Chapter 12, Problem 2AP

To determine

Prepare the cash flows from operating activities section for the year 2017 using direct method.

Explanation of Solution

Statement of cash flows: Statement of cash flows reports all the cash transactions which are responsible for inflow and outflow of cash and result of these transactions is reported as ending balance of cash at the end of reported period. Statement of cash flows includes the changes in cash balance due to operating, investing, and financing activities.

Cash flows from operating activities: Cash flows from operating activity represent the net cash flows from the general operation of the business by comparing the cash receipt and cash payments.

Direct method: The direct method uses the cash basis of accounting for the preparation of the statement of cash flows. It takes into account those revenues and expenses for which cash is either received or paid.

The below table shows the way of calculation of cash flows from operating activities using direct method:

Cash flows from operating activities (Direct method)

Add: Cash receipts.

Cash receipt from customer

Less: Cash payments:

To supplier

Interest expense

For operating expenses

Income tax expenses

Net cash provided from or used by operating activities

Table (1)

The cash flows from operating activities section for the year 2017:

L Company
Statement of Cash Flows (partial)-Direct Method
For the Year Ended December 31, 2017
Details	Amount ($)	Amount ($)
Cash flows from operating activities:
Receipts:
Collections from customers	97,400
Total cash receipts		97,400
Payments:
Cash payments to suppliers	(42,640)
Cash payments for salaries	(17,820)
Cash payments for rent	(9,040)
Cash payments for insurance	(3,780)
Cash payments for utilities	(2,740)
Cash payments for interest	(3,600)
Total cash payments		(79,620)
Net cash provided by operating activities		$17,780

Table (2)

Working notes:

The amount of cash receipts from customers.

Step 1: Calculate the change in accounts receivable.

$\begin{array}{c}\text{Change in accounts receivable}=\left(\begin{array}{l}\text{Ending balance}\\ -\text{Beginning balance}\end{array}\right)\\ =\text{\$5,600}-\$5,800\\ =\$200\left(\text{Decrease}\right)\end{array}$

Step 2: The Calculate the amount of cash receipts from customers.

$\begin{array}{c}\begin{array}{l}\text{Cash}\text{receipts}\text{from}\\ \text{Customers}\end{array}]=\text{Sales}\text{revenue }\left(\begin{array}{l}+\text{Decrease in Accounts Receivable}\\ \text{OR}\\ -\text{Increase in Accounts Receivable}\end{array}\right)\\ =\text{ Sales Revenue +Decrease in Accounts Receivable}\\ =\$97,200+\$200\\ =\$97,400\end{array}$

Calculate the cash payments to suppliers.

Step 1: Calculate the change in inventory.

$\begin{array}{c}\text{Change in inventory=}\left(\begin{array}{l}\text{Ending balance}\\ -\text{Beginning balance}\end{array}\right)\\ =\text{\$1,980}-\$1,540\\ =\$440\left(\text{Increase}\right)\end{array}$

Step 2: Calculate the change in accounts payable.

$\begin{array}{c}\text{Change in accounts payable}=\left(\begin{array}{l}\text{Ending balance}\\ -\text{Beginning balance}\end{array}\right)\\ =\text{\$4,400}-\$4,600\\ =\$200\left(\text{Decrease}\right)\end{array}$

Step 3: Calculate the amount of cash payments to suppliers.

$\begin{array}{c}\left(\begin{array}{l}\text{Cash}\text{paid }\\ \text{to }\text{suppliers}\end{array}\right)=\text{Cost of Goods Sold }\left(\begin{array}{l}+\text{Decrease in Accounts Payable}\\ \text{/}\text{Increase in Inventory}\\ \text{OR}\\ -\text{Increase in Accounts Payable }\\ \text{/}\text{Decrease in Inventory}\end{array}\right)\\ =\left(\begin{array}{l}\text{Cost of goods sold + Decrease in accounts payable}\\ \text{ + Increase in inventory}\end{array}\right)\\ =\$42,000+\$440+\$200\\ =\$42,640\end{array}$

Calculate the amount of cash paid for salaries expenses:

Step 1: Calculate the change in salaries payable.

