Cash flows differ from accounting earnings because ______.

Cash flows differ from accounting earnings because ______.

• A. accounting earnings includes deprecation
• B. accounting earnings recognize expenses based on economic benefit
• C. sales are recorded based on legal liability
• D. cash flows include depreciation

Answer: (A)

The main idea is that accounting earnings (net income) include depreciation as an expense, but depreciation is a non-cash charge. Cash flows, on the other hand, reflect actual cash receipts and payments. Because depreciation reduces reported earnings without freeing any cash in that period, earnings are lower than cash flows by the amount of depreciation. When converting net income to cash flow from operations, you add back depreciation to remove its non-cash effect. For example, if net income is reduced by 20 due to depreciation, cash flow from operations would be 20 higher once you adjust, assuming no other changes. This is why accounting earnings and cash flows can diverge.

The main idea is that accounting earnings (net income) include depreciation as an expense, but depreciation is a non-cash charge. Cash flows, on the other hand, reflect actual cash receipts and payments. Because depreciation reduces reported earnings without freeing any cash in that period, earnings are lower than cash flows by the amount of depreciation. When converting net income to cash flow from operations, you add back depreciation to remove its non-cash effect. For example, if net income is reduced by 20 due to depreciation, cash flow from operations would be 20 higher once you adjust, assuming no other changes. This is why accounting earnings and cash flows can diverge.