Class Notes (837,298)
Canada (510,219)
Commerce (1,910)
Lecture

Accounting - Chapters 5&7 Notes.docx

14 Pages
54 Views
Unlock Document

Department
Commerce
Course
COMMERCE 1BA3
Professor
Emad Mohammad
Semester
Fall

Description
CHAPTER FIVE: REPORTING AND INTERPRETING CASH FLOWS The Purpose of the Statement of Cash Flows  To provide information about: o Cash receipts o Cash payments o Net change in cash from the operating, investing, financing activities of a company during a specific period of time  Income statement, balance sheet, statement of changes in equity all require a trial balance to be made  Cash flow statement cannot be made using a trial balance  Cash flow statement is made using: o Balance sheet from last year o Balance sheet from this year o Income statement  Companies require a positive cash flow to keep running Format  Cash flow statement is divided into three sections: 1. Operating: o Mainly related to income items o Current assets and current liabilities o Ex. A/R, Prepaid Rent, A/P o Expect operating expenses to be positive o Calculates how long a business can go without shutting down 2. Investing: o Mainly related to long-term assets and investments o Purchase/sale of long-term assets and long-term investments o Ex. Bonds Payable, consolidation, mergers, investments in other companies o Expect investing activities to be negative 3. Financing: o Mainly related to long-term liabilities and owner’s equity o Long-term liabilities, shareholder’s equity o Ex. when issue shares and get money o Financing activities can be negative or positive  When will the cash flow from an investing activity be positive? o When you sell off all your long term assets o Bad sign if investing activities are positive because could mean business is liquidating Preparation  Cash flow statement is prepared differently from other basic financial statements: 1. Requires detailed info concerning changes in account balances that occurred between two periods of time (trial balance cannot provide this info) 2. Deals with cash receipts and payments (accrual concept is not used)  Need a minimum of three statements to create cash flow statement: o Comparative balance sheet (this year and last year) o Current income statement o Additional info Cash from Operating Activities  Cash from operating activities’ results from converting net income from accrual basis to cash basis  Can be calculated using two methods: indirect and direct Indirect Method  Preferred method because: o Easier to prepare o Focuses on differences between net earnings and net cash flow from operating activities o Reveals less company info to competitors  Only gives information that is already available by law  Want to match the Net Income to the Net Cash without giving any information out  Looks at items that increased/decreased net income but not cash  Starts with the Net Income and adjusts number to calculate operating cash flows  Operating activities is the only thing that differentiates between the indirect method and the direct method Ex. Kajana Inc. sold $5,000 of merchandise on credit and $1,000 of merchandise for cash from Rafiki Inc. The goods had cost $3,000 all purchased on credit. Journal Entry: Cash 1,000 A/R 5,000 Revenues 6,000 Cost of Goods Sold 3,000 Inventory 3,000 Income Statement Balance Sheet Cash Flow Statement Revenues = $6,000 A/R = $5,000 Net Income = $3,000 Expenses = 3,000 Cash = 1,000 Add: Income in A/P = 3000 Net Income = 3,000 A/P = 3,000 Less: Income in A/R = (5,000) Net Cash Flow = 1,000  A/R made income go up but did not make cash go up  Need to make net income match net cash  Add items that decrease income but do not affect cash: o Depreciation and amortization expense o Losses on disposal of assets o Decreases in current assets (ex. when collect cash on accounts receivable) o Increases in current liabilities  Subtract items that increase net income but do not effect cash: o Gains on disposal of assets o Increases in current assets o Decreases in current liabilities  Ex. depreciation expense decreases net income but is not a cash flow item so must add back depreciation expense to make net income match net cash Ex. You buy car on January 1, 2000 for $5,000. The car has a useful life of 5 years with a salvage value of $0. On December 31, 2003, the car was sold for $3,000. a) What is the cost of the car at the end of year three? $5000 on the balance sheet (historical cost) b) What is the Accumulated Depreciation – Car at the end of year three? $3000 ($1000 per year) c) What is the depreciation expense in year three? $1000 (expense of $1000 per year) d) What is the book value of the car at the end of year 3? Net Book Value = Historical Cost – Accumulated Depreciation $2000 = $5,000 - $3,000 e) What are the net proceeds? $3,000 f) What is the gain on disposal of the long-term asset? $1,000 (makes net income go up by $1,000 but not cash so $1,000 gain must be subtracted from net income to make it equal net cash) Rationales for Adjustments Gains and Losses on Disposal of Assets  Book value of an asset = cost – accumulated depreciation  Gain (loss) on disposal of an asset = proceeds – book value  Ex. An asset that cost $50,000 has an accumulated depreciation of $20,000 and is sold for $38,000 o Book value = 50,000 – 20,000 = $30,000 o Gain (loss) = 38,000 – 30,000 = $8,000  Proceeds from sale of asset are reported under cash flows from investing activities  Gain is a “paper gain” because increases net income but does not increase cash  Gains must be subtracted from net income to adjust income from accrual to cash basis  Same for losses but have