Density functional theory calculations have been performed at the B3LYP/6-311+G(d,p) and M06-2X/6-31G(d,p) levels to obtain an insight into the nature of the stepwise cycloaddition reactions of hydrazones with α-oxo-ketenes. Three reaction pathways are possible, two Diels–Alder reactions and a 1,3-dipolar cycloaddition (1,3-DC) reaction. Despite the high energy required for 1,2-hydrogen shift in hydrazone to form an azomethine imine, 1,3-DC reaction among the possible pathways is the most favorable. The mechanism has been explained on the basis of transition state stabilities, global and local reactivity indices of the reactants, intrinsic reaction coordinate calculation, and the electron localization function topological analysis of the bonding changes along the 1,3-DC reaction. The computed free energies and enthalpies agree with the experimental outcome.