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 (that is, more relevant) for analyzing the cash flow data, understanding the company’s operations, and identifying points to be investigated further? Explain why.

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KRALOVEC COMPANY Stat ement of Cash Flows For the year ended December 31, 2020 1. Direct method Cash flows from operating activities Cash collections from customers $ 6,446,000 Cash payments for operating expenses (4,883,000) Cash payments for interest (80,000) Cash payments for income taxes Net cash provided by operating activities (313,000) 1,170,000 Cash flows from investing activities Sake of machinery $ 140,000 Purchase of machinery (750,000) Net cash used by investing activities (610,000) Cash flows from financing activities Retirement of bonds (100,000) Payment of dividends (200,000) Net cash used by financing activities Net increase in cash during year Cash at beginning of year (300,000) 260,000 130,000 $ 390,000 Cash at end of year 2. Indirect method Cash flows from operating activities $ 705,000 Net income Adjustments to convert net earnings to net cash provided by operating activities: Depreciation expense Loss on sale of machinery $ 470,000 34,000 Increase in accounts receivable (100,000) 35,000 Decrease in inventory Increase in accounts payable 21,000 Decrease in interest payable Increase in taxes payable Net cash provided by operating activities (5,000) 10,000 465,000 1,170,000 Cash flows from investing activities Sale of machinery 140,000 Purchase of machinery Net cash used by investing activities (750,000) (610,000) Cash flows from financing activities Retirement of bonds (100,000) Payment of dividends (200,000) Net cash used by financing activities (300,000) Net increase in cash during year 260,000 Cash at beginning of year Cash at end of year 130,000 $ 390,000