 Hello and welcome to the session. This is Professor Farhad and this session we would look at the statement of cash flow activities. And specifically we're gonna be looking at the operating section and to be more specific using the indirect method. This topic is covered heavily in intermediate accounting and it's a very important topic on the CPA exam. As always, I would like to remind you to connect with me only then. If you haven't done so, YouTube is what I house my 1,500 plus accounting, auditing, finance and tax lectures. This is a list of all the courses that I cover, including CPA questions. On my website farhadlectures.com I offer PowerPoint slides, notes, multiple choice, true, false, additional exercises and practices quasi CPA simulations and 2,000 CPA questions. We're gonna do in this session just go ahead. We're gonna wet our feet and start to prepare an actual cash flow statement. We're gonna do it step by step. We're gonna take baby steps. But if you can follow these steps and you can copy them down and understand them, you'll be able to prepare and answer any questions about the statement of cash flow. So the first thing is what information do you need in order to prepare a cash flow statement? One, you would need comparative balance sheet and what do we mean by comparative balance sheet? It means you need the current year balance sheet number and the prior year. So for example, if you are preparing year 2020 cash flow statement, you will need the 2019 prior year balance sheet. This is what we mean by comparative. Two, balance sheet, the current year and the prior year. Two, the current year income statement. For the income statement, you only need the income statement for 2020. You only need one current income statement and you will need selected transaction data. Simply put, additional information. You need more information. Any information that's not captured in the balance sheet it's not captured in the income statement. There are three major steps to prepare the financial statement. The first step is to determine the change in cash. What does that mean, determine the change in cash? It means look at your cash on the balance sheet. Look at the current year, look at the prior year. Let's assume the current year your cash is 15,000. The prior year the cash is 10,000. What do we say? We say that cash increased by 5,000. So determine the change in cash because the purpose of the cash flow statement is to explain this increase in cash of 5,000. It could be a decrease. It doesn't matter. You have to compute the change and once you're done with the cash flow statement you have to explain how did that change occur and I'll walk you through this. Step two, determine the net cash flow from operating activities. So you have to start with the operating activities and for this session I'm gonna be using the indirect method and in the next session I will use the direct method. For this steps I'm gonna have five sub steps. So this is the majority of this lesson will be about this step. Basically we're gonna have five sub steps and step three is to determine the net cash flow from investing and financing. We're gonna look at a simple example for investing in financing but we'll work a more challenging and future session but in this session basically think of it we're gonna be focusing on this step. Now we're gonna be ignoring investing and financing but the focus is on step two. So let's take a look at an example to see how this all fits together. To see how this all fits together. So we're looking at the Stax Consulting Company that started January 2019. It issued 60,000 shares for $1 per value common stock for 60,000. Simply put they started the company and the investors invested $60,000. The company rented its office space, furniture and equipment and perform tax consulting services throughout the year. So they needed a space to operate the business so they rented office space, furniture and equipment and perform some services. So we have the comparative balance sheet and notice this is the prior year. The prior year did not exist. So all the prior year balances are zero. Now it says January 1st, 2019 or it could say sometime where it says it says December 31st, 2018. So December 31st, 2018 and January 1st, 2019 technically they're the same thing. So this is the prior year and this is the current year balance sheet. So basically the current year balance sheet we have cash, cash of 49,000. The prior year cash is zero. All the prior year balances are zero. So this is year one for the company. The company did not exist prior. So notice everything is increased. So cash, so basically we could kind of already accomplish step one. There was an increase in cash of 49,000. We're gonna have to explain that increase. Account receivable is 36,000, it was zero. Account spable was 5,000, it was zero. Common stock 60,000, it was zero. Retained earning 20,000, it was zero. Okay, so those are the changes. You have to compute the changes and you're gonna see why shortly for those. Then we have the income statement. We have revenues of 125 operating expenses of 85,000. Income before taxes of 40,000. Income tax expense of 6,000. And their income is 34,000. Additional information, remember we need two balance sheets. One income statement. And this is the additional information. Examination of selecting data indicates that dividend of 14,000 was declared and paid during the year. Okay, let's take a look at step one. And remember we said step one is to compute the change in cash. We already did this. So the change