Question

A company’s prepaid expenses are $15,000 at the beginning of the year and $8,000 at the end of the year. What adjustment to net income should be made if the indirect method is used?

Answer 1

Answer:

The correct answer to the following question is that the amount of $7000 would be added in to the net income.

Explanation:

Indirect method is one of the way in which cash flow statement can be made , where the net income would be taken as a starting point and then in that all non cash transactions would be made. In this method , the individuals items are not adjusted in the income statement , rather the net income itself is adjusted. Where the prepaid expenses are our current assets and here the prepaid expenses is decreasing at the end of year by $7000, so as we know that the decrease in current asset is added in the net income.

Answer 2

Answer:

The $7,000 balance of prepaid expenses should be added in the net income.

Explanation:

If the indirect method of cash flow statement is followed, then the decrease in current assets would increase the cash balance as it is an inflow of cash whereas the increase in current assets would decrease the cash balance as it is an outflow of cash.  

But in the current liabilities, the conditions are opposite which means a decrease in current liabilities would decrease the cash balance whereas the increase in current liabilities would increase the cash balance.

In the question, it is given that the opening balance of the prepaid expenses is $15,000 and the ending balance is $8,000 which show decrements of $7,000 which will add to the net income.

Hence, the $7,000 balance of prepaid expenses should be added in the net income.