Question

A company is reporting its statement of cash flows. To report the cash flows from operating activities, the company uses the indirect method. On its income statement, the company reports depreciation expense of $40,000 and a gain on sale of equipment of $13,000. Which of the following statements is true about reporting cash flows from operating activities?

The depreciation is added to net income while the gain is subtracted from net income to arrive at cash flows from operating activities.

The depreciation is subtracted from net income while the gain is added to net income to arrive at cash flows from operating activities.

Both the depreciation expense and the gain are added to net income to arrive at cash flows from operating activities.

Neither the depreciation expense nor the gain is shown in determining the cash flows from operating activities.

Answer 1

In the indirect method of cash flows from operating activities, depreciation is added to net income while the gain on sale of equipment is deducted to adjust the cash flows accordingly.

Step-by-step explanation:

When reporting cash flows from operating activities using the indirect method, adjustments are made to the net income to account for non-cash transactions and gains or losses from investing and financing activities. In this case, the ​depreciation expense of $40,000 is a non-cash charge, so it is added back to net income. Conversely, the gain on sale of equipment of $13,000 is subtracted from net income because it is a gain that did not involve operating cash flows. The correct statement is that depreciation is added to net income while the gain is subtracted from net income to arrive at cash flows from operating activities.