[morca87]

So the indirect method appears pretty easy as along you memorize the rule per the post below which is also noted within Becker CPA Review, but I’m having issues with the direct method. So I researched direct vs indirect method on another71 and found the following post (see “Post” below”). To me, the “direct” rule doesn’t appear to be consistent with Becker CPA and here’s the reason why:

Per Becker CPA, cash received from customers (increase cash) per the direct method, calculated as follows:

Revenues

– Increase in receivables

+ Decrease in receivables

+ Increase in unearned revenue

– Decrease in unearned revenue

______________________________________________

= Cash Received from Customers

Also here’s another example,

Per Becker CPA, cash paid to suppliers and employees (decreases cash), calculated as follows:

COGS

+ Increase in inventory

– Decrease in Inventory

– Increase in AP

+ Decrease in AP

___________________________________

= Cash paid to suppliers

Post:________________________________________________________________________________________________

Ok so for the INDIRECT method you are converting from Accrual to Cash basis:

So remember this: Every change in an account with a normal DR balance: has the opposit effect! – i.e. if the account increases, cash decreases!

Every change in an account with a normal CR balance: has the same effect!- i.e. if the account increases, cash increases!

For the DIRECT method, you are converting from Cash to Accrual basis (or that’s how I think about it anyway):

So remember this: Every change in an account with a normal DR balance: has the same effect! – i.e. if the account increases, cash increases!

Every change in an account with a normal CR balance: has the opposit effect!- i.e. if the account increases, cash decreases!

__________________________________________________________________________________________________

Question:

I don’t know why but for whatever reason the direct method is confusing me. If you apply the rule above per the post to the becker cpa example, it doesn’t appear consistent (i.e., Per the post, AR normally has a DR balance therefore if AR increases, cash increases, but per Becker CPA states the opposite, you subtract increase in AR from cash received from customers.

I feel like it’s me and I may be comparing apple to oranges.

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[Peach1024]

I don't really understand what the person was saying in the post you copied/pasted; I might just be misunderstanding. This is how I think of it though, and I know it works because I've done all the Cash Flow MCQs and simulations without issue. For clarify when I refer to accounts having a same or different “sign”, I mean debit/credit status. It's just easier for me to think in terms of (-) and (+) versus typing out debit/credit each time.

When you go from accrual to cash – in other words, starting with any income statement account and trying to figure out cash flows associated with it – cash has a direct relationship with accounts with the same sign as your income statement account. For example, assume the problem is this:

Net income: $100,000

Increase in AR: $20,000

Increase in AP: $30,000

What is cash flows from operations?

Net income is essentially a credit account, even though it's not really an “account” as much as it is a net result of revenues minus expenses. Anyway, since net income is a credit account and we're going from accrual to cash, cash will have a direct relationship with all credit accounts and an inverse relationship with all debit accounts. That means the following:

Increase in A/R of $20,000 = Decrease in cash of $20,000 (inverse relationship since A/R is a debit account)

Increase in A/P of $30,000 = Increase in cash of $30,000 (direct relationship since A/P is a credit account)

Cash flow from operations = $100,000 – $20,000 + $30,000

Note that this works for any situation – this is problem #41 from Becker's cash flow MCQs following:

COGS: $450,000

Decrease in inventory: $160,000

Decrease in A/P: $40,000

The question asks what should be reported on the statement of cash flows for payments to suppliers. COGS is an expense account, which means it has a debit balance. Since we're going from accrual to cash, that means cash will have a direct relationship with activity in all debit accounts.

Decrease in inventory of $160,000 = decrease in cash of $160,000, since inventory is a debit account

Decrease in A/P of $40,000 = increase in cash of $40,000, since A/P is a credit account

Payments to suppliers = $450,000 – $160,000 + $40,000 = $330,000

When you go from cash to accrual – in other words, starting with cash flows and trying to figure out what is reported on the income statement for it; this question is asked less frequently than accrual to cash – cash has a direct relationship with accounts with the different sign as the account you're starting with. For example, this is problem #18 in the Becker MCQs:

Cash paid for interest: $70,000 (expense – debit account)

Decrease in prepaid interest: $23,000

Decrease in interest payable: $17,000

What is interest expense on the income statement?

Decrease in prepaid interest of $23,000 = Increase of $23,000 (inverse relationship since prepaid interest is a debit account)

Decrease in interest payable of $17,000 = Decrease of $17,000 (direct relationship since interest payable is a credit account)

Interest expense = $70,000 + $23,000 – $17,000 = $76,000.

I hope this helps. I think everyone has to come up with a way they understand cash flow adjustments the best, but for me it's easiest to remember than if I'm going from an income statement account to cash flows I'm going from accrual to cash, and if I'm going from cash flows to an income statement account I'm going from cash to accrual.

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FAR - scheduled for 10/20/14

[spartancpa15]

It really helped me to think of the direct method using a J/E format. All you really need to remember are the accounts involved in each entry and just plug in the increases/decreases according to the normal balances of the accounts.

