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12-16
Demonstration Problem 12-1 Solution, part b., Direct Method
Cash Flows from Operating Activities
Rules provided for reference:
Rules for Computing Cash Flow from Operating Activities, Direct Method
Rule 1
Revenue, plus decreases, minus increases in related current
assets (accrued revenues)
Rule 2
Revenue, plus increases, minus decreases in related current
liabilities (unearned revenues)
Rule 3
Expense items, plus increases, minus decreases in related
current assets (prepaid expenses)
Rule 4
Expense items, minus increases, plus decreases in related
current liabilities (accrued expenses)
Rule 5
Ignore gains, losses, and noncash revenue and expense
items reported on the income statement
Equals
Net cash flow from operating activities
Cash Inflow from Revenue
Sales revenue
$98,000
Rule 1
Minus increase in accounts receivable
(1,000)
Cash inflow from revenue
$97,000
Cash Outflow for Inventory
Cost of goods sold
$62,000
Rule 3
Minus decrease in inventory
(4,000)
Rule 4
Minus increase in accounts payable
(2,000)
Cash outflow for inventory
$56,000
Cash Outflow for Salaries
Salaries expense
$14,000
Rule 4
Plus decrease in salaries payable
5,000
Cash outflow for salaries
$19,000
Cash flows from investing and financing activities are presented
the same way under both the indirect and direct methods.
12-17
Demonstration Problem 12-1 Solution, part b. Direct Method
Hatch Company
Statement of Cash Flows
For the Year Ended December 31, 2016
Cash flows from operating activities
Cash inflow from revenue
$97,000
Cash outflow for inventory
(56,000)
Cash outflow for salaries expense
(19,000)
Net cash inflow from operating activities
$ 22,000
Cash flows from investing activities
Cash inflow from equipment sale
4,000
Cash outflow for equipment purchase
(9,000)
Cash outflow for land purchase
(14,000)
Net cash outflow for investing activities
(19,000)
Cash flows from financing activities
Cash inflow from stock issue
7,000
Cash outflow for debt payment
(6,000)
Cash payments for dividends
(5,000)
Net cash outflow for financing activities
(4,000)
Net decrease in cash
(1,000)
Beginning cash balance
2,000
Ending cash balance
$ 1,000
12-18
Demonstration Problem 12-1 Solution, part b. T-Account Approach,
Direct Method (Provided for Instructor Convenience)
T-Accounts
Cash
Accounts Payable
Common Stock
Bal. 2,000
(b3) 56,000
6,000 Bal.
18,000 Bal.
Operating Activities
58,000 (b2)
7,000 (g1)
(a2) 97,000
56,000 (b3)
8,000 Bal.
25,000 Bal.
19,000 (c2)
Investing Activities
Salaries Payable
Retained Earnings
(d2) 4,000
9,000 (d3)
(c2) 19,000
9,000 Bal.
(b1) 62,000
7,000 Bal.
14,000 (e1)
14,000 (c1)
(c1) 14,000
98,000 (a1)
4,000 Bal.
(d1) 10,000
3,000 (d2)
Financing Activities
(h1) 5,000
(g1) 7,000
6,000 (f1)
Notes Payable
17,000 Bal.
5,000 (h1)
(f1) 6,000
20,000 Bal.
Bal. 1,000
14,000 Bal.
Accounts Receivable
Bal. 8,000
97,000 (a2)
(a1) 98,000
Bal. 9,000
Merchandise Inventory
Bal. 20,000
62,000 (b1)
(b2) 58,000
Bal. 16,000
Equipment
Bal. 27,000
6,000 (d2)
(d3) 9,000
Bal. 30,000
Accumulated Dep.
(d2) 5,000
12,000 Bal.
10,000 (d1)
17,000 Bal.
