Problem 15-18 (IAA)
Saturn Company reported that the financial statements contained the following errors:
Ending inventory Depreciation expense
2012 60,000 understated 120,000 overstated
2013 90,000 overstated 75,000 overstated
None of the errors were detected or o r corrected, and that no additional errors were made in 2014. 20 14. By what amount would current assets on December 31, 2014 be overstated or understated? a. 90,000 understated b. 90,000 overstated c. 30,000 overstated d. 0 Problem 15-19 (AICPA Adapted)
Glory Company reported the following errors in the financial statements:
Ending inventory Depreciation
2013 200,000 under 50,000 under
2014 300,000 over
An insurance premium of P150, 000 was prepaid in 2013 to cover 2013, 2014 and 2015. The entire amount was charged to expense in 2013. On December 31, 2014, fully depreciated machinery was sold for P250, 000 cash but the sale was not recorded until 2015. There were no other errors during 2013 and 2014 and no corrections have been made for any of the errors. Ignoring income tax, what is the effect of the errors on retained earnings on December 31, 2014? a. 300,000 overstated b. 250,000 understated c. 50,000 overstated d. 50,000 understated
565
Problem 15-20 (AICPA Adapted)
Shannon Company began operations on January 1, 2013. The financial statements contained the following errors: 2013 16,000 understated 6,000 understated 10,000 overstated 10,000 understated
Ending inventory Depreciation expense Insurance expense Prepaid insurance
2014 15,000 overstated
10,000 understated
On December 31, 2014, fully depreciated machinery was sold for P10, 800 cash but the sale was not recorded until 2015. No corrections have been made for any of the errors. Ignoring income tax, what is the total effect of the errors on 1. Net income for 2013? a. 20,000 over b. 20,000 under c. 26,000 under d. 0 2. Net income for 2014? a. b. c. d.
30,200 over 30,200 under 41,000 over 41,000 under
3. Retained earnings on December 31, 2014? a. b. c. d.
10,200 over 10,200 under 20,000 over 20,000 under
4. Working capital on December 31, 2014? a. b. c. d.
4,200 over 5,800 under 6,000 under 9,800 under
566
Problem 15-21 (IAA)
Zenson Company has determined the 2014 net income to be P5, 000,000. Revenue received in advance in 2014 of P250, 0000 was credited to a revenue account when received. Of the total, P50, 000 was earned in 2014, P120, 000 will be earned in 2015 and the remainder will be earned in 2016. Loss on sale of equipment of P150, 000 in 2014 was erroneously debited to retained earnings. What is the adjusted net income for 201 4? a. b. c. d.
4,650,000 4,850,000 4,930,000 4,600,000
Problem 15-22 (IAA)
Lea Company had correctly determined the following information related to operations for 2014. Revenue from sales Expenses
7,000,000 4,000,000
Income before income tax
3,000,000
During 2014, the entity discovered an error in depreciation in 2013. The correction of this error, which has not been recorded, will result in an increase in depreciation for 2013 of P200, 000. During 2014, an inventory loss of P400, 000 was due to government ban on certain highly flammable fabrics. This has not been recorded. What is the adjusted income before tax for 2014? a. b. c. d.
2,600,000 2,400,000 3,000,000 3,400,000
567
Problem 15-23 (PHILCPA Adapted)
Malampaya Company showed income before income tax of P6, 500,000 on December 31, 2014. The year-end verification of the transactions revealed the following errors:
P1, 000,000 worth of merchandise was purchased in 2014 and included in the ending inventory. However, the purchase was recorded only in 2015.
A merchandise shipment valued at P1, 500,000 was properly recorded as purchase at year-end. Since the merchandise was still at the port area, it was inadvertently omitted from the inventory on December 31, 2014.
Advertising for December 2014, amounting to P500, 000, was recorded when payment was made in January, 2015.
Rent of P300, 000 on an equipment applicable for six months was received on November 1, 2014. The entire amount was reported as income upon receipt.
Insurance premium covering the period from July 1, 2014 to July 1, 2015, amounting to P200, 000 was paid and recorded as expense on July 31, 2014. The entity did not make any adjustment at the end of the year.
What is the corrected income before tax for 2014? a. b. c. d.
