Entity Concept – According to the concept of a business entity, a business is considered to be an

entity separate from its owners, creditors or other businesses hence any liability incurred to
company has nothing to do with the owner. It’s all about business related transactions that are
recorded separately from owners or other business transactions

Historical Cost Assumption – The assets, instead of the current value, should be shown on the
balance sheet at the purchase cost. This means that assets and liabilities of a business are suppose
to be recorded at its original price that was paid not the current price by the market. Example –
when u buy a vehicle when u buy a vehicle at 5000, but 10 years later the value of vehicle
depreciates but due to historical cost assumption we record the 5000.

Matching Principle - Matching principle is that revenues and any expenses that helped to
generate that revenue must be recorded together in the same time period, so its matching and
assits a business to show accurate picture of the activities. For example, a company reports an

Revenue Principle - This principle states that when revenue it is earned and realised or
realizable, and not when the cash is collected or received. For example, if manicure shop
performs Rm100 worth of service in December but only receives payment in January, the
revenue should be recorded in December when it was earned.

Long-term liabilities that is affected by financing activities

bank loans and mortgages

Operating Activities different from investment activities

Cash flow statement operating activities differ from investment activities as operating cash flows
arise from normal revenue generating operations, such as cash receipts from revenue and cash
disbursements to pay for expenses. Investing cash flows, however, stem from a business
investing in or disposing of long-term assets.

List different users of accounting information and explain how these users can use the
accounting information to make important decisions.
The users of accounting information include employees, shareholders, managers, suppliers,
banks, customers, investors, potential investors, tax authorities, etc. These users are been
grouped into two internal and external users.

Employees: Employees use accounting information to see how well the company is doing so
that they are able to ask for higher salaries, promotions when the company is performing well,
the accounting information Is used to negotiate to get better pay. They also use this to get other
incentives such as health care, fitness and food subsidies.

Shareholders: Shareholders would use this information to assess the performance of the
company to see if it is profitable to remain their shares in the company or sell their shares off. If
a company’s shares are priced very high and owner thinks it’s worth it to see off for a large
amount of money they can do so.

Investors: Investors would use this for investment decisions, they will use this information to
asses a company’s ability to provide them with the maximum returns within the shortest amount
of time, if that is attractive to them then they can decide to invest in the company

Banks: Banks use this information before giving out a loan to the company it is for loan and
overdraft purposes, banks use this information to check if the business is able to pay back on a
loan if they have a lot of debts unpaid or not earning profits they may not proceed with the loan.

Suppliers: Suppliers use this information to decide on whether to continue supplying materials
to the company, this is done by checking if there would be a high risk of their credit worthiness
to see if the company is reliable on paying money back.

Managers: for business decisions and dividend payout

Customers: to determine the extent of company’s financial position.
Tax authority: for tax purposes

 Creditors- will judge a company’s ability to payback credit with this accounting
information before deciding on whether or to supply them with goods.
 Banks - will use this information to ensure a business is able to return bank loan before
deciding whether or not to lend money.
 Investors - will assess a company’s ability to provide maximum returns within the least
amount of time before deciding on investing in that company
 Government - uses this information to check if a business is providing taxes according to
their income
 Competitors - uses this information to ensure they are making accurate comparisons of
profitability and return on investments by analyzing market share of another company
and their performance.

Explain the difference between accrual accounting and cash-basis accounting

Accrual basis accounting records transactions as it occurs. Revenue is recorded or recognized
when its earned or when the services has been done. Contrastingly, expenses is recorded and
recognized when its incurred hence when a business has received or not received the payment
they still have to record it.

On the other hand, Cash basis only records cash receipts and payments, any payment without
cash is ignored. Revenue is recored when the cash is received, expenses is recorded when the
cash is paid. However this is not approved by accounting standards.

Accrual Basis; Revenue is recognised when services are performed

Cash Basis - Revenue is recognised when cash is received
Accrual Basis: Expense is recognised when it is incurred
Cash Basis: Expense is recognised when cash is paid

How do we use free cash flow to evaluate firm’s performance?

Free cash flow is the cash that is available from the operating activities after paying for dividends
to shareholders and planned investments ( long term assets ). This is used to analyse and estimate
how much free cash would be available for new unexpected opportunities

Describe how the statement of cash flows helps investors and creditors perform each of the
following functions:

Statement of cash flow is a statement that shows the sources of cash inflow and outflow, it
reports the reasons why cash increased of decreased during a span of time. For example, we can
see why net income on an income statement does not equal the change in cash balance

Predict the ability to make debt payments to lenders and pay dividends to stockholders.
Cash flow reports previous cash receipts and payments hence it helps to predict future cash flows
and are also a good indication of future cash flows

Evaluate management decisions.

Cash flow reports on past managers investments hence it helps evaluate management decisions,
when managers make good decisions this would in turn benefit a company’s performance

Predict future cash flows.

Cash flows reports a company’s cash on where it came from and how its spent hence investors
and shareholders are able to get the net balance and use it to predict a company’s ability to pay
back its debts to lenders and also pay its dividend to its stockholders

Discuss different strategies that businesses can implement in order to improve their cash
flow position.

