Question

Differentiate between the direct and indirect method by discussing each one. What are some of the advantages and disadvantages of each method? Are their industry specific companies that prefer either method? What are some of the arguments in favor of using the indirect method as opposed to using the direct method for reporting a statement of cash flows? Why is it desirable to use a worksheet when preparing the statement of cash flows?

Answer 1

a. Differences between Direct and Indirect Method of Cash flow Statement

Sl. No.	DIFFERENCE	DIRECT METHOD	INDIRECT METHOD
1	BASIS	Uses only cash transations	Net Income Basis.
2	Factors considered	Only the cash transactions considered into account to arrive the cash flow from operations.	Uses net income as the base and converts the income into cash flow through the use of adjustments.
3	Working and Preparation	No such working is required except reconciliations between cash items and other accrual based entries	Lots of adjustments to be made
4	Accuracy	Is very accurate since no adjustments needed	As adjustments are to be made hence it is not very accurate
5	Time-consuming	Its more time-consuming	Its less time-consuming

b. Advantages and Disadvantages:

	DIRECT METHOD	INDIRECT METHOD
Advantages	Easy to understand and transparent way of presenting the financial picture of the firm	Complete Picture of the firm will be shown since cash and non-cash transactions are included.
	Reliable	Widely used since Its less time-consuming
Disadvantages	More time-consuming since it takes to identify and record information that is necessary for the cash flow statement.	Lack of transparency since some exceptions to be considered

c.The companies which use accounting on cash basis follow Direct method, whereas if the company uses accrual basis of accounting they adopt Indirect method of cash flow.

d. Most of the businesses prefer the indirect method as it is easy to use, many international accounting standards prefer the indirect method since it gives an entirety of transactions both cash and non-cash and  clear view of cash flow receipts and payments.

e. Worksheet facilitate the user to capture the data within the worksheet quickly and computes accurately.Once the format is made and formulas are incorporated automatically calculates the cash flow statement. That's why many accountants like to prepare cash flow statement on worksheet..