In accounting, the gains and losses such as gains and losses on disposal of fixed assets or gains and losses on the sale of investments that we record to the income statement do not represent the cash inflow to the business or outflow from the business. In this case, when preparing the cash flow statement we need to make adjustments by removing these gains or losses from the net income in order to arrive at the net cash flows from operating activities.
In the income statement, these gains or losses represent other income or other expenses. Likewise, these gains or losses will increase or decrease the net income on the income statement respectively.
However, these gains or losses are considered the non-cash revenues or non-cash expenses in the cash flow statement. Hence, we need to remove them from the net income by deducting the amount of gains or adding back the amount of losses in the adjustments to reconcile net income to net cash flows from operating activities.
Gains or losses on the cash flow statement that we usually see are the gains or losses that resulted from investing and financing activities such as gains or losses on the disposal of fixed assets and gains or losses on the sale of investments.
As mentioned, when preparing the cash flow statement, we need to remove these gains and losses from the net income that we get from the income statement. In this case, we need to deduct the gain amount while the loss amount will need to be added back.
This is due to, the gains such as gains on disposal of the fixed asset or the gains on the sale of investments will increase the net income while the losses will decrease the net income on the income statement. Hence, we need to deduct the gains and add the losses in the adjustment that we need to make under the cash flows from operating activities.
Likewise, we can present the gains and losses on the cash flow statement in the form below:
Gains on cash flow statement
Losses on cash flow statement
For example, our income statement reports a net income of $500,000 for the period. And during the accounting period, we charged a $50,000 depreciation expense to the income statement and we also had a $10,000 gains on the disposal of fixed assets transaction during the period.
Additionally, at the end of the accounting period, we have analyzed the changes to non-cash current assets and current liabilities as below:
What is the net cash flow from operating activities under the indirect method of cash flow statement?
Solution:
We can prepare the cash flows from operating activities for the indirect cash flow statement by deducting the $10,000 gains on disposal of fixed assets from the $500,000 net income and making other adjustments as below:
So, we have a result of $480,000 net cash flows from operating activities after making the adjustment of the $10,000 gains on the disposal of fixed assets and other adjustments on the cash flow statement.
So, as we have seen above, it is safe for us to conclude that the gains and losses do not affect the cash flows provided by the operating activities in the cash flow statement. This is due to the gains and losses do not represent the cash flows.
The real cash flows are those cash receipts that are generated by the disposal of fixed assets or by the sale of the investments themselves. And those cash flows are recorded under the investing activities or financing activities on the cash flow statement.
The gains and losses here are the gains and losses resulting from the disposal of fixed assets or by the sale of the investments and they are merely the booking adjustments that are required in the accounting record (no cash involved).