Land
Bal. 15,000
(e1) 14,000
Bal. 29,000
12-19
Demonstration Problem 12-1 Workpaper, part a.1. Indirect Method,
Cash Flows from Operating Activities
Rules provided for reference:
Rules for Converting Net Income to Cash Flow from Operating Activities
Net Income ±
Rule 1
Add decreases and subtract increases in current assets
Rule 2
Add increases and subtract decreases in current liabilities
Rule 3
Add noncash expenses
Rule 4
Add losses, subtract gains
Equals
Net cash flow from operating activities
Noncash Current Asset and Current Liability Account Balances
Account Title
2016
2015
Change
Cash flows from Operating Activities
Net income
$
RULE
Add:
Rule 1
Rule 2
Rule 3
Subtract:
Rule 1
Rule 2
Rule 4
Net cash inflow from operating activities
$ 22,000
12-20
Demonstration Problem 12-1 Workpaper, part a.2. Indirect Method,
Cash Flows from Investing Activities
Equipment Account Information
Beginning balance in equipment
Add: Purchase of equipment (cash outflow)
Deduct: Sale of equipment (cash inflow)*
Ending balance in equipment
*Cash inflow for equipment sale:
Book value of equipment sold + gain
($ – $ ) + $ = $
Land Account Information
Beginning balance in land
Add: Purchases of land (cash outflow)
Ending balance in land
Demonstration Problem 12-1 Workpaper, part a.3. Indirect Method,
Cash Flows from Financing Activities
Notes Payable Account Information
Beginning balance in notes payable
Deduct: debt repayment (cash outflow)
Ending balance in notes payable
Common Stock Account Information
Beginning balance in common stock
Add: common stock issued (cash inflow)
Ending balance in common stock
Retained Earnings Account Information
Beginning balance in retained earnings
Add: Net income
Deduct: Dividends (cash outflow)
Ending balance in retained earnings
12-21
Demonstration Problem 12-1 Workpaper, part a.4. Indirect Method,
Statement of Cash Flows
Hatch Company
Statement of Cash Flows
For the Year Ended December 31, 2016
Cash flows from operating activities
Net income
$
Add:
Decrease in inventory
Increase in accounts payable
Depreciation expense (noncash)
Subtract:
Increase in accounts receivable
Decrease in salaries payable
Gain on sale of equipment (noncash)
Net cash inflow from operating activities
$
Cash flows from investing activities
Cash inflow from equipment sale
Cash outflow for equipment purchase
Cash outflow for land purchase
Net cash outflow for investing activities
Cash flows from financing activities
Cash inflow from stock issue
Cash outflow for debt payment
Cash payments for dividends
Net cash outflow for financing activities
Net decrease in cash
(1,000)
Beginning cash balance
Ending cash balance
$ 1,000
12-22
Demonstration Problem 12-1 Workpaper, part b., Direct Method
Cash Flows from Operating Activities
Rules provided for reference:
Rules for Computing Cash Flow from Operating Activities, Direct Method
Rule 1
Revenue, plus decreases, minus increases in related current
assets (accrued revenues)
Rule 2
Revenue, plus increases, minus decreases in related current
liabilities (unearned revenues)
Rule 3
Expense items, plus increases, minus decreases in related
current assets (prepaid expenses)
Rule 4
Expense items, minus increases, plus decreases in related
current liabilities (accrued expenses)
Rule 5
Ignore gains, losses, and noncash revenue and expense
items reported on the income statement
Equals
Net cash flow from operating activities
Cash Inflow from Revenue
Sales revenue
Rule 1
Cash inflow from revenue
Cash Outflow for Inventory
Cost of goods sold
Rule 3
Rule 4
Cash outflow for inventory
Cash Outflow for Salaries
Salaries expense
Rule 4
Cash outflow for salaries
Cash flows from investing and financing activities are presented
the same way under both the indirect and direct methods.
