{"id":4070,"date":"2020-10-25T02:24:20","date_gmt":"2020-10-25T02:24:20","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/wm-financialaccounting\/?post_type=chapter&#038;p=4070"},"modified":"2020-11-18T17:59:42","modified_gmt":"2020-11-18T17:59:42","slug":"direct-and-indirect-methods-compared","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/chapter\/direct-and-indirect-methods-compared\/","title":{"raw":"Direct and Indirect Methods Compared","rendered":"Direct and Indirect Methods Compared"},"content":{"raw":"<div class=\"textbox learning-objectives\">\r\n<h3>Learning Outcomes<\/h3>\r\n<ul>\r\n \t<li style=\"font-weight: 400;\">Distinguish between the direct and indirect methods of preparing a statement of cash flows<\/li>\r\n<\/ul>\r\n<\/div>\r\nCash flows from operating activities show the net amount of cash received or disbursed during a given period for items that normally appear on the income statement. You can calculate these cash flows using either the direct or indirect method. The direct method deducts from cash sales only those operating expenses that consumed cash. This method converts each item on the income statement directly to a cash basis. Alternatively, the indirect method starts with accrual basis net income and indirectly adjusts net income for items that affected reported net income but did not involve cash.\r\n\r\nThe direct method converts each item on the income statement to a cash basis. For instance, assume sales are stated at $45,785 on an accrual basis. If accounts receivable decreased by $15, from $1,750 to $1,735, cash collections from customers would have been $45,800, which you could calculate in a T account or in a table as follows:\r\n<div align=\"left\">\r\n<table class=\"fin-table gridded\">\r\n<tbody>\r\n<tr>\r\n<th scope=\"col\">Beginning balance<\/th>\r\n<td>$ \u00a0 \u00a0 1,750<\/td>\r\n<\/tr>\r\n<tr>\r\n<th scope=\"col\">Accrual basis sales<\/th>\r\n<td><span style=\"text-decoration: underline;\">45,785<\/span><\/td>\r\n<\/tr>\r\n<tr>\r\n<th scope=\"col\">Balance before payments<\/th>\r\n<td>47,535<\/td>\r\n<\/tr>\r\n<tr>\r\n<th scope=\"col\">Less: Ending balance<\/th>\r\n<td>1,735<\/td>\r\n<\/tr>\r\n<tr>\r\n<th scope=\"col\">Cash payments from customers<\/th>\r\n<td><span style=\"text-decoration: underline;\">$ \u00a0 45,800<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\nHere is a hypothetical example of a statement of cash flows prepared using the direct method:\r\n<table class=\"fin-table acctstatement\">\r\n  <caption>Rumble Corp.\r\n    Statement of Cash Flows\r\n    for the year ended 12\/31\/x1<\/caption>\r\n  <thead>\r\n    <tr class=\"u-sr-only\">\r\n      <th scope=\"col\">Description<\/th>\r\n      <th scope=\"col\">Amount<\/th>\r\n      <th scope=\"col\">Total<\/th>\r\n    <\/tr>\r\n    <tr>\r\n      <td><\/td>\r\n      <th colspan=\"2\" scope=\"col\"><i>In millions<\/i><\/th>\r\n    <\/tr>\r\n  <\/thead>\r\n  <tbody>\r\n    <tr>\r\n      <td colspan=\"3\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Cash flows from operating activities<\/strong>\r\n      <\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <td>Cash receipts from customers<\/td>\r\n      <td class=\"r\">$ 45,800<\/td>\r\n      <td class=\"r\"><\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <td>Cash paid to suppliers<\/td>\r\n      <td class=\"r\">(29,800)<\/td>\r\n      <td class=\"r\"><\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <td>Cash paid to employees<\/td>\r\n      <td class=\"r\">(11,200)<\/td>\r\n      <td class=\"r\"><\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <td>Cash generated from operations<\/td>\r\n      <td class=\"r line-single\">\r\n        <span class=\"u-sr-only\">Single Line<\/span>\r\n        4,800\r\n      <\/td>\r\n      <td class=\"r\"><\/td>\r\n    <\/tr>\r\n    <tr aria-hidden=\"true\">\r\n      <td colspan=\"3\"><\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <td>Interest paid<\/td>\r\n      <td class=\"r\">(310)<\/td>\r\n      <td class=\"r\"><\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <td>Income taxes paid<\/td>\r\n      <td class=\"r\">(1,700)<\/td>\r\n      <td