Why this is mistaken
The direction shortcut
The mistake sees Accounts Receivable rise from $8,000 to $10,000 and adds $2,000 to net income because the account increased. The same shortcut can lead you to subtract a payable increase because a larger liability feels negative.
Why it fails
Net income already includes the revenue that created the receivable under the bounded facts. When the receivable rises, collections were lower than that recognized revenue, so the increase is subtracted. When a supplier payable rises, payment was lower than the bounded credit amount, so the increase is added. The adjustment signs describe a cash-versus-accrual bridge, not whether the balance, transaction, or business condition is good or bad.
Corrective approach
Write the rollforward, solve for the missing cash activity, and then compare that cash activity with the amount already included in net income. Label the account as operating asset or operating liability only after verifying its scope. Reconcile acquisitions, write-offs, currency effects, and reclassifications before using the net balance change.
When this mistake may appear
- Opening and ending operating balances are supplied without a memorized sign table.
- This mistake sees the word increase and assumes Cash must also have increased.
Your work may contain this mistake if:
- Adds an increase in Accounts Receivable or Inventory to net income.
- Subtracts an Accounts Payable increase because liabilities are described as unfavorable.
- Uses the same sign for every account change without writing an account rollforward.