12-23
Demonstration Problem 12-1 Workpaper, part b. Direct Method
Hatch Company
Statement of Cash Flows
For the Year Ended December 31, 2016
Cash flows from operating activities
Cash inflow from revenue
$
Cash outflow for inventory
Cash outflow for salaries expense
Net cash inflow from operating activities
$
Cash flows from investing activities
Cash inflow from equipment sale
Cash outflow for equipment purchase
Cash outflow for land purchase
Net cash outflow for investing activities
Cash flows from financing activities
Cash inflow from stock issue
Cash outflow for debt payment
Cash payments for dividends
Net cash outflow for financing activities
Net decrease in cash
(1,000)
Beginning cash balance
Ending cash balance
$ 1,000
12-24
Demonstration Problem 12-1 Workpaper, part b. T-Account Approach,
Direct Method (Provided for Instructor Convenience)
T-Accounts
Cash
Accounts Payable
Common Stock
Bal. 2,000
Operating Activities
Investing Activities
Salaries Payable
Retained Earnings
Financing Activities
Notes Payable
Bal. 1,000
Accounts Receivable
Merchandise Inventory
Equipment
Accumulated Dep.
Land
12-25
Quiz Questions for Chapter 12
Use the following information to answer the next three questions.
Comparative Balance Sheets, December 31
2016
2015
Cash
$ 200
$ 500
Accounts receivable
2,200
4,000
Prepaid rent
3,000
1,000
Inventory
8,000
5,000
Land
19,000
13,000
Total assets
$32,400
$23,500
Accounts payable
$12,000
$ 6,500
Note payable
7,000
10,000
Common stock
6,400
1,500
Retained earnings
7,000
5,500
Total equity
$32,400
$23,500
Income Statement for 2016
Sales revenue
$ 20,000
Cost of goods sold
(15,200)
Gross margin
4,800
Rent expense
(1,000)
Net income
$ 3,800
1. The amount of net cash flow from operating activities for 2016 was
a. $6,100.
b. $9,100.
c. $ 600.
d. $18,800.
2. The amount of net cash flow from investing activities for 2016 was
a. $(9,000).
b. $(1,000).
c. $(4,000).
d. $(6,000).
3. The amount of net cash flow from financing activities for 2016 was
a. $(5,300).
b. $(400).
c. $(4,900).
d. $2,300.
12-26
4. Which of the following statements is true regarding preparing the statement of cash flows?
a. The information needed to prepare the statement of cash flows can be obtained from last year’s bal-
ance sheet and comparative income statements.
b. Revenue and expense accounts are most important in determining cash flows from financing activi-
ties.
c. Long-term asset accounts are used to determine cash flows from investing activities.
d. Cash paid for inventory is classified as an investing activities cash outflow.
5. Which of the following cash transactions is classified as an investing activity on the statement of cash
flows?
a. Cash borrowed.
b. Cash received from issuing stock.
c. Cash collected on a loan.
d. Cash received from revenue.
6. Jackson Hole, Inc. owns equipment that cost $25,000. The equipment has a four-year useful life and a
$5,000 salvage value. Assuming the company uses straight-line depreciation, the amount of deprecia-
tion expense that would appear each year on the statement of cash flows presented using the direct meth-
od would be
a. zero.
b. a $6,250 cash outflow under operating activities.
c. a $5,000 cash outflow under investing activities.
d. a $5,000 cash outflow under operating activities.
7. A building costing $55,000 with $16,500 of accumulated depreciation was sold for $40,000. How would
the cash flow from the sale appear on the statement of cash flows?
a. $1,500 in operating activities and $38,500 in investing activities.
b. $40,000 in investing activities.
c. $38,500 noncash financing and investing activities and $1,500 in operating activities.
d. $40,000 in financing activities.
8. The owners of X Company invested $2,000 in the company. X Company used the cash to invest in Y
Company. On X’s statement of cash flows these transactions would be classified, respectively, as
a. an investing activity and an investing activity.
b. a financing activity and a financing activity.
c. a financing activity and an investing activity.
d. an investing activity and a financing activity.
9. Issuing a note for the purchase of land is an example of
a. an investing activity.
b. a financing activity.
c. a noncash investing and financing activity.
d. a transaction that would not appear on the statement of cash flows.
10. The sum of the three major components (operating activities, investing activities, and financing activi-
ties) on a statement of cash flows will add up to
a. the change in the Cash account balance between the beginning and ending of the period.
b. the ending cash balance.
c. the amount of cash inflow for the period.
d. net income for the period.