Offer discount for early payment

One way to improve cash flow is to get customers to pay earlier and make sure they pay, hence giving them some
benefits if they pay earlier would have a higher chance of them paying earlier. For example, offering 10% off if
customers pay within 3 days. This helps customer save some money and company received the payments from
customers for cash flow to be better.
Liquidating old stock
Liquidating old inventory can be helpful to improve cash flow, by identifying which stocks that
are older and not selling company can either re-market it, sell it in bundles or even put a
discount on them to make the stock seem more attractive hence customers will be interested to
buy then stock would be liquidated.

Take out small business loan

Cut down unnecessary expenses

By reducing unnecessary expenses the company can decrease cash being tied up in getting more
raw materials or goods/ services that are not that essential for the business, hence ordering a
lesser amount of supplies( accurate just right amount ) from suppliers can help with the cash
flows.

Increasing profit margin

Increasing profit margin means more cash would be coming in which helps to improve cash
flows, company can do this by reduce the amount of discounts given to customers instead use
other forms of marketing to attract customers, increase prices of items so that company will
receive more profits and companies can also create loyalty programs such as accumulating points
to receive some free gifts, this attract customers to come back and creates more loyal customers
to purchase more products providing more profit.

Take advantages of technology

To make customers pay, we can use the advanced technology by implementing E-wallets giving
customers more methods for customers to pay, such as using credit cards, using online payments
such as grabpay and Maybank pay. This makes it more convenient for customers, hence more
customers will make payments fast improving cash flows.

Checking customers’ credit

When a customer is not willing to pay a service in cash. Safe to assume they would want
to pay in credit. When they opt for the second choice, we would have to conduct a credit
check. If the customer has a bad credit, we can assure that they would not be able to pay
on time. For instance, customers would be penalized to a certain amount if they do not
pay on time.
Discuss three limitations of ratio analysis.

Historic analysis
Ratios are calculated based on previous year financial performances or for one period of time
hence the indicators of performance are not in current time. Calculating ratios takes a long
time, by the time it's calculated it may be outdated and the analysis information is usually old
taken from previous years.

Manipulation of ratios
Ratios are derived from financial statements which can be manipulated by companies by
window dressing to get the best ratios so that performance seems better than its actual
performance hence this ratio and information becomes unreliable as the real nature of the
business is not reflected. For example a company may manipulate its profi

No complete explanation
Ratios does not give a complete explanation as it only indicates one area of a business
performance, we use ratio to identify problems but it doesn't explain the causes of the
problem. For example, if we discover a company's profit margin ratio decreasing from 14%
to 10%, we wouldn't be able to know the cause of it. We are only able to predict the cause of
it hence this is a limitation when using ratios as we aren't able to fully analyse the problem
and the cause to solve the issue.

What should the net change in cash section of the statement of cash flows always reconcile
with?

The net change in cash section is derived from the beginning period cash and cash equivalents
minus by the end period of cash and cash equivalents. The net change in cash would end up
being equivalent to the sum of operating, investing and financial cash flow. So, it means that
beginning cash plus operating, minus financing and investing will equal to ending cash.
LECTURE 1
What distinguishes a proprietorship from other types of business organizations?
A proprietor does have any partners or other people involved only one person contributing,
unlike for a company, limited liability and partnership where there is partners or share capital for
capital contribution, additionally the owner of the business is only one person a sole proprietor
hence all the liabilities and responsibility goes to the sole proprietor and there are no
shareholders or partners involved.

What are the advantages of corporations?

Sole Proprietorship
Advantages
• Less paperwork & additional formalities (registration is easy, fast, and fewer documents
are needed)
• Simple administration (not compulsory for statutory audit)
• Lower compliance cost
• Suitable for newly start-up business with low entry cost
• Not required to disclose financial statements to public

Disadvantages
• Unlimited liability, personal assets may have to be used to satisfy business debts
• Ownership funds is restricted to personal resources of proprietor
• Experience and knowledge is limited
• Access to non-ownership funding (supplies of goods and services on credit) is often
limited

Partnership
Advantages
• Greater access to capital
• Different skills (professional, administrative, technical)
• Grater management flexibility
• Taxation advantages

Disadvantages
• Higher level of regulation
• Giving up profit and assets
• Reduce decision making authority
• Mutual agency imposes extra responsibility for the business actions of other partners
• Unlimited liability

Company
Advantage
• Limited liability ( personal liability protection )
• Suitable for business
 • Affordable to maintain business with the higher operation costs
• Ownership stocks easily transferred to someone else

Disadvantage
• More paperwork
• More expensive
• Complex administrations
• Higher compliance costs
• Public has access to financial affairs of the company

Limited Liability Partnership ( LLP )

Advantage
• Less paperwork
• Registration easy and fast as lesser documents needed
• Limited liability, most simple administration
• Audit is not compulsory
• Lower compliance cost
• Low entry cost suitable for start-up business
• Not required to disclose financial statements to public

Disadvantage
• Local resident compliance officer is required to setup the LLP hence cost incurred
• Need at least 2 members so if one member wants to leave they may have to dissolve
• Public disclosure of financial accounts

Differentiate between financial accounting and managerial accounting.

