Page 637 - Accounting Principles (A Business Perspective)

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Accrual Basis Add Deduct Cash Basis Flows from
(Cash operating
activities)
Sales $140,000 $10,000* $130,000
Cost of goods sold $100,00 $6,000† 4,000‡ $102,000
0
Operating expenses 25,000 2,000§ 23,000
Depreciation 5,000 5,000
expense
______ -0-
$130,000 125,000
Net income $10,000 $ 5,000
* Increase in
Accounts
Receivable.
†Decrease in
Accounts Payable.
‡ Decrease in
Merchandise
Inventory.
§ Increase in
Accrued Liabilities
Payable.
Exhibit 129: Working paper to convert income statement from accrual basis to cash basis
As a general rule, an increase in a current asset (other than cash) decreases cash inflow or increases cash
outflow. Thus, when accounts receivable increases, sales revenue on a cash basis decreases (some customers who
bought merchandise have not yet paid for it). When inventory increases, cost of goods sold on a cash basis increases
(increasing cash outflow). When a prepaid expense increases, the related operating expense on a cash basis
increases. (For example, a company not only paid for insurance expense but also paid cash to increase prepaid

insurance.) The effect on cash flows is just the opposite for decreases in these other current assets.
An increase in a current liability increases cash inflow or decreases cash outflow. Thus, when accounts payable
increases, cost of goods sold on a cash basis decreases (instead of paying cash, the purchase was made on credit).
When an accrued liability (such as salaries payable) increases, the related operating expense (salaries expense) on a
cash basis decreases. (For example, the company incurred more salaries than it paid.) Decreases in current
liabilities have just the opposite effect on cash flows.
Welby Company had no prepaid expenses. The current assets and current liabilities affecting the income
statement items changed as follows:
Increase Decrease
Accounts receivable $10,000
Merchandise inventory $4,000
Accounts payable 6,000
Accrued liabilities payable 2,000
Thus, Welby converted its income statement to a cash basis as shown in Exhibit 129.
The indirect method makes certain adjustments to convert net income to cash flows from operating activities.

Welby must analyze the effects of changes in current accounts (other than cash) on cash. The firm should also take
into account noncash items such as depreciation that affected net income but not cash. Welby had only one such
item—depreciation expense of USD 5,000. Applying these adjustments to Welby's financial statements and other
data in Exhibit 128 yields the following schedule:
Cash flow from operating activities:
Net income $10,000
Adjustments to reconcile net income to net
cash provided
by operating activities:

Accounting Principles: A Business Perspective 638 A Global Text