Question

Which is added to net income in determining cash flows from operations (using an indirect format for the statement of cash flows)?

Answer 1

Depreciation expense and changes in working capital accounts are added back to net income when calculating cash flows from operations using the indirect method, since these items affect profits without affecting cash.

Step-by-step explanation:

When determining cash flows from operations using the indirect method on the statement of cash flows, certain items are added back to net income. One such item is depreciation expense, which is a non-cash expense that reduces net income but does not affect cash flow. Other adjustments could include changes in working capital accounts such as increases in accounts payable or decreases in accounts receivable, as these are also non-cash effects on net income. The essence of the indirect method is to adjust the net income for items that affected reported profits but did not involve actual cash transactions.

In determining cash flows from operations through the indirect method on the statement of cash flows, various adjustments are made to net income. Depreciation expense is added back as it is a non-cash charge that reduces net income but doesn't impact actual cash flow. Additionally, changes in working capital accounts, like increases in accounts payable or decreases in accounts receivable, are adjusted as they represent non-cash effects on net income. The indirect method aims to reconcile reported profits with actual cash transactions by making adjustments for these non-cash items. It provides a more accurate representation of the cash generated or used by operating activities, enhancing the understanding of an organization's liquidity and ability to meet its short-term obligations. This method is widely used in cash flow statements to provide a clearer picture of the cash movements within a business.

Answer 2

Depreciation and amortization are added to net income in determining cash flows from operations using an indirect format.

Step-by-step explanation:

In determining cash flows from operations using an indirect format for the statement of cash flows, depreciation and amortization is added to net income.

Depreciation and amortization are non-cash expenses that represent the wear and tear or the expensing of intangible assets over time. These expenses are added back to net income because they do not involve an actual outflow of cash, but they are included in the calculation to provide a more accurate representation of cash flows from operations.

Depreciation expenses are added back to net income when determining cash flows from operations using the indirect format. Since depreciation is a non-cash expense that reduces net income, but does not affect actual cash flow, it is reversed out in the Statement of Cash Flows to show the true cash position. Companies often reinvest available cash to grow and sustain operations, which can lead to increased production and sales. However, while reinvestment is vital, it is not relevant to the adjustment of net income while preparing a cash flow statement using the indirect method.