Hello in this lecture we’re going to talk about creating a statement of cash flows using the indirect method, we will be able to define a statement of cash flows, create a statement of cash flows explain a process of creating a statement of cash flows designed to limit mistakes and define the indirect method. So what we’ll do is we’ll work through basically a problem and look through the statement of cash flows. We want to think about a few things we want to think about how to create a statement of cash flows, we want to think about a few definitions of what is a statement of cash flows, we want to kind of explain what the purpose is of a statement of cash flows and going through the process can help us to do that. Also want to point out that creating the statement of cash flows can help us with setting up a problem in such a way that we can limit the amount of mistakes that we will make. So a statement of cash flows is something that in a lot of firms, people generally often have problems to create the statement of cash flows. And it’s good practice to go in there and and create the statement of cash flows and try to create a system in which it’s easy for us to have checkpoints and see where a problem is going to happen.
So that’s also something that we will work through with a statement of cash flows. Because at the end of the process, just like if we’re creating a balance sheet, it’s easy for us to get to the end, and it doesn’t. It’s not in balance, it’s not working, and not have any checkpoints to go back and try to figure out, well, where is it off? Why is it off, and then you start the entire thing over. So creating a process in which you can have checkpoints and go back and try to figure out where it went off is good, not just for accounting, but for any any type of process. If you’re trying to figure something out. You want to see, okay, where can we find defined points in which we know that we’re correct here. We know we’re correct there, then we can move forward in a systematic way. I also want to point out that a statement of cash flows is really good for learning accrual concepts. So you can get a lot of Statement of Cash Flow questions right? If you just Memorize the types of areas within the statement of cash flows. But if you’re actually going to work a long problem like this or work a statement of cash flows and create one from scratch, if you can do that explain that you really are getting the concepts of accrual concept and cash concepts. Because what we’re doing is we’re converting from an accrual concept to an a cash concept. And when we do it in an indirect method, we’re doing that indirectly, which is kind of conceptually difficult. So if you’re able to do the steps, then that’s really good.
If you’re able to do the steps and explain those steps, then you will have a really good understanding. And that’s good practice to understand the accrual concept, what the accrual concepts are and how they compare to a cash concept. So the way a statement of cash flows will be created generally, is that we’ll take a look at the financial statements, and then we’ll put a worksheet together the worksheet being over here, and then we’ll take that worksheet and we’ll create the statement of cash flows from it. So that’s going to be our strategy. That’ll be our process. Notice that first of all, the statement of cash flows is a beginning and end, it has a beginning and an end, just like the income statement, it’s over time, because we’re measuring cash flows over time. The funny thing about a statement of cash flows is we will do that using basically balance sheet accounts. And that the reason that’s fine is because the balance sheet accounts are going to be as of a point in time. So the balance sheet accounts are as of a point in time, we’re using that to create something that is, has a beginning and an end, such as the income statement. So the reason we’ll do that is because we have a balance sheet, we’ll be using the beginning point in time, which is the same as the end of the prior period, in this case, the end of last year 20 x four, and we will take the current balance sheet amount, so we have a comparative balance sheet here as of 20 x five in this case, and we will then look at the difference the difference will be the change. So obviously, if we’re looking at the end period here for cash 123 450 compared to the beginning of cash 61 550 then the difference in that, in essence is the change. So that’s the whole story. That’s like the big picture story of what happened to cash.
Well, that’s the change in cash, of course, cash went up and down and whatnot. That’s more detail in the story. But in essence, we have that change in cash. That’s going to be our you know, towards the end of the cash flow statement. That’s the end of our story, we’re going to kind of back into what happened, why do we have this change in cash? First thing we’re going to do to do that is basically convert the already converted balance sheet back into kind of like a trial balance. And this is really good practice to do, because we have practice going from a trial balance to creating the financial statements. So going from a debit and credit trial balance to creating the financial statements. It’s good practice to go back the other way, because now we’re going to take basically the plus and minus financial statements, plug them back into a debit credit format, so that we can use that worksheet to then create the financial statements. So this would be the first step I’m going to remove the subtotals, we’re going to take the plus and minus format, convert it back and debits and credits. So for example, for 2015, we’re just taking this number here, that’s where the cash is gone, we’re going to take the accounts payable, it’s going to go back here, we’re going to take the inventory, it’s going to go here, we’re going to take the prepaid expenses, those are the assets going to go here, we eliminate the total, we’re not going to total up here. However, that’s a good check point, we can add these up.
