Compare and contrast the two methods that may be used to present operating cash flows in the statement of cash flows. Which method is preferred by firms and by outsiders?
What will be an ideal response?
ANSWER:
SFAS No. 95 allows operating cash flows to be presented using either the direct or indirect methods. The direct method reports literal cash flows related to income statement classifications. The indirect method starts with accrual income and adjusts it for the non-cash items in it. Both methods result in the same cash flow from operations number, but more new information is reported with the direct method, and FASB seems to favor it. However, the direct method may be more costly since not all companies organize their accounting records in such a way that it produces the necessary data. In addition, if the direct method is used, a separate schedule must reconcile net operating cash flow with net income. Because of the cost issue, most American firms use the indirect method. However, there has been a limited amount of empirical research that indicates that the direct method is preferred to the indirect, particularly by outside users.
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