Chapter 13

“How Well Am I Doing?”

Statement of Cash Flows

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 Statement of Cash Flows
Are cash flows Can we meet
sufficient to our obligations
support ongoing to creditors?
operations?
Why is there a
difference
between net
Will the company
income and net
have to borrow
cash flow?
money to make
needed
investments? Can we pay
dividends?
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 Learning Objective
LO1

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

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 Definition of 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

Sources Uses
Net Income Always
Net Loss Always
Changes in noncash assets Decreases Increases
Changes in liabilities* Increases Decreases
Changes in capital stock
accounts Increases Decreases
Dividends paid to stockholders Always
Total sources - Total uses = Net cash flow

* Contra asset accounts, such as the Accumulated Depreciation and

Amortization account, follow the rules for liabilities.

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 Constructing the Statement of Cash
Flows

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

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

Decreases in noncash assets accounts imply

sources of cash.
Example: Accounts receivable
decreases when a customer
pays their bill.

When the customer pays the

bill, the company’s cash
increases.

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 Constructing the Statement of Cash
Flows

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

3/31/2007 3/31/2006 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
Decrease 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
Decrease 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
LO2

To classify transactions
as operating activities,
investing activities, 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
Acquiring or loan
selling investment
securities

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 TheFull-Fledged
The Full-Fledged Statement
Statement of Cash
of Cash Flows:
Flows:Financing Activities
Financing Activities
Financing activities relate
to transactions involving
borrowing from creditors or
repaying creditors and
engaging in transactions with
the company’s owners.

Interest on debt is
classified as an
operating activity

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 Organization of the Full-Fledged Statement of
Cash Flows
Operating Activities:
Net income XYZ Company
Changes in current assets Cash Flow Statement
Changes in noncurrent assets that For affect net income
the Period (e.g.,
Ending depreciation)
MM/DD/YY
Changesflows
Cash in current liabilities (except for debts to lenders and dividends
payable) I. Operating Activities $ XXX
are divided
Changes in noncurrent liabilities
II. that affect netActivities
Investing income XXX
into three
Investing Activities: III. Financing Activities XXX
categories.
Changes in noncurrent assets that are not included in net income
Net Cash Flows for the
Period $ XXX
Financing Activities:
Add: Beg. Cash Balance XXX
Changes in the current liabilities that are debts to lenders rather than
obligations to suppliers, employees, or the Balance
Ending Cash government $ XXX
Changes in noncurrent liabilities that are not included in net income
Changes in capital stock accounts
Dividends
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 Organization of the Full-Fledged Statement of
Cash Flows

Operating Activities

Investing Activities
Reconciliation of the Net
Increase or Decrease in
Financing Activities Cash with the Change in the
Balance of the Cash
Account
Noncash Investing
and Financing
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Activities
© The McGraw-Hill Companies, Inc., 2007
 Operating Activities
Net Income (Loss) $ XXX
Add: Decr. in Current Noncash Assets XXX
Incr. in Current Liabilities XXX
Depreciation Charges XXX
Losses XXX
Less: Incr. in Current Noncash Assets (XXX)
Decr. in Current Liabilities (XXX)
Gains (XXX)
Net Cash Flows from Operating Activities $ XXX

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.
Impact on Net Income
Sources Uses
Current
Decreases Increases
Noncash Assets
Current
Increases Decreases
Liabilities

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 Operating Activities
Net Income (Loss) $ XXX
Add: Decr. in Current Noncash Assets XXX
Incr. in Current Liabilities XXX
Depreciation Charges XXX
Losses XXX
Less: Incr. in Current Noncash Assets (XXX)
Decr. in Current Liabilities (XXX)
Gains (XXX)
Net Cash Flows from Operating Activities $ XXX
Impact on Net Income
Sources Uses
Current
Decreases Increases
Noncash Assets
Current
Increases Decreases
Liabilities
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 Operating Activities
Net Income (Loss) $ XXX
Add: Decr. in Current Noncash Assets XXX
Incr. in Current Liabilities XXX
Depreciation Charges XXX
Losses XXX
Less: Incr. in Current Noncash Assets (XXX)
Decr. in Current Liabilities (XXX)
Gains (XXX)
Net Cash Flows from Operating Activities $ XXX
Impact on Net Income
Sources Uses
Current
Decreases Increases
Noncash Assets
Current
Increases Decreases
Liabilities
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 Operating Activities
Net Income (Loss) $ XXX
Add: Decr. in Current Noncash Assets XXX
Incr. in Current Liabilities XXX
Depreciation Charges XXX
Losses XXX
Less: Incr. in Current Noncash Assets (XXX)
Decr. in Current Liabilities (XXX)
Gains (XXX)
Net Cash Flows from Operating Activities $ XXX
Depreciation and Amortization charges are added back
to net income because they are decreases in noncash
assets.
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 Operating Activities
Net Income (Loss) $ XXX
Add: Decr. in Current Noncash Assets XXX
Incr. in Current Liabilities XXX
Depreciation Charges XXX
Losses XXX
Less: Incr. in Current Noncash Assets (XXX)
Decr. in Current Liabilities (XXX)
Gains (XXX)
Net Cash Flows from Operating Activities $ XXX