And if those add up to this total, we’re doing good so far. Then we’re going to keep on moving on to the next account equipment is going to go here, accumulated depreciation. Notice there’s no negative here, but it says less. So that’s a plus and minus statement, we need to convert that to a debit and credit. We will then I’m going to represent the credits with brackets here. So I’m going to put bracketed 110 750. Now a lot of people will not do that, because that’s a common error to mess things up before doing things quickly. If we check, do our check figure here we would say, well, it’s this minus this shooting This check number, so we’ll be able to check that. Or we could say this plus this plus this plus this plus this minuses which we can highlight, if it was in Excel should equal our total assets. And if we do that we’re doing good so far, then we would keep on moving on accounts payable, accounts payable credit. So it’s a positive number here, we’re represented represented as a credits on our worksheet, and then we’ve got the short term, that’s your credit, we would add the two credits up, adds up to our subtotal, we will not include the subtotal, but that’s a good check figure, then we’ve got the long term, here’s the long term credit, we have the common stock, so common stock is going to be a credit. We have the retained earnings, it’s going to be paid in capital, our credit, and then we have the retained earnings, which will be a credit. And once again, we can check and see if this is unbalanced by saying the debits minus the credits should then equals zero.
So the debits are positive number credits or negative number. That’s how we’ll represent this in a shortened worksheet limiting the amount of color And we will need an order to make the worksheet. And of course, we’ll do the same thing for the 2000 X for pulling these numbers in in the same fashion. And if we do that, then the debits and credit for 2000 x four will add up to zero. If the debit to credit for 2000 x five add up to zero and the debits and the credits for 2000 x four add up to zero will then take the change for all those amounts. So 2000 x five is 123 450 minus 2000 x 461 550 means there’s a change, there’s a difference of 61 nine, we’ll do that all the way down, we’ll take the change all the way down between these amounts. And if this adds up to zero, and this adds up to zero, and then we took the change of all those, then that must add up to zero. And that’s what we’ll be working with. So now we’re going to be working with this. This are the numbers that we will work with in order to create our statement of cash flow. Now once we have this, we’re going to We’re going to take these numbers and we’re going to find a home for these numbers, we have a basic statement of cash flows. On the right hand side, just an outline of it. The major piece of the outline you want to take a look at is we have the cash flows from operations, the cash flows from investing, cash flows from financing, those are the three factors of the statement of cash flows, you’ll want to memorize those. And our question then is, if we just go through all these accounts, we need to find a home in one of those three sections and plug them in there.
As long as we do that, then, as long as we find a home for everything, the total will basically add up to the zero, obviously, because if we found a home for all these, and we have them going the same way, the same sign, whether it be plus or minus, over here, then it has to add up to zero. So what we’re going to do is we’re going to find a home for everything except cash. Why? Because cash is our indie number. So we’re going to find a home for all this stuff. The Cash Balance is going to be down here the increase in cash. So if we find a home for everything, except cash here, and we subtotal all that up and add that up, then it’ll add up to the change in cash, which is what we’re looking for when we’re talking about the flow of cash. So we’re going to talk about what the cash flow is in terms of the cash flow from operations, the cash flow from investing the cash flow from financing, we’re going to go in systematically one by one and everything, every change in every account on the balance sheet except cash. And then if we add those up, we will then come to the change in cash. That of course, is our check figure if that if that doesn’t happen, that’s like as not being in balance, and we have a problem. And we’re going to set up a system so that we reduce the number of problems that we have as we go through. The first thing we’re going to start off with is a net income.
Now this has to do with the difference I want to talk about. briefly about the difference between the direct method and the indirect method. So the cash flows from operation is basically just taking the income statement and converting it from an accrual basis to a cash basis. If we thought about that the most logical thing if I was going to ask someone, could you convert the income statement from a accrual basis to a cash basis? What they would probably do is say, Well, yeah, we would then try to figure out what income is, or revenue is on a cash basis, I would convert revenue to receipts from customers, and all the expenses, we would convert expenses from an accrual basis to a cash basis and say all expenses are cash paid for expenses. So then we would say, you know, record cash received from customers minus expenses that were actually paid with cash gives us the net income on a cash basis. So that would be the direct method in essence that we would do. We’re going to use the indirect method for a couple reasons. The main reason is because oftentimes generally accepted accounting principles and other regular require it even if we use the direct method. So therefore, a lot of companies will use it. And because of that most likely, the direct indirect method is widely used. So it’s going to be used far more that, probably because of that. Second reason is that we already figured out net income. I mean, we figured out net income, it might be a lot of work, it could be more work, we would think to basically recreate the entire income statement on a cash basis, it might be easier for us to say, hey, let’s take what we have now, we already figured out what net income is and like, back out whatever we need to back out, in order for us to get to net income on a cash basis. That’s basically what we’re doing. So I’m not in the direct method is good. I’ve worked in firms that use the direct method, I think it’s easy for us to explain the direct method to clients, but are the indirect method is far more used widely and if you can understand the indirect method, again, that really gives you an understanding of the relationship between the accrual and cash basis. Because we’re kind of backing in indirectly to these changes, so it’s good to think through. So the first thing we’ll start with is net income. And the first question is well, net incomes on the income statement, and we’re talking about changes in balance sheet accounts. Let’s go to the income statement to find what net income is.
