STRUCTURE OF THE BALANCE SHEET

1
CHAPTER 4
FINANCIAL REPORTING ANALYSIS BY REVSINE
COLLINS JOHNSON 2nd Edition

• STRUCTURE OF THE BALANCE SHEET
• STATEMENT OF CASH FLOWS

Slides Authored by Brian Leventhal University
of Illinois at Chicago
2
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts

• A. There are three basic elements of the balance
  sheet

Assets Liabilities Owners Equity

• 1. Assets are the probable future economic
  benefits obtained or
  controlled by an entity as
  a result of past transactions
  or events.

3
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts

• A. There are three basic elements of the balance
  sheet

Assets Liabilities Owners Equity
2. Liabilities are
probable future sacrifices
arising from present obligations
to transfer assets or provide
services to other entities as a
result of past transactions
or events.
4
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts

• A. There are three basic elements of the balance
  sheet

Assets - Liabilities Owners Equity
3. Equity is the residual interest in the assets
of an entity that remains after deducting its
liabilities.
5
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts

• A. There are three basic elements of the balance
  sheet

Assets Liabilities Owners Equity
4. Generally accepted accounting principles
(GAAP) balance sheet carrying amounts are a
mixture of
-
historical costs
- current costs (also
called fair value) - net
realizable value, and
- discounted present values.
6
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Assets Liabilities Owners Equity

• B. The balance sheet provides information for
  assessing
  
• - rates of return
  - capital structure
  - liquidity
  
  - solvency, and
  -financial flexibility.

7
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Assets Liabilities Owners Equity

• B. The balance sheet provides information for
  assessing

• 1. Rates of return measures are used to evaluate
  operating efficiency and profitability.
• a. Two common returns measures are return on
  assets (ROA) and return on common equity (ROCE).
  
• b. By comparing ROA to ROCE, users can gain
  insight into whether leverage (e.g., debt
  financing) is enhancing the return earned by
  shareholders.

8
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Assets Liabilities Owners Equity

• B. The balance sheet provides information for
  assessing

2. Capital structure is the relative proportion
of financing for assets that comes from debt or
equity sources.

An important decision in
corporate finance is determining the optimal
capital structure.
9
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Assets Liabilities Owners Equity

• B. The balance sheet provides information for
  assessing

3. The related footnotes provide information for
evaluating liquidity, solvency, and capital
structure.
10
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Assets Liabilities Owners Equity
3. The related footnotes Balance Sheet provide
information for evaluating liquidity, solvency,
and capital structure.

• a. Liquidity measures how readily assets can be
  converted to cash
  relative to how soon
  liabilities will have
  to be paid in cash.

11
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Assets Liabilities Owners Equity
3. The related footnotes Balance Sheet provide
information for evaluating liquidity, solvency,
and capital structure.

• b. Solvency refers to the ability of a company to
  generate sufficient cash flows to maintain its
  productive capacity and still
  meet interest and principal payments on
  long-term debt.

12
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Assets Liabilities Owners Equity
3. The related footnotes Balance Sheet provide
information for evaluating liquidity, solvency,
and capital structure.

• c. Financial flexibility refers to a companys
  ability to adjust to unexpected
  downturns in the economic
  environment in which it operates
  or to take advantage of
  investment opportunities as they arise.

13
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Assets Liabilities Owners Equity

• C. A classified balance sheet groups similar
  items so that important relationships are
  revealed.
• 1. Assets a. Current
  assets. b. Long-term investments. c. Property,
  plant, and equipment. d. Intangible
  assets. e. Other (long-term) assets.

14
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Assets Liabilities Owners Equity

• C. A classified balance sheet groups similar
  items so that important relationships are
  revealed.
• 2. Liabilities a. Current
  liabilities. b. Long-term liabilities.

15
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Assets Liabilities Owners Equity

• C. A classified balance sheet groups similar
  items so that important relationships are
  revealed.
• 3. Owners equity a. Capital
  stock. b. Additional paid-in capital. c. Retai
  ned earnings.

16
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
If cash consists exclusively of U.S. dollar
amounts, the balance sheet account reflects the
historical amount, which is identical to the
current market value of cash.

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• ASSETS
• Current Assets
• Cash Cash Equivalents 3,345 1,453
• Short-Term Investments 699 171
• Accounts Receivable, net 5,125 5,057
• Inventories
  3,422 3,745
• Deferred Income Taxes 3,162 2,362
• Other current assets 750
  743
• Total Current Assets 16,503
  13,531

17
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Cash amounts denominated in foreign currency
units is translated into U.S. dollar equivalents
at the balance sheet date using the current rate
of exchange. This portion of cash is carried at
its current market price.

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• ASSETS
• Current Assets
• Cash cash Equivalents 3,345 1,453
• Short-Term Investments 699 171
• Accounts Receivable, net 5,125 5,057
• Inventories
  3,422 3,745
• Deferred Income Taxes 3,162 2,362
• Other current assets 750
  743
• Total Current Assets 16,503
  13,531

18
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
The intended holding period of the company that
owns the securities determines how the debt and
equity securities are measured on the balance
sheet.

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• ASSETS
• Current Assets
• Cash cash Equivalents 3,345 1,453
• Short-Term Investments 699 171
• Accounts Receivable, net 5,125 5,057
• Inventories
  3,422 3,745
• Deferred Income Taxes 3,162 2,362
• Other current assets 750
  743
• Total Current Assets 16,503
  13,531

19
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Some investments will be carried at original
(historical) cost, some at amortized cost, and
others at current cost.

