CASH FLOW STATEMENT – INDIRECT METHOD
Contents
1 OBJECTIVES – CASH FLOW STATEMENT ................................................................................. 2
1.1 Three Types of Business Activities ................................................................................... 2
1.2 Relationship to Balance Sheet.......................................................................................... 2
1.3 Two Methods of Derivation ............................................................................................. 2
2 INDIRECT METHOD ................................................................................................................. 3
2.1 Cash Flow from Operating Activities ................................................................................ 5
2.2 Cash Flow from Investing Activities ................................................................................. 7
2.3 Cash Flow from Financing Activities................................................................................. 9
2.4 Noncash Investing and Financing Cash Flows ................................................................ 11
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1 OBJECTIVES – CASH FLOW STATEMENT
Four objectives:
• Predicts future cash flows
• Evaluates management decisions
• Determines ability to pay dividends and interest
• Shows the relationship of net income to cash flows
1.1 Three Types of Business Activities
Create revenues, expenses,
Operating
gains and losses – net income
Investing Increase and decrease long-term
assets
Related to long-term liabilities
Financing
and owners’ equity
1.2 Relationship to Balance Sheet
1.3 Two Methods of Derivation
• Indirect Method → reconciles from net income to net cash provided by operating activities
• Direct Method → Reports all cash receipts and cash payments from operating activities
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2 INDIRECT METHOD
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To illustrate the statement of cash flows, we use The Roadster Factory, Inc. (TRF), a dealer in
auto parts for sports cars. Using the comparative balance sheets for 2015 and 2016 and the
income statement for 2016, prepare the statement of cash flows using the indirect method.
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2.1 Cash Flow from Operating Activities
• Transactions that make up net income
• From the income statement
o Net income
o Depreciation, depletion, amortization expense
o Gains and losses on sale of long-term assets
• From the comparative balance sheets
o Increase or decrease in each current asset
o Increase or decrease in each current liability
A. Depreciation, Depletion, & Amortization Expenses
• Added back to net income to convert net income to cash flow
• No effect on cash, decreases net income
• Add-back cancels the deduction on the income statement
The Roadster Factory, Inc. reports depreciation expense on their income statement of $18,000
B. Gains and Losses on the Sale of Long-Term Assets
• An adjustment to net income
• Subtract gains from operating activities
• Add losses from operating activities
The Roadster Factory sold equipment for $62,000. The book value was $54,000, so there was a
gain of $8,000.
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C. Changes in Current Assets and Current Liabilities, Excluding Cash
• Increase in a noncash current asset decreases cash
o Accounts Receivable increased by $15,000
o Prepaid Expenses increased by $1,000
• Decrease in noncash current assets increases cash
o Inventory decreased by $3,000
C. Changes in Current Assets and Current Liabilities, Excluding Cash
• Increase in a current liability increases cash
o Accounts Payable increased by $34,000
• Decrease in current liabilities decreases cash
o Salary and Wages Payable decreased by $2,000
o Accrued Liabilities decreased by $2,000
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2.2 Cash Flow from Investing Activities
• Affect long-term assets
o Plant assets, long-term Investments
• Increase represents purchase of long-term assets
o Decreases cash
• Decrease represents sale of long-term assets
o Increases cash
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219,000 + 196,000 – 18,000 – 54,000 = 343,000
62,000 = 54,000 + 8,000
0 + 21,000 – 0 = 21,000
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2.3 Cash Flow from Financing Activities
• Affect liabilities and stockholders’ equity
o Notes Payable, Bonds Payable, Long-Term Debt, Common Stock, Paid-in Capital in
Excess of Par, and Retained Earnings
• Most data from balance sheet
• Increases are offset by increases in cash
• Decreases are offset by decreases in cash
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77,000 + 94,000 – 11,000 = 160,000
158,000 + 4,000 = 162,000
86,000 + 50,000 – 17,000 = 119,000
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2.4 Noncash Investing and Financing Cash Flows
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