Some of the adjustment items in Exhibit 4 are for expenses that affect noncurrent
accounts but not cash. For example, depreciation of fixed assets and amortization of
intangible assets are deducted from revenue but do not affect cash.
Some of the adjustment items in Exhibit 4 are for revenues and expenses that
affect current assets and current liabilities but not cash flows. For example, a sale
of $10,000 on account increases accounts receivable by $10,000. However, cash is not af-
fected. Thus, the increase in accounts receivable of $10,000 between two balance sheet
dates is deducted from net income in arriving at cash flows from operating activities.
Cash flows from operating activities should not include investing or financing
transactions. For example, assume that land costing $50,000 was sold for $90,000 (a
gain of $40,000). The sale should be reported as an investing activity: “Cash receipts
from the sale of land, $90,000.” However, the $40,000 gain on the sale of the land is in-
cluded in net income on the income statement. Thus, the $40,000 gain is deducted from
net income in determining cash flows from operations in order to avoid “double count-
ing” the cash flow from the gain. Losses from the sale of fixed assets are added to net
income in determining cash flows from operations.
The effect of dividends payable on cash flows from operating activities is omitted
from Exhibit 4. Dividends payable is omitted because dividends do not affect net in-
come. Later in the chapter, we will discuss how dividends are reported in the state-
ment of cash flows. In the following paragraphs, we will discuss each of the adjustments
that change Rundell Inc.’s net income to “Cash flows from operating activities.”Depreciation
The comparative balance sheet in Exhibit 3 indicates that Accumulated Depreciation—
Building increased by $7,000. As shown below, this account indicates that depreciation
for the year was $7,000 for the building.The $7,000 of depreciation expense reduced net income but did not require an out-
flow of cash. Thus, the $7,000 is added to net income in determining cash flows from
operating activities, as follows:586 Chapter 13 Statement of Cash Flows
Net income, per income statement $XX
Add: Depreciation of fixed assets and amortization of
intangible assets $XX
Decreases in current assets (receivables, inventories,
prepaid expenses) XX
Increases in current liabilities (accounts and notes payable,
accrued liabilities) XX
Losses on disposal of assets XX XX
Deduct: Increases in current assets (receivables, inventories,
prepaid expenses) $XX
Decreases in current liabilities (accounts and notes payable,
accrued liabilities) XX
Gains on disposal of assets XX XX
Net cash flow from operating activities $ XXExhibit 4
Adjustments to Net
Income—Indirect
MethodACCUMULATED DEPRECIATION—BUILDING
Jan. 1 Balance 58,300
Dec. 31 Depreciation for year 7,000
Dec. 31 Balance 65,300