Introduction to Accounting
The statement classifies cash inflows and outflows into three categories:
- Operating activities section explains cash generated through revenue and cash spent for expenses.
- Investing activities include cash received or spent on productive assets and investments in the debt or equity of other companies.
- Financing activities describe cash transactions associated with resource providers (i.e., owners and lenders).
Illustration 1-13: Cash flow categories
1.9 Financial statements model
To better understand effects of transactions on financial statements and see connections between financial statement elements, a statements model was created. The two forms of such a model are vertical and horizontal. As its name implies, the vertical model arranges financial statements elements from top to bottom on a page. Horizontal, on the other hand, is so named because it arranges financial statements elements horizontally across a page. In the horizontal model, the balance sheet is presented to the left, followed by the income statement, and the statement of cash flows.
Let us demonstrate the usefulness of the horizontal model and apply it to the five transactions we covered before. Note that if a transaction does not affect the model, a related cell will show "n/a" in it. In the statement of cash flows, FA means cash flows from financing, IA means cash flows from investing, and OA means case flows from operating activities.
- Obtained capital acquisition: $5,000
- Borrowed cash: $2,000
- Received cash revenue: $3,000
- Paid expenses with cash: $1,000
- Distributed cash to owners: $500
Illustration 1-14: Horizontal statements model for Friends Company
Event No |
Balance Sheet |
Income Statement |
Cash Flow |
|||||||||
Cash |
= |
Liabilities |
+ |
Equity |
Rev. |
- |
Exp. |
= |
Net Income |
|||
1 |
5,000 |
= |
n/a |
+ |
5,000 |
n/a |
- |
n/a |
= |
n/a |
5,000 |
FA |
2 |
2,000 |
= |
2,000 |
+ |
n/a |
n/a |
- |
n/a |
= |
n/a |
2,000 |
FA |
3 |
3,000 |
= |
n/a |
+ |
3,000 |
3,000 |
- |
n/a |
= |
3,000 |
3,000 |
OA |
4 |
(1,000) |
= |
n/a |
+ |
(1,000) |
n/a |
- |
(1,000) |
= |
(1,000) |
(1,000) |
OA |
5 |
(500) |
= |
n/a |
+ |
(500) |
n/a |
- |
n/a |
= |
n/a |
(500) |
FA |
Totals |
8,500 |
= |
2,000 |
+ |
6,500 |
3,000 |
- |
(1,000) |
= |
2,000 |
8,500 |
|
With respect to Events No. 1 and 2, it is clear that only the balance sheet and statement of cash flows are affected. There is no effect on the income statement. Furthermore, you can see that Event No. 1 increases assets and equity and that the cash inflow is defined as a financing activity. Event No. 2 has a similar effect, except that liabilities increase instead of equity. Event No. 3 affects three financial statements. Assets and equity increase on the balance sheet. The recognition of revenue causes net income to increase, and the cash inflow is shown as an operating activity on the statement of cash flows. Event No. 4 is the opposite of Event No. 3. Assets, equity and net income decrease. Cash flow statement shows this decrease as an operating activity. Finally, Even No. 5 acts to decrease cash and equity. The cash distribution is not shown anywhere in the income statement. That's because distribution is not an expense and thus, is not included in the determination of net earnings. Cash distribution is categorized as a financing activity in the cash flow statement.
Using horizontal model helps a lot in understanding the effects produced by each event, so it is advisable to use it as often as possible while learning principles of financial accounting.
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