Cash flow

GillyD

daft question of the day but if there is a gain on the disposal of an asset why is this deducted from the cash flow in the reconciliation when its inceasing income

PGM

This is a confusing topic;

The gain or loss is only a accounting figure, its the cash you get for it less NBV.

Its not a cash recieved figure.

So you need to take that entry out, reverse it, which seems odd as it then reduces the cash flow.

But then in the asset section you put in the ACTUAL cash recieved.

GillyD

Thanks PGM not sure that I understand it any better I will just have to get it into my thick skull to treat it as a non cash item in the reconciliation. For some reason cash flows are doing my head in including the journal adjustments I know we did some of this last year but it all seems like a long time ago. Weve hadvnt had many lessons on this topic due to tutor illness and the exam is a week away not hopeful.

PGM

Imagine you sell an asset for 10k

1, The book value (NBV) is 12k, you will show a loss on disposal of 2k. But you don't want a -2k on the cashflow when you have recieved 10k cash. So you need to reverse the loss of 2k, adding that back. Then in the investment section show a receipt of 10k

2, The book value is 6k, you'd show a gain of 4k. But likewise you don't want to show just a cashflow of 4k when you've actually received 10k. So you reverse the 4k gain, deducting it from the cashflow (the bit that seems odd). And then add the actual amount of 10k to the investment section.

So with both scenarios above, you end up with the same 10k on the cashflow. You're ignoring all accouting adjustments and putting on the cash flow what actual went into the bank.

Henry

GillyD,
PGM is right but you could perhaps look at it another way.

Lets use a simple example:

Asset at Cost = £500
less Dep to date = £25
NBV = £475
Add Gain on disposal £10
Disposal Proceed = £485

This is the sort of example we normally use to work out the disposal proceeds. Now what is happening here is that we are selling the asset for more than it's written down value and the gain is only a notional gain arising because of the amount of depreciation charged. So in effect we have over-allocated the depreciation charge. Since we need to add back depreciation (non-cash item) in the "Reconciliation of profit to net cash flow from operations", by deducting the gain simultaneously we are reducing the amount of depreciation allocated to balance out the differential between the NBV and the disposal proceeds.

So if we restated the example above we would have

Asset at Cost = £500
less Dep to date = £25 - 10 (gain) = 15
Disposal Proceed = £485

Note therefore that the total depreciation charge for the year includes the depreciation (in this case the £25) on the asset sold. The full disposal proceeds of £485 (including the gain of £10) would then be added to the "Cashflow from Investing" - so we have not "thrown away" the gain at all.

Hope this helps.

GillyD

ah I get it now, thanks guys now I actually understand it.

Steve Collings

Hi,

I wrote an article on the statement of cash flows a couple of years ago - though it is still very relevant.

I hope it helps.

Regards
Steve