Krenshaw Company reported a net income of $9,000 for the year ended December 31, 2016. During 2016, accounts receivable increased by $2,000, merchandise inventory decreased by $2,000, accounts payable increased by $1,000, long-lived fixed assets increased by $2,000, unearned revenues decreased by $1,000 and a $4,000 impairment loss was recorded. Assuming no other adjustments to net income are needed, the net cash inflow from operating activities using the indirect method was

Question

BlackTom AI · Accepted Answer

To tackle the indirect method, begin with the net income and adjust for non-cash items and changes in working capital.
Option evaluation will proceed one by one to show how each item affects cash flow from operating activities.
First, net income is $9,000. This is our starting point for the reconciliation to cash from operations.
Impairment loss of $4,000 is a non-cash charge, so we add it back to net income because it reduced net income without using cash.
Next, accounts receivable increased by $2,000. An increase in AR indicates more sales on credit and a lower cash collection in the period, so we subtract $2,000.
Merchandise inventory decreased by $2,000. A decrease in inventory implies goods were sold without a cash outlay described in the period, so we add $2,000 to cash flow.
Accounts payable increased by $1,000. An increase in AP means we have delayed payments to suppliers, which preserves cash, so we add $1,000.
Unearned revenues decreased by $1,000. This indicates revenue recognized without additional cash received in the period, effectively reducing cash flow from operations, so we subtract $1,000.
Note that long-lived fixed assets increasing by $2,000 relates to investing activities (purchases of assets) and does not affect the operating activities section, so it is not adjusted here.
Putting it all together: starting from $9,000, +$4,000 (impairment) −$2,000 (AR increase) +$2,000 (inventory decrease) +$1,000 (AP increase) −$1,000 (unearned revenue decrease) = $13,000.
Now quickly scan the other options to see why they don’t fit. The choices $12,000, $9,000, $11,000, $10,000, and $14,000 would require a different combination of the adjustments above, but the net effect described by the movements in AR, inventory, AP, and unearned revenues, together with the non-cash impairment, aligns with $13,000.
In summary, the indirect method reconciles net income to cash by incorporating non-cash items and adjusting for working capital changes, and the specific changes here culminate in a $13,000 net cash inflow from operating activities.

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