6,900,000 6,400,000 6,500,000 6,300,000
568
Problem 15-24 (IAA)
Blonde Company provided the following information for each year: 2014 4,600,000 2,346,000 1,598,000 1,441,000 157,000
Sales Cost of goods sold Expenses Beginning retained earnings Dividends paid
2013 4,350,000 2,305,000 1,533,000 1,077,000 148,000
In 2015, the entity discovered that ending inventory for 2013 was understated by P100, 000 and the ending inventory for 2014 was overstated by P300, 000. 1. What is the corrected income for 2013? a. b. c. d.
512,000 612,000 412,000 912,000
2. What is the corrected income for 2014? a. b. c. d.
856,000 256,000 556,000 356,000
3. What is the corrected balance of retained earnings on December 31, 2014? a. b. c. d.
2,240,000 1,640,000 2,340,000 1,540,000
569
Problem 15-25 (IAA)
Mariot Company reported income before tax of P3, 700,000 for 2013 and P5, 200,000 for 2014. An audit produced the following information:
The ending inventory for 2013 included 5, 000 units erroneously priced at P59 per unit. The correct cost was P95 per unit.
Merchandise costing P175, 000 was shipped to Mariot Company, FOB shipping point, on December 26, 2013. The purchase was recorded in 2013, but the merchandise was excluded from the ending inventory because it was not received until January 4, 2014.
On December 28, 2013, merchandise costing P30, 000 was sold to Deluxe Company. Deluxe had asked Mariot in writing to keep the merchandise until January 2, 2014. The merchandise was included in the inventory count. The sale was correctly recorded in December 2013.
Gray Company sold merchandise costing P15, 000 to Mariot Company. The purchase was made on December 29, 2013 and the merchandise was shipped on December 30, 2013. Terms were FOB shipping point. Because the bookkeeper was on vacation, neither the purchase nor the receipt of goods was recorded until January 2014?
What is the correct income before tax for 2014? a. b. c. d.
4,875,000 4,815,000 4,890,000 5,525,000
570
Problem 15-26 (IAA)
Rebecca Company is in the process of adjusting the accounts at the end of 2014. The records revealed the following information:
The entity failed to accrue sales commissions at the end of each year as follows: 2012 2013
220,000 140,000
In each case, the sales commission were paid and expensed in January of the following year.
Errors in ending inventories for the last three years were discovered to be as follows: 2012 2013 2014
400,000 understated 540,000 overstated 150,000 understated
The unadjusted retained earnings balance on January 1, 2014 is P12, 600,000 and the unadjusted net income for 2014 was P3, 000,000. Dividends of P1, 750,000 were declared during 2014. 1. What is the adjusted net income for 2014? a. b. c. d.
3,830,000 3,150,000 3,680,000 3,530,000
2. What is the adjusted balance of retained earnings on December 31, 2014? a. b. c. d.
14,000,000 13,320,000 13,850,000 11,000,000
571
Problem 15-27 (IAA)
Holden Company reports on a calendar-year basis. The financial statements contained the following errors: 2013 (100,000) 40,000 80,000
Over (under) statement of ending inventory Depreciation understatement Failure to accrue salaries at year-end
2014 40,000 60,000 120,000
As a result of the errors, what was the effect on net income for 2014? a. b. c. d.
240,000 understated 240,000 overstated 320,000 understated 320,000 overstated
Problem 15-28 (AICPA Adapted)
During the course of an audit of the financial statements of Julie Company for the year ended December 31, 2014, the following data are discovered:
Inventory on January 1, 2014 had been overstated by P300, 000.
Inventory on December 31, 2014 was understated by P500, 000.
An insurance policy covering three years had been purchased on January 1, 2013 for P150, 000. The entire amount was charged as an expense in 2013.
During 2014, the entity received a P100, 000 cash advance from a customer for merchandise to be manufactured and shipped during 2015. The amount had been credited to sales revenue. The gross profit on sales is 50%. Net income for 2014 per book was P2, 000,000. What is the proper net income for 2014? a. b. c. d.
2,650,000 2,350,000 1,650,000 2,050,000
572
Problem 15-29 (AICPA Adapted)
Galaxy Company provided the following financial statement information:
Revenue Expenses Net income
2015 1,350,000 980,000 370,000
2014 1,000,000 650,000 350,000
Total assets Total liabilities Total owner’s equity
1,750,000 500,000 1,070,000
1,050,000 350,000 700,000
The entity failed to record P120, 000 of accrued wages at the end of 2014. The wages were recorded and paid in January 2015. The correct accruals were made on December 31, 2015. 1. What is the corrected net income for 2014? a. b. c. d.
