“When presenting the cash flow statement using the indirect method, the gain or loss is eliminated from net income in arriving at cash flow from operations and the reacquisition price is reported as an outflow from financing.” Anyone understand why this is true for the indirect method?
Two important points here: 1) The indirect method calculates cash flow from operations, and a sale of equipment is cash flow from investing. 2) Gain/loss takes into account non-cash charges like depreciation, as it is simply sale price- NBV. We don’t care about net book value as we’re tracking cash, so we want to measure the sale price, as that is the cash received. Therefore the gain/loss on sales of equipment is simply added back to net income to remove it from the CFO calculation. The proceeds from the sale of equipment will be measured in cash flow from investing.
To expand on that point, CFO is used to represent just that - Operations cash flows. Buying P.P.&E., raising capital by issuing equity, etc aren’t operational cash flows. Those items go in different sections. The reason that you take out any gains/losses on retirement of debt is that the decision isn’t really an operational one (you didn’t sell more widgets). By taking these out of CFO, you remove their effect on the operational cash flows so you arrive at a cash number that solely expresses the results of operational uses of cash.
also a point to remember in this regards of gain/loss on sale of equipment: your starting point for CFO using the indirect method is Net Income. Net Income already includes the Gain/Loss component embedded in it. When you go to calculate the CFI -> entire Sale price of equipment (which includes gain/loss) is included. If you did not remove the Gain/Loss from Net Income -> you would be double counting that amount. Cheers