[Anonymous]

Bear Co. prepares its statement of cash flows using the indirect method. Bear sold equipment with a CV of 500,000 for cash of 400,000. How should Bear report the transaction in the operating and investing activities sections of its statement of cash flows?

Operating // Investing

a. 100,000 addition to net income // 400,000 cash flow

b. 100,000 subtraction to net income // 400,000 cash flow

c. 100,000 addition to net income // 500,000 cash flow

d. 100,000 subtraction to net income // 500,000 cash flow

Answer A. Cash receipts from the sale of property, plant, and equipment of 400,000 are reported as a cash inflow from investing activities. Under the indirect method, the net cash flow from operating activities is determined by adjusting net income for the effects of items included in net income whose cash effects relate to investing or financing cash flows. Losses and expenses whose cash effects are related to investing or financing cash flows are added to income. Bear recognized a loss on disposal of equipment of 100,000. Accordingly, 100,000 is reported as an addition to net income in operating activities section of the statement of cash flows.

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If the CV is 500,000 and you received cash of 400,000, shouldn’t the 100,000 loss be subtracted instead of added?

[sdguy]

“If the CV is 500,000 and you received cash of 400,000, shouldn’t the 100,000 loss be subtracted instead of added?”

No. Look at this this way. Your starting place on Indirect cash flow statement is Net Income. To that number, you add/subtract what you need, to get a final number, “Cash flow from operating activities” Right?

So your starting place here was Net Income, which included the $100K loss already. This 100K loss is NOT an operating activity, it's an investing activity. So you need to add the $100K back in to your net income, to get an accurate “Cash Flow from OPERATIONS ONLY” number. Then adjust for it in Investing section below.

Does that make sense? Let me know if you need further explanation.

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[Anonymous]

Thanks, this makes a lot of sense. I probably should re-read this at least 10 more times just to drill it into my head.

[Anonymous]

For this question, I'm just wondering, why do you add the 20,000 insurance expense, since it doesn't necessarily say whether or not cash was paid for this insurance expense?

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Rory’s Co.’s prepaid insurance was $50,000 at December 31, Year 2, and $25,000 at December 31, Year 1. Insurance expense was $20,000 for Year 2 and $15,000 for Year 1. What amount of cash disbursements for insurance would be reported in Rory’s Year 2 net cash flows from operating activities presented on a direct basis?

A. $55,000

B. $45,000

C. $30,000

D. $20,000

Answer B. The $45,000 amount is calculated as follows:

Insurance expense – Year 2 $20,000

Increase in prepaid insurance ($50,000 – $25,000) 25,000

Total $45,000

[Author]

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