Accounting for Accruals
The statement of cash flows follows:
Illustration 2-11: Statement of cash flows for Candely Services for 20X6
Candely Services |
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Cash Flows from Operating Activities |
|
Cash Receipts from Revenue |
$ 2,000 |
Cash Payments for Expenses |
(1,000) |
Net Cash Flow from Operating Activities |
1,000 |
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Cash Flows from Investing Activities |
0 |
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Cash Flows from Financing Activities |
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Cash Receipts from Borrowing |
0 |
Cash Receipts from Capital Acquisitions |
3,500 |
Cash Payments for Distributions |
0 |
Net Cash Flow from Financing Activities |
3,500 |
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Net Increase in Cash |
4,500 |
Plus: Beginning Cash Balance |
0 |
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Ending Cash Balance |
$ 4,500 |
The statement of cash flows explains the movements (inflows and outflows) of cash during an accounting period. Candely Services was established in 20X6. Therefore, the beginning cash balance is zero. Due to consulting services provided by Mr. Candely, the cash account balance increased by $2,000. In the same period $1,000 was spent on operating the business (salary expense). This creates the net cash flow from operating activities of $1,000 ($2,000 - $1,000). In addition, the capital acquisition contributed $3,500 to the cash inflow (financing activities). The combination of these factors explains the $4,500 ($1,000 + $3,500) increase in cash during the 20X6 accounting period.
Observe that the amount of net income ($1,300) reported on the income statement is different from the amount of net cash flows from operations ($1,000) as well as from net change in cash ($4,500). This takes place because the accrual accounting is used. Under the accrual accounting, as we stated above, cash flows do not go side-by-side with recognition of events, recognition of revenue and expense in particular.
2.3 Illustration #2 of accrual accounting
Let us expand the example with Candely Services until the next accounting period. We will introduce a few more transactions that apply to 20X7. The transactions are listed below:
- During 20X7 revenue of $2,700 was recognized on account.
- $3,000 of accounts receivable was collected.
- Salary expense of $1,400 was incurred.
- $1,200 cash was paid to settle salaries payable.
- $500 cash was distributed to the owner.
- On April 31, 20X7 Mr. Candely's business invested into a $1,000 certificate of deposit (CD). The CD carries a 6% annual interest and 1-year maturity term.
- On December 31, 20X7 the company adjusted the books to recognize interest revenue earned on the CD.
The table below summaries the effects of the 20X7 transactions on the accounting equation.
2.3.1 Summary of transactions for illustration #2 of accrual accounting
Illustration 2-12: Effects of transactions for Candely Services for 20X7
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Assets |
= |
Liab. |
+ |
Equity |
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# |
Cash |
+ |
Accounts Receivable |
+ |
% Rec. |
+ |
CD |
= |
Salaries Payable |
+ |
Cont. Capital |
+ |
Retained Earnings |
BB |
$4,500 |
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$800 |
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$ 0 |
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$ 0 |
= |
$500 |
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$3,500 |
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$1,300 |
1) |
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+ 2,700 |
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+ 2,700 |
2) |
+ 3,000 |
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(3,000) |
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3) |
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1,400 |
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(1,400) |
4) |
(1,200) |
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(1,200) |
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5) |
(500) |
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(500) |
6) |
(1,000) |
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+1,000 |
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7) |
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40 |
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40 |
EB |
$4,800 |
+ |
$500 |
+ |
$40 |
+ |
$1,000 |
= |
$700 |
+ |
$3,500 |
+ |
$2,140 |
The first five transactions are familiar to us, so we will go straight to Event No. 6 and No. 7.
Page 5 of 10
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