 Hello and welcome to this session and which would look at a comprehensive example that deals with the statement of cash flows. The statement of cash flows consist of three sections, operating, investing and financing. For the operating section, we're gonna be illustrating the indirect method which will start with net income and we follow by sorting adjustments. Now on the prior session, we look into details into those steps but I'm gonna go over them briefly. We add non-cash expenses to net income such as depreciation, amortization and I added here a loss. Losses are a separate category but think of them as non-cash expenses and I explained why in the prior session. Just like we add the losses, we deduct the gains. Again, if you don't understand this concept, please look at the prior session because I don't wanna take the time here, I want to take advantage of this to look at an comprehensive example. The why is in the prior session. Then we analyze current assets and current liabilities and see how they relate to cash flows and what adjustments do we have to make. So if your current assets increase from the prior year, it's a negative to cash, cash goes down. If your current assets went down, your cash flow goes up. There is an inverse, I'm just gonna summarize here. There is an inverse relationship between current assets and cash flows. Now why, please look at the prior recording and there is a direct or a positive relationship between current liabilities and cash flows. So simply put, if you borrow money, your cash goes up. If you pay down loans, your cash goes down. So you need to know this, but again, this is a summary of everything that we learned. Then we will look at the investing section and the financing section. So it's gonna be a comprehensive example. Embrace yourself, it may take us 20 to 25 minutes to finish this example. Let's go ahead and get started. Before we proceed any further, I have a public announcement about my company, foreheadlectures.com. foreheadaccountinglectures is a supplemental educational tool that's gonna help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions as well as exercises. Go ahead, start your free trial today. No obligation, no credit card required. Data from balance sheet accounts. Notice this is not even a formal balance sheet, just a bunch of accounts for year one and year two. And the first thing you want to compute is the change in cash. So basically our goal is to explain this change increase of 20,500 between year one and year two. So you are giving the balance sheet accounts. You are not giving a balance sheet, formal balance sheet. You are not giving an income statement. You are giving additional information. An equipment was sold, the selling price 2,500. Portion depreciated was 40% of it. And the cost of the equipment was 15,000. This is basically note one. Note two, portion of long-term notes payable was issued. Portion of long-term notes payable paid by issuing stocks. So we paid 10,000 of our liabilities with stocks. Cash dividend paid 5,000. On January 1st, the building was completely destroyed. The insurance proceeds was 38,000. Notice we sold a piece of equipment. A building was destroyed by a flood. So notice we have a lot of investing activities. Investment available for sale was sold above cost by 2,000. Cash of 16,000 was paid for the acquisition of equipment. We're not told what that amount is. So this is basically an unknown amount. We just, all we are told we purchased some equipment. Long-term note was issued for the acquisition of equipment. So notice we sold equipment, we purchased equipment, we issued notes for equipment. Interest and income taxes was 2,000 and 6,500. Not much is giving. So how are we going to proceed? The first thing is we're gonna start with the operating section and with the operating section we need to compute or need to derive net income. Net income is not giving. How are we gonna derive net income? Well, the only way to derive net income is to look at the retained earnings. So if we analyze retained earnings, let's look at it here. We are giving a beginning balance of 6,000, ending balance of 20,500. Well, let's do that. So let me go ahead and draw a T account and analyze retained earnings. So this is a T account. Let me just make it this little bit bigger. So we have, no, this is too big. We have retained earnings, retained earnings. The beginning balance was 6,000. The ending balance was, the ending balance was 20,750. That's all what we know. We were not, the company did not pay the dividend and the reason is because you are told you paid 5,000 in dividend, cash dividend paid. But if you look at the balance sheet and you examine dividend payable, you see that we had dividend payable from the prior year of 5,000. Well, we are not told we declared dividend this year. It means we paid this for last year. Notice dividend payable went to zero. So there was no dividend for this year. Then the only difference between 20,750 and 6,000 must have been an increase from net income. So if we find the difference, we would conclude that net income was 14,750. Therefore, net income for this example is 14,750. Now we are starting to put the income statement together, the statement of cash flows together, starting with net income. Now we need to make the adjustments. Remember, we have certain adjustments to make. We have depreciation, loss on sale, so on and so forth. Well, we are told that we sold a piece of