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“How Well Am I Doing?


Statement of Cash Flows

Chapter Fifteen

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Purpose of the Statement of Cash Flows

Are cash flows Why is there a


sufficient to difference
support ongoing between net
Can we meet income and net
operations?
our obligations cash flow?
to creditors?

Will the company


have to borrow Can we pay
money to make dividends?
needed
investments?

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Learning Objective 1

Classify changes in
noncash balance
sheet accounts as
sources or uses of
cash.

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Cash

The term cash on the statement of cash


flows refers broadly to both currency and
cash equivalents.
Currency and
Bank Accounts
T-bills

Cash

Money Market Commercial


Funds Paper
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Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts

Changes in Changes in
Capital Stock Liabilities

Net Cash
Flows for a
Dividends Period Changes in
Paid to Noncash
Stockholders Assets

Net Income

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Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts

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Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts

Increases in noncash asset


accounts imply uses of cash.

Example: Inventory is
purchased on credit from
a supplier.

It is implied that cash


was used to acquire the
inventory.

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Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts

Increases in liability accounts imply


sources of cash.
Example: Inventory is
purchased on credit from
a supplier.

It is implied that an increase


in a payable has the effect
of increasing cash available
for other uses.

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Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts

Decreases in noncash assets


accounts imply sources of cash.

Example: Accounts receivable


decreases when a company
pays its bill.

When the customer pays the


bill, the company’s cash
increases.

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Constructing the Statement of Cash Flows Using Changes
in Noncash Balance Sheet Accounts

Decreases in liability accounts


imply uses of cash.

Example: A company
pays a note payable held
by a creditor.

When the payment is made,


cash decreases.

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A Simplified Statement of Cash Flows: An Example

Ed's Pizza Hut


Comparative Balance Sheet Account Balances

3/31/2008 3/31/2007 Change


DR (CR) DR (CR) Incr. (Decr.)
Cash $ 71,000 $ 90,000 $ (19,000)
Accounts Receivable 23,000 40,000 (17,000)
Inventory 350,000 300,000 50,000
Land 68,000 100,000 (32,000)
Equipment 84,000 84,000 -
Accumulated Depr. (45,000) (39,000) 6,000
Accounts Payable (38,000) (27,000) 11,000
Salaries Payable (9,000) (14,000) (5,000)
Note Payable - Joe Doe - (50,000) (50,000)
Common Stock (500,000) (450,000) 50,000
Retained Earnings (4,000) (34,000) (30,000)
$ - $ -

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A Simplified Statement of Cash Flows: An Example

Additional Information:
 There was a net loss for the year of $27,000.
 Depreciation charges for the year were $6,000.
 During the year, Ed sold land originally costing
$32,000 for $32,000.
 During the year, Ed paid dividends of $3,000 to the
stockholders.
 Ed issued $50,000 of common stock to settle the
note due to Joe Doe.

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A Simplified Statement of Cash Flows: An Example

Here is a summary of the sources


of cash for Ed’s Pizza Hut.

Ed's Pizza Hut


Sources of Cash
Decrease in A/R $ 17,000
Decrease in Land 32,000
Increase in A/P 11,000
Depreciation charges 6,000
Total sources of cash $ 66,000

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A Simplified Statement of Cash Flows: An Example

Here is a summary of the uses of


cash for Ed’s Pizza Hut.
Ed's Pizza Hut
Uses of Cash
Net loss $ 27,000
Increase in Inventory 50,000
Increase in Salaries Payable 5,000
Dividends paid 3,000
Total uses of cash $ 85,000

The net cash flow for Ed’s Pizza Hut is ($19,000):


$66,000 in sources minus $85,000 in uses.
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A Simplified Statement of Cash Flows

Ed's Pizza Hut


Sources of Cash
Decrease in A/R $ 17,000 This simplified
Decrease in Land 32,000
Increase in A/P 11,000 approach does
Depreciation charges 6,000 not follow the
Total sources of cash $ 66,000
format required
for external
Ed's Pizza Hut
Uses of Cash
reporting
Net loss $ 27,000 purposes. It is
Increase in Inventory 50,000
Increase in Salaries Payable 5,000
for illustrative
Dividends paid 3,000 purposes only.
Total uses of cash $ 85,000

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Learning Objective 2

Classify transactions
as operating,
investing, or
financing activities.

