Essay, Research Paper: Depreciation

STATEMENT OF CASH FLOWS
Information about cash flows can influence decision makers in many ways . For example , if a company’s regular operations bring in more cash than it uses , investors will value the company higher than if property and equipment must be sold to finance operations . Information about cash flow can help creditors decide whether a company will have enough cash to pay its debts as they mature. Management and investors use cash flow information to evaluate a company’s ability to meet unexpected obligations . Cash flow information is also used to evaluate company’s ability to take advantage of new business opportunities that may arise.
In November 1987, the FASB issued Statement of Financial Accounting Standards “statement of cash flow “ This standard requires businesses to include a statement of cash flow in all financial reports that contain both a balance sheet and an income statement. The primary purpose of this statement is to present information about a company’s cash receipts and disbursements during the reporting period.
Direct Method of Presenting Cash Flow from Operating Activities
When you prepare a statement of cash flow , the net cash provided by operating activities can be calculated two different ways . One is called Direct Method the other is Indirect Method .When the direct method is used , you separately list each major class of operating cash receipts and each major class of cash payments . Then the payments are subtracted from the receipts to determine the net cash provided by operating activities. The FASB encourage companies to use direct method.
Indirect Method of Presenting Cash Flow from Operating Activities
The indirect method is not as informative as direct method because it does not disclose the individual cash inflows and outflows from operating activities. Instead the direct method discloses only the net cash provided by operating activities .
When the indirect method is used , the net income is listed first . Then it is adjusted for items that are necessary to reconcile net income to the net cash provided by operating activities . For example , you know that depreciation expense is subtracted in the calculation of net income . But , depreciation expense does not involve a current cash payment. Therefore, depreciation expense is added back to net income in the process of reconciling net income to the net cash provided by operating activities.
Cash and Cash Equivalents
In Statement of Financial Accounting Standards , the FASB concluded that a statement of cash flow should explain the difference between the beginning and the ending balances of cash and cash equivalents. Prior to this new standard ,cash equivalents were generally understood to be short term , temporary investments of cash . However , not all short-term investments meet the FASB definition of cash equivalents . To qualify as a cash equivalent , an investment must satisfy two criteria . These are:
1- The investments must be readily convertible to a known amount of cash.
2- The investments must be sufficiently close to its maturity date so that its
market value is relatively insensitive to interest rate changes.

Classifying Cash Transactions
A statement of cash flow describes the changes in cash plus cash equivalents. Therefore, cash payments to purchase cash equivalents and cash receipts from selling cash equivalents are not reported on the statement. All other cash receipts and payments are classified as operating , investing or financing activities. Within each category , individual cash receipts and payments are summarized and described in a manner that clearly presents the general nature of the company’s cash transactions . Then , the summarized cash receipts and payments within each category are netted against each other . A category provides a net cash flow if the receipts in the category exceed the payments . And if the payments in a category exceed the receipts , the category is a net user of cash during the period.
Operating Activities
You should recognize the operating activities generally include only transactions that relate to the calculation of net income . However, some income statement items are not related to the operating activities . As disclosed in a statement of cash flows , operating activities involve the production or purchase of merchandise and the sale of goods and services to customers . Operating activities also include the expenditures related to administering the business . In fact , cash flow from operating activities include all cash flows from transactions that are not defined as investing or financing activities .

Cash Flows from Operating Activities
Cash Inflows Cash Outflows
-Cash sales to customers -Payments to employees for salaries and
-Cash collections from credit customers wages
-Receipts of cash dividends from stock -Payments to suppliers of goods and services
investments in other entities -Payments to government agencies for taxes
-Refunds from suppliers fines and penalties
-Cash collected from a lawsuit -Interest payments, net of amounts capitalized
-Receipts of interest payments -Cash refunds to customers

Investing Activities
Transactions that involve making and collecting loans or that involve purchasing and selling plant assets , other productive assets , and investments are called investing activities. Usually , investing activities involve the purchase or sale of assets that are classified on the balance sheet as plant and equipment , intangible assets , or long term investments . However, the purchase and sale of short term investments other than cash equivalents are also investing activities.
Cash Flows from Investing Activities
Cash Inflows Cash Outflows
-Proceeds from selling assets -Payments to purchase assets
-Proceeds from collecting loans -Payments to acquire securities
-Proceeds from selling securities -Payments to acquire dept securities
-Proceeds from sale of loans made by -Payments in the form of loans made to other
the enterprise parties

