Question

“The statement of cash flow can be presented either in the ‘direct’ or ‘indirect’ methods.” Differentiate both presentation methods.

Answer 1

Statement of cash flows is one the major financial statements of a company which tells us specifically the amounts of cash and cash equivalents got effected by the changes in the balances of accounts and incomes for the year ended , by breaking down three activities namely ,operating actvities , investing activities and financing activities.

In general we have two methods of presenting a cash flow statement , direct method and indirect method . Obviously the end results will be same in both the cases to match the ending cash balance of the company by adding(deducting) the net cash inflow(outflow) and beginning cash balance.The heads of investing activities and financing activities will be presented exactly same in both the direct and indirect methods.So we know that the only change in treatment is for the section cash flow from operating activities.

In direct method the actual payments and receipts of cash(cash received from customers,cash paid to employees etc.) are entered, in the section cash flow from operating activities, as it tells the change in cash that took place over the period.Whereas in indirect method the operating activities section begins with the net income (loss) of the company from the income statement and adjustments of all non cash items( depreciation, impairment of assets , increase or decrease of working capital etc.) are entered to arrive at the final destination of cash flow from operating activities. The direct method uses the cash basis of accounting whereas indirect method uses the accrual method . More detailed information of cash receipts and payment can be derived from direct method which is not available on indirect method. Indirect method is easier than direct method because accrual basis of accounting is a requirement of Generally Accepted Accounting Principles (GAAP) and indirect method uses accrual method only.

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