Question

• Evaluate two (2) major differences between GAAP and IFRS with respect to the statement of cash flows. Give your opinion on which method you prefer. Provide a rationale for your response.
• Imagine you are the senior accountant at your organization and management is unsure of the difference between the indirect method and the direct method of preparing a statement of cash flows. Outline a brief memo to management differentiating between the direct method and indirect method. Advise management on which method the company should use to prepare the statement of cash flows. Provide at least two (2) specific examples on why the method you selected would be beneficial to the company.

Answer 1

Difference between GAAP and IFRS with respect to the statement of cash flows:
Particulars	US GAAP	IFRS
interest received	operating activities	operating or investing activities
interest paid	operating activities	operating or investing activities
dividends received	operating activities	operating or investing activities
dividends paid	financing activities	operating or investing activities
taxes paid	operating activities	mainly operating activities, but a portion of tax expense can be allocated to investing or financing activities if it can be directly assigned
Restricted Cash	An entity is required to include restricted cash in its beginning and ending balance of cash and cash equivalents on the statement of cash flows. Entities should present the change in total cash, cash equivalents and amont described as restricted cash.	No specific guidance
As you can see, IFRS are less restrictive. Both interest received and dividends received can be classified as operating or investing activities. U.S. GAAP allow to classify them as operating activities only.

Difference between Direct and Indirect method with respect to the statement of cash flows:
Particulars	Direct Method	Indirect Method
Difference	When using the direct method, you list cash flows in the operations section of the cash flow statement. Cash flows due to operations arise from customer collections and cash paid to suppliers, employees and others. The section also reports cash paid for income tax and interest. The problem in trying to use the direct method is that a company might not keep the information in the required form. For example, companies using accrual accounting lump together cash and credit sales -- they would have to make special provision to track cash sales separately.	In the indirect method, you adjust net income to convert it from an accrual to a cash basis. This requires you 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. You also 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 indirect method uses readily available information and most companies find it easier to employ. Management and shareholders might fret if a company consistently reports net income exceeding cash flows -- they will want to identify the sources of non-cash income and determine whether these are masking serious problems with the business. If you believe that “cash is king,” you will look to the cash flow statement to measure the company’s liquidity -- the ability to pay bills and avoid defaulting on debt. Cash shortages can lead to bankruptcy, whereas excess cash might indicate a need to take steps such as increasing investments, paying down debt, increasing executive salaries or distributing dividends.