Question

The opening and closing balances are the same regardless of which method you are using. The cash flow statement is prepared after the books have been closed. If there are erroneous postings, then the closing balances will be affected as well, not just individual line items that impact cash. Also, think of the journal entry method used in the direct method in this text. Aren't we using ending ledger balances to determine cash flows? For example, if Sales =$500, and A/R has decreased by $2, then cash collected per direct method is $502.

Dr. Cash 502
Cr. A/R 2
Cr. Sales 500

Both the cash flow gives same result and movement in cash for the financial year. The calculation of activities are different for cash from operating activities.

Direct Method use deep analysis of Cash Collection and payment where as indirect method use net income and difference between working capital chages.

At the end of all the calculation both the methods end up giving same result of cash from operating activities.

Like in the given example sale and debtors reduction gave $502 inflow of cash and as per indirect method changes in the accounts receivable more by 2 decrease shows positive change in the receivables and adding $500 sales to it would be $502 as cash from operating activities.

Although Direct method consider to be more accurate and proper way of generating cash flow statement.

There could be chances of error in the indirect statement if there was error posting a journal affect the cash balance not to get tally.

But if we are appropriate with the income statement and other posting then both the statements are valid for calculating cash flows.

QUESTION: If there is an error in the cash account, it will affect the cash flow statement regardless of which method is used. The point of the cash flow statement is to reconcile the change in cash from one period to the next, right?

Answer 1

Ans. The statements given above are correct.

There are two methods for cash flow from operating activities direct and Indirect method. Both methods use different approaches but at the end they both gives same results as long as there are no mistakes. It is true that indirect method uses income statement as the starting point and if there are mistakes in income statement , cash flows will be affected. However, direct method does not depends on income statement and hence it is not affected by the same.

The aim of cash flows is to identify the sources and uses of cash during the period and aims at reconciling opening cash with closing cash.