Page 639 - Accounting Principles (A Business Perspective)

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The net income amount is in the income statement. We enter both net income and dividends on the statement of
cash flows in Exhibit 130, Part B. The USD 10,000 net income is the starting figure in determining cash flows from
operating activities. Thus, we enter the net income of USD 10,000 on the statement in the cash flows from

operating activities section. The dividends are shown as a deduction in the cash flow from financing activities
section.
• The Equipment account increased by USD 20,000. The dividends are shown as a deduction in the cash flow
from financing activities section. The additional data indicate that USD 20,000 of equipment was purchased
during the period. A purchase of equipment is a deduction in the cash flows from investing activities section.
• The USD 5,000 increase in the Accumulated Depreciation—Equipment account equals the amount of
depreciation expense in the income statement for the period. As shown earlier, because depreciation does not

affect cash, under the indirect (addback) method we add it back to net income on the statement of cash flows
to convert accrual net income to a cash basis.
• The USD 30,000 increase in common stock resulted from the issuance of stock at par value, as disclosed in
the additional data (item 2) in Exhibit 128. An issuance of stock in the statement of cash flows is a positive
amount in the cash flows from financing activities section.
After we have analyzed the noncurrent accounts, we can prepare the statement of cash flows from the
information generated. Part A of Exhibit 130 presents the statement of cash flows for Welby using the direct
method. Part B shows the statement of cash flows for Welby using the indirect method. The appendix to this

chapter shows how a working paper can be used to assist in preparing a statement of cash flows for the Welby
Company under the indirect method. However, we believe you will gain a greater conceptual understanding by not
using a working paper.
The statement of cash flows has three major sections: cash flows from operating activities, cash flows from
investing activities, and cash flows from financing activities. The format in the operating activities section differs for
the direct and indirect methods. The direct method adjusts each item in the income statement to a cash basis. The
indirect method makes these same adjustments but to net income rather than to each item in the income statement.

Both methods eliminate not only the effects of noncash items, such as depreciation, but also gains and losses on
sales of plant assets.
The only item in the cash flows from investing activities section is the cash outflow of USD 20,000 for the
purchase of equipment. In a more complex situation, other items could be included in this category.
Two items are under the cash flows from financing activities section: The issuance of common stock resulted in a
cash inflow of USD 30,000 and the payment of dividends resulted in a cash outflow of USD 4,000.
The last line of the statement is the USD 11,000 increase in cash for the year. Other examples could result in a
decrease in cash for the year.
If the direct method is used, the reconciliation of net income to net cash flows from operating activities (the

indirect method) must be shown in a separate schedule. However, if the indirect method is used and the
reconciliation is shown in the statement of cash flows, no such separate schedule is required. Possibly this is one of
the reasons why so many companies use the indirect method.
However, if the indirect method is used, the amount of interest and income taxes paid must be provided in
related disclosures, usually immediately below the statement of cash flows. For instance, if Welby Company had
paid interest of USD 200 and income taxes of USD 8,000, these facts would be reported as follows:

Accounting Principles: A Business Perspective 640 A Global Text