equipment. Notice here we are told we sold a piece of equipment. When we sell a piece of equipment, we might have a gain, we might have a loss. Let's see what we have in this example. The cost of the equipment was 15,000. That's given to you. The cost of the equipment is 15,000. It was depreciated 40%. So 15,000 times 0.4 times 0.4. For this asset, we took 6,000 of depreciation. If we took 6,000 of depreciation, it means the book value or the adjusted basis from a tax perspective, 15,000 minus 6. It has a basis of 9,000. Well, if it has a basis of 9,000, and we sold it for 2,500. So we sold something for 2,500. It has a basis of 9,000. It means we had a loss of 6,500. Therefore, remember, what do we do with losses? We add losses. So that's the first adjustment. We are going to add loss of 6,500 for this equipment. So we are done with this equipment. Now we're gonna come back and deal with it when it comes to the investing section that we are done with this. What else? We are told a building was completely destroyed and the insurance proceeds was 38,000. Now, well, we have to know if we have any gain or any loss on this building. Let's go back to our balance sheet accounts and see, examine our building account. And if we look at our buildings, we had a building on the books for 29,750. Okay, it has an accumulated depreciation. That building has accumulated depreciation of 6,000. And it looks like that building is gone. So what happened? That's the building. So the insurance paid us 38,000. So we received from the insurance 38,000. The building has a cost of 29,750. That's the original cost minus 6,000 of accumulated depreciation. So notice this exercise is really challenging. And the reason is I am not giving you the information directly. You have to look it up. Now, typically in a cash flow statement, you are gonna be giving the net book value because you're gonna be giving the building plus the depreciation next to each other. So I'm not doing this just to make your life a little bit harder. So the basis, just kind of not a little harder. I want you to learn where to get the information from because in a CPA simulation, that's how they do it. So the basis for that building was 23,750. So the basis was 23,750, 23,750. Now we're gonna take 38,000 minus 23,750. The company had a gain of 14,250. So from the insurance proceeds, so we're done with four. So we had the gain, what do we do with gain? The opposite of a loss, we deduct the gain. Now, the next thing we need to analyze or figure out is depreciation. Now, again, we're not giving depreciation. When you're not giving depreciation, you have to analyze accumulated depreciation to find out what really happens to your depreciation. So let's see what we are giving. I'm gonna add up all accumulated depreciation. I'm gonna do this right here. So we have an accumulated depreciation account. The starting balance was 10,500, which is 4,500, plus 6,000. And the ending balance is 2,000. We know this is a little bit unusual because accumulated depreciation by its nature should go up, actually it went down, which is fine. We know that we sold some asset. What do we know? We know we sold an asset, this asset here. We know that we sold this asset here. We know we sold this asset. And if you remember, we already took from this asset, we said 15,000 times 40%. We know that we took 6,000 of depreciation. Well, if we took 6,000 and we got rid of the asset, therefore we debited accumulated depreciation. I'm gonna put this from number one for 6,000. Well, that doesn't account for everything, because 10,500 minus 6,000 does not equal to 2,000. So also remember, in addition to this, we got rid of this building because this building is gone. So if we get rid of this building, we need to get rid of its accumulated depreciation. So remember, we had 6,000 for the building. Let me do in a different color because I don't want it to be the same color. So remember, we had 6,000 of depreciation for this building now, this 6,000 is zero. Therefore, we got rid of another 6,000, which is this 6,000. Well, that's 6,000. Well, again, 10,500 minus 6,000 minus 6,000, that's gonna give us a negative balance of 2,000. Well, that's not, well, that's not negative balance, sorry, not 2,000, negative balance of 1,500. But the balance is 2,000 because if we take 10,500 minus those two, it doesn't equal to 2,000. What does that mean? It means somehow to make it balance, it must have, we booked depreciation expense of, this is basically a plug of, let me use a totally different color, plus 3,500. So we know this, this is the beginning balance, we know this. We know the 6,000 from note one. We know the 6,000 from the insurance proceeds and we know the ending balance. So we need to have a plug and that plug's gonna be our depreciation expense. Therefore, if I take 10,500, if my plug is 3,500, that's 14,000, minus, so this side is 14,000, minus 12,000 on this side, I will get the 2,000. So the depreciation must have been 3,500. Depreciation is done. So let me clear my screen and move on to see if I have anything else of a non-cash expense. I do have a patent. Patent, the beginning balance was 6,250 and now the balance is 5,000. I was not told that I sold my patent. I was not told I sold any patent. Well, in the absence of that, the only thing I can say is patent went down by 1,250, means I had an amortization expense, which is just like depreciation of 1,250, because my patent went down, so it