Final answer:
Adding an increase in Interest Payable to net income when using the indirect method for cash flow statements corrects for the effect of incurred expenses decreasing net income without affecting cash. This adjustment ensures that the cash flow statement accurately reflects the company's cash position for operating activities.
The correct opiton is not given.
Step-by-step explanation:
When the indirect method is used to determine net cash provided by (used in) operating activities, adding an increase in Interest Payable to net income eliminates the effect of recording expenses that decreased net income, but did not impact cash. This adjustment is required because the accrual basis of accounting records expenses when they are incurred, not when they are paid.
Thus, if interest expense is recorded without an actual cash outflow, the interest payable increases, and the net income decreases. However, since no cash has left the company, we add back the increase in interest payable in the cash flow statement to reflect the correct cash position.
For example, if a company has an interest expense of $500 that has not been paid out in cash, it would decrease net income by $500, but would not affect the cash balance. Therefore, when preparing the cash flow statement using the indirect method, the $500 increase in Interest Payable is added back to the net income to reconcile net income to net cash provided by operating activities.
The correct opiton is not given.