While preparing cash flow statement, purchase of goodwill is treated as:

Investing activity

The correct answer is option 3- Investing activity.

Goodwill purchased is a cash outflow item as it is purchased by the company. While preparing the cash flow statement it is shown in investing activity because it is an intangible asset which is purchased by the company for earning profits in long term.

As per AS-3, investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Investing activities relate to purchase and sale of long-term assets or fixed assets such as machinery, furniture, land and building, etc. Transactions related to long term investment are also investing activities. Separate disclosure of cash flows from investing activities is important because they represent the extent to which expenditures have been made for resources intended to generate future income and cash flows.