in cash is 49,000. So basically we're gonna be doing all this work to explain why did that cash increase by 49,000. Step two, determine the net cash flow from operating activities. Remember I told you step two will have a lot of sub steps, five sub steps. So this step's gonna have five additional steps or sub steps. Okay, we're gonna, the company must determine the revenues and expenses on a cash basis. That's the purpose of the operating cash flow is to look at net income from a cash basis perspective. We're gonna eliminate the effect of income statement transaction that do not result in an increase or decrease of cash. So we are gonna take out any transaction from the income statement that does not involve any change in cash. Simply put, we're gonna convert net income to net cash from operating activities through either the direct or the indirect for our purposes today. Or for this session we're gonna be using the indirect method. Let me show you a picture of what we're doing. So first we compute net income using the accrual basis. Net income is revenues minus expenses. So net income is we have revenues coming in, we have expenses deducted and we come up with net income. Remember those revenues and those expenses are on accrual basis. So what we need to do, we need to eliminate any non-cash revenue and we need to eliminate any non-cash expenses. Simply put, anything that's non-cash, we're only gonna keep the cash revenue and the cash expenses. Anything that's non-cash, whether it's a revenue and whether it's an expense will be eliminated. We have to take it out. Now, how are we gonna do so? I'm gonna show you how, but this is the idea of it. And we go from net income to net cash flow from operating activities and this is step two. Now let's go through the five steps that I told you about in step two and those are very important. Those are the sub-steps in step two, okay? Step one, you start with net income because your goal is to convert net income. So you will start with net income and net income will be given on the income statement. Sometime net income may not be given, sometime you have to analyze retained earnings to come up with net income. We'll work an example later on, but oftentimes net income is given. Step two, you're gonna deduct any gains and I will explain why later. Step three, you're gonna add any losses. I'll explain this later, okay? I'm gonna add any non-cash expenses such as depreciation, amortization, write down, bet that expense. So step four, let's talk a little bit more about step four. I'm gonna scan the income statement. I'm gonna look at my income statement and I'm gonna look for any non-cash expenses. What are examples of non-cash expenses? Depreciation, depreciation, amortization, write down, bet that expenses. Those are expenses that I debit and expense, but I credit something other than cash. Let me tell you, for example, depreciation. When you book depreciation expense, you debit depreciation expense, $15,000. You credit accumulated depreciation, $15,000. We call this a non-cash expense because we did not credit a cash. Let's take a look at bad debt. When we debit bad debt expense, $3,000, we credit allowance for bad debt, $3,000. Again, notice we don't credit, we don't credit, we don't credit cash. So those are considered non-cash expenses. Those are considered non-cash expenses. So what we do is we add those non-cash expenses. Step five, step five, we analyze current assets and current liabilities. Now hopefully you know what current assets are, account receivable, inventory, prepaid supplies. Hopefully you know what current liabilities are, accounts payable, short-term notes payable, could be considered the current liability, payroll liabilities, taxes payable, rent payable, any short-term liability. Now analyzing current assets and current liabilities, I'm gonna explain this on the next session. So those two, I'll explain later. This one is easy. I already told you what you need to do with this. Now I'm gonna focus on step five. Now how do we analyze current assets and current liabilities? And this is important. This is extremely important because knowing how to analyze current assets and current liabilities, it's gonna help you with the direct method. It's gonna help you converting from cash to accrual or accrual to cash. And this is a topic that's very important, okay? So let me show you how to analyze current assets and current liabilities, specifically non-cash current assets, which is we don't analyze cash because cash is what we're trying to explain. So we're gonna analyze non-cash, non-current assets. And what does analyze mean? Analyze mean you compute the change from the prior period, that's all. So let's take a look at it. Then we analyze current liabilities. If current asset went up, so if the change in current asset is positive, so if current asset went up, we have an account receivable went from 1,000 to 3,000, it went up. It means cash flow went down. If current asset, if the change in current asset is down, cash flow is up. Notice they work in the opposite direction. They have an opposite relationship. So if I ask you, what is the relationship between current asset and cash flow, you would say the relationship is negative or inverse or opposite. Now, it's not only for current asset, this concept applies to all assets. So every time you're analyzing an asset other than cash, when the asset goes up, we assume that cash went down. And when the asset went down, we assume cash went up. I will explain why shortly when we look at an actual account to