Question

A company purchased $300,000 worth of equipment with an expected life of 11 years and no residual value. After 7 years, the company sold the equipment for $94,500. If the company uses straight-line depreciation and employs the indirect method to determine cash flows from operating activities, how would the sale of the equipment be reported in the statement of cash flows?

Options:

a) $94,500 is recorded as a cash inflow from investing activities, and no other sections of the statement are affected.

b) $94,500 is recorded as a cash inflow from investing activities, and $14,591 is added to convert net income to net cash flow provided by operating activities.

c) $94,500 is recorded as a cash inflow from investing activities, and $14,591 is subtracted to convert net income to net cash flow provided by operating activities.

d) $94,500 is recorded as a cash inflow from operating activities.

Answer 1

Option b is correct, with the cash inflow from the equipment sale reported under investing activities and the loss on sale added back to the net income in the operating activities section when using the indirect method.

Step-by-step explanation:

The correct answer to the question is option b: $94,500 is recorded as a cash inflow from investing activities, and $14,591 is added to convert net income to net cash flow provided by operating activities. This is because when using the indirect method for the statement of cash flows, non-cash expenses like depreciation are added back to the net income. The equipment was purchased for $300,000 with a useful life of 11 years, thus having a straight-line depreciation of $27,273 per year ($300,000 / 11 years). After 7 years, accumulated depreciation is $190,909 ($27,273 * 7 years). The carrying amount of the equipment at the time of sale would therefore be $109,091 ($300,000 - $190,909).

When the equipment is sold for $94,500, the company incurs a loss of $14,591 ($109,091 - $94,500), which is included in the operating activities section as an adjustment to the net income. However, the actual cash received from the sale of equipment, $94,500, is reported under investing activities as it pertains to a long-term asset transaction.