![]() Other examples of gains and losses that require a similar treatment are gains or losses on discontinued operations, and gains on early payment of debts etc. If a statement of cash flows is prepared, the gain of $300 will, therefore, be deducted from the net operating income in the operating activities section and the total proceeds of $1,500 will be shown in the investing activities section of the statement of cash flows. The gain of $300 ($1,500 – 1,200) will be considered for the computation of net operating income. For example, if a company sells some of its old equipment having a book value of $1,200 for $1,500. Since these gains and losses are the result of non operating activities, their effect is eliminated by adding any non operating loss to and deducting any non operating gain from net operating income figure. ![]() The gains and losses resulting from non operating activities are included in the income statement. Adjustments for non operating gains or losses: The examples of accounts that create such timing differences include prepaid expenses, inventories, accounts receivable, accrued expenses payable, and accounts payable. The changes in the balances of such assets and liabilities over period represent differences between revenues and expenses recognized for income statement purpose and the net cash flows from operating activities. So, recognition of revenues and expenses without debiting or crediting cash account give rise to assets and liabilities. The Accounts Receivable (an asset) in the above example is debited in place of cash on the event of a credit sale. When a revenue is recorded without debiting cash, an asset is debited in place of cash or when an expense is recorded without crediting cash, a liability is credited in place of cash. We recognize it by debiting ‘Accounts Receivable’ account and crediting ‘Sales’ account. For example, when we make a sale on account, we recognize it immediately rather than waiting for the time the customer will make the payment. Under accrual based accounting system, revenue is recognized when it is earned and expenses are recognized when the benefit is taken rather than the time the cash changes the hand. The proper presentation is given below: Adjustments for timing differences: The depreciation is a non-cash expense that must be added back to net income as an adjustment to reconcile net income to net cash provided (or used) by operating activities. How XYZ should treat the depreciation expense for preparing the operating activities section using indirect method? ![]() The only non cash expense reported in the income statement was depreciation of $2,200. The income statement of XYZ company shows a net income of $75,000 for the year ended 31 December, 2013. The following example illustrates the treatment of depreciation for preparing operating activities section. The other examples of expenses that require a similar treatment are depletion of natural resources, amortization of intangible assets and amortization of bond discounts etc. The purchase of a depreciable asset is an investing activity and the outflow of cash that occurs as a result of such a purchase is reported under investing activities section.Īs non-cash expenses reduce net operating income without reducing cash, they are added back to net operating income under indirect method. A popular example of non-cash expense is depreciation. Non-cash expenses reduce net operating income but do no affect cash. Adjustments to reconcile net income to net cash flows from operating activities: Adjustments for non cash expenses: The rest of this article explains how these adjustments are made to net operating income (or loss) to arrive at net cash flow from operating activities. ![]() For this purpose, net operating income (or loss) figure is taken from the income statement and is adjusted for non cash expenses, timing differences and non operating gains or losses. Under indirect method (also known as reconciliation method), we convert net operating income (or loss) to net cash provide (or used) by operating activities during the year. Example of indirect method of operating activities section.Adjustments to reconcile net income to net cash flows from operating activities.If you are looking for direct method, please read ‘operating activities section by direct method’ article. This article is focused on indirect method of preparing operating activities section of the statement of cash flows.
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