explain it to you. Let's look at current liabilities. If current liability went up, it means cash flow went up. If a current liability went down, it means cash flow went down. We can say that there is a positive or the same relationship, they work the same way. When one goes up, the other one goes up. When the other one goes down, the other one goes up. Now write these shortcuts down. The same concept applies to all liabilities. I'll explain this for you now. Think about it for a moment. If you have a loan and from prior year, your loan went down. So if you have a loan, loan is a typical example of a liability. If you have an accounts payable, let's use accounts payable. If you have an accounts payable and your accounts payable went down, could you tell me why that your accounts payable go down? When accounts payable go down because you pay cash, it means cash went down. Same concept applies if your accounts payable went up. If your accounts payable went up, it means you are not using cash. You are using credit to buy your material, to buy your goods, to buy your services. If you're not using cash, it means cash is going up. So hopefully this current liabilities is easier to explain than assets, but I'm gonna explain assets shortly. But think about it from a loan perspective. If your loan goes down, if you have a loan and it went down, the balance went down. The reason it went down because you paid it down means your cash went down. If you have a loan and your loan balance went up, what do we assume? We assume that you borrowed more money. Same concept applies to all liability. Now, let's apply what we just learned on our company. So let's go back and this is what we have. This is what we have for this company. So we're gonna first analyze account receivable. Then we're gonna analyze accounts payable. So for this example, it's very straightforward and simple. We only have one current asset and one current liability. And they both went up. Now, what did I tell you? If a current asset went up, it means cash went down. If current asset went up, it means cash went down. Okay, and we'll explain why. Okay, let's explain why. So we have the beginning balance of account receivable is zero. The ending balance is 36. This zero and this 36, both of these came from the balance sheets, from the competitive balance sheet. This is the prior year and this is the current year ending balance. So the prior year started with zero and the current year ended with 36. Now, we know from the income statement, this revenue came from the income statement. We know revenue was 125,000. Well, every time we have revenue, we debit account receivable. Okay, so this is coming from the income statement. So if the balance was zero, we debit account receivable 125, we must have received 89,000 from customers. How did I know this? So this is basically a plug or not plug. It's computed. I computed this from a T account perspective. So what I did, I said my beginning balance is zero. I know that I increase account receivable by 125 because my revenue went up by 125, but my balance and receivable is 36. It means I received from customers 89,000. Now this analysis is very important for the direct method. So just we're gonna go over the direct method again. I just wanted to show it to you here because that's gonna be very beneficial. But what does that mean? Remember what I told you, the increase in account receivable is deducted. Every time account receivable went up, it means cash flow went down. So let's start with the cash flow statement. We start with net income. Remember step one is net income. So net income is 34,000 coming from the income statement. If you go back to the income statement, net income is 35,000, 34,000. Then you start to make adjustment to reconcile net income to net cash flow provided by operating activities. You analyze account receivable. And you notice account receivable went up. It means it's a negative. So we deduct 36,000 from 34,000. Why? Because we did sell 125. So our total sales was 125. But we only received 89,000 in cash. It means the remainder of the sale is 36,000. It means of the 125,000 in sales, 36 is non-cash. And remember, I need to eliminate any non-cash revenues. And this is a non-cash revenue. So the 36,000, it's still a revenue, but it's a non-cash revenue. I did not receive the cash. I only received how much cash? I only received 89,000. My revenue was 125 from the income statement, but I only received 89,000. All I have to do is find the difference in the beginning balance and the ending balance. And if a count receivable went up, it means I received less cash. And what I do is 34,000, and I deduct 36,000. Now the same concept applies to all other current liabilities. You will do the same thing for all other current liabilities. You analyze them. If they went up, you deduct them from that income. If they went down, you add them to net income and we'll work a year two and a year three example for this company. Let's analyze accounts payable. Accounts payable went up by $5,000. Remember, the prior balance was zero and it went up to 5,000 because all the prior balance for this company were zero. Well, when accounts payable increase, it means expenses on an accrual basis exceeds those on a cash basis. What does that mean? If your accounts payable are going up, if your accounts payable are going up, think about it for a moment. You are buying on credit. Okay, you are buying on credit. Let's assume you have $50,000 of expenses just for the sake of the illustration. And I know your accounts payable