Questions: Multiple Choice Question Sheldon Company's balance in prepaid insurance at the beginning and end of the year was 2,500 and 1,000, respectively. This will be reported on the statement of cash flows using the indirect method as: - a decrease of 1,500 which will be added to net income - an increase of 1,500 which will be added to net income - an increase of 1,500 which will be subtracted from net income - a decrease of 1,500 which will be subtracted from net income

The answer is: a decrease of \$1,500 which will be added to net income.

Explanation for each option:

1. a decrease of \$1,500 which will be added to net income:

   • This is the correct answer. In the indirect method of the statement of cash flows, changes in current assets and liabilities are adjusted to reconcile net income to net cash provided by operating activities. A decrease in prepaid insurance (a current asset) means that less cash was tied up in prepaid expenses, which effectively increases cash flow. Therefore, the decrease of \$1,500 in prepaid insurance is added to net income.

2. an increase of \$1,500 which will be added to net income:

   • This is incorrect. The balance in prepaid insurance decreased from \$2,500 to \$1,000, which is a decrease, not an increase.

3. an increase of \$1,500 which will be subtracted from net income:

   • This is incorrect. Not only is the change a decrease, but even if it were an increase, it would not be subtracted from net income. An increase in prepaid insurance would mean more cash was used, which would be subtracted from net income.

4. a decrease of \$1,500 which will be subtracted from net income:

   • This is incorrect. While the change is indeed a decrease, a decrease in a prepaid expense (current asset) is added to net income in the indirect method, not subtracted.

In summary, the correct treatment of a decrease in prepaid insurance in the statement of cash flows using the indirect method is to add the amount of the decrease to net income.