Financial accountings ( FA ) main purpose is to make periodic reports for stakeholders and FA
emphasizes on fast activities, and have internal (managers) and external users (customers). FA’s
have to be reported either annually or semi annually and need to go through external auditing and
uses only quantitative data. FA’s reports about historical data and focuses on the entire
organization. FA accounting reports are guided by rules and principals like GAAP and IFRS.

Wherelese

Managerial accounting ( MA ) main purpose is to provide information to assist managers in

making good decisions. It reports on current and future decisions of a company weekly daily or
montly depending on when management wants it. It is for Internal users only like managers, it
reports on present past and current both qualitative and quantitative data on focused single
products or specific segment and does not need to follow any rules and doesn’t need to go
through external auditing.
 FA MA
Users Internal and external Internal
Frequency of Annually or semi annually Weekly, daily, monthly
report
Timely nature Historical in nature Present, current or future
Objective To report to shareholders To management for decision
Regulation IFRS , GAAP This has NO regulation

Recommended answers
Financial Accounting Management Accounting

The primary objective of FA is to make The primary objective of MA is to provide

periodic reports to stakeholders.
Financial accounting emphasis on fast
activities
FA is guided by rules and principles like
GAAP
FA is subjected to external assessment
auditing
FA mostly once in a year
FA focus on the entire organization
FA used quantitative data only
information of management to make decision
MA emphasis on current and future decisions
MA does not follow rules and principles
MA is not subject to external assessment
MA can be weekly depending on
management demand
MA focus on a single product or segment.
MA used both qualitative and quantitative
data

For each user of accounting information, identify if the user would use financial accounting
(FA) or managerial accounting (MA).
a. Investor (FA)
b. Banker (FA)
c. Internal Revenue Service (tax collection) LHDN (FA)
d. Manager of the business (MA)
e. Controller (MA)
f. Stockholder (FA)
g. Human resources director (MA)
h. Creditor (FA)
 Proprietorship Partnership Corporation
Business entity yes yes yes
Legal entity no no yes
Limited liability no no yes
Unlimited life no no yes
Business taxed no no yes
One owner allowed yes no yes

Advantages and Disadvantages of partnership

Advantage
Generally, partnerships are easy to establish and since there is more than one owner, there is a
bigger pool of resources (financial or otherwise) at the business’ disposal.

Disadvantage
Both the brothers are vulnerable to unlimited liability for anything to do with the business,
whether caused by one or the other and may even lose the business as well as their personal
assets. The business shall automatically cease upon the death of either one of them, although
partners can independently make commitments without the other’s approval.
All this only applies if there is no partnership agreement stipulating otherwise.

A limited partnership is also possible in cases where there is a need to limit the extent of
liability to one party. It is recommended that they should consider starting a general partnership
with a tailor-made Partnership Agreement spelling out each brother’s responsibility, authority,
commitment and liability as well as operational and strategic roles.

Consider the following account: (Asset, Liability. Equity, Expenses, Income)

a. Accounts Payable (L)
b. Cash (A)
c. Owner, Capital (Equ)
d. Accounts Receivable (A)
e. Rent (exp)
f. Service Revenue (income)
g. Office supplies (A)
h. Owner, Withdrawals (Equ)
 i. Land (A)
j. Salaries (exp)

Lecture 2
1 Dora started business with RM8,000 and deposited money in the business bank
account Increase assets (Bank); Increase Equity (Capital, Dora Traders)

2 Purchased supplies RM200 on credit. Increase Assets (Supplies); Increase

Liability (Accounts Payable).

3 Paid RM200 to a creditor by cheque. Decrease Liability (Accounts Payable);

Decrease Assets (Bank).

4 Dora withdrew RM250 from Dora Services Bank Account. Decrease Equity
(Withdrawals); Decrease Assets (Bank).

5 Accrued Service Revenue, RM3,000 Increase Assets (Accounts Receivable);

Increase Equity (Service Revenue).

6 Received cash RM1,000 for a service to be performed next month. Increase

Assets (Cash); Increase Liability (Unearned Liability).

7 Paid utility bill RM500. Decrease Equity (Utility Expense); Decrease Assets
(Cash).

8 Signed a contract worth RM10,000 with a customer. No entry required.

9 Received RM50,000 loan from a local bank. Increase Assets (Bank); Increase
Liability (Loan).

10 Accrued salary expense, RM1,000. Decrease Equity (Salary expense);

Increase Liability (Salary Payable).

Why decrease equity when the salary hasn’t came in?

1) Purchased equipment for RM10,000 on account. Increase assets (Equipment); Increase
Liability (Accounts Payable)

2) Paid RM5000 to a creditor. Decrease liability (Accounts payable); Decrease Assets

(Cash).

3) The owner withdrew RM500 cash from a business. Decrease Equity (Withdrawals);
Decrease Assets (Cash).

4) Sold goods, RM11,000 on cash. Increase Assets (Cash); Increase Equity (Sales Revenue).

5) Sold goods on account, RM26,000. Increase Assets (Accounts Receivable); Increase

Equity (Sales Revenue).

6) Received electricity bill for RM2,200. The bill is yet to be paid. Decrease Equity (Utility
Expense); Increase Liability (Utility Payable).

