“Why can't we pay our shareholders a dividend?” shouted your new boss. “This income statement you prepared for me says we earned $5 million in our first half-year!”

You were hired last month as the chief accountant for Enigma Corporation which was organized on July 1 of the year just ended. You recently prepared the financial statements below:

You have just explained to your boss, Robert James, that although net income was $5 million, operating activities produced a net decrease in cash. Unable to understand your verbal explanation, he has asked you to prepare a written report.

Required:

Prepare a report explaining the apparent discrepancy between Enigma's profitability and its cash flows. To increase the chances of your boss's understanding the situation, include in your report a determination of net cash flows from operating activities by both the direct and indirect methods. Your report should also include a narrative explanation of how it is possible for operating activities to simultaneously produce a positive net income and negative net cash flows.