Determine the cash flow from operations given the following table. Item Amount Cash payment of dividends $30 Sale of equipment $25 Net income $25 Purchase of land $15 Increase in accounts payable $20 Sale of preferred stock $25 Increase in deferred taxes $5 Profit on sale of equipment $15 A) $45. B) $20. C) $35. D) $15. Can any body explain why Profit on sale of equipment is classified as CFO ? I thought it was CFI
it is, but if this is the indirect method then you must account for the profit on the sale of equipment (I think)
guys this was discussed yesterday as well on a post. Profit on Sale of equipment is already included in your Net Income calculation. So for indirect method, where Net Income is your starting point, and the Profit is not really “Cash earned by operations” it must be backed out for the CFO Calculation. If you had a loss in sale of equipment, it would be added back for the CFO Calculation. What goes into the CFI calculation is the “Proceeds from Sale of Equipment”. This is a major distinction that needs to be drilled into memory for the Cash flow statement. In the Direct method, since you are using the individual items like Sales, COGS, etc. etc. to calculate the CFO - the Profit does not make it there. HTH
Thanks CP now I understand … NI - 25 increase in AP - 20 increase in deferred tax assets - 5 Profit on sale of equipment - (15) CFO - 35 Answer C
There was another question on same principle -------- When calculating cash flow from operations (CFO) using the indirect method which of the following is most accurate? A) The indirect method requires an additional schedule to reconcile net income to cash flow. B) When recognizing a gain on the sale of fixed assets, the amount is a deduction to operating cash flows. C) In using the indirect method, each item on the income statement is converted to its cash equivalent. D) Accumulated depreciation would be a deduction to calculate the net cash flow, because this is a non-cash activity. Your answer: B was correct! When recognizing a gain on the sale of fixed assets, the amount is a deduction to operating cash flows. This is because the gain would be double counted in the investing section and in net income. Therefore, the gain must be removed from net income. The direct method of cash flow calculation converts the income statement items to their cash equivalents, not the indirect method. When calculating cash flow from operations, the current period depreciation (expense) amount should be used and not total accumulated depreciation. Also, depreciation is added to net income in order to calculate CFO using the indirect method.
It took me time to understand this but it’s as simple as you’re not in the business of selling your own fixed equipment so it shouldn’t counted in Operations. Simple as that.
charu_mulye Wrote: ------------------------------------------------------- > Thanks CP now I understand … > NI - 25 > increase in AP - 20 > increase in deferred tax assets - 5 > Profit on sale of equipment - (15) > > CFO - 35 > > Answer C how do you know it’s a deferred tax assets? the question doesn’t say anything. based on my understanding, if it is an increase in deferred tax assets, we need to subtract it from the calculation of CFO. But if it’s an increase in deferred tax liabilities, we have to add it to the calculation of CFO. But on your calculation you stated it as “increase on deferred tax asset” and you added it to the calculation. Please someone confirm on this. thanks
I think Charu is assuming it’s a liability (as most commonly tax deferals are), because an increase in an asset account would be subtracted from net income.
yeah deferred tax is liability. (my mistake in writing asset) Otherwise none of the answer option matches (if we assume it as asset) sorry if that has created any confusion.
CP, can you help me understand the difference between proceeds vs gain/loss on the sale of equipment? I know it’s basic but just need some clarification. thanks.
Gain from sale of equipment is already included in Net Income calculation but it is a non cash item and hence must be subtracted from net income when calculating OCF. Similarly, depreciation expense is a non cash expense which is subtracted in the calculation of Net Income and is then added back to Net Income in OCF calculation.
Obviously loss works in the opposite way…
In response to aarguello Say the company sold a piece of equipment on its books for 20K (Depreciated book value ) for 25K. It is recognizing a gain of 5K. This 5 K has already become a part of the Net Income. So when you start out with the NI (Indirect method) to create your statement of Cash flows - you would start with the NI and then remove the 5K gain, while calculating your CFO. However the Sales Proceeeds - which were 25K would be in its entirety included in the CFI. If you had failed to remove the 5K gain on Sale - you would be inadvertently accounting for the 5K twice - once as part of Net Income and again when you included the 25K as CFI amount. So you need to remove it once. Hope this helps.
Got it. Thanks, CP.