7) Applied for a loan at a local bank. No Entry required.

8) Received RM50,000 loan from a local bank. Increase Assets (Bank); Increase Liability
(Loan).

9) Received RM100,000 on shares issue. Increase Assets (Bank); Increase Equity (Capital).

• Sam’s Snack Food received cash from the owner and gave capital to Sam. ( Increase asset
(cash); Increase equity (Sam, Capital)

• Cash purchase of land for a building site. Increase asset (Land); Decrease asset (Cash)
• Paid case on accounts payable. Decrease asset (Cash); Decrease liability (Accounts
Payable)
• Purchased equipment; signed a note payable. Increase asset (Equipment); Increase
liability (Notes Payable)
• Performed service for a customer on account. Increase asset (Accounts Receivable);
Increase equity (Service Revenue)
 • Employees worked for the week but will be paid next Tuesday. Increase liability (Salaries
Payable); Decrease equity (Salaries Expense)
• Received case from a customer on accounts receivable. Increase asset (Cash); Decrease
asset (Accounts Receivable)
• Borrowed money from the bank. Increase asset (Cash); Increase liability (Notes Payable)
• Owner withdrew cash. Decrease asset (Cash); Decrease equity (Shane, Withdrawals)
• Incurred utilities expense on account. Increase liability (Accounts Payable); Decrease
equity (Utility Expense)

Compute the amount of net income or net loss during June 2016.

a. The owner contributed $12,500 to the business and made no withdrawals.

b. The owner made no contribution and withdrew case of $12,000.
c. The owner made contribution of $19,000 and withdrew case of $11,000.

Answer:

a. b. c.

Owner’s equity, May 31, 2016 ($144,000 – $99,000) $ 45,000 $ 45,000 $ 45,000
Owner contribution 12,500 0 19,000
Net income for the month 7,500 32,000 12,000
65,000 77,000 76,000
Owner withdrawals 0 (12,000) (11,000)
Owner’s equity, June 30, 2016 ($209,000 – $144,000) $ 65,000 $ 65,000 $ 65,000

2016 total assets = 38,000, total liabilities = 12,000

End of 2016 total assets = 50,000 , total liabilities = 10,000

Equity increase of decreasing during 2016?

Assets = Liabilities + Equity

Beginning of 2016 $38,000 = $12,000 + ?
$38,000 = $12,000 + $26,000

End of 2016 $50,000 = $10,000 + ?

$50,000 = $10,000 + $40,000

Owner’s equity increased in 2016 by $14,000 ($40,000 – $26,000).

Define the accounting equation and its elements.

Measures the resources at the disposal of the business + claims to those resources ( Assets =
Liabilities + Owners Equity )

The Financial Statement

After analyzing and recording all transactions = Total assets = Total liabilities + Capital/Owners
equity

Lecture 3
Revenue
Income generated from the operations. i.e., revenue is an income generated from the sales of
goods or services related to the company’s primary activities.

Revenue recognition
The principle states that a firm should record revenue on its book of accounts when it is earned
and it is realized or realizable and NOT when the cash is collected.

Revenue Principle
- Revenue recognition principle = revenue realised and earned
- Revenues should be recognized when the major economic activities have been completed
- Sales are recognized when the goods are sold and delivered to customers or services are
rendered
Following criteria observed before realization can occur
- Goods or services are provided for the buyer
- The buyer accepts liability to pay for the goods or services
- The monetary value of the goods and services has been established
- The buyer will be in a situation to pay for the goods and services

Recognition of revenue
• The realization concept develops rules for the recognition of revenue
• The concept provides that revenues are recognized when it is earned, and not when
money is received
• It is only when you can be reasonable certain as to how much will be received that you
can recognise profits or gains

Effect on capital account

Net profit shown as balancing figure on the DR side of profit and loss account = no credit entry
has been made to complete double entry

• Net profit increase capital of owner, credit entry must be made in capital account by
transferring net profit from profit loss account Every sale made at a profit (and other
income received) increases the capital of the proprietor.
• Each sale made at a loss or each item of expense decreases the capital of the proprietor.
• Instead of altering capital after each transaction, the respective profit and loss and
revenue and expenses are collected together using suitably described accounts.
• All balances are brought together in one financial statement [income statement] and the
increase in capital [net profit] is determined

Why do you think that the balance sheet is not part of the double entry system?
• A balance sheet is a financial statement that summarises the position of a business at the
end of a period.
• It contains all the balances on the accounts held in the accounting books at that time.
• As it is prepared after the income statement, all the accounts have already been balanced
off.
 • All we do is to lift the balances carried forward from the accounts and place them in an
appropriate position in the statement

Questions tutorial 3

Revenue definition = revenue recorded when performed service

State the amount of revenue that should be recognized by Garrett Ltd in the year ended 31
December 2019 for each item below, justifying your answer by reference to the revenue
definition, recognition and measurement criteria in the IASB Conceptual Framework:

COMPANY revenue for 2019 were RM50,000, 90% collected in 2019. Past experience indicates
that about 98% of all credit Revenues are eventually collected.
The entire RM50,000 should be recognized as sales revenue in 2019 as the service was provided
during the year. 2% of net credit sales will be recorded as bad debts.

