Statements on the direct preparation of the statement of cash flows refer to the items in the list below and the information provided above.
Compiling the cash flow statement using the direct method would be an easy task if all businesses kept very detailed cash records that could easily be summarized in this cash account:
Most businesses record excessive transactions in their cash accounts and do not record enough detail to summarize the information. Therefore, the cash flow statement is prepared by analyzing all accounts except cash accounts. Remember that in accounting all transactions involve at least two accounts. When money goes up or down, at least one other account changes too. If cash increases, this increase may also decrease another equity account, for example, B. Accounts receivable from customers (customer payments) or equipment (equipment sales), or increase the sales account (cash sales). Similarly, if cash decreases, there may be an increase in another asset account, such as inventory (inventory purchases) or equipment (equipment purchases), or a decrease in a liability account, such as accounts payable (payment on creditors) or accounts payable. (loan payment) or an increase in an expense account (seller's payment). The table summarizes many cash activities and the associated closing accounts used to analyze each activity listed.
operational activities
In preparing the operating section, certain accounts in the current assets and liabilities section of the balance sheet are used to identify the cash flows received and incurred in generating net income.
Customer Cash WithdrawalsConsists of cash sales (cash sales) and cash receipts from credit customers. Activity on customer and sales accounts is used to determine cash receipts from customers. Accounts receivable decreased by $663 because the company received more cash from customers than it sold on credit. The $663 reduction is added to the income statement income of $129,000 to determine the cash received from customers as reported on the statement of cash flows of $129,663. If the accounts receivable balance had increased, the money collected from customers would be determined by subtracting the increase in the accounts receivable balance from the sales balance, because an increase in accounts receivable means that your customers owe you money for their purchases (your sales) .
Cash payments to suppliers.This represents the amount the company pays for the goods it intends to sell to its customers. A two-step calculation is needed to find vendor cash payments of $71,976. First, the $107 increase in the inventory account is added to the cost of goods sold (recorded on the income statement) of $70,950 to arrive at $71,057 as the cost of goods purchased. An increase in inventory means that a company has bought more than it has sold. Since the amount paid for goods includes inventory sold and inventory to be sold, the change in inventory affects cash payments to vendors. A second step is necessary to determine the amount actually paid for the goods purchased. The reduction in accounts payable of $919 is then added to the value of purchases of $71,057 to calculate cash paid to vendors of $71,976. The reduction in accounts payable is added to the value of the purchases because a reduction in accounts payable means that more cash was paid than the goods that were purchased on credit.
If the balance in the inventory account had decreased, the decrease would be deducted from the cost of goods sold to calculate the cost of goods purchased, since the decrease indicates that fewer goods were purchased than sold during the period. If accounts payable to vendors had increased, the amount of the increase would have been deducted from the cost of goods purchased to determine cash payments to vendors, since the increase in accounts payable means that you have a loan from your suppliers and you haven't paid for it yet. for your cash purchases.
Cash payments for operating expenses.This includes salaries and other operating costs. There are two steps involved in calculating cash payments for business expenses. First, the total amount of operating expenses on the income statement is reduced from $42,600 to $14,400 of depreciation expense because depreciation is a non-cash expense. Second, the balance is adjusted for changes in the balances of the related balances. For Brothers' Quintet, Inc., the related balances and changes in those account balances are: $142 increase in prepaid expenses; salary increase to be paid for $320; and $1,295 reduction in accrued expenses. Operating expenses before depreciation are $28,200. Added to this total is the $142 increase in prepaid expenses, less the $320 increase in wages payable, and the $1,295 decrease in accrued expenses to arrive at cash payments to vendors of $29,317. As in the previous calculations, the calculation changes with the direction of change in the balances of the related balance sheet accounts. Operating expenses net of depreciation and amortization would be reduced by a decrease in the prepaid account balance, increased by a decrease in the payroll account balance, and decreased by an increase in the accrued expense account balance.
Cash payments of Income Tax.It represents the amounts paid by the company as income tax. The amount is calculated by taking the income tax expense and increasing it by the amount of a decrease in the income tax account payable balance or decreasing it by the amount of an increase in the income tax account payable balance. income tax. In this case, there is no accrued tax, so the income tax expense is equal to the amount paid for income tax.
Payment of interest in cash.This represents the amounts paid by the company as interest. The amount is calculated by increasing interest expense by the amount of a decrease in the interest payable account balance or by decreasing it by the amount of an increase in the interest payable account balance. In this case, there is no balance in the accrued interest account at the end of the period, so the money paid for interest equals the interest expense.
investment activity
To identify investment activity, it is necessary to analyze long-term asset accounts.
purchase of equipmentThis includes cash amounts paid for equipment. If a promissory note had been signed in exchange for part or all of the purchase price of the equipment, only the amount of cash actually paid would be recorded as payment in the statement of cash flows. The portion of the purchase price represented by the promissory note would be reported separately if the amount was material.
Proceeds from the sale of equipment (or other non-current assets).The money received from the sale is reported here. Revenue is not adjusted for any gain or loss that has also been recognized on the sale, since only revenue represents cash, the gain or loss represents the difference between the book value of the assets and the amount received. For Brothers' Quintet, Inc., the book value is $10,000 ($15,000 cost - $5,000 accumulated depreciation). The loss is $3,000, calculated by subtracting the book value of $10,000 from the income of $7,000, and is reflected in the income statement. The $7,000 product represents the actual cash received from the sale and is the amount reported on the statement of cash flows. Analysis of long-term capital accounts includes the following:
financing activity
To identify financing activities, long-term liability accounts and equity accounts must be analyzed.
Income from bank loans.The proceeds from the bank loan of $4,000 represents an additional loan during the year. Financial liabilities are not shown net of capital. Each is treated as a separate activity that must be reported in the statement of cash flows.
Loan payment.The loan payment of $12,000 represents cash payments made to the bank during the year.
Proceeds from the sale of shares.This represents money raised by issuing new shares to investors.
Cash Dividend Payment.This is the dividend amountpaymentduring the year. Since the statement of cash flows only includes cash activities, declaring a dividend does not result in reporting the statement, only when dividends are paid are they included in the statement of cash flows. When looking at the retained earnings account, the other activity is net income. Cash activities related to the generation of net income are included in the operating activities section of the statement of cash flows and therefore not in the financing activities section.
Reconciliation of Net Income to Cash Flow from Current Business Activities
When using the direct method to prepare the statement of cash flows, the Financial Accounting Standards Board requires companies to disclose a reconciliation of net income to net cash provided by (through) operating activities that would have been reported if the indirect method had been used. to prepare the statement.