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
financing activities, purchases $50 million in
items on the property during the year
statement of cash and sells other property
for $30 million.
flows should be  Instead of showing the
presented in gross net change of $20
amounts rather million, the company
than in net must report the gross
amounts of both
amounts. transactions.
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 Operating Activities: Direct 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
Note that no matter which format is used, the same amount of
net cash flows from operating activities is generated.
McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007
 Learning Objective
LO3

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

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

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

3/31/2007 3/31/2006 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 List each account
Equipment
Contra Assets, Liabilities, appearing on the
Contra assets
Accumulated depreciation comparative balance
Current liabilities
Accounts payable
sheets except for cash
Salaries payable and cash equivalents
Noncurrent liabilities
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 (5,000) balance for each
Noncurrent liabilities
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 Code each entry on
Land (32,000) Source
Equipment - the worksheet as a
Contra Assets, Liabilities,
Contra assets
source or use of
Accumulated depreciation 6,000 Source cash.
Current liabilities
Accounts payable 11,000 Source
Salaries payable (5,000) Use

{
Noncurrent liabilities
Notes payable (50,000) Use
Recall that the transaction
Stockholders' equity
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
Equipment
(32,000) Source
-
32,000
-
Code sources
Contra Assets, Liabilities, of cash as
Contra assets
Accumulated depreciation 6,000 Source 6,000 positive
Current liabilities
Accounts payable 11,000 Source 11,000 numbers and
Salaries payable
Noncurrent liabilities
(5,000) Use (5,000)
uses of cash
Notes payable (50,000) Use (50,000) as negative
Stockholders' equity
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 Make any
Source Cash Flow Adjust- Adjusted Classifi-
Change or Use? Effect ments Effect necessary
cation
Assets (except cash and
Current assets adjustments,
Accounts receivable
Inventory
$ (17,000) Source
50,000 Use
$ 17,000
(50,000)
-
-
$ 17,000
(50,000)
including
Noncurrent assets adjustments
Land (32,000) Source 32,000 - 32,000
Equipment - - - - for gains and
Contra Assets, Liabilities,
Contra assets
losses. The
Accumulated depreciation
Current liabilities
6,000 Source 6,000 - 6,000 net effect of
Accounts payable 11,000 Source 11,000 - 11,000 these should
Salaries payable (5,000) Use (5,000) - (5,000)
equal zero.

{
Noncurrent liabilities
Notes payable (50,000) Use (50,000) 50,000
We -need to make an adjustment
Stockholders' equity
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)

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 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 Classify
Land (32,000) Source 32,000 - 32,000 Investing
Equipment - - - - each
Contra Assets, Liabilities,
Contra assets entry as
Accumulated depreciation
Current liabilities
6,000 Source 6,000 - 6,000 Operating operating,
Accounts payable 11,000 Source 11,000 - 11,000 Operating investing
Salaries payable (5,000) Use (5,000) - (5,000) Operating
Noncurrent liabilities or
Notes payable
Stockholders' equity
(50,000) Use (50,000) 50,000 -
financing
Common stock 50,000 Source 50,000 (50,000) - activity.
Retained earnings
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)

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 Preparing the Statement of Cash Flows:
Step 7
Ed's Pizza Hut
Statement of Cash Flows
For the Period Ending 3/31/2007
Operating Activities
Net loss $ (27,000)
Add: Decrease in accounts receivable 17,000
Increase in accounts payable 11,000 Copy the data from
Increase in depreciation 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)

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 Preparing the Statement of Cash Flows:
Step 8
Ed's Pizza Hut
Statement of Cash Flows
For the Period Ending 3/31/2007
Operating Activities
Net loss $ (27,000)
Add: Decrease in accounts receivable 17,000
Increase in accounts payable 11,000 Prepare a cash
Increase in depreciation 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
McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007
 Preparing the Statement of Cash Flows
Ed's Pizza Hut
Statement of Cash Flows
For the Period Ending 3/31/2007
Operating Activities
Net loss $ (27,000)
Add: Decrease in accounts receivable 17,000 In addition, on the
Increase in accounts payable 11,000 face of the statement
Increase in depreciation 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
McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007
 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.

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 Learning Objective
LO4

To use the direct

method to determine
the net cash provided
by operating activities.
(Appendix 13A)

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 Appendix
Chapter 13A
13
The Direct Method of
Determining the Net Cash
Provided by Operating Activities

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 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.