was amortized. I'm not told this. Again, on the CPA exam, the information will be given to you. Also, I am told that I sold an investment, okay? I had an investment for 3,000 and notice here I was told in note five the investment were sold, investment available for sale were sold. Sales price was 2,000 above cost. So basically put, if 2,000 above cost, that means I have a gain of 2,000. How do I know this? I'm told it's 2,000 above cost. Well, if that's the case, if I have a gain, what do I do with gains? Just like with all the gains, I deduct the gains. I deduct the gains of 2,000. Now again, the investments, I'm gonna have to deal with it in the investment section later, because I had 3,000 and it went to zero. It means I sold it. This is the investment that I sold. All that I'm accounting for is the gain. Now I think I'm done with all my non-cash expenses. Now non-cash expenses and non-cash gains. Now I need to analyze my account receivable inventory and accounts payable and yes, an accounts payable. So let's start with, let's start with account receivable. Let's find the difference in account receivable. My account receivable, the difference between year two and year one, it went up, account receivable went up 2250. Well, if it went up, it means that's negative the cash of 2250. Now, we have to be careful. Why? Because if you are giving allowance for doubtful account, you have to analyze account receivable net. Means you have to take simply quote one. I take year one and year two. Here's how I have to do it. So for year one, I have 11,000 minus 4,500. So I need to find out what's my net receivable. 11,000 minus 4,500. And that's gonna give me 6,500 for year one. For year two, I have to do the same thing. I have 13,250 minus 3,000 minus 3,000. That's gonna give me 10,250. Now I am ready to deduct 10,250 minus 6,500. And that's gonna give me an increase in receivable of 3,750. An increase in receivable means negative receivable for cash flow, 3,750. Now I have to analyze my inventory. That's pretty straightforward. I would look at my inventory year two minus inventory year one. My inventory went up by 3,000. It means I deduct inventory of 3,000. It means I purchased more inventory. The only thing I have to worry about is accounts payable went from 3,000 to 5,000. My payable went up. If my payable went up, it means my cash went up. It means I am operating and using other people's money. Therefore the difference is 2,000 and I'm gonna add that difference. Now I'm ready to net all my adjustments. If I net them all, they net to not negative 9,750. Now I'm ready to find out whether I have cash provided or cashed used. So my net income was 14,750 minus the net provided by operating section 9750 will give me net cash provided by operating of 5,000. I'm done with the first section. The next section I need to deal with is the investing section. And you know there is those equipment account. I have to analyze the equipment account to figure out the investing section. Okay, so let's figure out the equipment. So let's see what we are told about the equipment from the balance sheet. From the balance sheet, I'm giving an equipment balance of 20,000 beginning, 45 ending. So let's do this, let's analyze this. So 20,000 beginning and 45,000 is the ending. I know I had more, seems I purchased equipment. That's fine. But here's what I was told. I was told I sold an equipment. It has a cost of 15,000. So from this transaction, I have to deduct 15,000. I'm done with one. Point two, portion of long-term debt was issued for stock. That's not equipment. Point three is cash dividend. Point four is building. Point five is investment. Cash was paid for the acquisition of investment. Well, for one thing, I mean, I made a mistake. Let me start with the equipment properly. 2,000, 20,000 debit, sorry. 20,000 debit and 45 debit ending balance and I sold for 15,000. This is number one. I just wanna make sure we do it properly. Now I know I was told that I purchased equipment for cash. I don't know that amount. I know long-term note was issued for the acquisition of 16,000. I know that I also from note seven, from note seven, I know I added to my equipment 16,000. Let's see if there's anything else for the equipment. That's it. So I'm giving beginning balance. I'm giving ending balance. I'm told one equipment was sold. I'm told one equipment was purchased for using loan. So what's left? So this is the, this is this number here. So let's see. So what's that number? I have 20,000 beginning, plus 16,000 plus the addition, minus 15,000. And if I net this, this and this, I get 21, somehow I get 45. Well, if I take the difference between 21 and 45, I must have purchase equipment of, this is again a plug of 24,000. Now let me double check. If I started with 20,000, purchase equipment indeed 24 and purchase another equipment using loan for 16, then I sold an equipment for 15,000. Indeed my balance balances. So basically 20,000 plus, plus 24, plus 16, minus 15, equal to 45. So now I know I purchase equipment worth of 24,000. And because of that, it means I paid into, I purchased the equipment. So I know I purchased equipment of 24. Okay, I know I purchased equipment for 24. I'm told I sold the piece of equipment for 2,500. That was directly given from here. Okay. So now I accounted for my equipment. The purchase as well as the sale. Now you can net these out. You can net these out. Most likely on the CPA exam, it's gonna be basically 