Yellowgirl55 asked:
Here is the problem
Here is the problem
1.)Cash flows from operating activities—indirect method
Indicate whether each item would be added to or deducted from net income in determining net cash flow from operating activities by the indirect method.
a) Amortization of patent
***The correct answer is ADDED but can someone explain it to me please?
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You are confusing net income with net cash flow. It is an expense, but doesn’t affect the cash flow. It’s similar to depreciation, bad debt, and other non-cash expenses.
In arriving at net income, you would have deducted amortization of patent since it is a legitmate expense. But this amortization is merely a journal entry which did not involve cash. When preparing the cash flow statement, you want to find out the cash generated from op’g activities, and if your starting point is net income, you’d need to add back amortization of patent.
To give a simplified example, let’s say you have only 3 items, cash sales, cash COGS, and amortization of patent
Cash sales $500,000
less cash COGS ($350,000)
Gross profit $150,000
less:
Amortization of patent ($50,000)
Net income $100,000
For cash flow statement purposes, you start with net income
Net income $100,000
add:
Amortization of patent $50,000
Cash generated from operations $150,000, which is the figure you want.