class=\"r\"><\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <td>Net cash from operating activities<\/td>\r\n      <td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n      <td class=\"r line-single\">\r\n        <span class=\"u-sr-only\">Single Line<\/span>\r\n        $2,790\r\n      <\/td>\r\n    <\/tr>\r\n    <tr aria-hidden=\"true\">\r\n      <td colspan=\"3\"><\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <td colspan=\"3\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Cash flows from investing activities<\/strong>\r\n      <\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <td>Purchase of property, plant, and equipment<\/td>\r\n      <td class=\"r\">(580)<\/td>\r\n      <td class=\"r\"><\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <td>Proceeds from sale of equipment<\/td>\r\n      <td class=\"r\">150<\/td>\r\n      <td class=\"r\"><\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <td>Net cash used in investing activities<\/td>\r\n      <td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n      <td class=\"r line-single\">\r\n        <span class=\"u-sr-only\">Single Line<\/span>\r\n        (430)\r\n      <\/td>\r\n    <\/tr>\r\n     <tr aria-hidden=\"true\">\r\n      <td colspan=\"3\"><\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <td colspan=\"3\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Cash flows from financing activities<\/strong>\r\n      <\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <td>Proceeds from issuance of common stock<\/td>\r\n      <td class=\"r\">1,000<\/td>\r\n      <td class=\"r\"><\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <td>Proceeds from issuance of long-term debt<\/td>\r\n      <td class=\"r\">500<\/td>\r\n      <td class=\"r\"><\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <td>Dividends paid<\/td>\r\n      <td class=\"r\">(460)<\/td>\r\n      <td class=\"r\"><\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <td>Net cash used in financing activities<\/td>\r\n      <td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\r\n      <td class=\"r line-single\">\r\n        <span class=\"u-sr-only\">Single Line<\/span>\r\n        1,040\r\n      <\/td>\r\n    <\/tr>\r\n     <tr aria-hidden=\"true\">\r\n      <td colspan=\"3\"><\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <th scope=\"row\">Net increase in cash and cash equivalents<\/th>\r\n      <td class=\"r\"><\/td>\r\n      <td class=\"r\">3,400<\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <th scope=\"row\">Cash and cash equivalents at beginning of period<\/th>\r\n      <td class=\"r\"><\/td>\r\n      <td class=\"r\">1,640<\/td>\r\n    <\/tr>\r\n    <tr>\r\n      <th scope=\"row\">Cash and cash equivalents at end of period<\/th>\r\n      <td class=\"r\"><\/td>\r\n      <td class=\"r line-single line-double\">\r\n        <span class=\"u-sr-only\">Single Line<\/span>\r\n        $5,040\r\n        <span class=\"u-sr-only\">Double Line<\/span>\r\n      <\/td>\r\n    <\/tr>\r\n  <\/tbody>\r\n<\/table>\r\n\r\nThe indirect method adjusts net income (rather than adjusting individual items in the income statement) for (1) changes in current assets (other than cash) and current liabilities, and (2) items that were included in net income but did not affect cash. We\u2019ll explore this in more detail in a later section.\r\n<div class=\"textbox tryit\">\r\n<h3>practice question<\/h3>\r\nhttps:\/\/assessments.lumenlearning.com\/assessments\/23840\r\n\r\n<\/div>","rendered":"<div class=\"textbox learning-objectives\">\n<h3>Learning Outcomes<\/h3>\n<ul>\n<li style=\"font-weight: 400;\">Distinguish between the direct and indirect methods of preparing a statement of cash flows<\/li>\n<\/ul>\n<\/div>\n<p>Cash flows from operating activities show the net amount of cash received or disbursed during a given period for items that normally appear on the income statement. You can calculate these cash flows using either the direct or indirect method. The direct method deducts from cash sales only those operating expenses that consumed cash. This method converts each item on the income statement directly to a cash basis. Alternatively, the indirect method starts with accrual basis net income and indirectly adjusts net income for items that affected reported net income but did not involve cash.