When inventory increases by $10 and is paid with cash, which statement is true?

When inventory increases by $10 and is paid with cash, which statement is true?

• A. No changes to the Income Statement; Cash Flow from Operations decreases by $10
• B. Income Statement increases; Cash Flow from Operations increases
• C. Income Statement decreases; Cash Flow from Operations increases
• D. Income Statement increases; Cash Flow from Operations decreases

Answer: (B)

When you buy inventory with cash, you’re swapping one current asset for another and not recording an expense yet. The cost remains on the balance sheet as Inventory until the goods are sold, so the Income Statement shows no change this period. However, paying cash for inventory reduces cash, which lowers cash flow from operating activities. In other words, the purchase is a use of cash in operations, so cash flow from operations decreases by the amount spent (10 in this case). If you later sell the inventory, the expense (cost of goods sold) will hit the Income Statement then, not at the moment of purchase. So the correct idea is: no change on the Income Statement now; cash outflow from operations decreases by 10.

When you buy inventory with cash, you’re swapping one current asset for another and not recording an expense yet. The cost remains on the balance sheet as Inventory until the goods are sold, so the Income Statement shows no change this period.

However, paying cash for inventory reduces cash, which lowers cash flow from operating activities. In other words, the purchase is a use of cash in operations, so cash flow from operations decreases by the amount spent (10 in this case). If you later sell the inventory, the expense (cost of goods sold) will hit the Income Statement then, not at the moment of purchase.

So the correct idea is: no change on the Income Statement now; cash outflow from operations decreases by 10.