And I’m going to try to find a home for all of these first, remember, our goal is to find a home for all these changes. And so I would like to find what net income is as it relates to a change in a balance sheet account. So what is net income? We can think about this as basically these these trial balances are basically post closing meaning there’s no income statement here. This is just the balance sheet. So the income statement has closed out to the balance sheet, where does the income statement close out to and a corporation closes out to retained earnings. Therefore, that retained earnings amount here this increase from 120 552 to 30. Must be partially in due to retained earnings. I mean, net income mainly due to net income. So that change in retained earnings is probably net income. So I’m going to note that in this worksheet, I’m always going to flip the sign. So that’s just going to be a conformity of this worksheet. So whatever the sign is here, this is a negative indicated by the brackets, we’re going to flip the sign over here. So we’re gonna start with net income, which is a positive 104 500. So what happened here is that retained earnings went from 125, five and a credit up to three to 30 credit. So we have this 104 change, we’re going to assume 1045 change, we’re gonna assume that that is net income. Now, if I go to the income statement, which I’m not going to do now, if my current income statement, I may have a number that’s different than the 1045, it might be a different number.
So I’m going to recognize that and highlight that and say, You know what, I’m going to look at the income statement later. And there might be something else in retained earnings. It’ll be easy for me to figure that out. I can go to the I can go to the general ledger and see if there’s anything other than net income posted to the general ledger. There’s only going to be a few things posted to the general ledger for the retained earnings. But I don’t want to start parsing out this number now. So you might ask what else could be in there, dividends could be in there. So we if we paid dividends, it might be affecting retained earnings. But again, I don’t want to start making breaking these numbers up into multiple different numbers, I want to first find a home for these numbers, then recognize the breakout of those numbers in a systematic way. So recognize that that might not be net income, that’s okay. I know it’s part of net income going to go back to it, we will fix it at a later time in an efficient way. So then we’re just going to go down the list so we’re going to skip cash because the ending thing is going to be cash that’s going to be down here. And we’re going to go to accounts receivable so accounts receivable went from a debit of 80,007 50. up I mean down to 77 100. So first question, Is that going to be an a cash flow from operating, investing or financing? One way to think about it is we can think that What’s gonna be the other side of a journal entry that basically increases accounts receivable? Why does the accounts payable go up? When we make a sale on account, we debit accounts receivable and we credit income revenue.
That means the other account is a revenue account, which is an income statement account. And that’s one way to kind of think of that, well, that means it must be operating, because the operating activity has to do with us changing the income statement from an accrual basis to a cash basis. So we’re backing into the income portion by looking at the change in the balance sheet accounts. And the change in the income statement account related to accounts receivable is an income revenue which is an income statement account. Therefore, it must be going in the cash flow from operations. Also note that if we look at the cash flow from operations, we’ve got two sections here and one section is generally called changes in current assets and current liabilities. So basically all changes in current assets and Current liabilities, including accounts receivable would be in this section within the operating section. Now, then there’s the question of does it increase or decrease the net income from operations in this case, if we’re thinking about a cash basis, now, there’s a couple ways to do that in terms of a cheat sheet. One is that in terms of this worksheet, we’re just going to flip the sign on everything. So that’s a negative, I’m going to flip the sign and make it a positive. You don’t even have to think about it because that’s the way the worksheet works. Other way you could think about it in terms of just having a cheat sheet being brackets mean that we’re going to decrease it if it’s an increase. So that seems kind of funny. But if if it went up, increase, then it’s going to be a decrease brackets in this worksheet. And if it’s a decrease, meaning it is here, went from 80,007 50, down 771, then it doesn’t have brackets mean it’s not a negative, it’s going to be an increase here. So you want to have a cheat sheet in mind, but When you do want to think through it, if you’re doing a test or something, or you’re actually making a cash flow statement, you do not want to think through every time why the accounts receivable decreasing as an increased here, you just want to, you know, memorize the rule, but it is good to think through it a few times. So we’ll think through it one time for accounts receivable, then we’ll apply the rule so all assets will be the same will go by this rule and liabilities will be the opposite.
So I’m going to think through this one time. And then we’ll think the same logic applies elsewhere where you can think through it later if you so what we want to do is think about what happens when we have an increase in account receivable. What happens what’s the journal entry when we have a decrease in accounts receivable? So when we have an increase in accounts receivable, what happens? We made a sale on account. Therefore people owe us more money and the receivables go up with a debit and revenue goes up with a credit. On the other hand, when we decrease accounts receivable, what happens is we receive cash and we reduce the receivable account. So if we If we think about that, in terms of the general ledger, we’re going to debit accounts receivable here on this transaction and credit accounts payable here. So when accounts receivable goes up, what’s happening to the income statement is that we’re increasing net income, net income is going up because the income went up income as net income as income minus expenses. But no cash was received at that time. So under a cash basis, we’re increasing the net income when we shouldn’t be because on an accrual basis, we should because that’s when we earned the money on the cash basis, we shouldn’t because we haven’t gotten cash.
