Exercise-10: Computation of net cash flows from operating activities – indirect method

Learning objective:
This exercise illustrates the computation of a company’s net cash flows from its operating activities under the indirect method.

Exercise-10(a):

The following information has been taken from the income statement and balance sheet of Virginia Inc.

Income statement:

• Net income: $192,500
• Depreciation expense: $62,500
• Amortization of intangible assets: $20,000
• Gain on sale of equipment: $45,000
• Loss on sale of investments: $17,500

Balance sheet:

• Accounts receivable on January 1, 2024: $190,000
• Accounts receivable on December 31, 2024: $167,500
• Inventory on January 1, 2024: $287,500
• Inventory on December 31, 2024: $251,500
• Prepaid expenses on January 1, 2024: $5,000
• Prepaid expenses on December 31, 2024: $11,000
• Accounts payable on January 1, 2024: $205,000
• Accounts payable on December 31, 2024: $189,500
• Accrued expenses payable on January 1, 2024: $77,500
• Accrued expenses payable on December 31, 2024: $90,000

The accounts payable balances provided above relate to suppliers of merchandise only.

Required: Using the above information, compute the net cash flows from operating activities under indirect method.

Solution:

The increases or decreases in working capital accounts have been computed below:

• 1 – Decrease in accounts receivable: $190,000 – $167,500
• 2 – Decrease in inventory: $287,500 – $251,500
• 3 – Increase in accrued expenses payable: $90,000 – $77,500
• 4 – Increase in prepaid expenses: $11,000 – $5,000
• 5 – Decrease in accounts payable: $205,000 – $189,500

Exercise-10(b):

The income statement of VG Company for the year ended December 31, 2017 is given below:

The following additional information is also provided to you:

1. The depreciation expense of $15,000 is included in the administrative expenses shown in the above income statement.
2. Accounts receivable decreased by $90,000 during the year.
3. Accounts payable decreased by $68,750 during the year.
4. Prepaid expenses increased by $42,500 during the year.
5. Accrued expenses decreased by $25,000 during the year.

You are requested to compute the net cash flow from operating activities of VG Company using the income statement and additional information given above.

Solution

*Decrease in inventory has been computed by taking beginning inventory and ending inventory figures from the income statement:
= $475,000 – $400,000
= $75,000