Question

Do you think that the indirect method of reporting cash flows from operations should be eliminated, allowing only the direct method in the SCFs? Discuss. Textbook: Accounting Theory: Conceptual Issues in a Political and Economic Envirnoment (9th edition) by Wolk, Dodd & Rozycki

Textbook: Accounting Theory: Conceptual Issues in a Political and Economic Envirnoment (9th edition) by Wolk, Dodd & Rozycki

Answer 1

The two methods - direct and indirect method present slightly different information.

The main difference between the direct method and the indirect method is the cash flows from operating activities. There is no such difference in the cash flows reported in the investing and financing activities sections. In the direct method, the cash flows from operating activities will include the amounts for cash from customers and cash paid to suppliers. In this method, the cash flow from operations is calculated directly. In the Indirect Method, the cash flow from operations is calculated by taking the net income of the company and then making adjustments. The adjustments are made to convert the total net income to the cash amount from operating activities.

The present system, which is the use of indirect method, should probably be eliminated. The cost of preparing information is lower if one simply presents only the indirect method. This is the reason that one why the indirect method is used much more frequently when compared to the direct method.

It is more easy for a user to generate the indirect method than the direct method, but the presence of non-cash flow transactions affecting working capital accounts (non articulation) can be a problem. If the direct method is presented, the indirect approach must also be shown as a supplementary schedule. The direct method must also provide a reconciliation of net income to the cash provided by operating activities.

We believe that it would be best to use or presentboth the methods as both methods provide useful information. The indirect method presenting a reconciliation through the income statement, while the direct method showing a direct cash flow approach to operations.

Thus, we propose that both the methods should be presented since the information is complementary or we can use just the direct method. In any case, the present situation of using only the indirect method is somewhat unsatisfactory.