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The Full-Fledged Statement of Cash Flows:
Operating Activities

Operating activities are


those activities that enter
into the determination of
net income.
Changes in
noncurrent
Transactions
balance sheet
affecting current
accounts that
assets
directly affect net
Transactions income
affecting current
liabilities

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The Full-Fledged Statement of Cash Flows:
Investing Activities

Investing activities relate to


transactions involving the
acquiring or disposing of
noncurrent assets.

Lending money to
Acquiring or
another entity and
selling property,
subsequently
plant and
collecting on the
equipment
loan
Acquiring or
selling securities

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The Full-Fledged Statement of Cash Flows:
Financing Activities

Financing activities relate to


transactions involving borrowing
from creditors or repaying
creditors and engaging in
transactions with the
company’s owners.
Payment of
dividends (note
Issuing stock and
that interest on
purchasing
debt is classified
treasury stock
as an operating
Issuing long-term activity)
debt and
repayment of debt.

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The Full-Fledged Statement of Cash Flows: An
Overview

Operating Activities:
Net income
Changes in current assets
Changes in noncurrent assets that affect net income (e.g., depreciation)
Changes in current liabilities (except for debts to lenders and dividends
payable)
Changes in noncurrent liabilities that affect net income
Investing Activities:
Changes in noncurrent assets that are not included in net income
Financing Activities:
Changes in the current liabilities that are debts to lenders rather than
obligations to suppliers, employees, or the government
Changes in noncurrent liabilities that are not included in net income
Changes in capital stock accounts
Dividends
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The Full-Fledged Statement of Cash Flows: An
Overview

Operating Activities

Investing Activities
Reconciliation of the
beginning cash balance
Financing Activities with the ending cash
balance
Noncash Investing
and Financing
Activities
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Operating Activities

Includes those activities that enter into the


determination of net income.
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Operating Activities

Sources of cash are added to net


income and uses of cash are
subtracted from net income.

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Operating Activities

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Operating Activities

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Operating Activities

Depreciation and Amortization charges are added


back to net income because they are decreases in
noncash assets.
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Operating Activities

Gains are Losses are added


subtracted from net back to net income.
income.
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Investing Activities

Add: Proceeds from sale of land,


buildings, equipment, or other
noncurrent assets $ XXX
Receipt of principal from
investments XXX
Less: Payments to acquire land,
buildings, equipment, or other
noncurrent assets (XXX)
Payments to acquire
investments (XXX)
Net Cash Flows from Investing Activities $ XXX

Includes transactions that involve the


acquisition or disposal of noncurrent assets.
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Financing Activities

Add: Proceeds from borrowings $ XXX


Proceeds from issuing capital
stock XXX
Proceeds from sale of bonds XXX
Less: Principal payments on
borrowed funds (XXX)
Payments related to bond
maturities (XXX)
Dividend payments (XXX)
Net Cash Flows from Financing Activities $ XXX

Includes transactions involving receipts


from or payments to creditors and owners.
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Other Issues: Gross or Net?

Example:
For investing and ● Assume Macy’s
purchases $50
financing million in property
activities, items on during the year and
sells other property
the statement of for $30 million.
cash flows should ● Instead of showing
the net change of
be presented in $20 million, the
gross amounts company must
report the gross
rather than in net amounts of both
amounts. transactions.

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Other Issues: Direct Method or Indirect Method?

Two Formats for Reporting Operating Activities

Direct Method Indirect Method

Reports the Starts with


cash effects of accrual net
each operating income and
activity converts to
cash basis
No matter which format is used, the same amount of net
cash flows from operating activities is generated.
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Learning Objective 3

Prepare a statement
of cash flows using
the indirect method to
determine the net
cash provided by
operating activities.

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A Full-Fledged Statement of Cash Flows:
An Example
Ed's Pizza Hut
Comparative Balance Sheet Account Balances

3/31/2008 3/31/2007 Change


DR (CR) DR (CR) Incr. (Decr.)
Cash $ 71,000 $ 90,000 $ (19,000)
Accounts Receivable 23,000 40,000 (17,000) Let’s revisit the
Inventory 350,000 300,000 50,000 comparative
Land 68,000 100,000 (32,000) balance sheet
Equipment 84,000 84,000 - account balances
Accumulated Depr. (45,000) (39,000) 6,000 for Ed’s Pizza Hut.
Accounts Payable (38,000) (27,000) 11,000
Salaries Payable (9,000) (14,000) (5,000)
Note Payable - Joe Doe - (50,000) (50,000)
Common Stock (500,000) (450,000) 50,000
Retained Earnings (4,000) (34,000) (30,000)
$ - $ -