24 minus 15,000. What you do, it will be one line. So it's gonna be 24,000 minus 2,500. So basically the net is 21,500. I have it separate so you can see the difference between the two. So this is the investing. I also know that I received 25,000 insurance proceeds. Well, if that's the case, that's proceeds from the flood that's investing, plus 38. Now, what else do I need to do? I need to account for an investment that I sold because I was told an investment was sold for 2,000 above cost. I already accounted for the gain. If it's 2,000 above cost, we have to assume this is what I had last year, 3,000. This is the cost and I sold the 2,000 above cost. But if I sold the 2,000 above cost, I must have sold it for 5,000. Again, this exercise is a little bit challenging. I'm not giving you anything directly. Everything is given indirectly. Now, I accounted for everything for the investing section. Now I net it out and the investing section is 21,250. So I'm done with part two. Now, what's left for me is part three, which is cash flow from financing activities. Well, we know, we are told immediately that we paid 5,000 in dividend. Well, that was a crude dividend. It means it has to be payment of 5,000. Now, also, I was told that I issued a note, note spable, portion of long-term note paid by issuing common stock. So here's what happened. You have to be careful here. I issued a note by issuing, portion of long-term note paid by issuing common stock. Let's look at my notes. My notes went from, let's first look at the short-term notes. Went from 4,000 to 3,000. That's all we're gonna know about my short-term notes. So payment of short-term notes, it was negative 1,000 because it went down. Now, my long-term notes payable went from 25 to 31. Now it's worth examining this. Okay, let me delete everything so that we can analyze long-term notes. So now long-term notes, we have the beginning balance of 25, the ending balance of 31. So it appears as if I borrowed money. Well, let's account for everything we need to account for. Okay, we are told that portion of long-term notes payable was paid by issuing stocks. So I increase my stocks by 10,000. So stocks, common stock went up by 10,000 and my notes payable went down by 10,000. Okay, so this is considered non-cash investing and financing activities. Why? It means I increased it by 10, reduced it by 10. It was both non-cash, but I have to reduce my notes by 10,000. So my notes was reduced by 10,000. Well, I did not account for everything. So this is what note is this? This is from note two. This is from number two. So I accounted for the $10,000 by reducing my note, but that's not good enough. Why? Because if I take 25,000, if I take, let me go back here, if I take 25,000 minus 10,000, that's not equal to 31. It's not equal to the ending balance. I'm missing something. Well, at least I'm done with this one. I accounted for the 10,000 issuing of the notes. I accounted for this one. I accounted for this one, the 10,000. I accounted for this one. I'm also told here that long-term note was issued for the acquisition of equipment. Well, it means I increased my notes by 16,000. Again, this is a non-cash investing and financing. So it means I debited equipment for 16,000 and I credited a notes payable for 16,000. This is non-cash investing and financing. Yes, I increased my note, but I did not increase my cash. I increased my equipment. I have to disclose this non-cash investing and financing. And number two was also non-cash investing and financing. Let's see if this makes sense. I started with 25, issued a note for 16, paid off a note for 10,000 for common stock, and voila, I have my 31,000. So 25 plus 16 minus 10 equal to 31. I accounted for my notes payable. And guess what? None of my activities in notes payable was cash. None of it was cash. It means what do I have to do from a cash perspective? Nada, nothing. Just notes. I have to disclose this information. Now, I can net out my financing activities. This is the third section. And of the third section, I net it out. It's 6,000. Now I net, I net them all out. In other words, I will take 5,000 plus 21,500 minus 6,000. I will net this, the this, the this to see what's my net. And it appears that my increase in cash, I had a cash increase of 22,500. Now, hopefully you remember what this number coming from, 22,500 is the difference. It's the increase in cash. So good. It seems my cash flow statement worked. So I will take my beginning balance, 13,000, which is my beginning balance, plus 20,500, equal to my ending balance of 33,500. Everything matches, 33,500. It worked. Now, what else do I have to do? I have to disclose because I paid interest of 2,000. I paid income taxes of 6,500. This will need to be disclosed. And I also have to disclose my non-cash investing and financing activities, which is the 10,000 and the 16,000 separately. This is a comprehensive example for the statement of cash flows. If you can follow this example, if you can complete this example, I can assure you, you can answer any question on the CPA exam, any question. Now, again, on the exam, the information will be given to you directly. You'll be given a complete income statement. The information is easier here. This is, I believe, as complicated or as demanding as it gets, because we have to analyze and kind of work hard on every single question. This concept is important. Good luck, study hard, and of course, stay safe. I'm always here for you.