Question

Brighton, Inc. uses the indirect method to determine its cash flow from operations. During the course of the year, Brighton, Inc.'s Accounts Receivable increased by $10,000 and its Accounts Payable decreased by $5,000. As a result of these two items, the net addition (or subtraction) to convert net income to cash flow from operations equals:

A. ($5,000).
B. $5,000.
C. ($15,000).
D. $15,000.

Answer 1

Using the indirect method, adjustments are made for changes in balance sheet accounts when calculating cash flow from operations. Increases in Accounts Receivable are subtracted, and decreases in Accounts Payable are also subtracted from net income. The total adjustment in this scenario is a subtraction of $15,000 from net income.

Step-by-step explanation:

When using the indirect method for the cash flow statement, changes in balance sheet items are adjusted to net income to calculate cash flow from operations. An increase in Accounts Receivable is an indication that the company has made sales for which it has not yet received cash, and therefore, this amount needs to be subtracted from net income. Conversely, a decrease in Accounts Payable suggests that the company has paid off some of its liabilities, which means that cash was used, and this decrease should also be subtracted from net income.

If Accounts Receivable increased by $10,000, it means the company did not receive this cash, hence we subtract this amount from net income. Simultaneously, Accounts Payable decreased by $5,000, which implies that the company has paid this out in cash, decreasing the cash balance, so we also subtract this amount from net income. The combined effect of these two changes amounts to $15,000 ($10,000 + $5,000) being subtracted from net income to adjust to the cash flow from operations.

Therefore, the answer to the question is C. ($15,000).