Mastery Problem: Preparing the Statement of Cash Flows (Advanced)

Question Content Area

A Statement of Cash Flows explains how changes in balance sheet accounts and income statement accounts cause the change in cash from the beginning of the period to the end of the period. Recall that revenues and expenses are reported on the

balance sheetincome statementretained earnings statementcash flow statementincome statement

on an accrual basis. Consequently, some of the cash for the revenue earned may not have been

collected paidcollected

as of the statement date. Conversely, some of the cash for the expenses reported may not have been

collected paidpaid

as of the statement date. This void caused by accrual accounting is filled by the statement of cash flows by explaining the sources from which a company has acquired cash (inflows) and how the company has used its cash (outflows). A statement of cash flows helps the reader of the financial statements:

• assess a company's ability to produce future cash flows
• judge a company's ability to meet obligations and pay dividends
• estimate the company's need for external financing

Cash inflows and outflows come from three categories: operating activities, financing activities and investing activities.

Determine whether the activities described in the following table are operating, investing, or financing activities that affect cash flow.

Company purchased a factory for cash	Operating ActivitiesInvesting ActivitiesFinancing ActivitiesInvesting Activities
Inventory decreased from previous year	Operating ActivitiesInvesting ActivitiesFinancing ActivitiesOperating Activities
Company issued long-term bonds	Operating ActivitiesInvesting ActivitiesFinancing ActivitiesFinancing Activities
Company paid common dividends	Operating ActivitiesInvesting ActivitiesFinancing ActivitiesFinancing Activities
Accounts Receivable balance increased from previous year	Operating ActivitiesInvesting ActivitiesFinancing ActivitiesOperating Activities

In addition to recognizing what type of activity transactions are describing, it is important to recognize whether a transaction is an increase in cash or a decrease in cash. Determine whether the activity described results in an increase in cash or a decrease in cash.

Company purchased a factory for cash	Increase in CashDecrease in CashDecrease in Cash
Inventory decreased from previous year	Increase in CashDecrease in CashIncrease in Cash
Company issued long-term bonds	Increase in CashDecrease in CashIncrease in Cash
Company paid common dividends	Increase in CashDecrease in CashDecrease in Cash
Accounts Receivable balance increased from previous year	Increase in CashDecrease in CashDecrease in Cash

Feedback Area

Feedback

Think about the entries that are made and how they affect cash. For example, an increase in inventory would require a use of cash. The entry would be a debit to Inventory and a credit to Cash. This decreases cash. A decrease in inventory would have the opposite effect. It would be an increase to cash.

Question Content Area

There are two methods of reporting the Statement of Cash Flows, the direct method and the indirect method. Examples of the two methods are shown. Selected information from Rowe Publishing Company's Income Statement and Balance Sheets are provided as support to the following Statements of Cash Flows.

Selected information from Rowe Publishing Company's Income Statement

Selected information from Rowe Publishing Company's Balance Sheets

Direct method:

Rowe Publishing Company Statement of Cash Flows For the Year Ended December 31, 20Y8
Cash flows from operating activities:
Cash collected from customer	$ 1,042,000
Cash paid to suppliers	(586,000)
Cash payments to employees	(347,000)
Cash payments for interest	(16,000)
Paid income taxes	(29,000)
Net cash flows from operating activities		$ 64,000
Cash flows from investing activities:
Equipment purchase	($ 25,000)
Net cash used for investing activities		(25,000)
Cash flows from investing activities:
Repayment of notes payable	$ (35,000)
Proceeds from issuance of bonds payable	50,000
Payment of dividends	(35,000)
Net cash used for financing activities		(20,000)
Net increase (decrease) in cash		$ 19,000
January 1, 20Y8, cash balance		66,000
December 31, 20Y8, cash balance		$ 85,000

Indirect method:

Rowe Publishing Company Statement of Cash Flows For the Year Ended December 31, 20Y8
Cash flows from operating activities:
Net income		$69,000
Adjustments to reconcile net income to net cash flow from operating activities:
Depreciation expense	$ 15,000
Changes in noncash current operating assets and liabilities:
Increase in accounts receivable	(9,000)
Increase in inventory	(20,000)
Increase in accounts payable	12,000
Increase in salaries payable	4,000
Decrease in income taxes payable	(7,000)	(5,000)
Net cash flows from operating activities		$ 64,000
Cash flows from investing activities:
Equipment purchase	($ 25,000)
Net cash used for investing activities		(25,000)
Cash flows from financing activities:
Repayment of notes payable	($ 35,000)
Proceeds from issuance of bonds payable	50,000
Payment of dividends	(35,000)
Net cash used for financing activities		(20,000)
Net increase (decrease) in cash		$ 19,000
January 1, 20Y8, cash balance		66,000
December 31, 20Y8, cash balance		$ 85,000

Notice that the difference between the two methods is the

operatinginvestingfinancingoperating

activities section. The direct method adjusts each item on the income statement from the accrual basis to the cash basis and the indirect method starts with net income and adds back non-cash items and increases and decreases in the balances in current assets.

Question Content Area

Comparative balance sheets for Byron Manufacturing as of December 31, 20Y8 and 20Y7 are shown. Complete the Changes column to determine net cash flows during the year.

