I am working through the cash flow section and stumbled upon the following questions:
Depreciation expense would be classified as:
A. Operating Cash Flow
B. Investing Cash Flow
C. No Cash Flow Impact
Correct answer is C - Doesn’t this depend on whether you use the direct or indirect method? Wouldn’t depreciation expense be considered under Operating Activites under the indirect method because you have to add back non cash transaction while it would be disregarded in the direct method? If so, how are we supposed to know the correct answer if there is no clear explanation in the question. It is my understanding that both IFRS and GAAP prefer the use of the direct method and so do we have to make this assumption in a question like this?
Depreciation expense isn’t a cash flow; the cash flow occurs when you pay for the asset you’re depreciating.
The reason that you add depreciation expense when you use the indirect method for CFO is that . . . well . . . depreciation expense isn’t a cash flow. You deducted depreciation expense to arrive at net income, so you add it back in to offset the deduction. You’re not adding it back in because it’s a cash flow; you’re adding it back in _ because it’s not a cash flow _.
You seem to be under the misapprehension that some things are cash flows under the direct method but not under the indirect method and vice versa. Cash flows are cash flows; how you account for them doesn’t change that. If you pay cash, that’s a cash outflow, no matter how you account for it. If you receive cash, that’s a cash inflow, no matter how you account for it. If you don’t pay cash and you don’t receive cash, that’s not a cash flow, no matter how you account for it.
Cash is the king. You can rig Income Statement. You can rig Balance Sheet. But, you cannot manipulate Cash Flow Statement. Because, cash is hard-core. It is physical in nature. It can be measured precisely.
Cash does not care if you are following GAAP or IFRS or Direct Method or Indirect Method or Straight Line Depreciation or Accelerated Depreciation.
You are saying what i am saying. I should have been more clear and said - you cannot manipulate ‘cash’ instead of ‘cash flow statement’. That should have removed confusion.
People commonly see income statement accounts, EBITDA precisely, as a proxy of cash flow. I always state it is not the best approach, but many times get ignored. In fact cash flows are hard to manipulate, however you can play with operating cash flow to make the firm to seem more stable operatively and to appear to be less risky than it is.
^^Cash flow statement as well as all other financial statements are published by its cut off balance at the certain date, usually on December 31st. So it can be manipulated by pumping certain items including cash balance exact at this date. Remember that only insiders (management) know the real situation before all others.
While I agree that it is more difficult to manipulate the cash balances in FS, it is possible to cheat shareholders and creditors by management in such manner. Finally, there are evident cases where companies just had such manipulation worked. One of the common examples is negative WCs pumping by deffering payments to suppliers, employees, tax evasion etc. All directed to smoothing balances on 31/12. During the long term it is difficult to maintain such pump of cash balance.