Disposal of Assets
If a company disposes of (sells) a long-term asset for an amount different from the amount in the company's accounting records (its book value), an adjustment must be made to the net income shown as the first amount on the cash flow statement.
For example, let's say a company sells one of its delivery trucks for $3,000. That truck is shown in the company's records at its original cost of $20,000 less its accumulated depreciation of $18,000. When these two amounts are combined, their the net amount is known as the book value (or the carrying value) of the asset. In this example, the book value of the truck is $2,000 ($20,000 - $18,000).
Because the cash received/proceeds from the sale of the truck was $3,000 and the book value was $2,000 the difference of $1,000 is recorded in the account Gain on Sale of Truck—an income statement account which increases the company's net income. [If the truck had sold for $1,500 ($500 less than its $2,000 book value), the difference of $500 would be reported in the account Loss on Sale of Truck and would reduce the company's net income.]
One of the rules in preparing a statement of cash flows is that the entire proceeds received from the sale of a long-term asset must be reported in the section of the SCF entitled investing activities. This presents a problem because any gain or loss on the sale of an asset is also included in the company's net income which is reported in the SCF section entitled operating activities. To avoid double counting, each gain is deducted from the net income and each loss is added to the net income listed as the first item in the operating activities section of the cash flow statement.
Let's illustrate this by returning to Good Deal Co.'s activities.
July Transactions and Financial Statements
On July 1 Matt decides that his company no longer needs its office equipment. Good Deal used the equipment for one month (May 31 through June 30) and had recorded one month's depreciation of $20. This means the book value of the equipment is $1,080 (the original cost of $1,100 less the $20 of accumulated depreciation). On July 1 Good Deal sells the equipment for $900 in cash and records a loss of $180 in the account Loss on Sale of Equipment on its income statement. There were no other transactions in July.
The income statement and the SCF for the month of July illustrate how the disposal of the equipment is reported:
Let's review the cash flow statement for the month of July 2020:
Net income for July was a net loss of $180. There were no revenues, expenses, or gains, but there was an entry of $180 in the account Loss on Sale of Equipment.
There was no depreciation expense in July because the asset was sold on July 1. Also, the current assets and current liabilities did not change in July, so cash was not affected. (We could have omitted the line "Depreciation Expense".)
The net amount of cash provided or used by operating activities was $0.
Good Deal received $900 from the sale of its office equipment.
There was no change in short-term loans payable, long-term liabilities, or owner's equity during July (other than the $180 loss on sale of equipment).
The sum of the amounts on the SCF for the one month of July was a positive cash inflow of $900. This amount agrees to our check figure—the increase in the Cash account balance from June 30 to July 31.
Let's review the cash flow statement for the seven months of January through July 2020:
Net income for the seven months was $100. This includes the company's revenues, gains, expenses, and losses.
Included in the net income for the seven months is $20 of depreciation expense. This expense reduced net income but did not reduce the Cash account; therefore on the SCF we add the $20 depreciation expense to the $100 of net income amount.
Also included in the net income was the $180 entry into the Loss on Sale of Equipment account. This loss was reported on the income statement thereby reducing net income. However, cash was not reduced. Cash of $900 was actually received from the sale of the equipment and it appears in its entirely in the investing activities section of the cash flow statement.
Inventory on July 31 is $200 (4 calculators at a cost of $50 each). Since the company began with no inventory, this increase in the Inventory account means that $200 of cash was used to increase inventory.
Supplies increased from none to $150. The increase in the Supplies account is assumed to have had a negative effect of $150 on the Cash account.
Combining the amounts so far, we see that the net amount of cash from operating activities is a negative $50. In other words, rather than providing cash, the operating activities used a net $50 of cash.
There is cash outflow (or payment) of $1,100 to purchase the office equipment on May 31. There was also a $900 cash inflow (or receipt) from the sale of the office equipment on July 1. Combining these two amounts results in the net outflow ("cash used in investing activities") of $200.
There was an owner's investment of $2,000 made on January 2.
The SCF's bottom line amount of a positive $1,750 results from combining the amount totals of the three sections—operating, investing, and financing activities. This $1,750 agrees to the check figure—the increase in the Cash account balance from the beginning of January to July 31.
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