230,000 350,000 470,000 250,000
2. What is the corrected net income for 2015? a. b. c. d.
490,000 370,000 250,000 430,000
3. What is the correct amount of total liabilities on December 31, 2014? a. b. c. d.
470,000 230,000 400,000 500,000
4. What is the correct amount of owner’s equity on December 31, 2015? a. 1,070,000 b. 1,190,000 c. 1,010,000 d. 950,000
573
Problem 15-30 (AICPA Adapted)
Jenny Company reported net income of P9, 000,000 in 2014. The audit of the records revealed that the ending inventory of 2013 was understated by P500, 000. Insurance payment of P900, 000 in 2012 was charged to expense. The insurance coverage related equally to 2012, 2013 and 2014. Revenue received in advance of P1, 000,000 in 2014 was treated as earned in 2014 but it will actually be earned in 2015. Interest payable of P2, 000,000 at the end of 2014 was not recorded. What is the corrected net income for 2014? a. b. c. d.
5,200,000 6,700,000 6,000,000 7,200,000
Problem 15-31 (AICPA Adapted)
Emma Company revealed the following errors in the financial statements: December 31, 2013 inventory understated December 31, 2014 inventory overstated Depreciation for 2013 overstated December 31, 2014 accrued rent income overstated December 31, 2014 accrued salaries understated
500,000 800,000 250,000 300,000 150,000
The understatement of the 2013 ending inventory pertains to goods in transit purchased FOB shipping point which were not recorded in 2013 but paid in 2014. On December 31, 2014, fully depreciated machinery was sold for P100, 000 cash but the sale was not recorded until 2015. What is the effect of the errors on retained earnings on December 31, 2014? a. 1,150,000 understated b. 1,150,000 overstated c. 900,000 understated d. 900,000 overstated
574
CHAPTER 16 STATEMENT OF CAH FLOWS Definition
A statement of cash flows is a component of financial statements summarizing the operating, investing and financing activities of an entity. In simple language, the statement of cash flows provides information about the cash receipts and cash payments of an entity during a period. An entity shall prepare a statement of cash flows and present it as an integral part of the financial statements for each period for which financial statements are presented. Purpose of statement of cash flows
The primary purpose of a statement of cash flows is to provide relevant information about cash receipts and cash payments of an entity during a period. Cash flow information is useful in assessing the ability of the entity to generate cash and cash equivalents. The statement of cash flows also enhances the comparability of operating performance by different entities. Users of an entity’s financial statements are interested in how the entity generates and uses cash and cash equivalents. This is the case regardless of the nature of the entity’s activities. Entities need cash for essentially the same reasons however different in their principal revenue producing activities might be. Entities need cash to conduct their operations, to pay their obligations and to provide returns to their investors.
575
Cash and cash equivalents
The statement of cash flows is designed to provide information about the change in an entity’s cash and cash equivalents. Cash comprises cash on hand and demand deposits. Cash equivalents are short-term highly liquid investments that are readily convertible to known amount of cash and which are subject to an insignificant risk of change in value. PAS 7, paragraph 7, provides that an investment normally qualifies as a cash equivalent only when it has a short maturity of three months or less from date of acquisition. In other words, the investment must be acquired three months or less before the date of maturity. Examples of cash equivalents
a. b. c. d.
Three-month BSP treasury bill Three-year BSP treasury bill purchased three months before date of maturity Three-month time deposit Three-month money market instrument or commercial paper
Thus, a BSP treasury bill that was purchased three years ago cannot qualify as cash equivalent even if the remaining maturity is three months or l ess. Equity securities cannot qualify as cash equivalents because shares do not have a maturity date. However, preference shares with specified redemption date and acquired three months before the redemption date can qualify as cash equivalents.
576
Components of cash and cash equivalents
An entity shall disclose the components of cash and cash equivalents and shall present a reconciliation of the amounts in the statement of cash flows with the equivalent items reported in the statement of financial position. It is also necessary to disclose the accounting policy used in deciding which items are included in determining cash and cash equivalents. Classification of cash flows
Cash flows are inflows and outflows of cash and cash equivalents. The statement of cash flows shall report cash flows during the period classified as operating, investing and financing activities. Classification by activity provides information that allows users to assess the impact of those activities on the financial position of the entity an d the amount of its cash and cash equivalents. Bank borrowings are generally considered as financing activities. However, bank overdrafts which are repayable on demand form an integral part of an entity’s cash management. In these circumstances, bank overdrafts are included as component of cash and cash equivalents. A characteristic of such banking arrangement is that the bank balance often fluctuates from being positive to overdrawn. In the Philippines, bank overdrafts generally are not permitted.
