Question

On the statement of cash flows, we have discussed that we add back depreciation expense, we add back losses, and we subtract gains. Why does the statement of cash flows require these actions and where does the impact of gains and losses get reported?

Answer 1

In the statement of cash flows, we add back depreciation expense because all non cash expenditure are added to get cash flows from operating activities and depreciation is a non cash expenditure. Non cash expenditure means expenditure which is not incurred in cash but only debited to profit and loss account. Losses which are not of operating nature such as loss on sale of fixed asset is added back because we are required to calculate operating cash flows and similarly, gains which are not of operating nature are subtracted because we are required to calculate operating cash flows.

The impact of gains and losses is reported in investing activities. For example, A company has sold an equipment for $1000 and book value of such equipment was $800. We can see that there is gain on sale of equipment of $1000 - $800 = $200. In the statement of cash flows, this gain on sale of equipment of $200 is not reported separately but instead total sale value of $1000 is reported as cash inflows under "Investing actitivities". Similarly, loss on sale of fixed asset is not reported separately but instead total sale value of $1000 is reported as cash inflows under "Investing actitivities".