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A cash flow statement can be presented in either the direct or indirect format. The investing and financing sections wil

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Presentation of Cash Flow Statement (2 Methods) Article shared by : ADVERTISEMENTS:

A cash flow statement can be presented in either the direct or indirect format. The investing and financing sections will be the same under either format. However, the operating section will be different. Direct Method: Direct method is that method whereby major classes of gross cash receipts and gross cash payments are disclosed. Enterprises that utilize the direct method should report separately the following classes of operating cash receipts and payments: ADVERTISEMENTS:

1. Cash collected from customers, including lessees, licensee, and other similar items. 2. Interest and dividends received. 3. Other operating cash receipts, if any. 4. Cash paid to employees and other suppliers of goods or services, including supplies of insurance, advertising, and other similar expenses. ADVERTISEMENTS:

5. Interest paid. 6. Income-taxes paid. 7. Other operating cash payments, if any. Companies that use the direct method must provide a reconciliation of net income to net cash flow from operating activities in a separate schedule in the financial statements. According to AS-3 cash flow Statement: The direct method provides information which may be useful in estimating future cash flows and which is not available under the indirect method and is, therefore, considered more appropriate than the indirect method. Under the direct method, information about major classes of gross cash receipts and gross cash payments may be obtained either: (a) From the accounting records of the enterprise; or (b) By adjusting sales, cost of sales (interest and similar income and interest expense and similar charges for a financial enterprise) and other items in the statement of profit and loss for: ADVERTISEMENTS:

(i) Changes during the period in inventories and operating receivables and payables; (ii) Other non-cash items; and (iii) Other items for which the cash effects are investing or financing cash flows. Illustration 1: From the following Profit and Loss Account of ABC Ltd. for the year ended 31st March, 2013, calculate cash generated from “Operating Activities” by Direct Method:

Notes: 1. Non-cash charges such as depreciation, Goodwill written off, Preliminary expenses written off have been ignored as these do not involve any outflow of cash. 2. Dividend received and profit on sale of Plant is to be treated under cash flow from ‘Investing activities’. 3. Commission Accrued does not involve any cash inflow, hence ignored. 4. Changes in current assets and current liabilities are ignored. Illustration 2: From the following Profit and Loss A/c and additional information of M/s Anurag Enterprise, compute cash flow from operations:

Indirect Method: Under the indirect method, the net cash flow from operating activities is determined by adjusting net profit or loss for the effects of: (a) Changes during the period in inventories and operating receivables and payables; (b) Non-cash items such as depreciation, provisions, deferred taxes, and unrealized foreign exchange gains and losses; and (c) All other items for which the cash effects are investing or financing cash flows. Alternatively, the net cash flow from operating activities may be presented under the indirect method by showing the operating revenues and expenses excluding non-cash items disclosed in the statement of profit and loss and the changes during the period in inventories and operating receivables and payables. The indirect method starts with net income and reconciles it to net cash flow from operating activities. The cash flow from operating activities is found by adjusting net income for: (i) Changes in current assets and current liabilities, and (ii) Depreciation expense. Depreciation expense is not a cash flow. Because it decreases net income, it is added back to net income in order to arrive at the operating cash flow. The following summarizes the process:

The indirect method is more widely used, since it shows the relationship between the income statement and the Balance Sheet and therefore aids in the analysis of these statements. Reporting Cash Flows from Investing and Financing Activities: An enterprise should report separately major classes of gross cash receipts and gross cash payments arising from investing and financing activities. Both the approaches, direct and indirect result in the same amount for cash flow from operations after making necessary adjustments. However, both the approaches have the arguments, pros and cons. The arguments in favour of direct approach are that it identifies the major categories of cash receipts and cash payments arising from operating activities; it provides a more useful basis for estimating future cash flows; and it provides information that is not otherwise available in the balance sheet and profit and loss account. The direct method is a better indicator of company solvency, has a sounder conceptual framework and reflects accepted business practice. It permits an evaluation of cash flow relating to specific line items of income statement such as sales and cost of goods sold. The empirical evidence indicates that the direct method is superior over the indirect method in predicting future operating cash flows and future net operating cash flows. On the other hand, followers of the indirect approach argue that indirect method is less costly and more convenient to use by firms. It is argued that the direct approach would require information that is hard to collect and sensitive. One difficulty with the direct approach is that some of the cash flows may have characteristics of more than one category of cash flow. However, the indirect method has also been criticized on two grounds. First, it contains unnecessary detail and may confuse the users. Another limitation of the indirect method is that the adding of expenses such as depreciation suggests that expenses are a source of cash. The conceptual and practical problems which underline the indirect method are as follows: (i) Ambiguity in the definition of “operations.” (ii) Diversity in reporting practices. (iii) Impact of changes in the reporting entity on the non-cash current accounts. (iv) Use of absorption costing in accounting for manufactured inventory. (v) Measurement of current portion of long-term leases. (vi) Reclassifications between current and non-current accounts. Figures 18.2 and 18.3 shows respectively direct and indirect method of preparing cash flow statement.

Illustration 1: (Cash flow from operation-Indirect Method) From the following, calculate cash from operation by Indirect Method:

Illustration 2: (Indirect Method) The following data are provided for ABC Ltd:

Illustration 3: (Direct and Indirect Methods) From the following particulars, prepare Cash Flow Statement for the year ended 31st March, 2013 using: (a) Direct Method (b) Indirect Method

Illustration 4: From the following details relating to the Accounts of Grow More Ltd. prepare Cash Flow Statement:

(i) Depreciation @ 25% was charged on the opening value of Plant and Machinery. (ii) During the year one old machine costing 50,000 (WDV 20,000) was sold for Rs. 35,000. (iii) Rs. 50,000 was paid towards income tax during the year. (iv) Building under construction was not subject to any depreciation. Prepare Cash flow Statement.

Illustration 5: (Loss on Machinery discarded) Following are the Balance Sheets of Suhani Ltd. as on 31st March, 2012 and 2013:

Additional Information: (i) Depreciation on Plant and Machinery has been charged @ 15%. (ii) A machine costing Rs. 10,000 (W.D.V. Rs. 3,000) has been discarded. An old machine costing Rs. 50,000 (W.D.V. Rs. 20,000) has been sold for Rs. 35,000. (iii) A profit of Rs. 10,000 has been earned by sale of investments. (iv) Debentures have been redeemed at 5% premium. (v) Rs. 45,000 income tax has been paid and adjusted against provision for taxation. Prepare Statement of changes in Financial Position-cash basis.

Illustration 6: (Cash Flow Statement Indirect Method) Presented below is the comparative Balance Sheets for Jyoti Ltd. at 31st March:

Additional information: (i) Operating expenses include depreciation expense of Rs. 70,000 and amortisation of prepaid expenses of Rs. 4,400. (ii) Land was sold for cash at book value. (iii) Cash dividends of Rs. 74,290 were paid. (iv) Net income for 2006 was Rs. 26,890. (v) Equipment was purchased for Rs. 65,000 cash. In addition equipment costing Rs. 40,000 with a book value of Rs. 13,000 was sold for Rs. 15,000 cash. (vi) Bonds were redeemed at face value by issuing 3,000 Equity Shares of Rs. 10 at par. Instructions: Prepare a Statement of Cash Flows for 2013 using the indirect method [AS-3 (Revised)].

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