FAR Flashcards
Cash Flows (21 cards)
The purpose of the statement of cash flows…
Is to learn why cash changed. It provides information about a company’s cash receipts (cash coming in) or cash disbursements (cash going out) during a period.
The Statement of Cash Flows is for the year that the period ended.
It is for that year only, just like the income statement is.
For the Statement of Cash Flows, you must
Debit DR. cash or Credit CR. cash for it to go on the statement.
Remember: All the financial statements (income statement, balance sheet) are
Prepared using accrual accounting. The only statement that is prepared using the cash basis is the Statement of Cash Flows. The Statement of Cash Flows is the LAST financial statement prepared. In essence, you are converting from Accrual basis to Cash basis.
Cash and cash equivalents is a…
Required disclosure as part of your significant accounting policies. Side note: there are two GAAP or acceptable methods of preparing a statement of cash flows: the Direct Method or Indirect Method.
The Statement of Cash Flows is made up of three distinct sections:
Operating, Investing, and Financing. You have cash inflows and cash outflows for all three of the sections. Then, in each section, you take the cash flows and net them to get one number.
a. When the CASH INFLOWS are MORE than the cash outflows, you have a NET CASH PROVIDED in that respective section (Operating, Investing, or Financing).
b. When the CASH OUTFLOWS are MORE than the cash inflows, you have a NET CASH USED in that respective section (Operating, Investing, or Financing).
With a Statement of Cash Flows, we are taking out Cash balance and seeing the net change from one year to the next year. The question is, how did that cash increase? Where did it come from?
For example, December 31, Year 2, cash was $2,000 and on December 31, Year 1, cash was at $1,000. The NET CHANGE was $1,000.
a. When you calculate the Statement of Cash Flows from Operating, Investing, or Financing, the total net of those sections should equal $1,000.
When you have Operating, Investing, and Financing sections of the Statement of Cash Flows, cash is…
Either Debited or Credited. When you net all three sections, it will give you the INCREASE or DECREASE in cash that we saw on the comparative balance sheet. It should match.
If you see a question that says, “What should be reported when preparing a Statement of Cash Flows,” what does the word reported mean in this context?
It can mean three things:
1. Financial statements,
2. Separate schedules that must be included, or
3. Footnote disclosures
There is no such thing as Cash flow per share.
Earnings per Share (EPS), yes, BUT there is no such thing as cash flow per share.
Stock Dividends, Stock Splits, and Retained Earnings Appropriated are NOT in the Statement of Cash Flows, and they are NOT a Supplemental Disclosure.
When preparing the Statement of Cash Flows, you are going to need…
The Balance Sheet for this current year (2012) and the previous year (2011). Why do you need both years for the balance sheet? Because you need to find out the net changes on the balance sheet from the prior year to the current year.
a. You will need the net change for the Investing Section (Long-term assets) and the Financing Section (Long-term liabilities and Stockholders’ Equity). How did liabilities and stockholders’ equity change from last year to this year? This is the PURPOSE of the Statement of Cash Flows and this is what you are trying to discover.
How do you calculate the ending cash balance (if not given)?
Operating $XXX
Add: Investing $XXX
Add: Financing $XXX
Add: Beginning Cash Balance $XXX
= ENDING CASH BALANCE $XX
Statement of Cash Flows Effects
Assets =
Current assets and current liabilities (short-term) [Operating Section]
Long-term assets [Investing Section]
Liabilities + Stockholders’ Equity
Long-term liabilities [Financing Section]
Stockholders’ Equity [Financing Section]
Beginning Cash Balance
Add: Net Change in Cash During the Year [Summation of OIF: Operating, Investing, and Financing
= Ending Cash Balance
Statement of Cash Flows IMPACT
Accounting Equation: Assets = Liabilities + Stockholders’ Equity
Assets =
1. Current Assets [Operating Activities]
2. Long-Term Assets [Investing Activities] (PEN HAT)
Liabilities =
1. Short-Term Liabilities [Operating Activities]
2. Long-Term Liabilities [Financing Activities]
Stockholders’ Equity =
1. Capital Transactions [Financing Activities]
Operating Activities - INdirect Method [Start with Net INcome]
The operating section of cash flows comes from making adjustments in order to reconcile net income (the use of accrual accounting) to net cash flows. It also comes through analyzing:
a. Use the “FAKE” Cash Method for Current Assets & Current Liabilities ONLY: The debits and credits will be the change accounts for the current assets/current liabilities for the Operating Section of the Cash Flows. It is called “FAKE” because there is NOT a real cash inflow or real cash outflow for some of these Current Assets and Current Liabilities change accounts. For example, if prepaid assets when down from Year 2 to Year 1 and you credit prepaid expense, the debit would be fake cash.
