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Income Flows Versus Cash Flows The text states, "Over sufficiently long time periods, net income equals...

Income Flows Versus Cash Flows
The text states, "Over sufficiently long time periods, net income equals cash inflows minus cash outflows, other than cash flows with owners." Demonstrate the accuracy of this statement in the following scenario: Two friends contributed $50,000 each to form a new business. The owners used the amounts contributed to purchase a machine for $100,000 cash. They estimated that the useful life of the machine was five years and the salvage value was $20,000. They rented out the machine to a customer for an annual rental of $25,000 a year for five years. Annual cash operating costs for insurance, taxes, and other items totaled $6,000 annually. At the end of the fifth year, the owners sold the equipment for $22,000, instead of the $20,000 salvage value initially estimated. (Hint: Compute the total net income and the total cash flows other than cash flows with owners for the five-year period as a whole.)
Transaction or Event Cash Equipment Common Stock Net Income
Cash Contributed by Owners
Purchase of Machine for Cash
Recognition of Rent Revenue
Recognition of Operating Expenses
Recognition of Depreciation
Sale of Machine
Totals
Business   Accounting   
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Homework Answers

Answer #1

Following table will show all the transactions in details :-

Transaction or event cash equipment common stock net income
Cash contributed by owners 100000 0 100000 0
Purchase of machine for cash (100000) 100000 0 0
Recognition of rental revenue 125000 0 0 125000
Recognition of operating expenses. (30000) 0 0 (30000)
Recognition of depriciation 0 (80000) 0 (80000)
Sale of machine 22000 (20000) 0 2000
Total 117000 0 100000 17000

From above table we can clearly see that Cash inflow minus Cash outflow (excluding owners capital i.e. 100000) amounts to $17000 which is exactly equal to net income for those periods amounting to $17000.

Therefore, we can conclude that net income equals Cash inflow minus Cash outflow other than Cash flows with owners.

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