went up by 5,000. It means of the 50,000, 5,000 was non-cash. She did not pay for it. It means 45,000 was cash. Okay, this is what it means. If your accounts payable went up. Now, if you have expenses of 50,000 and your accounts payable went down, it means you had expenses of 50,000 and you paid down your payable. That's an additional cash decrease, okay? But all we have to do, again, if accounts payable went up, it means it's a positive to your cash. Therefore, let's complete the second step in this cash flow statement. Remember, we start with net income. We have no gain, no losses for this example. We have no depreciation, none of that. And then we account receivable increase. We deducted it. Account payable increase, we added. Remember, if a liability went up, that's a positive to our cash. Therefore, we'll take 34,000 minus 36 plus five. The net amount is 3,000. Therefore, net cash provided by operating activities is $3,000. Now, we don't have any other current assets or current liabilities to analyze, but if we had any other current liabilities, we will use the same concept. If a liability went up, it's a positive. If a liability went down, it's negative. And the purpose we're doing this is to eliminate any non-cash expenses and any non-cash revenues, okay? Now, let's finish the third step, which is determining the net cash flow from investing and financing. Let's take a look at the balance sheet again. There's no long-term assets who really don't have any investing for this example. Financing, we have common stock of 60,000. And remember, we paid dividend. When they told us they paid dividend, they declared and paid dividend of 14,000, okay? So notice there is no investing section. So we finished this, we already finished operating. For this section, we only have financing. So issuance of common stock, we sold common stock, we received cash. That's positive to cash. Then we are told that we paid dividend of 14,000. So dividend is a payment, is a finance. When you pay dividend, so pay, when you pay dividend, it's financing. If you receive dividend, so if you receive dividend because you invest in another company, if you receive dividend, receiving dividend is an operating, but paying is investing. So notice the net cash provided by financing is 46, 46. So cash from operating is 3,000. Cash from financing is 46. We net them plus 49, 49 plus zero, which the beginning cash equal to 49,000. Now we explain the increase in cash of 49,000. 3,000 of it came from operating activities. 46,000 of it came from financing activities. Both they result in an increase of cash of 49,000. So what we did is we just completed year one, we just completed year one, year one, year one balance, year one cash flow statement. Let's look at year two. Okay, so this is the complete cash flow. You know, we started with net income, analyze current assets and current liabilities. That's the only thing we had for operating, and no investing, we had financing. This is a complete one, okay? Now let's take a look at year two. So this is what we have for year two to work with. This is what we have for year two to work with. So what I'm gonna do, I'm gonna go ahead and capture this on another screen, and we're gonna do this statement together, and actually you should pause and work at yourself first, but if you want to, we can do it together. So let me go ahead and we'll work this year too. So this was, now this is the prior year. Now this is the prior year. So this is the, let me just capture this again one more time. Okay, let's capture it. Okay, so now this is the prior year and this is the current year. So this is the comparative balance sheet, and you are giving an income statement, and you are giving additional information. So that's what we need to complete a cash flow statement. So the first thing we have to do is to start with net income, whatever net income is. This is our starting point in any problem. So let's go ahead and start with net income. What is our net income for this example? Our net income is 134,000, 134,000. So let's start with that. 134,000. So we say net income, I'll do the, I'll do the, I'll start here and I will abbreviate. I'm done with step one, net income, 134,000. My step one is done. Step two, step two was add any gains, deduct any losses. I'm sorry, deduct any gains, add any losses. I don't have, I'm just gonna put it down, just kind of no gain, no losses for this example. How did I know no gain and no losses? I look at my income statement, they have no gain and no losses. Therefore, I don't have to worry about this. This is step two and step three. Step four was add any non-cash expenses, such as depreciation, amortization, write down, so on and so forth. If I inspect my income statement, I have depreciation expense of 21,000. So add depreciation expense of 21,000. Okay, I'm done with that step. Now step five is analyze current assets and current liabilities, specifically non-cash current assets and non-cash current liabilities. Well, let's take a look at what we have. Cash is, I don't have to, you know, cash is, you don't analyze because you're trying to explain that 12,000 decrease in cash. Let's start with account receivable. Let me highlight account receivable. Account receivable went from 36 to 26. So account receivable, we can say it went down, went down. So decrease in AR. There was a decrease of 10,000, then AR is an asset. If we have less account receivable, it means we received more money. So that's plus 10,000. When account receivable goes down, it means we collected more cash than