Question

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

Answer -  

Difference between direct and indirect method of CFS

Under indirect method when the indirect method of presenting a corporation's cash flow from operating activities is used, this section of CFS will begin with a corporation net income. The net income is then followed by the adjustments required to change the accrual accounting net income to the cash flows from operating activities.

Under direct method when the direct method of performing a corporation cash flows from operating activities is used, the amount of net revenue is not the starting point. Instead, the direct method lists the cash amounts collected and paid by the corporation.

Adjustments and classifications difference between both methods

Under Indirect methods -

A few of the typical adjustments are:

• Adding back depreciation expense
• Adding the decrease in accounts receivable
• Deducting the increase in inventory
• Adding the increase in accrued expenses payable

Under direct method

Here are a few of the more common classifications that will be seen under the direct method:

• Cash from customers
• Cash paid to employees
• Cash paid to suppliers

Direct method is used by GAAP because it is straightforward and easier to understand.