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Chapter TenLecture Notes

Reporting The Results of Operations: The Activity and

Cash Flow Statements

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The Activity and Cash-Flow Statements

The Activity Statement – Compares an entity's cumulative revenue and support to its

expenses for any period of time - like a fiscal year.– Shows whether the organization was able to cover its costs.

Names for an Activity Statement: Income Statement, OperatingStatement, Statement of Revenues and Expenses, or Profit and Loss (P&L) Statement.

The Cash Flow Statement looks at where an entity obtained its cash and where it spent cash during some time period.

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Meals for the

HomelessActivity

Statement

Revenues and Support 2011 2010

Meals

Client Revenue $ 10,000 $ 8,000

City Revenue 20,000 16,000

Shelter Counseling

Client Revenue 1,000 1,000

County Revenue 10,000 10,000

Fundraising

Foundation Grants 70,000 50,000

Annual Ball 12,000 11,000

Telephone Solicitation 25,000 28,000

Mail Solicitation 48,000 45,000

Total Revenue and Support $196,000 $169,000

Expenses:

Food $ 17,000 $ 16,000

Kitchen Staff 35,000 33,000

Counseling Staff 35,000 34,000

Rent on Kitchen Locations 15,000 14,000

Administration and General 75,000 65,000

Bad Debts 4,000 4,000

Depreciation 10,000 10,000

Total Expenses $191,000 $176,000

Change in Net Assets: Increase/(Decrease) $ 5,000 $ (7,000)

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The Activity or Operating StatementRevenues and Support

Revenues and Support:- represent inflows that the organization has received or is entitled to receive.- result in an inflow of Assets to the organization and an increase in Net Assets.

Revenues are generally the result of an exchange for goods and services that the organization has provided.

Support is the result of gifts, grants, and other contributions to the organization.

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Expenses and Net Income

Expenses:- represent the recognition of the use of an asset to generate revenue and support or otherwise carry on the operations of the entity.- result in an outflow of assets and a decrease in Net Assets.

Net Income is the difference between revenues/support and expenses. - Profits are an excess of revenues over expenses. Also called a surplus or increase in net assets.- Losses are an excess of expenses over revenues. Also called a deficit or decrease in net assets.

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Recognizing Revenue and Support

Revenue is recognized if:- the goods or services have been provided to the customer,- the amount to be collected can be objectively measured, and- there is a reasonable likelihood of collection.

Support is recognized if:- all of the conditions of the gift have been met,- the value of the pledge can be objectively measured, and- there is a reasonable likelihood of collection.

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Recognizing Expenses

Expense Recognition depends on the type of expense:

- Product costs are those directly connected to providing goods and services. They are recognized:

– The Matching principle says that expenses should be recorded in the same period as the revenue they were used to generate.

- Period Costs, like rent, are those related to the passage of time. They are recognized:

– in the time period in which they are incurred.

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Expired and Unexpired Costs

Suppose Meals bought 100 large cans of green beans at a cost of$1,000 in March.

- At acquisition, Meals would recognize the beans as anasset (Inventory). They are also an unexpired cost.

- If they paid for the beans in cash, Cash would go down by $1,000. Otherwise Accounts Payable increases $1,000.

In May, Meals used 50 of the cans of beans to produce meals. - At use, the beans become an expense (expired cost) of $500

(50 cans * $10 per can = $500), and the value of the asset (Inventory) is reduced by $500.

This is a Product Cost. The inventory becomes an expense when used to provide service.

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Uncollectible Accounts

Assume that Meals begins the year with $125,000 in Pledges Receivable, and $15,000 in the Allowance for Uncollectible Pledges contra account.

During the year $50,000 of new contributions are received in cash and also $50,000 of new pledges are made, but cash is not received.

Experience shows that 10% of pledges are never collected. During the following year it is decided that specific pledges totaling $3,000 will never be collected.

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$ Cash

Pledges

Rec.

Allow. For

Uncoll. Pledges

=

Liab.

Net Assets

Beg. Bal. Yr 1 125,000 (15,000) 0 110,000

Contribution 50,000 50,000 Support

Pledges 50,000 50,000 Support

Estimated

Uncoll.

