Cash flow from investing

CFA Level I
#1

I have a quick question about cash flow from investing and how to derive it.

I’m given a balance sheet and income statement. I’ll only provide info on the few line items relevant to CF from investing

assets:

PP&E: $920 (2007) $900 (2006)

Accumulated depreciation: $290 (2007) $250 (2006)

liabilities:

Bank note: $100 (2007) $0 (2006)

Income statement:

Depreciation: $100

Gain on sale of old machine: $10

Notes:

Fixed assets were sold for $30. Original cost of these assets was $80 and $60 of accumulated depreciation has been charged to original cost

Firm borrowed $100 on a 10 year note. The proceeds paid for new equipment

Depreciation for the year was $100 (accumulated depreciation was up $40 and depreciation on sold assets was $60)

The book says CFI: sale of fixed assets - new fixed assets = 30 - 100 = -$70. But the bits about PP&E and depreciation throw me off a bit. I don’t understand why PP&E goes up by $20. They purchased new assets for $100, they sold assets for $30. If the original cost of the sold assets was $80, then wouldn’t depreciation on sold assets be $60 (i.e. why isn’t it $50, the difference between purchase price and selling price), or is it independent of the purchase price and the sale price of the asset?

Why does it say in the first note that $60 of accumulated depreciation was charged to the assets original cost, then subsequently say that accumulated depreciation increased by $40?

If the assets sold were worth 80, why isn’t PP&E for 2006 $980? Why wouldn’t the increase in equipment ($100) increase it further still? I guess my problem is, I have zero idea how PP&E and depreciation work with each other and the book does a pretty poor job of explaining it. Thanls for any and all help.

#2

According to the information given:

Dr: Cash 30

Dr: Accumulated depreciation 60

Cr: Gain on sale 10

Cr: Fixed assets 80

-> the historical cost of the assets sold is 80

Let’s call the amount of cash used to purchase new fixed assets A

-> 900 - 80 + A = 920 -> A = 100 (the question also confirms that the firm borrows 100 and uses that to purchase the new assets)

-> CFI = 30 - 100 = -70

The original cost of the fixed assets sold is 80, and the accumulated depreciation associated with them is 60. It is 60, not 50 because the firm gains 10 when it sells these assets. When these assets are sold, 80 is removed from the PPE account and 60 is removed from the accumulated depreciation amount. The total depreciation expense of the year is 100, but 60 of it is removed, so the accumulated depreciation account only increases by 40 (250 -> 290). 40 is the amount of depreciation of other assets that are not sold. The PPE account decreases by 80 (assets are sold) and then increases by 100 (new assets are purchased) so the net amount is 20 (900 -> 920). Hope this helps. Correct me if I am wrong though.

#3

Let’s look at each transaction and see how it affects the various accounts:

  • Sale of fixed assets:
    • Cash increases by $30 (debit)
    • Gross PP&E decreases by $80 (credit)
    • Accumulated depreciation decreases by $60 (debit)
    • Gain on sale of equipment increases by $10 (credit)
    • Total debits: $30 + $60 = $90
    • Total credits: $80 + $10 = $90
    • Cash flow: +$30, CFI
  • Borrowing on a 10-year note:
    • Cash increases by $100 (debit)
    • Notes payable increases by $100 (credit)
    • Total debits: $100
    • Total credits: $100
    • Cash flow: +$100, CFF
  • Purchasing new equipment:
    • Cash decreases by $100 (credit)
    • Gross PP&E increases by $100 (debit)
    • Total debits: $100
    • Total credits: $100
    • Cash flow: −$100, CFI
  • Recording annual depreciation:
    • Depreciation expense increases by $100 (debit)
    • Accumulated depreciation increases by $100 (credit)
    • Total debits: $100
    • Total credits: $100
    • Cash flow: $0

Now let’s look at the changes in the account balances:

  • Cash: $30 + $100 − $100 = +$30
  • Gross PP&E: −$80 + $100 = +$20
  • Accumulated depreciation: −$60 + $100 = +$40
  • Gain on sale of equipment: +$10
  • Notes payable: +$100
  • Depreciation expense: +$100

Now let’s look at the ending account balances (for those for which we have beginning balances):

  • Gross PP&E: $900 + $20 = $920
  • Accumulated depreciation: $250 + $40 = $290
  • Gain on sale of equipment: $0 + $10 = $10
  • Depreciation expense: $0 + $100 = $100

Finally, let’s look at cash flows:

  • CFI: +$30 − $100 = −$70
  • CFF: +$100