 Hello and welcome to the session. This is Professor Farhad in which we would look at a comprehensive example that deals with the statement of cash flows using the indirect method. So we're going to go through the operating site, the operating section, investing and financing. So let's walk through the map and what we need to do. Under the operating section using the indirect method, we are going to start with net income. Then we are going to make the following adjustments. What are the adjustments that we make? Well, we are going to add non-cash expenses. What does that mean? Well, non-cash expenses are expenses that we debit expense, for example, $10,000 and we credit something other than cash for $10,000. So those expenses are non-cash. Why? Because we credit it something other than cash. What could be an example? Depreciation. We debit the depreciation expense, we credited accumulated depreciation, amortization, bad debt expense. Those are non-cash expenses and any non-cash expense you can think of. Also under non-cash expenses, I added losses. We consider a loss as a non-cash expense because a loss reduces net income without reducing the expenses. And again, we're going to see some application of this. We're going to deduct any gains. Why? Because when we sell a piece of equipment, when we sell a piece of land, let's assume we sold land for $110,000, the cost of the land is $100,000. What entry do we make? We debit cash $110,000, we credit land $100,000, and we have a gain of $10,000. So notice we have a gain of $10,000, the gain increased net income. But the full amount of cash is counted in the investment section. Therefore, we need to take out the gain from net income because it increased net income without increasing our operating cash. Well, it increased our investing cash, but we are dealing with the operating section. Therefore, we deduct the gain. Just kind of, you know, you need to know the rules. Now, what's important too is analyzing current assets and current liabilities. And here you need to know how to analyze current assets and current liabilities. If there is any increase in current assets other than cash, so if a count receivable goes up, if inventory goes up, we deduct this increase in current assets. Why? Because every time we increase account receivable, it means we are selling on account. Selling on account means it's a cruel sale, not cash sales, and we are converting our net income to cash net income. Therefore, we need to deduct any increase in account receivable. Same concept for inventory. When we have more inventory, it means we are not selling inventory or we are acquiring, which is it's using up our cash. Therefore, we deduct. Same thing with prepaid. When our prepaid goes up, it means we are acquiring prepaid. Our cash will go down, will deduct. And the opposite is true. You add any decreases in in current assets. So if a count receivable went down, it means we are collecting cash, collecting more cash from customers than we are selling on account. Therefore, we increase. Therefore, let me show you how you would remember this. If current assets go up, you deduct from cash flow. If current assets went down, you add to the cash flow. You add to your net income, it means you increase your cash flow. This is for the assets. Let's examine the rules for liabilities. Liabilities. You deduct any decrease in current liabilities. Simply put, what I'm saying is if current liabilities goes down, it's a negative cash flow. Hold on a second. Is this true? Yes. When would your liabilities go down? When you pay them. Therefore, it's a negative cash. The opposite is true. When your current liabilities go up, you add to your cash flow. When would your current liabilities go up? It's when you operate your business and don't pay the cash now. Simply put, you debit an expense and you credit a liability. For example, you debit an expense 10,000. You credit a liability 10,000. Your expenses went up. You did not pay cash. Therefore, by increasing your liability, you have a positive cash flow to your net income. Also, we need to prepare the investing section and we need to prepare the financing section. So those are the three sections. And the best way to do so, to illustrate everything that we learned is to look at an example. Now, the example I'm going to be looking at will be a little bit more involved. So it may take us at least 30 minutes to finish. So get ready and embrace yourself. Before we look at the example, I would like to remind you whether you are an accounting student or a CPA candidate. And most likely you are either a student or a CPA candidate to take a look at my website, farhatlectures.com. The reason you are watching because you are looking for some help, go a step further. On my website, I provide you additional resources, multiple choice, true, false, lectures, exercises. That's going to help you with your accounting courses as well as your CPA exam. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation like this recording. Share it with other. Connect with me on Instagram, Facebook, Twitter and Reddit. This is the example we're going to be working with. Two years of balance sheet, year X1 and year X2. Also, we do have additional data. We sold an equipment. The selling price was $2,500. It was 40% depreciated. The cost of the equipment was $15,000. Portion of long-term notes payable, paid by issuing stocks. We issued $10,000 of stocks to pay it off a liability. Cash dividend paid was $5,000. On January 1, X2, the building was completely destroyed by a flood. We had a building destroyed by the flood. The insurance gave us $38,000. Investment available for sale were sold above the cost by $2,000. Cash was paid for the acquisition of equipment, which is we're not giving that number. Long-term note was issued for the acquisition of equipment. We bought equipment for $16,000. So notice there's a lot of activities in the equipment. We sold equipment. We purchased equipment for cash and we purchased equipment using note. Amount paid in cash, interest $2,000, income taxes $6,500. Now, again, what do we need to do? We need to start by looking at the operating section and let's take a look at the operating section starting with net income. Hold on a second. We're not giving net income. Oh, okay. No problem. We can't solve this problem. On the contrary. Yes, we can. So if you are not giving net income, usually on the exam, an income statement could be provided to you. Sometime it's not. If an income statement is not provided, what do you need to do? You need to analyze the account that relate to net income. What account relate to net income? How can we derive net income? It's through retained earnings. How do we do so? Well, let's analyze retained earnings. If we see retained earnings, it's an equity account that started at $6,000 and up $20,750. Now, we need to compute the difference. Simply put, what's the difference in this account? $20,750 minus $6,000. There's a difference of $14,750, the difference between those two. Well, we are not told anything about dividend except that we paid dividend of $5,000, but that dividend was already accrued. So already it's a part of retained earnings. So what happened is this, the only difference is the only difference between retained earning and the beginning and ending is net income of $14,750. Again, we did not declare dividend this period. We paid dividend, but that dividend was already accrued. In other words, it's for the prior period. That's the only thing that we know about dividend. Therefore, we can start by saying net income for our purposes, guess what? It was $14,750. We started with net income. So we started our cash flow statement. We started this process. Let me just delete this because we need more space to work with this. Now, the second thing we're going to look at after we compute net income, remember, we have to deal with non-cash expenses such as losses, depreciation, any non-cash expenses and any gains that we need to deduct. Well, let's see. We know that we sold a piece of equipment. So let's examine this account here, that piece of equipment. A piece of equipment was sold. We are giving the cost of the original equipment, how much the selling price and how much depreciation was taking. So let's see. We sold the equipment, the original, we sold it for $2,500. Well, the cost was $15,000. Now, we are told 40% of this asset was depreciated. If we take $15,000 times .4, so we had depreciation of 9. This means this asset had a book value of 9. At a book value of 9, we sold it for $2,500. So the difference $9,000 minus $2,500 is a loss. Well, now we have a loss and what do we do with losses? We add back the losses. Losses are added back. Therefore, we're starting to add back our non-cash expenses and a loss. So basically, the equipment we took care of this equipment. Basically, this is done. Now, what else were we told? We were told that a building was totally destroyed and we received $38,000. Well, we have to do the same thing. And if we go back to the balance sheet, if we go back to the balance sheet, we noticed that we had a building of $29,750 in year X1 and year X2 it was gone. So that building is gone. And the accumulated depreciation for that building was $6,000. So simply put, we had the building with the book value. We have to do the same thing. So the building was $29,750 minus $6,000. So let's compute the book value of the building. It was destroyed right at the beginning of the year. Therefore, we account for all the depreciation. The book value was $23,750. That was the book value. We are told the insurance gave us $38,000. Well, $38,000 minus $23,750. Let's see how much appears that we had a gain on this one. $38,000 minus $23,750 of $14,250. This was a gain. This was a gain on the income statement. What do we do with gain? The opposite of losses. We are going to deduct the gain. Now, you're saying, so what about the $38,000 that we received? Don't worry. We're going to account for those under the investing section. But as part of the gain, it has to be taken out from the operating section because the whole amount will be part of the investing rather than the operating. Now, what else? So we're basically done with this information. We're basically done with the cash dividend table. We're already accounted for that. We're already accounted for the insurance proceeds. We accounted for that as well. What else? What else do we have to know? Depreciation. Let's compute our depreciation expense. Depreciation expense is not giving, so we have to compute depreciation expense. How do we compute depreciation expense? Well, since we don't have depreciation expense, we have to rely on accumulated depreciation. What do we have under accumulated depreciation? We know that accumulated depreciation the prior year was 10,500. So it started at 