COMPANY received RM8,000 cash in advance from a customer in November 2019, for the
services to be performed in January 2020.
RM8,000 of cash received in advance cannot be recognized as revenue in 2019 because the
service will be performed in January 2020. However, this will be reported as a liability (unearned
revenue) for 2019. The unearned revenue will be recorded as revenue in 2020 after the service is
performed.

COMPANY started renting out its excess office space on 1 December 2019, on which date the
company received RM6,000 cash from its tenant for 4 months’ rent, in advance.
The amount of revenue recognized in 2019 is RM1,500 (RM6,000*1/4). This means revenue
from rent is recognized for the month of December 2019. The remaining RM4,500 should be
recorded under unearned revenue (liability).
COMPANY received RM10,000 Interest from Bank on January 2019, the Interest was earned on
December 2018.
Revenue of RM10,000 is not recorded in 2019 as the interest was earned in 2018.

COMPANY received a car as settlement for services performed on credit for RM6,000. On the
date of sale, the car had a fair value of RM6,500 and a carrying amount in the customer’s records
of RM5,000.

Revenue of RM6,000 is recorded in 2019 as service was provided to the customer.

Comparing cash and accrual basis accounting for expenses

Mrs. Singh pays her son’s rent in advance. Last November 15th, she paid $1,500 for the rental of
her son’s room for the weeks beginning Jan 1st until April 16th, 2014. Calculate how much rent
expense Mrs. Singh should record on March 31st under.

a. accrual basis? b. cash basis?

a. With a total of $1,500 for 15 weeks from Jan 1st until 16th April, with 13 weeks completed
at $100 per week, the Rent Expense incurred as at March 31st should be $1,300.

b. Nothing – no cash exchanged hands (HOW DO U KNOW NO CASH INVOLVED)

4. Comparing cash and accrual basis accounting for revenues

Tariq’s Tax Services collect their fees at the end of the completed tax filing for their customers.
In some cases, customers do not pay immediately upon receipt of the copy of the filing but
request for a quotation and invoice for services after which they might take a month or two to
pay. At the end of June, Tariq has collected 60% of the total $4,980 owed by customers for tax
services completed.

Calculate how much fees Tariq’s Tax Services should record under the
a. cash basis? b. accrual basis?

Answer:

a. $ 2,988 Fees using cash basis ( 40% )

 b. $4,980 Fees using accrual basis ( 60% )

5. Applying the revenue recognition principle

Takiko Gym collects membership fees quarterly at the beginning of each quarter. Members thus
pay a total amount of $450 in January, April, July and October for three months of monthly
membership fees in advance. Using the Revenue Recognition Principle explain

a. how the fees collected should be recorded as revenue by Takiko Gym.

Revenue is only recognized as earned so although the cash is collected for those months, the
revenue is recorded every month as $150 per month. Cash is recorded as received at $450 for
each of those 3 months only.

b. why the unearned revenue is considered a liability?

Because the $450 has not been earned until the three months are completed so they are owed
to the customers until each quarter is over

6. Applying the matching principle

Suppose on January 1, Antonio’s Tavern prepaid rent of $6,000 for the full year.

At June 30, how much rent expense should be recorded for the period January 1 through June
30?

6000/12 =500 Rent Per Month.

End of June, rent expense should be recorded = $500 x 6 = $3,000.

7. Comparing cash and accrual basis accounting and applying the revenue recognition
principle

Momentous Occasions is a photography business that shoots videos at college parties. The
freshman class pays $1,000 in advance on March 3 to guarantee services for its party to be held
on April 2. The sophomore class promises a minimum of $2,800 for filming its formal dance and
actually pays cash of $4,100 on February 28 at the dance.

Answer the following questions about the correct way to account for revenue under the accrual
basis:
a. Considering the $1,000 paid by the freshman class, on what date was revenue earned? Did
the earnings occur on the same date cash was received?

Considering the $1,000 paid by the freshman class, the revenue was earned on April 2. The
revenue (April 2) did not occur on the same date as cash was received (March 3).

b. Considering the $4,100 paid by the sophomore class, on what date was revenue earned? Did
the earnings occur on the same date cash was received?
Considering the $4,100 paid by the sophomore class, the revenue was earned on February 28.
The revenue occurred on the same date as cash was received.

Tutorial 4-7 (STATEMENTS)

LECTURE 8 ( questions )
Cash flow items must be categorized into one of four categories. Identify each item as operating
(O), investing (I), financing (F), or non-cash (N).
a. Cash purchase of merchandise inventory
b. Cash payment of dividends
c. Cash receipt from the collection of long-term notes receivable
d. Cash payment for income taxes
e. Purchase of equipment in exchange for notes payable
f. Cash receipt from the sale of land
g. Cash received from borrowing money
h. Cash receipt for interest income
i. Cash receipt from the issuance of common stock
j. Cash payment of salaries

SOLUTION

a. Operating f. Investing
b. Financing g. Financing
c. Investing h. Operating
d. Operating i. Financing
e. Non-cash j. Operating
How do we use free cash flow to evaluate firm’s performance?