Byron Manufacturing Balance Sheets As of December 31, 20Y8 and 20Y7
Assets	20Y8	20Y7
Current assets:
Cash	5,210	9,340
Accounts receivable	10,350	9,010
Inventory	19,890	18,610
Total current assets	35,450	36,960
Property, plant, and equipment
Building	494,000	494,000
Equipment	280,000	271,300
	774,000	765,300
Accumulated depreciation	(147,350)	(119,250)
Net property, plant, and equipment	626,650	646,050
Total assets	662,100	683,010
Liabilities and Equity
Current liabilities:
Accounts payable	55,490	36,260
Salaries payable	9,330	11,700
Income taxes payable	970	9,930
Total current liabilities	65,790	57,890
Long-term liabilities:
Bonds payable	350,000	399,000
Equity:
Common stock	183,000	147,000
Retained earnings	63,310	79,120
Total equity	246,310	226,120
Total liabilities and equity	662,100	683,010

Additional information needed to prepare the statement of cash flows using the indirect method:

1. Net income was $2,940
2. Byron paid $18,750 in cash dividends
3. Byron issued $51,120 in bonds payable for cash
4. Byron retired $100,120 in bonds with cash
5. No fixed assets were sold or disposed of during the period

Now prepare the statement of cash flows for Byron Manufacturing using the indirect method. Select Increase or Decrease and enter the amounts.

Byron Manufacturing Spreadsheet to Prepare the Statement of Cash Flows For the Year Ended December 31, 20Y8
	Beginning		Increase/Decrease		Ending
Balance Sheet Accounts	Balance		Debit	Credit		Balance
Cash	fill in the blank a029d700a01c015_1		fill in the blank a029d700a01c015_2	fill in the blank a029d700a01c015_3	(m)	fill in the blank a029d700a01c015_4
Accounts receivable	9,010	(h)	1,340			10,350
Inventory	18,610	(i)	fill in the blank a029d700a01c015_5	fill in the blank a029d700a01c015_6		19,890
Building	494,000					494,000
Equipment	271,300	(b)	fill in the blank a029d700a01c015_7	fill in the blank a029d700a01c015_8		280,000
Accumulated depreciation	119,250		fill in the blank a029d700a01c015_9	fill in the blank a029d700a01c015_10	(c)	147,350
Accounts payable	36,260			19,230	(j)	55,490
Salaries payable	11,700	(k)	fill in the blank a029d700a01c015_11	fill in the blank a029d700a01c015_12		9,330
Income taxes payable	9,930	(l)	8,960			970
Bonds payable	399,000	(e)	fill in the blank a029d700a01c015_13	fill in the blank a029d700a01c015_14	(d)	350,000
Common stock	147,000			36,000	(f)	183,000
Retained earnings	79,120	(g)	fill in the blank a029d700a01c015_15	fill in the blank a029d700a01c015_16	(a)	63,310
			Increase/Decrease in Cash
Statement of Cash Flows			Debit	Credit
Cash flow from operating activities
Net income		(a)	fill in the blank a029d700a01c015_17
Adjustments to reconcile net income to net cash flow from operating activities
Depreciation expense		(c)	fill in the blank a029d700a01c015_18
Increase in accounts receivable				1,340	(h)
Increase in inventory				fill in the blank a029d700a01c015_19	(i)
Increase in accounts payable		(j)	19,230
Decrease in salaries payable				fill in the blank a029d700a01c015_20	(k)
Decrease in income taxes payable				8,960	(l)
Cash flows from investing activities
Purchase equipment				fill in the blank a029d700a01c015_21	(b)
Cash flows from financing activities
Issued bonds payable		(d)	fill in the blank a029d700a01c015_22
Retired bonds payable				fill in the blank a029d700a01c015_23	(e)
Issued common stock		(f)	36,000
Paid dividend				fill in the blank a029d700a01c015_24	(g)
Net increase (decrease) in cash		(m)	fill in the blank a029d700a01c015_25
			283,040	283,040

Now you can prepare the Statement of Cash Flows using the indirect method. Fill in the Statement based on the spreadsheet. Select Increase or Decrease and enter the amounts.

Byron Manufacturing Statement of Cash Flows For the Year Ended December 31, 20Y8
Cash flows from operating activities:
Net income		$ fill in the blank a029d700a01c015_26
Adjustments to reconcile net income to net cash flow from operating activities:
Depreciation expense	$ fill in the blank a029d700a01c015_27
IncreaseDecrease in accounts receivable	(1,340)
IncreaseDecrease in inventory	fill in the blank a029d700a01c015_30
IncreaseDecrease in accounts payable	19,230
IncreaseDecrease in salaries payable	fill in the blank a029d700a01c015_33
IncreaseDecrease in income taxes payable	(8,960)	33,380
Net cash provided by operating activities		$ 36,320
Cash flows from investing activities:
Purchase of equipment	$ (8,700)
Net cash used for investing activities		(8,700)
Cash flows from financing activities:
Proceeds from issuance of bonds payable	$ fill in the blank a029d700a01c015_35
Retired bonds payable	(100,120)
Issued common stock	fill in the blank a029d700a01c015_36
Payment of dividends	(18,750)
Net cash used for financing activities		(31,750)
Net increase (decrease) in cash		$ fill in the blank a029d700a01c015_37
Cash, 1/1/20Y8		fill in the blank a029d700a01c015_38
Cash, 12/31/20Y8		$ fill in the blank a029d700a01c015_39

The major causes of differences between Byron Manufacturing's net income and net cash from operating activities are the noncash

depreciation expenseincrease in accounts payable proceeds from issuance of bonds payabledecrease in customer refunds payable

and the

depreciation expenseincrease in accounts payable proceeds from issuance of bonds payabledecrease in income taxes payable

(showing that the company paid for fewer expenses than were expensed on the income statement).