Question

Using an indirect method statement of cash flows from a publicly traded company, discuss an item that was recorded when calculating net income, but is adjusted as an increase or decrease to determine cash provided by (used by) operating activities, specifically an asset, liability, gain, or loss. Include a summary of how that item impacted net income (or net loss) and why there is an adjustment necessary to determine cash from operations.

Answer 1

• Item(s) that was recorded when calculating net income, but was later adjusted as an increase or decrease to determine cash provided by (used by) operating activities can be:
  >Depreciation expense
  Other items can be:
  >Gain or Loss from sale of plant asset
  >Gain or Loss from sale of investments
• Cash Flows statement only takes into account the ‘CASH’ flows, which means only cash inflows and outflows are to be reflected in that statement. However, when preparing the Statement of Cash Flows from INDIRECT METHOD, the Net Income is adjusted to find the correct cash flows.
• Net Income, as we know, contains cash and non cash revenues and expenses. One of the non cash item that is considered in determining Net Income is ‘depreciation expense’.
  Depreciation expense, being an expense, decreases the Net Income. Hence, this being a ‘non cash item’, the Net Income is ‘increased’ by depreciation expense when finding out the net cash provided (used by) operating activities.
• Gain or Loss on sale of plant assets or investments are also found on Income Statement, which are later adjusted in Operating activities section of Cash Flow Statement.
• Gains are DEDUCTED from Net Income in Statement of Cash flows, because these had increased the Net Income in Income Statement.
• Losses are ADDED to Net Income in Statement of Cash Flows, because these had decreased the Net Income in Income Statement.