577
Operating activities
Operating activities are the cash flows derived primarily from the principal revenue producing activities of the entity. In other words, operating activities generally result from transactions and other events that enter into the determination of net income or loss. Examples of cash flows from operating activities are: a. b. c. d. e.
Cash receipts from sale of goods and rendering of services Cash receipts from royalties, rental, fees, commissions and other revenue Cash payments to suppliers for good and services Cash payments for selling, administrative and other expenses Cash receipts and cash payments of an insurance enterprise for premiums and claims, annuities and other policy benefits f. Cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities g. Cash receipts and payments for securities held for dealing or trading purposes
Trading securities
PAS 7, paragraph 15, provides that cash flows arising from the purchase and sale of dealing or trading securities are classified as operating activities. Similarly, cash advances and loans made by a financial institution are usually classified as operating activities since they relate to the main re venue producing activity of that entity. Investing activities
Investing activities are the cash flows derived from the acquisition and disposal of long-term assets and other investments not included in cash equivalent. As a simple guide, investing activities include cash flows from transactions involving nonoperating assets.
578
Examples of cash flows from investing activities
a. Cash payments to acquire property, plant and equipment, intangibles and other long-term assets. b. Cash receipts from sales of property, plant and equipment, intangibles and other longterm assets. c. Cash payments to acquire equity or debt instruments of other entities and interests in joint ventures (current and long-term investments). d. Cash receipts from sales of equity or debt instruments of other entities and interests in joint venture. e. Cash advances and loans to other parties (other than advances and loans made by financial institution). f.
Cash receipts from repayment of advances and loans made to other parties.
g. Cash payments for future contract, forward contract, option contract and swap contract. h. Cash receipts from future contract, forward contract, option contract and swap contract. Financing activities
Financing activities are the cash flows derived from the equity capital and borrowings of the entity. In other words, financing activities are the cash flows that result from transactions between the entity and its owners (equity financing) and between the entity and its creditors (debt financing). As a simple guide, financing activities include the cash flows from transactions involving nontrade liabilities and equity of an entity.
579
Examples of cash flows from financing activities
a. Cash receipts from issuing shares or other equity instruments (for example, issuance of ordinary and preference shares). b. Cash payments to owners to acquire or redeem the enterprise’s shares (for example, payment for treasury stock). c. Cash receipts from issuing debentures, loans, notes, bonds, mortgages, and other short or long term borrowings. d. Cash payments for amounts borrowed. e. Cash payments by a lessee for the reduction of the outstanding liability relating to a finance lease.
Note that cash payments to settle such obligations as trade accounts and notes payable, income tax payable, accrued expenses and similar items are operating activities, not financing activities. Noncash transactions
PAS 7, paragraph 43, provide that investing and financing transactions that do not require use of cash or cash equivalents shall be excluded from the statement of cash flows. Such transactions shall be disclosed elsewhere in the financial statements either in the notes to financial statements or in a separate schedule or in a way that provides all relevant information about these transactions. The statement of cash flows is “strictly” a cash concept. Accordingly, the following noncash transactions are disclosed separately: a. Acquisition of asset either by assuming directly related liability or by means of a finance lease. b. Acquisition of asset by means of issuing share capital or bonds payable. c. Conversion of debt to equity, for example conversion of bonds payable to share capital. d. Conversion of preference share to ordinary share.
580
Interest
PAS 7, paragraph 33, provides that interest paid and interest received shall be classified as operating cash flows because they enter into the determination of net income or loss. Alternatively, interest paid may be classified as financing cash flow because it is a cost of obtaining financial resources. Alternatively, interest received may be classified as investing cash flow because it is a return on investment.
For a financial institution, interest paid and interest received are usually classified as operating cash flows. Cash flows from interest paid and interest received shall be classified in a consistent manner from period to period as either operating, investing or financing activities. Dividends
PAS 7, paragraph 33, provides that dividend received shall be classified as operating cash flow because it enters into the determination of net income. Alternatively, dividend received may be classified as investing cash flow because it is a return on investment.
