Question

In previous years, Easycash Ltd presented its cashflow statement using the ‘indirect method’ however in the current year the CEO has requested that the ‘direct method’ be used.

Prepare a response to the CEO discussing whether this is a change in an accounting policy referring to the relevant Australian accounting standards. Outline the disclosures that would be required with a change in an accounting policy and discuss the differences between the two methods, and if one method is considered more useful than the other method.

Your response should be referenced where appropriate (APA style).

Answer 1

Explanation:

As per the consistency principle, the companies are mandatory to use the same technique and standards that the company is previously using for the purpose of organizing the financial statements, until and lest the change is compulsory. Therefore, a alteration in the technique of making cash flow statement of the company will be measured as a change in the accounting policy of the company under GAAP, and Australian accounting standards as well because GAAP is also included in Australian accounting standards.

The revelation necessary to account for voluntary change in accounting policy are as follows:

• Nature of change in accounting policy: The nature of change in the accounting policy is necessary to be unveiled by the company.

• Reason for accounting policy change: The Company should describe in brief the purpose as to why the company has taken this choice to change the accounting policy.

• Current and prior period adjustments: The Company is also necessary to reveal the changes that will happen in current period and prior period financial statements as a consequence of this change in accounting policy.

• And, if the accounting principle has been altered, the clarification of how the change is executed and changes caused by the net accounting policy are also to be revealed.

Difference between direct method and indirect method of cash flows statements:

The cash flow statement mentions to the statement that shows the cash receipts and cash payment of the company, and it is organised to conclude the net increase or decrease in the cash balance of the company. The operating section is dissimilar for both the methods, but the investing and financing section are same for both methods.

Direct method

• It starts with the amount of cash collected from customers.
• Under this method, the cash received from customers, cash paid to suppliers and employees are documented under the operating section.

Indirect method

• It starts with the net income of the company.
• Under this method, the net income of the company is adjusted to convert the net income into the cash flows under operating activities.

Both the method of preparing the cash flow statements fulfill their purpose of determine the net increase or decrease in the cash balance of the company, and it cannot be said that one method is better than the other because both the methods have different purpose.

The direct method of preparing the cash flow statements requires more work as the net income per the accrual accounting is convert to cash flows from operating activities, but it also provide the details of the changes in the amount of cash balance of the company. This method is most preferred by investors and creditors as it tells the sources of cash inflows and outflows.

The indirect method of preparing cash flows statement uses the already available information in the system, and it groups the cash inflows and outflows under these heads, but it will not provide detailed information as compared to the direct method.