Gain or loss on sale of investment on cash flow statement
Gain or loss on sale of investment
When we make the sale of the investment assets, such as debt investment or stock investment, there may be a gain or loss as a result of the sale. This gain or loss on sale of investment will occur when the sale price of the investment is different from its fair value recorded on the balance sheet as at the selling date.
Generally, if the sale price is higher than the fair value, there will be a gain on the sale of the investment. On the other hand, if the sale price is less than its fair value, there will be a loss on the sale of the investment.
In this case, we can make the journal entry for gain on sale of investment by debiting the cash account and crediting the investment account and the gain on sale of investment account.
| Account | Debit | Credit |
|---|---|---|
| Cash | xxxx | |
| Investment | xxxx | |
| Gain on sale of investment | xxxx |
On the other hand, the journal entry for loss on sale of investment will be the debit of the cash and the loss on sale of investment and the credit of investment account.
| Account | Debit | Credit |
|---|---|---|
| Cash | xxxx | |
| Loss on sale of investment | xxxx | |
| Investment | xxxx |
This gain or loss on the sale of investment in the journal entries above is usually recorded as other revenues or other expenses on the income statement. However, this gain or loss on the sale of investment does not represent cash flows.
Hence, we will need to remove the gain or loss on the sale of investment from the net income when we prepare the cash flows from operating activities in order to reconcile the net income to the net cash.
The cash receipt (debit cash) generated by the sale of investment is the one that represents the cash flows. And this cash receipt will be recorded in the cash flows from investing activities.
Cash flow statement
Cash flow statement is a financial statement that reports cash flows in the company during the period with three main components. These three components include cash flows from operating activities, cash flows from investing activities and cash flows from financing activities.
Cash flows from operating activities are the cash flows that generate revenues and expenses in regular business activities. The gain or loss on the sale of investment that we need to adjust will include in this cash flows from operating activities under the indirect method.
The adjustment of deducting the gain or adding back the loss on the sale of investment to the net income will be done with other various adjustments in order to arrive at the net cash flows from operating activities.
Meanwhile, cash flows from investing activities are the cash flows that are related to the investment and fixed assets. And the cash receipt from sale of the investment is one example of the cash flows from investing activities. Other examples include purchasing investments, and buying and disposing of fixed assets, etc.
And cash flows from financing activities include activities that we use to obtain cash in order to start or expand our business operating. These include borrowing loans, selling shares of stock, paying interest and dividends as well as paying back the loan and buying back the shares of stock, etc.
Gain on sale of investment on cash flow statement
As mentioned, gain on sale of investment is usually recorded under other revenues account that appears on the income statement as a result of the sale of the investment. And this gain on the sale of investment does not affect cash flows as it does not represent cash flows. It represents the difference between the sale price and the value of the investment recorded on the balance sheet.
Likewise, when we prepare the schedule for cash flows from operating activities, we need to deduct the amount of gain on the sale of investment from the net income in order to arrive at the net cash.
| Cash flows from operating activities | |||
| Net income | xxxx | ||
| Adjustments to reconcile net income to net cash flows from operating activities | |||
| Depreciation and amortization | xxxx | ||
| Gain on sale of investment | (xxxx) | ||
| Increase in non-cash current assets | (xxxx) | ||
| Increase in current liabilities | xxxx | ||
| Net cash flows from operating activities | xxxx | ||
Loss on sale of investment on cash flow statement
On the other hand, loss on sale of investment is the other expenses account that we record on the income statement after selling the investment for less than its fair value recorded on the balance sheet.
Similar to the above, the loss on the sale of investment does not affect cash flows from operating activities. Hence, any amount recorded as the loss on the sale of investment during the period needs to be added back to the net income in order to reconcile it to the net cash.
In this case, we can make the adjustment in the cash flows from operating activities by adding back the loss on the sale of the investment to the net income as below:
| Cash flows from operating activities | |||
| Net income | xxxx | ||
| Adjustments to reconcile net income to net cash flows from operating activities | |||
| Depreciation and amortization | xxxx | ||
| Loss on sale of investment | xxxx | ||
| Decrease in non-cash current assets | xxxx | ||
| Decrease in current liabilities | (xxxx) | ||
| Net cash flows from operating activities | xxxx | ||
So as a result, when we prepare the indirect cash flow statement, we need to deduct the gain on sale investment to the net income or add back the loss on sale investment to the net income in order to arrive at the net cash flows from operating activities.
| Gain on sale of investment => deduct the gain from net income |
| Loss on sale of investment => add back the loss to net income |
Gain on sale of investment on cash flow example
For example, we have a $2,500 gain on the sale of investment and a $6,500 depreciation expense charged on the income statement during the accounting period. And at the end of the accounting period, we have the changes in non-cash current assets and current liabilities as below:
| Current assets | Year 0 | Year 1 | Changes |
|---|---|---|---|
| Inventory | 95,800 | 112,000 | 16,200 |
| Accounts receivable | 31,200 | 34,800 | 3,600 |
| Prepaid expenses | 25,300 | 23,900 | (1,400) |
| Current liabilities | |||
| Accounts payable | 55,300 | 53,200 | (2,100) |
| Accrued liabilities | 27,500 | 31,300 | 3,800 |
| Income taxes payable | 12,800 | 9,200 | (3,600) |
We have a $58,200 net income on the income statement for the period.
Prepare a schedule of cash flows from operating activities under the indirect method.
Solution:
With the information provided in the example above, we can prepare the schedule of cash flows from operating activities as below:
| Cash flows from operating activities | |||
| Net income | $58,200 | ||
| Adjustments to reconcile net income to net cash flows from operating activities | |||
| Depreciation expense | 6,500 | ||
| Gain on sale of investment | (2,500) | ||
| Increase in inventories | (16,200) | ||
| Increase in accounts receivable | (3,600) | ||
| Decrease in prepaid expenses | 1,400 | ||
| Decrease in accounts payable | (2,100) | ||
| Increase in accrued expenses | 3,800 | ||
| Decrease in income taxes payable | (3,600) | ||
| Net cash flows from operating activities | $41,900 | ||