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statement using the indirect method it is not available to calculate using the direct method. In addition, the extraction of such information is likely to be costly for companies. Finally, for reasons of confidentiality, customers may not wish to reveal comprehensive details of their cash flows from customers or to suppliers.Good answerIndirect method – some investors and creditors assess future cash flows by estimating future income and then allowing for accruals adjustments. Consequently information about past accruals adjustments may be useful to help estimate future adjustments.Go into detail about how to calculate both methods i.e. list the steps involved.
McKeith and Collins, Financial Accounting & Reporting, 2ndeditionMore detail about research into company failures and the use of the direct method indetermining this.Difficulty: Level IIMcKeith - Chapter 10 #48McKeith Chapter 104. Fencewell Limited is a small limited company exempt from the requirement to include a cash flow statement as part of its financial statements. Mr Allison,Managing Director of Fencewell Limited telephones you with the following dilemma.“I am sure that I am profitable. Indeed, I cost all the jobs personally and always ensure that a profit will be made but there just never seems to be money in the Bank. How can this be?”Write a brief report to Mr Allison giving reasons why this situation can arise and explain why a cash flow statement may be of use to him.Basic answerAccounting profit does not necessarily lead to an increase in cash.Statement of comprehensive income prepared on the basis of realization and matching rules and not receipts and payments and consequently a sale may not necessary cause an immediate change in the cash position.The statement of comprehensive income does not record the cost of purchasing non-current assets but instead allocates the cost of these assets over their expected useful lives in the form of the annual depreciation expense.Sales are recognized in the statement of comprehensive income even though they may be on credit and the cash not received until later.Purchases are recorded when incurred and again, they may be on credit and consequently not paid for until a later date.
McKeith and Collins, Financial Accounting & Reporting, 2ndeditionLoan repayments are not shown through the statement of comprehensive income.Inventory purchases for resale and still held at the year end may result in cash having been spent however no effect on profit.Dividends may have been paid.Taxation may have been paid.A cash flow statement is a statement which links the statement of comprehensive income and statement of financial position and shows the reasons for any changes in the bank balance over the year. The cash flow statement details how much cash has been generated by trading operations and how much has come into the business by other means i.e. loans or share issues. It also shows where the cash has been spent – on interest, tax, dividends, or purchasing non-current assets.This can be used to direct attention to problem areas, e.g. sales may well be