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The Statement of Cash Flow
The Statement of Cash Flow
The Statement of Cash Flow
DEFINITION OF CASH:
In preparing a statement of cash flows, the term cash is broadly defined to include both cash
and cash equivalents. Cash equivalents consist of short term, highly liquid investments such as
treasury bills, commercial paper, and money market funds that are made solely for the purpose
of generating a return on temporary idle funds. Instead of simply holding cash, most companies
invest their excess cash reserves in these types of interest bearing assets that can be easily
converted into cash. These short term liquid investments are usually included in marketable
securities on the balance sheet. Since such assets are equivalent to cash, they are included
with cash in preparing a statement of cash flows
OPERATING ACTIVITIES:
Operating activities involve the cash effects of transactions that enter into the determination of
net income, such as cash receipts from sales of goods and services and cash payments to
suppliers and employees for acquisition of inventory and expenses
INVESTING ACTIVITIES:
Investing activities generally involve long term assets and include (a) making and collecting
loans (b) acquiring and disposing of investments and productive long lived assets.
FINANCING ACTIVITIES:
Financing activities involve liability and stock holder’s equity items and include obtaining cash
from creditors and repaying the amounts borrowed and obtaining capital from owners and
providing them with a return on, and a return of, their investment. Below is the typical
classification of cash receipts and payments according to operating, investing and financing
activities.
Investing Activities:
Cash inflow:
From sale of property, plant and equipment.
From sale of long term investments.
Generally Non-current
Assets
Cash Outflows:
To purchase property, plant and equipment.
To purchase long term investments.
To make loans to other entities.
Financing Activities:
Cash inflows:
From borrowing of long term loans.
From issuance of debt (bonds and notes). Generally Non-current
Liabilities and
Equity Items
Cash outflows:
To owner as withdrawals
To lenders for payment of long term debt
1. DIRECT METHOD:
(Also called the income statement method) reports cash receipts and cash disbursements from
operating activities. The difference between these two amounts in the net cash flow from
operating activates. In other words, the direct method deducts from operating cash receipts the
operating cash disbursements. The direct
Method results in the presentation of a condensed cash receipts and cash disbursements
statement.
2. INDIRECT METHOD:
(Or reconciliation method) starts with net income and converts it to net cash flow from operating
activities. In other words, the Indirect method adjusts net income for items that affected
reported net income but didn’t affected cash. To compute net cash flows from operating
activities, noncash changes in the income statement are added back to net income, and net
cash credits are deducted.
ILLUSTRATIVE EXAMPLE 1:
The following are items taken from the records of Intelligent Company for 2020:
a. Profit after income tax expense, P1, 820,000.
b. Payment for purchase of land, P400, 000.
c. Payment of long-term loans, P600, 000.
d. Depreciation expense, P750, 000.
e. Additional investments by the owner, P700, 000.
f. Patent amortization expense, P270, 000.
g. Income tax expense, P780, 000.
h. Interest expense, P100, 000.
i. Increase in accounts receivable, P340, 000.
j. Cash withdrawals of the owner, P500, 000.
k. Decrease in accounts payable, P26, 000.
l. Increase in interest payable, P18, 000.
m. Increase in income tax payable, P60, 000.
Additional information: The company’s statement of financial position reported the cash
balance of P800, 000 as of January 1, 2020 and P3,152,000 as of December 31, 2020.
Required: Prepare the Intelligent Company’s 2020 Statement of Cash Flows using the
indirect method.
SOLUTION:
INTELLIGENT COMPANY
CASH FLOW STATEMENT
FOR THE YEAR ENDED DECEMBER 31. 2020
COMPUTATIONS:
Profit before interest and income tax:
Profit before interest and income tax P2, 700,000 SQUEEZE
Interest expense (100,000)
Income tax (780,000)
Profit after interest and income tax P1, 820,000
NOTE: INCREASE means the ending balance is GREATER than the beginning balance. While
DECREASE means ending balance is LESS than the beginning balance.
If the problem only states the changes of accounts, here’s the assumption for computation
purposes:
• If there is an INCREASE of an account (That is the ending balance is GREATER than
the beginning balance), let us assume that the difference is equal to the ending balance
while the beginning balance assumed to be ZERO.
• If there is a DECREASE of an account (That is the ending balance is LESS than the
beginning balance), let us assume that the difference is equal to the beginning balance
while the ending balance assumed to be ZERO.
Interest paid:
Interest payable, beginning balance P0
Since there is an INCREASE in interest payable, the difference of P18, 000 is assumed to be
the ending balance while the beginning balance is assumed to be ZERO
Since there is an INCREASE in income tax payable, the difference of P60, 000 is assumed to
be the ending balance while the beginning balance is assumed to be ZERO
ILLUSTRATIVE EXAMPLE 2:
The Wisdom Company reported the following condensed profit or loss for
2020:
Sales P1,000,000
Cost of goods sold 580,000
Gross profit P420, 000
Operating Expenses
Depreciation Expense P80,000
Salaries Expense 120,000 200,000
Profit before income tax P220,000
Income tax expense 66,000
Profit P154,000
SOLUTION
A. DIRECT METHOD
WISDOM COMPANY
CASH FLOW STATEMENT
DECEMBER 31, 2020
*Purchases on account:
Inventories, beginning balance P43,000
SQUEEZ
Purchases on account 669,000
E
Total goods available for sale P712,000
AP, ending balance -132,000
Cost of goods sold P580,000
COMPUTATIONS:
NOTE: INCREASE means ending balance is GREATER than the beginning balance. While
DECREASE means ending balance is LESS than the beginning balance.