Indirect Method

Indirect method vs direct method

Indirect starts with net income and adjusts for noncash items nonoperating gains or losses and connector accounts

Removing noncash expense depreciation

Add back to net income

Removing nonoperating gain equipment sale

Subtract from net income

Rule for asset connector accounts

Change is reflected in the opposite direction increase subtract decrease add

Rule for liability connector accounts

Change is reflected in the same direction increase add decrease subtract

Accounts receivable increases

Subtract less cash collected than sales

Accounts receivable decreases

Add more cash collected than sales

Inventory increases

Subtract more cash spent on purchases

Inventory decreases

Add less cash spent on purchases

Prepaid expense increases

Subtract more cash paid in advance

Prepaid expense decreases

Add less prepaid this period

Accounts payable increases

Add delayed cash payments saved cash

Accounts payable decreases

Subtract more cash paid to reduce liabilities

Salary payable increases

Add expenses accrued but not yet paid

Salary payable decreases

Subtract extra cash used to pay liabilities

Treatment of interest or dividends received US GAAP

Operating cash inflow

Treatment of interest paid US GAAP

Operating cash outflow

Reason for controversy over classification

Dividends and interest resemble investing inflows and financing outflows but are reported as operating

IFRS flexibility vs US GAAP

IFRS allows classification choice while US GAAP requires fixed categories