ACCTG 211 1st Edition Lecture 15 Outline of Last Lecture I Statement of Cash Flows II Two Methods of Flows III Unit 7 Example Problem Outline of Current Lecture II Recap of Direct Method III Introducing Indirect Method IV Example of Indirect Method Current Lecture I II Important Items from Unit 7 a Why SOCF i Provides financial statement readers with both an accrual based and a cash based picture of business results ii What is needed to prepare SOCF iii Balance Sheet Income Statement Additional information provided b Basic format of SOCF i The change in Cash from the Balance sheet is split into three cash flow categories CFFO Operating CFFI Investing CFFF Financing ii CFFO is related to Income Statement activities CFFI is related to changes in Long Term Asset accounts CFFF is related to changes in Long Term Liabilities accounts and changes in Equity accounts iii Reconciliation at bottom of SOCF Net Change in CF Beg Cash End Cash There are 2 different ways to prepare CFFO Direct and Indirect methods a Direct Method i Goal derive CFFO directly Cash Inflows minus Cash Outflows Equals CFFO ii Key turn each item on the Income Statement into an Operating Cash Flow iii Process solve for the cash effect in each accrual based Income Statement item by evaluating a roll forward of related accrual account s b Indirect Method These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute III i Goal indirectly reconcile accrual based Net Income to CFFO ii Key start with Net Income then unwind accrual effects to arrive at CFFO iii Process start with Net Income then deal with any Depreciation or Amortization or Depletion then deal with any gains or losses on the sale of Long Term Assets then deal with any changes in accrual accounts Current Assets or Current Liabilities c Direct Method vs Indirect Method i If direct method is used companies must also present a reconciliation of Net Income to CFFO So companies that use the direct method must also provide the indirect method ii Both methods result in the same CFFO Example CFFO Direct Method a Goal derive CFFO directly Cash Inflows minus Cash Outflows Equals CFFO b Starting point Top of the Income Statement Sales c How to solve i Key turn each item on the Income Statement into an Operating Cash Flow 1 Sales Cash Collected from Customers Inflow 2 COGS Outflow 3 Selling Expenses 4 General Expenses IV Cash Paid to Vendors for Inventory Cash Paid for Selling Expenses Outflow Cash Paid for General Expenses Outflow 5 Interest Expense Cash Paid for Interest Outflow 6 Income Tax Expense Cash Paid for Income Taxes Outflow a Result Net Income is converted into Cash Flows from Operating Activities either a net Inflow or net Outflow ii Process solve for the cash effect in each accrual based Income Statement item by evaluating a roll forward of related accrual account s 1 Cash Collected from Customers Sales use A R 2 Cash Paid to Vendors for Inventory COGS use Inv then A P 3 Cash Paid for Selling Expenses Sell Exp no accrual acct 4 Cash Paid for General Expenses 5 Cash Paid for Interest IntExp no accrual acct 6 Cash Paid for Income Taxes Inc Tax Exp use Tax Pay a Depreciation Expense has no associated operating cash flows so pull that out first Then deal with Rent Expense via Prepaid Rent Remaining 500 had no accrual account so assumed cash only Indirect Method V a Indirect Method follows a different process to derive CFFO i Start with Net Income not Sales ii Then unwind accrual effects of Net Income to arrive at CFFO iii The Indirect Method is a reconciliationof Net Income to CFFO iv We will follow a scripted process v Important to note items in the Operating section of a SOCF employing the Indirect method are NOT cash flows in and of themselves rather they are reconciling itemsthat help us understand how to unwind the accrual effect of Net Income to arrive at CFFO Indirect Method EXAMPLE a Goal indirectly reconcile accrual based Net Income to CFFO b Starting point Bottom of the Income Statement Net Income c Objective reconcile accrual based Net Income to CFFO d Four Steps for Indirect Method Operating Section i Step 1 Start with Net Income accrual based 1 Step 1 Start with Net Income ii Step 2 Add Back Depreciation Expense or Amortization Expense or Depletion Expense 1 Step 2 Add Back Depreciation Expense 2 What is the journal entry to record depreciation 3 Does this journal entry involve cash 4 Step 2 Add Back Depreciation Expense 5 An increase in depreciation expense leads to a decrease in accrual based income 6 But for depreciation itself cash based NI does not change relative to accrual based NI 7 Step 2 Add Back Depreciation Expense 8 The goal of the indirect method is to reconcile accrual based income with cash based income 9 In the reconciliation eliminate the effect of depreciation iii Step 3 Add Back Loss or Back out Gain on Sale of L T Assets 1 Step 3 Add Back Loss on Sale of Long Term Assets 2 In the JE where a loss appears is the loss a debit or a credit 3 Is the loss itself a cash item or a non cash item 4 Losses act like expenses in that they decrease Net Income 5 An increase in a loss on the sale of long term assets leads to a decrease in accrual based income 6 But for the loss itself cash based NI does not change relative to accrual based NI note the cash increase associated with the sale of the L T asset will be dealt with as an investing activity 7 The goal of the indirect method is to reconcile accrual based income with cash based income 8 In the reconciliation eliminate the effect of the loss on sale 9 In the JE where a gain appears is the gain a debit or a credit 10 Is the gain itself a cash item or a non cash item 11 Gains act like revenues in that they increase Net Income 12 An increase in a gain on the sale of long term assets leads to an increase in accrual based income 13 But for the gain itself cash based NI does not change relative to accrual based NI note the cash increase associated with the sale of the L T asset will be dealt with as an investing activity 14 The goal of the indirect method is to reconcile accrual based income with cash based income 15 In the reconciliation eliminate the effect of the gain on sale 16 Let s use an increase in A R as an example 17 An increase in A R is associated with an increase in Revenue 18 No cash involved in this accrual 19 iv Step 4 Deal With Changes in CA or CL Accrual Accounts 1 Back Out Increase in