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A Full-Fledged Statement of Cash Flows:
An Example

Let’s also refresh our memory regarding the


following additional information.
Additional Information:
 There was a net loss for the year of $27,000.
 Depreciation charges for the year were $6,000.
 During the year, Ed sold land originally costing
$32,000 for $32,000.
 During the year, Ed paid dividends of $3,000 to
the stockholders.
 Ed issued $50,000 of common stock to settle the
note due to Joe Doe.
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Preparing the Statement of Cash Flows: Step 1


Ed's Pizza Hut
Statement of Cash Flows Worksheet
Source Cash Flow Adjust- Adjusted Classifi-
Change or Use? Effect ments Effect cation
Assets (except cash and
Current assets
Accounts receivable
Inventory
Noncurrent assets
Land
Equipment
List each account
Contra Assets, Liabilities, appearing on the
Contra assets
Accumulated depreciation comparative balance
Current liabilities
Accounts payable sheets except for cash
Salaries payable
Noncurrent liabilities
and cash equivalents
Notes payable and retained earnings.
Stockholders' equity
Common stock
Retained earnings
Net loss
Dividends
Total (net cash flow)

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Preparing the Statement of Cash Flows: Step 2


Ed's Pizza Hut
Statement of Cash Flows Worksheet
Source Cash Flow Adjust- Adjusted Classifi-
Change or Use? Effect ments Effect cation
Assets (except cash and
Current assets
Accounts receivable $ (17,000)
Inventory 50,000
Noncurrent assets
Land (32,000)
Equipment -
Contra Assets, Liabilities, Compute the change
Contra assets
Accumulated depreciation 6,000 from the beginning
Current liabilities
Accounts payable 11,000 balance to the ending
Salaries payable
Noncurrent liabilities
(5,000)
balance for each
Notes payable (50,000) account.
Stockholders' equity
Common stock 50,000
Retained earnings
Net loss (27,000)
Dividends 3,000
Total (net cash flow)

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Preparing the Statement of Cash Flows: Step 3


Ed's Pizza Hut
Statement of Cash Flows Worksheet
Source Cash Flow Adjust- Adjusted Classifi-
Change or Use? Effect ments Effect cation
Assets (except cash and
Current assets
Accounts receivable $ (17,000) Source
Inventory 50,000 Use
Noncurrent assets
Land (32,000) Source
Code each entry on
Equipment - the worksheet as a
Contra Assets, Liabilities,
Contra assets source or use of
Accumulated depreciation
Current liabilities
6,000 Source
cash.
Accounts payable 11,000 Source
Salaries payable (5,000) Use

{
Noncurrent liabilities
Notes payable (50,000) Use
Stockholders' equity Recall that the transaction
Common stock 50,000 Source involving the Notes Payable and
Retained earnings Common Stock was noncash.
Net loss (27,000) Use
Dividends 3,000 Use
Total (net cash flow)

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Preparing the Statement of Cash Flows: Step 4


Ed's Pizza Hut
Statement of Cash Flows Worksheet
Source Cash Flow Adjust- Adjusted Classifi-
Change or Use? Effect ments Effect cation
Assets (except cash and
Current assets
Accounts receivable $ (17,000) Source $ 17,000
Inventory 50,000 Use (50,000)
Noncurrent assets
Land (32,000) Source 32,000
Equipment - - Code sources
Contra Assets, Liabilities,
Contra assets
of cash as
Accumulated depreciation
Current liabilities
6,000 Source 6,000 positive
Accounts payable 11,000 Source 11,000 numbers and
Salaries payable (5,000) Use (5,000)
Noncurrent liabilities uses of cash
Notes payable
Stockholders' equity
(50,000) Use (50,000)
as negative
Common stock 50,000 Source 50,000 numbers.
Retained earnings
Net loss (27,000) Use (27,000)
Dividends 3,000 Use (3,000)
Total (net cash flow) $ (19,000)

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Preparing the Statement of Cash Flows: Step 5


Ed's Pizza Hut
Statement of Cash Flows Worksheet
Source Cash Flow Adjust- Adjusted Make any
Classifi-

Assets (except cash and


Change or Use? Effect ments Effect necessary
cation

Current assets adjustments,


Accounts receivable $ (17,000) Source $ 17,000 - $ 17,000
Inventory 50,000 Use (50,000) - (50,000) including
Noncurrent assets
Land (32,000) Source 32,000 - 32,000
adjustments
Equipment - - - - for gains and
Contra Assets, Liabilities,
Contra assets losses. The
Accumulated depreciation 6,000 Source 6,000 - 6,000
Current liabilities net effect of
Accounts payable
Salaries payable
11,000 Source
(5,000) Use
11,000
(5,000)
-
-
11,000
(5,000)
these should
equal zero.

