Needles Powers Crosson Principles of Accounting 12e Supplement: The Direct Method of Preparing the Statement of Cash Flows 15 C H A P T E R © human/iStockphoto

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. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Cash Receipts from Interest and Dividends  Although 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. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Cash Payments for Purchases  The cost of goods sold must be adjusted for changes in inventory to arrive at net purchases.  Net purchases must be adjusted for the change in accounts payable to arrive at cash payments for purchases. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Cash Payments for Purchases  These relationships may be stated in equation 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. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Cash Payments for Operating Expenses (slide 1 of 2)  Operating expenses do not match the 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 ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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.  These expenses must be subtracted from operating expense to arrive at cash payments for operating expenses. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Cash Payments for Operating Expenses  The three adjustments to 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 follows. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Cash Payments for Income Taxes  The amount of income taxes expense that 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. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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.) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.