What are the most important non-cash items that get adjusted in the cash flow statement, and where do they show up?

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AcadiFi · Accepted Answer

Non-cash items are transactions that affect net income but do not involve actual cash inflows or outflows. They must be adjusted in the cash flow statement (indirect method) to reconcile net income with actual cash generated.

**Comprehensive List of Non-Cash Items**

| Non-Cash Item | Effect on Net Income | CFO Adjustment |
|---|---|---|
| Depreciation | Reduces income | Add back |
| Amortization (intangibles) | Reduces income | Add back |
| Impairment charges (goodwill, assets) | Reduces income | Add back |
| Stock-based compensation | Reduces income | Add back |
| Deferred tax expense | Increases tax expense | Add back |
| Deferred tax benefit | Decreases tax expense | Subtract |
| Bond discount amortization | Increases interest expense | Add back |
| Bond premium amortization | Decreases interest expense | Subtract |
| Gain on sale of assets | Increases income | Subtract (reclassify to CFI) |
| Loss on sale of assets | Decreases income | Add back (reclassify to CFI) |
| Unrealized foreign exchange gains | Increases income | Subtract |
| Unrealized foreign exchange losses | Decreases income | Add back |
| Provision for doubtful accounts | Reduces income | Add back |
| Restructuring charges (non-cash portion) | Reduces income | Add back |
| Equity method income (beyond dividends) | Increases income | Subtract excess over dividends |

**Example:** Stratton Industries reports net income of $1,200,000 with these non-cash items:

- Depreciation: $180,000
- Stock-based compensation: $95,000
- Impairment of patent: $60,000
- Gain on sale of old equipment: $25,000
- Amortization of bond discount: $12,000
- Unrealized FX loss: $8,000

Adjustments to arrive at CFO (before working capital changes):
$1,200,000 + $180,000 + $95,000 + $60,000 - $25,000 + $12,000 + $8,000 = **$1,530,000**

**Why Gains and Losses Are Removed**
Gains and losses on asset sales are non-operating. The full cash proceeds appear in CFI. If you leave the gain in CFO, you double-count: once in net income (CFO) and once as cash proceeds (CFI). Removing the gain from CFO fixes this.

**Equity Method Nuance**
If a company reports $50,000 in equity income from an investee but only received $30,000 in dividends, the $20,000 excess must be subtracted because it represents non-cash income. Only the $30,000 dividend is a real cash inflow.

**Exam Tip:** The most tested non-cash items are depreciation, gains/losses on sales, stock-based compensation, and deferred taxes. For each, ask: "Did cash actually move?" If not, adjust CFO to remove the income effect.

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What are the most important non-cash items that get adjusted in the cash flow statement, and where do they show up?

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