6. Depreciation in Cash Flows

Let's use this problem as a way to talk about depreciation expense. Now, in an ideal world, depreciation expense would just be listed on your test, but you can look over here and see that none of these expenses have depreciation expense broken out. It's somewhere wrapped up in this operating expense. So when depreciation expense isn't listed, you have to go figure it out for yourself. Now, if you look over here on the balance sheet, you see accumulated depreciation. Now, you may be thinking, "Okay, that's fine. I know accumulated depreciation. I know what that account looks like. It started at 52 in Year 1, and it ended at 50.

So then 2,000." But hang on. I thought depreciation expense was depreciation expense debit, accumulated depreciation credit. So that 2,000 can't be the depreciation expense because you would have to have put that over on the credit side. Well, you would be correct. This is not right. So the problem with this is there were also some asset disposals during the year. So let's draw this accumulated depreciation account again. Started at 52 and ended at 50.

Let's see what else we can find. Let's look in this information here. New plant assets were purchased for cash during the year. That may be relevant. Old plant assets having an original cost of 57,500 were sold for 1,500. Okay, that's probably definitely relevant. 57,500, 1,500. Bonds matured, that's irrelevant. Cash dividend, that's irrelevant. Unfortunately, these kinds of problems not only test if you know how to do cash flows, but test basically if you know how to do everything in the class because you need to know how to do an asset disposal, you need to know how accumulated depreciation works, depreciation expense works, and cash flows.

So let's see if we can work through it. For an asset disposal, we get some amount of cash. We get rid of some plant, property, and equipment. We also get rid of the associated accumulated depreciation. And then we could have either a loss or we could have a gain. The problem tells us old plant assets having an original cost of 57,500 were sold for 15. Well, we know now that 15 cash goes there, and the original cost of these assets was 57,500. So we're gonna credit the original amount we put the assets in for, and we're gonna increase our cash by 1,500 because we received 1,500 for it.

Now, this still isn't enough information because we don't know the accumulated depreciation associated with these assets, and we don't know gain and loss, so we can't figure it out quite yet. If you come up here, you'll see loss on sale of plant assets, 7,500. So now we can fill this in and say the loss was 7,500. If there's a loss, there's no gain. So now we can figure out how much accumulated depreciation we got rid of. So we'll take the 57,500 less 7,500 less 1,500, and we get 48,500. We now know that 48,500 of accumulated depreciation was associated with the assets that were disposed of.

This needs to go over here in the accumulated depreciation account. When we sold these assets, we got rid of the accumulated depreciation that was associated with those assets. Now this account looks a little more complete, and we know that the missing amount is 46,500. 52,000 plus 46,500 less 48,500 leaves you with 50,000. And we know from some of the earlier stuff that the way you increase accumulated depreciation is by putting depreciation expenses in. So as you're putting depreciation expenses in, accumulated depreciation is going up. So this is the depreciation expense. That journal entry looks like this. Depreciation expense, 46,500.

Accumulated depreciation, 46,500. Now, if the problem said find cash flow from operations, you would have started with your net income, and you would have immediately thought, I need to add in depreciation expense. You come over here and you look and you think, well, depreciation expense isn't on here. It's not listed out separately, and so you have to go and figure it out for yourself. So if you end up with a problem where you don't have depreciation expense listed as one of your expenses, it's just lumped under operating, odds are you're gonna have a loss, it'll show you accumulated depreciation, and then there has to be some indication of the original cost of the assets that were sold and how much cash you got for them.

If you have all of that, you can put together the asset disposal journal entry and figure out, well, when I got rid of these old plant assets, how much accumulated depreciation did I get rid of? Then once you know how much accumulated depreciation you got rid of, you know that it was removed by debiting, so you fill in the debit side of this account. So this 48,500, that's the disposal right there. Then finally, you can get what you want, which is the depreciation expense, and that's just the mathematical difference that makes this account correct.