If the Financial Accounting Standards Board (FASB)/ International Accounting Standards Board (IASB) proposed changes get, the direct methodology for making ready the statement of cash flows is needed, eliminating the selection of using the indirect methodology.

Sadly, several students notice the direct methodology a lot of confusing than the indirect.

However, if you keep in mind the first purpose of the statement of cash flows, that is to give the users of the financial statements relevant information concerning cash a business brings in and pays out throughout a financial period, you must be ready to stay more focused with the entire preparation procedure.

FASB has considered the direct technique of reporting cash flows preferred to the indirect method; in FASB’s view, the direct method achieves the income statement’s primary objective more (to give relevant data regarding the entity’s cash receipts and cash payments) and also the overall objective of economic reporting (to provide information that’s helpful to users in creating investment and credit decisions).

FASB conjointly asserts that a direct method statement is more helpful to a broad vary of users and enhances their ability to predict cash flows, and to assess the link between amounts reportable on the income statement and also the statement of cash flows.

Many financial statement users share FASB’s preference for the direct technique.

A majority of financial analysts surveyed by the CFA Institute agreed that presenting operating cash flows using the direct technique more allows them to forecast future cash flows of an entity than the indirect method.

Here’s a list of the most common kinds of receipts and payments utilized in the direct methodology format:

  • Receipts received from Customers
  • Payments paid to Suppliers
  • Payments paid to workers
  • Interest Payments
  • Taxation Payments

In order to work out the receipts and payments from every source, you have to use a singular formula. The receipts from customers equal net income for the period and the start assets less the ending accounts receivable.

Equally the payments created to suppliers are calculated by adding the purchases, ending inventory, and beginning accounts receivable then subtracting the start inventory and ending accounts payable.

Plus, the direct technique conjointly needs a reconciliation report to be created to test the accuracy of the operating activities.

The reconciliation itself is extremely just like the indirect technique of reporting operating activities.

It stars with net income and adjusts non-cash transactions like depreciation and changes in balance sheet accounts.

Since making this reconciliation is about as much as work just preparing an indirect statement, most corporations merely select to not use the direct technique.

Here is an example of a cash flow statement prepared using the direct method:

The statement of cash flows simply presented is understood as the direct approach. In several respects, this presentation of operating cash flows resembles a cash basis income statement.

An acceptable alternative is the “indirect” approach. Before moving on to the indirect approach, remember that corporations using the direct approach should supplement the cash flow statement with a reconciliation of income to cash from operations.

This reconciliation could also be found in notes related to the financial statements:

Notice that this reconciliation starts with the online financial gain, and adjusts to the $800,000 net cash from operations. Some clarification might prove helpful:

  • Depreciation is added back to net income.
  • Gain on sale of land is deducted because it increased income.
  • Gain on sale of land is deducted because it increased income.
  • The decrease in inventory is added.
  • An increase in accounts payable is added as it represents expenses not paid.

This can become confusing as most can think why depreciation is added back.  Remember, the full proceeds of an asset sale are reported within investing activities, regardless of whether the sale produced a gain or loss.