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• ASSETS
• Current Assets
• Cash cash Equivalents 3,345 1,453
• Short-Term Investments 699 171
• Accounts Receivable, net 5,125 5,057
• Inventories
  3,422 3,745
• Deferred Income Taxes 3,162 2,362
• Other current assets 750
  743
• Total Current Assets 16,503
  13,531

20
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Gross accounts receivable equal the face amounts
arising from past transactions.

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• ASSETS
• Current Assets
• Cash cash Equivalents 3,345 1,453
• Short-Term Investments 699 171
• Accounts Receivable, net 5,125 5,057
• Inventories
  3,422 3,745
• Deferred Income Taxes 3,162 2,362
• Other current assets 750
  743
• Total Current Assets 16,503
  13,531

21
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Gross accounts receivable are reduced by
an estimate of the accounts receivable
that will ultimately not be
collected.

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• ASSETS
• Current Assets
• Cash cash Equivalents 3,345 1,453
• Short-Term Investments 699 171
• Accounts Receivable, net 5,125 5,057
• Inventories
  3,422 3,745
• Deferred Income Taxes 3,162 2,362
• Other current assets 750
  743
• Total Current Assets 16,503
  13,531

So,  Net Accounts Receivable are carried at net
realizable value.
22
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
The measurement of inventory depends on the
relationship between historical costs and current
market prices.

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• ASSETS
• Current Assets
• Cash cash Equivalents 3,345 1,453
• Short-Term Investments 699 171
• Accounts Receivable, net 5,125
  5,057
• Inventories 3,422
  3,745
• Deferred Income Taxes 3,162 2,362
• Other current assets 750
  743
• Total Current Assets 16,503
  13,531

When costs are lower than market price, the
carrying amount for inventory is historical
cost
23
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
The measurement of inventory depends on the
relationship between historical costs and current
market prices.

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• ASSETS
• Current Assets
• Cash cash Equivalents 3,345 1,453
• Short-Term Investments 699 171
• Accounts Receivable, net 5,125
  5,057
• Inventories 3,422
  3,745
• Deferred Income Taxes 3,162 2,362
• Other current assets 750
  743
• Total Current Assets 16,503
  13,531

When cost exceeds market, Inv. are carried at
current market price, market price is defined as
net realizable value.
24
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• ASSETS
• Total Current Assets
  16,503 13,531
• Property, Plant Equipment,net 9,246
  10,049
• Other Assets 11,578
  5,148
• Total Assets 37,327
  28,728

Property,Plant Equipment are on the balance
sheet at
Historical Cost -
Accum.Deprec.Book Value(Net)
When a long-lived asset becomes impaired
that is, when its carrying amount may no
longer be recoverable
the
fixed asset is reduced to its lower fair value.
25
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Accounts payable
accrued liabilities are on the balance
sheet at the amount of the original liability
(historical cost).

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• LIBILITIES
• Current Liabilities
• Notes payable
  current portion of
  
  long-term debt 2,504 2,909
• Accounts payable 3,015 2,305
• Accrued liabilities 6,897
  6,226
• Total Current Liabilities 12,416
  11,440
• Long-term debt
  3,089 2,633
• Deferred Income Taxes 3,481
  1,188
• Other liabilities 1,513
  1,245
• Total Liabilities 16,503
  13,531

26
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
The initial balance sheet carrying amount is the
discounted present value of the sum of (1) the
future principal repayment plus (2) the
periodic interest payments.

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• LIBILITIES
• Current Liabilities
• Notes payable
  current portion of
  
  long-term debt 2,504 2,909
• Accounts payable 3,015
  2,305
• Accrued liabilities
  6,897 6,226
• Total Current Liabilities 12,416
  11,440
• Long-term debt 3,089
  2,633
• Deferred Income Taxes 3,481
  1,188
• Other liabilities 1,513
  1,245
• Total Liabilities 16,503 13,531

27
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Fixed Rate Debt, this
carrying amount will differ from current
market prices when interest rates have
changed subsequent to issuance.

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• LIBILITIES
• Current Liabilities
• Notes payable
  current portion of
  
  long-term debt 2,504 2,909
• Accounts payable 3,015
  2,305
• Accrued liabilities
  6,897 6,226
• Total Current Liabilities 12,416
  11,440
• Long-term debt 3,089
  2,633
• Deferred Income Taxes 3,481
  1,188
• Other liabilities 1,513
  1,245
• Total Liabilities 16,503 13,531

28
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Variable Rate Debt, this carrying
amount will equal the present value of the
future principal and interest
flows.

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• LIBILITIES
• Current Liabilities
• Notes payable
  current portion of
  
  long-term debt 2,504 2,909
• Accounts payable 3,015
  2,305
• Accrued liabilities
  6,897 6,226
• Total Current Liabilities 12,416
  11,440
• Long-term debt 3,089
  2,633
• Deferred Income Taxes 3,481
  1,188
• Other liabilities 1,513
  1,245
• Total Liabilities 16,503 13,531

29
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• LIBILITIES
• Current Liabilities
• Notes payable
  current portion of
  
  long-term debt 2,504 2,909
• Accounts payable 3,015
  2,305
• Accrued liabilities
  6,897 6,226
• Total Current Liabilities 12,416
  11,440
• Long-term debt
  3,089 2,633
• Deferred Income Taxes 3,481 1,188
• Other liabilities 1,513
  1,245
• Total Liabilities 16,503 13,531

Deferred income taxes are reported at their
undiscounted amount.(Original Amount)
30
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Mandatorily redeemable preferred stock
incorporates elements of both debt and equity.
These securities are typically afforded
mezzanine treatment.

