How to Account for a Gain / Loss on Sale in Cash Flow Statement with the Indirect Method

When using the indirect method for preparing a cash flow statement, the gain on the sale of an asset is adjusted because the cash flow statement starts with net income, which includes the gain. However, the gain does not affect cash directly; it merely reflects the result of an asset being sold above its book value. Here's how to adjust for it:

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Steps to Account for Gain on Sale of an Asset:

1. Start with Net Income

  • Begin the cash flow statement with the net income reported on the income statement.

2. Adjust for Non-Cash Items

  1. Subtract the gain on the sale of the asset from net income. This is because the gain increases the net income but does not involve an actual inflow of cash related to operating activities; it is considered a non-cash item.

3. Include the Actual Cash Received

  • In the cash flows from investing activities section, include the total cash proceeds received from the sale of the asset. This reflects the actual cash inflow resulting from the transaction.

Example

Suppose a company reports a net income of $100,000, which includes a gain of $15,000 from the sale of machinery. The machinery was sold for $35,000. Here’s how these figures would be reflected in the cash flow statement using the indirect method:

Net Income: $100,000

Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:

  • Subtract the gain on sale of machinery: -$15,000

Net Cash Provided by Operating Activities: Adjusted accordingly

Cash Flows from Investing Activities:

  • Add cash received from the sale of machinery: $35,000

Journal Entry Review (Related to Cash Flow)

  • Debit Cash $35,000 (reflects in investing activities)
  • Credit Machinery $50,000
  • Debit Accumulated Depreciation $30,000
  • Credit Gain on Sale of Asset $15,000 (adjustment in operating activities)
Was it a loss?

Note, if it is a loss, you do the same thing except now the loss reduces income, is offset in the cash flow statement still, the asset goes away on the balance sheet along with accumulated depreciation for the asset, and finally you record the cash proceeds under investing activities in the cash flow statement.

By adjusting for the gain in the operating activities section and reporting the actual cash received under investing activities, the cash flow statement accurately reflects the cash impact of the sale and separates it from operational cash flows, giving a clearer picture of the company’s cash generation and utilization. This method helps ensure that cash flows from operating activities are not overstated by the gain on the sale of assets.

Article found in Accounting and Finance.