to add Ex. Assume in a given year a company only has three transactions: 1. Provided services for $30,000 cash 2. Paid $10,000 for all operating expenses 3. Sold an asset with a cost of $70,000 and accumulated depreciation of $46,000 for $28,000 To calculate accrual income must calculate gain (loss) on the sale of the asset: BV = 70,000 – 46,000 = $24,000 Gain (loss) = 28,000 – 24,000 = $4,000 Accrual Income Cash Income Revenues $30,000 Operating revenues $30,000 Expenses (10,000) Operating expenses (10,000) Gains 4,000 Operating cash income $20,000 Net Income $24,000 Add: Sale of assets 28,000 Cash Income $48,000 Prepare Statement of Cash Flows Cash from operating activities: Net Income $24,000 Adjustments Subtract gain on sale of assets (4,000) Cash from operating activities $20,000 Cash from investing activities: Sale of assets 28,000 Net cash flows $48,000 Subtracting Increases in Current Assets  Company provides services on account  accrual income increases and so does balance of A/R  Ending A/R = Beginning A/R + Revenues – Collections  Cash income does not change because sale was on account  Subtract increase in current assets to change accrual income to cash income  Same logic applies to adding decreases in current assets Ex. Mac Inc. had the following transactions in its first year of operations: 1. Provided services, of $80,000 of which $60,000 were collected 2. Paid $25,000 for all operating expenses Accrual Income: Cash Income: Revenues $80,000 Revenues $60,000 Expenses (25,000) Expenses (25,000) Net income $55,000 Cash income $35,000 Change in A/R: Ending A/R = Beginning A/R + Revenues – Collections Ending A/R – Beginning A/R = Revenues – Collections Change in A/R = 80,000 – 60,000 = 20,000 increase Prepare Statement of Cash Flows Cash from operating activities: $55,000 Net Income Adjustments Subtract increase in A/R (20,000) Cash from operating activities $35,000 (which is equal to cash income) Adding Increases in Current Liabilities  Company receives service but does not pay for it  accrual income decreases and accrued liabilities increases  Ending S/P = Beginning S/P + Salaries Expense – Payments to Employees  Cash income does not change  Must add increase in current liabilities to adjust accrual income to cash income  Same logic applies to subtracting decreases in current liabilities Ex. Park Inc. had the following transactions in its first year of operations: 1. Provided services of $40,000 for cash 2. Employees earned salaries of $15,000 of which they paid $10,000 Accrual Income: Cash Income: Revenues $40,000 Revenues $40,000 Expenses (15,000) Expenses (10,000) Net income $25,000 Cash income $30,000 Change in S/P Ending S/P = Beginning S/P + Salaries Expense – Payments to Employees Ending S/P – Beginning S/P = Salaries Expense – Payments to Employees Change in S/P = 15,000 – 10,000 = 5,000 increase Prepare Statement of Cash Flows Cash from operating activities: Net Income $25,000 Adjustments Add Increase in S/P 5,000 Cash from operating activities $30,000 (which is equal to cash income) The Direct Method  Net cash provided (or used) by operating activities is calculated by adjusting each item in the income statement from accrual basis to cash basis  Following items are calculated (one inflow and three outflows): (1)Inflow of cash collections from customers: o Ending A/R = Beginning A/R + Revenues – Collections (2)Outflow of cash you pay for income tax/interest: o Ending IT (B/S) = Beginning IT (B/S) + Income Tax Expense (I/S) – Income Tax Paid (3)Outflow of cash to suppliers for inventory: (4)Outflow of cash for operating expenses (rent, insurance, admin, salaries, wages, advertisements, utilities, hydro) o Ending Prepaid Insurance (B/S) = Beginning Prepaid Insurance (B/S) + Payment for Insurance – Insurance Expense (I/S) o Ending Insurance Payable (B/S) = Beginning Insurance Payable (B/S) + Insurance Expense (I/S) – Cash Payment for Insurance o Will have either insurance payable or prepaid insurance (cannot have both at the same time) Payment to Suppliers  Two-step process 1. Calculate purchase: Ending Inventory = Beginning Inventory + Purchases – COGS 2. Calculate payment for purchases: Ending A/P = Beginning A/P + Purchases – Payments  Ending Supplies (B/S) = Beginning Supplies (B/S) + Purchase of Supplies – Supplies Expense (I/S) Payments for Operating Expenses  Operating Expenses: o + Increases in prepaid insurance o – Increases in accrued liabilities o – Decreases in prepaid expenses o + Decreases in accrued liabilities  Ending Prepaid Expenses = Beginning Prepaid Expenses + Payments for Prepaid Expenses – Operating Expenses  Change in P/E = Payments for P/E – Operating Expenses  Payments for Operating Expenses = Operating Expenses + Changes in P/E  Ending Accrued Liabilities = Beginning A/L + Operating Expenses – Payments for A/L  Changes in A/L = Operating Expenses – Payments for A/L  Payments for A/L = Operating Expenses – Changes in A/L Payments for Income Taxes and Interest  For income taxes: Ending IT Payable = Beginning IT Payable + IT Expense – Payments for IT  For interest: Ending Interest Payable = Beginning Interest Payable + Interest Expense – Interest Payments CHAPTER SEVEN: REPORTING AND INTERPRETING SALES REVENUE, RECEIVABLES AND CASH Sales Revenue  Revenue recognition principle says to recognize revenues when: o The earnings process is complete or nearly complete o An exchange transaction takes place
More Less

Related notes for COMMERCE 1BA3

Log In


OR

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


OR

By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.


Submit