Question

Statement-I : Snow Limited earned a profit of Rs 2,00,000 after charging depreciation of Rs 50,000 on machinery. So, operating profit before working capital changes would be Rs 2,50,000.
Statement-II : Depreciation is added back to net profit as it does not result in any cash flow.
Choose the correct option from the following:

• A. Only Statement-I is true.
• B. Only Statement-II is true.
• C. Both the Statements are false.
• D. Both the Statements are true.

Hint:

In Cash Flow from Operating Activities (Indirect Method): - Start with Net Profit Before Tax and Extraordinary Items. - Add back Non-Cash Expenses (like Depreciation, Amortization, Loss on Sale of Asset). - Add back Non-Operating Expenses (like Interest paid). - Deduct Non-Operating Incomes (like Interest received, Dividend received, Profit on Sale of Asset). - The result is Operating Profit Before Working Capital Changes.

Answer 1

The Correct Option is D

Step 1: Evaluate Statement-I:
Operating profit before working capital changes is calculated by starting with Net Profit *before tax* and adding back non-cash and non-operating expenses, and deducting non-operating incomes. Depreciation is a non-cash operating expense.
Given Profit (presumably Net Profit *before tax*, though not explicitly stated) = Rs 2,00,000 (after depreciation).
Depreciation = Rs 50,000.
To find Profit *before* depreciation, we add it back: Rs 2,00,000 + Rs 50,000 = Rs 2,50,000.
This matches the calculation for operating profit before working capital changes (assuming no other non-cash/non-operating items or taxes impacting the figure significantly). So, Statement-I appears true in the context of Cash Flow Statement preparation.
Step 2: Evaluate Statement-II:
Depreciation is an accounting expense that allocates the cost of a fixed asset over its useful life. It is charged to the Profit and Loss account, reducing the net profit. However, it does not involve an actual outflow of cash in the period it is charged. In preparing a Cash Flow Statement using the indirect method, depreciation is added back to net profit because it reduced the profit without affecting cash. So, Statement-II is true.
Step 3: Conclude based on Evaluation:
Both Statement-I and Statement-II accurately describe common adjustments and concepts used in calculating operating profit before working capital changes and preparing cash flow statements. Statement-I shows the calculation, and Statement-II provides the reason for adding back depreciation in cash flow analysis.
Conclusion:
Both statements are true.