Principles of financial accounting 12e by needles crosson chapter 15 sup

Determining Cash Flows from Operating Activities  The principal difference between the indirect and direct methods appears in the cash flows from operating activities section of the

Principles of

Accounting

12e

Supplement: The Direct Method of Preparing the Statement of Cash Flows

15C H A P T E R

Determining Cash Flows from

Operating Activities

 The principal difference between the

indirect and direct methods appears in

the cash flows from operating activities

section of the statement of cash flows.

– The indirect method starts with net income

from the income statement and converts it to net cash flows from operating activities by

adding or subtracting items that do not affect net cash flows.

– The direct method converts each item on the income statement to its cash equivalent.

Cash Receipts from Sales

 Credit sales are not direct cash inflows

because the collections of accounts receivable

in any one accounting period are not likely to equal credit sales.

– Some receivables may be uncollectible,

sales from a prior period may be collected

in the current period, and sales from the current period may be collected in the next period.

Cash Receipts from Sales

 The relationship among sales, changes in the accounts receivable, and cash

receipts from sales are reflected in the

formula that follows.

– For Eureka Corporation, sales were $698,000

in 2014 and accounts receivable decreased by

$8,000 Thus cash received from sales is

$706,000, as computed below.

Cash Receipts from Interest and Dividends

received are most closely associated

with investment activity and are often

called investment income, the FASB

classifies the cash received from these

items as operating activities.

Cash Payments for Purchases

adjusted for changes in inventory to

arrive at net purchases.

change in accounts payable to arrive at cash payments for purchases.

Cash Payments for Purchases

form as follows.

– For Eureka Corporation, cost of goods sold

is $520,000, inventory increased by

$34,000, and accounts payable increased

by $7,000 Thus, cash payments for purchases is $547,000, as computed below.

Cash Payments for Operating Expenses

(slide 1 of 2)

amount of cash paid to employees,

suppliers, and others for goods and

services Three adjustments must be

made to operating expenses to arrive

at the cash outflows.

– Adjustment for changes in prepaid

expenses

Cash Payments for Operating Expenses

(slide 2 of 2)

– Adjustment for changes in liabilities

resulting from accrued expenses, such as wages payable and payroll taxes payable.

– Adjustment for expenses that do not

require a current outlay of cash, such as depreciation, amortization, and depletion expenses.

operating expense to arrive at cash payments for operating expenses.

Cash Payments for Operating Expenses

are summarized in the equations that follow.

– Eureka’s operating expenses (including depreciation

of $37,000) were $147,000, prepaid expenses decreased by $4,000, and accrued liabilities increased by $3,000 Thus, Eureka’s cash payments for operating expenses are $103,000, computed as

Cash Payments for Income Taxes

appears on the income statement rarely

equals the amount of income taxes actually paid during the year.

– To determine cash payments for income

taxes, income taxes are adjusted by the change in Income Taxes Payable.

Cash Payments for Income Taxes

 In other words, the following equation is

applicable:

– In 2014, Eureka reported income taxes of $7,000 on its income statement and a decrease of $2,000 in Income Taxes Payable on its balance sheets Thus, cash

payments for income taxes are $9,000, computed as follows.

Compiling the Statement of Cash Flows

 The only differences between the statement of cash flows under the direct method and the

statement of cash flows under the indirect

method occur in the first and last sections.

– The first section shows the net cash flows from

operating activities on a direct basis.

– The last section is the same as the cash flows from operating activities section of the statement of cash flows under the indirect method (The FASB requires that a schedule must be provided that reconciles net income to net cash flows from operating activities when the direct method is used.)