The purpose of the income statement

to summarize the profit-generating activities that occurred during a particular reporting period.

The purpose of the statement of cash flows

to provide information about the cash receipts and cash disbursements of an enterprise that occurred during the period.

Income from Continuing Operations

Revenues: Inflows of resources resulting from providing goods or services to customers.

Expenses: Outflows of resources incurred in generating revenues.

Gains and Losses: Increases or decreases in equity from peripheral or incidental transactions of an entity.

Income Tax Expense: Because of its importance and size, income tax expense is a separate item.

Operating versus Nonoperating Income

Operating Income: Includes revenues and expenses directly related to the principal revenue-generating activities of the company

For example, it includes sales revenues from selling the products it manufactures as well as all expenses related to this activity.
Similarly, operating income might also include gains and losses from selling equipment and other assets used in the manufacturing
process.

Nonoperating Income: Includes gains and losses and revenues and expenses related to peripheral or incidental activities of the
company

For example, it includes interest and dividend revenue, gains and losses from selling investments, interest expense in nonoperating
income, and depreciation and amortization expense. Other income (expense) is often the classification heading companies use in the
income statement for nonoperating items. On the other hand, a financial institution like a bank would consider those items to be a part
of operating income because they relate to the principal revenue-generating activities for that type of business.

Income Statement (Multiple-Step)

 IMPORTANT
(matching)

*Earnings quality: the ability of reported earnings to predict a company’s future earnings. (Transitory Earnings vs Permanent Earnings)

Restructuring Costs: Costs associated with the shutdown or relocation of facilities or downsizing of operations are recognized in the
period incurred.

*Goodwill Impairment and Long-lived Asset Impairment: Involves asset impairment losses or charges. Any long-lived asset,
whether tangible or intangible, should have its balance reduced if there has been a significant impairment of value.

Earnings per share (EPS): shows the amount of income earned by a company expressed on a per-share basis.

Basic EPS: Net income less preference dividends divided by Weighted-average number of ordinary shares outstanding for the period.

*Diluted EPS: Reflects the potential dilution that could occur for companies that have certain securities outstanding that are convertible
into ordinary shares or share options that could create additional ordinary shares if the options were exercised.

*Comprehensive Income: An expanded version of income that includes gains and losses that traditionally have not been included in
income statements.

IMPORTANT
(short-answer)
The Statement of Cash Flows

- Provides relevant information about a company’s cash receipts and cash disbursements.
- Helps investors and creditors to assess
o future net cash flows
o liquidity
o long-term solvency
- Required for each income statement period reported.

IMPORTANT
(Short-answer)
Indirect and Direct Methods

Companies favor the indirect method for two reasons:

1. Easier and less costly to prepare.
2. Focuses on differences between net income and net cash flow from operating activities.
 Classification of Cash Flows

Operating Activities Investing Activities Financing Activities

Income Statement Items Changes in Changes in

Investments and Long-Term Asset Items Long-Term Liabilities and
Stockholders’ Equity Items

Operating Activities
Inflows from: (+)
l sales to customers.
l interest and dividends received from investments (either Operating or Investing according to IFRS)

Outflows for: (-)

l purchase of inventory.
l salaries, wages, and other operating expenses.
l interest on debt and dividends paid (either Operating or Financing according to IFRS)

Investing Activities

Inflows from: (+)

l sale of long-lived assets used in the business.
l sale of investment securities (shares and bonds).
l collection of nontrade receivables.
l interest or dividends received from investments(either Operating or Investing according to IFRS)

Outflows for: (-)

l purchase of long-lived assets used in the business.
l purchase of investment securities (shares and bonds).
l loans to other entities.

Financing Activities

Inflows from: (+)

l sale of shares to owners.
l borrowing from creditors through notes, loans, mortgages, and bonds.

Outflows for: (-)

l owners for the repurchase or reacquisition of shares previously sold.
l creditors for the repayment of the principal amounts of debt.
l interest on debt and dividends paid(either Operating or Financing according to IFRS
 Significant Noncash Activities

( Transactions without paying in the moment )

1. Direct issuance of common stock to purchase assets.
2. Conversion of bonds into common stock.
3. Issuance of debt to purchase assets.
4. Exchanges of plant assets.

Companies report noncash activities in either a

o separate schedule (bottom of the statement) or
o separate note to the financial statements.

( Didn’t report in the cash flow because cash flow statement deals with cash only, so reporting if cash paid or earned )

Two Formats for Reporting Operating Activities

Direct Method: Reports the cash effects of each operating activity.

Indirect Method: Starts with accrual net income and converts to cash basis.