PAS 7, paragraph 34, provides that dividend paid shall be classified as financing cash flow because it is a cost of obtaining financial resources. Alternatively, dividend paid may be classified as operating cash flow in order to assist users to determine the ability of the entity to pay dividends out of operating cash flows.
The classification of dividend received and dividend paid as either operating, investing or financing activity shall be made on a consistent basis from period to period.
581
Income taxes
PAS 7, paragraph 35, provides that cash flows arising from income taxes shall be separately disclosed as cash flows from operating activities unless they can be specifically identified with investing and financing activities. Tax cash flows are often difficult to match to the originating underlying transaction, so most of the time all tax cash flows are classified as arising from operating act ivities. Illustration – Operating activities
Simple Company reported the following comparative statement of financial position and income statement for 2014. Assets
2014
Cash Accounts receivable Inventory Prepaid insurance Property, plant and equipment Accumulated depreciation Patent
2013
3,000,000 940,000 175,000 15,000 2,000,000 ( 550,000) 40,000
2,000,000 350,000 100,000 20,000 2,000,000 ( 500,000) 50,000
5,620,000
4,020,000
Accounts payable Accrued salaries payable Accrued interest payable Income tax payable Unearned rent income Mortgage payable Share capital Retained earnings
170,000 25,000 10,000 350,000 10,000 500,000 2,000,000 2,555,000
150,000 10,000 15,000 250,000 40,000 500,000 2,000,000 1,055,000
Total liabilities and equity
5,620,000
4,020,000
Total assets Liabilities and Equity
582
Income Statement Year ended December 31, 2014
Sales Cost of sales: Inventory – January 1 Purchases
6,500,000 100,000 3,200,000
Goods available for sale Inventory – December 31 Gross income Rent income
3,300,000 ( 175,000)
Total income
3,125,000 3,375,000 80,000 3,455,000
Expenses: Salaries Insurance Other expenses Depreciation Amortization of patent Interest expense Income before tax Income tax
950,000 40,000 500,000 50,000 10,000 55,000
Net income
1,605,000 1,850,000 350,000 1,500,000
Direct method
PAS 7, paragraph 18, provides that an entity shall report cash flows operating activities using either the direct method or indirect method. The direct method shows in detail or itemizes the major classes of gross cash receipts and gross cash payments. The cash receipts are listed one by one, the cash payments are listed one by one, and the difference represents the net cash flow from operating activities. In essence, the direct method is the “cash basis” income statement. Actually, the statement of cash flows is a conversion from the accrual basis to the cash basis of accounting. Accordingly, some formulas may be necessary for determining cash receipts and cash payments.
583
Computation of collections
Trade accounts and notes receivable – beginning Add: Sales (accrual basis)
xx xx
Total Less: Trade accounts and notes receivable – end
xx xx
Collection of accounts and notes receivable
xx
Computation of payments to merchandise creditors
Trade accounts and notes payable – beginning Add: Purchases (accrual basis)
xx xx
Total Less: Trade accounts and notes payable – end
xx xx
Payment to merchandise creditors
xx
Computation of payments for expenses
Expenses (accrual) Add: Prepaid expense – end Accrued expense – beginning
xx xx xx
Total Less: Prepaid expense – beginning Accrued expense – end
xx xx xx
Expenses paid
xx xx
Computation of collection of other income
Income other than sales (accrual) Add: deferred income – end Accrued income – beginning
xx xx xx
Total Less: deferred income – beginning Accrued income – end
xx xx xx
Collection of other income
xx xx
584
Computations under the direct method
1.