(5,000) (5,000) Bad Debt

Expense

End. Bal. Yr 1 50,000 175,000 (20,000) 0 205,000

Beg. Bal. Yr 2 50,000 175,000

(20,000) 0 205,000

Write Off (3,000) 3,000

End Bal. Yr 2 50,000 172,000 (17,000) 0 205,000

Uncollectible Accounts, continued

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Inventory Expense

Inventory expenses represent the cost of using supplies to create goods or services. Inventory expense and the ending inventory value are calculated using the following relationship:

Beginning Inventory + Purchases - Consumption = Ending 5 + 10 - ??? = 2

Tracking inventory use– Perpetual inventory– Periodic inventory

LIFO and FIFO inventory flow assumptions

Does the choice of FIFO or LIFO impact inventory expenses and ending inventory value? Why?

Why would a not-for-profit organization want to use LIFO?

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FIFO and LIFO Examples

Suppose that the Big City public health clinic started the year with 2,000 vials of methadone for its drug rehab clinic. They cost $10 each. During the year the clinic bought 3,000 more vials for $15 each. If they had 1,000 left at the end of the year, what was their inventory expense and how much was the remaining inventory worth?

2,000 vials + 3,000 vials - ??? vials = 1,000 vials

Inventory

Method

Beginning

Balance Purchases

Consumption

(Inventory

Expense)

Ending

Balance

LIFO $20,000 $45,000 3,000 x $15 +1,000 x $10 =$55,000

$10,000

FIFO $20,000 $45,000 2,000 x $10 +2,000 x $15 = $50,000

$15,000

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Deferred Revenue

Deferred or unearned revenues arise when an organization is paid in advance for goods or services.

Deferred usually is long term, and unearned usually is short term.

Why is deferred revenue a liability?

A museum sells a five-year membership for $250.

- How much of the $250 should be recorded as deferred revenue?

- How much of the $250 would the museum recognize asrevenue during the first year of the membership?

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Where the Income Statement and Balance Sheet Meet

Event Statement Impact Note

Revenue

Recognized

You provide a

good or service and earn revenue

AR or Cash up B/S

Revenue up A/S

AR is a “holding area”

for unpaid bills that you have sent out

No impact

on revenue

Someone pays

a bill you sent

AR down B/S

Cash up B/S

No impact

on expenses

When you buy

something

AP up or

Cash down B/S

Inventory up B/S

AP is where you keep

track of what you owe to others

Expense

Recognized

When you use something

Asset down or

Liability up B/S

Expense up A/S

B/S stands for the Balance Sheet, and A/S stands for Activity Statement.

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Reflecting the Change in Net Assets on the Balance Sheet

Net income is reported as a change in net assets on the balance sheet.

Activity Statement

Balance Sheet

Total Revenue and Support $81,000

Total Expenses - 80,050

Increase in Net Assets $ 950

Unrestricted Temp. Rest. Perm. Rest.

Beginning Balances $113,000 $15,000 $10,000

Increase in Net Assets 950

Ending Balances $113,950 $15,000 $10,000

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The Cash Flow Statement

The Statement of Cash Flows focuses on the sources and uses of cash for the organization. It divides those cash flows into:

- Cash flows from Operations,- Cash flows from Investing, and- Cash flows from Financing.

Why does an organization need both an operating statement and a cash flow statement?

Why is it important to know the sources and uses of cash flow? Isn't knowing if cash increased or decreased enough?

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Revenues and SupportMeals    Client revenue $ 10,000    City revenue 20,000  Shelter Counseling    Client revenue 1,000    County revenue 10,000  Fund-Raising    Foundation grants 70,000    Annual ball 12,000    Telephone solicitation 25,000    Mail solicitation 48,000Total Revenues and Support $196,000Expenses  Food $

17,000  Kitchen staff 35,000  Counseling staff 35,000  Rent on kitchen locations 15,000  Administration and general 75,000  Bad debts 4,000

  Depreciation 10,000Total Expenses $191,000Increase/(Decrease) in Net Assets $  5,000

Example: Meals for the HomelessActivity StatementFor Year Ending 12/31/11

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The Increase in Net Assets is a first approximation of Cash Flow from Operations.

Now, make adjustments for:

1. "Expenses not requiring cash“: Depreciation or amortization.