Cash received from customers:

Dr – Cash received (plug to solve for)

Dr/Cr – Inc/Dec in A/R

Cr/Dr – Inc/Dec in Unearned Revenue

Cr – Sales Revenue

Cash paid to suppliers:

Dr – COGS

Dr/Cr – Inc/Dec in Inventory

Cr/Dr – Inc/Dec in A/P

Cr – Cash paid (plug to solve for)

Cash paid for operating expenses:

Dr – Income statement expense

Dr/Cr – Inc/Dec in Prepaid Asset

Cr/Dr – Inc/Dec in Accrued Liability

Cr – Cash paid (plug to solve for)

FAR - Aug '14 - 90
AUD - Jan '15 - 91
REG - May '15 - 93
BEC - July '15 - 85

Used CPAexcel exclusively
Master of Science in Accounting (focus in Tax) May '15

[TeeBark]

Hi, thanks for your help with explaining but there's a nitpicky thing I'm struggling with. Aren't we double-counting with regards to inventory when calculating net cash from operating activities? Here's my thoughts:

– Inventory purchases are included in the COGs calculation, and the higher the purchases, the higher the COGS.

– Net Income will be reduced by a higher COGs. Thus cash available from operating activities will be lower thanks to the lower Net Income.

– On top of that, any increase in the inventory account on the balance sheet is included in the calculation as a cash outflow

See what I mean? Any input would be most appreciated!

A - Passed
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B - Feb 2015
'The best way out is always through'

[Mike J]

I don't want to step on anyone's toes here. Just write it out as a journal entry instead of trying to apply that weird mneumonic.

Just think about what you're doing. You can get lost in memorizing stuff and lose track of things. I know, it used to happen to me when I first started studying for FAR.

If you're buying or selling Inventory, you're probably involving A/P and COGS with INVENTORY.

Journal Entries are your friend–especially when stumped. For instance, expenses such as COGS are normally DEBIT balances. Therefore, you debit the expense amount given. Next, to INCREASE an Asset, DEBIT the Inventory account; to DECREASE it, CREDIT the account. Next, to INCREASE a liability CREDIT the payable account; to DECREASE it, DEBIT. Balance the journal entry with what you're solving for–cash. Sometimes, the problem will ask for the expense amount so solve for that–a debit balance most likely.

Therefore: DR COGS

DR Inventory [for the amount of the increase]

DR A/P [for the amount of the decrease]

CR Inventory [for the amount of the decrease]

DR A/P [for the amount of the increase]

DR/CR Cash [to plug]

AUD - 90
BEC - 79
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REG - 77

They don't trust JUST ANYBODY to count beans

[Mike J]

Sorry, Spartan. I missed your post.

AUD - 90
BEC - 79
FAR - 77
REG - 77

They don't trust JUST ANYBODY to count beans

[spartancpa15]

No problem Mike, glad to see someone else with the right idea!

You're right, journal entries are always your friend.

In this case you don't even have to memorize the journal entries, just think about which accounts relate to the three entries I posted and their normal balances. Then solve for the cash credit/debit.

TeeBark, I'm not sure what you mean, but there is definitely no double counting of inventory. Just think through the journal entries logically and it will come together.

EDIT: Actually, it sounds like maybe you might be mixing up the indirect method and the direct method. The indirect method involves adjusting net income to get to net cash from operating activities. The direct method uses actual cash amounts for the computation, which is what the journal entries are for.

FAR - Aug '14 - 90
AUD - Jan '15 - 91
REG - May '15 - 93
BEC - July '15 - 85

Used CPAexcel exclusively
Master of Science in Accounting (focus in Tax) May '15

[Mike J]

Yes. Indirect may require more memorization.

Direct uses the J/E's.

My advice for the INDIRECT method is to write the following format out whenever you're asked for Op Activities and just plug-in the info given. Apply it and it will stick

Simple format: NI & 5 additions & 5 subtractions.

Net Income (read: like Jeff says INdirect uses net INcome).

Add Non-cash expenses [basically your AJE's such as Depr, Amort, Warranty]

Subtract Non-cash revenues [Investee in Subsid Income]

Add Losses

Subtract Gains

Add DECREASES in Current Assets

Subtract INCREASES in Current Assets

Add INCREASES in Current Liabilities

Subtract DECREASES in Current Liabilities

[same direction]

Add Bond Discount

[remember D in Add and D in Discount]

Subtract Bond Premium

Rock on!

AUD - 90
BEC - 79
FAR - 77
REG - 77

They don't trust JUST ANYBODY to count beans

[jooann]

Need help with this problem.

Karr, Inc. reported net income of $300,000 for 20×4. Changes occurred in several Balance Sheet accounts as follows:

Equipment $25,000 increase
Accumulated depreciation 40,000 increase
Note payable 30,000 increase

Additional information:

During 20×4, Karr sold equipment costing $25,000, with accumulated depreciation of $12,000, for a gain of $5,000.
In December 20×4, Karr purchased equipment costing $50,000 with $20,000 cash and a 12% note payable of $30,000.
Depreciation expense for the year was $52,000.
In Karr's 20×4 Statement of Cash Flows, net cash provided by operating activities should be:

Correct answer: 347,000

Could anybody help me illustrate this problem using Mike's NI & 5 additions & 5 subtractions formula?
I've been trying to solve this too much and I can't get 347.
Maybe I'm thinking way too much.

Motto for this exam: 배수의 진
International student and non-accounting major.

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