Caselette Problem:

(Some kind of accountant you are!)

Early in 2020, Jay Pia, a recent graduate of Senior High School of Notre Dame of Tacurong College, delivers the following
financial statements to Mr. Julius Iskol of Iskol, Inc. After a quick review, Mr. Iskol exclaims, “What do you mean I had a net income
of ₱20,000? I borrowed ₱40,000 from the bank and my cash balance decreased by ₱2,000. I must have had a
loss! Some kind of accountant you are! How should Mr. Jay Pia answer Mr.Iskol?

Iskol, Inc.
Comparative Statement of Financial Position
December 31, 2020 and 2019

ASSETS 2020 2019

Cash ₱ 3,000 ₱ 5,000
Accounts Receivable 18,000 8,000
Inventory 20,000 15,000
Equipment 52,000 20,000
Accum. Dep. (10,000) ( 5,000)
TOTAL ASSETS ₱ 83,000 ₱43,000
======= ======
LIABILITIES AND EQUITY

Accounts Payable ₱ 4,000 ₱ 9,000

Note Payable- long term 40,000 -
Iskol, Capital 39,000 34,000
TOTAL LIABILITIES AND EQUITY ₱83,000 ₱43,000
======= ======

Iskol, Inc.
Combined Statement of Income and Changes in Equity
December 31, 2020

Sales ₱240,000
Less: Cost of Goods Sold 150,000
Gross Margin ₱ 90,000
Less: Operating Expenses
(incl. Depreciation of P5,000) 70,000
Net Income ₱ 20,000
Add: Iskol, Capital - 1/1/20 34,000
Total ₱ 54,000
Less: Iskol, Drawings 15,000
Roberts, Capital – 12/31/20 ₱ 39,000
======

How would you answer Mr. Iskol?

Learning Objectives
1. Describe statement of cash flows.
2. Convert accrual basis to cash basis.
3. Classify an item whether operating, investing and financing activities.
4. Outline the structure of and information reported in the three main categories of the cash flow
statement: operating, investing, and financing.
5. Compare and contrast the two methods of preparing statement of cash flows.
6. Prepare a statement of cash flows under two methods of preparing statement of cash flows.
7. Solve problems correctly and with perseverance.
 STATEMENT OF CASH FLOWS (PAS 7)

Statement of Cash Flows

 provides information about the cash receipts and cash payments of an entity during a period.
 The statement of cash flows shows historical changes of cash and cash equivalents during the period.

Entity A acquires equipment by issuing shares of stocks. How should Entity A report the transaction in the
statement of cash flows? This is not reported

Why Do We Need the Cash Flow Statement?

1. It explains the change during the period on cash and cash equivalents.
2. Sometimes earnings fail and situations exist where net income does not give an accurate picture of the
economic performance of a company for a certain period.
 When a company reports large noncash expenses, it may give a gloomier picture of current
operations than is warranted.
 Reported earnings may be positive, but operations are actually consuming rather than generating
cash.
3. Everything is on one page: the cash flow statement includes information on operating, investing, and
financing activities.
 How successful were operations for the year?
 What new investments were made in property, plant, and equipment?
 Where did the money come from this year to finance all of this?
4. It is used as a forecasting tool.
 The cash flow statement is an excellent tool to analyze whether operating, investing, and financing
plans are consistent and workable.
 A pro forma cash flow statement is a prediction of what the actual cash flow statement will look
like in future years if the operating, investing, and financing plans are implemented.

Adjusting procedures used to convert accrual amounts to the cash basis when using the direct method:

Accrual Basis Adjustment Required Cash Basis

Net Sales +Beg. A/R – Ending A/R = Cash receipts from customers

Other revenues:
Rent revenue +Ending Unearned Rent = Cash received for rent
- Beg. Unearned Rent

Int. Revenue + Beg. Int. Receivable = Cash received for interest

- Ending Int. Receivable
Cost of goods sold + Ending Inventory
- Beginning Inventory = Cash paid for inventory
+ Beg. A/P
– Ending A/P
Operating expenses (excluding depreciation and other non-cash items):
Insurance expense +Ending Prepaid Insurance = Cash paid for insurance
- Beg. Prepaid Insurance
Wages expense +Beg. Wages Payable = Cash paid for wages
-Ending Wages Payable
Income tax expense +Beg. Inc. Taxes Payable = Cash paid for income taxes
-Ending Inc. Taxes Payable
_____________
Net cash provided by (used in) operating activities

* In a statement of cash flows prepared using the direct method, if prepaid expenses increased during the year,
the cash paid for expenses would be expenses add the increase in prepaid expenses from the beginning to the
end of the year.

