Sarah Winzenried

Cash Flow Statement Review Sheet Cash flows from operating activities Net income Indirect method First line Direct method Does not appear Assets Cash Accounts receivable Inventories Total current assets Gross fixed assets Accumulated depreciation Net fixed assets Investment in affiliates Intangible assets Total assets Liabilities and Equity Accounts payable Accrued expenses Notes payable Total current liabilities Long-term debt Deferred income taxes Capital stock Additional paid-in capital Retained earnings Total liabilities and equity 2011 $20,000 65,000 35,000 120,000 100,000 (24,000) 76,000 8,000 16,000 $220,000

Adjustments to income statement Depreciation expense Add back Does not appear Amortization expense1 Add back Does not appear Stock compensation expense Add back Does not appear Gain (loss) on sale of asset Subtract (add back) Does not appear Increase (decrease) in deferred taxes Add back (subtract) Adjust tax expense to determine taxes paid3 2 Equity in income (loss) in affiliates Subtract (add back) Does not appear Interest expense (payment) Does not appear (info item only) Interest paid reported Adjustments due to accrual based accounting Increase (decrease) in accounts receivable Subtract (add) Increase (decrease) in inventory Subtract (add) Increase (decrease) in prepaid expenses Subtract (add) Increase (decrease) in accounts payable Add (subtract) Increase (decrease) in accrued expenses Add (subtract) Adjust sales to determine cash received4 5 Adjust COGS to determine cash paid *6 Adjust operating expenses to determine cash paid *5 Adjust COGS to determine cash paid *6 Adjust operating expenses to determine cash paid

Assignment 2 2010 $19,000 70,000 30,000 119,000 90,000 (21,000) 69,000 6,000 26,000 $220,000

Cash flows from investing activities Increase in property, plant and equipment Cash outflow reflecting any cash expenditures. *Note: If acquisition is financed (e.g., mortgage), only a memorandum information item Decrease in property, plant and equipment Cash inflow reflecting full amount of cash received. Increase (decrease) in marketable securities Cash outflow from purchase; cash inflow from sale Increase (decrease) in other long-term assets Cash outflow for acquisitions; cash inflow from sales 1, 2 Be wary of income statement adjustments (equity-method investments, intangibles) Cash flows from financing activities Increase (decrease) in notes or bonds payable Increase (decrease) in common stock accounts Payment of cash dividends Payment of cash interest on debt
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30,000 16,000 15,000 61,000 55,000 15,000 1,500 36,000 51,500 $220,000

25,000 28,000 27,000 80,000 48,000 18,000 1,000 24,000 49,000 $220,000

2011 Sales $94,000 Less: Cost of goods sold 52,000 Gross profit 42,000 Operating expenses 14,000 EBITDA 28,000 Depreciation expense 6,000 Amortization expense 10,000 Operting income (EBIT) 12,000 Interest expense 4,500 Equity in earnings (loss) of affiliate 2,000 Gain (loss) on sale of fixed assets (2,000) Income before taxes 7,500 Income taxes 2,700 Net income $4,800 Note: Company received cash of $25,000 when it sold fixed assets that had book value of $27,000. Also, included in the amount of fixed assets at year end 2011 is $30,000 of new equip that was acquired by fully financing with $30,000 of long-term debt.

Cash inflow from issuance of new debt; cash outflow for repayment of existing debt Cash inflow from issuance of new stock; cash outflow for purchase of treasury stock Cash outflow Appears as information item with indirect method; sp

Statement of Cash Flows (Direct Method) Cash Flows from Operating Activites: Cash Received from customers $99,000 Cash Paid to Suppliers ($52,000) Payments for Operating Expenses ($26,000) Interest Paid ($4,500) Income Taxes Paid ($5,700) Net Cash Flows from Operating Activities $10,800 Statement of Cash Flows (Indirect Method) Cash Flows from Operating Activites: Net Income $4,800 Adjustments: Depreciation Expense $6,000 Amortization Expense $10,000 Loss on Sale of Asset $2,000 Decrease in Deferred Taxes ($3,000) Equity in Income in Affiliates ($2,000) Decrease in Accounts Receivable $5,000 Increase in Inventory ($5,000) Increase in Accounts Payable $5,000 Decrease in Accrued Expenses ($12,000) Net Cash Flow from Operating Activites $10,800 Cash Flows from Investing Activities: Inflow from Selling Fixed Assets Outflow for Purchase of Fixed Assets Net Cash Used for Investing Activities Cash Flows from Financing Activities: Decrease in Notes Payable Decrease in Long-Term Debt Issuance of Common Stock Payment of Cash Dividends Net Cash Used for Financing Activities

