Question

In: Accounting

Using the following statement of comprehensive income accounts, how would a gain on the sale of...

Using the following statement of comprehensive income accounts, how would a gain on the sale of land and depreciation expense be reflected in the cash from operating activities section of a statement of cash flows? (These items will be added to or subtracted from income before income tax to compute cash flow from operating activities.)

Sales revenues $31,000
Gain on sale of land 900
Cost of goods sold (21,000)
General and administrative expenses (3,500)
Depreciation expense (2,250)
Interest expense (850)
Income tax expense (2,000)

a.The gain is added, and the depreciation expense is subtracted.

b.The gain is subtracted, and the depreciation expense is added.

c.The gain is not included, and the depreciation expense is added.

d.Neither item is included.

Using the following information, compute the amount of cash provided by operating activities.

Payments for miscellaneous expenses $1,131
Payment to stockholders as dividends 450
Payment for income tax 235
Payment for interest 143
Collections on account 4,686
Payments for inventory 2,974

ANSWER: __________________

Solutions

Expert Solution

OPTION B IS CORRECT

EXPLANATION TO THE GAIN IS SUBTRACTED AND EXPENSE IS ADDED.

Gain on sale of land: The gross proceeds from sale of asset is included in the investing activities and the gain arising out of sale of fixed assets is deducted from operating activities in the indirect method. The reason behind this is operating activities are the activities which are directly attributable to the business. Since sale of assets is not a regular business activity and it is investing activity. That is why the gain is deducted from the net operating activities and already included in the investing activities.

Depreciation Expense - The depreciation expense is a non-cash expense which is charged at the end of the year while preparing financial statements. This expense is charges ultimately to have lower tax payment. Other important point to keep in mind while solving cash flow statement is that cash flows includes only cash payments and cash receipts not non cash income or expense. This is the reason we add back this expense.

BELOW ARE THE REASONS WHY OTHER OPTIONS ARE INCORRECT

Option a - .The gain is added, and the depreciation expense is subtracted.

The gain is not added because it’s not regular business activity and expense cannot be subtracted and it can only add back because it’s a charge created not actual cash expense to the business.

Option c - The gain is not included, and the depreciation expense is added.

The gain is already included in the net income we just need to subtract from it because it’s not regular business activity and yes, depreciation can be added back as said above,

Option D - Neither item is included.

This is wrong as said above gains are subtracted as its non-operating income and included as a gross sale in investment activity and depreciation is excluded as said above.

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