Question

A company bought $1,150,000 of equipment with an expected life of 28 years and no residual value. After 24 years the company sold the equipment for $128,500.

If the company uses straight-line depreciation and the indirect method is used to determine cash flows from operating activities, which of the following reflects how the sale of the equipment would be reported in the statement of cash flows?

(Do not round intermediate calculations. Round your answer to nearest whole number.)

a.$128,500 is recorded as a cash inflow from investing activities and $35,786 is added to convert net income to net cash flow provided by operating activities.

b.$128,500 is recorded as a cash inflow from investing activities and $35,786 is subtracted to convert net income to net cash flow provided by operating activities.

c.$128,500 is recorded as a cash inflow from operating activities.

d.$128,500 is recorded as a cash inflow from investing activities and no other sections of the statement are affected.

Answer 1

a.$128,500 is recorded as a cash inflow from investing activities and $35,786 is added to convert net income to net cash flow provided by operating activities.

Step-by-step explanation:

Depreciation is the systematic allocation of the cost of an asset to the income statement over the estimated useful life of that asset.

It is determined as the depreciable value of the asset over the estimated useful life of the asset where the depreciable value is the difference between the cost and salvage value of the asset

Mathematically,

Depreciation = (Cost - Salvage value)/Estimated useful life

Depreciation

= $1,150,000/28

= $41,071.43

The carrying amount or net book value of an asset is the difference between the historical cost of the asset and the accumulated depreciation.

Carrying amount of asset after 24 years

= $1,150,000 - 24 ($41,071.43)

= $ 164,285.71

When an asset is disposed, this carrying amount has to be derecognized and the proceed from the sale recognized. The difference between these two amounts is the gain/loss on disposal.

Gain/(loss) on disposal

= $128,500 - $164,285.71

= ($35,785.71)

The net profit/loss, depreciation, changes in current assets (other than cash) and liabilities are considered as operating activities including income taxes. Depreciation and Loss on disposal will be added to net income while gain on disposal will be subtracted.

The sale of assets, interest received, purchase of investments are examples of investing activities while the issuance of stocks, debt principal deduction (loan settlement), issuance of debt securities etc are examples of financing activities.