Chapter 14A – Lecture Notes
14A-1
I. Appendix 14A: The direct method of determining the
net cash provided by operating activities (Slide #1 is a
title slide for the appendix)
Learning Objective 4: Use the direct method to
determine the net cash provided by operating activities.
A. Computing net cash provided by operating activities
i. The direct method computes net cash
provided by operating activities by
reconstructing the income statement on a
cash basis from top to bottom.
1. The amount of net cash provided by
operating activities under the direct method
will always agree with the amount
computed using the indirect method.
B. Similarities and differences in the handling of data
i. The adjustments for accounts that affect
revenue are the same in the direct and
indirect methods.
1. In either case, increases in the accounts are
deducted and decreases in the accounts are
added.
ii. The adjustments for accounts that affect
expenses are handled in opposite ways for
the direct and indirect methods. Under the
indirect method, the adjustments are made to
net income, whereas under the direct
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Chapter 14A – Lecture Notes
14A-2
method the adjustments are made to the
expense accounts themselves. For example:
1. In the indirect method, an increase in
prepaid expenses is deducted from net
income. However, in the direct method an
increase in prepaid expenses is added to
operating expenses.
iii. Regarding gains and losses on sale of assets,
no adjustments are needed at all under the
direct method.
1. These gains and losses are ignored because
they are not part of sales, cost of goods sold,
operating expenses, or income taxes.
iv When a company uses the direct method it
must prepare a reconciliation between net
income and the net cash provided by
operating activities. If it uses the indirect
method it must disclose the amount of interest
and income taxes paid during the year.
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