In the statement of cash flows, how is depreciation treated under the indirect method and under the direct method?

• A. An operating activity adjustment under the indirect method; under the direct method, it appears as part of operating cash flows if presented.
• B. A financing activity under both methods.
• C. An investing activity under indirect method.
• D. A non-cash investing or financing activity.

Answer: (A)

Depreciation is a noncash expense; it lowers reported income but doesn’t use cash in the period.

Under the indirect method, you start with net income and add back noncash expenses like depreciation to arrive at cash from operating activities. That adjustment compensates for the fact that depreciation reduced net income without converting to cash.

Under the direct method, operating cash flows are shown as actual cash receipts and payments. Since depreciation isn’t a cash flow, it doesn’t appear as a separate line item in the direct-method operating section. If depreciation is shown at all in a direct-method presentation, it would be included only as part of an optional or supplemental presentation, not as a cash flow item.