Bad5shah

What is the difference between the direct and the indirect method of calculating cash flow from operations?

A) The indirect method starts with gross income and adjusts to cash flow from operations, while the direct method starts with gross profit and flows through the income statement to calculate cash flows from operations.

B) Balance sheet items are not included in the cash flow from operations for the direct method, while they are included for the indirect method.

C) The direct method starts with sales and follows cash as it flows through the income statement, while the indirect method starts with net income and adjusts for non-cash charges and other items.

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The main difference between the direct and indirect methods of calculating cash flows is the way that cash flow from operations is calculated. The direct method starts with sales and follows cash as it flows through the income statement, while the indirect method starts with income after taxes and adjusts backwards for non-cash and other items. Both methods will have the same result for operating cash flows. The direct and indirect method calculates the financing and investing cash flows the same way and both methods will result in the same cash flow figure.

Bad5shah

The correct set of cash flow treatments as they relate to interest paid according to U.S. generally accepted accounting principles (GAAP) and International Accounting Standards (IAS) GAAP is:

U.S. GAAP

IAS GAAP

A) CFF CFF

B) CFO or CFF CFO

C) CFO CFO or CFF

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U.S. GAAP treats interest paid as CFO whereas IAS GAAP treats interest paid as either CFO or CFF.

Bad5shah

According to U.S. Generally Accepted Accounting Principles (GAAP) and International Accounting Standards (IAS) GAAP, should dividends paid be treated as a cash flow from financing (CFF) or as a cash flow from operations (CFO)?

U.S. GAAP

IAS GAAP

A) CFF CFF or CFO

B) CFF or CFO CFO

C) CFO CFF

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U.S. GAAP treats dividends paid as CFF whereas IAS GAAP treats dividends paid as either CFO or CFF.

Bad5shah

The CORRECT set of cash flow treatments as they relate to interest and dividends received according to U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS) is:

U.S. GAAP

IFRS

A) CFO CFI or CFO

B) CFI or CFO CFI

C) CFI CFO

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U.S. GAAP treats interest and dividends received as CFO whereas under IFRS interest and dividends received may be treated as either CFO or CFI.

Bad5shah

Independence, Inc. reports interest received and dividends paid as part of its cash flow from operations. This treatment is acceptable under:

A) IFRS but not under U.S. GAAP.

B) U.S. GAAP but not under IFRS.

C) either IFRS or U.S. GAAP.

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IFRS permits interest received to be reported as either cash flow from operations or cash flow from investing, and permits dividends paid to be reported as either cash flow from operations or cash flow from financing. U.S. GAAP requires interest received to be reported as cash flow from operations, but requires dividends paid to be reported as cash flow from financing.

Bad5shah

For the year ended December 31, 2007, Challenger Company reported the following financial information:

Revenue	$100,000
Cost of goods sold	(40,000)
Cash operating expenses	(20,000)
Depreciation expense	(5,000)
Tax expense	(3,000)
Net income	$32,000
Increase in accounts receivable	$7,500
Decrease in inventory	$2,500
Increase in short-term notes payable	$3,000
Decrease in accounts payable	$1,000

Calculate cash flow from operating activities using the direct method and the indirect method.

Direct method

Indirect method

A) $31,000 $34,000

B) $31,000 $31,000

C) $34,000 $34,000

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CFO is the same under both methods, the only difference is presentation. Direct method: $92,500 cash collections ($100,000 revenue – $7,500 increase in receivables) – $38,500 cash paid to suppliers (– $40,000 COGS + $2,500 decrease in inventory – $1,000 decrease in payables) – $20,000 cash operating expenses – $3,000 tax expense = $31,000. Indirect method: $32,000 net income + $5,000 depreciation expense – $7,500 increase in receivables + $2,500 decrease in inventory – $1,000 decrease in payables = $31,000. The increase in short-term notes payable is a financing activity.

Bad5shah

Consider the following:

Argument #1:	The indirect method presents a firm’s operating cash receipts and payments and is thus more consistent with the objectives of the cash flow statement.
Argument #2:	The indirect method provides more information than the direct method and is more useful to analysts in estimating future operating cash flows.

Which of these arguments support the use of the indirect method for presenting cash flow from operating activities in the cash flow statement?

A) Argument #2 only.

B) Neither argument.

C) Argument #1 only.

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It is the direct method, not the indirect method, that presents operating cash receipts and payments and is thus more consistent with the objectives of the cash flow statement. The direct method provides more information than the indirect method and is preferred by analysts who are estimating future cash flows.

Bad5shah

The difference between cash flow from operations (CFO) under the direct method and CFO under the indirect method is:

A) balanced by an opposite difference in cash flow from investing.

B) disclosed as a reserve in the footnotes to the cash flow statement.

C) always equal to zero.

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The direct and indirect methods are two ways of presenting the same total for cash from operations.

Bad5shah

Use the following information to calculate cash flows from operations using the indirect method.

• Net Income: $12,000
• Depreciation Expense: $1,000
• Loss on sale of machinery: $500
• Increase in Accounts Receivable: $2,000
• Decrease in Accounts Payable: $1,500
• Increase in Income taxes payable: $500
• Repayment of Bonds: $3,000

A) Increase in cash of $7,500.

B) Increase in cash of $10,500.

C) Increase in cash of $9,500.

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Cash flow from operations would be calculated as +Net Income $12,000 + Depreciation $1,000 + Loss on sale of machinery $500 − A/R $2,000 − A/P $1,500 + Income taxes payable $500 = $10,500.
Repayment of Bonds is a financing activity and would not be included with operating activities. Depreciation is not a cash flow activity and is therefore always added back to net income to calculate CFO. The loss on the sale of machinery is not a cash outflow so it is also added back to calculate CFO. Accounts receivable is subtracted when there is an increase as this increases net income but does not affect cash.

Bad5shah

Use the following financial data for Moose Printing Corporation to calculate the cash flow from operations (CFO) using the indirect method.

• Net income: $225
• Increase in accounts receivable: $55
• Decrease in inventory: $33
• Depreciation: $65
• Decrease in accounts payable: $25
• Increase in wages payable: $15
• Decrease in deferred taxes: $10
• Purchase of new equipment: $65
• Dividends paid: $75

A) Increase in cash of $248.

B) Increase in cash of $173.

C) Increase in cash of $183.

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CFO for Moose Printing Corporation is calculated as follows:
+Net Income $225 − A/R $55 + Inventory $33 + Depreciation $65 − A/P $25 + Wages Payable $15 − Deferred taxes $10 = $248.
The purchase of new equipment would be an investing activity and, therefore, would not be included in the CFO. Dividends paid would be a financing activity and would not be included in the CFO.