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1. Cash collections from customers
Net sales $5,000,000
Add: Accounts receivables, beginning of the year 2,500,000
7,500,000
Less: Accounts receivables, end of the year (1,500,000)
Cash collections from customers $6,000,000
2. Cash paid to suppliers
Purchases $4,000,000
Add: Accounts payable, end of the year 1,900,000
5,900,000
Less: Accounts payable, beginning of the year (2,000,000)
Payments to suppliers $3,900,000
3. Cash paid for operating expenses
Operating expenses $3,000,000
Add: Accrued expenses, beginning of the year 500,000
3,500,000
Less: Accrued expenses, end of year (400,000)
Less: Depreciation on property, plant, and equipment (600,000)
Cash paid toward operating expenses $2,500,000
The indirect method is the more popular of the two methods despite the recommendation by IAS 7 to present the cash flows from operating activities
under the direct method. A possible reason for this could be that the indirect method is easier to use than the direct method because it derives net cash flows
from operating activities from the net operating results for the year as reported in the income statement. Under the indirect method, the first item presented
is the net income (or loss) for the year as reported in the income statement. Noncash items of revenue and expense are added or deducted to arrive at net
cash provided by operating activities. For instance, depreciation on property, plant, and equipment is added back because these expenses reduce (increase)
net income (loss) for the year without affecting cash from operating activities. Similarly, gain on sale of property, plant, and equipment is deducted from net
income for the year because it does not affect cash flow from operating activities. Changes in inventory, accounts receivable, and other operating assets and
liabilities are used to convert the accrual-basis net income (loss) for the year to arrive at cash flows from operating activities.
Facts
CASE STUDY 4
Excellent Inc. has provided the following information and requests you to prepare the operating activities of the statement of cash flows under the indirect
method:
Net income before taxes $400,000
Depreciation on property, plant, and equipment 200,000
Loss on sale of building 100,000
Interest expense 150,000
Interest payable, beginning of the year 100,000