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Assume that the indirect method is used to determine net cash provided by (used in) operating...

Assume that the indirect method is used to determine net cash provided by (used in) operating activities and that Prepaid Insurance decreased during the year. That decrease is added to net income because:

A it includes the impact of increasing cash and increasing net income.

B it accounts for purchasing more insurance during the period than has been expensed.

C the company paid additional premiums this period in excess of the Insurance Expense recorded on the income statement.

D   a decrease in Prepaid Insurance causes an increase in Insurance Expense and a decrease in net income, but it does not involve cash so it is added back to net inco

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Answer #1
  • The correct Option is Option ‘D’: a decrease in Prepaid Insurance causes an increase in Insurance Expense and a decrease in net income, but it does not involve cash so it is added back to net income.
  • This is why Decrease in Prepaid Expenses is “Added” to Net Income, because even though the Net Income decreases as a result of increased Insurance expense (decreased Prepaid insurance), such decrease in Net Income is not because of any actual cash flow. Hence, the decrease is neutralized by adding back the ‘decrease’ in Prepaid insurance while preparing Cash flows from operating activities (Indirect method)
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