2. Changes in balance sheet accounts related to operations.

Adjusting the Increasein Net Assets to Cash Flow

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The Statement of Cash Flows

Cash Flows from Operating Activities 2011 2010

Increase in Net Assets $ 5,000 $ (7,000)

Add Expenses Not Requiring Cash:

Depreciation 10,000 10,000

Other Adjustments:

Add Decrease in Inventory 2,000 2,000

Add Increase in Accounts Payable 0

1,000

Subtract Increase in Receivables (17,000) (12,000)

Subtract Decrease in Wages Payable (1,000) 0

Subtract Increase in Prepaid Expenses (1,000) 0

Net Cash Used for Operating Activities $ (2,000) $ (6,000)

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2011 2010

Cash Flows from Investing Activities

Sale of Stock Investments $ 4,000 $ 4,000

Purchase of Delivery Van (32,000)

Net Cash from Investing Activities $ 4,000 $ (28,000)

Cash Flows from Financing Activities

Increase in Mortgages and Notes Payable $ 25,000

Repayments of Mortgages (5,000) (4,000)

Net Cash from Financing Activities $ (5,000) $ 21,000

Net Increase/(Decrease) in Cash $ (3,000) $ (13,000)

Cash, Beginning of Year 4,000 17,000

Cash, End of Year $ 1,000 $ 4,000

The Statement of Cash Flows,continued

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Meals for the HomelessStatement of Financial Position

As of December 31, 2011 and December 31, 2010

Assets 2011 2010 Liabilities & Net Assets 2011 2010Current Assets  Cash $  1,000 $  4,000 Liabilities  Marketable securities 3,000 3,000 Current Liabilities  Accounts receivable,    Wages payable $   2,000 $    3,000    net of estimated     Accounts payable 3,000 3,000    uncollectibles of Notes payable 5,000 5,000    $8,000and $7,000 55,000 38,000   Current portion of  Inventory (LIFO) 2,000 4,000  mortgage payable 4,000 5,000  Prepaid expenses 1,000 0  Total Current Liabilities $ 14,000 $  16,000  Total Current Assets $ 62,000 $ 49,000Long-Term Assets   Long-Term Liabilities  Fixed assets    Mortgage payable $  12,000 $ 16,000    Property $ 40,000 $ 40,000 Total Long-Term Liabilities $  12,000 $ 16,000    Equipment, net 35,000 45,000   Total Liabilities $  26,000 $ 32,000 Investments 8,000 12,000   Total Long-Term Assets $ 83,000 $ 97,000   Net Assets $119,000 $114,000Total Assets $145,000 $146,000   Liabilities and Net Assets $145,000 $146,000

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Cash flows relating to investment and financing activities are listed separately. - Why? - Are these adjustments shown in the Activity Statement too?

Indirect vs. Direct Method for Statement of Cash Flows

The Cash Flow Statement

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Depreciation Expense

Depreciation expense represents the current period’s share of the cost of using a capital asset over its life.

- Depreciation expense illustrates the matching principal. - Depreciation expenses may be calculated either on

a straight-line or an accelerated basis. Why would you use accelerated depreciation?

Straight-Line Depreciation ExampleCost of a van $32,000Less: Salvage (Residual) Value 2,000Depreciable Amount $30,000 Useful life 5 yearsDepreciation Expense per year $ 6,000

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A Mixed Balance Sheet and Operating Statement Transaction

HOS paid $48,000 in wages to its employees; $30,000 represented money owed to employees for work last year and $18,000 is for work performed this year.

Assets = Liabilities + Revenues - Expenses

Cash Wages Labor Payable Expense

- $48,000 = - $30,000 + No Change - $18,000

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Operating Statement Transactions

HOS provided services and billed patients $81,000. It also consumed $4,000 worth of inventory in delivering those services. There are two transactions here.

Net AssetsTransaction 1 Assets = Liabilities + Revenues - Expenses

A/R Revenue + $81,000 = no change + $81,000 - no change

Transaction 2 Assets = Liabilities + Revenues - Expenses Inventory Supply Expense - $4,000 = no change + no change - $4,000

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A Noncash Example

HOS owed its staff $27,000 for wages for the last two weeks of 2011 which were not due for payment until the first week in 2012.

Assets = Liabilities + Revenues - Expenses

Wages Payable Labor Expenseno change = + $27,000 + no change - $27,000