1. 1 Chapter Ten Lecture Notes Reporting The Results of Operations: The Activity and Cash Flow Statements

2. 2 The Activity and Cash-Flow Statements n 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. n Names for an Activity Statement: Income Statement, Operating Statement, Statement of Revenues and Expenses, or Profit and Loss (P&L) Statement. n The Cash Flow Statement looks at where an entity obtained its cash and where it spent cash during some time period.

3. 3 Meals for the Homeless Activity Statement Revenues and Support20112010 Meals Client Revenue$ 10,000$ 8,000 City Revenue20,00016,000 Shelter Counseling Client Revenue1,000 County Revenue10,000 Fundraising Foundation Grants70,00050,000 Annual Ball12,00011,000 Telephone Solicitation25,00028,000 Mail Solicitation 48,000 45,000 Total Revenue and Support$196,000$169,000 Expenses: Food$ 17,000$ 16,000 Kitchen Staff35,00033,000 Counseling Staff35,00034,000 Rent on Kitchen Locations15,00014,000 Administration and General75,00065,000 Bad Debts4,000 Depreciation 10,000 Total Expenses$191,000$176,000 Change in Net Assets: Increase/(Decrease) $ 5,000$ (7,000)

4. 4 The Activity or Operating Statement Revenues and Support n 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. n Revenues are generally the result of an exchange for goods and services that the organization has provided. n Support is the result of gifts, grants, and other contributions to the organization.

5. 5 Expenses and Net Income n 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. n 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.

6. 6 Recognizing Revenue and Support n 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. n 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.

7. 7 Recognizing Expenses n 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.

8. 8 Expired and Unexpired Costs n 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 an asset (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. n 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. n This is a Product Cost. The inventory becomes an expense when used to provide service.

9. 9 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.

10. 10 $Cash Pledges Rec. Allow. For Uncoll. Pledges = Liab. Net Assets Beg. Bal. Yr 1 125,000(15,000) 0110,000 Contribution50,000 Support Pledges 50,000 Support Estimated Uncoll. (5,000) Bad Debt Expense End. Bal. Yr 150,000 175,000(20,000) 0205,000 Beg. Bal. Yr 250,000 175,000(20,000) 0205,000 Write Off (3,000) 3,000 End Bal. Yr 250,000 172,000(17,000) 0205,000 Uncollectible Accounts, continued

11. 11 Inventory Expense n 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 n Tracking inventory use – Perpetual inventory – Periodic inventory n LIFO and FIFO inventory flow assumptions n Does the choice of FIFO or LIFO impact inventory expenses and ending inventory value? Why? n Why would a not-for-profit organization want to use LIFO?

12. 12 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 BalancePurchases Consumption (Inventory Expense) Ending Balance LIFO$20,000$45,0003,000 x $15 +1,000 x $10 =$55,000 $10,000 FIFO$20,000$45,0002,000 x $10 +2,000 x $15 = $50,000 $15,000

13. 13 Deferred Revenue n Deferred or unearned revenues arise when an organization is paid in advance for goods or services. n Deferred usually is long term, and unearned usually is short term. n Why is deferred revenue a liability? n 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 as revenue during the first year of the membership?

14. 14 Where the Income Statement and Balance Sheet Meet EventStatement ImpactNote 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.

15. 15 Reflecting the Change in Net Assets on the Balance Sheet n 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 UnrestrictedTemp. Rest.Perm. Rest. Beginning Balances$113,000$15,000 $10,000 Increase in Net Assets 950 Ending Balances$113,950$15,000 $10,000

16. 16 The Cash Flow Statement n 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. n Why does an organization need both an operating statement and a cash flow statement? n Why is it important to know the sources and uses of cash flow? Isn't knowing if cash increased or decreased enough?

17. 17 Revenues and Support Meals 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 48,000 Total Revenues and Support $196,000 Expenses Food$ 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 10,000 Total Expenses $191,000 Increase/(Decrease) in Net Assets $ 5,000 The first estimate of cash flow from operations is the change in net assets. Example: Meals for the Homeless Activity Statement For Year Ending 12/31/11

18. 18 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 Increase in Net Assets to Cash Flow

19. 19 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 Other Adjustments: Add Decrease in Inventory 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)

20. 20 20112010 Cash Flows from Investing Activities Sale of Stock Investments $ 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

21. 21 Meals for the Homeless Statement of Financial Position As of December 31, 2011 and December 31, 2010 Assets 2011 2010 Liabilities & Net Assets 2011 2010 Current Assets Cash$ 1,000$ 4,000Liabilities 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$ 49,000 Long-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$114,000 Total Assets $145,000 $146,000 Liabilities and Net Assets $145,000$146,000

22. 22 n n Cash flows relating to investment and financing activities are listed separately. - Why? - Are these adjustments shown in the Activity Statement too? n Indirect vs. Direct Method for Statement of Cash Flows The Cash Flow Statement

23. 23 Depreciation Expense n 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 Example Cost of a van $32,000 Less: Salvage (Residual) Value 2,000 Depreciable Amount$30,000  Useful life 5 years Depreciation Expense per year$ 6,000

24. 24 A Mixed Balance Sheet and Operating Statement Transaction n 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 PayableExpense - $48,000 = - $30,000 + No Change- $18,000

25. 25 Operating Statement Transactions n 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 Assets Transaction 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

26. 26 A Noncash Example n 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 Expense no change = + $27,000 + no change - $27,000