we sold on account. We collected more cash than we sold on account. How did I know I collected more cash? My account receivable went down. My prepaid went from zero to 6,000. My prepaid went up. So we had an increase in prepaid. Prepaid is a current asset. Now think about it. How do I acquire prepaid? Well, I have to pay for them. It means I had to pay $6,000. It means my cash went down by $6,000. So I'm gonna put these pluses and parentheses negative. So land-land is not a current asset. I'm pretty much done with my current assets because land is an investing activity. It's a property, land and equipment. Let's take a look at my liabilities. I have accounts payable. Accounts payable went from 5,000 to 40,000. It means my accounts payable went, my accounts payable went up. My accounts payable went up by 35,000. Well, I have an increase in a liability. It means I have more cash. So it's plus 35,000. Now, any other current liabilities? No, because bond is a long-term. So I'm done with my operating activities. Now what do I have to do? I have to net it. So 135 plus 21 plus 10 minus six plus 35 equal to 194,000. So that's net cash, provided by operating activities. So from operating the business, I generated 194,000 in cash. Notice way more than what my accrual net income. And the reason is, part of the reason is that accounts payable. I was operating the business and not paying for my goods. I was borrowing. How did I know I was borrowing? My accounts payable went up. So I'm done with the operating activity. I'm done with the operating activity of the cash flow statement. Now let's move on to the second, which is the second part is investing. Now investing, I have to analyze my long-term assets, which is land, building, accounts like that. Let's take a look at my land. So now I'm focusing on land. I'm focusing on building. I'm focusing on equipment. Now notice accumulated depreciation that the 11 and the 10, I already accounted for those because 11 plus 10 equal to 21. So the accumulated depreciation and the way I accounted for those. And it's always good to double check. Make sure your increase in accumulated depreciation equal to your depreciation expense. Sometimes they don't equal because you sold an asset. We'll work an example later on to deal with this, but make sure they equal to each other. So let's go back and highlight what we need to analyze. And they're all increases. They are all increases. Now it's also important to read the additional information. Okay. The company declared and paid dividend that's financing the company obtained 150,000 through the issuance of long-term that that's borrowing, that's financing, land, building, and equipment were acquired for cash. So notice, letter C it says everything was acquired was acquired paying cash. Well, that's easy. I purchased land and it's all cash. How did I know it's all cash? They told me right here, it's all cash. I purchased land, it was $70,000, that's negative. I purchased building, that was $200,000. It's all cash, that's negative. I purchased equipment, $68,000. So all in all, those are the three activities because I don't have any other investments. All in all, I paid, if I net them, so that's net, net cash used, net cash used from investing, by investing activities, by investing. And if I add them, they'll add up to 338,000. So notice, from operating, I brought 194,000, but investing, I spent 338,000. I still have to do financing now. The financing part. Remember financing, I have to analyze long-term debt and equity, okay? So basically I'm done with land, I'm done with building, so pretty much I don't have to look at the asset section anymore, I'm done with the asset section. Now all I have to do is look at bonds, common stock and retained earnings, okay? Well, bonds, they already told us right here in the problem B, and that's why you need to read those, we issued 150,000 and we obtained cash. So bond issued, it's 150,000. It brought us cash, 150,000 plus. Let's look at common stock. Common stock, 60,000 and state at 60,000, it didn't make any difference. Now, they already told us too in the problem that cash dividend was 18,000. Payment of dividend or dividend payment, that's gonna be negative, negative 18,000. Negative 18,000. That's all what I have. Now, let's assume before I proceed, let's assume if they did not tell us cash dividend is 18,000. Let's see if we can figure this one out without that information because sometime you might have to do so. Let's analyze retained earnings. Retained earnings went from 20,000 to 136. So retained earning, the beginning balance was 20,000. The ending balance was 136. We know that we generated an income of 134,000. It means we have to add here 134,000. And we know that dividend reduces retained earnings. So if we go 20,000 plus 134, that's gonna give us 154, but the answer is 136. It means here we paid dividend of 18,000. So luckily we are giving that information, but if it's not given, you have to know how to compute dividend. So this is the beginning retained earnings. This is the ending retained earnings. This is net income, which is increased retained earnings and dividend reduces retained earnings. Now sometime they may give you beginning retained earnings ending retained earnings and dividend. You have to find out net income. You could also do that as well. Okay, so remember they're giving you three of the four. So you have to find the fourth. Let's go back to financing. From financing, it's if we net them, it's a positive 132,000, okay? So we would say that it's net cash provided, net