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College Accounting

College Accounting. Heintz & Parry 20 th Edition. 23. Appendix: Statement Of Cash Flows: The Direct Method. 1. Describe the direct method of reporting cash flows from operating activities. THE DIRECT METHOD.

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College Accounting

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  1. College Accounting Heintz & Parry20th Edition

  2. 23 Appendix: Statement Of Cash Flows: The Direct Method

  3. 1 • Describe the direct method of reporting cash flows from operating activities.

  4. THE DIRECT METHOD • Under the direct method, revenues and expenses reported on the income statement are adjusted to reflect the cash received or paid for each item • The investing and financing activities sections of the statement of cash flows are the same under both the direct and the indirect methods

  5. 2 • Prepare a schedule for the calculation of cash generated from operating activities under the direct method by adjusting revenues and expenses for changes in current assets and current liabilities associated with operations.

  6. STATEMENT OF CASH FLOWS EXAMPLE: Simplex Company has prepared its income statement and statement of retained earnings for the year ended December 31, 20-2 and the balance sheets for December 31, 20-1 and 20-2. Now it needs to prepare its statement of cash flows.

  7. Simplex Company Comparative Balance Sheet December 31, 20-2 and 20-1 Increase (Decrease) 20-2 20-1 Assets Current assets: $(110,000) Cash $ 90,000 $200,000 Accounts receivable 160,000 190,000 (30,000) Merchandise inventory 180,000 200,000 (20,000) The statement of cash flows will explain how the cash account decreased by $110,000 in 20-2. $(160,000) Total current assets $430,000 $590,000 Property, plant, and equipment: Land $ 40,000 $ 40,000 $ 0 Building 140,000 0 140,000 Equipment 100,000 0 100,000 Total property, plant, and equip. $280,000 $ 40,000 $ 240,000 $710,000 $630,000 $ 80,000 Total assets

  8. Simplex Company Schedule for the Calculation of Cash Generated from Operating Activities For Year Ended December 31, 20-2 Cash Flow Income Statement Additions Deductions Sales $900,000 Cost of goods sold 600,000 Gross profit $300,000 Operating expenses 177,000 Income before taxes $123,000 Income tax expense 43,000 Net income $ 80,000 The revenues and expenses from the income statement are used in computing the “cash flow generated from operating activities.”

  9. Simplex Company Schedule for the Calculation of Cash Generated from Operating Activities For Year Ended December 31, 20-2 Cash Flow Income Statement Additions Deductions Sales $900,000 Cost of goods sold 600,000 Gross profit $300,000 Operating expenses 177,000 Income before taxes $123,000 Income tax expense 43,000 Net income We’ll start with the sales. Sales (revenues) are recognized when earned, regardless of the amount of cash actually received. Sales must be converted to the amount of “cash received from customers.” $ 80,000

  10. CASH RECEIVED FROM CUSTOMERS Accounts Receivable Beg. bal. 190,000 To convert sales into the “cash received from customers,” we need to examine the accounts receivable account.

  11. CASH RECEIVED FROM CUSTOMERS Accounts Receivable Beg. bal. 190,000 Sales ? Sales increase the accounts receivable account.

  12. CASH RECEIVED FROM CUSTOMERS Accounts Receivable Beg. bal. 190,000 Sales ? ? Payments received Accounts Receivable is decreased by customersmaking payments.

  13. CASH RECEIVED FROM CUSTOMERS Accounts Receivable Beg. bal. 190,000 Sales ? ? Payments received Accounts Receivable decreased by $30,000 during 20-2. 160,000 End. bal.

  14. CASH RECEIVED FROM CUSTOMERS Accounts Receivable Beg. bal. 190,000 Sales ? ? Payments received 160,000 End. bal. When Accounts Receivable decreases, Cash received from customers > Sales.

  15. CASH RECEIVED FROM CUSTOMERS Accounts Receivable Beg. bal. 190,000 Sales 900,000 ? Payments received 160,000 End. bal. Sales for the year were $900,000.