Sales plus decrease in AR = 94000 + 5000 CGS + increase in Inventory - increase in AP = 52,000 + 5,000 - 5,000 Operating Expenses + Decrease in Accrued Expenses = 14,000 + 12,000 Pulled directly from the Income Statement Income Tax Expense + Decrease in Deferred Taxes = 2,700 + 3,000 Other items: Cash Paid for Inventory subtract, Cash Paid to Suppliers and employees subtract, Interest and dividends received add. *Direct

Taxes paid = Tax expense in taxes payable in deferred taxes 4 Cash received from customers = Sales in accounts receivable 5 Cash paid to suppliers = COGS + in inventory in accounts payable 6 Cash paid for operating expenses = Cash expenses + in prepaid expenses in accrued expenses Dividends Paid = (Retained Earnings2010 + Net income2011 Dividends paid2011 = Retained Earnings2011) (Beg RE + NI DIV = End RE) Fixed Asset Acquisitions = (Net Fixed Assets2010 Divestitures2011 Depreciation2011 + Acquisitions2011 = Net Fixed Assets2011) Another way to do this: Determining cash paid for new fixed assets: Beginning of year "net" fixed assets $69,000 Less: Sale of "net" fixed assets during year ($27,000) BV Less: Depreciation Expense for year ($6,000) Plus: purchase of new fixed assets (plug) X End of year net fixed assets $76,000 So X = 58,000 Exam Review Problem: Given the following data (note that not all information may be needed to complete the exercise): Decrease in accounts payable $11,000 Decrease in deferred taxes $10,000 Depreciation expense $40,000 Increase in allowance for bad debts (bad debt expense) $4,000 Increase in inventory $8,000 Issuance of notes payable for cash $14,000 Net income $100,000 Payment of cash dividends $22,000 Payment of cash interest on debt $5,000 Purchase of new equipment with cash $60,000 Repayment of bonds payable with cash $35,000 Repurchase of companys own common stock with cash $30,000 Sale of investment for cash (no gain or loss recorded) $11,000 Sale of old equipment (net book value of $19,000) for cash $23,000 Stock compensation expense $25,000 a. Using the indirect method, what is the net cash flow from operating activities? Net Income $100,000 Add back depreciation 40,000 Add back stock compensation expense 25,000 Subtract decrease in deferred taxes (10,000) Subtract gain on sale of equipment (4,000) Add decrease in accounts receivable 4,000 (or add back bad debt expense) Subtract increase in inventory (8,000) Subtract decrease in accounts payable (11,000) Cash flow from operating activities $136,000 What is the net cash flow from investing activities? Net proceeds from sale of investment $11,000 Net proceeds from sale of equipment 23,000 Purchase of new equipment (60,000) Cash flow for investing activities ($26,000) What is the net cash flow from financing activities? Proceeds from issuing notes payable $14,000 Repayment of bonds payable (35,000) Repurchase of common stock (30,000) Payment of dividends (22,000) Cash flow for financing activities ($73,000) What was the net change in cash? $136,000 $26,000 $73,000 = $37,000

$25,000 ($10,000) $15,000

($12,000) ($23,000) $12,500 ($2,300) ($24,800)

Net Increase in Cash $1,000* (*Difference in cash account from 2010 2011) Supplemental Disclosure of Cash Flow Information: Interest Paid $4,500 Income Taxes Paid $2,700 Supplemental Disclosure of Noncash Investing and Financing Activities: Equipment acquired (investing) and increasing long-term debt (financing)

$30,000

Inc CA CL +

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VOCABULARY Goodwill an intangible asset representing the unrecorded assets of a firm. It appears in the accounting records only if the firm is acquired for a price in excess of fair market value of its net assets. Treasury Stock Capital stock of a company, either common or preferred, that has been issued and reacquired by the issuing company but hasnt been reissued or retired. It reduces stockholders equity. Deferred Taxes a balance sheet account, classified as an asset or liability depending on the nature of the timing differences. The differences are the result of any situation that recognizes revenue or expense in a different time period for tax purposes than for financial statements.

