Q6: Firms are required to present their cash flows from operating activities in their Statement of Cash Flows in one of two ways. What are these two ways?
AASB107 also requires firms to report their cash flows from operating activities using one of two methods (direct and indirect):
“An entity shall report cash flows from operating activities using either:
(a) the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or
(b) the indirect method, whereby profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows.
AASB 107 para 18
In para 19, the accounting standard goes further and particularly ‘encourages’ firms (but does not require them) to use the direct method:
“Entities are encouraged to report cash flows from operating activities using the direct method.”
AASB 107 para 19
In practice, we will find many of our firms will use both the direct and indirect method. Often they will use the direct method to set out their Statement of cash flows and will include the indirect method in a footnote. So many of our firms will effectively give us two forms of Statement of cash flows; one as the Statement of cash flows itself (direct method) and the other by way of footnote (indirect method). Ryman Healthcare has done this in its 2019 Annual Report: Statement of cash flows (page 83, direct method; Footnote 21, page 112, indirect method). The direct method provides information that is not available in the Income statement and Balance sheet (namely major areas of cash receipts and payments in the year); and the indirect method reconciles the operating profit and cash flows from operating activities (by adjusting profit in the Income Statement for non-cash items and accruals).
Also, see Martin’s videos Two Methods to Present Operating Cash Flows.