Question

Why do you add non cash items back to the statement of cash flows and why do you add unearned revenue to statement of cash flows ?

Answer 1

Under the Indirect Method, the following treatments are done :

1. Add back Non cash items (earlier debited like depreciation etc)

It must be noted that the adding back of non cash items is to the Net profit (Starting point of Operating activities).

Our aim of the Cash flow statement is to check the real inflow/outflow of cash and cash equivalents.

So while preparing Statement of profit and loss, we must have debited or deducted non cash items like depreciation, amortization of assets etc, which reduced our Net profit. But these items, do not actually involve and outflow of cash. Therefore, while preparing Cash flow statement we need a true picture of REAL CASH FLOW, hence we will add back these non cash expenditures which we would have previously deducted/debited in Statement of Profit and Loss/ Profit and Loss account.

2. Unearned Revenue added

Unearned revenue basically refers to the income/revenue which we have received cash for, but did not show in Statement of Profit and Loss. These items are in the form of current liabilities in the balance sheet(can also be called prepaid revenue). For example an Insurance company receives the premium from its customers in advance . Therefore, this income is not earned yet but we have actually received it, hence it is a CASH INFLOW.

Therefore, it shall be added to show the real cash flow position.