<\/p>\n<p>The direct method converts each item on the income statement to a cash basis. For instance, assume sales are stated at $45,785 on an accrual basis. If accounts receivable decreased by $15, from $1,750 to $1,735, cash collections from customers would have been $45,800, which you could calculate in a T account or in a table as follows:<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table gridded\">\n<tbody>\n<tr>\n<th scope=\"col\">Beginning balance<\/th>\n<td>$ \u00a0 \u00a0 1,750<\/td>\n<\/tr>\n<tr>\n<th scope=\"col\">Accrual basis sales<\/th>\n<td><span style=\"text-decoration: underline;\">45,785<\/span><\/td>\n<\/tr>\n<tr>\n<th scope=\"col\">Balance before payments<\/th>\n<td>47,535<\/td>\n<\/tr>\n<tr>\n<th scope=\"col\">Less: Ending balance<\/th>\n<td>1,735<\/td>\n<\/tr>\n<tr>\n<th scope=\"col\">Cash payments from customers<\/th>\n<td><span style=\"text-decoration: underline;\">$ \u00a0 45,800<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<p>Here is a hypothetical example of a statement of cash flows prepared using the direct method:<\/p>\n<table class=\"fin-table acctstatement\">\n<caption>Rumble Corp.<br \/>\n    Statement of Cash Flows<br \/>\n    for the year ended 12\/31\/x1<\/caption>\n<thead>\n<tr class=\"u-sr-only\">\n<th scope=\"col\">Description<\/th>\n<th scope=\"col\">Amount<\/th>\n<th scope=\"col\">Total<\/th>\n<\/tr>\n<tr>\n<td><\/td>\n<th colspan=\"2\" scope=\"col\"><i>In millions<\/i><\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td colspan=\"3\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Cash flows from operating activities<\/strong>\n      <\/td>\n<\/tr>\n<tr>\n<td>Cash receipts from customers<\/td>\n<td class=\"r\">$ 45,800<\/td>\n<td class=\"r\"><\/td>\n<\/tr>\n<tr>\n<td>Cash paid to suppliers<\/td>\n<td class=\"r\">(29,800)<\/td>\n<td class=\"r\"><\/td>\n<\/tr>\n<tr>\n<td>Cash paid to employees<\/td>\n<td class=\"r\">(11,200)<\/td>\n<td class=\"r\"><\/td>\n<\/tr>\n<tr>\n<td>Cash generated from operations<\/td>\n<td class=\"r line-single\">\n        <span class=\"u-sr-only\">Single Line<\/span><br \/>\n        4,800\n      <\/td>\n<td class=\"r\"><\/td>\n<\/tr>\n<tr aria-hidden=\"true\">\n<td colspan=\"3\"><\/td>\n<\/tr>\n<tr>\n<td>Interest paid<\/td>\n<td class=\"r\">(310)<\/td>\n<td class=\"r\"><\/td>\n<\/tr>\n<tr>\n<td>Income taxes paid<\/td>\n<td class=\"r\">(1,700)<\/td>\n<td class=\"r\"><\/td>\n<\/tr>\n<tr>\n<td>Net cash from operating activities<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\">\n        <span class=\"u-sr-only\">Single Line<\/span><br \/>\n        $2,790\n      <\/td>\n<\/tr>\n<tr aria-hidden=\"true\">\n<td colspan=\"3\"><\/td>\n<\/tr>\n<tr>\n<td colspan=\"3\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Cash flows from investing activities<\/strong>\n      <\/td>\n<\/tr>\n<tr>\n<td>Purchase of property, plant, and equipment<\/td>\n<td class=\"r\">(580)<\/td>\n<td class=\"r\"><\/td>\n<\/tr>\n<tr>\n<td>Proceeds from sale of equipment<\/td>\n<td class=\"r\">150<\/td>\n<td class=\"r\"><\/td>\n<\/tr>\n<tr>\n<td>Net cash used in investing activities<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\">\n        <span class=\"u-sr-only\">Single Line<\/span><br \/>\n        (430)\n      <\/td>\n<\/tr>\n<tr aria-hidden=\"true\">\n<td colspan=\"3\"><\/td>\n<\/tr>\n<tr>\n<td colspan=\"3\"><span class=\"u-sr-only\">Subcategory, <\/span><strong>Cash flows from financing activities<\/strong>\n      <\/td>\n<\/tr>\n<tr>\n<td>Proceeds from issuance of common stock<\/td>\n<td class=\"r\">1,000<\/td>\n<td class=\"r\"><\/td>\n<\/tr>\n<tr>\n<td>Proceeds from issuance of long-term debt<\/td>\n<td class=\"r\">500<\/td>\n<td class=\"r\"><\/td>\n<\/tr>\n<tr>\n<td>Dividends paid<\/td>\n<td class=\"r\">(460)<\/td>\n<td class=\"r\"><\/td>\n<\/tr>\n<tr>\n<td>Net cash used in financing activities<\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span><\/td>\n<td class=\"r line-single\">\n        <span class=\"u-sr-only\">Single Line<\/span><br \/>\n        1,040\n      <\/td>\n<\/tr>\n<tr aria-hidden=\"true\">\n<td