Student Forums CMA Part 1 Section B: Planning, Budgeting and Forecasting B.6. Top-Level Planning and Analysis 4. Question ID: HOCK CMA.P1A5.12 (Topic: Top-Level Planning and Analysis)

# 4. Question ID: HOCK CMA.P1A5.12 (Topic: Top-Level Planning and Analysis)

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Topic
• #220565
Inam
Participant

Hi Sir,

How depreciation calculated in below
Net cash flow from operating activities, using the indirect method, is:

Net income \$3,526
− Increase in accounts receivable (1,530)
− Increase in inventory (900)
+ Depreciation expensed 3,595
+ Increase in accounts payable 300
+ Increase in accrued liabilities 600
Net cash flow from operating activities \$5,591

Regards

Viewing 6 replies - 1 through 6 (of 6 total)
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• #220568
Lynn Roden
HOCK international

Hi Inam,

The pro forma income statement includes these two lines:

 COGS (including \$3,200 depreciation) 72,820 General & admin. exp. (including \$395 depreciation) 12,320

The total of the two depreciation amounts given in the parentheses is \$3,200 + \$395 = \$3,595.

Lynn

#229240
Christopher Bateman
Participant

Did the interest expense just disappear?

#229242
Lynn Roden
HOCK international

Hello Christopher,

The interest expense is a cash outflow from operating activities on the statement of cash flows. The statement of cash flows begins with net income of \$3,526. Net income of \$3,526 has been reduced by interest expense of \$1,396. Therefore, the interest expense reduces net cash flow from operating activities because it reduces net income, and net income is the beginning of the calculation of net cash flow from operating activities under the indirect method.

Lynn

• This reply was modified 5 months ago by Lynn Roden.
#229302
Christopher Bateman
Participant

I think i understand now!

• This reply was modified 5 months ago by Christopher Bateman.
#238224
John Bouquet
Participant

Hello,

Can you help explain the inventory movement? Why does the ending inventory balance exclude depreciation, but the beginning inventory amount include it?

#238228
Lynn Roden
HOCK international

Hello John Bouquet,

The Statement of Cash Flows measures changes in cash that have taken place from the end of one year to the end of the following year. In this question, that is changes in cash that are projected to take place during Year 2.

Depreciation on manufacturing equipment, a noncash expense, is not expensed when it is recorded. Instead, under absorption costing it is applied to products manufactured as part of fixed overhead cost applied and thus it becomes part of the inventory cost of the manufactured goods. It is expensed as part of cost of goods sold when the goods are sold.

Any transactions that affected inventory or any other accounts during any year previous to Year 2 are not relevant for calculating cash flow for Year 2. Since the depreciation included in beginning inventory was a noncash transaction that occurred during the prior year, it is not relevant to calculating pro forma net cash flow from operating activities for Year 2.

However, any transactions that are projected to affect inventory during Year 2 are relevant. Thus, projected depreciation for Year 2 is deducted from Year 2’s pro forma ending inventory. However, because the depreciation included in the beginning inventory (Year 1’s actual ending inventory) was booked during Year 1 and so is not a Year 2 transaction, it is not deducted from the beginning inventory when calculating Year 2 cash flow from operating activities.

Lynn

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