If accrued compensation increases by $10, what is the effect on Cash Flow from Operations, assuming a 40% tax rate?

• A. Up by $4
• B. Down by $6
• C. Up by $16
• D. No change

Answer: (A)

An increase in accrued compensation affects cash flow from operations through changes in working capital and the tax treatment of the expense.

When accrued compensation goes up by 10, you record an expense that reduces net income by 10, but you haven’t actually paid cash yet. This tax shield saves 40% of that amount in taxes, so taxes decrease by 4, and net income falls by 6 (10 expense minus 4 tax saving).

In the indirect method for the cash flow from operations, you add back the non-cash portion of the expense (the full 10) to net income. So the CFO change is +10 from the adjustment, offset by the -6 effect on net income, giving a net increase of 4.

Therefore, cash flow from operations increases by 4.