When cash is paid to a supplier for purchases previously made on account, cash decreases. The accounts payable balance decreased $919. Similarly, the $142 increase in the prepaid expenses balance is also deducted from net income. As inventory is purchased, cash is assumed to be paid, so the $107 increase in the inventory balance is subtracted from net income (a decrease in the inventory balance would be added to net income). If the accounts receivable balance increases, the amount of the increase is subtracted from net income, the opposite of what happens when the balance decreases. Therefore, the $663 is added back to net income. As cash is increased when cash is collected from customers, a decrease in the accounts receivable balance represents an increase in cash. The accounts receivable balance decreased $663 from $19,230 to $18,567. Next, net income is adjusted for the changes in most current asset, current liability, and income tax accounts on the balance sheet. Net income first needs to be adjusted by significant non‐cash items from the income statement: depreciation expense and the loss on the sale of the equipment. Given the financial statements and information for the Brothers' Quintet, Inc., net income is $6,300. As depreciation expense and amortization expense are deducted in calculating net income (expenses are subtracted from revenues to determine net income), and depreciation and amortization expense do not result in cash payments by the company, depreciation expense and amortization expense are added back to net income. Significant non‐cash items on the income statement include depreciation and amortization expense and gains and losses from the sales of assets or retirement of debt. The operating activities section starts with net income per the income statement and adjusts it to remove the significant non‐cash items. Remember that under the accrual basis of accounting, revenues and expenses are recorded following the revenue recognition and matching principles which do not require cash receipts to record revenues or cash payments to record expenses. The indirect method assumes everything recorded as a revenue was a cash receipt and everything recorded as an expense was a cash payment. The discussion on the indirect method of preparing the statement of cash flows refers to the line items in the following statement and the information previously given about the Brothers' Quintet, Inc.Īlthough the total cash provided by operating activities amount is the same whether the direct or indirect method of preparing the statement of cash flows is used, the information is provided in a different format. The Cost of Goods Manufactured Schedule. ![]()
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