Question

When preparing the operating section of the statement of cash flows, using the indirect method, how must gains and losses be handled? Why?

a) Gains are added to net income; Losses are subtracted from net income; To accurately reflect cash flows
b) Gains are subtracted from net income; Losses are added to net income; To reverse accrual accounting entries
c) Gains and losses are ignored; To simplify the statement of cash flows
d) Gains and losses are reported as separate sections; To provide detailed information

Answer 1

In the operating section of the statement of cash flows using the indirect method, gains are subtracted from net income and losses are added to net income to reverse non-cash accrual accounting entries.

Step-by-step explanation:

When preparing the operating section of the statement of cash flows using the indirect method, gains and losses must be handled in a specific way. The correct answer is b) Gains are subtracted from net income; Losses are added to net income; To reverse accrual accounting entries. This is because the indirect method starts with net income and then adjusts for items that affected reported net income, but did not involve actual cash transactions. Therefore, any gains on the statement must be subtracted because they increase net income but do not reflect actual cash coming into the business. Conversely, any losses must be added back to net income because they decrease net income but do not reflect a cash outflow.