Free cash flow is the amount of cash available from operating activities after paying for
planned investments in long-term assets and after paying cash dividends to shareholders.
Many companies use free cash flow to estimate the amount of cash that would be available
for unexpected opportunities.

Lecture 9
Statement of cash flows :

A statement that explains the sources of cash inflow (cash came from) and cash outflow (how it
was spent).
- reports why cash increased or decreased during the period
- covers a span of time (i. e., one year)

The statement of cash flows explains why net income as reported on the income statement does
not equal the change in the cash balance.

How Is the Statement of Cash Flows Prepared Using the Direct Method?
• The Financial Accounting Standards Board (FASB) & International Accounting
Standards Board (IASB) prefers the direct method of reporting cash flows from operating
activities.
• This method provides clearer information about the sources and uses of cash than the
indirect method.
• Only the operating section differs between the two methods.
• Investing & financing sections are the same for the two methods.

Direct method
• Restates Income Statement in terms of cash
• Shows cash receipts and payments from operating activities
• Preferred method
– Provides clearer information about cash receipts and payments

Non-cash Investing and Financing Activities

• Companies make investments that do not require cash.

• Such transactions are called non-cash investing and financing activities.
• These activities appear as a separate schedule at the bottom of the statement of cash flows
or in the notes to the financial statements.
How do operating activities in the cash flows statement differ from investing activities?

While both are a section of the statement of cash flows, operating activities create revenue or
expense in the entity’s business while investing activities increase or decrease long-term
assets.

Define non-cash investing and financing activities.

Companies do make investments that do not require cash. They also obtain financing other
than cash. Such transactions are called non-cash investing and financing activities.

Differentiate between the indirect and direct method.

The indirect method starts with net income and adjusts it to net cash provided by operating
activities. The direct method restates the income statement in terms of cash. The direct
method shows all the cash receipts and all the cash payments from operating activities.

How do we use free cash flow to evaluate firm’s performance?

Free cash flow is the amount of cash available from operating activities after paying for
planned investments in long-term assets and after paying cash dividends to shareholders.
Many companies use free cash flow to estimate the amount of cash that would be available
for unexpected opportunities.

Discuss two adjustments if there are changes in the current asset and current liability
accounts.

The adjustments required depend on the nature of the change. An increase in a current asset
other than cash causes a decrease in cash. If Accounts Receivable, Merchandise Inventory, or
Prepaid Expenses increases, then cash decreases. Therefore, we subtract the increase in the
current asset from net income to get net cash flow from operating activities. A decrease in a
current asset other than cash causes an increase in cash.

Give two examples of long term assets that affected by investing activities.

Examples of investing activities that affect long-term assets include the cash receipt from
selling and the cash outflow for the purchase of these long-term assets. In addition, it
includes the making (cash outflow) and collecting (cash inflow) of long-term notes
receivable.

Give two examples of long term liabilities that affected by financing activities.

Financing activities include cash inflows and outflows involved in long-term liabilities and
equity. This includes issuing stock, paying dividends, and buying and selling treasury stock.
It also includes borrowing money and paying off long-term liabilities such as notes payable,
bonds payable, and mortgages payable.
Describe cash flows receipts from operating activities.

It reflects the day-to-day operations of the business such as cash receipts (cash inflows) from
customers for the sales of merchandise inventory and services and the cash outflows for
purchases of merchandise inventory or payment of operating expenses. The operating
activities section also includes cash receipts (cash inflows) for interest and dividend income
and cash payments (cash outflows) for interest expense and income tax expense.

Explain the statements of cash flows prepared using a spreadsheet.

The spreadsheet starts with the beginning balance sheet and concludes with the ending
balance sheet. Two middle columns—one for debit amounts and the other for credit amounts
—complete the spreadsheet. These columns, labeled “Transaction Analysis,” hold the data
for the statement of cash flows. Accountants can prepare the statement directly from the
lower part of the spreadsheet. This appendix is based on the Smart Touch Learning data used
in this chapter. We illustrate this approach only with the indirect method for operating
activities. This method could be used for the direct method as well.

Provide two examples of payments to suppliers.

Payments to suppliers include all payments for merchandise inventory, and operating
expenses except employee compensation, interest, and income taxes.

What accounts on the balance sheet must be evaluated when completing the financing
activities section of the statement of cash flows?

The long-term liability accounts and the equity accounts must be evaluated when completing
the financing activities section of the statement of cash flows.

What is free cash flow, and how is it calculated?

Free cash flow is the amount of cash available from operating activities after paying for
planned investments in long-term assets and after paying dividends to shareholders. It is
calculated as: Net cash provided by operating activities – Cash planned for investments in
long-term assets – Cash dividends.

How does the direct method differ from the indirect method when preparing the operating
activities section of the statement of cash flows?

In the indirect method, start with net income and then adjust it to cash basis through a
series of adjusting items. When calculating the direct method, take each line item of the
income statement and convert it from accrual to cash basis.

Why might a spreadsheet be helpful when completing the statement of cash flows?
 Companies face complex situations, and a spreadsheet can help in preparing the cash
flow statement. It details the balance sheet accounts’ beginning and ending balances as
well as the debit and credit amounts to each account.

