Indirect-Method Cash Flow Statement: Classifying a Disposal and Working-Capital Swing
Kestrel Manufacturing provides the following for the year:
- Net income $420,000; depreciation $85,000.
- Equipment with original cost $200,000 and accumulated depreciation $130,000 was sold for $55,000 cash.
- Accounts receivable increased $40,000; inventory decreased $25,000; accounts payable decreased $15,000.
- A $100,000 long-term note was issued; $60,000 of dividends were paid.
The staff accountant prepared a draft statement that (1) reports the $55,000 disposal proceeds as an operating inflow, (2) adds the full $85,000 depreciation without adjusting for the depreciation on the sold asset, and (3) treats the $40,000 receivables increase as an inflow because 'receivables are an asset.'
1. Compute the gain or loss on the equipment sale and identify the correct classification of the proceeds and the gain/loss in the indirect-method operating section.
Read the worked answer
Book value = cost $200,000 − accumulated depreciation $130,000 = $70,000. Proceeds $55,000 → loss on sale = $15,000.
Correct treatment:
- The $55,000 proceeds are an investing cash inflow, not operating. The accountant's item (1) is wrong.
- The $15,000 loss is added back in the operating section (it reduced net income but involved no operating cash). If it had been a gain, it would be subtracted.
- Depreciation add-back should reflect depreciation on assets still held; depreciation on the sold asset is embedded in the $130,000 accumulated depreciation and should not be double-counted. The $85,000 figure should be confirmed to relate to continuing operations.
2. Prepare the operating section (indirect method) and correct the receivables error. What is net cash from operating activities?
Read the worked answer
Indirect-method operating section:
| Item | Amount |
|---|---|
| Net income | $420,000 |
| Depreciation | +$85,000 |
| Loss on sale of equipment | +$15,000 |
| Increase in AR | −$40,000 |
| Decrease in inventory | +$25,000 |
| Decrease in AP | −$15,000 |
| Net cash from operating | $490,000 |
Correction of item (3): an increase in receivables means sales exceeded cash collected, so it is a subtraction (use of cash), not an inflow. The accountant's sign was reversed. Net operating cash = $420,000 + $85,000 + $15,000 − $40,000 + $25,000 − $15,000 = $490,000. The $55,000 proceeds belong in investing, and financing includes the $100,000 note inflow and $60,000 dividend outflow.