Question

(Appendix 11A) Preparing a Statement of Cash Flows-Direct Method

Financial statements for Rowe Publishing Company are presented below.

Required:

Prepare a statement of cash flows for 2011, using the direct method to determine net cash flow from operating activities.

Answer 1

Cash flows from operating activities highlight the effect of those cash items that affect net income. Cash flows from investing activities shows increase or decrease in long-term assets and investments. Cash flows from financing activities underline the effect of cash which in turns affect shareholder’s equity and long-term liabilities.

1) Direct Method : Cash flow statement based on direct method is a profit and loss account on cash basis. Under this method, cash receipts from operating activities, i.e. cash sales, cash collected from customers etc. and cash payments for operating activities such as cash purchases, payment to creditors, etc. are disclosed.

Under the direct method, information about key classes of gross cash inflows and gross cash outflows may be obtained either:

(a) From the accounting records of the business, or

(b) By adjusting sales, cost of sales, i.e. interest and similar income and interest expense and similar charges and other items in the statement of profit and loss for:

i) Variations in inventories and operating receivables and payables,

ii) Other non-cash items, and

iii) Other items for which the cash affects results into investing or financing cash

flows.

Using the data provided by Company RP, direct method is being used to determine the net cash flows from operating activities. The statement of cash flows for the year ending 2011 is prepared in Table 1 below:

Table 1

Company RP Statement of Cash Flows For the year ended December 31, 2011
I.	Cash flows from operating activities	Amount ($)	Amount ($)
	Cash receipts from customers ($1,051,000 + $231,000 – $240,000)	1,042,000
	Less: Cash paid to creditors ($578,000 + $121,000 + $190,000 – $170,000 – $133,000)	(586,000)
	Cash paid to employees ($351,000 + $11,000 – $15,000)	(347,000)
	Cash paid for interest expense	(16,000)
	Cash paid for income taxes	(29,000)
	Net cash flow from operating activities		64,000
II.	Cash flows from investing activities
	Purchase of Equipment	(25,000)
	Net cash flow from investing activities		(25,000)
III.	Cash flows from financing activities
	Cash paid to repay notes payable	(35,000)
	Cash received for issuing bonds	50,000
	Cash paid for dividends	(35,000)
	Net cash flow from financing activities		(20,000)
	Net increase / (decrease) in cash		19,000
	Cash and cash equivalents at the beginning of year		66,000
	Cash and cash equivalents at the end of year		85,000