JGMH Inc. sold a piece of equipment during the period for $230,000 and recorded a gain of $45,000 on the sale. How should this gain be treated when preparing the operating activities section of the statement of cash flows using the indirect method?

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Question restatement: JGMH Inc. sold equipment for $230,000 and recorded a gain of $45,000 on the sale. How should this gain be treated in the operating activities section of the cash flows statement (indirect method)?

Option 1: The gain is added back to net income in the operating activities section.
This is incorrect. A gain on the sale of equipment increases net income, but under the indirect method we adjust net income to reconcile to cash from operating activities. Adding the gain would overstate cash provided by operations because the cash inflow from the sale is reported in investing activities, not operating activities.

Option 2: A sale of equipment is an investing activity; the transaction will not affect the operating activities section.
This statement is misleading for the indirect method. While the cash flow from the sale is indeed classified as an investing activity, the gain (or loss) affects net income and must be adjusted in the operating activities section to convert accrual net income to cash basis. So the transaction does indirectly affect operating activities through the adjustment for the gain or loss.

Option 3: The gain is subtracted from net income in the operating activities section.
This is correct. In the indirect method, you start with net income and adjust for non-cash items and non-operating items. A gain on sale increases net income but does not provide operating cash; thus you subtract the gain to reverse its effect and reflect actual cash from operations.

Option 4: The entire sales price is subtracted from net income in the operating activities section.
This is incorrect. The entire cash proceeds from the sale are part of investing activities. Subtracting the full sale price from net income in operating activities would misclassify cash flows and double-count the transaction's effects. The correct treatment is to adjust for the gain (not the full sale price) in operating activities while reporting the cash inflow in investing activities.

JGMH Inc. sold a piece of equipment during the period for $230,000 and recorded a gain of $45,000 on the sale. How should this gain be treated when preparing the operating activities section of the statement of cash flows using the indirect method?Single choice

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