Direct and Indirect Cash Flows

Direct and Indirect Cash Flows

Caren Evans

ACC 291

Mr. Abdullah

February 08, 2015

There are two different methods that organizations can choose from when preparing their statement of cash flows, the direct method and the indirect method. This summary will discuss the differences between the two methods and why the Financial Accounting Standards Board allows both of these methods to be used.

Differences between Direct and Indirect Presentation

The direct method is a presentation of net cash from operating activities for the statement of cash flows that lists major operating cash receipts less major operating cash payments. It separately lists each major item of operating cash receipts, such as cash received from customers, and each major item of operating cash payments, such as cash paid for merchandise. The cash payments are subtracted from cash receipts to determine the net cash used by operating activities. This is unlike the indirect presentation, which reports net income and then adjusts it by adding and subtracting items to yield net cash from operating activities on the statement of cash flows. The indirect method reports net income and then adjusts it for items necessary to obtain net cash provided or used by operating activities. The indirect method reports the necessary adjustments to reconcile net income to net cash provided or used by operating activities (n.d., 2013)

Why the FASB Allows Both Methods

The Financial Accounting Standards Board, FASB, indicated that the traditional accounting information system design constrained standard setting in FASB Statement 95, “A Statement of Cash Flows”. The FASB decided to allow both methods primarily due to the design limitations of traditional accounting systems. According to the Statement 95 from the FASB, this statement requires that a statement of cash flows classify cash receipts and payments according to whether they stem from operating, investing, or financing activities and provides...