300116 Direct Method St of Cash Flows 1A5 Flashcards
In its 20X1 income statement, Kilm Co. reported cost of goods sold of $450,000. Changes occurred in several balance sheet accounts as follows:
Inventory $160,000 decrease
Accounts payable—suppliers 40,000 decrease
What amount should Kilm report as cash paid to suppliers in its 20X1 cash flow statement, prepared under the direct method?
$250,000
$650,000
$330,000
$570,000
Question #300116
$330,000
The requirement is to determine the current period’s amount of cash paid for goods acquired from suppliers no matter when the goods were acquired. Therefore, the total purchases made during the current period (whether on credit or for cash) and the amount of purchases from the previous period not paid for in the previous period must be examined because they represent the amount that could have been paid to suppliers during the current period.
A decrease in inventory during the period indicates that purchases were less than the cost of goods sold. Therefore, the current period’s amount of purchases is determined by subtracting the decrease in inventory from cost of goods sold. The ending accounts payable represents what is still owed to suppliers at the end of the current period for purchases. A decrease in accounts payable during the current period indicates that suppliers were paid an amount of cash greater than the amount of the current period’s purchases. Therefore, adding the decrease in accounts payable to purchases of the period yields the cash paid to suppliers in the current period.
Cost of Goods Sold $450,000
Inventory decrease (160,000)
Purchases $290,000
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Purchases $290,000
Accounts Payable decrease 40,000
Cash paid to suppliers $330,000
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Accounts Payable
Accounts payable are obligations to suppliers of merchandise or of services purchased on open account, with payment usually due in 30 to 60 days.
Direct Method for Statement of Cash Flows
The direct method is one of the two optional methods of presentation of the statement of cash flows, the method preferred by the Financial Accounting Standards Board (FASB). The direct method presents gross cash receipts and payments from operating activities; cash amounts may be derived from accrual based records by adjusting income statement items for changes in the related balance sheet accounts, e.g., cash collected from customers is found by adjusting sales for the change in accounts receivable during the period. (FASB ASC 230-10-45-25)
In governmental accounting, cash flow statements presented for proprietary funds and governmental entities engaged in business-type activities must use the direct method. (GASB 2450)
The direct method presents major classes of cash flows: cash collected from customers, interest and dividends received, interest paid, cash paid to employees and suppliers, income taxes paid, and other cash payments.
If the direct method is used, a reconciliation of net income to net cash provided by operating activities must be presented as a supplemental disclosure. This reconciliation must present all major classes of adjustments: accruals of expected future operating cash receipts and payments (receivables and payable), deferrals of past cash receipts and payments (inventory, prepaid items, deferred income and expenses), noncash income/expenses (depreciation, amortization, provisions for bad debts), and gains and losses from transactions classified as investing or financing activities (sale of productive assets, sale of debt, liquidating dividend, retirement of debt).
Statement of Cash Flows
The statement of cash flows is one of the required financial statements. Cash receipts and cash payments are classified into three categories:
- Operating activities—all transactions and other events that are not investing or financing; generally include transactions that enter into the determination of net income. These include production and delivery of goods and services, interest and dividends received, and payment of interest.
- Investing activities—all transactions related to the making or collecting of loans and the acquiring and disposing of debt, equity instruments, or property, plant, and equipment.
- Financing activities—all transactions related to obtaining resources from owners and providing them with a return on, and a return of, their investment, and to obtaining and repaying debt.
Separate disclosure of noncash investing and financing activities is also required. Examples of such activities include obtaining an asset by entering into a finance lease, by exchange for another asset, or by the issuance of stock or debt.
The statement of cash flows can be prepared using either the direct or the indirect method.
FASB ASC 230-10-45 and 10-55
In governmental accounting, cash flow statements are presented for proprietary funds and governmental entities engaged in business-type activities. The direct method must be used and there are four headings in the statement: cash flows from operating activities, from noncapital financing activities, from capital and related financing activities, and from investing activities. (GASB 2450)
2115.10
Several additional matters of form and content of the statement of cash flows (SCF) are as follows:
a. The SCF presents net cash flows from operating, investing, and financing activities to reconcile the change in cash (and cash equivalents) for the period.
2115.10
b. In reporting cash flows from operating activities, enterprises are encouraged to use the direct method, with disclosure of at least the following:
(1) Cash collected from customers
(2) Interest and dividends received
(3) Other operating cash receipts
(4) Cash paid to employees and other suppliers of goods and services
(5) Interest paid
(6) Income taxes paid
(7) Other operating cash payments
2115.10
c. Alternatively, the enterprise may use the indirect method of determining cash flows from operating activities, in which the calculation begins with net income and eliminates noncash amounts included in the determination of that figure as well as any transactions that are classified as investing or financing activities (e.g., gains or losses on sales of assets).
2115.10
d. Regardless of whether the direct or indirect method is used to determine cash flows from operating activities, the following items are required to be disclosed in the SCF or related notes:
(1) Amount of income taxes paid during the period
(2) Amount of interest paid during the period
(3) Reconciliation of net income and net cash flows from operating activities (If the direct method is used, this is ordinarily done in a related note; if the indirect method is used, this is ordinarily part of the SCF section on operations.)
2115.10
e. Information about noncash investing and/or financing activities must be disclosed outside the main body of the SCF.
f. Cash-flow-per-share information shall not be presented.
g. FASB ASC 230-10-05-3 contains the following exceptions:
(1) The following organizations are exempt from the requirement to present an SCF: defined benefit pension plans and highly liquid investment companies that meet specified conditions.
(2) Cash receipts and payments of the following types are classified as operating cash flows in the SCF: securities specifically acquired for resale and carried in a trading account, and loans that are acquired specifically for resale and are carried at the lower of cost or market value.
2115.10
h. FASB ASC 942-230-45-1 and 230-10-45-14 include the following exceptions:
(1) Banks, savings institutions, and credit unions may report certain cash receipts and cash payments as net amounts rather than gross amounts. These receipts and payments include deposits placed with other financial institutions and withdrawals of deposits, time deposits accepted, and repayments of deposits, as well as loans made to customers and principal collections of loans.
(2) Cash flow results from future contracts, forward contracts, option contracts, or swap contracts that are accounted for as hedges of identifiable transactions or events may be classified in the same category as the cash flows from the items being hedged, provided that the accounting policy is disclosed.
FASB ASC 230-10-55-3