Therefore, if over the long term over the entire year, this journal entry happened more than this journal entry, then that means we recorded more sales in which we had not yet received cash, then we receive cash. Therefore we need to decrease net income if we’re converting from an accrual basis to a cash basis is If on the other hand, this entry happened more more than this entry. That means Over time, the receivable would have gone down. And when it goes down, that means we got cash, we reduce receivable, we got cash. And we’re not recording revenue in this time period in which we got the cash. Because under an accrual basis, we recorded last time period, you know, when we earned the revenue. So at this point in time, under a cash basis, we got to say, well, we should be increasing the net income under a cash basis if accounts receivable goes down, because this is happening here and we got cash. So we have to record the revenue at the point in time when we got cash. So that’s the reasoning behind it. But again, you just kind of want to learn the rule here. And the rule will be either in the worksheet that you make, or you want to have kind of like a cheat sheet like this. Alright, so then we’re just going to go down the list we got inventory next. So inventory is an asset, it’s going to follow the same rule as the receivable. We know the other side of inventory often As we’re going to sell the inventory, therefore, we’re going to reduce the inventory. The other side is an expense Cost of Goods Sold cost of goods sold as part of the income statement. Therefore, the inventory is going to go into the operating cash flows from operating. And note that we can kind of see a cheat sheet on that. And we know that the changes in current asset and liabilities go on the operating section. So that means that this is going to go into the operating section, it went in 2014, from 257, down to 246.
Therefore, we’re going to follow our rule, and we’re going to increase the statement of cash flows in the operating section by that change 10 100. And again, this worksheet, we’re just going to flip the sign that’s a negative here to positive here, you can also see the cheat sheet here an increase is going to be a negative a decrease is going to be positive if we’re talking about assets. So as of now the operating section we started with net income, then we’re going to increase in income by this, increase it by that that’s what’s going to go here so far. Well, let’s keep going and then Got the prepaid expenses, same thing, it’s an asset. And it’s going to follow the same rules. It’s a current asset. If we think about the other side of prepaid expenses, it’s going to be if the most common, it’s like insurance, prepaid insurance. So the other side of prepaid insurance is insurance expense, which is an income statement accounts. Therefore, it’s part of the operating activities. It’s also a current asset, and therefore it goes into this section of the operating activities. It’s going to follow the same rules as all assets in this section over the operating activities, in that in this case, it’s going from 17 down to 15. One, that means it’s going to be added back for similar logic as the accounts receivable account. And also in this worksheet, we know that all negatives is going to be positive. We’re just going to flip the sign on everything. So at this point in time, we’ve got the 145 and the operating, plus this plus this plus this that’s what’s going to go here at this point in time. Let’s move to the next account.
Next account is equipment. Notice equipment is not A current asset or liability, so we got to think through this more deeply now, is it going to be operating? Is it going to be investing? Is it going to be financing? And in this case, if we think about equipment when we buy equipment what’s what’s the effect on equipment on the journal entry? Well, if we bought equipment, then we’re going to debit equipment, and we’re going to credit cash or some kind of loan, whatever we bought it for. And neither of those accounts no matter what they are, is not an income statement account. And therefore, since the operating activity have to do with the income statements, not going to be an operating, so then we have investing or financing left over and it’s actually investing. And this used to confuse me when it wasn’t investing because when I used to think of investing I used to think of that’s like stocks and bonds and equipments not investing. It’s an asset. But, but when we think about it, obviously, when we buy equipment, we’re putting money into equipment so that we can use it in order to help our purpose, which is to generate money. revenue in the future. So we are in that sense, investing in the equipment to help us generate revenue in the future. Therefore, it is an investment, we can see that it went from 200 in 2004 to up to 110 750. So we’re just going to make an assumption for now. I mean, again, I could go look at the geo and see exactly what happened is not going to be a lot of activity in an equipment account generally, because we don’t make too many purchases of equipment over the years, we look at the T account. But I’m just going to assume overall, that we bought equipment, and we’re going to assume so we’re going to say it’s going to be cash paid for the purchase of equipment.