Financing Activities
A companies transactions with its owners and long term creditors are called financing activities. Also , financing activities include borrowing cash on a short term basis. However, cash payments to settle credit purchases of merchandise, whether on account or by note, are operating activities. Payments of interest expense are also operating activities.
Cash Flows from Financing Activities
Cash Inflows Cash Outflows
-Proceeds from the issuance of -Payments of dividends and other distributions
securities to owners
-Proceeds from the issuance of -Payments to purchase treasury stock
bonds and notes payable -Repayments of cash loans
-Proceeds from other short or long -Payments of the principal amounts involved
term borrowing transactions in long term credit arrangements
Preparing a Statement of Cash Flows
The information you need to prepare a statement of cash flow comes from a variety of sources . These include comparative balance sheets at the beginning and the end of the accounting period , an income statement for the period and a careful analysis of each non cash balance sheet account .
Grover Company (Example)
Grover Company’s December 31, 1989 and 1990 balance sheets and 1990 income statement are illustrated. The objective is to prepare a statement of cash flow that explains the $5000 increase in cash , based on these financial statements and the additional information about 1990 transactions that follows:
1- All accounts payable balances resulted from merchandise purchases .
2- Plant assets that cost $70,000 were purchased by paying $10,000 cash and issuing $60,000 of bonds payable to seller.
3- Plant assets with an original cost of $30,000 and accumulated depreciation of $12,000 were sold for $12,000 cash. The result was a $6,000 loss.
4 The proceeds from issuing 3,000 shares of common stock was $15,000.
5- The $16,000 gain on retirement of bonds resulted from paying $18,000 to retire bonds with a book value of $34,000.
6- Cash dividends of $14,000 were declared and paid.
GROVER COMPANY
Balance sheet
December 31, 1990 and 1989
1990 1989
Assets
Current Assets:
Cash $ 17,000 $ 12,000
Accounts Receivable 60,000 40,000
Merchandise Inventory 84,000 70,000
Prepaid Expenses 6,000 4,000
Total Current Assets $ 167,000 $ 126,000
Long Term Assets:
Plant Assets $250,000 $210,000
Less: accumulated depreciation 60,000 190,000 48,000 162,000
Total Assets: $357,000 $288,000
Liabilities
Current Liabilities:
Accounts Payable $ 35,000 $ 40,000
Interest Payable 3,000 4,000
Income Taxes Payable 22,000 12,000
Total Current Liabilities $ 60,000 $ 56,000
Long Term Liabilities:
Bonds Payable 90,000 64,000
Total Liabilities: $ 150,000 $ 210,000
Stockholders’ Equity
Contributed Capital:
Common stock $10 par value $ 95,000 $ 80,000
Retained earnings 112,000 88,000
Total stockholders’ equity 207,000 168,000
Total liabilities and stockholders’ equity $ 357,000 $ 288,000
GROVER COMPANY
Income Statement
For Year Ended December 31, 1990
Sales....................................................... $ 590,000
Cost of goods sold...................................... $ 300,000
Wages and other operating expenses............. 216,000
Interest expense......................................... 7,000
Income taxes expense................................. 15,000
Depreciation expense.................................. 24,000 (562,000)
Loss on sale of plants.................................. (6,000)
Gain on retirement of debt............................ 16,000
Net Income................................................ $ 38,000

Operating Activities
We begin the analysis by calculating the cash flows from operating activities. In general, this involve adjusting the income statement items that relate to operating activities for changes in their related balance sheet accounts.
Cash Received From Customers:
Accounts receivable increased from $40,000 to $60,000 , cash receipts from customers are equal to sales of $590,000 plus the $40,000 beginning balance less the $60,000 ending balance, or $570,000.