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• LIBILITIES
• Total Liabilities 16,503 13,531
• Company-obligated
• Mandatorily redeemable
• Preferred securities of
• subsidiary Trust holding
• solely company
• Guaranteed debentures 484 --

31

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• STOCKHOLDERS EQUITY
• Preferred stock, 100 PV
• Authorized shares
• .5 (non issued) ----
  ----
• Common Stock, 3 PV
• Authorizes shares
  20012000, 1,400
• Issued outstanding
• 2001,612.82000601.1 1,838 1,804
• Additional paid-in capital 2,572 1,894
• Retained earnings 8,780 8,254
• Non-owner changes to equity 3,154 270
• Total Stockholders Eq. 16,344 12,222

Common Stock is reported at historical par
value.
32

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• STOCKHOLDERS EQUITY
• Preferred stock, 100 PV
• Authorized shares
• .5 (non issued) ----
  ----
• Common Stock, 3 PV
• Authorizes shares
  20012000, 1,400
• Issued outstanding
• 2001,612.82000601.1 1,838 1,804
• Additional paid-in capital 2,572 1,894
• Retained earnings 8,780 8,254
• Non-owner changes to equity 3,154 270
• Total Stockholders Eq. 16,344 12,222

Additional paid-in capital is reported at
historical cost as the excess of original issue
price and par value.
33
This measures the net of the cumulative earnings
less cumulative dividend distributions of the
company since inception. This is reinvestment to
grow!

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• STOCKHOLDERS EQUITY
• Preferred stock, 100 PV
• Authorized shares
• .5 (non issued) ----
  ----
• Common Stock, 3 PV
• Authorizes shares
  20012000, 1,400
• Issued outstanding
• 2001,612.82000601.1 1,838 1,804
• Additional paid-in capital 2,572 1,894
• Retained earnings 8,780 8,254
• Non-owner changes to equity 3,154 270
• Total Stockholders Eq. 16,344 12,222

34
Since different measurement bases pervade the
balance sheet, income statement so retained
earnings is a mixture of historical costs,
current values, and present values.

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• STOCKHOLDERS EQUITY
• Preferred stock, 100 PV
• Authorized shares
• .5 (non issued) ----
  ----
• Common Stock, 3 PV
• Authorizes shares
  20012000, 1,400
• Issued outstanding
• 2001,612.82000601.1 1,838 1,804
• Additional paid-in capital 2,572 1,894
• Retained earnings 8,780 8,254
• Non-owner changes to equity 3,154 270
• Total Stockholders Eq. 16,344 12,222

35

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• STOCKHOLDERS EQUITY
• Preferred stock, 100 PV
• Authorized shares
• .5 (non issued) ----
  ----
• Common Stock, 3 PV
• Authorizes shares
  20012000, 1,400
• Issued outstanding
• 2001,612.82000601.1 1,838 1,804
• Additional paid-in capital 2,572 1,894
• Retained earnings 8,780 8,254
• Non-owner changes to equity 3,154 270
• Total Stockholders Eq. 16,344 12,222

This measures the net of the cumulative
unrealizable gains and losses from other
comprehensive income components recognized in
current and prior years
36

• Motorola Balance Sheet
• Dec 31
• 2001 2000
• STOCKHOLDERS EQUITY
• Preferred stock, 100 PV
• Authorized shares
• .5 (non issued) ----
  ----
• Common Stock, 3 PV
• Authorizes shares
  20012000, 1,400
• Issued outstanding
• 2001,612.82000601.1 1,838 1,804
• Additional paid-in capital 2,572 1,894
• Retained earnings 8,780 8,254
• Non-owner changes to equity 3,154 270
• Total Stockholders Eq. 16,344 12,222

This account is debited for unrealized losses
and credited for unrealized gains. All
amounts are shown net of tax effects.
37
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Q. Extracting Analytical Insights

• 1. One tool for gaining insights into the
  companys operations and for
  analyzing its assets and
  financial structures is to
  prepare a common-size balance sheet.

38
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Q. Extracting Analytical Insights

• 2. The account titles and formats for balance
  sheets prepared in other countries can sometimes
  differ from those prepared in the U.S.
• In the U.S. assets are presented in decreasing
  order of liquidity.
• In the U.K., Germany, Netherlands, and other
  European countries, fixed assets are presented
  first followed by current assets displayed in an
  increasing order of liquidity.

39
I. Classification Criteria and Measurement
Conventions for Balance Sheet
Accounts
Q. Extracting Analytical Insights

• 3. Analysts must pay attention to the differences
  in accounts and valuation techniques that are
  allowed by different countries
  GAAP procedures.

40
II. Statement of Cash Flows

• A. The statement of cash flows shows the user why
  a firms investments and financial structure have
  changed between two periods.
• 1. The critical issue then becomes the timing of
  income recognition.

41
II. Statement of Cash Flows

• 2. The connection between successive balance
  sheet positions and the statement of cash flows
  can be shown

a. Assets Liabilities Owners equity
b. Cash Noncash assets Liabilities
Owners equity
c. Cash Liabilities - Noncash assets Owners
equity
d. DCash DLiab - DNoncash assets DOwners
equity
42
II. Statement of Cash Flows

• 2. The connection between successive balance
  sheet positions and the statement of cash flows
  can be shown

D Cash D Liab D Noncash assets D Owners
equity

• e. The cash flow statement simultaneously
  provides an explanation of why a firms cash
  position has changed between successive balance
  sheet dates
• and explains changes that have taken place in
  the firms noncash asset, liability, and
  stockholders equity accounts over the same time
  period.

