Preface Beerbo wants help interpreting information from its financial statements in order to create its statement of cash flows (SCF). To help Beerbo, you provide examples and explanations to help answer Beerbo's questions as follows: BeerWhen adjusting my net income to determine cash from operating activities (CFOA), why must I reverse the effect of depreciation expense? You:Assume you purchase equipment four years ago for $50,000 cash: DR. Equipment....... CR. Cash (cash) ..50,000 ..50,000 You:That represents a $50,000 cash outflow from investing activities (CFIA). Now assume you recognize $40,000 in depreciation over the next four years and sell the equipment for $10,000 cash: DR. Cash (cash)... DR. Accumulated Depreciation - Equipment. CR. Equipment......... .10,000 .40,000 ..50,000 You: The $10,000 represents a cash inflow. So, over the four year period that you owned the equipment, you had a net $40,000 cash outflow from owning the car. In other words, there is (in fact) a cash effect of depreciation, but it is capture in the investing activities (CFIA) section of your SCF. In the meantime, you must make sure that no depreciation is shows up in your operating activities (CFOA) section, so you have to reverse the effects of depreciation expense from your accrual-basis net income in order to determine your cash-basis income from operations. BeerWhen adjusting my net income to determine CFOA, why must I reverse the effect of losses/gains from the sale of my long-term assets? You:Consider the same facts above, but assume you sell your equipment for $8,000 cash: DR. Cash... DR. Accumulated Depreciation - Equipment DR. Loss on Sale...... CR. Equipment.. ..8,000 .40,000 ..2,000 ...50,000 You:Now, your net cash outflow from owning the car is $42,000: $40,000 due to depreciation; $2,000 due to a loss on sale. Again, these cash effects are going to be captured in your CFIA section and should not appear in your CFOA section. So, like depreciation, you have to reverse the effect of losses (or gains) from your accrual-basis net income in order to determine your cash-basis income from operations.