D-very important: distinguish between the direct and indirect methods of presenting cash from operating activities and describe arguments in favor of each method;

Question 1

USGAAP and IFRS encourage Direct CF statement presentation method

Answer 1

Each accrual based IS line item is converted to cash receipts or cash payments.

Easier to understand. Direct method converts accrual IS (cash may be recognized out of order) to cash-basis inc. statement: rev n exp are recognized when cash is received or paid.

Question 2

Most firms use indirect method

Answer 2

Indirect method: Starting point = NI = Bottom Line

Bottom line converts NI to op. cash flow by making adjustments for transactions that affect net income but are not cash transactions. These adjustments include elimination noncash expenses (e.g. depreciation and amortization ), non operating items (e.g. gains and losses), and changes in balance sheet accounts resulting from accrual accounting events.

Question 3

Indirect v direct presentation of CF statement is a matter of…

Answer 3

presentation of CF’s from Op. activities. (Fin and Inv is EXACTLY THE SAME)

Question 4

Direct method and NI similiarities

Answer 4

Direct method begins w/ cash inflows from customers and then deducts cash outflows for purchases, operating expenses, interest, and taxes

Question 5

Direct v. Indirect major diff

Answer 5

Presentation

Top line direct = cash inflows from customers - outflow expenses
top line indirect = bottom line

Question 6

Primary direct method adv:

Answer 6

Presents the firms op. cash receipts and payments = more info ( the knowledge of past reciepts and payments is useful in estimating future operating CF’s)

Question 7

Primary indirect method adv:

Answer 7

Focus’ on the diff. between NI and Op CF = useful link to inc statement when forecasting future op. CF’s

Analysts forecast NI and then derive op. CF by adjusting NI for the differences between accrual accounting and the cash basis of accounting.

Question 8

Disclosure Req’s (GAAP IFRS)

Answer 8

GAAP:Direct: Disclose adjustments necessary to reconcile NI to CF from Op. activities Same info as indirect.

IFRS don’t care.

IFRS: Direct or indirect, payment for interest and taxes must be disclosed separately in the CF statement.

PAyment for int and taxes under GAAP: CF statement or footnotes