When calculating CFO (indirect method), I am always confused why a gain on the sale of equipment is included from the income statement. I understand why depreciation is added back, but are there any other items that are added or substracted other than depreciation and gain/loss from sale of equipment?
gain/loss on sale of equipment should be CFI not CFO
Here is a schweser problem I just completed (sorry, it is a little bit hard to read with this formatting): Eagle Company’s financial statements for the year ended December 31, 2005 were as follows (in millions): Income Statement Sales 150 Cost of Goods Sold (48) Wages Expense (56) Interest Expense (12) Depreciation (22) Gain on Sale of Equipment 6 Income Tax Expense ( 8) Net Income 10 Balance Sheet 12-31-04 12-31-05 Cash 32 52 Accounts Receivable 18 22 Inventory 46 44 Property, Plant & Equip. (net) 182 160 Total Assets 278 278 Accounts Payable 28 33 Long-term Debt 145 135 Common Stock 70 70 Retained Earnings 35 40 Total Liabilities & Equity 278 278 Cash flow from operations (CFO) for Eagle Company for the year ended December 31, 2005 was (in millions). A) $41. B) $29. C) $37. Using the indirect method: Add: Net Income $10 Add: Depreciation Expense 22 Less: Gain from Sale of Equip. (6) Less: Increase in Accounts Receivable (4) Add: Decrease in Inventory 2 Add: Increase in Accounts Payable 5 Cash flow from operations (CFO) 29
proceeds from sale is CFI Gain/Loss is CFO Remove/Add. (Only for Indirect Method). Reason: you are starting from the Net Income. If you had a gain on sale of equipment - it is already a part of the Net Income. So now you need to remove it. You would be including Proceeds from Sale as CFI. (and that includes the Gain). If you included it in the CFO as well - you would be double counting the gain.
+1 cpk123 Gain/Loss is not under any CFS as it is non-cash. The reason to remove gain/loss is that it is a non-cash item (same as depreciation). CFS only includes cash items. So if you are using indirect method starting with net income, you will need to remove any non-cash items used in deriving net income in order to get the CFO.
No revenant, you did not get this one correct. You said, gain on sale of equipment is non-cash item. No, it is very much a cash item, but a CFI item and not CFO item. Any proceeds from Sale of Equipment will go to CFI in TOTAL, including any gain or loss on that sale reported in Income Statement. This is why we will need to subtract any gain (and add back loss) reported from sale of equipment from Net Income while getting CFO. Hope this clarifies.
Hi rus1bus I am not wrong to say that gain/loss itself reported on the net income is non-cash. Because we know that sales proceeds including gain/loss is cash item to be classified under CFI. If it is the net book value that is recorded under CFI, then perhaps it would be more appropriate to classify gain/loss as cash item. Perhaps its just different school teaching method.
I get your point now. You are saying gain/loss is on the Carrying Value of the Equipment. And Carrying Value is Historical Cost adjusted by Accumulated Depreciation. So, just as accumulated depreciation is non-cash, so is any gain/loss on it. Makes sense. Thanks.
Do you mean there is another way? Please enlighten, thanks.
No revenant, there is only one way. Just that our understanding on WHY gain on sale of equipment should be subtracted from NI to get CFO, is different. But, as long as we know to subtract it, we are fine.
I think it makes things clearer if you thought of two parts Proceeds from Sale - which includes Gain/Loss on Sale -> part of CFI. Gain/Loss from Sale -> part of Net Income -> already included if you start from Net Income to calculate the CFO -> and is strictly a NON-Cash addition to the Net Income. It is NON-Cash - because you did not do anything in your business (operationally) to generate that part of your cash flows. A company would not be able to OPERATE as a continuing entity if it just produced funds by selling its assets. So back that (gain/Loss on Sale) OUT to calculate the CFO part of Cash flows.
Proceeds-Cash, dont mess with CFO Gain/Loss in that Net Income-Take it out bro.
I know this question doesn’t ask for CFF, but if Net Income was 10, and the increase in Retained Earnings was only 5, should you assume that the difference was paid in dividends (and should be decreased from CFF)?
job71188 Wrote: ------------------------------------------------------- > I know this question doesn’t ask for CFF, but if > Net Income was 10, and the increase in Retained > Earnings was only 5, should you assume that the > difference was paid in dividends (and should be > decreased from CFF)? yessir