$\begin{array}{c}\text{Change in salaries payable =}\left(\begin{array}{l}\text{Ending balance}\\ -\text{Beginning balance}\end{array}\right)\\ =\text{\$880}-\$700\\ =\$180\left(\text{Increase}\right)\end{array}$

Step 2: Calculate the amount of cash paid for income taxes.

$\begin{array}{c}\left(\begin{array}{l}\text{Cash paid }\\ \text{for salaries}\end{array}\right)=\text{Salaries expense}\left(\begin{array}{l}+\text{Decrease in salaries payable}\\ \text{OR}\\ -\text{Increase in salaries payable}\end{array}\right)\\ =\left(\text{Salaries expense}-\text{Increase in salaries payable}\right)\\ \text{=}\left(\text{\$18,000}-\$180\right)\\ =\$17,820\end{array}$

Calculate the amount of cash paid for rent expenses:

Step 1: Calculate the change in prepaid rent.

$\begin{array}{c}\text{Change in prepaid rent =}\left(\begin{array}{l}\text{Ending balance}\\ -\text{Beginning balance}\end{array}\right)\\ =\text{\$220}-\$180\\ =\$40\left(\text{Increase}\right)\end{array}$

Step 2: Calculate the amount of cash paid for rent expenses.

$\begin{array}{c}\left(\begin{array}{l}\text{Cash paid for }\\ \text{rent expenses}\end{array}\right)=\text{Rent expenses}\left(\begin{array}{l}-\text{Decrease in prepaid rent}\\ \text{OR}\\ +\text{Increase in prepaid rent}\end{array}\right)\\ =\left(\text{Rent expense}-\text{Increase in prepaid rent}\right)\\ \text{=}\left(\text{\$9,000 + }\$40\right)\\ =\$9,040\end{array}$

Calculate the amount of cash paid for insurance expenses:

Step 1: Calculate the change in prepaid insurance.

$\begin{array}{c}\text{Change in prepaid insurance =}\left(\begin{array}{l}\text{Ending balance}\\ -\text{Beginning balance}\end{array}\right)\\ =\text{\$260}-\$280\\ =\$20\left(\text{Decrease}\right)\end{array}$

Step 2: Calculate the amount of cash paid for insurance expenses.

$\begin{array}{c}\left(\begin{array}{l}\text{Cash paid for }\\ \text{insurance expenses}\end{array}\right)=\text{Insurance expenses}\left(\begin{array}{l}-\text{Decrease in prepaid insurance}\\ \text{OR}\\ +\text{Increase in prepaid insurance}\end{array}\right)\\ =\left(\text{Insurance expense}-\text{Decrease in prepaid insurance}\right)\\ \text{=}\left(\text{\$3,800}-\$20\right)\\ =\$3,780\end{array}$

Calculate the amount of cash paid for utilities expenses:

Step 1: Calculate the change in utilities payable.

$\begin{array}{c}\text{Change in utilities payable =}\left(\begin{array}{l}\text{Ending balance}\\ -\text{Beginning balance}\end{array}\right)\\ =\text{\$220}-\$160\\ =\$60\left(\text{Increase}\right)\end{array}$

Step 2: Calculate the amount of cash paid for utilities expense.

$\begin{array}{c}\left(\begin{array}{l}\text{Cash paid for}\\ \text{ utilities expense}\end{array}\right)=\text{Utilities expense}\left(\begin{array}{l}+\text{Decrease in utilities payable}\\ \text{OR}\\ -\text{Increase in utilities payable}\end{array}\right)\\ =\left(\text{Utilities expense}-\text{Increase in utilities payable}\right)\\ \text{=}\left(\text{\$2,800}-\$60\right)\\ =\$2,740\end{array}$