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Under the indirect method, an increase in merchandise inventory during the year is treated how when reconciling net income to operating cash flow?
AAdded to net income
BDeducted from net income
CReported under financing activities
DIgnored because inventory is non-cash
Answer & Solution
Correct answer: B. Deducted from net income
1. Rule: increases in current assets are deducted from net income.
2. Inventory is a current asset; an increase means cash was used to build stock.
3. Therefore the increase is deducted.
4. A decrease in a current asset would instead be added.
_Source: Jonick, Principles of Financial Accounting (CC BY-SA 4.0), §7.2.3 "Add/Deduct rules for working capital", p.272_
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