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GAAP Regulated by SEC (Securities and Exchange Commission, which has legal authority, and FASB (Financial Accounting Standards Board), which has primary practical authority. Recent moves to codify GAAP and converge with IFRS (International Financial Reporting Standards). Foundations of Accounting Entity Business entity is separate and distinct from owners of entity. Going concern Entity will remain in business for an indefinite but continuing period of time. Finite reporting periods - Calendar year vs. fiscal year vs. natural business year. Historical cost valuation of assets with adjustments for conservatism (lower of cost or market) or specific exceptions. Conservatism Choice of accounting treatment based on least favorable impact on current net income and financial position. Realization Revenue recognized when reasonably and objectively determined (point of sale, end of or during production, etc.) Matching Costs of operations matched to sales generation, either direct or systematic. Consistency Similar accounting treatment from one period to the next. Disclosure Full disclosure of all facts that may influence the judgment of informed readers (with reasonable summaries of data). Materiality must consider relative size and importance of each information item. Industry-specific deviations some industry-specific variation of GAAP allowed. Transactions approach Report transactions that can be measured in monetary terms. Accrual-based reporting, not cash-based revenue recognized when realized, expenses recognized when incurred;requires complex year-end adjustments. Types of Financial Ratios Liquidity- Ability to meet short-term obligations Solvency - Ability to meet long-term obligations Activity - Efficiency of day-to-day operations Profitability - Ability to generate earnings Investment - Market-based risk/return measures Common-sized Income Statement Vertical analysis expresses each item on the income statement as a percentage of total sales (the base amount). Horizontal analysis expresses each item as a relative percentage of that same item in a base year. Common-sided Balance Sheet Vertical analysis expresses each item on the balance sheet as a percentage of total assets (the base amount). Horizontal analysis expresses each item as a relative percentage of that same item in a base year. Annual reports contain a great quantity of information. Financial statements (Balance sheet, Income statement, Statement of stockholders equity, and Statement of cash flows) Notes to the financial statements Auditors report Five-year summary of key financial data High and low stock prices Managements discussion and analysis Other material included at the imagination and discretion of management The Financial Statements Income statement - Dated for specific period, summarizing revenues and expenses and reporting net income (loss) that increases (decreases) retained earnings. Multi-step provides profit measures / Single-step groups all revenue items together & deducts categories of expense. Balance sheet - Shows financial condition as of point in time, listing the assets (resources) and liabilities (debts) of the business and the equity (owners interest). Statement of stockholders equity - Covers same time period as income statement, reconciling beginning and ending balances of equity accounts (capital stock, retained earnings, etc.). Links income statement and balance sheet. Reconciles beginning & ending balances of stockholder accts. Statement of cash flows - Covers same time period as income statement, summarizing net cash flows from operating, from investing, and from financing activities. Footnotes Integral part of financial statements that includes a summary of significant accounting policies, details of income statement and balance sheet accounts, contingent liabilities, and a disclosure of subsequent events and required adjustments of the financial statements Auditors Opinion Unqualified highest degree of reliability the financial statements have been audited and the internal controls assessed, and the financial statements present fairly the financial position, results of operations, and cash flows of entity in conformity with GAAP. Exceptions to unqualified opinion: Qualified: limitations to unqualified opinion Adverse: statements DO NOT present fairly Disclaimer: insufficient audit work to render judgment GENERIC INCOME STATEMENT aka: profit & loss statement,earnings statement, operating statement, or statement of operations. Sales $4,000 Less: Cost of goods sold 2,500 Gross profits $1,500 Less: Selling, general and administrative exp. 400 EBITDA $1,100 Less: Depreciation and amortization 300 Operating income (EBIT) $800 Less: Interest and other nonoperating exp./losses (175) Plus: Interest and other nonoperating inc./gains 50 Other unusual gains or (losses) (75) Equity in net earnings (losses) of affiliates 25 Income (loss) from continuing operations $625 Income (loss) from continuing operations $625 (Provision for) benefit from income taxes (200) Income (loss) from continuing operations $425 Income (loss) from discontinued operations, net (35) Gains (losses) from extraordinary items, net (65) Net income (loss) $325 Net income (loss) attributable to noncontrolling interests 85 Net income (loss) attributable to common stockholders $240 Other Comprehensive Income - Presented as a separate statement or combined with the income statement. Net income + changes in accumulated other comprehensive income (AOCI) Other comprehensive income sources: Foreign currency translation adjustments Unrealized gains and losses on available-for-sale marketable securities and on derivative instruments used on cash flow hedges Adjustments to minimum pension liability GENERIC STATEMENT OF OTHER COMPREHENSIVE INCOME Net income (loss) $240 Other comprehensive income (loss), before tax: Foreign currency translation adjustments (40) Net changes to available-for-sale securities (15) Unrealized gains/(losses) on cash flow hedges 20 Net changes to retirement-related benefit plans (55) Total other comprehensive income/(loss) (90) Income tax (expense)/benefit related to items of other comprehensive income 35 Other comprehensive income (55) Total comprehensive income $195

