Indirect Cash Flow - Cash Flow from Operation Calculations

CFA Level I FRA
#1

Use the following financial data for Moose Printing Corporation, a U.S. GAAP reporting firm, to calculate the cash flow from operations (CFO) using the indirect method.

  • Net income: $225
  • Increase in accounts receivable: $55
  • Decrease in inventory: $33
  • Depreciation: $65
  • Decrease in accounts payable: $25
  • Increase in wages payable: $15
  • Decrease in deferred taxes: $10
  • Purchase of new equipment: $65
  • Dividends paid: $75

The correct answer according to Kaplan is an “increase of cash by 248” with the below explanation:

CFO for Moose Printing Corporation is calculated as follows:

+Net Income $225 − A/R $55 + Inventory $33 + Depreciation $65 − A/P $25 + Wages Payable $15 − Deferred taxes $10 = $248.

The purchase of new equipment is an investing activity and therefore is not included in CFO. Dividends paid is a financing activity and is not included in CFO.

Why do you not add back the purchase of new equipment (thus have CFO as 313, =248+65). In other examples you see that you subtract out a gain from sale of land (CFI). The purchase of new equipment is CFI, so why do you not ADD that back in just as you SUBTRACT gain from sale of land?

#2

Because gain from sale of land was included in the income statement in the other example, hence that amount was also included in net income. So, to arrive CFO, they subtracted that gain to clear CFO measure from non operating cash flows. I am sure, later they included that gain in CFI section.

#3

Thank you.

Wouldnt the purchase of new equipment also impact NI just as the gain from sale of land impacts NI. If they both impact NI and they both are CFI, why would you not adjust both (subtract gain from sale of land and add back purchase of new equipment) to determine CFO?

#4

Purchase of new equipment should not be included in income statement. It should be reflected in cash flow statement if it is already paid for, or on the balance sheet (accounts payable, or like) if the payment is yet to be made. So, purchase of new equipment does not impact NI, and you won’t make any adjustments like in case of “gains from sale of fixed assets”.

#5

Is it not included in net income because equipment is capitalized and thus is depreciated instead of expensed, which depreciation is already added back due to it being a non cash item?

#6

Yes.