  16. CASH RECEIVED FROM CUSTOMERS Accounts Receivable Beg. bal. 190,000 Payments rec’d. Sales 930,000 900,000 160,000 End. bal. Cash received from customers = Sales + Decrease in A/R = $900,000 + $30,000

  17. Simplex Company Schedule for the Calculation of Cash Generated from Operating Activities For Year Ended December 31, 20-2 Cash Flow Income Statement Additions Deductions Sales $900,000 $930,000 $30,000 Cost of goods sold 600,000 Gross profit $300,000 Operating expenses 177,000 Income before taxes $123,000 Income tax expense 43,000 Cash received from customers $ 80,000 Net income

  18. Simplex Company Schedule for the Calculation of Cash Generated from Operating Activities For Year Ended December 31, 20-2 Cash Flow Income Statement Additions Deductions Sales $900,000 $30,000 $930,000 Cost of goods sold 600,000 Gross profit $300,000 Operating expenses 177,000 Income before taxes $123,000 Income tax expense 43,000 Net income $ 80,000 Cost of goods sold is adjusted next.

  19. CASH PAID FOR MERCHANDISE Merchandise Inventory Beg. bal. 200,000 We need to determine the amount of merchandise purchased during the year.

  20. CASH PAID FOR MERCHANDISE Merchandise Inventory Beg. bal. 200,000 Purchases ? Purchases increaseinventory.

  21. CASH PAID FOR MERCHANDISE Merchandise Inventory Beg. bal. 200,000 ? Cost of goods sold Purchases ? Selling goods (merchandise) reduces inventory.

  22. CASH PAID FOR MERCHANDISE Merchandise Inventory Beg. bal. 200,000 Purchases ? ? Cost of goods sold End. bal. 180,000 Inventory decreased by $20,000 during 20-2.

  23. CASH PAID FOR MERCHANDISE Merchandise Inventory Beg. bal. 200,000 Purchases ? ? Cost of goods sold End. bal. 180,000 When Merchandise Inventory decreases during the year, Cost of goods sold > Purchases.

  24. CASH PAID FOR MERCHANDISE Merchandise Inventory Beg. bal. 200,000 600,000 COGS Purchases ? End. bal. 180,000 Cost of goods sold for 20-2 is $600,000.

  25. CASH PAID FOR MERCHANDISE Merchandise Inventory Beg. bal. 200,000 600,000 Purchases 580,000 COGS End. bal. 180,000 Purchases for 20-2 = Cost of Goods Sold – Decrease in Merchandise Inventory = $600,000 – $20,000

  26. CASH PAID FOR MERCHANDISE Merchandise Inventory Beg. bal. 200,000 COGS 600,000 Purchases 580,000 End. bal. 180,000 Cost of merchandise purchased = $580,000

  27. Simplex Company Schedule for the Calculation of Cash Generated from Operating Activities For Year Ended December 31, 20-2 Cash Flow Income Statement Additions Deductions $ 30,000 Sales $900,000 $930,000 Cost of goods sold 600,000 $(20,000) Gross profit $300,000 Operating expenses 177,000 $123,000 Income before taxes Decrease in Merchandise Inventory Income tax expense 43,000 Net income $ 80,000

  28. CASH PAID FOR MERCHANDISE Accounts Payable Beg. bal. 180,000 End. bal. 120,000 Now that we know Simplex’s purchases, we need to determine how much cash was paid for these goods.

  29. CASH PAID FOR MERCHANDISE Accounts Payable Beg. bal. 180,000 Payments ? 580,000 Purchases 120,000 End. bal. Purchases increase Accounts Payable, and cash payments on these purchases decrease Accounts Payable.