colspan=\"3\"><\/td>\n<\/tr>\n<tr>\n<th scope=\"row\">Net increase in cash and cash equivalents<\/th>\n<td class=\"r\"><\/td>\n<td class=\"r\">3,400<\/td>\n<\/tr>\n<tr>\n<th scope=\"row\">Cash and cash equivalents at beginning of period<\/th>\n<td class=\"r\"><\/td>\n<td class=\"r\">1,640<\/td>\n<\/tr>\n<tr>\n<th scope=\"row\">Cash and cash equivalents at end of period<\/th>\n<td class=\"r\"><\/td>\n<td class=\"r line-single line-double\">\n        <span class=\"u-sr-only\">Single Line<\/span><br \/>\n        $5,040<br \/>\n        <span class=\"u-sr-only\">Double Line<\/span>\n      <\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>The indirect method adjusts net income (rather than adjusting individual items in the income statement) for (1) changes in current assets (other than cash) and current liabilities, and (2) items that were included in net income but did not affect cash. We\u2019ll explore this in more detail in a later section.<\/p>\n<div class=\"textbox tryit\">\n<h3>practice question<\/h3>\n<p>\t<iframe id=\"lumen_assessment_23840\" class=\"resizable\" src=\"https:\/\/assessments.lumenlearning.com\/assessments\/load?assessment_id=23840&#38;embed=1&#38;external_user_id=&#38;external_context_id=&#38;iframe_resize_id=lumen_assessment_23840\" frameborder=\"0\" style=\"border:none;width:100%;height:100%;min-height:400px;\"><br \/>\n\t<\/iframe><\/p>\n<\/div>\n\n\t\t\t <section class=\"citations-section\" role=\"contentinfo\">\n\t\t\t <h3>Candela Citations<\/h3>\n\t\t\t\t\t <div>\n\t\t\t\t\t\t <div id=\"citation-list-4070\">\n\t\t\t\t\t\t\t <div class=\"licensing\"><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Original<\/div><ul class=\"citation-list\"><li>Direct and Indirect Methods Compared. <strong>Authored by<\/strong>: Joseph Cooke. <strong>Provided by<\/strong>: Lumen Learning. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by\/4.0\/\">CC BY: Attribution<\/a><\/em><\/li><\/ul><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Shared previously<\/div><ul class=\"citation-list\"><li>Accounting Principles: A Business Perspective. <strong>Authored by<\/strong>: James Don Edwards, University of Georgia &amp; Roger H. Hermanson, Georgia State University. <strong>Provided by<\/strong>: Endeavour International Corporation. <strong>Project<\/strong>: The Global Text Project. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by\/4.0\/\">CC BY: Attribution<\/a><\/em><\/li><\/ul><\/div>\n\t\t\t\t\t\t <\/div>\n\t\t\t\t\t <\/div>\n\t\t\t <\/section>","protected":false},"author":90270,"menu_order":6,"template":"","meta":{"_candela_citation":"[{\"type\":\"original\",\"description\":\"Direct and Indirect Methods Compared\",\"author\":\"Joseph Cooke\",\"organization\":\"Lumen Learning\",\"url\":\"\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"\"},{\"type\":\"cc\",\"description\":\"Accounting Principles: A Business Perspective\",\"author\":\"James Don Edwards, University of Georgia & Roger H. Hermanson, Georgia State University\",\"organization\":\"Endeavour International Corporation\",\"url\":\"\",\"project\":\"The Global Text Project\",\"license\":\"cc-by\",\"license_terms\":\"\"}]","CANDELA_OUTCOMES_GUID":"","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-4070","chapter","type-chapter","status-publish","hentry"],"part":850,"_links":{"self":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/4070","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/wp\/v2\/users\/90270"}],"version-history":[{"count":6,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/4070\/revisions"}],"predecessor-version":[{"id":5620,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/4070\/revisions\/5620"}],"part":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/parts\/850"}],"metadata":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/4070\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/wp\/v2\/media?parent=4070"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapter-type?post=4070"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/wp\/v2\/contributor?post=4070"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/wp\/v2\/license?post=4070"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}