43
II. Statement of Cash Flows

• 3. The change in a firms cash position between
  successive
  balance sheet dates will
  not equal the reported
  earnings for
  that period.

44
II. Statement of Cash Flows

• 3. The change in a firms cash position
  between successive balance sheet dates will not
  equal the reported earnings for that period.

a. Reported net income will not equal cash flow
from operating activities because
of differences between
accrual-based and
cash-based accounting.
45
II. Statement of Cash Flows

• 3. The change in a firms cash position
  between successive balance sheet dates will not
  equal the reported earnings for that period.

• Changes in cash may be caused by nonoperating
  investing activities like the
  purchase or sale of property,
  plant,
• and equipment.

46
II. Statement of Cash Flows

• 3. The change in a firms cash position
  between successive balance sheet dates will not
  equal the reported earnings for that period.

c. Changes in cash may be caused by nonoperating
financing activities like
the issuance of
stock or bonds or the
repayment of a bank
loan.
47
II. Statement of Cash Flows

• B. The cash flow statement summarizes
  the cash inflows and outflows of a company broken
  down into three activities

• 1. Cash flows from operating activities result
  from the cash effects of transactions and events
  that affect operating income.
• 2. Cash flows from investing activities result
  from the cash effects of transactions and events
  that affect long-term assets.
• 3. Cash flows from financing activities result
  from the cash effects of transactions and events
  that affect long-term liabilities and owners
  equity (other than net income).

48
II. Statement of Cash Flows
Lets Look at an Example of Cash
Accrual Accounting
49
HRB Advertising Company
HRB Advertising opened on April 1,
2001. The corp.s for the remainder of 2001 are
as follows
1. Each of the 3 partners contributed 3500
cash on April 1 for shares of the companys stock.
Accrual Basis Income Statement Operating
Activities Net Income
Cash Flow Statement Operating Activities Total
Operating Cash Flow Investing Activities Financi
ng Activities Change in Cash
Stock Issuance 10,500
50
HRB Advertising Company
HRB Advertising opened on April 1,
2001. The corp.s for the remainder of 2001 are
as follows
2. HRB rented office space Beg. April 1, and
paid the full years rental of 2000 per month or
24,000 in advance.
Accrual Basis Income Statement Operating
Activities Net Income
Cash Flow Statement Operating Activities Total
Operating Cash Flow Investing Activities Financi
ng Activities Change in Cash
Rent Expense (24,000)
Stock Issuance 10,500
51
HRB Advertising Company
3. The Company borrowed 10,000 from a bank on
April 1. The loan and accrued interest is
payable Jan. 1, 2002 w/ interest at 12 per year.
Accrual Basis Income Statement Operating
Activities Net Income
Cash Flow Statement Operating Activities Total
Operating Cash Flow Investing Activities Financi
ng Activities Change in Cash
Rent Expense (24,000)
Bank borrowing 10,000
Stock Issuance 10,500
52
HRB Advertising Company
4. HRB purchased office eq. With a 5 year life
for 15,000 cash on April 1. Equipment is
depreciated straight-line no salvage value.
Accrual Basis Income Statement Operating
Activities Net Income
Cash Flow Statement Operating Activities Total
Operating Cash Flow Investing Activities Financi
ng Activities Change in Cash
Rent Expense (24,000)
Equipment purchase (15,000)
Bank borrowing 10,000
Stock Issuance 10,500
53
HRB Advertising Company
5. HRB sold and billed customer for 65,000 of
advertising services rendered between April 1
and Dec 31. Of this
amount, 20,000 was still uncollected by year-end.
Accrual Basis Income Statement Operating
Activities Net Income
Cash Flow Statement Operating Activities Total
Operating Cash Flow Investing Activities Financi
ng Activities Change in Cash
Advertising Revenue 45,000
Advertising Revenue 65,000
Rent Expense (24,000)
Adverting Rev.(Accrual Actg.) Revenue
Earned Services Performed 65,000
Equipment purchase (15,000)
Bank borrowing 10,000
Stock Issuance 10,500
54
HRB Advertising Company
6. By year-end, the company used and paid the
following operating costs (a) utilities 650,
(b) salaries, 36,250 and (c) supplies 800.
Cash Flow Statement Operating Activities Tot
al Operating Cash Flow Investing
Activities Financing Activities Change in Cash
Accrual Basis Income Statement Operating
Activities Net Income
Advertising Revenue 45,000
Rent Expense (24,000)
Advertising Revenue 65,000
Utilities Expense (650)
Utilities Expense (650)
Salary Expense (36,250)
Salary Expense (36,250)
Supplies Expense (800)
Supplies Expense (800)
Equipment purchase (15,000)
Bank borrowing 10,000
Stock Issuance 10,500
55
HRB Advertising Company
7. The company had accrued (unpaid) expenses
at year-end as follows (a) utilities 75 (b)
salaries 2,400 and (c) interest 900.
Accrual Basis Income Statement Operating
Activities Net Income
Cash Flow Statement Operating Activities Tot
al Operating Cash Flow Investing
Activities Financing Activities Change in Cash
Advertising Revenue 45,000
Advertising Revenue 65,000
Rent Expense (24,000)
Utilities Expense (650)
(725)
Utilities Expense (650)
Utilities Expense(Used) 650 75 725
Salary Expense (36,250)
Salary Expense (36,250)
(38,650)
Supplies Expense (800)
Salary Expense(Used) 36,250 2,400 38,650
Supplies Expense (800)
Interest Expense (900)
Interest Expense(Used) 10,000.129/12 900
Equipment purchase (15,000)
Bank borrowing 10,000
Stock Issuance 10,500
56
HRB Advertising Company
8. Supplies purchased on account and unpaid at
year-end is 50. Supplies on hand at year-end is
100.
Accrual Basis Income Statement Operating
Activities Net Income
Cash Flow Statement Operating Activities Tot
al Operating Cash Flow Investing
Activities Financing Activities Change in Cash
Advertising Revenue 45,000
Advertising Revenue 65,000
Rent Expense (24,000)
Utilities Expense (650)
Salary Expense (36,250)
Supplies Expense (800)
(750)
Supplies Expense (800)
Supplies Expense(Used) Purchased End.
Supplies 750 (800 50) - 100
Equipment purchase (15,000)
Interest Expense (900)
Bank borrowing 10,000
Stock Issuance 10,500
57
HRB Advertising Company
9. Annual Depr. Exp. On office Eq. Is 3000.
Since the Eq. Was acquired on April 1, the Dep
Exp for 2001 is 3,000 9/12 2,250.
Accrual Basis Income Statement Operating
Activities Net Income
Cash Flow Statement Operating Activities Tot
al Operating Cash Flow Investing
Activities Financing Activities Change in Cash
Advertising Revenue 45,000
Advertising Revenue 65,000
Rent Expense (24,000)
Utilities Expense (650)
Salary Expense (36,250)
Supplies Expense (800)
Equipment purchase (15,000)
Interest Expense (900)
Depreciation Exp. (2,250)
Bank borrowing 10,000
Stock Issuance 10,500
58
HRB Advertising Company
10. The office space was used for 9 months
18,000.
Accrual Basis Income Statement Operating
Activities Net Income
Cash Flow Statement Operating Activities Tot
al Operating Cash Flow Investing
Activities Financing Activities Change in Cash
Advertising Revenue 45,000
Advertising Revenue 65,000
Rent Expense (24,000)
Utilities Expense (650)
Salary Expense (36,250)
Rent Used(Accrual Actg.) Cost per Month
Months Used 18,000
2,000 9
Supplies Expense (800)
Rent Expense (18,000)
Equipment purchase (15,000)
Interest Expense (900)
Depreciation Exp. (2,250)
Bank borrowing 10,000
Stock Issuance 10,500
59
HRB Advertising Company
LETS GET THE FINAL RESULTS !!!!
Accrual Basis Income Statement Operating
Activities Net Income
Cash Flow Statement Operating Activities Tot
al Operating Cash Flow Investing
Activities Financing Activities Change in Cash
Advertising Revenue 45,000
Advertising Revenue 65,000
Rent Expense (24,000)
Rent Expense (18,000)
Utilities Expense (650)
Salary Expense (36,250)
Supplies Expense (800)
(16,700)
Interest Expense (900)
Equipment purchase (15,000)
Depreciation Exp. (2,250)
Bank borrowing 10,000
Stock Issuance 10,500
20,500
3725
(11,200)
60
HRB Advertising Company
Direct approach shows the individual
operating cash inflows and outflows directly.
61
HRB Advertising Company
Indirect approach arrives at net cash flows
from operations by adjusting net income for the
differences between accrual-basis earnings and
cash-basis earnings.
Cash Flow Statement Operating Activities Net
Income 3,725 Plus
Depreciation 2,250 Increase in S/P
2,400 Increase in A/P 50 Increase
in Util/P 75 Increase in Int/P
900 5,675 Minus Increase in
A/R (20,000) Increase in Prpd
Rent (6,000) Increase in Supplies (100)
(26,100) Cash Flow from operations (16,700)
62
HRB Advertising Company
Indirect approach arrives at net cash flows
from operations by adjusting net income for the
differences between accrual-basis earnings and
cash-basis earnings.

