Question

Question: What are some of the arguments in favor of using the indirect (reconciliation) method as opposed to the direct method for reporting a statement of cash flows?

Short answer

Answer

The indirect method is preferred over the direct method of cash flow because it does not require additional efforts for preparation; it is according to the accrual basis of accounting and also defines the difference between the net income and cash from operations.

Step-by-step solution

Definition of Cash Flow Statement

The statement prepared by the business entity providing the information regarding all the transactions that increase or decrease the cash balance is known as the cash flow statement. Such a statement is prepared in three sections.

Arguments in favor of using the indirect method

1. The indirect method highlights the difference between the net income of the business entity and the cash generated from the operations.
2. The direct method statement of cash flow confuses the financial statement's users with knowledge of only the accrual basis of accounting.
3. Direct method cannot be justified based on cost-benefit analysis because it will require additional efforts as all other statements are prepared based on accrual accounting.