Statements

Balance Sheet (Statement format)

COMPANY NAME
Statement of financial position as at 31st December 2015
$ $ $
Current Assets:
Closing inventory XX
Account receivables XXX
Less provision for bad debts (XX) XX
Cash in hand XX
Cash at bank XX
Prepaid expenses XX XXX
Non-current assets:
Motor vehicle XXX
Less depreciation on motor vehicle (XX) XXX
Land and building XX
Equipment XX
Less depreciation on equipment (xx) XX XXX
XXXX
Current liabilities:
Account payables XX
Unearned revenue XX
Accrued expenses XX XXX
Non-current liab: long term loan XX XXX
Financed by:
Capital XX
Add Profit XX
 Less net loss (XX)
XXX
Less drawings (XX) XXX
XXXX

Balance Sheet
(Statement
format)
COMPANY NAME
Dr. Balance Statement as at 31st December 2019
Cr.
Non-current assets RM RM Non-current liabilities RM RM
Premises XX Loan on mortgage XX
Motor vehicle XX Long term loan XX
Delivery Van XX XXX/1000
Building XX
Fixtures and fittings XX
Equipment XX
Machineries XX
XXX/2,000
Current Assets: Current liabilities:
Account receivable XX Creditors/acct payables XX
Cash at bank XX Accrued expenses XX
Cash in hand XX Credit card bills XX
Accrued income XX Short term loan XX
Inventory/stock XX Prepaid income XX
Supplies XX Unearned revenue XX XXX/ 1,800
Short term investment XX
Prepaid expenses XX XXX/2000 Owner’s equity:
Capital XX
Add Profit XX
Less Loss (XX)
Less drawings (XX) XXX/1,200
XXXX/ XXXX/4,000
4,000
 Income Statement (Statement format)

ABC ltd
Income Statement for the year ended 31st December 2001
RM RM
Incomes: Service revenue XXX
Rent income XX
Interest received XX
Sales XX
Commission received XX
Discount received XX
XXXX
Less expenses:
Rent XX
Motor expenses XX
Salaries XX
Discount allowed XX
Electricity XX
Sundry expenses XX
Depreciation XX
Delivery expenses XX
Insurance XX (XXX)
Net profit XXXX
Net Loss (XXX)
 Income Statement (T format)
COMPANY NAME
Dr Cr
st
Income Statement for the year ended 31 December 2019
EXPENSES REVENUES
Insurance XX Service revenue XX
Rent XX Sales XX
Salary XX Discount received XX
Electricity XX Interest received XX
Commission XX Rent received XX
Discount allowed XX Net loss 350
Carriage outward XX
Depreciation XX
Net profit 920
6,000/7,500 6,000/7500
TIPS
Formular 1: Where the activity for the period is not given
Ending balance of the activity XXX
Less: Opening balance of the activity (XXX)
Activity for the period XXX

Format 2: Where activity of the period is GIVEN

Activity for the period XXX
Add: Opening balance of the activity XX
Less the closing balance of the activity (XX)
Required XXX

Note that: Sales (Opening and ending balance is account receivables)

Purchases (opening and closing balances: account payables)
Other operating expenses (op and cl = accrued liabilities)

Format 2: Where activity of the period is GIVEN

Credit sales for the period $68,000
Add: Account receivables opening balance $25,000
Less Account receivables closing balance ($27,000)
cash collections from customers $66,000

Cash collections from customers.

Sales Revenue $ 68,000

+ Beginning Accounts Receivable + 25,000
− Ending Accounts Receivable − 27,000
= Cash receipts from customers $ 66,000

Payments of operating expenses

Operating Expenses $ 4,427
+ Beginning Accrued Liabilities + 847
− Ending Accrued Liabilities − 936
= Cash receipts from customers $ 4,338

Amount borrowing, paying no long term liabilities

Beginning Long term liabilities $ 463

− Ending Long term liabilities − 478
= Amount borrowing $ 15

Cash receipt from issuance of common stock

Ending Ordinary Shares $

− Beginning Ordinary Shares −
= Cash receipt $
Cash payments for merchandise inventory.
(Cost of goods sold is $81,000.)

Cost of Goods Sold $ 81,000

−Beginning Merchandise Inventory − 25,000
+Ending Merchandise Inventory + 26,000
+Beginning Accounts Payable + 13,000
−Ending Accounts Payable − 10,000
Cash paid for merchandise inventory $ 85,000

Compute the acquisition of plant assets. The business sold no plant assets during the year.
Assume the company paid cash for the acquisition of plant assets.

Ending plant assets $108,250

Less opening plants assets $80,350
Plants acquired during the year $27,900

Compute the payment of a long-term note payable. During the year, the business issued a
$4,600 note payable.

Note payable during the year $4,600

Add beginning note payable $11,000
Less closing note payable ($10,000)
Payment for long term note payable during the year $5,600

Compute cash payments for merchandise inventory.

