Cash Flow Statement and Depreciation
Q: Depreciation charged during the year will come under which activities?
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.
For 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,