Direct Method Cash Flow Statements: Their Time Has Come

Abstract

Research indicates that the direct method of preparing the statement of cash flows is preferred by users (Broome 2004; Knutson 1993). SFAS No. 95 expresses a preference for the direct method, but allows firms to use the indirect method (FASB 1987). This compromise was the result of a concerted lobbying effort by companies who argued the direct method would require costly modifications to their accounting information systems. While this may have been true in the 1980s, technological advances do not justify the continued use of the indirect method when users clearly prefer the direct method.

However, currently available accounting information systems do not generally provide an efficient way to generate a statement of cash flows using the direct method. This article illustrates a work around for preparing the direct method statement using current accounting software, discusses some of the difficulties in using the work around, and suggests some modest changes that software developers could make that would make preparing the direct method statement of cash flows as easy as producing an income statement or a balance sheet.