Final answer:
When completing the statement of cash flows using the indirect method, a decrease in merchandise inventory would be shown as an increase to cash. This suggests more inventory was sold than purchased, indicating a lower cash outflow for inventory and thereby increasing the cash on hand.
Step-by-step explanation:
If merchandise inventory decreases during the year, the correct answer when completing the statement of cash flows using the indirect method is that a decrease in a current asset would be shown as an increase to cash. This is because the statement of cash flows is reconciling the net income to the actual cash flow from operating activities.
When inventory decreases, it implies that more inventory has been sold than purchased. Since inventory is paid for with cash, if you buy less inventory (or decrease it), the cash outflow for inventory is lower, thus there is more cash on hand.
In other words, when using the indirect method for the statement of cash flows, adjustments to net income are made for changes in operating assets and liabilities. A decrease in current assets other than cash suggests that cash was not used to purchase additional amounts of those assets, which could be reflected as an increase in cash flow.
However, depreciation is an example of a non-cash expense that is added back to net income in the indirect method, because although it reduces net income, it does not affect the company's cash balance.