Cash received from customers = Sales - Increase in accounts receivable
If the balance of accounts receivable decreases
Cash received from customers = Sales + Decrease in accounts receivable
$570,000 of cash Grover Company received from customers is shown on the statement of cash flows as a cash inflow from operating activities.
Cash Payments For Merchandise:
$14,000 increase in merchandise inventory is added to cost of goods of $300,000 to get purchase of $314,000. Purchases of $314,000 plus a beginning balance of $40,000 , less the ending balance of $35,000 , equals each payments of $319,000 .
+ Increase in merchandise inventory
Purchases = Cost of goods sold
- Decrease in merchandise inventory
And,
+ Decrease in accounts pay.
Cash payments for merchandise = Purchases
- Increase in accounts pay.
Grover Company’s payments of $319,000 for merchandise are reported on the statement of cash flows as a cash outflow from operating activities.
Cash Payments for Wages and Other Operating Expenses:
Prepaid expenses increased by $2,000 during the period , the cash payments for wages and other operating expenses were $2,000 more than the reported expense. Thus, the amount for wages and other operating expenses is $216,000 plus $2,000 or $218,000
If Grover Company’s balance sheets had shown accrued liabilities , you would also have to adjust the expense for the change in accrued liabilities.
Cash paid for Wages and +inc. prepaid exp. +dec. accrued liab.
wages and other = other operating
operating expenses expenses - dec. prepaid exp. -inc. accrued liab.

Payments for Interest and Taxes:
Interest payments were $8,000 and income tax payments were $5,000
+ decrease in related payable
Cash Payment = Expense
- increase in related payable
Investing Activities:
Investing activities usually refer to transactions that affect long term assets. Recall from the information that was provided about Grover Company’s transactions that the company purchased plant assets and also sold plant assets. Both of these activities are investing activities.
Purchase of plant assets:
Grover Company purchase plant assets that cost $70,000 by issuing $60,000 of bonds payable to the seller and paying the $10,000 balance in cash. The
$10,000 payment is reported as a cash outflow on the statement of cash flows.
Sale of Plant Assets:
Grover Company sold plant assets that cost $30,000 and were depreciated $12,000. The result of sale was a loss of $6000 and a cash receipt of $12,000. This cash receipt is reported on the statement of cash flows as a cash inflow from investing activities.
Financing Activities:
Financing activities usually relate to a company’s long term dept and stockholder’s equity accounts. In the information about Grover Company, there were four transactions that involved financing activities . One of these , the $60,000 issuance of bonds payable to purchase plant assets. The remaining tree transactions were the retirement of bonds , the issuance of common stock , and the payment of cash dividends.
Payment to Retire Bonds Payable:
Grover Company’ December 31 ,1990, balance sheet showed bonds payable of $34,000 . These were retired for $18,000 cash in 1990. The income statement reports the $16,000 difference as a gain. The statement of cash flows shows the $18,000 payment as a cash outflow from financing activities.
Receipt from Common Stock Issuance:
During 1990, Grover Company issued 3000 shares of common stock for $5 per share. This $15,000 cash receipt is reported on the statement of cash flow as a financing activity. Look at the December 31, 1989, and 1990 balance sheets. Notice that the Common Stock account balance increased from $80,000 at the beginning of 1990 to $95,000 at the end of 1990. Thus, $15,000 stock issue reconciles the change in the Common Stock account.
Payment of Cash Dividends:
According to the facts provided about Grover Company’s transactions , cash dividend of $14,000 were paid during 1990. This payment is reported as a cash outflow from financing activities . Also , note that the effects of this $14,000 payment and the reported net income of $38,000 fully reconcile the beginning and ending balances of retained earnings .
GROVER COMPANY
Statement of Cash Flows ( Direct Method )
For Year Ended December 31, 1990
Operating Activities:
Cash received from customers......................... $ 570,000
Cash provide by operating activities.................. $ 570,000
Cash paid for merchandise ............................. (319,000)
Cash paid for wages and other expenses........... (218,000)
Interest paid ................................................. (8,000)
Income taxes paid.......................................... (5,000)
Cash disbursed for operating activities............... (550,000)
Net Cash Provided By Operating Activities............ $ 20,000
Investing Activities:
Receipt from sale of plant asset......................... $ 12,000
Payment to purchase plant asset........................ (10,000)
Net Cash Used In Investing Activities.................... 2,000
Financing Activities:
Payments to retire bonds................................. $ (18,000)
Proceeds from issuing stock............................. 15,000
Dividends paid............................................... (14,000)
Net Cash Provided By Financing Activities............. (17,000)

Net Increase (decrease) In Cash.......................... $ 5,000
Cash and Cash Equivalents , beginning of year....... $ 12,000
Cash and Cash Equivalents , end of year............... $ 17,000


Word Count: 2337