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

C HAP TE R

15

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

Principles of
Accounting
12e
Needles
Powers
Crosson
© 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.

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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.

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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.

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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.

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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.

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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.
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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.

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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.