Which of the following statements does not correctly describe an adjustment to net income when determining cash flows from operating activities using the indirect method?

Question

BlackTom AI · Accepted Answer

When analyzing adjustments to net income under the indirect method for cash flows from operating activities, each option reflects a different category of adjustment and its proper sign.
Option 1: 'An increase in income taxes payable will be subtracted from net income.' Increases in current liabilities, such as taxes payable, are typically added back to net income because they represent amounts already expensed but not yet paid in cash. Therefore, subtracting an increase in taxes payable would misstate the cash effect; the correct treatment is to add the increase to net income.
Option 2: 'A gain on the sale of a depreciable asset will be subtracted from net income.' This aligns with the indirect method: gains are included in net income but do not relate to operating cash flows, so they are deducted to reconcile net income to actual operating cash flow.
Option 3: 'An increase in prepaid expenses will be subtracted from net income.' Prepaid expenses are unused cash payments recorded as assets; when their balance increases, it indicates more cash was paid upfront, so the adjustment reduces net income to reflect the cash outflow, which is correct for the indirect method.
Option 4: 'An increase in wages payable will be added to net income.' Wages payable rising means accrued wages are recorded but not yet paid in cash, increasing liabilities. This reduces cash outflow, so the adjustment adds back to net income, which is appropriate.
Overall, each adjustment that is described as adding or subtracting aligns with the standard treatment under the indirect method, except for the specific sign assigned to an increase in income taxes payable, which should be added, not subtracted, from net income.

ACCT 2051 (070) Exam #3

Which of the following statements does not correctly describe an adjustment to net income when determining cash flows from operating activities using the indirect method?

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The indirect method starts with net earnings and converts them to net cash provided by operating activities. This means that:

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