cash provided, provided 132,000. And that's the third component. Now let's net those three components. Let me get my calculator here and net the three components. So 194,000 minus 338 plus 132. So the net change is net 12,000. So the net, let me go back to red. Let me do it in a different color here. This is the last component of the cash flow statement. So the net change, the net change. When I net those three items together, the net change is negative 12,000. I will take the net change and I add to it my cash January 1st, my beginning cash, my beginning cash is 49,000. Now my ending cash should be 37. Now I don't know if this is correct or not, I have to go to the balance sheet and find out if my cash is 37. And voila, my cash is 37. And this negative 12,000 here, I was able to explain it, it worked. So basically this company from operating, they had positive cash, but they invested a lot in property, plant and equipment. And how did they come up with the other cash? They borrowed the money, 132. So what they did is they generated some money from the operation. They borrowed some money and all this money went into investing in the company, buying more assets in the company. Okay, now what we can do, we can work a third year example, it will be a little bit more involved, but I want you to, let's go through it, let's go through it because it's very important that you can handle this. If you can handle those examples, third year example, then you should be good to go. So this is the cash flow statement that I just prepared for you. Okay, this is the solution for it, so you can look at it. Now, let's take a look at this example. Let's take a look at this example. And this is year three, okay? And this is year three, okay? So remember the prior year cash was 37, now year 2021 cash is 54. So cash went up by 17,000. Our job is to now explain why the cash went up by 17,000. So we are giving competitive balance sheet, we are giving an income statement and we are giving a lot of additional information which we'll need to have to spend some time on this to kind of explain this information, okay? Let's start as we always start, start with the operating section. So the operating activity, we start with net income. Luckily net income is given to us, net income is 125,000, 125,000. Step two, add any gains, add any losses, subtract any gains. Let's look at the balance, the income statement. Loss, I have a loss of 12,000. So I sold a piece of equipment and I had a loss of $2,000. Now I'm gonna have to explain why do I add a loss of $2,000 because that's counterintuitive. Counterintuitive means why am I adding a loss? Isn't loss like I lost money? Why am I adding $2,000? Well, in order to understand how did this work, let's go through a journal entry. So I'm just gonna, let's go through the journal entry, okay? So let's see if that information is given to us, cost of $166,000, okay. Equipment with a cost of $41,000 and a book value of $36,000 was sold for $34,000 cash. So here they're telling us where the loss came from. Okay, so you have to read the note. So let me journalize this entry for you. If I have an equipment with a cost of $41,000, book value of $36,000 and I sold it for $34,000. What's the entry? Well, the entry is this. I debit cash, I debit my cash, I debit my cash, $34,000. I credit my equipment because I got rid of this equipment. It has a cost of $41,000. I credit my equipment of $41,000. And if I credit equipment, I also have to debit accumulated depreciation because I have to get rid of accumulated depreciation. Now how much is accumulated depreciation? They told me my book value is 36. So it means if it has a cost of $41,000 and a book value of $36,000, it means I removed $5,000 of accumulated depreciation. Why? Because you need to know this. Book value equal to cost minus accumulated depreciation. I have the cost of $41,000. They told me the book value is 36,000. So I must have $5,000 of accumulated depreciation. Now the entry does not balance. I'm still missing a loss. So this is a loss of $2,000. I debit a loss of $2,000. So this is the entry, loss on sale, loss on sale of equipment. So this is the entry that I made when I sold this asset. So I debited loss on sale, okay? In case you're wondering, why is it a loss? Because I received $34,000 cash for an asset with a book value of 36, the book value of 36. I received less cash than the book value. I have a loss of 2,000. Just in case you're also wondering, why is it a loss? Because I received less cash than the book value. You should know this. But anyway, now you know it. Now notice this $2,000 went to the income statement. Now, did we lose $2,000 in cash? Not at all. If anything, we received cash from this transaction, we received cash of 34,000. But the loss goes on the income statement. It reduced our net income. So the loss reduced net income. So the loss reduced net income by 2,000 without reducing our cash by 2,000. What does that mean? It means what we have to do since we started with net income 125, we had to add back that loss that reduced our net income. Because remember, we have to eliminate any non-cash expenses. Think of a loss as a non-cash expense. It reduced our net income without reducing our cash. And the opposite applies to gain. Again, increase our net income without increasing our cash. So if we had a gain, we would subtracted the gain for the same reason. I'm gonna subtract gain of zero because we have no gain. But since in case we had any gain, we deduct the gain. So when step one, step two, and step three. Step