Creating the Statement of Cash Flows (Indirect Method)



Creating the Statement of Cash Flows

PMBA

Fall 2006

1. The Statement of Cash Flows using the Indirect Method ALWAYS begins with Net Income in the Operating Activities Section.

2. Next, you should always add back any non-cash expenses, such as depreciation.

3. Next, you need to look at the increases and decreases for current assets.

a. You will deduct all increases in current assets. For example, if Accounts Receivable increased, you will DEDUCT the increase from Net Income. This is because there is MORE Revenue recorded in Net Income under the Accrual Method of Accounting (which the Income Statement uses) than under the Cash Method. The increase in Accounts Receivable will not be collected in Cash until NEXT YEAR. Thus this increase will be accounted for on the Statement of Cash Flows NEXT YEAR.

b. You will add all decreases in current assets. For example, if Accounts Receivable decreased, you will ADD the decrease to Net Income. This is because there is LESS Revenue recorded in Net Income under the Accrual Method of Accounting (which the Income Statement uses) than under the Cash Method. The decrease in Accounts Receivable at year end is due to your collecting more Cash this year than you recorded in Sales. Since you collected more in Cash than you had in Sales, you must add this decrease to Net Income to get to the Cash Basis of Accounting.

4. Next, you need to look at the increases and decreases for current liabilities.

a. You will add all increases in current liabilities. This is opposite of the treatment for current assets, which should make sense to you. For example, if Wages Payable increased, you will ADD this increase to Net Income. This is because you have deducted more wage expense from Net Income on the Accrual Basis during the period than you have paid out in Cash. You will pay this Cash you owe NEXT YEAR. Thus Net Income on the Cash Basis should be higher than Net Income on the Accrual Basis.

b. You will deduct all decreases in current liabilities. Again this is opposite of the treatment for current liabilities. For example, if interest payable decreased, this means you have paid MORE interest in CASH during the period than you have expensed using the Accrual Basis of Accounting. Thus, on the Cash Basis of Accounting, Net Income is lower than on the Accrual Basis.

5. There are no differences in the treatment of Investing Activities and Financing Activities when using the Indirect Method versus the Direct Method of The Statement of Cash Flows. In both of these sections, you need to keep thinking to yourself, “CASH IN? or CASH OUT?” If you received cash from a loan, that is CASH IN from Financing. If you paid off part of the loan, that is CASH OUT. If you purchased a building, that is CASH OUT from Investing. If you sold a building, that is CASH IN. All of these cash transactions should be in your Cash T-Account.

6. If you are using the Direct Method of the Statement of Cash Flows, the Operating Activities section is simply a list of the Cash transactions from operations listed in your Cash T-Account. Again, think CASH IN? or CASH OUT?

7. The Statement of Cash Flows is FUN!

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download