* In a statement of cash flows prepared using the direct method, if wages payable (accrued expense) increased
during the year, the cash paid for wages would be wages expense less the increase in wages payable from the
beginning to the end of the year.

Example 1:
Detmer Company's prepaid rent was ₱40,000 at December 31, 2020, and ₱15,000 at December 31,
2019. Detmer's income statement for 2020 reported rent expense as ₱10,000. What amount of cash
disbursements for rent would be reported in Detmer's net cash flows from operating activities for 2020
presented on a direct basis? Answer: ₱35,000

Example 2:
The following information was taken from the 2020 financial statements of Winchester Corporation:
Accounts receivable, Jan. 1, 2020 ₱ 108,000
Accounts receivable, Dec. 31, 2020 152,000
Sales on account and cash sales 2,190,000
Uncollectible accounts 5,000

No accounts receivable were written off or recovered during the year. If Winchester prepares a
statement of cash flows using the direct method, what amount should be reported as collected from
customers in 2020? Answer: ₱ 2,146,000

Example 3:
A company reported interest expense of ₱540,000 for the year. Interest payable was ₱35,000
and ₱75,000 at the beginning and the end of the year, respectively. What was the amount of
interest paid? Answer: ₱540,000

Example 4:
Tropical Tours reported revenue of ₱400,000 for its year ended December 31, 2020. Accounts
receivable at December 31, 2019 and 2020, were ₱35,000 and ₱32,000, respectively. Using
the direct method for reporting cash flows from operating activities, Tropical Tours would
report cash collected from customers of:

Accounts receivable
12/31/19 35,000
Sales 400,000 Collections ? 403,000
32,000
Example 5:
Nevada Boot Co. reported net income of ₱216,000 for its year ended December 31, 2020.
Purchases totaled ₱152,000. Accounts payable balances at the beginning and end of the year
were ₱36,000 and ₱33,000, respectively. Beginning and ending inventory balances were
₱44,000 and ₱46,000, respectively. Assuming that all relevant information has been
presented, Nevada Boot would report operating cash flows of:

Net income ₱216,000

Deduct increase in inventory ( 2,000)
Deduct decrease in A/P ( 3,000)
Cash flows from operating activities ₱211,000

Three categories of business activities:

• Operating activities -Transactions and events that enter into the determination of net income.
• Investing activities -Transactions and events that involve the purchase and sale of securities, property,
plant, equipment, and other assets not generally held for resale, and the making and collecting
of loans.
• Financing activities -Transactions and events whereby resources are obtained from or repaid to
owners and creditors.

Non-cash transactions (not included in the SCF - disclosures)

Operating activities:
Cash receipts from:
 Sale of goods or services
 Sale of securities held trading
 Interest revenue, royalties, rental, fees, commissions, dividend revenues and other revenues *
 Receipts from insurance premium, claims, annuities and other policy benefits
 Refund for income tax unless specifically identified with financing and investing activities
*included in the operating activities because it enters into the determination of net income or loss.

Cash payments for:

 Inventory purchases
 Payment of salaries and wages
 Interest expense*
 Taxes (unless specifically identified with financing and investing activities)
 Selling, administrative and other expenses
 Purchase of trading securities
*interest expense is included in the operating activities because it enters into the determination of net
income or loss.

Investing activities:
Cash receipts from:
 sales of property, plant and equipment.
 intangibles and other long-term assets.
 sales of equity or debt instruments of other entities and interests in joint ventures
 repayment of advances and loans made to other parties
 future contract, forward contract, option contract and swap contract

Cash payments to/for:

 acquire property, plant and equipment, intangibles and other long-term assets.
 acquire equity or debt instruments of other entities and interests in joint ventures (current and long-
term investments)
 advances and loans to other parties (other than advances and loans made by financial institution)
 future contract, forward contract, option contract and swap contract
Financing activities:
Cash receipts from:
 Issuing shares or other equity instruments
 Issuing debentures, loans, notes, bonds, mortgages, and other short or long-term borrowings

Cash payments to/for:

 Owners to acquire or redeem the enterprise’s shares
 Amounts borrowed
 Reduction of the outstanding liability relating to finance lease
 Dividend paid

Methods of preparing statement of cash flows:

1. Direct Method
2. Indirect Method

Indirect Method:
ABC Company
Statement of Cash Flows
For the Year Ended December 31, 2020

Cash flows from operating activities:

Net income ₱100,000
Adjustments:
Depreciation expense 40,000
Gain on sale of equipment ( 5,000)
Increase in accounts receivable ( 30,000)
Decrease in inventory 30,000
Increase in accounts payable 20,000
Net cash provided by operating activities ₱155,000

