A company orders $10 of inventory and pays cash, but has not manufactured or sold yet. Which of the following best describes the effects on the three financial statements?

• A. Income statement: nothing; Cash flow from operations decreases by $10; Balance sheet: inventory increases $10, cash decreases $10
• B. Income statement: revenue increases by $10; Cash flow from operations increases by $10; Balance sheet: cash increases $10
• C. Income statement: expense increases by $10; Cash flow from investing decreases by $10; Balance sheet: cash decreases $10
• D. Income statement: no change; Cash flow from financing increases by $10; Balance sheet: assets unchanged

Answer: (A)

Spending cash to acquire inventory is an asset-to-asset swap that doesn’t affect earnings yet, because nothing is sold or expensed at this point. On the income statement, there is no revenue or cost of goods sold recorded when inventory is purchased, so earnings show no change. The cash flow from operations reflects the cash outlay, decreasing by 10. The balance sheet shows cash down by 10 and inventory up by 10, with total assets unchanged and no change to liabilities or equity.

This aligns with the idea that purchasing inventory ties up cash in a current asset and will only affect the income statement later when the inventory is sold or written down.