And notice what I’m assuming is we paid cash for it. And very well may not be true, because you know, if I bought a lot of equipment, we might have financed it and fairly likely that we did, but I again, I don’t want to start parsing off this number until because it could get very complicated when when we start looking at different pieces of equipment we purchase and how we financed it. This number could get split up in very complicated ways. And that and before I do that, I want to find a home for all the whole numbers, and then go go back and start parsing them up. So I’m gonna make it yellow, I’m gonna say, Yeah, I recognize that it’s very likely that I did not pay cash for that equipment, but I’m gonna, you know, think about that at a later time. So then we’re going to move on to the accumulated depreciation. So once again, not a current liability or asset, therefore, it’s not necessarily in the operating activity, we’re gonna have to think about it a little bit deeper, and we’re going to say, well, what’s the journal entry that would be affecting accumulated depreciation, and that’s the one where we were going to depreciate the equipment. In this case, we’re going to debit depreciation expense, credit accumulated depreciation, therefore, this increase here, the other side of it is an expense. It’s depreciation expense. So that that’s an income statement account. So it is going to be in the operating activity. Even though it’s not part of the current assets and current liabilities, because the other side of it is depreciation, so rather than us calling it, this is going to be the change in accumulated depreciation, we’re going to recognize what the income side of that is what the income side of that change is, in this case, which is just depreciation. We’re going to put it up here in this subsection, which says income statement item, not affecting cash. What does that mean? Well, it means that within this net income of 1045, there is depreciation, which had nothing to do with cash because we debited depreciation expense and credited accumulated appreciation, which has nothing to do with cash at that point in time. At that point in time, no cash was affected at that point in time, depreciation expense, decreased net income, and on a cash basis.
It shouldn’t have, therefore, that 1045 under a cash basis needs to go back up by the depreciation of 15 750 because we put it down according to an accrual basis and under cash basis. It shouldn’t have gone down. So it’s got to go back up. So now we’ve got under the operating, we got the 1045 plus the 15 plus this plus this, plus this. That’s what this is going to be so far. So let’s go to the next one. Next one, we’ve got accounts payable liability. Now note, once again, it’s a current liability. So we kind of know what’s going to go in the operating section right here because it’s in that subsection. If we think about when does when, what’s the journal entry for accounts payable? Well, we could think, well, we bought something like an expense, maybe on accounts, we would debit some kind of expense, credit accounts payable, and therefore the expense is an income statement account and the income statement account has to do with the operating activities, and therefore it should go in the operating activities. And you might be saying, Well, what if we bought like inventory, which is an asset, we debit inventory, and we credit the payable. And that’s true, but you know, inventory, ultimately it’s going to be expensed and cost of goods sold. So in any case, it’s the easiest way way to think about it is that we bought an expense, and debit accounts payable. And if you think about it that way, and you want to think about liabilities, you can go through the same reasoning that we did for the accounts receivable. And try to think of why it’s gonna follow these rules.
What are the rules going to be? Well, it went from, first of all the rule is it’s it’s a positive number here, we’re going to flip the sign, and we made it a negative here, that’s the rule for the worksheet. Second of all, we know that it went from 2000 X for one or two, down to 17 750. And if it decreases, it’s going to do we’re doing the opposite of all the assets, it’s going to decrease the cash flow from operating or cash flow from operating here. Therefore, it’s going to be a negative. Now again, you just want to know the rule. Here’s the cheat sheet on the rule. It’s going to be obviously the opposite of all assets. And, but if you want to think through it, think through it a few times. But have the cheat sheet there if you’re gonna make the problem or take a test on it. So now the operating activity has the net income plus this plus this plus this pluses and minuses. That’s what’s going to go here. Let’s move on to the next account. Next, we’ve got short term notes payable. So a note payable. Obviously not. Well, it could be a current liability. So you would think actually, it could go there, but it’s a note. It’s a note payable, however, and note what when would a note payable be affected? We’re saying it went from 10 up to 15 from 2000, X for up to 2000 x five by 5000.
Why would we owe more money on a notes payable? Well, maybe we borrowed money, and if that happened, we would debit cash and we would credit the note payable. And that has nothing to do with the income statement and therefore wouldn’t be in the operating activity. Now notice we could have borrowed something other than cash, we could have borrowed money, we could have bought something and financed it. But even in that case, it wouldn’t be an operating activity. So I’m wondering, I’m going to make an assumption, I’m going to say, well, it’s either investing or financing. Clearly, if we’re, if we’re loaning and borrowing money, that’s, that’s actually a financing activity, it’s gonna be down here in the financing section. And so we’re gonna follow our same rules, I’m gonna flip the sign, it’s a negative here, so I’m gonna make it a positive here. And the logic being that well, it went up. Therefore, I’m going to assume that we borrowed cash. And again, I’m going to make that yellow because, I mean, I could have financed something, I don’t know what really happened, I got to go to the geo and pull out whatever happened in order to figure that out. But before I go on the GL and whatnot, in parsing this number up, I’m going to make the easy assumption first, just so we can find a home for all these numbers. Then I want to make sure that we are in balance or we are tied out to the change in cash and then go back and parse that out.
Alright, so let’s go to the next one. Where we have the long term note payable, same concept, right if we bought if it went from here, up, then we’re going to, it has nothing, we’re going to assume we borrowed more money, we’re going to debit cash, we’re going to credit the note payable. And once again, that has nothing to do with the income statement, therefore it has nothing to do with operating. We are again, financing, we’re borrowing money. So that’s going to be down here in the financing. And again, I’m going to make this assumption, it’s, it’s very likely that something else happened. I’m gonna go look at the geo, I’m going to figure out exactly what happened. But if it went from here up, then I’m assuming that we borrowed cash. Now, if it went down, of course, I would assume that we paid cash on the note. So it’s going up, I’m assuming we borrow cash, could it could have been something else that happened? We’re gonna go in there, we’re gonna dig through that there’s not gonna be too many transactions in the notes payable, general ledger, hopefully, because we didn’t like borrow money all year long, unlike the cash account, obviously would have a lot of detailed in the geo. So we’re going to parse that out later and make it yellow and say, Yeah, I know that we might have had some But what’s going on there, but we’re gonna find a home for all these accounts for it’s gonna be in balance, then we’ll go back and parse those out.
