Which is a Better Method for Reporting Cash Flows from Operating Activities-Direct or Indirect Method?

Main Article Content

Dumisani Rumbidzai Muzira

Abstract

This paper is a response to the ongoing debate in the accounting profession on whether the direct method is better than the indirect method when reporting cash flows from operating activities. The debate has its roots from the standard setters who prefer the direct method and are even debating on whether to make the direct method mandatory. The contention being that the direct method is a better method than the indirect method when reporting cash flows from operating activities since the disaggregation of its components suggests more disclosure. More disclosure in financial statements has been a cry from the financial statement users such as the creditors and investors. This qualitative argument will therefore show the merits of both the direct and the indirect               method before getting to a conclusion on which method is better than the other. Further, it is a contribution to the ongoing debate in the accounting profession that can guide the standard setters as they deliberate on the possibility of making the direct method mandatory. In addition, a contention map and an argument map are used as roadmaps of the ideas being discussed in this study.

Keywords:
Direct method, indirect method, cash flows, operating activities

Article Details

How to Cite
Muzira, D. R. (2020). Which is a Better Method for Reporting Cash Flows from Operating Activities-Direct or Indirect Method?. Asian Journal of Economics, Business and Accounting, 16(1), 19-28. https://doi.org/10.9734/ajeba/2020/v16i130228
Section
Review Article

References

Abu-Abbas BM. Direct, Indirect, or Both Methods of Reporting Operating Statement of Cash Flows. International Journal of Finance and Accounting. 2014;3(6):335-340.

Financial Accounting Standard Board. FASB and IASB joint discussion paper preliminary views on financial statement presentation; 2008.

Available:http://www.fasb.org/cs /BlobServer?blobcol=urldata&blobtable =MungoBlobs&blobkey=id&blobwhere

=1175818749677&blobheader=application%2Fpdf

Ding W, Jeanjean T, Stolowy H. The usefulness of disclosing both direct and indirect cash flows: An empirical study. 2006;1-27.

SEC, An Analysis of IFRS in Practice; 2011.

Available:https://www.sec.gov/spotlight

/globalaccountingstand- ards/ifrs-work-plan-paper-111611-practice.pdf

Lightstone K, Wilcox K, Beaubien L. Misclassifying cash flows from operations: Intentional or not? International Journal of Accounting and Information Management. 2012;22(1):18-32.

Eisenhardt KM. Agency theory: An assessment and review. Academy of Management Review. 1989;14(1):57-74.

Ang JS, Cole RA, Lin JW. Agency costs and ownership structure. The Journal of Finance. 2000; 55(1):81-106.

Hill CW, Jones TM. Stakeholder‐agency theory. Journal of Management Studies. 1992;29(2): 131-154.

Stice JD, Stice EK, Cottrell DM, Stice D. Teaching operating cash flow: One matrix for analysis–two methods for presentation. Advances in Accounting Education: Teaching and Curriculum Innovations. 2018;22:199-215.

Broome OW. Statement of cash flows: time for change!. Financial Analysts Journal. 2004;60 (2):16-22.

Trout KR. Review of the direct method statement of cash flows and the associated teaching implications. Journal of Higher Education Theory and Practice. 2019;19(2):156-169.

Goyal MK. A survey on popularity of the direct method of cash flow reporting. Journal of Applied Management Accounting Research. 2004;2(2):41-52.

IASB. Exposure draft of an improved conceptual framework for financial reporting: The objective of financial reporting and qualitative characteristics of decision-useful financial reporting information; 2008.

Available:http://www.assb.gov.sg/docs/attachments

/EDofChapters1and2theJointImprovedConceptualFramework.pdf

Motlagh AJ. Accounting: Cash flow statement. IOSR Journal of Business and Management. 2013;7(4):109-116.

Ahmed K, Ali MJ. Determinants and usefulness of analysts’ cash flow forecasts: Evidence from Australia. International Journal of Accounting and Information Management. 2013;21(1):4-21.

Kavanagh SC, Swanson C. Tactical financial management: Cash flow and budgetary variance analysis. Government Finance Review; 2009.

Available:http://www.gfoa.org/sites/default/files/GFR_OCT_09_8.pdf

Lucey T. Management Accounting (3rd ed.). Shepherds Bush Green, London: DP; 1992.

Shadi F, Reza M. Further Evidence on the Usefulness of Direct Method Cash Flow Components for Forecasting Future Cash Flows. The International Journal of Accounting. 2013: 1-34.

Bhandari SB, Iyer R. Predicting business failure using cash flow statement based measures. Managerial Finance. 2013;39(7):667-676.

Accounting Standards Codification. FASB Accounting Standards updates: Statement of Cash Flows (Topic 230); 2016.

Available:ttps://asc.fasb.org/imageRoot/55/95454355.pdf

Hughes M, Hoy S, Andrew B. Cash flows: The gap between reported and estimated operating cash flow elements. Australasian Accounting, Business and Finance Journal. 2010;14(1):96-114.

Haber J, Wallace K. Preparing the statement of cash flows using the direct method. The CPA Journal; 2017.

Foerster S, Tsagarelis J, Wang G. Are cash flows better stock return predictors than profits?. Financial Analysts Journal. 2017;73(1):73-99.

Abdullah S, Majed A, Aymen M. The preference of direct or indirect methods in preparing the statement of cash flows in decision making: An Academic Perspective. International Journal of Economics and Finance. 2016;8(2).

Klammer T. Statement of cash flows: Preparation, presentation and use. John Wiley & Sons; 2018.