16 3 Prepare the Statement of Cash Flows Using the Indirect Method Principles of Accounting, Volume 1: Financial Accounting

These financial statements are used as internal documents to direct the firm’s operations. They are also used as reporting documents for the firm’s investors, creditors, members of the board of directors, and government agencies. The indirect method presents the statement of cash flows beginning with net income or loss, with subsequent additions cash flow statement format indirect method to or deductions from that amount for non-cash revenue and expense items, resulting in cash flow from operating activities. Often used interchangeably with the term, “statement of cash flows,” the cash flow statement tracks the real inflows and outflows of cash from operating, investing and financing activities over a pre-defined period.

• Since accrual accounting is used in the majority of companies, items like interest income could be earned during one financial period but actually received in the following financial period.
• Companies tend to prefer the indirect presentation to the direct method because the information needed to create this report is readily available in any accounting system.
• Changes in long-term assets for the period can be identified in the Noncurrent Assets section of the company’s comparative balance sheet, combined with any related gain or loss that is included on the income statement.
• Further assume that there were no investing or financing transactions, and no depreciation expense for 2018.
• The remainder of this section demonstrates preparation of thestatement of cash flows of the company whose financial statementsare shown in Figure 16.2, Figure 16.3, and Figure 16.4.

These adjustments include deducting realized gains and other adding back realized losses to the net income total. To see the real impact on Cash Flow, the increase in accounts payable must be added back to Net Income. If an asset account decreases, cash must have come in exchange for the Asset decrease. Your balance sheet shows an original value of $15,000 and accumulated depreciation of $10,000.

How to prepare a cash flow statement using the indirect method

Under the indirect method, the format of the cash flow statement (CFS) comprises of three distinct sections. The two methods by which cash flow statements (CFS) can be presented are the indirect method and direct method. The Cash Flow Statement Indirect method is used by most corporations, begins with a net income total and adjusts the total to reflect only cash received from operating activities. Under U.S. GAAP, interest paid and received are always treated as operating cash flows. While each company will have its own unique line items, the general setup is usually the same.

Reliance on any information provided on this site or courses is solely at your own risk. This means that though Net Income is reported as decreased in the process, in reality – the cash has not been given out. In other words, an increase in a Current liabilities needs to be added back into income. To record this transaction, you show proceeds from the sale of the crane of $7,000 under investing activity. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.

Direct cash flow method vs. indirect cash flow method

The additional information provided for 2012 indicates Home Store, Inc., paid off bonds during the year with a principal amount of $18,000. This is reflected in the financing activities section of the statement of cash flows as an $18,000 decrease in cash. In the case of Propensity Company, the decreases incash resulted from notes payable principal repayments and cashdividend payments. Propensity Company had an increase in the current operatingliability for salaries payable, in the amount of $400. The payablearises, or increases, when an expense is recorded but the balancedue is not paid at that time. The operating activities cash flow is based on the company’s netincome, with adjustments for items that affect cash differentlythan they affect net income.

• To see the real impact on Cash Flow, the increase in accounts payable must be added back to Net Income.
• The sole noncash expense on Propensity Company’s income statement, which must be added back, is the depreciation expense of $14,400.
• Alternatively, a small negativecash flow from operating might serve as an early warning thatallows management to make needed corrections, to ensure that cashsources are increased to amounts in excess of cash uses, for futureperiods.
• For example, in the Propensity Company example, there was a decrease in cash for the period relating to a simple purchase of new plant assets, in the amount of $60,000.
• The statement of cash flows prepared using the indirect method adjusts net income for the changes in balance sheet accounts to calculate the cash from operating activities.
• The indirect method measures how much a company made or spent through various sources over a given period.
• In other words, an increase in a Current liabilities needs to be added back into income.

The net income on the PropensityCompany income statement for December 31, 2018, is $4,340. OnPropensity’s statement of cash flows, this amount is shown in theCash Flows from Operating Activities section as Net Income. Increases in net cash flow from financing usually arise when the company issues share of stock, bonds, or notes payable to raise capital for cash flow. Propensity Company had two examples of an increase in cash flows, one from the issuance of common stock, and one from increased borrowing through notes payable. The operating activities cash flow is based on the company’s net income, with adjustments for items that affect cash differently than they affect net income. The net income on the Propensity Company income statement for December 31, 2018, is $4,340.

What is Cash Flow Statement?

A gain is subtracted from net income and a loss is added to net income to reconcile to cash from operating activities. Propensity’s income statement for the year 2018 includes a gain on sale of land, in the amount of $4,800, so a reversal is accomplished by subtracting the gain from net income. On Propensity’s statement of cash flows, this amount is shown in the Cash Flows from Operating Activities section as Gain on Sale of Plant Assets.