Excerpts from Raimo Corporation's comparative balance sheet appear below: Which of the following is the correct treatment within the operating activities section of the statement of cash flows using the indirect method?
A)The change in Inventory is added to net income;The change in Accounts Payable is added to net income
B)The change in Inventory is added to net income;The change in Accounts Payable is subtracted from net income
C)The change in Inventory is subtracted from net income;The change in Accounts Payable is added to net income
D)The change in Inventory is subtracted from net income;The change in Accounts Payable is subtracted from net income

Question

Excerpts from Raimo Corporation's comparative balance sheet appear below:  Which of the following is the correct treatment within the operating activities section of the statement of cash flows using the indirect method?
A)The change in Inventory is added to net income;The change in Accounts Payable is added to net income 
B)The change in Inventory is added to net income;The change in Accounts Payable is subtracted from net income 
C)The change in Inventory is subtracted from net income;The change in Accounts Payable is added to net income 
D)The change in Inventory is subtracted from net income;The change in Accounts Payable is subtracted from net income

Quizplus · Accepted Answer

The indirect method of the statement of cash flows starts with net income and makes adjustments to reconcile it to cash flows from operating activities. The change in inventory and accounts payable are both related to operating activities.

An increase in inventory means that the company has spent cash to purchase additional inventory, which is a use of cash. Therefore, the change in inventory needs to be subtracted from net income to arrive at cash flows from operating activities.

An increase in accounts payable means that the company has received goods or services but has not yet paid for them, which is a source of cash. Therefore, the change in accounts payable needs to be added to net income to arrive at cash flows from operating activities.

Therefore, the correct treatment within the operating activities section of the statement of cash flows using the indirect method is: 
- Subtract the change in inventory from net income 
- Add the change in accounts payable to net income.

Thus, option C is the correct choice.

Excerpts from Raimo Corporation's Comparative Balance Sheet Appear Below