Indirect and Direct Methods of Reporting Cash Flows

Cash flows provided (used) by operating activities are reported in one of two ways: the direct method or the indirect method. These two different methods apply only to the operating activities section.

The direct method Presentation of net cash from operating activities for the statement of cash flows that lists major operating cash receipts less major operating cash payments. 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 provided (used) by operating activities. The operating activities section of Exhibit 16.7 reflects the direct method of reporting operating cash flows.


The indirect method Presentation that 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. reports net income and then adjusts it for items necessary to obtain net cash provided or used by operating activities. It does not report individual items of cash inflows and cash outflows from operating activities. Instead, the indirect method reports the necessary adjustments to reconcile net income to net cash provided or used by operating activities. The operating activities section for Genesis prepared under the indirect method is shown in Exhibit 16.9.

The net cash amount provided by operating activities is identical under both the direct and indirect methods.

This equality always exists. The difference in these methods is with the computation and presentation of this amount. The FASB recommends the direct method, but because it is not required and the indirect method is arguably easier to compute, nearly all companies report operating cash flows using the indirect method.

EXHIBIT 16.9 Operating Activities Section—Indirect Method

Point: To better understand the direct and indirect methods of reporting operating cash flows, identify similarities and differences between Exhibits 16.7 and 16.11.

To illustrate, we prepare the operating activities section of the statement of cash flows for Genesis. Exhibit 16.10 shows the December 31, 2010 and 2011, balance sheets of Genesis along with its 2011 income statement. We use this information to prepare a statement of cash flows that explains the $5,000 increase in cash for 2011 as reflected in its balance sheets. This $5,000 is computed as Cash of $17,000 at the end of 2011 minus Cash of $12,000 at the end of 2010. Genesis discloses additional information on its 2011 transactions:

EXHIBIT 16.10 Financial Statements

1. The accounts payable balances result from merchandise inventory purchases.
2. Purchased $70,000 in plant assets by paying $10,000 cash and issuing $60,000 of notes payable.
3. Sold plant assets with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss.
4. Received $15,000 cash from issuing 3,000 shares of common stock.
5. Paid $18,000 cash to retire notes with a $34,000 book value, yielding a $16,000 gain.
6. Declared and paid cash dividends of $14,000.