Statement of Cash Flows: Direct Method - Lesson 4 - YouTube

Ok, let's look at equity and earnings.

Now equity and earnings, this was from that investment under the equity method.

Why would something go to the income statement?

Let's see, because we have an investment in that equity and earnings.

Remember what we learned is when I buy the investment, debit investment, credit cash,

when you earn money, you're worth more.

The equity method says since you're worth more, my investment is worth more.

Now, when you earn it, I record it as income even though I haven't touched it yet, why

not?

Because I have significant voting influence, 30, 50 percent.

I'm reasonably assured of getting it in the form of a dividend down the road.

So my journal entry is debit investment, credit, equity, and earnings.

Now, investment balance sheet, here it is, boom, gone.

Equity and earnings, is what?

Is an income statement account, as earnings?

Is this earnings on the income statement, yes?

Is it cash, no?

It wasn't a debit to cash, it was a debit to investment.

So, when you come back over here, here it is.

It's part of my income statement.

Is it cash, no?

So, I can ignore it.

It's not direct cash in or out, ignore it.

However, in the indirect, is it in there, yes.

Was it cash, no?

So, I'll be taking that out.

Depreciation, I'll be adding that back.

See what I'm saying?

'Cause this is income that wasn't cash, back it out.

An expense that wasn't cash, add it back.

That's for indirect, we're not there yet.

But for direct, ignore it.

Income tax expense is $60 so, let's see what's going' on here.

So income tax expense, income tax expense, is 60 bucks.

So now what we need to do is to figure out, OK that was my expense.

Remember we talked about deferred taxes not too long ago?

I hope it's still fresh in your head.

But what we need to do is we need to figure out what caused the changes.

Some of the changes are going to be due to deferred taxes, some, tax payable.

We're going to have a credit to tax payable.

Let's look at what the increase was, went up by 40.

Looking for 40, done.

We also have a deferred tax liability that went down by 10.

So let's get rid of that.

Therefore, I've got an income tax expense of 60, I have current tax payable of 40, I

have a deferred tax liability that's going down, the difference must be cash, which is

70 minus 40, or 30.

What do I call that?

Payments for taxes.

Coming back here on my direct method, payment for taxes, and that's going to be an outflow

of 30.

The next one is going to be gain on sale of AFS.

So I sold an investment, I sold an investment.

And when I sold an investment, what that means is for some reason, I had a gain on the sale

of this investment.

Now one of the things is, this gain on sale, let's think about it.

I have a gain on the sale of a what, an Investment.

An investment, an investment!

Hmm, so let's think about it.

If you sell an investment, don't give me any LIP, loans, investments, PP and E. If you

sell an investment, that cash should be what kind of inflow?

Operating, or investing?

Good guess, investing.

Therefore this $10 is not an operating gain, it should be an investing gain.

It's really shown along with the investment.

For example, let's say we sold an investment.

I got cash of 60, let's say the investment was in my books for 50, and I have a gain

of 10.

Then, what kind of activity is this?

Sale of investment.

How much should go on my statement of cash flows, the 60.

Where does it go, investing?

So, where does this 10 go?

This 10 is a gain, but it's not really an operating gain.

It should be investing gain.

So what do I do, ignore it.

Because it's not operating, it's investing.