Balance Sheet Also called statement of condition or statement of financial position Shows financial condition or financial position of a company on a particular date Summarizes what the firm owns and what the firm owes to outsiders and to internal owners Assets = Liabilities + Equity GENERIC BALANCE SHEET Cash and cash equivalents $100 Marketable securities 200 Accounts receivable (net) 300 Short-term deferred tax benefits 400 Inventories 500 Prepaid expenses 50 Other current assets 150 Total current assets 1,700 Property, plant, and equipment (net) 1,000 Goodwill 150 Intangible assets (net) 200 Other long-term investments 300 Long-term deferred tax benefits 50 Total assets $3,400 Accounts payable $300 Accrued liabilities 400 Accrued income taxes payable 500 Current portion of long-term debt 100 Short-term debt (notes payable) 200 Dividends payable 50 Other current liabilities 150 Total current liabilities 1,700 Long-term debt, less current portion 600 Deferred income taxes 50 Other long-term obligations 100 Other long-term debt 150 Total liabilities $2,600 Commitments and contingences Preferred stock $50 Common stock 100 Retained earnings 750 AOCI (loss) 150 Treasury stock (100) Total stockholders equity 950 Noncontrolling interests (150) Total equity $800 Total liabilities and equity $3,400 Statement of Cash Flows Reports cash inflows and outflows Cash flows are reported based on the three business activities of a company: Cash flows from operating activities Cash flows from the companys transactions and events that relate to its operations. Cash flows from investing activities Cash flows from acquisitions and divestitures of investments and long-term assets. Cash flows from financing activities Cash flows from issuances of and payments toward borrowings and equity. Indirect Method is used by most companies. Direct is used by CVS. Cash Flow Statement Checklist Cash flows from operating activities (indirect method) Begin with reported net income + add-back noncash expenses such as depreciation and amortization, stock compensation expense, bad debt expense, and add increases (subtract decreases) in deferred taxes + remove losses from disposal of assets (investments, fixed assets, etc.) and from recognition of losses from investments accounted for under the equity method remove gains from disposal of assets (investments, fixed assets, etc.) and from recognition of income from investments accounted for under the equity method + decreases in current asset accountsa and increases in current liabilityb accounts increases in current asset accountsa and decreases in current liabilityb accounts a except for increases and decreases in marketable securities which should typically be accounted for under cash flows from investing activities b except for increases and decreases in notes payable and other short-term debt items that should typically be accounted for under cash flows from financing activities Cash flows from operating activities (direct method) Begin with cash receipts from customers (Sales in accounts receivable) + cash receipts from other income sources (dividends and interest received) cash payments to suppliers (COGS + in inventory in accounts payable) cash payments for other operating expenses (Expense items + in prepaid expenses in accrued expenses) cash payments for interest (Interest expense in interest payable) cash payments for taxes (Tax expense in taxes payable in deferred tax liabilities and + in deferred tax assets) Cash flows from investing activities + Cash proceeds from the sale of fixed assets, investments, and other noncurrent assets c Cash expenditures for purchases of fixed assets , investments, and other noncurrent assets Cash flows from financing activities + Cash proceeds from issuing new notes payable or other short-term sources of debt financing, from issuing new bonds and other long-term sources of debt financing, and from issuing new preferred or common stock Cash expenditures for repaying short-term or long-term sources of debt financing and for repurchasing common stock (e.g., treasury stock) payment of dividendsd
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estimate of dividends paid can be made as follows: Beginning-of-year balance in retained earnings + net income during year end-ofyear balance in retained earnings = dividends paid

Net change in cash = Cash flows from operating activities + cash flows from investing activities + cash flows from financing activities