Investing activities section is the second section of the statement of cash flows that reports the cash flows arising from the sale and acquisition of long term assets and investments. It typically involves the movement of cash on account of following activities:
- purchase and sale of productive long-term assets,
- purchase and sale of investments,
- making and collecting loans, and
- purchase and sale of intangible assets.
The acquisition or sale of long term assets and investments during a period can be determined by making an analysis of opening and closing balances from comparative balance sheet. An addition in the balance of an asset indicates that the company has acquired or constructed an asset during the period. A reduction, on the other hand, indicates that the asset has been sold during the period. Such acquisitions and sales are known as investing activities and the rest of this article explains how inflows and outflows of cash caused by such activities is reported in the statement of cash flows.
Understanding cash and non-cash investing activities:
The assets are acquired using cash or other medium of exchange. When a medium other than cash is used to acquire an asset we call it a non-cash investing activity. For example, a company can purchase a piece of equipment for $1,000 by making payment in cash which is a cash transaction or it can purchase a tract of land by issuing shares to the vendor which is a non-cash transaction. When we prepare a statement of cash flows, we are concerned only with cash transactions. The significant non-cash investing activities are, however, disclosed in the foot notes under the caption ‘non-cash investing and financing activities’.
Purchase and sale of long term productive assets:
Long term productive assets (also named as non-current assets or fixed assets) are purchased to keep and use in business for a long period of time. They are capital assets and are purchased to maintain or enhance the production or trading capabilities of the entity. Examples of such assets include plant and machinery, equipment, tools, building, vehicles, furniture and land etc. Since long term assets are not purchased with the intention of resale in the ordinary course of business, the cash flows resulting from their purchase and sale (including any gain on their sale) is classified as ‘cash flows from investing activities’ and is reported under investing activities section of the statement of cash flows.
Gains or losses on sale of fixed assets:
The sale of a used fixed asset normally results in a non-operating gain or loss. As non-operating gains or losses are included for the determination of net operating income, their effect is eliminated from the net operating income in the operating activities section. It is done in the following way:
- Deduct from net operating income any gain on sale of fixed assets included in income statement.
- Add to net operating income any loss on sale of fixed assets included in income statement.
Consider the following example for understanding hoe these gains and losses are handled while preparing a statement of cash flows:
The Big Brand company earned a net income of $65,000 for the year 2013 paydayloanstennessee.com/cities/oneida/. During the year, it sold one of its old plants for $6,400 and purchased a tract of land for $1,500. The plant was purchased several years ago for $10,000 and was being depreciated using straight line method. The accumulated depreciation – plant at the time of sale was $4,000.
- Calculate gain or loss (if any) on sale of plant. How should it be adjusted in operating activities section assuming company uses indirect method to prepare its statement of cash flows?