Which of the following statements regarding operating cycles is true when preparing the statement of cash flows using the indirect method?

• A. Depreciation expense is added back to net income because it does not involve a cash outflow.
• B. A decrease in inventory is subtracted from net income because it indicates a cash outflow.
• C. An increase in accounts receivable is added to net income because it represents cash collected.
• D. Cash paid for dividends is included as an operating activity.

Answer: (A)

Verified step by step guidance

1. Understand the indirect method of preparing the statement of cash flows: The indirect method starts with net income and adjusts for non-cash expenses, changes in working capital, and other non-operating items to calculate cash flows from operating activities.
2. Analyze the treatment of depreciation expense: Depreciation is a non-cash expense, meaning it reduces net income but does not involve an actual cash outflow. Therefore, it is added back to net income in the operating activities section.
3. Evaluate the impact of a decrease in inventory: A decrease in inventory indicates that inventory was sold, which typically results in a cash inflow. Therefore, it is added to net income, not subtracted.
4. Assess the effect of an increase in accounts receivable: An increase in accounts receivable means that more sales were made on credit, not collected in cash. This represents a reduction in cash flow and is subtracted from net income.
5. Clarify the treatment of dividends: Cash paid for dividends is classified as a financing activity, not an operating activity, under the statement of cash flows.