All right, then the next two, I’m going to put these two together common stock paid in capital. Why? Because note that common stock is as the issuance of stock, that’s kind of like the investing of the stock. Now, when we think about common stock, there’s two kind of things when we buy common stock. Usually, if we buy common stock on the stock market, we’re not buying it from the company, we’re buying it from other investors, it’s not the company issuing stock. If the company issue stock, then the company’s the one receiving the money. That doesn’t happen like all the time. So the common stock may not change a lot from year to year. Of course, an example problem we want to have an example of the common stock changing so we can put it in the example problem. So it went from 200 up to 215, meaning we issued stock so we issued more stock, got more investments in the company in that way. Now, we also have an additional paid in capital. Why? Because remember, when we issue stock, we might issue it at a par value, which is just like a made up value, so that we can have an even value to the amount posted in the common stock. However, when we sell it, we’re gonna sell it for whatever we can, which most likely will be higher than the par value. So the additional paid in capital is the amount of money that we issued the stock for above the par value. That’s why these two are basically related. That’s why I’m gonna record them related. So we’re going to make the assumption that we debited cash, we sold common stock for cash.
So and that means that the change the 15 and the 30. is us. is that happening? So not neither part of those accounts are part of the income statement doesn’t have anything to do with operation. It’s going to be financing. Why do we issue stock because we’re financing the company we’re trying to get money into the company through a financing process, and therefore we’re going to assume once again, that cash received From issuing of stock is the effecting, I’m not gonna make that yellow because I happen to know that we don’t need to dig down on that. So it’s going to go up, and therefore, we’re taking that change 15 to 30 flipping the sign, so that 45 negative, flipping it to a positive we received cash. So in the cash flows from financing, we have this plus this plus this. That’s what’s going to go here so far. Now, that’s what we have over now, we found a home for all of these except cash. And therefore we can add this up and see if the difference adds up to cash. If we have all these going the right way. Remember, we flipped the sign on all of these. Therefore, if we flip the sign on all of these, it should be equal to the 61 nine. Let’s see if that’s the case. We got the net income. This is the cash flow from operations, net income plus this plus this both of those minus this adds up to this 51 650. That’s the cash flow. That’s how much cash we have received. From our If it was a negative, we would have cash used from operation. cash flows from investing activities, all we have is this 60 to 250. It’s a negative, so it’s a decrease. So we’re going to say, net cash flows from investing activities is a decrease in cash flows from investing activities 60 to 250. operate financing activity to get the five close to 25 with 45. So we borrowed money. In this case, it looks like and we issued stock, so it’s all increases, we’re gonna add those up 70 to five, then the 51 650 plus minus 60 to 250. Plus the 72 five, add up to 61. Nine. Yes, that adds up to our change in cash. So we are in balance so far.
So that’s great that we’re looking good so far. However, of course, we have these issues where we’re going to go back to some of these accounts and say, you know, we recognize that there’s some issues that we’re going to figure out and find out systematically. How to fix those and see if there’s any changes that need to be made to certain accounts. Now, the first yellow account we had was actually net income. That’s where we started, we started off with account, we were kind of questioned over. But we didn’t want to parse out the account at that time, because we wanted to go back and do it systematically. Now we know we are in balance here, what we’re going to do, I’m going to do something similar to kind of like an adjusted trial balance and say, let’s make an adjusting column. And let’s increase it similar to a debit and credit, make sure that we increase and decrease something so that we end up with something notice this is just adding up this column and this column that is in balance, meaning that we still equal the change in cash 61 nine. So if we go back and say, Hey, net income is wrong, I know what net income is. It’s this it’s this 158 100 so if I put that if I start with that, then I have to change it from the 1045 it’s gonna go increase by 50 362 that number, so I got an increase. So I got an increase net income. But if I do that, then it’s gonna throw me out of balance. So what I got to put the other side somewhere. So we’re going to figure out what that change is. Let’s do it systematically, well, we’re going to parse out this number between the two components.
