Conversions of Cash Flows from the Indirect to the Direct Method

The first step is to separate the net income into total revenues and total expenses. Where will the analyst find that information?

Incorrect. The balance sheet will be used in the conversion in step three but does not provide total revenues and total expenses.

Incorrect. The cash flow statement does not provide information about total revenues and total expenses.

The next step is to remove all non-cash and non-operating items and separate remaining items into relevant cash flow items. Which of the following will not be considered a non-cash item?

Incorrect. The loss on sale of an asset will be considered a non-cash item since it represents the difference between the book value of the asset and cash received. It does not actually represent the amount paid on the sale of the asset.

So given these three steps, consider a scenario in which Brown Delivery had sales of $453,939 and accounts receivable increased by $39,838. How much cash was received from customers?

Incorrect. Depreciation expense is a non-cash item. When the expense increases, no cash is being paid out. Amortization and depletion are other non-cash expenses.

Correct. The increase in accounts receivable will reduce the sales, since an increase means all credit sales were not collected in cash.

Incorrect. An increase in accounts receivable means all sales were not collected yet.

Incorrect. An increase in accounts receivable means all sales were not collected yet.

To summarize: [[summary]]

An analyst may want to study a company's trends in cash receipts and payments but only have a cash flow statement prepared under the indirect method and not the direct method. If a direct-format statement is not available, the analyst can __convert reported cash flows from operating activities under the indirect method to the direct method__ by following three steps.

Correct. Other operating expenses represent items that have been paid with cash. The third step in the conversion process is to convert accrual amounts of revenues and expenses to cash receipts and payments by adjusting for increases/decreases in current assets and current liabilities.

Correct. The analyst will have to use the income statement to find the company's total revenues and total expenses.

Balance sheet

Cash flow statement

Income statement

Loss on sale of an asset

Other operating expenses

Depreciation expense

$414,101

$453,939

$493,777

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