12-27
Quiz Answers
Question
Answer
1
A
2
D
3
B
4
C
5
C
6
A
7
B
8
C
9
C
10
A
12-28
Summary Outline of a Lesson Plan for Chapter 12
I. Explain accrual to cash conversions. First teach students to identify the relation-
ships between cash flows and changes in balance sheet accounts.
A. Purchase of land.
B. Convert a simple direct method example of cash flows from operating activities to
the indirect method.
C. Explain the general rules for converting net income to cash flows from operating
activities.
II. Use financial statements as the source of data for preparing the statement of
cash flowsÄindirect method. Use Demonstration Problem 12-1 to illustrate using
comparative balance sheets and an income statement as the source of data. Have stu-
dents begin by identifying changes in current asset and current liability accounts, then
using the rules to obtain cash flows from operating activities. Explain changes in the
remaining balance sheet items and prepare a formal statement of cash flows.
III. Reconstruct the statement of cash flows using the direct method (appendix).
Again use Demonstration Problem 12-1. Illustrate presenting cash flows from op-
erating activities using the indirect method. Apply the rules for converting net in-
come to cash flow from operating activities:
Rule 1
Revenue plus decreases, minus increases in related current
assets (accrued revenues)
Rule 2
Revenue plus increases, minus decreases in related current
liabilities (unearned revenues)
Rule 3
Expense items plus increases, minus decreases in related
current assets (prepaid expenses)
Rule 4
Expense items minus increases, plus decreases in related
current liabilities (accrued expenses)
Rule 5
Ignore gains, losses, and noncash revenue and expense
items reported on the income statement
Equals
Net cash flow from operating activities
IV. Time considerations and homework assignments. Spend one hour introducing ac-
crual to cash conversions and the rules for converting net income to cash flows from
operating activities under the indirect method. It takes another hour to prepare the
complete statement of cash flows under the indirect method. Explaining the direct
method of presenting cash flows from operating activities takes thirty minutes. Prob-
lems 12-19A or 12-19B and 12-21A or 12-21B are similar to the demonstration prob-
lem. Although these problems specifically require either the direct or indirect method
of determining cash flow from operating activities, we suggest you instruct students
to work the operating activities sections of the problems you’ve assigned using both
the direct and indirect methods.
12-29
Summary Outline of an Alternate Lesson Plan for Chapter 12
(T-account Approach, Direct Method)
I. Use T-accounts to explain accrual to cash conversions. First teach students to
identify the relationships between cash flows and changes in balance sheet accounts.
Introduce relationships that are progressively more difficult.
A. Purchase of land.
B. Conversion of accrual-based revenue to cash received.
C. Determining cash paid for inventory.
II. Use financial statements as the source of data for preparing the statement of
cash flowsÄdirect method. Use Demonstration Problem 12-1 to illustrate using
comparative balance sheets and an income statement as the source of data for deriv-
ing the statement of cash flows. Have students begin the problem by opening T-
accounts for all the balance sheet items. Reconstruct the journal entries that recorded
income statement transactions. Explain changes in the remaining balance sheet items
and prepare a formal statement of cash flows.
III. Reconstruct the statement of cash flows using the indirect method. Reuse the da-
ta in Demonstration Problem 12-1 to illustrate presenting cash flows from operating
activities using the indirect method. Apply the rules for converting net income to
cash flow from operating activities:
Rule 1. Add decreases and subtract increases in current asset account balances.
Rule 2. Add increases and subtract decreases in current liability account balances.
Rule 3. Add noncash expenses to net income.
Rule 4. Add losses to net income and subtract gains from net income.
IV. Time considerations and homework assignments. Spend one hour of class time
introducing accrual to cash conversions. It takes another hour and a half to explain
the T-account analysis. Explaining the indirect method of presenting cash flows from
operating activities takes thirty minutes. Problems 12-19A or 12-19B and 12-21A or
12-21B are similar to the demonstration problem. Although these problems specifi-
cally require either the direct or indirect method of determining cash flow from oper-
ating activities, we suggest you instruct students to work the operating activities sec-
tions of the problems you’ve assigned using both the direct and indirect methods.