four, whenever we have to add any depreciation, any depreciation, any depreciation, amortization, any non-cash expenses. So let's take a look at the income statement, cost of goods, sold operating expenses, interest, loss. It doesn't look there is the depreciation, but we might be given depreciation indirectly. So let's see. So since depreciation expense is not listed here, let's read, because here it's very important to read the notes. Operating expenses include depreciation of 33. There you go. All right, so we have 33 of depreciation. So we're gonna add depreciation of 33,000. Okay, that's why you have to read the notes. That's why. So the depreciation is sitting right here in this 221. So we did the depreciation. Now we have to analyze current assets and current liabilities. Let's identify the current assets. Account receivable, inventory, and prepaid. We have three current assets and we only have one current liability. Now we're gonna have to analyze the changes, which it's already done for you here, but we have to see how do they all fit. So account receivable went down, went from 26 to 48. Good, it's a decrease. Account receivable going down, it means I have more cash. I have 42,000 more cash. I collected 42,000 more cash. My inventory went up, up increase in inventory. If I increase in inventory, it means I'm buying more inventory. Why do I have more inventory? I'm either buying or selling less. Anyway, it's an asset and it's increasing. Therefore, I'm gonna have to reduce my cash. Again, think of inventory. It's either going up, I am buying more inventory or think of it, I'm not selling. Either or, my cash is going down. But think of it, I'm buying more inventory than the prior period. And indeed, I went from zero to 54. I'm buying more inventory. Now you might be saying, what if I buy this inventory on account? No worries. We're gonna worry about on account when we analyze accounts payable. Prepaid went from $6,000 to $4,000. Now, the prepaid, there was a decrease in prepaid. Well, if a current asset goes down, that's positive to cash. Let me explain this for you. Prepaid. If a prepaid goes down, it means the prepaid is being expensed. And what entry do we make when the prepaid is expensed? When the prepaid is expensed, we debit an expense. Whatever that expense is, let's assume we prepaid our rent. We debit prepaid rent, we debit rent expense and we credit prepaid rent. Let's assume this was for $2,000. $2,000. So notice, our prepaid overall went down by $2,000. Notice, it means we increased our expenses, but this is not cash, okay? So remember, we paid for the prepaid in the prior year. Now we're using it. As we're using it, it means we are saving cash now. That's why if a prepaid is, if it's a decrease in prepaid, it means positive the cash. Now let's analyze the liabilities. Current liabilities went from $40,000 to $33,000. Now, a decrease in AP. Well, if it is a decrease, it means it's a decrease in cash. It means I'm paying down my liability. And that's basically everything for the operating section. So I'm gonna net all these out, $125,000, plus $33,000, plus $2,000, plus $42,000, minus $54,000, plus $2,000, minus $7,000. And at $125,000, equal to $59,000. And this is my net cash provided by operating activities. So notice, my net income was $125,000, but cash wise, I was only, I only generated $59,000, which is opposite of the prior year. The prior year, my net cash provided was higher, okay? So I'm basically done with my operating activity. So I just, I can just axe these out. I don't need them anymore. Now I'm gonna focus on my, I'm gonna do investing. I'm gonna focus on my investing, investing section. Under the investing section, I have to analyze my land, my building, so on and so forth. Let's start with land. Land went from 70 to 45, land went down. Building, since there's no change in building, basically it's nonexistent. I don't have to worry about it. I did already took care of depreciation, but I might have, I already took care of depreciation. My equipment went from 68 to 193. My equipment did change. So operating expenses included, we took care of letter A, okay? Land was sold at its book value for cash. B, look at letter B here. It means we sold the land and we sold it exactly for a book value. It meant there was no gain, no loss on the sale. Well, let's think about it. Land went from 70 to 45. It means we sold $25,000 worth of land. Sold land, and as a result, because I sold the land, I have a positive 25,000. So we sold a piece of land that's worth 25,000. So we're done with the land. Equipment went up. Now we need to see if there's anything about equipment. So we're done with B. Cash dividend of 55,000, that's financing the interest expense of 12,000 was paid in cash. We'll take, we took care of that. We took care of that in a sense that it was already included in net income. Equipment with a cost of 166 was purchased for cash. What does that mean? It means we purchased a piece of equipment and we paid for it 166. Equipment purchased negative 166. Equipment with a cost of 41 and a book value of 36 was sold for 34,000. Sold equipment, sold equipment for 34, that's positive. Okay, then bonds that's financing, common stock is financing. I'm pretty much done with my investing. Let me net them out. 25 plus minus 166 plus 34, it's negative 107. Again, I'm still growing the company. I'm still investing. So net cash used by investing, still negative. Okay, that's the second component of the cash flow statement, 107. The third component, so pretty much E is out. I can X