As discussed in ASC 230-10-45-28, cash flows related to operating activities may be presented in one of two ways — the direct method or the indirect method. The presentation of investing and financing activities are identical under the direct and indirect methods. Although the presentation of operating cash flows differs between the two methods, both methods result in the same amount of net cash flows from operations. While ASC 230-10-45-25 encourages the use of the direct method, the large majority of reporting entities elect to use the indirect method. The concepts underlying classification within ASC 230 were conceived and explained solely from the perspective of the direct method. While the indirect method represents an alternative presentation model, it is not an alternative classification methodology. Accordingly, even when a reporting entity is using the indirect method, it should consider the direct method framework when evaluating the proper classification of a cash flow.

As discussed in ASC 230-10-45-25, the direct method requires the presentation of major types of gross cash receipts and gross cash payments and their arithmetic sum, which represents the net cash flow from operating activities. At a minimum, the following types of operating receipts and disbursements are required in a direct method presentation:

To illustrate how operating cash flows (prepared on the cash basis of accounting) relate to net income (prepared on the accrual method of accounting), as discussed in ASC 230-10-45-28, the direct method also requires a reconciliation of net income to net cash flows from operating activities. Net income, including earnings attributable to the controlling and noncontrolling interests, is the starting point to reconcile cash flows from operating activities. The reconciliation removes the effects of the following:

As discussed in ASC 230-10-45-25 and ASC 230-10-45-28, when the indirect method is used, a reporting entity does not report the gross cash receipts and gross payments required by the direct method. Instead, only the reconciliation of net income to net operating activities, as described above, is reported.

Reporting entities have latitude in how they present an indirect method reconciliation, as there is no prescribed format. As with most forms of practical expediency, the indirect method yields information that is less useful than the direct method. For example, because the individual line items within a reconciliation of net income to net operating cash flows do not represent cash flows, they by themselves provide no incremental information about a reporting entity's cash flows.

Although ASC 230 encourages the use of the direct method, a reporting entity can change from the indirect to the direct method (or vice versa) retrospectively. This retrospective change in the presentation of the statement of cash flows would not be considered a discretionary accounting change and would not require an assessment of preferability.

Even when a reporting entity is using the indirect method, the direct method may be helpful in evaluating the proper classification of cash flows. Example FSP 6-1 illustrates how a reporting entity can use the direct method to isolate cash flows from operations to ensure that the presentation under the indirect method of cash flows from operations is the same.

EXAMPLE FSP 6-1
Foreign currency cash flows in operating and financing cash flows

FSP Corp is a US dollar functional currency entity with two Euro-denominated liabilities: a €1,000 account payable due in 30 days and a €100,000 long-term note due in 3 years that may be repaid at any time, in any increment. At the beginning of the quarter, the spot rate for Euros was $1.20 per €1. The account payable was remeasured at the beginning of the quarter at $1,200 and the long-term note at $120,000. FSP Corp has $50,000 of cash and cash equivalents on the balance sheet at the beginning of the quarter.

A week later, when the spot rate for Euros is $1.15 per €1, FSP Corp pays the €1,000 account payable and settles €40,000 of the note payable. When preparing its financial statements at the end of the quarter, the exchange rate for remeasurement of the remaining €60,000 of long-term note payable is $1.10 per €1. FSP Corp records the following journal entries.

Ignoring interest and taxes, what is the treatment in the cash flow statement for these three journal entries under the direct and indirect methods?

Treatment on the cash flow statement:

Whether a reporting entity uses the direct or indirect method to present its operating cash flows, ASC 230-10-45-3 prohibits disclosure of cash flow per share or any component of cash flow per share.