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In 2010, Palacio Corporation sold an automobile for $5,000. The automobile had a book value of $7,500 at the time of the sale.

-In its statement of cash flows prepared on the indirect method, Palacio should
A) classify the actual $5,000 cash inflow as a component of cash flows from financing activities.
B) add the $2,500 loss that resulted from this transaction to net income.
C) subtract the $2,500 loss that resulted from this transaction from net income.
D) add the $4,000 gain that resulted from this transaction to net income.
E) subtract the $4,000 gain that resulted from this transaction from net income.

Question

Use the following information to answer questions :
In 2010, Palacio Corporation sold an automobile for $5,000. The automobile had a book value of $7,500 at the time of the sale.

-In its statement of cash flows prepared on the indirect method, Palacio should
A) classify the actual $5,000 cash inflow as a component of cash flows from financing activities.
B) add the $2,500 loss that resulted from this transaction to net income.
C) subtract the $2,500 loss that resulted from this transaction from net income.
D) add the $4,000 gain that resulted from this transaction to net income.
E) subtract the $4,000 gain that resulted from this transaction from net income.

Quizplus · Accepted Answer

The correct answer is B) add the $2,500 loss that resulted from this transaction to net income. This is because, in the indirect method of preparing a cash flow statement, non-cash expenses and losses are added back to net income to adjust for the fact that they reduced net income but did not involve an outflow of cash. In this case, the sale of the automobile resulted in a $2,500 loss ($5,000 sale price - $7,500 book value), which should be added back to net income in the cash flow from operating activities section.

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