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Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773

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BuyFindarrow_forward

Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773
Textbook Problem
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An increase in inventories is deducted from net income to arrive at operating cash flow because

  1. a. cash payments to customers were larger than the purchases made during the period.
  2. b. purchases are larger than the cost of goods sold by the amount that inventories increased.
  3. c. cash payments to customers were less than the purchases made during the period.
  4. d. purchases are less than the cost of goods sold by the amount that inventories increased.
  5. e. All of these.

To determine

Identify the reason for which an increase in inventories is deducted from net income to obtain the operating cash flows.

Explanation

Operating Cash Flow:

The cash flow obtained from the operational and profit generating activities in a firm are termed as the operating cash flow. The operating cash flows increase or decrease the current assets and current liabilities of a firm.

b.

When the purchases are more than the cost of goods sold by the amount from which inventories are increased then that amount is deducted from the net income to obtain the operating cash flows. This is because the amount of cost of goods sold is reported in the net income but if the amount of purchases is more, then to maintain the accrual basis of accounting, this adjustment is required. Therefore, b is the correct option.

a.

When the cash payments to the customers are larger than the amount of purchases made in that period, then it shows a decrease in cash. This transaction requires no adjustment with the net income as there is no involvement with inventory...

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