As discussed in the chapter, there are two methods for presenting the information in the operating activities section of the statement of cash flows: the direct method and the indirect method. Accounting standards generally express a preference for the direct method but allow the indirect method. The vast majority of companies prepare their statements of cash flows using the indirect method of presentation.

Presented below are two statements of cash flows for Kralovec Company. In the first one, the operating activities section is presented using the direct method; in the second statement, the indirect method is used.

Required:

a. As discussed in Chapter 2, understandability is an important qualitative characteristic of financial statements. With this in mind, compare the two statements above and comment on the understandability of the direct versus the indirect method of presentation in the operating activities section. Which approach do you think most users of financial statements would prefer?

b. Looking only at the first statement (presented using the direct method), analyze the cash flow data for Kralovec Company and note any significant points that can be observed from it regarding the company’s operations during the year. Then repeat this process, looking only at the second statement (presented using the indirect method).

c. Based on your experience in working through part “b,” which method of presentation do you find more useful (i.e. more relevant) for analyzing the cash flow data, understanding the company’s operations, and identifying points to be investigated further? Explain why.