A tutorial question and its suggested solution was:

Q. There are two methods of calculating cash flow from operating activities: the direct method (gross flows) and the indirect method (reconciliation).

(a) Explain the difference between the two methods.

(b) Which method is required by the Australian Accounting Standards?

(c) Which method is preferable? Why?

Solution:

(a) The direct method or gross flows method shows the cash received and paid for the different operating activities. Typical operating activities include:

• cash received from customers
• cash paid to suppliers and employees
• tax paid
• interest received (if part of day-to-day operations)
• dividends received (if part of day to day operations, could be investing)
• interest paid (if part of day-to-day operations, could be financing).

The indirect or reconciliation method simply shows the net differences between the profit after tax and the cash flow from operating activities.

(b) Both methods are required according to the Australian Accounting Standard (the direct method in the accounts and the indirect method in the notes).

(c) This is a debatable question; however, the indirect method is possibly more appropriate or informative for the lay reader of reports.

Required:

In your own words, explain the indirect method of presenting operating cash flows and why the format is useful to decision makers.