If we go look at the GL, it will tell us it will tell you the activity. If we look at a book problem, then it’ll give us something like this. It’ll say, he says that declared paid cash dividend, we gotta just know cash dividend. That means that if a journal entry would look like this mean, if we paid a cash dividend, that means that we debited the retained earnings because we’re taking it out of the retained earnings. That was the difference that we used to come up with this 1045 that we assumed with all net income, and then we credit cash. So that’s the journal entry. This would be the now let’s think about that journal entry in terms of a change to our cash flow statement, what two accounts what two names are Our cash flow statement can relate to this journal entry to make us have uneven adjustments. And of course, net income has to change. So we know that net income has to go from 1045 up by that amount in order to get to our adjusted our net income, which is on the income statement here. And the other side then must be the cash we paid for the difference the cash paid, that was paid for the dividend. So we’re going to create a new account, I’m going to say cash paid for dividends, we’re going to put that as part of the fight as part of the financing activities, which is where the dividends will go. And it’s going to go from zero. And now we go it’s a decrease in cash, decrease in cash. So now we had a change, we had a change to our operating activities, went from here to here. We had an equivalent change down here in our financing activities. We’re still in balance. So we’re, that’s not going to throw us off. We’re good. That’s exactly what happened there. Let’s go back and let’s go find out our next difference and see what that is.
So The next one is depreciation here. So again, what we do is we look on the income statement say, well depreciation on the income statement equivalent to this 15 750. Because, you know, we got to that depreciation by looking at the change in the accumulated depreciation, which is usually the recording of the depreciation expense. That’s how we came up with this 15 750. But if we look at the accumulated depreciation, there might be something else affecting it. So we have to compare that we could first compare this to the income statement, say, Hey, what’s depreciation expense on the income statement? Well, it’s 38, six, that’s not the change in the accumulated depreciation. Well, that means that if I was going to take it from the income statement, then I would have to put this 38 six, that’s what should be there. That’s what we have to increase net income by in order to adjust for the depreciation expense that we’ve reduced it by. And if I was to do that, then I would have to increase this number by 20 to 850. To bring it up to that 38 If I do that, well that’s gonna throw me out of balance, you know? So we got to do we have to do something else. So let’s go think about let’s look at the geo and think about, okay, what’s in the GL related to accumulated depreciation other than just recording depreciation expense, what else could affect it? In this case, we sold equipment. When we sell equipment, we also have to account for the accumulated depreciation that is on the books in relation to that particular piece of equipment. Now, this one gets a little confusing. If you can get this one then you have a good understanding know how this one can really throw you off.
If we started out with depreciation, instead of backing into depreciation, because if you’re at this point in time, and you go to your supervisor and say, Hey, this depreciation is throwing me off, but I know that I’m on track. I’ve got everything in balance. But there’s one thing I got to figure out how to adjust this change to account for that this journal entry related to the depreciation we can dig that out, rather than going in and saying my entire thing doesn’t work. So if we figured out this journal entry, what would be the journal entry related to that we can go into our geo we can double click on the, on the geo on our software and we come up with Okay, this is what happened, we sold the equipment, we got 26,050 for it, that’s the cash related to it, we took the equipment off the books, so, that particular piece of equipment cost us 51 we had to take that off equipments a debit, we credited the equipment to take it off the books at 51,000. Then we also had to take the accumulated depreciation related to the equipment off the books, which is what most people often forget. And so obviously, all equipment has this other account related to it accumulated depreciation, which we must take off the books. So we got to figure out what how much of the accumulated depreciation is related to this one particular piece of equipment, make sure to take that off the books and then the difference is going to be the gain or loss, in this case a loss. So we’d have to dig out this journal entry and say, okay, that’s the journal entry. How can we then convert that journal entry into basically what we need in terms of these accounts up here. So that we haven’t, you know, something that’s unbalanced that will keep us in balance. So we know that we have to fix the depreciation account here. So we know that the depreciation is going to be going up up by the 20 to 850, in order to equal the 38 six, which equals what’s on our income statement. Then we have the cash received from the sale of equipment now, I mean, we got cash up here, we can see the 26 that we received. And we didn’t record that anywhere we got we sold equipment, we didn’t, we didn’t put that on our cash flow statement.
So we got cash from the sale of equipment and if we receive cash, remember, equipment is an investment, therefore, it’s going to go in the investing activities, we’re actually gonna create a new line, you might have been wondering why there was a blank line there. We’re gonna create a new line called cash received from investing activity. We’re gonna put that in here. I’m going to add that 26 here that’s going to be part of it. So we’re going to, that’ll be the other piece part of that now this equip And this credit to equipment. Where did we put that? Where did we put the change to equipment on our statement of cash flows, we put that into cash paid for the purchase of equipment. But this part of that decrease had to do with this sale of equipment. So this 51,000 wasn’t part of the cash pay to purchase equipment in this case. And that’s why this 51 is going to be part of this line item here. So this was the original change, we’re going to we’re going to put that 51 a negative and say that if we paid all cash for the equipment that we purchased, we must have paid 113 250 for it. Now, again, that might not be the end of the story because we could have financed part of that or there could be other transactions involved. But we’re going to make that adjustment here. And then we have the final loss. Now notice that this loss, if it has to do with equipment, we want anything related to it to be in the end. Investing activity. And under the income statement, this loss here, so we’ve already recorded the cash related to this investing section, we don’t want any of the gain or loss are related to it in the operating section. And when we recorded this loss, it was recorded in the net income in the operating section. Therefore, up here we have this, we had this loss included in this 1045. That’s where this piece is going to go, we’re going to create a new line which again, you probably were wondering, why is there like a blank blue line there, we’re gonna say that, hey, we, we brought this net income down, buy this loss, and we don’t want that loss related to the equipment here. We want anything related to the equipment in the investing activity, therefore, we’re going to increase the loss here.