IMPORTANT
(Matching or Short-answer)

1. Issued 100,000 shares of $5 par value common stock for $800,000 cash.

Answer: Financing

2. Borrowed $200,000 from Castle Bank, signing a 5-year note bearing 8% interest.

Answer: Financing

3. Purchased two semi-trailer trucks for $170,000 cash.

Answer: Investing

4. Paid employees $12,000 for salaries and wages.

Answer: Operating

5. Collected $20,000 cash for services performed.

Answer: Operating
 Step 1: Operating Activities
Summary of Conversion to Net Cash Provided by Operating Activities—Indirect Method

1- Non cash activities =

• all positive values (I didn’t pay cash)

2- Gains and Losses =

• gain = deduct
• loss = add

3- Changes in current assets and current liabilities =

• Increase in Asset = deduct
• Decrease in Assets = add
• Increase in Liabilities = add
• Decrease in Assets = deduct

Dividend = BNG. Retained earning + Net income – END. Retained earning

When it is mentioned in the income statement that it is begun at the beginning then the BNG. Retained earnings will be equal to zero

EXPLAINATION: (MY NOTES)

Steps to develop an indirect method of the net cash flow income statement

The first step Operating Activities:

Include:
1- Net income
2- Adjustment of the non-cash effects
3- Changes in operating assets and liabilities
= Net cash flow from the operating activities

The second step Investing and Finance Activities:

Include:
1- Net cash flow from the operating activities (founded in step one)
2- Cash flow from investing activities
3- Cash flow from financing activities (long-term liabilities + shareholder)

Cash balance, January 1 = dividend

Cash balance December 31 = the calculation of the income statement (should be equal to the cash given in the question)
QUESTION 1:

ANSWER:
Question 2:

Additional information for 2017:

1. Depreciation expense was comprised of $6,000 for building and $3,000 for equipment.
2. The company sold equipment with a book value of $7,000 (cost $8,000, less accumulated depreciation $1,000) for $4,000
cash.
3. Issued $110,000 of long-term bonds in direct exchange for land.
4. A building costing $120,000 was purchased for cash. Equipment costing $25,000 was also purchased for cash.
5. Issued common stock for $20,000 cash.
6. The company declared and paid a $29,000 cash dividend.
Answer:

Step 1: operating activities

1- Cash flow from operating activities

• Net income
2- Adjustments to reconcile net income to net cash provided by operating activities:
• Non-cash activities such as (depreciation, amortization, or depletion expenses)
3- Deduct gain and losses
4- Changes in noncash current assets and current liabilities

Cash flows from operating activities:

Net income $ 145,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense 9,000
Loss on disposal of equipment 3,000
Decrease in accounts receivable 10,000
Increase in inventory (5,000)
Increase in prepaid expenses (4,000)
Increase in accounts payable 16,000
Decrease in income taxes payable (2,000)
Net cash provided by operating activities $ 172,000

Step 2: Investing and financial activities

Company purchased land of $110,000 by issuing long-term bonds. This is a significant noncash investing and financing activity that
merits disclosure in a separate schedule.

Answer:
Net cash provided by operating activities 172,000
Cash flows from investing activities:
Purchase of building (120,000)
Purchase of equipment (25,000)
Sale of equipment 4,000
Net cash used by investing activities (141,000)
Cash flows from financing activities:
Issuance of common stock 20,000
Payment of cash dividends (29,000)
Net cash used by financing activities (9,000)
Net increase in cash 22,000
Cash at beginning of period 33,000
Cash at end of period $ 55,000

Disclosure: Issuance of bonds to purchase land $ 110,000

 Full answer:

Cash flows from operating activities:

Net income $ 145,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense 9,000
Loss on disposal of equipment 3,000
Decrease in accounts receivable 10,000
Increase in inventory (5,000)
Increase in prepaid expenses (4,000)
Increase in accounts payable 16,000
Decrease in income taxes payable (2,000)
Net cash provided by operating activities 172,000
Cash flows from investing activities:
Purchase of building (120,000)
Purchase of equipment (25,000)
Sale of equipment 4,000
Net cash used by investing activities (141,000)
Cash flows from financing activities:
Issuance of common stock 20,000
Payment of cash dividends (29,000)
Net cash used by financing activities (9,000)
Net increase in cash 22,000
Cash at beginning of period 33,000
Cash at end of period $ 55,000
 IMPORTANT T/F

U. S. GAAP vs. IFRS

Both U.S. GAAP and IFRS require a statement of cash flows and classify cash flows as operating, investing, or financing.

IFRS
• Dividends and Interest Received either Operating or investing activity.
• Dividends paid and Interest paid either Operating or Financing.
U.S GAAP
• Dividends Received, Interest Received, and Interest Paid are Operation activity.
• Only Dividends Paid is Financing activity.