  30. CASH PAID FOR MERCHANDISE Accounts Payable 180,000 Beg. bal. Payments ? 580,000 Purchases End. bal. 120,000 Accounts Payable decreased by $60,000 during 20-2. Purchases < Cash paid

  31. CASH PAID FOR MERCHANDISE Accounts Payable Beg. bal. 180,000 Payments 640,000 580,000 Purchases End. bal. 120,000 Cash paid for merchandise = Purchases + Decrease in Accounts Payable = $580,000 + $60,000

  32. Simplex Company Schedule for the Calculation of Cash Generated from Operating Activities For Year Ended December 31, 20-2 Cash Flow Income Statement Additions Deductions $30,000 Sales $900,000 $930,000 60,000 640,000 Cost of goods sold 600,000 $(20,000) Gross profit $300,000 Operating expenses 177,000 Income before taxes $123,000 Decrease in Accounts Payable Income tax expense 43,000 Net income $ 80,000

  33. Simplex Company Schedule for the Calculation of Cash Generated from Operating Activities For Year Ended December 31, 20-2 Cash Flow Income Statement Additions Deductions Sales $900,000 $930,000 $30,000 60,000 Cost of goods sold 600,000 $(20,000) 640,000 Gross profit $300,000 177,000 Operating expenses Income before taxes $123,000 Income tax expense 43,000 Net income $ 80,000 Operating expenses are generally adjusted for prepaid expenses, accrued liabilities, and depreciation.

  34. Simplex Company Schedule for the Calculation of Cash Generated from Operating Activities For Year Ended December 31, 20-2 Cash Flow Income Statement Additions Deductions Sales $900,000 $930,000 $30,000 60,000 Cost of goods sold 600,000 $(20,000) 640,000 $290,000 Gross profit $300,000 Operating expenses 177,000 177,000 Income before taxes $123,000 Income tax expense 43,000 $ 80,000 Net income Simplex does not have any of these items, so there is no need to adjust operating expenses.

  35. Simplex Company Schedule for the Calculation of Cash Generated from Operating Activities For Year Ended December 31, 20-2 Cash Flow Income Statement Additions Deductions $30,000 Sales $900,000 $930,000 60,000 Cost of goods sold 600,000 $(20,000) 640,000 $290,000 Gross profit $300,000 Operating expenses 177,000 177,000 Income before taxes $123,000 $113,000 Income tax expense 43,000 43,000 $ 80,000 $ 70,000 Net income The balance sheet reports no receivables, payables, or other items related to income taxes. Thus, reported tax expense represents the amount of cash paid.

  36. Simplex Company Statement of Cash Flows For Year Ended December 31, 20-2 Cash flows from operating activities: Cash received from customers $930,000 Cash paid for merchandise $(640,000) Cash paid for operating expenses (177,000) Cash paid for income taxes (43,000) (860,000) Total cash disbursed for operating activities Net cash provided by operating activities $ 70,000 Now that the operating section is completed, we will add in the investing and financing sections.

  37. Simplex Company Statement of Cash Flows For Year Ended December 31, 20-2 Cash flows from operating activities: Cash received from customers $ 930,000 Remember, the investing and financing sections are the same for both the direct and the indirect methods. Cash paid for merchandise $(640,000) Cash paid for operating expenses (177,000) Cash paid for income taxes (43,000) Total cash disbursed for operating activities (860,000) Net cash provided by operating activities $ 70,000 Cash flows from investing activities: Purchased building $(140,000) Purchased equipment (100,000) Net cash used by investing activities (240,000) Cash flows from financing activities: $ 10,000 Issued note payable Issued common stock 70,000 Paid cash dividends (20,000) (Continued…)

  38. Cash flows from financing activities: Issued note payable $ 10,000 Issued common stock 70,000 (20,000) Paid cash dividends Net cash provided by financing activities 60,000 Net decrease in cash $(110,000) Operating $ 70,000 Investing (240,000) Financing 60,000 $(110,000)

  39. Cash flows from financing activities: Issued note payable $ 10,000 70,000 Issued common stock Paid cash dividends (20,000) 60,000 Net cash provided by financing activities Net decrease in cash $(110,000) Cash balance, January 1, 20-2 200,000 $ 90,000 Cash balance, December 31, 20-2 What about more complex companies?

  40. 3 • Prepare a schedule for the calculation of cash generated from operating activities under the direct method, including necessary adjustments when the company reports the following: • a. Changes in current assets and current liabilities associated with operations. • b. Depreciation expense. • c. Gains or losses on the sale of long-term assets. • d. Receivables and payables associated with interest revenue, interest expense, and tax expense.

