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Running Head: Direct Vs Indirect presentation of Cash Flows
Direct Vs Indirect presentation of Cash Flows
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Direct Vs Indirect presentation of Cash Flows
Direct Vs Indirect presentation of Cash Flows
Cash Flow Statement has three sections for three different set of activities which are
operating activities, investing activities and financing activities. The difference of direct versus
indirect presentation of cash flow occurs only in the section of operating activities. In case of
direct method we list cash flows in the operations section of the cash flow statement. In direct
method cash collected from customers, cash paid to suppliers or employees, cash paid for income
tax and interest all are listed in operating activities section, while in case of indirect method we
adjust the net income to convert it from accrual to a cash basis. In this case we add back the non
cash expenses such as depreciation, amortization, loss provision for accounts receivables and
others. Net income is also adjusted for change in the cash from starting to end account balance.
Indirect method of cash flow statement is widely used in the companies as companies
using accrual accounting method might not have the separate data for cash sales and credit sales.
So it would not be possible for them to make the cash flow statement with the direct method
approach (Clinch, G., Sidhu, B., & Sin, S. 2002).
Banks and public companies prefer direct method as business stakeholders find this type
of statement easier to read because direct cash flow statement includes the actual cash flow and it
does not include any non cash expense or income. On the other hand corporations prefer indirect
method due to excessive implementation cost of finding the actual cash expenses because of
accrual systems. Based on the necessity and requirement of both type of companies, Financial
Accounting Standard Board (FASB) allows direct and indirect both types of cash flow statement.
In my views indirect method is much simpler to any firm and it costs very less. So I
would like to prefer the indirect method of representing the cash flow statement based on the
reasons discussed above.
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Direct Vs Indirect presentation of Cash Flows
Reference
Clinch, G., Sidhu, B., & Sin, S. (2002). The usefulness of direct and indirect cash flow
disclosures.Review of Accounting Studies, 7(4), 383-404.