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Indirect Method (1)

Brian Krogol
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Alright. So on this next page we have some financial information for the abc company. We've got comparative balance sheets showing last year's balance and this year's balance. This is going to be important for those changes in current liabilities and those changes in current assets. And then as we scroll down, we've also have our income statement, right? And this is important because we need our net income and we need to be able to find depreciation, expense and our gains and losses to calculate our operating cash flows. So if you go to your next page, you're gonna see that we have an example here. So this is gonna be our in depth example where we're going to calculate our cash flows from operating activities using the indirect method and we're gonna be using that balance sheet and the income statement from the previous page. Okay. So let's take it step by step. We're gonna be using the indirect method and notice what we've got here. This is going to be this section of the cash flow statement. So notice we're only focused on the operating activity section of the cash flow statement here. So we're gonna start with net income and then we're gonna make our adjustments based on the steps that I showed you on the first page and then we're gonna end up with our net cash provided or used by our operating activities. Okay? So let's go ahead and start with our net income. Where are we gonna find our net income. Well that comes from the income statement, right? And we'll go up to our abc company income statement And we'll find our net income right here. So step one right here, net income is $145,000. Step one is done. Alright. We're well on our way to finding our net income, our operating cash flows here. So we're gonna have $145,000 as our starting point for our net income. Okay? And now we need to start making each of our adjustments. So we started here with net income. Next we need to add back our non cash expenses. So what are the non cash expenses we're gonna mostly most often look for, it's gonna be depreciation expense or possibly amortization expense most of the time that's just gonna be depreciation or they're gonna be added together. They'll say depreciation and amortization. So we're gonna be looking for depreciation expense here because that's the only one that shows up on their on their income statement. Remember this comes from the income statement. So we're going to scroll back up to abc company's income statement and we're gonna look for those non cash expenses and notice how they gave it to us here. They told us all the operating expenses excluding depreciation and then they told us depreciation separately here, depreciation expense is $9000. Okay, So we need to add back the $9000 for depreciation expense. So we would have it here, we would have it listed depreciation expense And we would put it in $9,000. We're gonna make a separate column here for our our adjustments, whoops. Let me make that line up there, $9,000. Okay, so that's our depreciation expense and that came out to $9,000 here. Okay, now let's do our effects of gains and losses. Right? Step three. Now, before I go into the to the example above, I wanna give you guys a little more clarity on why we remove the effects of gains and losses. So assume we had sold equipment for $8000 and and had accumulated. Excuse me, It had cost us $8000 with accumulated depreciation of 1000 and we received $4000 in cash from the sale. So notice in this situation we would have made a journal entry for cash for $4000 Right? So 4000 would have been our our cash debit and we would have had to get rid of the accumulated depreciation and the cost of the equipment. So we would get rid of the accumulated depreciation with a debit for 1000 and we would get rid of the equipment with the credit, right? Because it had a debit balance on our book. And now we're getting rid of it with a credit. So that gets the equipment off of our books, it gets the accumulated depreciation off of our books. And with the cash that was involved in the transaction. Finally, to balance this entry, we either have a loss or a gain in this case, our credits are bigger than our debits. So we're gonna have a loss, right? So we would have a loss On sale. So we would have had a loss on the sale of the equipment for 3000. And that's what would balance out this equation, right? And this loss would go to the income statement. But notice that that loss is not the cash amount. The cash amount is this $4,000, but that $4,000 would be an investing activity, right? Because this deals with the sale of a long term asset. And as we discussed long-term assets are investing activities. So in this case this $3,000 loss on the income statement, it shouldn't be part of our operating activities. It had reduced our net income, but we need to get rid of that effect. Okay, so that's why we removed the effects of gains or losses. It would have been the same thing if we had a gain that would have affected our net income. But it wouldn't be the cash amount. The cash amount in these transactions should be investing activities. And we don't need those gains to be inside of our our operating activity calculation. So let's go back up into our income statement and let's see if there are any gains or losses to get rid of here. So right here, we have number three, our loss on disposal of plan assets, it's going to be this 3000 right here. Just like in our example, we have a $3,000 loss uh, from the disposal of plant assets. So we need to get that out of our net income. So what do we need to do? We need to add back the loss, right. The loss had decreased loss on sale of plant assets. We need to increase our net income by that amount, which was 3000. So these are increases, right? We needed to add back depreciation. We needed to add back the loss on the sale of plan assets. And then that's all we need to do with the income statement. At this point, we've we've done the the expenses and the gains or losses. Why don't we pause here and we'll finish up this example by dealing with the changes in current assets and the changes in current liabilities. Cool, let's do that in the next video