Question

Differentiate between the direct method and indirect method of the statement of cash flows by discussing the details of each

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Answer 1

There are two methods of converting net profit into net cash flows from operating activities:-

1. Direct Method: Under this method, actual cash receipts (for a period) from operating revenues and actual cash payment (for a period) for operating expenses are arranged and presented in cash flow statement. The difference between cash receipts and cash payment is the net cash flow from operating activities.

Under this method noncash items like depreciation, amortization of intangible assets, Preliminary expenses, debenture discount etc. are ignored from cash flow statement. No adjustments are made for loss or gain on sale of fixed assets.

2. Indirect Method: In this method net profit (loss) is used as the base then adjusted for items that affected net profit but did not affect cash.

Non cash and non operating charges in the profit and loss account are added back to the net profit while non cash and non operating credits are deducted to calculate operating profit before working capital changes. Necessary adjustments are made for increase in current assets and current liabilities to obtain net cash from operating activities.

               Under direct and indirect method difference arising only in cash flow from operating activities,

                 Cash flow from investing activities and cash flow from financing activities are same under both   

                Methods.            

Example:

	ABC
	Statement of Cash Flow(Direct Method)
	For the year ended december 31,20Y3
	Cash Flow from operating activities
	Cash Received from customer	$ 14,87,060.00
	Cash paid to supplier	$ (9,20,480.00)
	Cash paid for operating expenses	$ (5,29,610.00)
	Net cash provided by operating activities=(A)	$       36,970.00
	Cash Flow from investing activities
	Purchased of Equipment	$     (55,330.00)
	Sale of Investment	$    1,03,990.00
	Purchased of Land	$ (1,22,050.00)
	Net cash used by investing activities=(B)	$     (73,390.00)
	Cash flow from financing activities
	Cash received from issue of common stock	$       10,760.00
	Cash received from issue of paid in capital excess of par common stock	$       73,680.00
	Dividend Paid	$     (34,300.00)
	Net cash used by financing activities=(C )	$       50,140.00
	Net increase in cash=(D )=(A)+(B)+(C)	$       13,720.00
	Cash January 1,20Y2=(E )	$    2,17,380.00
	Cash December 31st 20Y3=(D)+(E )	$    2,31,100.00
	ABC
	Statement of Cash Flow(InDirect Method)
	For the year ended december 31,2017
	Net Income		$             57,870.00
	Depreciation Expense	$          6,600.00
	Less: gain on sale of Investment	$     (14,900.00)
	Increase in Accounts Receivable	$       (6,980.00)
	Increase in Inventory	$       (9,160.00)
	Decrease in Accrued Payable	$       (3,970.00)
	Increase in Accounts Payable	$          7,510.00	$           (20,900.00)
	Net Cash provided by operating activities(A)		$             36,970.00
	Cash Flow from investing activities
	Purchased of Equipment	$    (55,330.00)
	Purchased of Land	$ (1,22,050.00)
	Sale of Investment	$    1,03,990.00
	Net cash used by investing activities		$           (73,390.00)
	Cash flow from financing activities
	Cash received from issue of common stock	$       10,760.00
	Retire of note payable	$       73,680.00
	Dividend Paid	$     (34,300.00)
	Net cash used by financing activities		$             50,140.00
	Net increase in cash	$                       -	$             13,720.00
	Cash January 1,2017		$          2,17,380.00
	Cash December 31st 2017	$                       -	$          2,31,100.00