Student Forums CMA Part 1 Section A: External Financial Reporting Decisions A.1. Financial Statements Question ID: ICMA 10.QA.P2.004 (Topic: The Indirect Method)

Question ID: ICMA 10.QA.P2.004 (Topic: The Indirect Method)

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  • #234728
    Fadi Eskander
    Participant

    When calculating the cash flow from operating activities, I answered correctly all the way until I got $35,000 but then I subtracted the decrease in long term debt, yielding an answer of $27,000. The correct answer was $35,000.

    Howcome the decrease of $8,000 in Long-term debt isn’t supposed to be subtracted? Isn’t long term debt a liability to be paid off from cash?

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  • #234738
    Lynn Roden
    HOCK international

    Hello Fadi Eskander,

    When you are calculating cash flow from operating activities according to the indirect method, you begin with net income. You then adjust that net income figure for items that are included in its calculation that are not operating activities (to take them out) or items that are not included in its calculation that are operating activities (to put them in).

    A decrease in long-term debt is a decrease in the principal amount of long-term debt. When a principal payment is made on outstanding long-term debt, the debtor debits its liability account to reduce it and credits cash. The principal payment made on the outstanding debt is not expensed on the income statement, so it is not included in the calculation of net income.

    The amount of the principal payment on long-term debt does not need to be subtracted from net income to calculate cash flow from operating activities because it is never included in the calculation of net income. It is not there to begin with, so it does not need to be subtracted.

    The amount of the decrease in long-term debt is a cash flow from financing activities, and it will be included in the cash flows from financing activities section of the SCF.

    Lynn

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