Accounts receivable – 2013 Add: Sales
350,000 6,500,000
Total Less: Accounts receivable – 2014
6,850,000 940,000
Collections from customers
5,910,000
2. Rent income Add: Unearned rent income – 2014
80,000 10,000
Total Less: Unearned rent income – 2013
90,000 40,000
Rent received
50,000
3. Accounts payable – 2013 Add: Purchases
150,000 3,200,000
Total Less: Accounts payable – 2014
3,350,000 170,000
Payments to merchandise creditors
3,180,000
4. Salaries Add: Accrued salaries payable – 2013
950,000 10,000
Total Less: accrued salaries payable – 2014
960,000 25,000
Salaries paid
935,000
5. Insurance Add: Prepaid insurance – 2014
40,000 15,000
Total Less: Prepaid insurance – 2013
55,000 20,000
Payment for insurance
35,000
6. Other expenses paid
500,000
585
7. Interest expense Add: Accrued interest payable – 2013
55,000 15,000
Total Less: Accrued interest payable – 2014
70,000 10,000
Interest paid
60,000
8. Income tax Add: Income tax payable – 2013
350,000 250,000
Total Less: Income tax payable – 2014
600,000 350,000
Payment for income tax
250,000
The net cash provided by operating activities under the direct method would appear as follows: Cash received from customers Rent received Cash payments to merchandise creditors Salaries paid Insurance paid Other expense paid
5,910,000 50,000 (3,180,000) ( 935,000) ( 35,000) ( 500,000)
Cash generated from operations Interest paid Income tax paid
1,310,000 ( 60,000) ( 250,000)
Net cash provided by operating activities
1,000,000
PAS 7, paragraph 32, provides that interest paid is disclosed separately whether it has been recognized in profit or loss or capitalized. Paragraph 35 provides that income tax paid is also disclosed or presented separately. Observe that the depreciation of P500, 000 and amortization of P10, 000 do not appear in the statement of cash flows using the direct method. The reason is that these are noncash expenses or expenses not requiring use of cash. PAS 7, paragraph 19, provides that entities are encouraged to report cash flows from operating activities using the direct method.
586
Indirect method
The indirect method means that the net income or loss is adjusted for the effects of transactions of a noncash nature, any deferrals or accruals of past or future operating cash receipts and payments, and items of income or expense associated with investing and financing activities. The indirect method of presenting the cash flow from operations begins with the accrual basis net income and applies a series of adjustments to convert the income to a cash basis. The following general guidelines are offered for the adjustments of net income to cash basis: 1. All increases in trade noncash current assets are deducted from net income. 2. All decreases in trade noncash current assets are added to net income. 3. All increases in trade current liabilities are added to net income. 4. All decreases in trade current liabilities are deducted from net income. 5. Depreciation, amortization and other noncash expenses are added back to net income to eliminate the effect they had on net income. 6. Any gain on disposal of property or gain on early retirement of nontrade liabilities is included in net income but it is a nonoperating item. Thus, this is deducted from net income. 7. Any loss on disposal of property or loss on early retirement of nontrade liabilities is deducted from net income but this is a nonoperating item. Thus, this is added back to net income.
587
Continuing the illustration, the changes in current assets and current liabilities are summarized as follows:
Accounts receivable Inventory Prepaid insurance Accounts payable Accrued salaries payable Accrued interest payable Income tax payable Unearned rent income
2014 940,000 175,000 15,000 170,000 25,000 10,000 350,000 10,000
2013 350,000 100,000 20,000 150,000 10,000 15,000 250,000 40,000
Increase (Decrease ) 590,000 75,000 ( 5,000) 20,000 15,000 ( 5,000) 100,000 ( 30,000)
The net cash provided by operating activities using the indirect method would appear as follows: Net income Increase in accounts receivable Increase in inventory Decrease in prepaid insurance Increase in accounts payable Increase in accrued salaries payable Decrease in accrued interest payable Increase in income tax payable Decrease in unearned rent income Depreciation Amortization of patent
1,500,000 ( 590,000) ( 75,000) 5,000 20,000 15,000 ( 5,000) 100,000 ( 30,000) 50,000 10,000
Net cash provided by operating activities
1,000,000
The direct method and indirect method are applicable only to operating activities. PAS 7, paragraph 21, provides that an entity shall report separately major classes of gross cash receipts and gross cash payments arising from investing and financing activities using the direct method.
588
Comprehensive illustrations
Illustrar Company provided the following statement of financial position on December 31, 2014 and 2013 and other financial data relating to activities during 2014:
Cash and cash equivalents Accounts receivable, net of allowance Notes receivable – trade Inventory Prepaid expenses Investment in equity securities, at cost Property, plant and equipment Accumulated depreciation Patent
Accounts payable Notes payable – trade Accrued expenses Note payable – bank (short term debt) Share capital, P100 par Share premium Retained earnings Treasury shares, at cost
2014 600,000 1,100,000 150,000 1,200,000 110,000 300,000 3,400,000 ( 900,000) –
2013 200,000 1,040,000 200,000 1,360,000 120,000 500,000 2,000,000 ( 600,000) 80,000
5,690,000
4,900,000
880,000 60,000 100,000 400,000 3,000,000 530,000 990,000 –
840,000 240,000 330,000 – 2,400,000 400,000 790,000 ( 100,000)
5,690,000
4,900,000
The statement of retained earnings for the year ended December 31, 2014 showed the following: Retained earnings – January 1 Add: Net income for 2014
790,000 1,000,000
Total Less: Cash dividends paid
1,790,000 300,000
Retained earnings – December 31
990,000
589
Additional information
The entity sold an investment in equity securities for P240, 000 cash. There were no other transactions affecting the investment in equity securities.
