met its performance obligations to them.
In this case, revenue = cash collected fro customers - unearned
revenue.
2) Cost of Goods Sold (cost of coffee beans used) does not equal cash
paid for inventory. What are the differences?
Espresso Fratelli purchased coffee on account. It will eventually have
to pay this amount to its suppliers. In addition, it did not use up all of its
coffee inventory.
In this case, COGS = Accounts Payable - Inventory (Coffee)

Accrual vs. Cash Flow Concepts


3) Supplies Expense does not equal Cash Paid for Supplies. What are
the differences?
Espresso Fratelli did not use up all of the supplies that it purchased.
These supplies will be used in future periods.
Supplies expense = cash paid to suppliers - inventory (supplies)
4) Rent expense does not equal cash paid for rent. What are the
differences?
Espresso Fratelli paid for six months rent in advance. It has only used
up one months worth of rent.
Rent expense = cash paid for rent - prepaid rent

Accrual vs. Cash Flow Concepts


5) Interest expense does not equal cash paid for interest. What are the
differences?
Interest is payable annually and is not due for another 11 months. Thus
no cash flow has occurred yet.

6) Depreciation expense does not equal cash paid for depreciation. What
are the differences?
The depreciation expense allocates an investing cash flow over several
periods. It does not involve an operating cash flow.

Conversion from cash basis to accrua/l basis

Converting Cash Basis Income to Accrual Basis


e
Incom
Increases
Assets
Liabilities

Decreases

Add

Deduct

Deduct

Add

Conversion from cash basis to accrual basis


We can reconcile Espresso Fratellis operating cash flows to its net income
as follows:
Revenue
- COGS

= cash collected from customers + Accounts Receivable - Unearned Revenue


= cash paid to suppliers + Accounts Payable - Inventory

- Rent Expense

= cash paid for rent - Prepaid Rent

- Supplies Expense

= cash paid for supplies - Supplies

- Wage Expense = cash paid for wages - Wages Payable


- Interest Expense
- Dep. Expense

= cash paid for interest - Interest Payable


= Depreciation Expense

Net Income
= operating cash flow + Accounts Receivable - Unearned Revenue
- Accounts Payable + Inventory + Prepaid Rent + Supplies
+ Wages Payable + Interest Payable Depreciation Expense
Net Income

= operating cash flow + Current Assets - Current Liabilities Depreciation Expense

Inferring Journal Entries


Inferring Journal Entries
Although many different events might affect any given account, there
are generally standard transactions that affect each balance sheet
account.
Examples: For each account, think about what will make the account
increase and what will make the account decrease:

Balance Sheet Account

Increase
Revenue

Accounts receivable
Interest revenue

Interest receivable
Merchandise inventory -

Decrease
Collect cash flow, increase
allowance for doubtful accounts

Supplies inventory

Inferring Journal Entries


Increase

Balance Sheet Account

Decrease

Cash

Expense

Cash

Expense

Cash, payable

Depreciation, sale of equipment

Asset

Cash

Wage expense

Cash

Interst expense

Cash

Cash

revenue

Prepaid insurance
Prepaid rent
Property, Plant & Equip
Accounts payable
Wages payable
Interest payable
Unearned revenue
Therefore, if you know the change in a balance sheet account from the
beginning of a period to the end of a period (the net increase or decrease in

the account), AND you know one reason for the change you can infer the other
reason for the change.

Practice Problem
Following is selected balance sheet information from Sarlaacs Plant Food, Inc. for the
years ended December 31, 2014 and 2015.

Account
12/31/14 12/31/15 Accounts Receivable
8,500
9,000
Merchandise Inventory
10,100
9,600
Prepaid Rent
2,400
2,000
Accounts Payable
8,900
7,900
Wages Payable
1,900
2,000
In addition, the following information for the year ended 12/31/15 is provided to you:
Accrual sales
Cash paid to suppliers for inventory purchased on account
Rent Expense
Cash paid for wages

$24,500
13,700
3,400
4,700

Practice Problem
Using this information, compute the following (NOTE: Assume that accounts payable
relates entirely to merchandise inventory):
a) Cash collected from customers

$________________

b) Cash paid for rent expense

$________________

c) Cost of goods sold

$________________

d) Wage expense

$________________

Back to Cash Flows


Two generally accepted formats can be used to
report operating activities:
Direct Method

Cash effect of each


operating activity is
reported directly in the
statement

Indirect Method

Net cash flow is derived


indirectly by starting with
reported net income and
adding or subtracting
items to convert that
amount to a cash basis

Conversion from cash basis to accrual basis


Reverses the differences between the accrual-based income statement
and cash flows from operating activities
Recall from the Espresso Fratelli example:
Net Income = operating cash flow + Current Assets - Current Liabilities
Depreciation Expense
operating cash flow = Net Income - Current Assets + Current Liabilities
+ Depreciation Expense

Converting Accrual Basis Income to Cash Basis


e
Incom
Increases
Assets
Liabilities

Decreases

Deduct

Add

Add

Deduct

Net Cash Flow from Operating ActivitiesIndirect


Versus Direct Method
Adjustments Needed to Determine Net Cash Flow from Operating Activities.
Illustration 23-18

Example Espresso Fratelli (Cont.)


Note that the beginning balances for all the Espresso Fratelli accounts
are zero.
We can calculate the net cash flow from operating activities using the
indirect method as follows:

In Class Excercise Cash Flows (Indirect Method)


The following data were taken from the books of the Hoth Snowmobile
Company:
Accounts receivable .......................
Accounts payable ..........................
Accumulated depreciation (no plant
assets were retired during the year)......
Inventories ...............................
Other current liabilities .................
Prepaid insurance .........................
Net income ................................
Long-term
liabilities
(no
principal
payments or retirements occurred
during 2014) ................................

2014
$ 170,100

2013
$ 150,750

103,500

126,000

234,000
238,500
45,000
10,800
319,500

198,000
195,000
27,000
12,000

1,500,000

1,500,000

Compute the net cash flow provided by (used in) operating activities during
2014 for the Hoth Snowmobile Company.
Intentionally Blank

foster.washington.edu