Final answer:
In financial reporting, we add back losses on sale and subtract gains on sale from net income to evaluate the core operating performance of the business.
Step-by-step explanation:
When calculating net income, we add back losses on sale and subtract gains on sale to account for the impact of these transactions on the overall profitability of the business. These adjustments are made because gains and losses on sale are considered non-operating activities and are not representative of the normal business operations. By adding back losses on sale and subtracting gains on sale, we can better evaluate the core operating performance of the business.
For example, let's say a company sells a piece of equipment for $10,000, resulting in a gain on sale. This gain is added back to net income because it is not directly related to the company's main business activities. On the other hand, if the company incurs a loss of $5,000 from selling inventory, this loss is subtracted from net income to accurately reflect the impact of the loss on the company's profitability.
By making these adjustments, we can get a clearer picture of the company's operating performance and make more informed financial decisions.