JE to record a decrease in Prepaid Expense:
DR. Fake cash
CR. Prepaid expense
However, the transaction did not REALLY result in a CASH INFLOW. Thus, you use FAKE CASH ONLY for changes in Current Assets and Current Liabilities. NO need to use it for the Investing and Financing section of the Cash Flows.
IMPORTANT: Create a separate “fake cash journal entry” for each change in current assets and current liabilities. At the end of it, net it all out to get the net cash used or provided by operating activities.
b. Use the MODIFIED FAKE Cash Method for “Noncash Items”. The following Noncash items are ALWAYS ADD-BACKS from NET INCOME when doing the reconciliation using the indirect method:
Depreciation expense,
Amortization expense,
Depletion expense,
Interest expense (NOT PAID),
Losses (from sale of assets, etc.),
Impairment losses,
Loss under the equity method of accounting for investments,
Amortization of discount on bonds payable,
Deferred Tax Liabilities [DTL’s], and
Warranty expense
Conversely, ALWAYS SUBTRACT from NET INCOME the following Noncash Items:
Gain on sale of PPE items,
Gain on early retirement of bonds (extinguishment),
Deferred Tax Assets [DTAs], and
Equity Method Investment Income (undistributed earnings)
In other words, whatever that non-cash item’s NORMAL BALANCE IS, the fake cash substitutes for the non-cash item.
IMPORTANT: Create a separate “modified fake cash journal entry” for each change in current assets and current liabilities. At the end of it, net it all out to get the net cash used or provided by operating activities.
Operating Activities - INdirect Method [Start with Net INcome] - Example of Amortization of Bond Discount
Amortization of bond discount [ADDITION from Net INcome]
Why? Because when a bond discount is amortized, a portion of the discount is recognized as interest expense. The result is that interest expense exceeds the amount of cash paid with each interest payment. The discount is gradually amortized over the bond term as additional interest expense because the firm received less than the amount due at maturity. Thus, since INTEREST EXPENSE has NORMAL DEBIT BALANCE, MODIFIED FAKE CASH follows the interest expense.
The J/E would be:
DR: Interest Expense [ADD to Net INcome]
CR: Amortization of bond discount
Operating Activities - INdirect Method [Start with Net INcome] - Example of Amortization of Bond Premium
Amortization of bond premium [SUBTRACTION from Net INcome]
Why? Because when a bond premium is amortized, a portion of the premium is recognized as a reduction in interest expense. Since interest expense is being reduced WITH A CREDIT MODIFIED FAKE CASH will follow the interest expense. The amortization of the bond premium will be SUBTRACTED from our Net INcome starting point.
The J/E for this would be:
DR: Amortization of bond premium
CR: Interest Expense [SUBTRACT to Net INcome]
Operating Activities - INdirect Method [Start with Net INcome] - How do Deferred Tax Liabilities (DTL’s) and Deferred Tax Assets (DTA’s) affect the Operating Section of the Statement of Cash Flows?
a) Deferred Tax Liabilities (DTL) [ADDITION to Net INcome] - Good for the financials.
What is the J/E to book a DTL?
DR: Income Tax Expense
CR; Deferred Tax Liability (DTL)
Notice: Deferred Tax Liabilities increase income tax expense. The MODIFIED FAKE CASH method will follow the normal income tax expense. Thus, the DTLs are ALWAYS ADDITION (ADDED to) Net INcome.
b) Deferred Tax Assets (DTA) [SUBTRACTION to Net INcome] - Bad for the financials.
What is the J/E to book a DTA?
DR: Deferred Tax Asset (DTA)
CR: Income Tax Expense / Benefit [SUBTRACTS to Net INcome]
Notice: Deferred Tax Assets lower income tax expense. The MODIFIED FAKE CASH method will follow it. Thus, DTAs are ALWAYS SUBTRACTIONS from NET INCOME.
Operating Activities - INdirect Method [Start with Net INcome] - Increase in your Equity Method Investment (i.e., owning 20 - 49% stock of another company)
For example, the investor owns 20% of the investee and the investee just made $100,000 in net income.
What is the J/E to show this?
DR: Investment in investee $20,000
CR: Equity in earnings $20,000 [SUBTRACT to Net INcome]
