Qna about using direct method calculation for CFO Other, using, about, method, direct

YouCanDoIt

Hi, this is qns from the schweser qbank:

Financial information for Jefferson Corp. for the year ended December 31st, was as follows:

Sales: $3,000,000
Purchases: 1,800,000
Inventory at Beginning: 500,000
Inventory at Ending: 800,000
Accounts Receivable at Beginning: 300,000
Accounts Receivable at Ending: 200,000
Other Operating Expenses Paid: 400,000

Based upon this data and using the direct method, what was Jefferson Corp.’s cash flow from operations (CFO) for the year ended December 31st?

A) $1,200,000.

B) $900,000.

C) $800,000.


Your answer: A was incorrect. The correct answer was B) $900,000.


CFO = sales $3,000,000 – purchases $1,800,000 – change in accounts receivable ($200,000 – $300,000) – other cash operating expenses $400,000 = $900,000.

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In the schweser notes, under the direct method, it states that "Add (Subtract) any increase(decrease) inventory balance as disclosed in the indirect method".

From the answer it provides, it seems that the calculation does not include the inventory.

1) Why they never include the inventory in the calculation? is it because the inventory beginning and inventory ending are not part of the indirect method?

2) Or next time if i encounter qns asking to use direct method for calculation and it state inventory in the question, i need to make sure that the inventory is part of the indirect method or else i can ignore it in the direct calculation.

Thanks for the help

johnnyBuz

I think it's because they have given you 'purchases' which includes inventory changes....if they had just given you COGS you would have had to adjust for inventory. But seeing as you have a 'purchases' figure, it has been done for you.

ramdabom

oh i see. So the trick is the word purchase. Thanks for the enlightenment