So that’s the adjustment. So this idea here being that we’re still kind of in balance, we’re not dealing with debits and credits, but we’re making this adjustment in such a way that we can figure it out and still remain In this change in cash being the same. And notice I’m checking this figure down here because this figure should be pulling over here as well. So I’m just looking as of this line item at this time right now. Alright, so then we have the next item that happened. So we have we have the purchase of equipment, we’re taking a look at this next yellow item, which we had a yellow item for. And we’re going to dig down on that and say we had a purchase of equipment. Is there anything else related to that in basically the equipment account, and here we had it, we had a purchase of equipment, which cost 113 250 and we paid cash 45 to 50 for it. So what must have been the journal entry, we can go through the GL find the journal entry, and we must have debited cash 113 250 I’m sorry, we debited equipment for the cost of equipment 113 250 we credited cash that’s how much we put down on the equipment, then we financed the rest for the 70,000. So then, the Question is, well, how are we going to convert that to basically the accounts over here in order to make this cash paid for the purchase of equipment, what it should be on a cash basis. And part of that is going to be here. Now remember last time, we brought it up by the 51,000 from the last transaction, and we were at 113 to 50 in this amount, and that would be what how much cash we had paid if we had paid all cash. Now this journal entry saying we didn’t pay all cash, we paid we financed part of it, and we only paid 43 to 50 in cash, therefore, we’re going to bring it down by the 70. So now we’re adding to the sale is the 51,000 from last time plus the 70.
So that we end up with the cash that was actually paid for equipment, which was the 43 to 50. The other side of this is remember what we had was the change in the debt down here. It was the 2005 and part of that now that we dig down into it had to do with With this, this debt change from this transaction, therefore the other side of this is going to be going to the cash paid for long term debt. And we had to actually flip the name of notes. Now we’ve got it was cash received. Now we realized that it really it’s a cash payment here. So we flipped the name, and said the 25 minus the 70 brings it down to what it should be, which is the 47 five. So now if we look at the final process here, notice that last time, we basically have been stopping at the change in cash, the 61 nine, the 61 nine. And that, of course, adds up to the 61 nine up here the change in cash. So remember, that’s what we found a home for everything. And we’ve looked at the change in cash. Now when we think about other financial statements that we don’t see the change in cash on the financial statements if we only have the financial statements as of 2005. So we don’t want to end the fight the cash flow statement as the change in cash, we really want to end it with the ending cash Balance.
And that’s easy enough to do so right? We’re gonna say, Well, if that’s the change in cash, we’re just gonna say, hey, let’s just let’s just add that to the beginning cash balance. And we’ll back into the cash balance as of the end of the time period. So really, this is our verification figure. This is the easiest one for me to use when we are creating the cash flow statement. But of course, when we’re comparing the statements, we want to end with the amount of cash at the end of the time period. So if this is the change, and we add to it what was in there at the beginning, which is this number, then we will end up with the cashflow as of the end of the time period that point in time on the balance sheet, so that we can compare the cash flow to the balance sheet, which would be equal to this number here. And again, if we do this change, notice what we have now is we started with these this column represents us finding a home for all of these numbers without thinking about parsing them out into their separate parts. This column represents us, parsing them out, going through the thought process and parsing them out in a systematic way. And note how some of those were pretty complicated to first parse those out.
If we try to do that as we go, it is very easy to get out of whack and then get to the end of the problem not to be tied out to the change in cash and have no idea really exactly where the problem is at. So I recommend putting together a system so that you can then think through those problems and take it to a supervisor or something and have a very pinpoint place at where you are out and try to be able to explain as clearly as possible, what the problem is to save you know, as much time as possible, then note that we can have the change over here, that will will result so our nd numbers are here. So here’s our ending numbers. Here’s our cash flow that we can then plug into a cash flow statement or just you know, hi these lines here, these are ending numbers. Here’s are the names of The items within the cash flow statements. Again, if you’re working a problem in cash flow, there’s two types of things you’re gonna have to know you got to memorize operating, investing financing. And if you know which items go in which section you get a lot of points on that. If you’re actually going to create a cash flow statement, then you really want to come up with a systematic way to do it, because it can be somewhat difficult to make sure that everything ties out towards the end. So we’re now able to define a statement cash flows create a statement of cash flows. explain the process of creating a statement of cash flows designed to eliminate mistakes, define the indirect method.