• Cash Flow Statement
• Operating Activities
• Net Income 3,725
• Plus
• Add noncash expenses
  (i.e., depreciation amortization
  bond discount losses on sales of property,
  plant, and equipment.) to
  net income.
• Cash Flow from operations (16,700)

63
HRB Advertising Company
Indirect approach arrives at net cash flows
from operations by adjusting net income for the
differences between accrual-basis earnings and
cash-basis earnings.

• Cash Flow Statement
• Operating Activities
• Net Income 3,725
• Plus
• Add net decreases
  in current assets.
• Add net increases in
  current liabilities.
• Cash Flow from operations (16,700)

64
HRB Advertising Company

• Cash Flow Statement
• Operating Activities
• Net Income 3,725
• Plus
• Minus
• Subtract net decreases in
  current liabilities.
• Subtract net increases in
  current assets.
• Subtract noncash gains
  (amortization bond premium gains on sales
  of property, plant, and equipment.) to net
  income.
• Cash Flow from operations (16,700)

Indirect approach arrives at net cash flows
from operations by adjusting net income for the
differences between accrual-basis earnings and
cash-basis earnings.
65
II. Statement of Cash Flows
Lets Look at an Example of Making a
Statement of Cash Flows
66
Putting together a Statement of Cash Flows

• HRB Comparative Balance Sheets
• 2001 2002 Change
• Assets
• Cash (11,200) 500
  11,700
• A/R 20,000 15,775 -
  4225
• Supplies Inventory 100 225
  125
• Prepaid Rent 6,000 6,000 ---
• Office Equipment 15,000 16,500 1,500
• Less A/D (2,250 (5,500) -
  3,250
• Total Assets 27,650 33,500 5,850

