“Jack’s T-Shirt Emporioum” produces novelty T-Shirts, with the primary equipment

Question

“Jack’s T-Shirt Emporioum” produces novelty T-Shirts, with the

primary equipment being a screen print machine.

“Jack’s” generates $60,000 a year in profit.

Jack (the owner) feels that he could increase sales if he had a new machine with advanced capabilities (e.g. embroidery), so he purchases a new machine for $30,000 (cash). Jack estimates this machine to have an effective useful life of 5 years, and $5,000 residual (salvage) value, so Depreciable Value = $25,000.

The new machine will depreciate over 5 years at $5,000 / year.

In this years financial statements, Jack reflects the purchase as a

$5,000 expense, thus reducing his profit to $55,000.

Jack will show a $5,000 expense for Machine Purchase over the following 4 years.

In the “Jack’s” example, what amount will be recorded in the Cash Flow Statement related to this machine purchase?

Explanation / Answer

In the cash flow statement, under investing activities, the entire 30000 paid in cash is recorded as an outflow because the cash flows statement is prepared on a cash basis while the profit and loss statement records depreciation under matching principle which proposes to expense only that year's expense instead of the entire cost as the asset is used for a five year period.

Under operating activities, depreciation will be added back to the net income because it is a non cash expense therefore doesn't reflect a cash outflow.

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