I am struggling understanding Direct method with Statement of Cash Flows. Can you someone explain to me the logic behind the correct answer?
The Hamrick Company owns several pieces of real estate and holds insurance policies to cover them against harm. The company recognized insurance expense of $51,000 on its current income statement. In addition, the company had a Prepaid Insurance account on several of these policies with the reported value dropping by $5,000 during the period. Finally, an Insurance Payable reported on the balance sheet has a reported value that rose from $35,000 at the beginning of the period to $42,000 by year's end. How much cash did Hamrick pay this year on its various insurance policies?
A $39,000 B $50,000 C $52,000 D $63,000
The prepaid insurance fell by $5,000 during the year. As a prepayment, account reductions occur when the expense recognized is greater than the cash paid. Apparently, the company paid $5,000 less for insurance than the amount recognized. Thus, it appears that the amount paid for insurance was not the $51,000 expense but rather $46,000 after the $5,000 drop in the amount paid is included. However, the Insurance Payable account went up by $7,000 during the year (from $35,000 to $42,000). A liability increases because payments are small; the amount paid is less than the expense by $7,000. That drop in the cash payment figure must also be included. The cash outlay was not $46,000 but rather $39,000 after the $7,000 increase in Insurance Payable is included. Both the drop in the prepaid account and the increase in the payable indicate that less money was paid by the company than the expense that was recognized. The cash payment was $39,000 ($51,000 less $5,000 and $7,000).
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