The following question is from Q-Bank. Please also refer to the solution provided by Schweser. My question is i. Why account-payable (a/p) and account-receivable (a/r) are treat alike in calculating CFO. My understanding was in indirect method a/p is having positive sign and a/r is having negative. ii. Why decrease in inventory is given positive sign. Isn’t that decrease in inventory increase cash i.e. it is the source of cash, thus cash flow increases and thus in indirect method it should have negative sign. Use the following financial data for Moose Printing Corporation to calculate the cash flow from operations (CFO) using the indirect method. * Net income $225 * Increase in accounts receivable 55 * Decrease in inventory 33 * Depreciation 65 * Decrease in accounts payable 25 * Increase in wages payable 15 * Decrease in deferred taxes 10 * Purchase of new equipment 65 * Dividends paid 75 A) Increase in cash of $248. B) Increase in cash of $183. C) Increase in cash of $173. D) Decrease in cash of $108. The correct answer was A. CFO for Moose Printing Corporation is calculated as follows: +Net Income $225 - A/R $55 + Inventory $33 + Depreciation $65 - A/P $25 + Wages Payable $15 - Deferred taxes $10 = $248. The purchase of new equipment would be an investing activity and, therefore, would not be included in the CFO. Dividends paid would be a financing activity and would not be included in the CFO.
Increase in Accounts Receivable and Decrease in Accounts Payable are USES of CASH Decrease in AR Increase in AP are Sources of Cash
How is wages payable not already accounted for?
Is the increase of wages payable we are talking about. it got deducted in the net income but not paid the whole amt so that difference needs to be added back. the difference is exactly the amount that increased wages payables
Increases in any Asset account result in cash deduction. Increases in any Liability account result in a cash addition. And vice versa, except for cash account, Dreary
I got it …thanks… I wasn’t thinking clearly
Guys, if you try to roboticly learn this (and most FSA) you are screwed. They didn’t just pull these rules out of their a$$es, there is a mothod to their madness. When you use the indirect method, starting with Net income, you are assuming at the start that by default all components of NI are cash. You then adjust it for those items on the statment that are not cash. Simple Income statement, first year of ops: Sales 200 Exp 75 NI 125 If everything was cash, then cash from ops is 125. Suppose instead that one $50 sale was on account, so that at year end you had AR of $50 (an increase of $50 since this is your first year, and last year was zero). That means you take the $125 NI, and subtract out the $50 increase since your sales were not all cash. This is where you get the adjustments for changes in working capital accounts.