Which of the following items is deducted from net income to arrive at cash flow from operations when using the indirect method?
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A. B. C. D.C
A decrease in accounts payable is an outflow.
When using the indirect method to calculate cash flow from operations, several adjustments are made to net income. The purpose of these adjustments is to convert the accrual-based net income figure into a cash-based figure that reflects the actual cash inflows and outflows from operating activities.
Out of the options provided, the item that is deducted from net income to arrive at cash flow from operations is "B. decrease in accounts receivable."
Here's a detailed explanation for each option:
A. Depreciation Expense: Depreciation is a non-cash expense that represents the allocation of the cost of a long-term asset over its useful life. It is added back to net income when calculating cash flow from operations because it does not involve any actual cash outflow. Therefore, it is not deducted.
B. Decrease in Accounts Receivable: Accounts receivable represents the amounts owed to a company by its customers for goods or services provided on credit. A decrease in accounts receivable indicates that cash has been received from customers, which is a cash inflow. Therefore, it is deducted from net income to arrive at cash flow from operations.
C. Decrease in Accounts Payable: Accounts payable represents the amounts owed by a company to its suppliers for goods or services received on credit. A decrease in accounts payable indicates that cash has been paid to suppliers, which is a cash outflow. However, when calculating cash flow from operations, a decrease in accounts payable is added back to net income because it represents an increase in working capital and not an operating cash outflow.
D. Amortization Expense: Similar to depreciation, amortization is a non-cash expense that represents the allocation of the cost of an intangible asset over its useful life. Amortization expense is added back to net income when calculating cash flow from operations because it does not involve any actual cash outflow. Therefore, it is not deducted.
In summary, when using the indirect method, the decrease in accounts receivable is deducted from net income to arrive at cash flow from operations. This is because a decrease in accounts receivable represents cash inflows from customers, which need to be accounted for in the cash flow statement.