Chapter21: The Statement of Cash Flows Revisited
Components of Net Income That Do Increase or Decrease Cash
For components of net income that increase or decrease cash, but by an amount different from that reported in the income statement, net income is adjusted for changes in the balances of related balance sheet accounts to convert the effects of those items to a cash basis. For example, sales of $100 million are included in the income statement as a component of net income, and yet, since accounts receivable increased by $2 million, only $98 million cash was collected from customers during the reporting period. Sales are converted to a cash basis by subtracting the $2 million increase in accounts receivable. Here's another example:
The income statement reports salaries expense as $13 million. Just because employees earned $13 million during the reporting period, though, doesn't necessarily mean UBC paid those employees $13 million in cash during the same period. In fact, we see in the comparative balance sheets that salaries payable increased from $1 million to $3 million; UBC owes its employees $2 million more than before the year started. The company must not have paid the entire $13 million expense. By analyzing salaries expense in relation to the change in salaries payable, we can determine the amount of cash paid to employees:
This inspection indicates that UBC paid only $11 million cash to its employees; the remaining $2 million of salaries expense is reflected as an increase in salaries payable. From a cash perspective, then, by subtracting $13 million for salaries in the income statement, UBC has subtracted $2 million more than the reduction in cash. Adding back the $2 million leaves UBC in the same position as if it had deducted only the $11 million cash paid to employees.
Following a similar analysis of the cash effects of the remaining components of net income, those items are likewise converted to a cash basis by adjusting net income for increases and decreases in related accounts.p. 1220
For components of net income that increase or decrease cash by an amount exactly the same as that reported in the income statement, no adjustment of net income is required. For example, investment revenue of $3 million is included in UBC's $12 million net income amount. Because $3 million also is the amount of cash received from that activity, this element of net income already represents its cash effect and needs no adjustment.14
14We determined in Part B (subsection 2) that there is no evidence that cash received from investments differs from investment revenue.