Cost of Goods Sold 81,000

- Beginning Merchandise Inventory -25,000
+ Ending Merchandise Inventory +26,000
+ Beginning Accounts Payable +13,000
- Ending Accounts Payable -10,000
Cash Paid for Merchandise Inventory 85,000

OPERATING ACTIVITIES
Cash Inflows/ Receipts

Collection from Customer

Beginning Accounts Receivables + Revenue – Ending Accounts Receivables

Cash Outflows/ Payments

Accrued Expenses (Salary, and other expenses)

Beginning Salaries Payable + Accrued Expenses – Ending Salary Payable

Prepaid Expenses (Rent, Utilities)

Ending Prepaid Expenses + Rent Expenses – Beginning Prepaid Expense

Sales (Opening & Ending Balance Accounts Receivables)

Purchases (Opening & Ending Balance Accounts Payables)
Other operating expenses (Opening & Ending Balance Accrued Liabilities)

INVESTING ACTIVITIES

Cash Outflows/ Payment

Acquisition of Long-Term Assets

Ending Long Term Assets - Beginning Long Term Assets
Or
Ending Plant Assets (Book value) + Depreciation – Beginning Plant Assets (Book value)

FINANCING ACTIVITIES

Cash Inflows/ Receipts

Issuance of Common Stock

Ending Ordinary Shares - Beginning Ordinary Shares

Issuance of Notes Payable

Ending Notes Payable - Beginning Notes Payable

Cash Outflows/ Payment

Payment of Notes Payable

Beginning of Note Payables + Cash Receipts from Notes Payable - Ending of Notes Payable

Payment of Dividends
Beginning Retained Earnings (or income) + Net Income after Tax - Ending Retained Earnings

Prepaid Expense
 Cash paid for rent
= Ending Prepaid Expense
+ Rent Expense
– Beginning Prepaid Expense
(paid last year but included in
Rent expense)

Accrued Expenses

Cash paid for salaries = Beginning Salary Payable

+ Salary Expense
- Ending Salary Payable

Investing activities

Computing Cash Flows from Investing Activities

Cash Payments:
For acquisition of plant assets
Purchase of Plant Assets = Ending Plant Assets (Cost) – Beginning
Plant Assets (Cost)

OR

Cash Payments:
For acquisition of plant assets
Purchase of Plant Assets = Ending Plant Assets (Book value) + Depreciation
– Beginning Plant Assets (Book value)

Financing activities

Computing Cash Flows from Financing Activities

Cash Receipts:
 From issuance of common stock (Ordinary shares)
Cash =Ending ordinary shares - Beginning ordinary shares
receipt

From issuance of notes payable/loan payable

Cash receipts/ Proceeds = Ending notes payable - Beginning notes
from borrowings/ Increase payable
in notes payable

Computing Cash Flows from Financing Activities

Cash Payments:

of notes payable/loan payable

Beginning + Cash receipt - Ending = Cash payment of notes payable

Notes Payable from issuance Notes
of note payable Payable

of dividends:

Beginning Retained + Net - Ending = Dividends paid

Earnings Income Retained
after Earnings
tax

Computing Cash Flows from Financing Activities

Cash Payments of Dividends:

Beginning + Net Income - Ending = Dividends paid
Retained after tax Retained
earnings Earnings
 Miss Ella’s Learning Centre
Statement of Operating Cashflows for the year ended 30th June 2016
Cashflows from operation activities: $ $ $
Receipts:
Collection from customers 184,000
Total receipts 184,000
Less Payments:
Suppliers 118,000
Employees 67,000
Total payments (185,000)
Net cash flows from operating activities (1,000)

Operating activities section of the statement of cash flows using the direct method.

MISS ELLA’S LEARNING CENTER

Statement of Cash Flows—Partial
Year Ended June 30, 2016

Cash Flows from Operating Activities:

Receipts:
Collections from Customers $ 184,000
Total Cash Receipts $ 184,000
Payments:
To Suppliers (118,000)
To Employees (67,000)
 Total Cash Payments (185,000)
Net Cash Provided (Used for) by Operating Activities $ (1,000)

RAYANA INC.
Statement of Cash Flows
For the Year Ended December 31, 2013
Cash flows from operating activities
Cash receipts from customers ($700,000 – $35,000) $665,000
Cash payments:
For operating expenses ($360,000 + $10,000) $370,000
For income taxes ($60,000 – $3,000) 57,000 427,000
Net cash provided by operating activities $238,000

Green Bean Inc.

Statement of cashflows for the year ended 31st December 2016
Cash flows for operating activities $ $
Receipts:
Collection from customers 618,000
Total receipts 618,000
Less Payments:
Suppliers 214,000
Employees 209,000
Total payments (423,000)
Net cash flows from operating activities 195,000
Cash flows from Investing activities
Receipts: -
Total receipts -
Less payments
Purchase of equipment 146,000
Total payments (146,000)
Net cash flows from investing activities (146,000)
Cashflows from financing activities :
Receipts: -
Total receipts -
Less payments:
Dividends 56,000
Total payments (56,000)
 Net cash flows from financing activities (56,000)
Net decreased in cash (7,000)
Beginning balance 57,000
Balance at end 50,000

Operation activities: These are activities that fall under day to day running of a business

Investing activities: These activities that aim to provide future benefits to the company

Financing activities: These are activities that fall under fund raising

Non-cash activities: These activities that does involve cash

2 methods: Direct method (Operation), using 2 methods that is direct and indirect method
produces different result.