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Chapter 5: Problem 12

Under the indirect method of preparing the statement of cash flows, each of the following items would be added to net income in measuring cash flows from operating activities (CFOA).Which (if any) of these items may be considered to be a source of cash? a. Depreciation expense b. Loss on sale of plant and equipment c. Reductions in customer accounts receivable d. Increases in supplier accounts payable

Short Answer

Expert verified
From the given items, Reductions in customer accounts receivable (c) and Increases in supplier accounts payable (d) can be considered as sources of cash.

Step by step solution

01

Analyzing 'Depreciation expense'

Depreciation expense is a non-cash expense that is added back to net income because it reduces net income but does not involve an actual outflow of cash. Even though it increases the cash flow from operating activities, it is not a source of cash. So, 'a' is not a source of cash.
02

Analyzing 'Loss on sale of plant and equipment'

A loss on the sale of plant and equipment is added back to net income because it represents a non-operating loss that reduced net income but has not involved an actual cash outflow from operating activities. However, it does not generate cash. So, 'b' is not a source of cash.
03

Analyzing 'Reductions in customer accounts receivable'

A reduction in accounts receivable means the company collected cash from its customers, hence reducing the amount of customer dues. This is indeed a source of cash from operating activities. Therefore, 'c' is a source of cash.
04

Analyzing 'Increases in supplier accounts payable'

An increase in accounts payable means the company purchased goods or services on credit, hence it has more money left because it didn't pay cash. This is a source of cash from operating activities. Therefore, 'd' is a source of cash.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Indirect Method
The indirect method is a way to prepare the cash flow statement, specifically focusing on the operating activities section. It begins with net income, as reported on the income statement, and then adjusts this amount for non-cash expenses, non-operating gains and losses, and changes in working capital. This method is often preferred because it is easier to apply with the available financial data.
  • Starts with net income
  • Adjusts for non-cash expenses like depreciation
  • Includes changes in working capital components
In practice, the indirect method provides a clear reconciliation between accrual accounting (used for the income statement) and cash accounting, which highlights the tangible change in cash balances.
Operating Activities
Operating activities are at the core of the cash flow statement. They reflect the cash generated or consumed by the main revenue-generating activities of a company. Under the indirect method, these activities begin with net income and make adjustments to convert this figure to cash.
  • Includes cash received from customers and cash paid to suppliers and employees
  • Adjusts for changes in working capital such as accounts receivable and payable
Cash flows from operating activities are crucial because they show the sustainability and efficiency of the core business operations over time.
Net Income
Net income is a company's total profit, reflecting the excess of revenues over expenses. It serves as the starting point in the indirect method of cash flow calculations. However, because net income includes both cash and non-cash items, it must be adjusted to reflect only cash activities when preparing a cash flow statement.
  • Includes revenues, expenses, gains, and losses
  • Adjusted for non-cash items like depreciation in cash flow statements
By beginning with net income and making the necessary adjustments, the statement of cash flows provides insight into how cash is moving through a company's operating system.
Cash Flow Analysis
Cash flow analysis examines the inflow and outflow of cash within a business, providing insights into its financial health. This analysis is critical to understanding whether a company can maintain liquidity, invest in new opportunities, and cover its obligations. In the context of operating activities, cash flow analysis helps identify actual cash generated by day-to-day operations.
  • Helps in assessing the liquidity needs of the business
  • Aids investors and management in understanding cash generation capabilities
Through cash flow analysis, companies can strategize better on managing their resources, optimizing operating efficiencies, and planning for the future.

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Most popular questions from this chapter

The Shifting Sands Company reported an increase in its property (land) account of \(\$ 4\) million during \(1999 .\) During 1999 , the firm sold land with an initial cost of \(\$ 12\) million for cash proceeds of \(\$ 9\) million and purchased additional land for \(\$ 16\) million. Determine the effects of these transactions on the following elements of the firm's 1999 financial statements: a. Net income (ignore income tax effects) b. Adjustments to net income to compute cash flows from operations (as in the indirect method) c. cash flows from investing activities

Determine the amounts of cash flows associated with each of the following: 1\. Sales revenue was \(\$ 20\) million; accounts receivable decreased by \(\$ 2\) million. 2\. Salary expense was \(\$ 7.5\) million; salaries payable decreased by \(\$ 1\) million. 3\. cost of goods sold was \(\$ 9\) million; inventories decreased by \(\$ 1.2\) million. Supplier accounts payable increased by \(\$ 1.6\) million.

Locate the three \(10-\) Q filings and the 10 -K for the most recently completed fis cal year for Cedar Fair, L.P, and H\&R Block. These statements can be retrieved from the EDGAR archives (www.sec.gov/edgarhp.htm). a. What is the main business of these two companies? What is the peak season for each of these two companies? Which quarter do you think will reflect this peak level of activity? b. From the financial statements in the 10 -K, identify the starting and ending dates for the most recently completed fiscal year

Determine the amounts of revenue or expense associated with each of the fol lowing cash flows: 1\. Cash received from customers was \(\$ 8.5\) million; accounts receivable in creased by \(\$ 1.6\) million. 2\. Paid salaries of \(\$ 3\) million; salaries payable decreased by \(\$ .6\) million. 3\. Paid cash of \(\$ 4.5\) million to suppliers; supplier accounts payable increased by \$.5 million. Inventories decreased by \(\$ 1\) million.

In each of the following cases, indicate whether the amount of cash inflow (or outflow is greater or less than the related revenue (or expense): a. A firm's accounts receivable balance has increased during the period. b. A firm's salaries payable balance has increased during the period. c. A firm's accumulated depreciation balance has increased during the period. d. A firm's inventory balance has increased during the period, and the supplier accounts payable balance has also increased by a greater amount.
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