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13. Indirect Approach to Presenting Operating Activities

As an alternative to the direct approach, companies may present an indirect statement of cash flows. The indirect approach is mostly a repackaging of the information found in the direct approach. It is so named because the "reconciliation" replaces the direct presentation of the operating cash flows. The indirect approach is presented on the following page. Except for the shaded areas, this statement is identical to the direct approach: The first shaded area reflects the substitution of the operating cash flow calculations. The second shaded area reflects a rule that the indirect approach must be supplemented with information about cash paid for interest and taxes (these amounts are found in the operating activities section of the direct approach).

EMERSON CORPORATION

Statement of Cash Flows (Indirect Approach)

For the Year Ending December 31, 20X5

Cash flows from operating activities:

Net income

$

1,000,000

Add (deduct) noncash effects on operating income

Depreciation expense $

120,000

Gain on sale of land

(150,000)

Increase in accounts receivable

(250,000)

Decrease in inventory

40,000

Increase in accounts payable

70,000

Decrease in wages payable

(30.000)

(200.000)

Net cash provided by operating activities

$

800,000

Cash flows from investing activities:

Sale o f land $

750,000

Purchase of equipment

(150,000)

Net cash provided by investing activities

600,000

Cash flows from financing activities:

Proceeds from issuing stock $

80,000

Dividends on common

(50,000)

Repayment of long-term loans

(900,000)

Net cash used in financing activities

(870,000)

Net increase in cash

$

530,000

Cash balance at January 1, 20X5

_

170,000

Cash balance at December 31, 20X5

$

700 000

Noncash investing/financing activities:

Issued preferred stock for building

$

300 000

Supplemental information:

Cash paid for interest

$

100,000

Cash paid for income taxes

300,000

14. Using a Worksheet to Prepare a Statement of Cash Flow

Given enough time and careful thought, one can generally prepare a statement of cash flows by putting together a rough shell that approximates the statements illustrated throughout this chapter, and then filling in all of the bits and pieces that can be found. Ultimately, the correct solution is reached when the change in cash is fully explained. This is like working a puzzle without reference to a supporting picture. But, complex tasks are simplified by taking a more organized approach. To that end, consider the value of a worksheet for preparing the statement of cash flows.

The worksheet examines the change in each balance sheet account and relates it to any cash flow statement impacts. Once each line in the balance sheet is contemplated, the ingredients of the cash flow statement will be found! A sample worksheet for Emerson is presented on the following page. In this worksheet, the upper portion is the balance sheet information, and the lower portion is the cash flow statement information. The change in each balance sheet row is evaluated and keyed to a change(s) in the cash flow statement. When you have explained the change in each balance sheet line, you should have accumulated (in the lower portion) the information necessary to prepare a statement of cash flows.

Emerson Corporation/Cash Flow Statement Worksheet/For the Year Ending Dec. 31, 20X5

Emerson Corporation/Cash Flow Statement Worksheet/For the Year Ending Dec. 31, 20X5

Specific explanations for each keyed item are found in the table below. The cash flow statement explanations are color coded such that blue is the final balancing step, red is cash outflow, black is cash inflow, and green is special.

Upper/Balance Sheet

Lower/Cash Flow Statement

(a)

debit (increase) cash

credit to balance - the remaining effect as net positive cash flow

(b)

debit (increase) accounts receivable

credit reflecting negative cash effect via receivables increase

(c)

credit (decrease) inventory

debit reflecting positive cash effect via inventory reduction

(d)

credit (decrease) land

credit gain and debit sale of land reflecting source of cash

(e)

debit building (increase)/credit preferred (increase)

debit and credit reflecting noncash investing/ financing

(f)

debit (increase) equipment

credit reflecting use of cash to purchase equipment

(g)

credit (increase) accumulated depreciation

debit reflecting noncash adjustment of income

(h)

credit (increase) accounts payable

debit reflecting positive cash effect via increased payables

(i)

debit (decrease) wages payable

credit reflecting negative cash effect via payables reduction

(j)

debit (decrease) loan payable

credit reflecting use of cash via loan repayment

(k)

credit (increase) stock and paid-in capital

debit reflecting source of cash via stock issue

(l)

debit (decrease) retained earnings

credit reflecting use of cash for dividends

(m)

credit (increase) retained earnings

debit reflecting source of cash via income

 
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