Accounting: The Language of Business - Vol. 1 (Part 97)

We account for one-sixth of the forces of gravity we see in the universe. There is no known objects accounting for most of the effective gravity in the universe. Something is making stuff move that is not anything we have ever touched.

Neil deGrasse Tyson

Statement of Cash Flows (Part C)

by

Charles Lamson

Current Assets and Current Liabilities

EXHIBIT 4 Adjustments to Net Income---Indirect Method

As shown in Exhibit 4 (from part 96 and reintroduced above), decreases in noncash current assets and increases in current liabilities are added to net income. In contrast, increases in noncash current assets and decreases in current liabilities are deducted from net income. The current assets and current liabilities accounts of Rundell Inc. are as follows:

The $9,000 increase in accounts receivable indicates that the sales on account during the year are $9,000 more than collections from customers on account. The amount reported as sales on the income statement therefore includes $9,000 that did not result in a cash inflow during the year. Thus, $9,000 is deducted from net income.

The $8,000 decrease in inventories indicates that the merchandise sold exceeds the cost of the merchandise purchased by $8,000. The amount deducted as cost of merchandise sold on the income statement therefore includes $8,000 that did not require a cash outflow during the year. Thus, $8,000 is added to net income. 

The $3,200 decrease in accounts payable indicates that the amount of cash payments for merchandise exceeds the merchandise purchased on account by $3,200. The amount reported on the income statement for cost of merchandise sold therefore excludes $3,200 that required a cash outflow during the year. Thus, $3,200 is added to net income.

The $2,200 increase in accrued expenses payable indicates that the amount incurred during the year for operating expenses exceeds the cash payments by $2,200. The amount reported on the income statement for operating expenses therefore includes $2,200 that did not require a cash outflow during the year. Thus, $2,200 is added to net income. 

The $500 decrease in income taxes payable indicates that the amount paid for taxes exceeds the amount incurred during the year by $500. The amount reported on the income statement for income tax therefore is less than the amount paid by $500. Thus, $500 is deducted from net income.

Gain on Sale of Land

The ledger or income statement of Rundell Inc. (from part 96 and reintrduced above) indicates that the sale of land resulted in a gain of $12,000. As we discussed previously, the sale proceeds, which include the gain and the carrying value [Carrying value is an accounting measure of value in which the value of an asset or company is based on the figures in the respective company's balance sheet (investopedia).] of the land, are included in cash flows from investing activities. The gain is also included in net income. Thus, to avoid double reporting, the gain of $12,000 is deducted from net income in determining cash flows from operating activities, as shown below.

Reporting Cash Flows from Operating Activities

We have now presented all the necessary adjustments to convert the net income to cash flows from operating activities for Rundell Inc. These adjustments are summarized in Exhibit 5 in a format suitable for the statement of cash flows.

EXHIBIT 5 Cash Flows from Operating Activities---Indirect Method

Cash Flows Used for Payment of Dividends

According to the retained earnings account of Rundell Inc., shown in part 96, cash dividends of $28,000 were declared during the year. However, the dividends payable account shown below indicates that dividends of only $24,000 were paid during the year.

The $24,000 of dividend payments represents a cash outflow that is reported in the financing activities section as follows: 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 648-651*

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