10,500, and it ended up to be 2000. And it ended up to be 2000. What do we know about this? What do we know about the changes in accumulated depreciation? We know that we sold a piece of equipment. And if you remember, when we sold this piece of equipment right here, it was 15,000. I shouldn't have deleted this times 40%. There was 6,000 of depreciation that was taken out. Therefore, I debited accumulated depreciation 6,000 for the sale of equipment. Well, that's 6,000. So I accounted for the 6,000. I also see from my balance sheet that I had 6,000 for the building. Remember that building that was destroyed by the flood also gone. Therefore, I removed it. That's another 6,000. And basically, I accounted for everything except it doesn't balance. So if I started with 10,500, take the 6,000 for the sale of the equipment, 6,000 for the flood, the building, because I removed the building, I removed the flood. So let's see 10,500 minus 12,000 in total. I should have used different numbers rather than both of them, 6,000. That's equal to negative 1,500. I have a positive 2,000. It means my depreciation for the year, this is the plug, happens to be, guess what, happens to be the difference, which is 3,500. So this is basically, it's a plug in a sense I work backward. I'm giving the beginning. I'm giving the ending. I was able to figure out how much accumulated depreciation was debited. It means what's left. It must be the depreciation expense that I took. Therefore, what do we do with depreciation expense? It's a non-cash expense. What do we do with that? We add back depreciation expense and depreciation expense, as I just computed it for you, 3,500. What else do I have? Do I have any other depreciation or non-cash expenses? Well, let's see. I had a patent here, a patent, and it went from 6,250 to 5,000. I am not told in any way, shape or form, and the additional information that I sold a patent. One reason could be I sold the patent. Well, if I did not sell the patent, and the patent went down in value, it means it was amortized. And remember, amortization like depreciation, it's a non-cash expense. Therefore, what do I need to do? I need to add back the amortization amount, which has happened to be 1,250. I'm pretty much done with all my, I believe I'm done with all my non-cash expenses and gains and losses. Now, what I need to do, remember, I have to analyze my current assets and current liabilities. Now, I will start to analyze them. And let me go back real quick. And kind of how do you analyze them? You find the difference. You find the difference between the two. And I see that a counter receivable went up. Let me see. A counter receivable went up and inventory went up as well. Well, what does that mean? If assets go up, if current assets go up, it means I am consuming cash. It's a negative cash. Therefore, well, I'm sorry, I'll have to come back to the gain. Give me one moment here. Since I did the receivable, let me just do the receivable and the inventory. The receivable and the inventory are deducted, are deducted. Why? Because they went up. Now, gain on the sale of the investment. I also had a current asset, 3,000 went down to zero. Well, it could be two things. It could be the value of it go down to, went down to zero. Or it could be I sold it. Well, let's scroll down and see if we are giving anything on this information. Investment was sold 2,000 above the price. Well, if we have 3,000, it was sold 2,000 above the cost. It means it was sold for 2,000 above 3, it was sold for 5. But since it was sold 2,000 above 3, it means we have a gain of 2,000. And what do we do with gains? We already know this. We deduct any gains. So this is where the deduction of the gain taking place. So this is the deduction of the gain. Now, you said you sold it for 5,000. Where is that going to be? Well, if I sold it for 5,000, that's part of my investments. That's going to add to my investments 5,000. So let me go ahead and show you. This is a good example where I did account for the investment. Since I sold it, since I sold the investment, I received 5,000 in total. 2,000 was part of it on the income statement as gain. I have to take it out of the income statement. Therefore, the full amount is on the investing section. Well, good. Now, I'm done also. So I'm done with account receivable inventory available for sale investments. I'm done with all of those. What's left? I have to analyze my liabilities. I have to analyze my liabilities. My liabilities, I have accounts payable. Accounts payable went from 3,000 to 5,000. So accounts payable went up. What does it mean when my liabilities went up? It means I'm operating without paying cash from a cash. It's a positive thing because I am operating not paying cash. Therefore, an increase in accounts payable, an increase in liability is plus to my cash. What about dividend payable? Isn't that a current liability? Yes, it is. However, dividend payable, although it's considered a working capital, but dividend is a financing activity. Therefore, this is going to be part of my financing. Just hold on that. Hold on that. Therefore, let me just finish now my operating section. Now, I'm ready to compute my operating section. And if I take net income and compute all the differences, compute all the differences, it appears that I have net cash provided by operating positive 5,000. So I'm done with my operating section. I believe I accounted for