Question

1. Explain the difference between the direct and indirect methods of preparing the operating section of the statement of cash flows. 2. Which method is preferred by GAAP?

Answer 1

1. The main difference between the two method lies in cash flow from operating activities.

As per direct method, net income is not the starting point for presenting cash flow from operating activities while for indirect method it is. Instead, the direct method lists the cash amounts received and paid by the corporation. Whereas in indirect method, adjustment of non cash items and current assets/liabilities are made from net income. The direct method also requires a reconciliation of net income to the cash provided by operating activities

2. GAAP prefer using direct method.

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