Statement of Cash Flows LO 2b – Adjustments to Net Income for Current Balance Sheet Items-Indirect Method

LO 2 After adjusting net income for noncash expenses and revenues (like depreciation and gains), the next step is to look for changes in current assets and current liabilities that impacted cash flows. These will be listed in the Operating Activities section as increases and decreases. Payments of dividends to stockholders is classified as a financing activity, not an operating activity. Bonds Payable is not a current liability, and all stockholders’ equity accounts are omitted. The Operating Activities section converts the accrual-based net income on the income statement into a cash-basis net income. This is done by analyzing the changes in current assets and liabilities, and adding or subtracting them from net income. Adding back non-cash expenses and deducting non-cash revenues are the first steps. Step 3: Select the current operating assets and liabilities that impact cash flows and determine their increases and decreases.

LO 2 The general rules are as follows: (1) increases in noncash current operating assets and decreases in current operating liabilities are deducted from operating activities and (2) decreases in noncash current operating assets and increases in current operating liabilities are added to operating activities.

Adjustments to Net Income LO 2 Adjustments to Net Income Accounts receivable (net): The $9,000 increase is deducted from net income. This is because the $9,000 increase in accounts receivable indicates that sales on account were $9,000 more than the cash received from customers. Thus, sales (and net income) includes $9,000 that was not received in cash during the year. Accounts receivable increased by $9,000, which is an adjustment amount that would be subtracted from net income in the calculation of net cash flows from Operating Activities. As a general rule, increases in current asset balances are reduction adjustments to net income on the statement of cash flows prepared under the indirect method. (continued)

Adjustments to Net Income LO 2 Adjustments to Net Income Inventories: The $8,000 decrease is added to net income. This is because the $8,000 decrease in inventories indicates that the cost of merchandise sold exceeds the cost of merchandise purchased during the year by $8,000. Accounts payable (merchandise creditors): The $3,200 decrease is deducted from net income. This is because a decrease in accounts payable indicates that the cash payments to merchandise creditors exceed the merchandise purchased on account by $3,200. Inventories decreased by $8,000, which is an adjustment amount that would be added to net income in the calculation of net cash flows from operating activities. As a general rule, decreases in current asset balances are increasing adjustments to net income on the statement of cash flows prepared under the indirect method. Accounts payable decreased by $3,200, which is an adjustment amount that would be deducted from net income in the calculation of net cash flows from operating activities. As a general rule, decreases in current liability balances are reduction adjustments to net income on the statement of cash flows prepared under the indirect method. (continued)

Adjustments to Net Income LO 2 Adjustments to Net Income Accrued expenses payable (operating expenses): The $2,200 increase is added to net income. This is because an increase in accrued expenses payable indicates that operating expenses reported on the income statement exceed the cash payments for operating expenses by $2,200. Income taxes payable: The $500 decrease is deducted from net income. This is because a decrease in income taxes payable indicates that taxes paid exceed the amount of taxes incurred during the year by $500. Accrued expenses increased by $2,200, which is an adjustment amount that would be added to net income in the calculation of net cash flows from operating activities. As a general rule, increases in current liability balances are increasing adjustments to net income on the statement of cash flows prepared under the indirect method. Income taxes payable decreased by $500, which is an adjustment amount that would be deducted from net income in the calculation of net cash flows from operating activities. As a general rule, decreases in current liability balances are reduction adjustments to net income on the statement of cash flows prepared under the indirect method.

Adjustments to Net Income LO 2 Adjustments to Net Income Rundell Inc. Increases in current assets decrease cash flows from operating activities, whereas decreases do the opposite. Increases in current liabilities increase cash flows from operating activities, whereas decreases do the opposite. Rundell Inc.

As indicated on this slide, Rundell’s net income of $108,000 provided a net cash flow of $100,500 from operating activities. This means, using cash basis accounting, they would have reported net income of $100,500. Transferring the previous slide to a formal statement of cash flows for Rundell, we can see that part of the statement is now complete.