\"IFRS and Preparing a Statement of Cash Flows\" Please respond to the following

ID: 2416347 • Letter: #

Question

"IFRS and Preparing a Statement of Cash Flows"

Please respond to the following:

Evaluate two (2) major differences between GAAP and IFRS with respect to the statement of cash flows. Give your opinion on which method you prefer. Provide a rationale for your response.

Imagine you are the senior accountant at your organization and management is unsure of the difference between the indirect method and the direct method of preparing a statement of cash flows. Outline a brief memo to management differentiating between the direct method and indirect method. Advise management on which method the company should use to prepare the statement of cash flows. Provide at least two (2) specific examples on why the method you selected would be beneficial to the company.

Explanation / Answer

(1) Statement of cash flows: Key differences between U.S. GAAP and IFRSs

The table below summarizes these differences and is followed by a detailed explanation of each difference.1

Definition of cash and cash equivalents

Cash and short-term, highly liquid investments are included. Bank overdrafts are excluded. Restricted cash is not included in cash and cash equivalents. Instead, changes in restricted cash should generally be presented as investing activities.

Cash and short-term, highly liquid investments are included. Bank overdrafts are included in certain situations.

Classification of components of transactions in the statement of cash flows

Components of a transaction are classified collectively on the basis of the predominant source of the cash flows.

Separate components of a single transaction are classified as operating, investing, or financing.

Statement of cash flows classification

More specific guidance is provided on items to be included in each category.

More flexibility exists regarding which items are to be included in each category.

Reporting cash flows from operating activities

Use of the direct or indirect method is allowed. Under both methods, net income must be reconciled to net cash flows from operating activities.

Use of the direct or indirect method is allowed. Net income must be reconciled to net cash flows from operating activities only under the indirect method.

Comparative periods

Presentation of comparative periods is not required.

The most recent two years must be presented.

Scope

Provides industry-specific guidance (e.g., not-for-profit entities (NFPs)).

Provides principles for classification of cash flows but little industry-specific guidance.

Scope exemptions

Limited scope exemptions exist for defined benefit plans and for certain investment companies.

No scope exemptions exist.

Disclosure of cash flows pertaining to discontinued operations

Before application of ASU 2014-08 — Separate disclosure is not required. If a company elects to report cash flows from discontinued operations, it must report them separately by category.

After application of ASU 2014-08 — Must disclose either the total operating and investing cash flows of the discontinued operation or the depreciation, amortization, capital expenditures, and significant operating and investing noncash items of the discontinued operation.

Disclosure of cash flows from discontinued operations under each category is required either on the face of the cash flow statement or in the notes.

Presentation of cash flow per share on the face of the financial statements

Prohibited.

Disclosure of cash flow per share is not explicitly prohibited.

Cash flows from hedging instruments

A company may classify cash flows from hedging activities in the same category as the cash flows from the hedged item provided that certain requirements are met and the accounting policy is disclosed.

Companies are required to classify cash flows from hedging activities in the same category as the cash flows from the item being hedged.

(2) The main difference between the direct method and the indirect method involves the cash flows from operating activities, the first section of the statement of cash flows. (There is no difference in the cash flows reported in the investing and financing activities sections.)

Under the direct method, the cash flows from operating activities will include the amounts for lines such as cash from customers and cash paid to suppliers. In contrast, the indirect method will show net income followed by the adjustments needed to convert the total net income to the cash amount from operating activities.

The direct method must also provide a reconciliation of net income to the cash provided by operating activities.

Most companies opt to report the cash flow statement using the indirect method because accrual accounting provides a better measure of the ebbs and flows of business activity. In addition, the indirect method proves to be less complex for reporting purposes. Imagine a company such as General Electric using the direct method to prepare its cash flow statement, which essentially is like going through the company's entire bank statement. However, companies may prepare the cash flow statement using the direct method with reconciliation to the indirect method as supplementary information.

Subject U.S. GAAP IFRSs