22.6: Preparing a Statement of Cash Flows Using the Indirect method Flashcards
What is the main objective of the indirect method when preparing a statement of cash flows?
The objective is to adjust net income for non-cash transactions and changes in working capital to calculate cash provided by or used in operating activities.
In which section of the statement of cash flows is the indirect method applied?
The indirect method is applied to the operating activities section.
What is the starting point for the indirect method of preparing cash flows from operating activities?
The starting point is net income from the income statement.
What types of adjustments are made to net income under the indirect method?
Adjustments are made for non-cash expenses (such as depreciation and amortization), changes in working capital accounts (such as accounts receivable and accounts payable), and non-operating gains and losses (such as gains or losses on the sale of assets).
How does depreciation affect cash flow in the indirect method?
Depreciation is added back to net income because it is a non-cash expense that reduces net income but does not involve an outflow of cash.
How are changes in current assets (e.g., accounts receivable or inventory) treated under the indirect method?
An increase in current assets (e.g., accounts receivable or inventory) is subtracted from net income because it indicates that cash was used but revenue was recognized.
A decrease in current assets is added to net income, reflecting that cash was received during the period.
How are changes in current liabilities (e.g., accounts payable or wages payable) treated under the indirect method?
An increase in current liabilities is added to net income because it means the company has delayed paying its obligations, conserving cash.
A decrease in current liabilities is subtracted from net income because it indicates that cash was used to settle obligations.
How are gains and losses from the sale of long-term assets handled in the indirect method?
Gains from the sale of long-term assets are subtracted from net income, and losses are added back.
This is because these gains and losses do not reflect cash flows from operating activities but from investing activities.
Why is net income adjusted for non-cash items in the indirect method?
Net income includes accrual-based revenues and expenses that may not involve cash transactions, so adjustments are made to reflect the actual cash flows related to operating activities.
How is income tax expense handled in the indirect method?
The income tax expense reported on the income statement is adjusted by any changes in taxes payable to determine the actual cash paid for taxes during the period.
How does the indirect method treat interest paid and received?
Interest paid and received is typically included in the operating activities section, but under IFRS, companies may classify interest paid as either operating or financing activities, and interest received as either operating or investing activities.
What are some typical non-cash adjustments that are added back to net income in the indirect method?
Typical non-cash adjustments include:
Depreciation and amortization,
Bad debt expense,
Deferred taxes,
Losses on disposal of assets.
What are the benefits of using the indirect method to prepare a statement of cash flows?
The indirect method links net income to cash flow from operating activities and is easier to prepare for companies using accrual accounting, as it starts with net income from the income statement and adjusts for non-cash items and changes in working capital.
How are changes in prepaid expenses treated under the indirect method?
An increase in prepaid expenses is subtracted from net income because it represents a cash outflow that has not yet been recognized as an expense, while a decrease is added to net income as it indicates a reduction in cash outflows.
How does the indirect method handle changes in salaries and wages payable?
A decrease in salaries and wages payable is subtracted from net income because it indicates cash outflows to employees that have not yet been fully reflected as an expense.
