The direct method

Learning objectives

• Explain the direct method, its usefulness (encouraged method) and the two ways of obtaining the information.L1, L2
• Calculate cash received from customers and cash paid to suppliers and employees from profit or loss and changes in balances.L2, L3

Normative references

• IAS 7 §18Operating cash flows are reported under one of two methods: the direct method, which shows the main classes of gross receipts and gross payments, or the indirect method, which starts from profit or loss and corrects it for non-cash transactions, for deferrals and accruals of past or future operating receipts and payments, and for income and expense items whose cash effects relate to investing or financing (wording before IFRS 18).
• IAS 7 §19Entities are encouraged to use the direct method: it provides information that may be useful in estimating future cash flows and that is not available under the indirect method. The major classes of gross cash receipts and payments may be obtained either from the accounting records or by adjusting sales, cost of sales and other items in the statement of profit or loss for changes in inventories and operating receivables and payables, other non-cash items, and other items whose cash effects are investing or financing cash flows.

Original summaries of the paragraphs (reference register), never a quotation of the standard.

17 questions

• The standard encourages entities to report operating cash flows using the direct method.L1
• The direct method discloses major classes of gross cash receipts and gross cash payments from operating activities.L1
• Under the direct method, gross receipts and payments can only be obtained from the entity's cash accounting records.L2
• Why does the standard encourage the direct method?L1
• Direct or indirect method: what changes in net operating cash flow?L2
• Calmira does not track its receipts by nature in detail. How can it prepare a direct-method statement?L2
• Which of these lines belong to a direct-method presentation?L1
• To compute cash paid to suppliers by adjusting cost of sales, which items must be taken into account?L2
• Brivora made sales of {sales}, all on credit. Its trade receivables move from {opening_receivables} to {closing_receivables}. Compute cash received from customers.L2
• During the year Peltane's credit sales reached {sales}; its receivables balance fell from {opening_receivables} at the start to {closing_receivables} at the end. What amount of customer receipts should be presented under the direct method?L2
• Tolquine's cost of goods sold is {cost_of_sales}. Inventories move from {opening_inventory} to {closing_inventory}, trade payables from {opening_payables} to {closing_payables}. Compute purchases for the period and cash paid to suppliers.L2
• At Fenbris, a distributor, cost of sales is {cost_of_sales} for the year. Inventory fell from {opening_inventory} to {closing_inventory} and supplier credit lengthened, payables moving from {opening_payables} to {closing_payables}. Determine purchases and the amount paid to suppliers.L3
• Zanbane's staff costs amount to {staff_costs}. Payroll liabilities (wages and contributions payable) move from {opening_payable} to {closing_payable}. Compute cash paid to and on behalf of employees.L2
• Velbris recognised revenue of {sales}. Its trade receivables move from {opening_receivables} to {closing_receivables} and advances received from customers (contract liabilities) from {opening_advances} to {closing_advances} (case data). Compute cash received from customers.L3
• For its customer receipts, Quelsane computes: sales 900,000 + increase in receivables 60,000 = 960,000. What is the error?L2
• For its supplier payments, Ormane uses: cost of sales 1,200,000 + decrease in payables 40,000 = 1,240,000, although its inventory rose by 90,000. What is the error?L3
• Sarlane's “direct method” statement shows customer receipts, supplier payments, then “depreciation 150,000” and “provisions charged 30,000” as receipts. What is the error?L3