1 Calculate Change in Balance Sheet Accounts
67
Putting together a Statement of Cash Flows

• HRB Comparative Balance Sheets
• 2001 2002 Change
• Assets
• Cash (11,200) 500
  11,700
• A/R 20,000 15,775 -
  4225
• Supplies Inventory 100 225
  125
• Prepaid Rent 6,000 6,000 ---
• Office Equipment 15,000 16,500 1,500
• Less A/D (2,250 (5,500) -
  3,250
• Total Assets 27,650 33,500 5,850

Answer to Increase in Cash for the period
on Statement
68
Putting together a Statement of Cash Flows
2 Classify what part of SCF the Balance Sheet
Items relate to. Operating Financing or Investing

• HRB Comparative Balance Sheets
• 2001 2002 Change
• Assets
• Cash (11,200) 500
  11,700
• A/R 20,000 15,775
  - 4225
• Supplies Inventory 100 225
  125
• Prepaid Rent 6,000 6,000
  ---
• Office Equipment 15,000 16,500
  1,500
• Less A/D (2,250) (5,500) -
  3,250
• Total Assets 27,650 33,500
  5,850

OP
OP
OP
INV
OP (Dep. Exp) and/or INV(Asset Sales)
69
Putting together a Statement of Cash Flows
3 Analyze changes and determine Cash Flow effect
along with info from Income Statement and other
data as needed

• HRB Comparative Balance Sheets
• 2001 2002 Change
• Assets
• Cash (11,200) 500
  11,700
• A/R 20,000 15,775 -
  4225
• Supplies Inventory 100 225
  125
• Prepaid Rent 6,000 6,000 ---
• Office Equipment 15,000 16,500 1,500
• Less A/D (2,250 (5,500) -
  3,250
• Total Assets 27,650 33,500 5,850

70
Putting together a Statement of Cash Flows
3 Analyze changes and determine Cash Flow effect
along with info from Income Statement and other
data as needed

• HRB Comparative Balance Sheets
• 2001 2002 Change
• Balance Sheet A/R 20,000 15,775 -4225
• Income St.

Operating activity
Revenues 92,000
A/R relates to what Income Statement item?
Beg. Bal 20,000
Cash Collections
92,000
Credit Sales
92,000
????
Cash Effect!!
????
96,225
End. Bal 15,775
Now, lets see how it looks on the SCF!
71
Putting together a Statement of Cash Flows

• HRB Comparative Balance Sheets
• 2001 2002 Change
• Balance Sheet A/R 20,000 15,775 - 4225
• Cash Collections 96,225
• Income St. Revenues 92,000
• Net Income (1,725)

Operating activity
SCF Indirect Method Operating
Activities Net Income (1,725) Plus
SCF Direct Method Operating Activities
Cash Revenues 96,225
Decrease in A/R 4225
72
Putting together a Statement of Cash Flows

• Revenues 92,000
• Expenses (93,725)
• Net Loss (1,725)
• Revenues 92,000
• dec. in A/R 4,225
• Cash Revenues96,225
• Its there but its hidden!

• HRB Comparative Balance Sheets
• 2001 2002 Change
• Balance Sheet A/R 20,000 15,775 - 4225
• Cash Collections 96,225
• Income St. Revenues 92,000
• Net Income (1,725)

Operating activity
SCF Indirect Method Operating
Activities Net Income (1,725) Plus
SCF Direct Method Operating Activities
Cash Revenues 96,225
Decrease in A/R 4225
73
Putting together a Statement of Cash Flows

• HRB Comparative Balance Sheets
• Balance Sheet 2001 2002 Change
• Supplies Inv. 100 225 125
• A/P (Supplies) 50 75 25
• Income St.

Operating activity
Supplies Exp. 1,200
Supplies relates to what Income Statement item?
Beg. Bal 100
1,200
Beg. Bal 50
Supplies Used
Cash Effect!!
????
????
1,325
1,300
????
1,325
Purchases on Account
1,200
Pur on Acc
????
Supplies Paid
End. Bal 75
End. Bal 225
74
Operating activity
Putting together a Statement of Cash Flows

• HRB Comparative Balance Sheets
• Balance Sheet 2001 2002 Change
• Supplies Inv. 100 225 125
• A/P (Supplies) 50 75 25
• Cash Paid (Supplies) 1,300
• Income St. Supplies Exp.1,200

SCF Indirect Method Operating
Activities Net Income
(1,725) Plus Minus
SCF Direct Method Operating Activities
Supplies (1,300)
Increase in A/P Sup. 25
Increase in Supplies (125)
75
Operating activity
Putting together a Statement of Cash Flows

• Revenues 92,000
• Expenses (93,725)
• Net Loss (1,725)
• Supplies Exp. (1,200)
• inc. in Sup. (125)
• - dec.in A/P 25
• Cash Supplies (1,300)
• Its there but its hidden!