{
Noncurrent liabilities
Notes payable (50,000) Use (50,000) 50,000 -
Stockholders' equity We need to make an adjustment
Common stock 50,000 Source 50,000 (50,000) for
- the noncash transaction
Retained earnings relating to Notes Payable and
Net loss (27,000) Use (27,000) - (27,000) Common Stock.
Dividends 3,000 Use (3,000) - (3,000)
Total (net cash flow) $ (19,000) $ - $ (19,000)

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Preparing the Statement of Cash Flows: Step 6


Ed's Pizza Hut
Statement of Cash Flows Worksheet
Source Cash Flow Adjust- Adjusted Classifi-
Change or Use? Effect ments Effect cation
Assets (except cash and
Current assets
Accounts receivable $ (17,000) Source $ 17,000 - $ 17,000 Operating
Inventory 50,000 Use (50,000) - (50,000) Operating
Noncurrent assets
Land (32,000) Source 32,000 - 32,000 Investing
Classify
Equipment - - - - each
Contra Assets, Liabilities,
Contra assets entry as
Accumulated depreciation 6,000 Source 6,000 - 6,000 Operating
Current liabilities operating,
Accounts payable
Salaries payable
11,000 Source
(5,000) Use
11,000
(5,000)
-
-
11,000
(5,000)
Operating
Operating
investing
Noncurrent liabilities or
Notes payable (50,000) Use (50,000) 50,000 -
Stockholders' equity financing
Common stock 50,000 Source 50,000 (50,000) -
Retained earnings activity.
Net loss (27,000) Use (27,000) - (27,000) Operating
Dividends 3,000 Use (3,000) - (3,000) Financing
Total (net cash flow) $ (19,000) $ - $ (19,000)

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Preparing the Statement of Cash Flows:
Step 7
Ed's Pizza Hut
Statement of Cash Flows
For the Period Ending 3/31/2008
Operating Activities
Net Loss $ (27,000)
Add: Decrease in A/R 17,000
Increase in A/P 11,000
Copy the data from
Increase in Depr. Charges 6,000
Less: Increase in Inventory (50,000) the worksheet into
Decrease in Salaries Payable (5,000) the Statement of
Net Cash Flow from Operations (48,000) Cash Flows section
Investing Activities
by section.
Proceeds from sale of Land 32,000
Financing Activities
Dividends paid (3,000)
Net change in cash (19,000)

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Preparing the Statement of Cash Flows:
Step 8
Ed's Pizza Hut
Statement of Cash Flows
For the Period Ending 3/31/2008
Operating Activities
Net Loss $ (27,000)
Add: Decrease in A/R 17,000
Increase in A/P 11,000
Prepare a cash
Increase in Depr. Charges 6,000
Less: Increase in Inventory (50,000) reconciliation at the
Decrease in Salaries Payable (5,000) bottom of the
Net Cash Flow from Operations (48,000) statement.
Investing Activities
Proceeds from sale of Land 32,000
Financing Activities
Dividends paid (3,000)
Net change in cash (19,000)
Cash, beginning 90,000
Cash, ending $ 71,000
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Example – Indirect Method

Ed's Pizza Hut


Statement of Cash Flows
For the Period Ending 3/31/2008
Operating Activities
Net Loss $ (27,000)
Add: Decrease in A/R 17,000 In addition, on the
Increase in A/P 11,000 face of the statement
Increase in Depr. Charges 6,000
Less: Increase in Inventory (50,000) or in a supplemental
Decrease in Salaries Payable (5,000) schedule, disclose
Net Cash Flow from Operations (48,000)
Investing Activities the issuance of
Proceeds from sale of Land 32,000 $50,000 of stock to a
Financing Activities
Dividends paid (3,000)
creditor, a noncash
Net change in cash (19,000) financing activity.
Cash, beginning 90,000
Cash, ending $ 71,000
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15-44

Interpretation of the Statement of Cash Flows

Examine the operating activities


section carefully.
 Ed’s Pizza Hut generated a negative
cash flow from operations of $48,000.
This is usually a sign of fundamental
difficulties.
 Ultimately, a positive cash flow is
necessary to avoid liquidating assets or
borrowing money to pay for day-to-day
activities.

