CFA Level IFinancial Statement AnalysisMedium
A company sells a piece of equipment for $80,000 cash. The equipment originally cost $100,000 and had accumulated depreciation of $40,000, giving it a book value of $60,000. The $20,000 gain on sale is included in net income. Under the indirect method, how should this transaction be reflected in the statement of cash flows?
- ASubtract the full $80,000 from CFO; report the $20,000 gain in the investing section
- BSubtract the $20,000 gain from CFO; report $80,000 in the investing section
- CAdd the full $80,000 to CFO; no adjustment is needed in the investing section
- DAdd the $20,000 gain to CFO; report $60,000 in the investing section
Show answer & explanationAnswer & explanation
Correct answer: B. Subtract the $20,000 gain from CFO; report $80,000 in the investing section
Under the indirect method, the gain must be removed from net income in CFO because it does not represent operating cash flow; the full $80,000 cash proceeds are reported as an investing cash inflow. Subtracting the $20,000 gain in CFO avoids double-counting, since the entire economic benefit is captured once in CFI.
Why the other options are wrong
- A. Incorrectly subtracts total proceeds from CFO instead of just the gain.
- C. Fails to remove the gain from CFO, causing double counting of the gain.
- D. Incorrectly adds the gain (gains should be subtracted) and understates investing proceeds.
Asset Sale — Indirect Method Cash Flow
When a long-lived asset is sold at a gain or loss, the gain/loss must be removed from net income in CFO (indirect method), and the total cash proceeds are reported as an investing cash inflow.
- Subtract gains / add back losses in CFO to avoid double counting
- Total sale proceeds (not book value) appear in CFI
- This adjustment applies only under the indirect method
Memory trick: Gain out of ops, cash goes to invest.