Question

1. Answer one of the following questions about the statement of cash flows.

   b. What two methods are used to prepare it? Identify similarities and differences between them.

2. Identify and explain the adjustment from net income to obtain cash flows from operating activities using the indirect method for one of the following items.

   b. Nonoperating gains and losses.

Answer 1

The two methods of preparing cash flow statement are

( I ) Direct Method:- As the name suggests it shows every major class of gross cash receipts and gross cash payments i.e. it uses only cash transactions ( cash spent and received ) to produce cash flow statement.

( ii ) Indirect method:- In this method we adjust net income to convert it from an accrual to a cash basis. We need to add back non-cash expenses such as depreciation, amortization, loss provision for accounts receivable and any losses on the sale of a fixed asset. We also need to adjust net income for changes between the starting and ending account balances in current assets -- excluding cash -- and current liabilities for the period. These accounts include accounts receivable, inventory, supplies, prepaid assets, payable liabilities and unearned revenues.

The main difference between the direct method and the indirect method of presenting the statement of cash flows (SCF) involves the cash flows from operating activities. (There are no differences in the cash flows from investing activities and/or the cash flows from financing activities.)

The direct method also requires a reconciliation of net income to the cash provided by operating activities. (This is done automatically under the indirect method.)

The main similarity is that the total sum at the bottom after all the addition is same under both the methods.