Question

Using the Exhibit below (Adjustments to Net Income (Loss) Using the Indirect Method, assume that the amount of Net Income on the Income Statement for the year was $101,800. When preparing the Statement of Cash Flow using the indirect method for the current year, which of the following statements would describe the proper presentation of net income on the Cash flow from operating activities section?

EXHIBIT

                                                                                      Increase

                                                                                    (Decrease)     

Net Income (loss)                                                         $XXX

Adjustments to reconcile net income to net cash flow       

from operating activities:

   Depreciation of fixed assets                                       XXX

   Losses on disposal of assets                                      XXX

   Gains on disposal of assets                                      (XXX)

Changes in current operating assets and liabilities:

   Increases in *noncash current operating assets     (XXX)

   Decreases in **noncash current operating assets   XXX

   Increases in **current operating liabilities              XXX

   Decreases in *current operating liabilities             (XXX)

          *SUBTRACT                                                         **ADD

Increases in accounts receivable                    Decreases in accounts receivable

Increases in inventory                                     Decreases in inventory

Increases in prepaid expenses                        Decreases in prepaid expenses

Decreases in accounts payable                       Increases in accounts payable

Decreases in accrued expenses payable        Increases in accrued expenses payable

A. Start the Cash Flow from Operating Activities section with the $101,800 - ANSWER

B. Include the $101,800 in with the Adjustment to reconcile net income to net cash flows from operating activities section as an addition

C. Include the $101,800 in the Changes in current operating assets and liabilities as an addition

D. Ignore the $101,800 and do not use it in the Cash Flow from Operating Activities section

I am lost on this problem. Can someone please explain the steps to me?

Answer 1

(A) Start the Cash Flow from Operating Activities section with the $101,800

Explanation:

Format for calculating cash flow from Operating Activities Using Indirect Method

Net Income		XXX
Adjustments to reconcile net Income to Net cash flow from Operating Activities
Depreciation on fixed Assets	XXX
Losses on disposal of Assets	XXX
Gains on disposal of Assets	(XXX)
		XXX
Net cash flow from Operating Activities before Working Capital Changes		XXX
Working Capital Changes:
Increase in Current Operating Assets	(XXX)
Decrease in Current Operating Assets	XXX
Increase in Current Operating Liabilities	XXX
Decrease in Current Operating Liabilities	(XXX)
		XXX
Net cash flow from Operating Activities		XXX

In this format, you can clearly analyse the treatment of Net Income (amounting to $101,800) in the cash flow from Operating Activities. Now from the given options, you have to choose the corrent option regarding the treatment of Net income in cash flow from Operating Activities.

Option (A): The cash flow statement starts with the net Income and the same fact is stated in the provided statement. Therefore, this option is correct.

Option (B): Net Income will not be included in "Adjustment to reconcile net income to net cash flows" because that section includes depreciation on assets, gain or loss on disposal of assets. Therefore, the given statement is incorrect.

Option (C): Net Income is not an Operating Current Asset ot Operating Current Liability. Therefore, it will not be included in "Changes in current operating assets and liabilities" Section. Therefore, this is not the correct option.

Option (D): As stated in the statement, we cannot ignore net Income from cash flow statement as it is a very important part of cash flow statament and ignoring the net income will render the cash flow statement as unsuitable for use. Therefore, we cannot ignore net income from cash flow statement and this option is also not correct.

TIP: Try to read all statements one by one and connect them to the format provided to see the treatment of net Income.

Note: If you still have doubts, feel free to ask in comment section.