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 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:
1 Increases in accounts receivable -
2 Decreases in accounts receivable + Adjustments for accounts that
Cost of goods sold (as reported)
affect revenue are the same in
Adjustments to a cash basis: the direct method and indirect
3 Increase in merchandise inventory +
4 Decrease in merchandise inventory - methods.
5 Increase in accounts payable -
6 Decrease in accounts payable +

Operating expenses (as reported)

Adjustments to a cash basis:
7 Increase in prepaid expenses +
8 Decrease in prepaid expenses - Adjustments for accounts that
9 Increase in accrued liabilities -
10 Decrease in accrued liabilities + affect expenses are handled in
11 Period's depreciation, depletion and
amortization charges
-
opposite ways for the direct and
indirect methods.
Income tax expense (as reported)
Adjustments to a cash basis:
12 Increase in accrued taxes payable -
13 Decrease in accrued taxes payable +
14 Increase in deferred income taxes -
15 Decrease in deferred income taxes +
McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007
 Direct Method: Gains and Losses

Regarding gains and

losses on sale of assets,
no adjustments are
needed at all under the
direct method.

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 The Direct Method: An Example
Ed's Pizza Hut
Comparative Balance Sheet Account Balances

3/31/2007 3/31/2006 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)
$ - $ -

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 The Direct Method: An Example

Ed's Pizza Hut

Income Statement
For the Year Ended 3/31/2007 Let’s assume that
Sales $ 1,000,000
Cost of goods sold 750,000 Ed’s Pizza Hut
Gross margin 250,000 prepared this
Operating expenses 277,000 income statement.
Net loss $ (27,000)

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 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

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 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

There is not an adjustment needed for

income taxes because Ed’s Pizza Hut has
a net loss of $27,000.
McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007
 The Direct Method: An Example
Ed's Pizza Hut
Statement of Cash Flows
For the Period Ending 3/31/2007
Operating Activities Notice that the
Cash received from customers $ 1,017,000 net cash
Cash paid for purchases (789,000)
Cash paid for operating expenses (276,000)
provided by
Net cash flow from operations (48,000) operating
Investing Activities activities agrees
Proceeds from sale of land 32,000
Financing Activities with that
Dividends paid (3,000) computed using
Net change in cash (19,000) the indirect
Cash, beginning 90,000
Cash, ending $ 71,000 method.

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 Learning Objective
LO5

To prepare a statement
of cash flows using the
T-account approach.
(Appendix 13B)

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 Appendix
Chapter 13B
13
The T-Account Approach to
Preparing the Statement of
Cash Flows

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 T-Account Approach
Ed's Pizza Hut
Comparative Balance Sheet Account Balances

3/31/2007 3/31/2006 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)
$ - $ -

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 T-Account Approach

 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.
McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007
 T-Account Approach
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

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 T-Account Approach
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
Decrease 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.
McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007
 T-Account Approach
Cash
Provided Used
27,000 Net loss

3,000 Cash dividends paid

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 T-Account Approach
Cash
Provided Used
Decrease in accounts receivable 17,000 27,000 Net loss
50,000 Increase in inventory

3,000 Cash dividends paid

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 T-Account Approach
Cash
Provided Used
Decrease in accounts receivable 17,000 27,000 Net loss
Depreciation charges 6,000 50,000 Increase in inventory

Proceeds from sale of land 32,000 3,000 Cash dividends paid

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 T-Account Approach
Cash
Provided Used
Decrease in accounts receivable 17,000 27,000 Net loss
Depreciation charges 6,000 50,000 Increase in inventory
Increase in accounts payable 11,000 5,000 Decrease in salaries payable
48,000 Net cash used by operating activities
Proceeds from sale of land 32,000 3,000 Cash dividends paid

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 T-Account Approach
Cash
Provided Used
Decrease in accounts receivable 17,000 27,000 Net loss
Depreciation charges 6,000 50,000 Increase in inventory
Increase in accounts payable 11,000 5,000 Decrease in salaries payable
48,000 Net cash used by operating activities
Proceeds from sale of land 32,000 3,000 Cash dividends paid

No Effect in the Cash

account.

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 T-Account Approach
Cash
Provided Used
Decrease in accounts receivable 17,000 27,000 Net loss
Depreciation charges 6,000 50,000 Increase in inventory
Increase in accounts payable 11,000 5,000 Decrease in salaries payable
48,000 Net cash used by operating activities
Proceeds from sale of land 32,000 3,000 Cash dividends paid
19,000 Net decrease in cash and cash equivalents

The net effect of these transactions on the

cash account is as shown.
Notice, the net decrease in cash is $19,000.

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007

 Preparing the Statement of Cash Flows
Ed's Pizza Hut
Statement of Cash Flows
For the Period Ending 3/31/2007
Operating Activities
Net loss $ (27,000)
Add: Decrease in accounts receivable 17,000 In addition, on the
Increase in accounts payable 11,000 face of the statement
Increase in depreciation 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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 End of Chapter 13

McGraw-Hill /Irwin © The McGraw-Hill Companies, Inc., 2007