  41. Multiplex Company Comparative Balance Sheet December 31, 20-2 and 20-1 Increase (Decrease) 20-2 20-1 Assets Current assets: Cash $ 17,980 $ 20,000 $ (2,020) Government notes 1,800 3,200 (1,400) Accrued interest receivable 100 300 (200) 8,705 Accounts receivable (net) 60,215 51,510 Merchandise inventory 64,570 67,500 (2,930) Step #1: Compute the change in cash and cash equivalents. 2,750 1,250 Supplies and prepayments 4,000 Total current assets $148,665 $145,260 3,405 Property, plant, and equipment Store equipment $ 48,000 $ 38,800 9,200 Less accumulated depreciation (18,000) (14,000) 4,000 Delivery equipment $ 47,000 $ 32,000 15,000

  42. CASH AND CASH EQUIVALENTS • To qualify as a cash equivalent: • An investment must be readily convertible to a known amount of cash • These are considered the same as cash when preparing the statement of cash flows 20-1 20-2 $20,000 Cash $17,980 1,800 3,200 Government Notes $19,780 $23,200 $3,420 decrease

  43. Multiplex Company Income Statement For Year Ended December 31, 20-2 Cash Flow Income Statement Additions Deductions Net sales $460,100 Cost of goods sold 270,100 Gross profit $190,000 Operating expenses 120,750 Step #2:Prepare a schedule to calculate cash from operating activities. Operating income $ 69,250 Interest revenue 155 Gain on sale of equip. 3,000 Interest expense 650 Income tax expense 24,000 Net income $ 47,755

  44. Multiplex Company Income Statement For Year Ended December 31, 20-2 Cash Flow Income Statement Additions Deductions Net sales $460,100 $(8,705) $451,395 Cost of goods sold 270,100 Gross profit $190,000 Operating expenses 120,750 Increase in Accounts Receivable Operating income $ 69,250 Interest revenue 155 Gain on sale of equip. 3,000 Interest expense 650 24,000 Income tax expense Net income $ 47,755

  45. Multiplex Company Income Statement For Year Ended December 31, 20-2 Cash Flow Income Statement Additions Deductions Net sales $460,100 $(8,705) $451,395 (2,930) Cost of goods sold 270,100 Gross profit $190,000 Operating expenses 120,750 Decrease in inventory indicates purchases were less than what was sold. Operating income $ 69,250 Interest revenue 155 Gain on sale of equip. 3,000 Interest expense 650 Income tax expense 24,000 Net income $ 47,755

  46. Multiplex Company Income Statement For Year Ended December 31, 20-2 Cash Flow Income Statement Additions Deductions $(8,705) Net sales $460,100 $451,395 (2,930) Cost of goods sold 270,100 $12,400 Gross profit $190,000 Operating expenses 120,750 Decrease in Accounts Payable indicates payments were more than purchases. Operating income $ 69,250 Interest revenue 155 Gain on sale of equip. 3,000 Interest expense 650 24,000 Income tax expense Net income $ 47,755

  47. Multiplex Company Income Statement For Year Ended December 31, 20-2 Cash Flow Income Statement Additions Deductions Net sales $460,100 $(8,705) $451,395 (2,930) Cost of goods sold 270,100 $12,400 279,570 Gross profit $190,000 $171,825 Operating expenses 120,750 Operating income $ 69,250 Operating expenses involve many accounts. Interest revenue 155 Gain on sale of equip. 3,000 Interest expense 650 Income tax expense 24,000 Net income $ 47,755

  48. OPERATING EXPENSES Supplies and Prepayments Beg. bal. 2,750 ? Supplies purchased and prepayments made 4,000 End. bal.

  49. OPERATING EXPENSES Supplies and Prepayments Beg. bal. 2,750 ? ? 4,000 End. bal. Supplies and prepayments consumed (operating expenses)

  50. OPERATING EXPENSES Supplies and Prepayments Beg. bal. 2,750 ? ? 4,000 End. bal. A $1,250 increase indicates more were purchased (paid) than were consumed (expensed).

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