Question

In: Accounting

Give an example of a company that reports positive accrual-basis net income but at the same...

Give an example of a company that reports positive accrual-basis net income but at the same time shows negative cash flows from operating activities.

Solutions

Expert Solution

  • We know that Income statement is prepared on Accrual basis, which means that Revenues and Expenses are recorded when they are earned or incurred, respectively, whether cash has been received or not.
  • However, Statement of Cash flows includes all Cash activities only, which include inflows and outflows of Cash and only Cash.
  • This may lead to a situation where there might be a positive Net Income under Income Statement BUT negative cash flows in Cash Flow Statement – Operating Activities.
  • Take the following example:

Service Revenue: $ 25,000, out of which $ 15,000 received in cash.
Rent Expenses: $ 9,000, out of which $ 5,000 is paid in cash [$ 4,000 outstanding]
Insurance expense: $ 12,000 all paid in cash.

Now, Income Statement will look like this:

Service Revenue

$    25,000.00

Expenses:

Rent Expenses

$      9,000.00

Insurance Expenses

$    12,000.00

Total expenses

$    21,000.00

Net Income

$      4,000.00

Also, the Statement of Cash Flows (Operating Activities) will look like this:

Cash Flows from Operating Activities:

Cash Collected from customers

$    15,000.00

Cash paid for Rent

$    (5,000.00)

Cash paid for Insurance

$ (12,000.00)

Net Cash from Operating Activities

$    (2,000.00)

  • As you can see from above, though the Net Income is positive with $ 4,000, there are Negative Cash Flows of $ 2,000

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