CFO: Total (gains) losses on derivatives, net

CFA Level I FRA
#1

Incorporated in “Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities” in the cash flow statement, I sometimes find an item with the text “Total (gains) losses on derivatives, net”. My question is if “Total (gains) losses on derivatives, net” is (1) or (2)?

(1) is a non-cash balancing adjustment, similar to Profit (loss) on the disposal of fixed asset, namely an balancing adjustment to depreciation (fair value in this case) that arises on disposal.

(2) is representing derivatives classified as trading securities, and that the cash expended in their purchase and proceeds from their sale are therefor reported as CFO under “Total (gains) losses on derivatives, net”

Am I supposed to adjust CFO for “Total (gains) losses on derivatives, net” or not? If (1) is true I guess I’m not suppose to adjust for it but If (2) is true I think I should reclassify this item as an CFI instead of CFO. Any help would be appreciated!

#2

When you use the indirect method for CFO, you start with net income and remove everything that isn’t:

  • Cash flow, or
  • Operations

Unless you’re in the business of buying and selling derivatives, the gains and losses that arise in your derivative transactions (and which appear on the income statement) are not operations; thus, you remove them from net income. Whether they’re cash gains/losses or accrual gains/losses doesn’t matter; you remove them because they’re not operations.