ExpertMedium2 marksMultiple Choice
ACCA · Question 24 · Preparing Basic Financial Statements
When preparing a Statement of Cash Flows using the indirect method, how should an increase in trade receivables and a decrease in trade payables be treated when reconciling profit before tax to cash generated from operations?
When preparing a Statement of Cash Flows using the indirect method, how should an increase in trade receivables and a decrease in trade payables be treated when reconciling profit before tax to cash generated from operations?
Answer options:
A.
Add the increase in receivables; add the decrease in payables.
B.
Deduct the increase in receivables; add the decrease in payables.
C.
Deduct the increase in receivables; deduct the decrease in payables.
D.
Add the increase in receivables; deduct the decrease in payables.
How to approach this question
Think about cash flow. If receivables go up, customers haven't paid you yet (less cash). If payables go down, you have paid your suppliers (less cash). Both reduce operating cash flow.
Full Answer
C.Deduct the increase in receivables; deduct the decrease in payables.✓ Correct
Under the indirect method, working capital changes are adjusted against profit. An increase in trade receivables means sales were made on credit and cash has not yet been received, so it is deducted from profit. A decrease in trade payables means the company has paid cash to suppliers to reduce its debt, so it is also deducted from profit.
Common mistakes
Reversing the logic and adding increases in assets.
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