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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.