I n t e r a c t I v e t e X t foundations in Accountancy/ acca financial accounting (ffa/FA) bpp learning Media is an acca approved Content Provider

PART F: PREPARING BASIC FINANCIAL STATEMENTS 

 

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1.8.2 Example: the direct method 

Boggis Co had the following transactions during the year.  

(a) 

Purchases from suppliers were $19,500, of which $2,550 was unpaid at the year end. Brought 

forward payables were $1,000. 

(b) 

Wages and salaries amounted to $10,500, of which $750 was unpaid at the year end. The 

accounts for the previous year showed an accrual for wages and salaries of $1,500.  

(c) 

Interest of $2,100 on a long-term loan was paid in the year.  

(d) 

Sales revenue was $33,400, including $900 receivables at the year end. Brought forward 

receivables were $400. 

Calculate the cash flow from operating activities using the direct method. 

Solution 

 

 $  

 $ 

Cash flows from operating activities  

 

 

Cash received from customers ($400 + $33,400 – $900) 

 32,900 

 

Cash paid to suppliers ($1,000 + $19,500 – $2,550) 

  (17,950) 

 

Cash paid to employees ($1,500 + $10,500 – $750) 

  (11,250) 

 

Interest paid 

 (2,100) 

 

Net cash flow from operating activities 

 

 1,600 

This may be a laborious task, however, and the indirect method described below may be easier. 

1.8.3 Using the indirect method 

This method is undoubtedly easier from the point of view of the preparer of the statement of cash flows. 

The net profit or loss for the period is adjusted for the following. 

(a) 

Changes during the period in inventories, operating receivables and payables 

(b) 

Non-cash items, eg depreciation, provisions, profits/losses on the sales of assets 

(c) 

Other items, the cash flows from which should be classified under investing or financing activities 

A proforma of such a calculation is as follows and this method may be more common in the exam. 

 

 $ 

Profit before tax (statement of profit or loss) 

 X 

Add depreciation 

 X 

        interest expense    

 X 

Loss (profit) on sale of non-current assets 

 X 

   (Increase)/decrease in inventories 

 (X)/X 

   (Increase)/decrease in receivables 

 (X)/X 

Increase/(decrease) in payables 

 X/(X) 

Cash generated from operations 

 X 

Interest paid 

 (X) 

Income taxes paid 

 (X) 

Net cash flows from operating activities 

  X 

It is important to understand why certain items are added and others subtracted. Note the following points. 

(a) 

Depreciation is not a cash expense, but is deducted in arriving at the profit figure in the statement 

of profit or loss. It makes sense, therefore, to eliminate it by adding it back. 

(b) 

By the same logic, a loss on a disposal of a non-current asset (arising through under-provision of 

depreciation) needs to be added back and a profit deducted. 

(c) 

An increase in inventories means less cash – you have spent cash on buying inventory. 

(d) 

An increase in receivables means the company's receivables have not paid as much, and therefore 

there is less cash. 

(e) 

If we pay off payables, causing the figure to decrease, again we have less cash. 

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CHAPTER 22  

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  STATEMENTS OF CASH FLOWS