everything. Let's go back to investing. Investing, we already know that we sold an investment for 5,000. We also know that we sold this piece of equipment, this one right here, for 2,500. So let's account for the easy part. That's also we sold it. It means it gave us cash. And remember, we took care of any gains and losses for that equipment as well. Remember, we had a loss and we took it out of the income. And now we have the sale of the equipment. Now, what else do we have to be aware of? Remember, we had few things about equipments. The equipment account, there was many things in the equipment account. So let's analyze the equipment accounts, kind of just kind of go through the equipment account and see if we what do we need to do. Equipment. The equipment account, we started at 20,000 and we end up with 45. So from a T account, we started at 20 and up at 45. What do we know? We know that we sold 15,000. This 15,000 is sold. We know that. So the account was credited. Okay. Now notice if we take 20 minus 15 is not equal to 45. So we have other things that we need to be maybe aware of. We are told that we issued a long term note and acquired equipment worth of 16. Well, if that's the case, it means our equipment account was increased by 16. If we take 20 plus 16 minus 15 is not equal to 45. We are also told that cash paid for the acquisition of the equipment. We don't know this cash amount paid. And this is what we need to know. Well, let's see. If we take 20,000 plus 16,000 of equipment minus 15,000, that's equal to 21, but now it's equal to 45. So if we deduct the 45 difference, it means we purchased. We purchased basically this is just solving the formula. We purchased, let me put it in a different color. We purchased 42,000 of equipment. So now we know, I'm sorry, not 42,000, 24,000 in cash. So now we know this number, 24,000, that's not giving to us. Now the beginning was giving, the ending was giving, the 15,000 is the sale, the 16,000 is giving. So what's left is 24. Therefore, what we can say, we purchase equipment as part of our investment, 24,000 worth of equipment. Okay, what else do we have to worry about? We have to worry about the building. And we know from the building we received that's giving to us of 38,000. How do we know this? It's right here. It's giving to us in the problem. Now we accounted for everything that's investing. Now we can net them out to find out what's the net investment. The net investment section is how much? Let's see, the net investment is 21,500. Okay, now we go from investing to financing. And financing, we already know that we paid 5,000 in dividend. So let's take care of the dividend first because we know that payment of dividend of 5,000, which is right here. Now there was a change in our common stock. Notice our common stock went from 45 to 35. Well, that's usually a financing of 10,000. But here's what we are told. Here's what we are told. We issued portion of long-term notes payable by issuing stocks 10,000. So that's non-cash. We're going to see where do we put this. But usually if we're not giving this information, we would say that we issued stocks of 10,000. But what else happened in the investing section? In addition to the dividend, payment of short-term notes. Short-term notes, if you notice here, where's the short-term notes, went from 4 to 3. Short-term notes is a current liability. It was paid down. If we paid it down, it means cash outflow. Therefore, it's negative 1,000. And nothing else, nothing else. Now we are ready to compute our net cash from financing, which is negative 6,000. Now let's net them all out. If we net investing, financing, and operating, it means we have an increase of 20,500. And let's see. If I find the difference between year 2 and year 1, that's 20,500. Great. It looks like it's going to balance. Not balance. It means it's correct. My beginning cash was 13. My ending is 33,500. My ending should be 33,500. And great. I was able to figure out my statement of cash flows. So notice this example, it involved a lot of stuff. It was not done yet. What else do we have to do? Well, you are told interest and income taxes were paid. You need to disclose this. So this is part of the disclosure. You need to say how much interest you paid. You need to show how much income taxes you paid. Also, you have to disclose additional information that's relevant that you issued stocks to pay off the debt. That's also a disclosure. This is a non-cash investing and financing. You also issued stocks. I'm sorry, you issued debt. You issued debt to buy equipment that's also need to be disclosed because those are non-cash investing and financing. So you will disclose interest, how much interest you paid income taxes, and those to the 10,000 and the 16,000 as non-cash. This is a comprehensive example. If you can go through this example and understand it, I believe you should be in good shape and you are ready for your CPA exam, ready for your cash flow statement. All what I'm going to ask you to do now, if you're not part of farhatlectures.com, go ahead, subscribe, work multiple choice questions through false exercises that's going to help you do better. The statement of cash flows is important. It's going to help you to go from accrual to cash, also from cash to accrual because that's also required of you. Again, on my website, you have the direct method, more examples, invest in yourself. Good luck and stay safe.