Assume the indirect method is used to compute cash flows from operations. For each item listed below, indicate the effect on net income in arriving at cash flows from operations by choosing one of the following terms.

Added to Net Income

Deduct from Net Income

1. Increase in accounts receivable

2. Increase in inventory

3. Decrease in prepaid expenses

4. Decrease in accounts payable

5. Increase in accrued liabilities

6. Increase in income taxes payable

7. Depreciation expense

8. Loss on sale of investment

9. Gain on disposal of equipment

10. Amortization expense

Basically there are three types of activities:

1. Operating activities: It includes those transactions which affect the working capital, and it records transactions of cash receipts and cash payments. The increase in current assets would be deducted from the net income whereas the increase in current liabilities would be added to the net income and vice versa.

2. Investing activities: It records those activities which include purchase and sale of the fixed assets

3. Financing activities: It records those activities which affect the long term liability and shareholder equity balance.

So,

1. Increase in accounts receivable - Deduct from Net Income

2. Increase in inventory - Deduct from Net Income

3. A decrease in prepaid expenses - Added to Net Income

4. A decrease in accounts payable - Deduct from Net Income

5. Increase in accrued liabilities - Added to Net Income

6. Increase in income taxes payable - Added to Net Income

7. Depreciation expense - Added to Net Income as it is a non-cash expense

8. Loss on sale of investment - Added to Net Income

9. Gain on disposal of equipment - Deduct from Net Income

10. Amortization expense - Added to Net Income

We simply apply the golden rules of accounting,

Debit all expenses, losses, and credit all income and gains