• HRB Comparative Balance Sheets
• Balance Sheet 2001 2002 Change
• Supplies Inv. 100 225 125
• A/P (Supplies) 50 75 25
• Cash Paid (Supplies) 1,300
• Income St. Supplies Exp.1,200

SCF Indirect Method Operating
Activities Net Income
(1,725) Plus Minus
SCF Direct Method Operating Activities
Supplies (1,300)
Increase in A/P Sup. 25
Increase in Supplies (125)
76
Putting together a Statement of Cash Flows
HRB Comparative Balance Sheets Balance
Sheet 2001 2002 Change Prepaid Rent
6,000 6,000 0 Income St.
Operating activity
Rent Exp. 24,000
Rent relates to what Income Statement item?
Rent Used 1/1-3/31
Beg. Bal 6,000
24,000
Cash Effect!!
????
6,000
????
24,000
Rent Paid in Advance this yr.
????
18,000
Rent Used 4/1-12/31
End. Bal 6,000
77

• Revenues 92,000
• Expenses (93,725)
• Net Loss (1,725)
• Rent Exp. (24,000)
• /- Prepaid
• Rent. 0
• Cash Rent (24,000)
• Cash Accrual are equal , no adj. needed

Putting together a Statement of Cash Flows
HRB Comparative Balance Sheets Balance
Sheet 2001 2002 Change Prepaid Rent
6,000 6,000 0 Cash Paid Rent
24,000 Income St. Rent Exp. 24,000
SCF Indirect Method Operating
Activities Net Income
(1,725) Plus Minus
SCF Direct Method Operating Activities
Rent (24,000)
Prepaid Rent /- 0
78
Putting together a Statement of Cash Flows
HRB Comparative Balance Sheets
- No Sales of
Equipment Balance Sheet 2001 2002
Change Acc. Depr. (2,250) (5,500)
(3,250) Income St.
Operating activity
Depr. Exp. 3,250
Depreciation relates to what Income Statement
item?
2,250 Beg. Bal
3,250
0
????
NO Cash Effect!!
????
3,250
Assets Sold
Deprecation Exp.
5,500 End. Bal
79
Putting together a Statement of Cash Flows

• Revenues 92,000
• Expenses (93,725)
• Net Loss (1,725)
• Depr. Exp. (3,250)
• non cash exp 3,250
• Cash Depr. 0

HRB Comparative Balance Sheets Balance
Sheet 2001 2002 Change Acc. Depr.
(2,250) (5,500) (3,250) Income St. Depr.
Exp. 3,250 (Non-Cash Item)
SCF Direct Method Operating Activities
SCF Indirect Method Operating
Activities Net Income
(1,725) Plus Minus
Depreciation 0
Depr. Expense 3,250
80
Putting together a Statement of Cash Flows
3 Analyze changes and determine Cash Flow effect
along with info from Income Statement and other
data as needed

• HRB Comparative Balance Sheets
• 2001 2002 Change
• Balance Sheet Off.Eq. 15,000 16,500 1,500
• Purchased Office Equipment for Cash.
  - No Sales of Equipment

Investing activity
Beg. Bal 15,000
Cash Effect!!
1,500
Eqip. Sold
1,500
????
????
0
Purchases
End. Bal 16,500
Now, lets see how it looks on the SCF!
81
Putting together a Statement of Cash Flows

• HRB Comparative Balance Sheets
• 2001 2002 Change
• Balance Sheet Off.Eq. 15,000 16,500 1,500
• Cash Paid for Office Eq. (1,500)
• Purchased Office Equipment for Cash.
  - No Sales of Equipment

Investing activity
SCF Direct Method Investing Activities
SCF Indirect Method Investing Activities
Equipment Purchase(1,500)
Equipment Purchase(1,500)
82
Putting together a Statement of Cash Flows
2 Classify what part of SCF the Balance Sheet
Items relate to. Operating Financing or Investing

• HRB Comparative Balance Sheets
• 2001 2002 Change
• Liabilities
• Utilities Payable 75 50
  - 25
• Interest Payable 900 675
  - 225
• A/P (Supplies) 50 75
  25
• Salaries Payable 2,400 4,200 1,800
• Bank Loan Payable 10,000 0 -
  10,000
• Note Payable 0 10,000
  10,000
• Total Liabilities 13,425 15,000 1,575

OP
OP
OP
OP
FIN
FIN
83
Putting together a Statement of Cash Flows
3 Analyze changes and determine Cash Flow effect
along with info from Income Statement and other
data as needed
HRB Comparative Balance Sheets 2001
2002 Change Balance Sheet Util/Pay 75 50
-25 Income St.
Operating activity
Utilities Exp. 1,050
Utilities relates to what Income Statement item?
75 Beg. Bal
1,050
Cash Effect!!
Utilities Paid
Utilities Used
1,075
????
????
1,050
Now, lets see how it looks on the SCF!
50 End. Bal
84
Putting together a Statement of Cash Flows

• Revenues 92,000
• Expenses (93,725)
• Net Loss (1,725)
• Utilities Exp. (1,050)
• decr.in Util/Pay (25)
• Cash Utilities (1,075)
• Its there but its hidden!

HRB Comparative Balance Sheets 2001
2002 Change Balance Sheet Util/Pay 75 50
-25 Utilities Paid
1,075 Income St. Utilities Exp.
1,050
Operating activity
SCF Indirect Method Operating
Activities Net Income (1,725) Minus
SCF Direct Method Operating Activities
Utilities (1,075)
Decrease in Util/Pay (25)
85
Putting together a Statement of Cash Flows
3 Analyze changes and determine Cash Flow effect
along with info from Income Statement and other
data as needed
HRB Comparative Balance Sheets 2001
2002 Change Balance Sheet Int/Pay 900 675
-225 Income St.
Operating activity
Interest Exp. 1,350
Interest relates to what Income Statement item?
900 Beg. Bal
1,350
Cash Effect!!
Interest Paid
Interest Used
1,575
????
????
1,350
Now, lets see how it looks on the SCF!
675 End. Bal
86
Putting together a Statement of Cash Flows

• Revenues 92,000
• Expenses (93,725)
• Net Loss (1,725)
• Int. Exp. (1,350)
• decr.in Int/Pay (225)
• Cash Interest (1,575)
• Its there but its hidden!

