Which statement best describes the indirect method of cash flow reporting?

Which statement best describes the indirect method of cash flow reporting?

• A. Excludes depreciation
• B. Is rarely used by accountants
• C. Reports gross cash receipts and payments
• D. Adjusts net income to reconcile to net cash from operating activities

Answer: (D)

The indirect method converts accrual net income into cash from operations by starting with net income and making adjustments for non-cash items and changes in working capital. This approach recognizes that some expenses (like depreciation) reduce reported income but don’t use cash, so they’re added back to net income. It also accounts for changes in current assets and current liabilities—such as accounts receivable, inventory, accounts payable, and accrued expenses—to reflect the actual cash that flowed in or out of operations. This is why it’s described as reconciling net income to net cash from operating activities. The method that presents gross cash receipts and payments is the direct method, which is not what the indirect method does. Depreciation is not excluded here; it’s added back because it’s a non-cash expense.

The indirect method converts accrual net income into cash from operations by starting with net income and making adjustments for non-cash items and changes in working capital. This approach recognizes that some expenses (like depreciation) reduce reported income but don’t use cash, so they’re added back to net income. It also accounts for changes in current assets and current liabilities—such as accounts receivable, inventory, accounts payable, and accrued expenses—to reflect the actual cash that flowed in or out of operations.

This is why it’s described as reconciling net income to net cash from operating activities. The method that presents gross cash receipts and payments is the direct method, which is not what the indirect method does. Depreciation is not excluded here; it’s added back because it’s a non-cash expense.