Question

Using the indirect method for reporting cash flows from operations, should a decrease in inventory be added to or subtracted from accrual based net income?

A) Added to

B) Subtracted from

C) No adjustment needed

D) Depends on the magnitude of decrease

Answer 1

A decrease in inventory should be added to accrual-based net income when using the indirect method for cash flow calculation because it signfies less cash was spent than reported on an accrual basis.

Step-by-step explanation:

When using the indirect method for reporting cash flows from operations, a decrease in inventory should be added to accrual-based net income. This is because a decrease in inventory indicates that less cash was spent purchasing inventory than what was reflected in the accrual-based net income. In accrual accounting, expenses are recorded when incurred, not necessarily when cash changes hands. Thus, to adjust net income to a cash basis, the decrease in inventory signifies that the company had a cash inflow (or less outflow) which wasn't captured in its net income calculation.

Therefore, the correct answer to the question is A) Added to.