Financial Accounting: An Integrated Statements Approach, 2nd Edition

Chapter 5 Accounting for Merchandise Operations 235

You should note that, except for depreciation, the adjustments in Exhibit 14 are for

changes in the current assets and current liabilities. This is because changes in the cur-

rent assets and current liabilities are related to operations and thus net income. For ex-

ample, changes in inventories are related to sales, while changes in accounts payable

are related to expenses.

Cash Flows from Operating Activities

The statement of cash flows shown in Exhibit 8 for Online Solutions was prepared

using the indirect method. To prepare the operating activities section, we need to

determine depreciation and the changes in the current assets and the liabilities during

the year. This information is included in Exhibit 15, which shows the comparative bal-

ance sheets for Online Solutions as of December 31, 2010 and 2009, and related changes.

Based on Exhibit 15, the net cash flows from operating activities is shown below.

Net income $ 60,400

Add: Depreciation expense—store equipment $ 3,100

Depreciation expense—office equipment 2,490

Decrease in office supplies 120

Decrease in prepaid insurance 350

Increase in accounts payable 8,150 14,210

Deduct:

Increase in accounts receivable $(24,080)

Increase in merchandise inventory (2,450)

Decrease in salaries payable (360)

Decrease in unearned rent (600) (27,490)

Net cash flows from operating activities $ 47,120

The depreciation expense of $3,100 for store equipment is determined from the in-

crease in the accumulated depreciation for store equipment. Likewise, the depreciation

expense of $2,490 for office equipment is determined from the increase in the accu-

mulated depreciation for office equipment. The changes in the current assets and cur-

rent liabilities are also taken from Exhibit 15.

Cash Flows Used for Investing Activities

The cash flows for investing activities section can also be prepared by analyzing the

changes in the accounts shown in Exhibit 15. For Online Solutions, the cash flows used

for investing activities is composed of two items. First, additional store equipment

of $7,100 was purchased, as shown by the increase in the store equipment. Likewise,

Net income $XXX

Add: Depreciation $XXX

Decreases in current assets (accounts receivable,

inventories, prepaid expenses) XXX

Increases in current liabilities (accounts payable,

notes payable, accrued expenses) XXX XXX

Deduct: Increases in current assets (accounts receivable,

inventories, prepaid expenses) $XXX

Decreases in current liabilities (accounts payable,

notes payable, accrued expenses) XXX XXX

Net cash flows from operating activities $XXX

Exhibit 14

Indirect Method
Adjustments

The typical adjustments to convert net income to net cash flows from operating ac-

tivities, using the indirect method, are shown in Exhibit 14.