HRB Comparative Balance Sheets 2001
2002 Change Balance Sheet Int/Pay 900 675
-225 Cash Interest Paid
1,575 Income St. Interest Exp. 1,350
SCF Indirect Method Operating
Activities Net Income (1,725) Minus
SCF Direct Method Operating Activities
Interest (1,575)
Decrease in Intl/Pay (225)
87
Putting together a Statement of Cash Flows
3 Analyze changes and determine Cash Flow effect
along with info from Income Statement and other
data as needed
HRB Comparative Balance Sheets 2001
2002 Change Balance Sheet Sal/Pay 2,400 4,200
1,800 Income St.
Operating activity
Salary Exp. 62,875
Salary relates to what Income Statement item?
2,400 Beg. Bal
Salary Paid
62,875
Salary Used
Cash Effect!!
????
61,075
????
62,875
Now, lets see how it looks on the SCF!
4,200 End. Bal
88
Putting together a Statement of Cash Flows

• Revenues 92,000
• Expenses (93,725)
• Net Loss (1,725)
• Sal. Exp. ( 62,875 )
• incr. Sal/Pay 1,800
• Cash Salary (61,075)
• Its there but its hidden!

HRB Comparative Balance Sheets 2001
2002 Change Balance Sheet Sal/Pay 2,400 4,200
1,800 Cash Salary Paid
61,075 Income St. Salary Exp. 62,875
Operating activity
SCF Indirect Method Operating
Activities Net Income (1,725) Plus
SCF Direct Method Operating Activities
Salary ( 61,075)
Increase in Sal/Pay 1,800
89
Putting together a Statement of Cash Flows
3 Analyze changes and determine Cash Flow effect
along with info from Income Statement and other
data as needed
HRB Comparative Balance Sheets 2001
2002 Change Balance Sheet Bank Loan 10,000 0
-10,000 Company paid off bank loan.

Financing activity
Beg. Bal 10,000
Cash Effect!!
10,000
New Loans
10,000
????
????
0
Payments
End. Bal 0
Now, lets see how it looks on the SCF!
90
Putting together a Statement of Cash Flows
HRB Comparative Balance Sheets 2001
2002 Change Balance Sheet Bank Loan 10,000 0
-10,000 Bank Loan Paid 10,000 Company
paid off bank loan.
Financing activity
SCF Direct Method Financing Activities
SCF Indirect Method Financiang Activities
Bank Loan Repayment (10,000)
Bank Loan Repayment (10,000)
91
Putting together a Statement of Cash Flows
3 Analyze changes and determine Cash Flow effect
along with info from Income Statement and other
data as needed
HRB Comparative Balance Sheets 2001
2002 Change Balance Sheet N/P 0
10,000 10,000 Company issued a Note Payable for
cash.
Financing activity
Beg. Bal 0
Cash Effect!!
10,000
New Loans
????
0
10,000
????
Payments
End. Bal 10,000
Now, lets see how it looks on the SCF!
92
Putting together a Statement of Cash Flows
HRB Comparative Balance Sheets 2001
2002 Change Balance Sheet N/P 0
10,000 10,000 Company issued a Note Payable for
cash 10,000.
Financing activity
SCF Direct Method Financing Activities
SCF Indirect Method Financiang Activities
Note Payable Issued 10,000
Note Payable Issued 10,000
93
Putting together a Statement of Cash Flows
2 Classify what part of SCF the Balance Sheet
Items relate to. Operating Financing or Investing
HRB Comparative Balance Sheets 2001 2002
Change Stockholders Equity Common Stock
10,500 16,500 6,000 Retained Earnings
3,725 2,000 - 1,725 Total
Stockholders Equity 13,425
15,000 1,575
FIN

FIN
OP
94
Putting together a Statement of Cash Flows
2 Classify what part of SCF the Balance Sheet
Items relate to. Operating Financing or Investing
HRB Comparative Balance Sheets 2001 2002
Change Stockholders Equity Common Stock
10,500 16,500 6,000 Retained Earnings
3,725 2,000 - 1,725
FIN
OP
Net Income ( 1,725) Dividends 0
R/E ( 1,725)
FIN
95
Putting together a Statement of Cash Flows
3 Analyze changes and determine Cash Flow effect
along with info from Income Statement and other
data as needed
HRB Comparative Balance Sheets 2001
2002 Change Balance Sheet Common Stock
10,500 16,500 6,000 Company issued a
Common Stock for cash 6,000.
Financing activity
Beg. Bal 10,500
Cash Effect!!
6,000
????
Stock Issued
0
6,000
????
Stock Retired
Now, lets see how it looks on the SCF!
End. Bal 16,500
96

Putting together a Statement of Cash Flows
HRB Comparative Balance Sheets 2001
2002 Change Balance Sheet Common Stock
10,500 16,500 6,000 Company issued a
Common Stock for cash 6,000.
Financing activity
SCF Direct Method Financing Activities
SCF Indirect Method Financiang Activities
Common Stock Issued 6,000
Common Stock Issued 6,000
97

• HRB Advertising
• Statement of Cash Flows
• 2001 2002
• Operating Activities
• Advertising Services 45,000 96,225
• Salaries (36,250)
  (61,075)
• Rent (24,000)
  (24,000)
• Utilities (650)
  (1,075)
• Supplies (800)
  (1,300)
• Interest -
  (1,575)
• Total Op. Cash Flow (16,700) 7,200
• Invest