Direct Method:
Taylor Company
Statement of Cash Flows
For the Year Ended December 31, 2020

Cash flows from operating activities:

Cash receipts from customers ₱ 315,000
Cash payments for:
Inventory ₱70,000
Operating expenses 58,000
Interest 2,000
Income taxes 30,000 (160,000)
Net cash provided by operating activities ₱ 155,000
Indirect Method:
ABC Company
Statement of Cash Flows
For the Year Ended December 31, 2020

Cash flows from operating activities:

Net income ₱100,000
Adjustments:
Depreciation expense 40,000
Gain on sale of equipment ( 5,000)
Increase in accounts receivable ( 30,000)
Decrease in inventory 30,000
Increase in accounts payable 20,000
Net cash provided by operating activities ₱155,000

Cash flows from investing activities:

Sale of equipment ₱ 7,000
Purchase of equipment (90,000)
Net cash used in investing activities (83,000)

Cash flows from financing activities:

Payment of dividends ₱(80,000)
Increase in long-term notes payable 50,000
Net cash used in financing activities (30,000)
Net increase in cash and cash equivalents ₱ 42,000
Cash and cash equivalents at beginning of year 40,000
Cash and cash equivalents at end of year ₱ 82,000

Direct Method:
Taylor Company
Statement of Cash Flows
For the Year Ended December 31, 2020

Cash flows from operating activities:

Cash receipts from customers ₱ 315,000
Cash payments for:
Inventory ₱70,000
Operating expenses 58,000
Interest 2,000
Income taxes 30,000 (160,000)
Net cash provided by operating activities ₱ 155,000

Cash flows from investing activities:

Sale of equipment ₱ 7,000
Purchase of equipment (90,000)
Net cash used in investing activities (83,000)

Cash flows from financing activities:

Payment of dividends ₱(80,000)
Increase in long-term notes payable 50,000
Net cash used in financing activities (30,000)
Net increase in cash and cash equivalents ₱ 42,000
Cash and cash equivalents at beginning of year 40,000
Cash and cash equivalents at end of year ₱ 82,000
 Six Step Process to Prepare a Cash Flow Statement

1. Compute how much the cash balance changed during the year.
2. Convert the income statement from an accrual-basis to a cash-basis summary of operations.
a. Eliminate expenses that do not involve the outflow of cash, such as depreciation.
b. Eliminate gains and losses associated with investing or financing activities.
c. Adjust for changes in the balances of current assets and current liabilities.
3. Analyze the long-term assets to identify the cash flow effects of investing activities.
4. Analyze the long-term debt and stockholders’ equity account to determine the cash flow
effects of any financing transactions.
5. Make sure that the total new cash flow from operating, investing, and financing activities is
equal to the net increase or decrease in cash as computed in Step 1, then prepare a formal
statement.
6. Prepare supplement disclosure of significant noncash transactions.

Iskol, Inc.
Comparative Statement of Financial Position
December 31, 2020 and 2019

ASSETS 2020 2019 Increase/(Decrease)

Cash ₱ 3,000 ₱ 5,000 ₱ (2,000)
Accounts Receivable 18,000 8,000 10,000
Inventory 20,000 15,000 15,000
Equipment 52,000 20,000 32,000
Accum. Dep. (10,000) ( 5,000) 5,000
TOTAL ASSETS ₱ 83,000 ₱43,000
======= ======
LIABILITIES AND EQUITY

Accounts Payable ₱ 4,000 ₱ 9,000 (5,000)

Note Payable- long term 40,000 - 40,000
Iskol, Capital 39,000 34,000 5,000
TOTAL LIABILITIES AND EQUITY ₱83,000 ₱43,000
======= ======

Iskol, Inc.
Combined Statement of Income and Changes in Equity
December 31, 2020

Sales ₱240,000
Less: Cost of Goods Sold 150,000
Gross Margin ₱ 90,000
Less: Operating Expenses
(incl. Depreciation of P5,000) 70,000
Net Income ₱ 20,000
Add: Iskol, Capital - 1/1/20 34,000
Total ₱ 54,000
Less: Iskol, Drawings 15,000
Roberts, Capital – 12/31/20 ₱ 39,000
======

Jay Pia should explain to Iskol that net income and cash flow are not the same thing. Net income
is measured on an accrual basis, not a cash basis. Roberts could prepare a statement of cash flows to
support the explanation.

