Question

P4-47. Computing Cash Flow from Operating Activities (Direct Method)

Refer to the income statement and comparative balance sheets for Wolff Company presented in P4-46. (below)

Wolff Company’s income statement and comparative balance sheets follow.

WOLFF COMPANY Income Statement For Year Ended December 31, 2016

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $635,000

Cost of goods sold. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $430,000

Wages expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86,000

Insurance expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000

Depreciation expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,000

Interest expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,000

Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29,000 579,000

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 56,000

WOLFF COMPANY Balance Sheets

Dec. 31, 2016 Dec. 31, 2015

Assets Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 11,000 $ 5,000

Accounts receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41,000 32,000

Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90,000 60,000

Prepaid insurance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000 7,000

Plant assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000 195,000

Accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (68,000) (51,000)

Total assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $329,000 $248,000

Liabilities and Stockholders’ Equity

Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,000 $ 10,000

Wages payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,000 6,000

Income tax payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,000 8,000

Bonds payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130,000 75,000

Common stock. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90,000 90,000

Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86,000 59,000

Total liabilities and equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $329,000    $248,000

REQUIRED

a. Compute Wolff Company’s cash flow from operating activities using the direct method. Use the format illustrated in Exhibit 4.5 in the chapter.

b. What can we learn from the direct method that may not be readily apparent when reviewing a cash flow statement prepared using the indirect method?

Answer 1

Cash flow statement: Cash flows from Operating Activities ($)2. Direct method of Cash flow Statement helps us to segregate and report the total Cash Revenues in form of collection of cash from Receivables and cash sales. It helps us to get an idea of Cash payments towards purchases and other expenses. Thus it helps us to keep exact or direct track of Operating cash receipts against cash payments. Whereas indirect cash flow Statement adjusts the net income as per income statement by adding or reducing in cash items and changes to working capital. Thus doesn't help in tracking pure Cash revenues and expenses during the year. Direct method gives is a glimpse of how our operating activities would've been recorded had it been Cash basis instead of accrual.