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The Direct Method of
Determining the Net Cash
Provided by Operating
Activities

Appendix 15A

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Learning Objective 4

Use the direct method


to determine the net
cash provided by
operating activities.
(Appendix 15A)

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Computing Net Cash Provided by Operating
Activities

The direct method computes


net cash provided by operating
activities by reconstructing the
income statement on a cash
basis from top to bottom.

Cash provided by operating activities


under the direct method will always
agree with the amount computed using
the indirect method.

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Similarities and Differences in Handling Data


Add (+) or
Deduct (-) to
Adjust to a
Revenue or Expense Item Cash Basis
Sales revenue (as reported)
Adjustments to a cash basis:
Increases in accounts receivable -
Decreases in accounts receivable + Adjustments for accounts
Cost of goods sold (as reported)
Adjustments to a cash basis:
that affect revenue are the
Increase in merchandise inventory + same in the direct and
Decrease in merchandise inventory -
Increase in accounts payable - indirect methods.
Decrease in accounts payable +

Operating expenses (as reported)


Adjustments to a cash basis:
Increase in prepaid expenses + Adjustments for accounts
Decrease in prepaid expenses -
Increase in accrued liabilities - that affect expenses are
Decrease in accrued liabilities
Period's depreciation, depletion and
+
- handled in opposite ways
amortization charges
for the direct and indirect
Income tax expense (as reported)
Adjustments to a cash basis:
methods.
Increase in accrued taxes payable -
Decrease in accrued taxes payable +
Increase in deferred income taxes -
Decrease in deferred income taxes +
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Direct Method: Gains and Losses

Under the direct method,


no adjustments for gains
and losses on the sale of
assets are needed.

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The Direct Method: An Example

Ed's Pizza Hut


Comparative Balance Sheet Account Balances

3/31/2008 3/31/2007 Change


DR (CR) DR (CR) Incr. (Decr.)
Cash $ 71,000 $ 90,000 $ (19,000)
Accounts Receivable 23,000 40,000 (17,000) Let’s revisit the
Inventory 350,000 300,000 50,000 comparative
Land 68,000 100,000 (32,000) balance sheet
Equipment 84,000 84,000 - account balances
Accumulated Depr. (45,000) (39,000) 6,000 for Ed’s Pizza Hut.
Accounts Payable (38,000) (27,000) 11,000
Salaries Payable (9,000) (14,000) (5,000)
Note Payable - Joe Doe - (50,000) (50,000)
Common Stock (500,000) (450,000) 50,000
Retained Earnings (4,000) (34,000) (30,000)
$ - $ -

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The Direct Method: An Example

Ed's Pizza Hut


Income Statement
For the Year Ended 3/31/2008
Sales $ 1,000,000
Cost of goods sold 750,000
Gross margin 250,000
Operating expenses 277,000
Net loss $ (27,000)

Let’s assume that Ed’s Pizza Hut


prepared this income statement.

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The Direct Method: An Example

Step 1: Translate sales revenue into cash

collected from customers.


Sales (as reported) $ 1,000,000
Add: Decrease in accounts receivable 17,000
Cash collected from customers $ 1,017,000

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The Direct Method: An Example

Step 2: Translate cost of goods sold into


cash disbursements for purchases.

Cost of goods sold (as reported) $ 750,000


Add: Increase in inventory 50,000
Less: Increase in accounts payable (11,000)
Cash paid for purchases $ 789,000

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The Direct Method: An Example

Step 3: Translate operating expenses into


cash paid for operating expenses.

Operating expenses (as reported) $ 277,000


Add: Decrease in salaries payable 5,000
Less: Increase in depreciation (6,000)
Cash paid for operating expenses $ 276,000

No adjustment for income taxes is


required because Ed’s Pizza Hut has a net
loss of $27,000.
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The Direct Method: An Example

Ed's Pizza Hut


Statement of Cash Flows
For the Period Ending 3/31/2008
Operating Activities Notice that the
Cash received from customers $ 1,017,000 net cash
Cash paid for purchases (789,000) provided by
Cash paid for operating expenses (276,000)
Net Cash Flow from Operations (48,000) operating
Investing Activities activities agrees
Proceeds from sale of land 32,000
with that
Financing Activities
Dividends paid (3,000) computed using
Net change in cash (19,000) the indirect
Cash, beginning 90,000
Cash, ending $ 71,000
method.

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End of Chapter 15

McGraw­Hill/Irwin Copyright © 2008, The McGraw­Hill Companies, Inc.