As shown in the statement, depreciation of ₱5,000 did not require a cash outlay and is thus added
back to net income in determining operating cash flows. Changes in the current operating
accounts, however, must be subtracted in deriving the amount of cash from operations. The increase
in receivables indicates that collections from customers were ₱10,000 less than sales reported in
the income statement. The ₱5,000 increase in inventory and the ₱5,000 decrease in accounts
payable indicate that the amount paid to suppliers during the year was ₱10,000 more than cost of
goods sold on the income statement. The net effect of depreciation and changes in current operating
accounts is net cash provided by operating activities of ₱5,000.
The statement of cash flows also shows that while Iskol obtained ₱40,000 from borrowing,
₱32,000 was paid to purchase equipment and ₱15,000 was used to pay dividends to stockholders.
When cash flows from operating, investing, and financing activities are combined, the ₱2,000 net
decrease in cash is fully explained.

Iskol, Inc.
Statement of Cash Flows
For the Year Ended December 31, 2020

Cash flows from operating activities:

Net income ₱ 20,000
Adjustments:
Depreciation expense 5,000
Increase in accounts receivable (10,000)
Increase in inventory (5,000)
Decrease in accounts payable (5,000)
Net cash provided by operating activities ₱ 5,000

Cash flows from investing activities:

Purchase of equipment ₱ (32,000)
Net cash used in investing activities (32,000)

Cash flows from financing activities:

Issuance of long-term note ₱ 40,000
Payment of dividends (15,000)
Net cash provided by financing activities 25,000
Net decrease in cash ₱ (2,000)
Cash at beginning of year 5,000
Cash at end of year ₱ 3,000

Cash Flow Patterns Over the Life of a Company

Start-up, High-Growth Company

Investing
Financing

Operating
A young, growing company requires cash inflow from financing activities to support capital
expansion and to subsidize negative operating cash flow from the buildup of receivables and
inventory.
Steady-State Company

Investing
dividends
Financing

Operating

A company that has stopped growing has just enough cash to finance replenishment of long-term
assets and pay dividends.

Mature Company

Investing
loan repayment

share repurchases
Financing

dividends

Operating

A mature company (a “cash cow”) has so much cash from operations that it can pay for capital
expansion and have cash left to repay loans, pay cash dividends, and even repurchase shares of stock.

Noncash investing and financing activities affect an entity’s financial position but not the entity’s
cash flow during a period. They should be disclosed separately, either in notes or in an accompanying
schedule.
Worksheet Preparation for Statement of Cash Flows
 Entries:

a) Cash flows – operating 67,200

Retained earnings 67,200

b) Retained earnings 12,000

Cash flows –financing 12,000

c) Cash flows – investing 48,000

Accum. Depreciation 24,000
Gain on sale of equipment 12,000
Plant assets 60,000

d) Plant assets 204,000

Cash flows –investing 180,000
Mortgage payable 24,000

e) Cash flows – operating 98,400

Accum. Depreciation 98,400

f) Cash flows – financing 36,000

Ordinary share 30,000
Share premium 6,000

g) Cash flows – operating 12,000

Accounts receivable 12,000

h) Inventory 48,000
Cash flows – operating 48,000

i) Prepaid expenses 1,200

Cash flows – operating 1,200

j) Cash flows – operating 6,000

Accounts payable 6,000

k) Cash flows – operating 2,400

Accrued liabilities 2,400

l) Cash and cash equivalents 16,800

Cash flows – operating 16,800
Exercises:

1. Hong Kong Clothiers reported revenue of ₱5,000,000 for its year ended December 31,
2020. Accounts receivable at December 31, 2019 and 2020, were ₱320,000 and
₱355,000, respectively. Using the direct method and “T” account for reporting cash flows
from operating activities, Hong Kong Clothiers would report cash collected from
customers of:

2. Lucia Ltd. reported net income of ₱135,000 for the year ended December 31, 2020.
January 1 balances in accounts receivable and accounts payable were ₱29,000 and
₱26,000 respectively. Year-end balances in these accounts were ₱30,000 and ₱24,000,
respectively. Assuming that all relevant information has been presented, Lucia's cash flows
from operating activities would be:

3. Frye Company uses the direct method to prepare its statement of cash flows. The
company had the following cash flows during 2020:

Cash receipts from the issuance of ordinary share ₱400,000

Cash receipts from customers 200,000
Cash receipts from dividends on long-term investments 30,000
Cash receipts from repayment of loan made to another company 220,000
Cash payments for wages and other operating expenses 120,000
Cash payments for insurance 10,000
Cash payments for dividends 20,000
Cash payments for taxes 40,000
Cash payment to purchase land 80,000
The net cash provided by (used in) all activities is -

a. ₱580,000.