Question

The most common non-cash expense deducted to determine net income is depreciation. To compute net cash flows from operating activities, depreciation must be _____ net income.

1) divided by
2) multiplied by
3) added by
4) subtracted from

Answer 1

To compute net cash flows from operating activities, depreciation must be added back to net income since it is a non-cash expense that reduces net income but does not reflect an outflow of cash.

Step-by-step explanation:

When calculating net cash flows from operating activities, a key adjustment involves the treatment of non-cash expenses such as depreciation. Depreciation is an allocation of the cost of tangible assets over their useful lives and does not involve an actual outflow of cash. Because it reduces reported net income but does not affect cash, it needs to be added back to net income in the cash flow statement to arrive at the net cash provided by operating activities.

An example demonstrating this concept within the broader context of national income accounting is: Net Domestic Product (NDP) is calculated by taking Gross Domestic Product (GDP) and deducting depreciation. If GDP plus income receipts from the rest of the world substract income payments to the rest of the world and then subtracting depreciation equals $560 + $10 - $8 - $40, then the NDP is $522 billion.