out E too. E is, I already took care of this. I can X out A, I can X out B because those are ready to care of them. D too, because interest expense is an operating activity, it's done, okay? So now what I'm left with is my financing section, financing. Financing, let's start by looking at, basically assets, I don't have to worry about assets anymore. Bonds payable, bonds went from 150 to 110. It was a decrease. I paid down my bonds by 40,000. It means cash went down, but let's make sure. Bonds were redeemed at their book value. It means when I sold back my bond, when I bought back my bond, I bought them exactly at book value, no gain and no loss. Well, if that's the case, redemption of bond, I redeemed my bond, I bought them back. Redemption of bonds, and I paid 40,000 because they were exactly bought back at no gain and no loss, for 40,000. I'm done with letter F, and I'm done with my bonds. Common stock went from 60 to 220, an increase of 160. Look at letter G, it says common stock was issued for cash. It means this whole thing was issued for cash. Good, it means I brought cash of 160,000. Sale of common stock, 160, plus 160. That's good. And the only thing that's left is dividend, and it's giving to you right here, cash dividend of 55,000. Dividend paid or payment of dividend, that's negative 55,000, okay? Now I'm ready to net my financing activities. Let's net them out, minus 40, plus 160, minus 55 will give me positive 65, and that's cash provided from financing. I'm still relying on financing, okay? So that's the third component. So what happened in this company? In this company, we generated $59,000 in cash, and that 59,000 in the 65,000, all the money that we made, and all the money that we borrowed went into growing the business. Went into growing the business. Now we're not done with the cash flow statement. Now we need to net them out. We need to net those straight. So 59 plus 107 minus, and 65 plus, we net them out. We net them out. The net change, we have to compute the net change. The net change is a net increase of 17,000. Net increase of 17,000. Let's make sure we got it. We go back to the cash flow statement. Cash increase of 17,000. Notice here, cash is increase of 17,000, went from 37 to 54. So that's good. Now what I have to do is I have to add to the increase. Cash January 1st, cash January 1st was 37. So 17 plus 37. That's gonna give me cash December 31st, which is 54,000, and it worked. Okay, now, is it possible that you might see something like this on the CPA exam? It's very possible, but not likely that you would have to complete a full cash flow statement. I mean, everything is possible, but I highly doubt that you might have to complete maybe an operating section, or you might have to complete, maybe you might have to complete this part here, or you might have to complete the whole thing, but it will not be as many transactions as I just showed you. Hopefully it's not. Okay, but you have to be ready to answer a lot of multiple choice questions. And we'll work on this in the next session. We'll answer multiple choice questions. Remember, we need comparative balance sheet. We need to analyze retained earning if needed. Remember, retained earning looks something like this. We have a beginning. The beginning should be giving if the balance sheet is given. Beginning retained earning. And the ending retained earning should be given. Remember, net income will increase retained earning and dividend will decrease retained earnings. So those are the four components. And you need to include all the changes that have passed through the cash that have resulted in an increase or a decrease in cash. So we need all this information. We need any information about write down, amortization, charges, similar book entries such as depreciation that they have no cash effect. Sometime we need to be aware of those, okay? And this is a summary of my steps. I really like my steps, but this is a summary for all the steps that I showed. You basically, you will start with net income. Those are the five steps. You add depreciation expense, amortization, amortization of discount. Those are more details. So if you have any amortization, okay, depreciation, amortization. If you have any increase in the third income tax slide, this is current liability going up. You add, okay? Those are additions. Those are all addition. You add any losses. I already told you this decrease in receivable. It's a current asset, current asset. I already told you about all these rules. Current asset, current liability, current liability. And what you deduct, I already went over the rules as well, okay? Again, this is the same thing that I just showed you earlier. Now the best way to really see if you understand what we just went over. We're gonna go over a series of multiple choice questions to test your knowledge. Again, this is a lot of information. I understand it's challenging, but if you understand this, this is a very extremely important topic on the exam. You get this under control. You increase your chances of passing and you cannot pass if you don't know how to complete a statement of cash flow, which is in turn, it's gonna help you with the cash to accrual adjustments as well. As always, I would like to remind you if you have any questions about this recording, please let me know. And don't forget to visit my website for headlectures.com for additional lectures and resources. And I strongly suggest consider subscribing. It's an investment in your career and study hard for your CPA exam. This topic is covered heavily.