Land was purchased in the current year for P1, 200,000, paying P1, 000,000 cash and issuing P200, 000 share capital at par value.
Equipment costing P200, 000 and having a carrying amount of P80, 000 was sold for P60, 000 cash.
Equipment of P400, 000 was purchased for cash.
The entity borrowed P400, 000 from a bank to be paid on June 30, 2015.
Share capital with par value of P400, 000 was issued for cash at a premium of P100, 000.
The treasury shares were reissued for P130, 000 c ash.
The patent was fully amortized.
Basic guidelines
a. Operating activities include the cash effects of transactions that enter into the determination of net income. b. Investing activities include the cash effects of transactions involving “nonoperating assets”. c. Financing activities include the cash effects of transactions involving nontrade “liabilities” and “equity”.
590
Introduction
In determining cash receipts and cash payments, it is necessary to analyze all accounts in the statement of financial position, with the exception of cash and cash equivalents. The net changes in all statement of financial position accounts are traced to their original entry. Accordingly, the preparation of the statement of cash flows requires reconstruction of original entries affecting the statement of financial position accounts. The cash effects of transactions can then be properly determined from the original entries. Retained earnings, P200, 000 increase
As a matter of procedure, it is practical and logical to analyze first the retained earnings account. The statement of retained earnings shows a net income of P1, 000,000 and cash dividend paid of P800, 000, resulting to a net increase of P200, 000. The original entries are properly numbers for easy reference. With respect to the net income, the original entry to close the same to retained earnings is: 1. Profit and loss Retained earnings
1,000,000 1,000,000
The net income is the principal cash inflow from operations and therefore the first item under operating activities. With respect to the cash dividend, the payment is recorded as follows: 2. Retained earnings Cash
800,000 800,000
The transaction affects retained earnings, a shareholder’s equity item. Therefore, the payment of cash dividend is shown under financing activities as a deduction because it decreases cash.
591
Accounts receivable, P600, 000 increase
The increase in accounts receivable is originally recorded as: 3. Accounts receivable Sales
60,000 60,000
The increase in accounts receivable increased net income but did not increase cash. Thus, the increase in accounts receivable is deducted from net income under operating activities. Remember the basic rule that all increases in trade current assets are deducted from net income. Note that the accounts receivable should be analyzed net of the allowance for doubtful accounts. Notes receivable – trade, P50, 000 decrease
The decrease in notes receivable is originally recorded as follows: 4. Cash
50,000 Notes receivable
50,000
The decrease in notes receivable increased cash but did not increase net income. Thus, the decrease in notes receivable is added to net income under operating activities. Again, remember the basic rule under the indirect method that all decreases in trade current assets are added to net income. Inventory, P160, 000 decrease
The decrease in inventory is originally recorded as follows: 5. Cost of sales Inventory
160,000 160,000
The decrease in inventory increased cost of sales and consequently decreased net income but did not decrease cash. Thus, the decrease in inventory is added back to net income under operating activities.
592
Prepaid expenses, P10, 000 decrease
The decrease in prepaid expenses is originally recorded as follows: 6. Expenses Prepaid expenses
10,000 10,000
The decrease in prepaid expenses increased expenses and consequently decreased net income but did not decrease cash. Thus, the decrease in prepaid expenses is added back to net income under operating activities. Investment in equity securities, P200, 000 decrease
The decrease represents sale of securities for P240, 000, or a gain of P40, 000. The original entry is 7. Cash
240,000 Investment in equity securities Gain on sale of investment
200,000 40,000
The transaction involves a nonoperating asset. Therefore, the cash received from sale of the investment shown under investing activities as an addition because it increases cash. The gain on sale of investment is previously included in the determination of net income but this is a nonoperating item. Therefore, the gain is deducted from net income under operating activities.
593
