Which of the following would be subtracted from net income when using the indirect method

What Is the Indirect Method?

The indirect method is one of two accounting treatments used to generate a cash flow statement. The indirect method uses increases and decreases in balance sheet line items to modify the operating section of the cash flow statement from the accrual method to the cash method of accounting.

The other option for completing a cash flow statement is the direct method, which lists actual cash inflows and outflows made during the reporting period. The indirect method is more commonly used in practice, especially among larger firms.

Key Takeaways

• Under the indirect method, the cash flow statement begins with net income on an accrual basis and subsequently adds and subtracts non-cash items to reconcile to actual cash flows from operations.
• The indirect method is often easier to use than the direct method since most larger businesses already use accrual accounting.
• The complexity and time required to list every cash disbursement—as required by the direct method—makes the indirect method preferred and more commonly used.

Understanding the Indirect Method

The cash flow statement primarily centers on the sources and uses of cash by a company, and it is closely monitored by investors, creditors, and other stakeholders. It offers information on cash generated from various activities and depicts the effects of changes in asset and liability accounts on a company's cash position.

The indirect method presents the statement of cash flows beginning with net income or loss, with subsequent additions to or deductions from that amount for non-cash revenue and expense items, resulting in cash flow from operating activities.

The indirect method is simpler than the direct method to prepare because most companies keep their records on an accrual basis.

Example of the Indirect Method

Under the accrual method of accounting, revenue is recognized when earned, not necessarily when cash is received. If a customer buys a $500 widget on credit, the sale has been made but the cash has not yet been received. The revenue is still recognized in the month of the sale.

The indirect method of the cash flow statement attempts to revert the record to the cash method to depict actual cash inflows and outflows during the period. In this example, at the time of sale, a debit would have been made to accounts receivable and a credit to sales revenue in the amount of $500. The debit increases accounts receivable, which is then displayed on the balance sheet.

Under the indirect method, the cash flows statement will present net income on the first line. The following lines will show increases and decreases in asset and liability accounts, and these items will be added to or subtracted from net income based on the cash impact of the item.

In this example, no cash had been received but $500 in revenue had been recognized. Therefore, net income was overstated by this amount on a cash basis. The offset was sitting in the accounts receivable line item on the balance sheet. There would need to be a reduction from net income on the cash flow statement in the amount of the $500 increase to accounts receivable due to this sale. It would be displayed as "Increase in Accounts Receivable (500)."

Indirect Method vs. Direct Method

The cash flow statement is divided into three categories—cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. Although total cash generated from operating activities is the same under the direct and indirect methods, the information is presented in a different format.

Under the direct method, the cash flow from operating activities is presented as actual cash inflows and outflows on a cash basis, without starting from net income on an accrued basis. The investing and financing sections of the statement of cash flows are prepared in the same way for both the indirect and direct methods.

Many accountants prefer the indirect method because it is simple to prepare the cash flow statement using information from the other two common financial statements, the income statement and balance sheet. Most companies use the accrual method of accounting, so the income statement and balance sheet will have figures consistent with this method.

However, the Financial Accounting Standards Board (FASB) prefers companies use the direct method as it offers a clearer picture of cash flows in and out of a business. However, if the direct method is used, it is still recommended to do a reconciliation of the cash flow statement to the balance sheet.

Video Transcript

Hello students: we are given a question here that there is a cash flow and we are given some operating activities like net income, depreciation expenses increase in the incomes, receivable and decrease in the accounts be able. Okay, we need to find the net cash flow from operating activities, so here we are supposed to know that the net income net income is like, as we are given here- 1 placed 23000 k. Students 1, like 23054 dollar and depreciation, expense, depreciation, expanse, a students. So basically it will be plus. So it is 26854 point we can write here, 26854 point kay students. Now the increase in the accounts receivable should have it. It is a davit amount increase in accounts, students increasing accounts, receivable receivable, so it should be a negative okay derived. We can say that the debito 66417 point and that decreasing decrease in accounts decrease in accounts payable students payable. So it should be. Like 16848 point. Okay, students, it is also 3. It amounts to 16848 point now. We need to solve it. So basically we can say that here we need to calculate this term as see 1. Like 23054 point, it is a great amount, okay plus 26854 point. It is also a great amount and then 16848 point. It is also an also a great amount, minus 26117, because the increasing accounts recivable is a debit amount. So we can say that the net cash flow is 1. Like 42039 point, so we can say that determine the net cash flow okay, so we can right here, hence, hence net cash flow students. Net cash flow is nothing but equal to 1. Like 42039 point- and this is going to be our final answer of this question- that's all thank you.

What is subtracted from net income when using the indirect method?

Which of the following would be added to net income using the indirect method?

When using the indirect method of calculating cash flows What do you subtract from net income to get cash flow from operating activities?

Which of the following would be an addition to net income when using the indirect method to derive net cash flows from operating activities *?