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Chapter 23: Q20Q (page 1372)

Question: What are some of the arguments in favor of using the indirect (reconciliation) method as opposed to the direct method for reporting a statement of cash flows?

Short Answer

Expert verified

Answer

The indirect method is preferred over the direct method of cash flow because it does not require additional efforts for preparation; it is according to the accrual basis of accounting and also defines the difference between the net income and cash from operations.

Step by step solution

01

Definition of Cash Flow Statement

The statement prepared by the business entity providing the information regarding all the transactions that increase or decrease the cash balance is known as the cash flow statement. Such a statement is prepared in three sections.

02

Arguments in favor of using the indirect method

  1. The indirect method highlights the difference between the net income of the business entity and the cash generated from the operations.
  2. The direct method statement of cash flow confuses the financial statement's users with knowledge of only the accrual basis of accounting.
  3. Direct method cannot be justified based on cost-benefit analysis because it will require additional efforts as all other statements are prepared based on accrual accounting.

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Most popular questions from this chapter

Briefly describe some of the similarities and differences between GAAP and IFRS with respect to cash flow reporting.

Question: The board of directors of Tirico Corp. declared cash dividends of \(260,000 during the current year. If dividends payable was \)85,000 at the beginning of the year and $90,000 at the end of the year, how much cash was paid in dividends during the year?

For purposes of the statement of cash flows, under IFRS, income taxes paid are treated as:

  1. cash flows from operating activities unless they can be separately identified as part of investing or financing activities.
  2. an operating activity in all cases.
  3. an investing or operating activity, depending on whether a refund is received.
  4. either operating, financing, or investing activity, but treated consistently to other companies in the same industry.

Moxley Corporation had January 1 and December 31 balances as follows.

1/1/17 12/31/17

Inventory \(95,000 \)113,000

Accounts payable 61,000 69,000

For 2017, cost of goods sold was $500,000. Compute Moxley’s 2017 cash payments to suppliers.


Question: (SCF Theory and Analysis of Transactions) Ashley Company is a young and growing producer of electronic measuring instruments and technical equipment. You have been retained by Ashley to advise it in the preparation of a statement of cash flows using the indirect method. For the fiscal year ended October 31, 2017, you have obtained the following information concerning certain events and transactions of Ashley.

1. The amount of reported earnings for the fiscal year was \(700,000, which included a deduction for a loss of \)110,000 (see item 5 below).

2. Depreciation expense of \(315,000 was included in the income statement.

3. Uncollectible accounts receivable of \)40,000 were written off against the allowance for doubtful accounts. Also, \(51,000 of bad debt expense was included in determining income for the fiscal year, and the same amount was added to the allowance for doubtful accounts.

4. A gain of \)6,000 was realized on the sale of a machine. It originally cost \(75,000, of which \)30,000 was undepreciated on the date of sale.

5. On April 1, 2017, lightning caused an uninsured building loss of \(110,000 (\)180,000 loss, less reduction in income taxes of \(70,000). This loss was included in determining income as indicated in item 1 above.

6. On July 3, 2017, building and land were purchased for \)700,000. Ashley gave in payment \(75,000 cash, \)200,000 market price of its unissued common stock, and signed a \(425,000 mortgage note payable.

7. On August 3, 2017, \)800,000 face value of Ashley’s 10% convertible debentures was converted into $150,000 par value of its common stock. The bonds were originally issued at face value.

Instructions

Explain whether each of the seven numbered items above is a cash inflow or outflow, and explain how it should be disclosed in Ashley’s statement of cash flows for the fiscal year ended October 31, 2017. If any item is neither an inflow nor an outflow of cash, explain why it is not, and indicate the disclosure, if any, that should be made of the item in Ashley’s statement of cash flows for the fiscal year ended October 31, 2017.
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