Question

(Ch. 11)

The ___________ method started with net income and adjusts it by eliminating the effects of transactions that do not involve cash

Answer 1

The method in question is the indirect method of preparing a cash flow statement. It adjusts net income for non-cash transactions and changes in working capital to determine cash flow from operating activities. Items like depreciation, changes in inventory, and changes in accounts receivable and payable are considered during adjustments.

Step-by-step explanation:

The method you are referring to is the indirect method of preparing a cash flow statement. Under this approach, the cash flow from operating activities is determined by adjusting the net income to eliminate the effects of non-cash transactions, as well as changes in working capital. The indirect method starts by listing the net income and then making adjustments for transactions that affected the reported net income but did not result in actual cash inflows or outflows during the period. This may include adding back non-cash expenses such as depreciation and amortization, and adjusting for changes in inventory, accounts receivable, and accounts payable.

To begin using the indirect method, you would start with the net income as reported on the income statement. Then, adjustments are made for items such as:

• Depreciation and amortization - since these are non-cash expenses, they are added back to net income.
• Changes in accounts receivable - an increase in accounts receivable is subtracted from net income, as this reflects sales that have not yet been collected in cash.
• Changes in inventory - an increase in inventory is subtracted from net income because it represents cash that has been spent but not recovered through sales.
• Changes in accounts payable - an increase in accounts payable is added to net income, as this represents expenses that have been recognized but not yet paid in cash.

Finally, after adjusting the net income for these items, the result is the net cash provided by or used in operating activities. This figure is part of the cash flow statement, which also includes cash flows from investing and financing activities to reflect the company's overall cash movement during the reporting period.

Answer 2

The indirect method started with net income and adjusts it by eliminating the effects of transactions that do not involve cash.

Step-by-step explanation:

The method referred to in the given schoolwork question is the indirect method of preparing the cash flow statement. This financial statement starts with net income and makes adjustments for transactions that do not involve cash to show the actual cash flow from operating activities. Some common adjustments include depreciation expense, changes in accounts receivable and payable, and other non-cash items.

To illustrate, if a company's net income is $100,000 and it has depreciation expenses of $10,000, an increase in accounts receivable of $5,000, and a decrease in accounts payable of $3,000, the cash provided by operating activities would be calculated as follows:

1. Start with net income: $100,000
2. Add back non-cash expenses like depreciation: $10,000
3. Subtract increase in accounts receivable because this represents sales that did not result in immediate cash: -$5,000
4. Add decrease in accounts payable because this implies cash was conserved, not spent: -$3,000

The adjusted cash provided by operating activities, in this case, would be $102,000 ($100,000 + $10,000 - $5,000 - $3,000).