Cash Flow Statement and Depreciation

Q: Depreciation charged during the year will come under which activities?


A:
Depreciation actually does not come under any of the categories of the cash flow statement. Depreciation is an expense but an expense that never involves cash.

Actually, depreciation is simply the systematic reduction in the value of a non-current (long-term) asset each year. The amount of this reduction is recognized as an expense each year and shown in the income statement.

delivery vehicleFor example, you purchase a delivery vehicle for your business for $50,000. You expect it to be used for 10 years in the business before replacing it. So you allocate $5,000 per year ($50,000 / 10 years) as an expense to the income statement. This expense is called depreciation.

From the asset point of view, after 2 years your business would have recorded $10,000 of accumulated depreciation ($5,000 each year for 2 years) against the asset's original value ($50,000), giving a carrying amount (the net value to your business) of $40,000 for the vehicle.

Occasionally you will see depreciation in a cash flow statement exercise or question. In this situation they will provide you with the income statement (and possibly the other financial statements of the business) and you will have to construct the cash flow statement from these. The income statement will include depreciation as one of the expenses there.

They may require you to start with the net profit in the income statement and go from this figure to a net cash flow figure. In this case you have to remove the differences between the two statements. One of those differences is depreciation, which occurs in the income statement but is not a part of cash flow.

Hope that helps!

By the way I have full, detailed explanations of depreciation (multiple lessons) and exercises in my basic accounting book.

All the best for your studies,
Michael Celender

Comments for Cash Flow Statement and Depreciation

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Depreciation (Direct vs Indirect Method)
by: Michael

The only time you see depreciation in a cash flow statement is when you start with figures from the income statement (profit and loss, same thing) to create the cash flow statement.

This is known as the indirect method of preparing the cash flow statement - one starts with figures from the income statement to prepare the statement of cash flows. The method I have used and shown in my cash flow statement lesson is called the direct method. This is a much simpler method than the indirect method of preparing the statement of cash flows.

Remember that depreciation is included as an expense in the income statement but is a non-cash expense - i.e. no cash moves during the year due to depreciation - only a decrease in the carrying amount of the asset. So when constructing the cash flow statement according to the indirect method, where depreciation has already been included in the income statement, we want to remove it so it is not a factor in our cash flow statement.

When constructing the cash flow statement according to the indirect method we start with the income statement's profit figure. Because the depreciation expense has already been deducted to get to this profit figure, we now add it back to get to our cash figures. This ensures that depreciation is removed as a factor from the cash flow statement.

There is no need to show depreciation in the cash flow statement if you are using the direct method.

FYI I don't cover the indirect cash flow method on this site because 1) the direct method is the format of the actual final cash flow statement anyway, 2) the indirect method is fairly complicated and 3) most accounting software can work out your cash flow figures and draw up the cash flow statement for you (in the usual direct method form) so as a practicing bookkeeper or accountant you probably won't need to know this method anyway.

I do not cover depreciation in any detail on this free website, but I do have a number of lessons on this subject in my accounting books.

Best,
Michael Celender

Depreciation is not part of the cash flow statement?
by: Confused

I am a bit confused as to your reasoning for depreciation not being a part of the cash flow statement. It is a non-cash expense within the SG&A that has a direct affect on net income. The cash outflow from the asset occurred when it was purchased, not as it depreciated. So, why would it not be added back into the net income within the cash flows from operating activities?

Cash Flow Statement & Depreciation
by: lapore

Depreciation, yes is an expense, but it also falls under operating activities. You less it.

Cash Flow Statement
by: blessing nkomo

How come there was depreciation included in an IOBZ SEPT 2012 FIN 2 answer?

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