Question

Cash flows from operating activities (indirect and direct methods).

Presented below is the income statement of Cowan, Inc.:

         Sales revenue                                                                         $380,000

         Cost of goods sold                                                                  225,000

         Gross profit                                                                             $155,000

         Operating expenses                                                                   85,000

         Income before income taxes                                                      70,000

         Income taxes                                                                             28,000

         Net income                                                                              $ 42,000

In addition, the following information related to net changes in working capital is presented:

                                                                                                              Debit                  Credit

         Cash                                                                                          $12,000

         Accounts receivable                                                                   20,000

         Inventories                                                                                                              $19,400

         Salaries payable (operating expenses)                                        8,000

         Accounts payable                                                                                                     14,000

         Income taxes payable                                                                   3,000

The company also indicates that depreciation expense for the year was $16,700 and that the deferred tax liability account increased $2,600.

Instructions

Prepare a schedule computing the net cash flow from operating activities that would be shown on a statement of cash flows:

(a)   using the indirect method.

(b)   using the direct method.

Answer 1

SOLUTION

A. Net cash flow from operating activities using indirect method

Particulars	Amount ($)
Cash flows from operating activities-
Net income	42,000
Adjustments of non-cash expenditure-
Depreciation	16,700
Operating profit before working capital changes	58,700
Adjustments for working capital changes-
Increase in accounts receivable	(20,000)
Decrease in inventories	19,400
Decrease in salaries payable	(8,000)
Increase in accounts payable	14,000
Increase in deferred tax liability	2,600
Decrease in income taxes payable	(3,000)
Cash flow from operating activities	63,700

B. Net cash flow from operating activities using direct method

Particulars	Amount ($)	Amount ($)
Cash flow from operating activities-
Sales	380,000
Less: Increase in accounts receivable	(20,000)	360,000
Cost of goods sold	225,000
Less: Increase in accounts payable	(14,000)
	211,000
Less: Increase in inventories	(19,400)	191,600
Gross profit		168,400
Operating expenses	85,000
Add: Decrease in salaries payable	(8,000)
	93,000
Less: Depreciation expense	(16,700)	76,300
		92,100
Taxes paid	28,000
Add: Decrease in income taxes payable	3,000
	31,000
Less: Increase in deferred tax liability	(2,600)	28,400
Cash flow from operating activities		63,700