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IAI Actuarial Core Principles · Business Finance · Interpreting company accounting information

Under the indirect method of preparing a cash flow statement, which adjustment is made to profit before tax when reconciling to cash generated from operations?

Depreciation is added back to profit under the indirect method because it is a non-cash expense that reduced profit without any cash leaving the business. Other working capital and disposal adjustments move in the opposite direction to the options that suggest otherwise.

  1. ASubtract depreciation because it reduces profit
  2. BAdd back depreciation because it is a non-cash chargeCorrect
  3. CAdd the increase in inventories because stock raises assets
  4. DSubtract the increase in trade payables because liabilities have risen
  5. Add the profit on sale of fixed assets because it is a cash inflow

Explanation

Depreciation is deducted in arriving at profit but involves no cash outflow, so it is added back. An increase in inventories absorbs cash and is subtracted, while an increase in payables is added. A profit on sale is deducted from operating profit and the proceeds go to investing activities.

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