 In this discussion, we will discuss the discussion question of Explain how the cash flows from operating activities section is created using the direct method Now if we don't know where to start or what exactly the direct method is We probably can first think that we're working on something related to cash flow statements because Support accounting instruction by clicking the link below giving you a free month membership to all of the content on our website Broken out by category further broken out by course each course then organized in a logical Reasonable fashion making it much more easy to find what you need then can be done on a youtube page We also include added resources such as excel practice problems pdf files and more like Quickbooks backup files win applicable So once again, click the link below for a free month membership to our website and all the content on it Because that's the section we're on So we may first just start off. What is a cash flow statement? And what are we trying to do? What are the operating activities and by explaining those things even if we don't know exactly what the direct method is We can probably pick up some points and then we'll get into the direct method So the statement of cash flows is going to be one of the major financial statements Included we have the balance sheet. We've got the income statement statement of equity statement of cash flows Statement of cash flows is going to be reporting the change in cash the activity on a cash basis and reporting those in three major categories operating investing financing Now the operating section is really the one we want to spend most of our time on because that's the main category The operating section you can think of as similar to like the income statement Of of the financial statements the balance sheet represents a point in time The income statement is really telling us the story the activity that is happening And that's what this statement of cash flows is doing. It's telling us a story the activity It's just using a different Item to tell us when the story is happening. The income statement is using accrual terms Revenue recognition principle and matching principle to tell us when activities happened And the cash flow statement is telling us basically when things happened Based on when the cash actually changed changed hands so The statement of cash flows is going to give us those cash flows and the operating activities then Is going to be similar to the income statement the bottom line of the operating activities is kind of like net income On a cash basis. So if we have cash flows from operations, that's kind of like similar to net income on the income statement So in other words the cash flows from operations is the major category typically That's where most of the activity is happening. There are probably going to be more line items more things going on Related to the statement of cash flows in the operating activities then financing or investing So once we get that then we can think okay, what is the direct method? And the direct method We can compare and contrast to the other method the other there's only two of them Then we can typically use and the others are going to be the indirect method Now it seems counterintuitive that the indirect method is actually the preferred method and that that's the one You know that we typically will see most of the time Part of the reason is it's required oftentimes even if we use the direct method To then have a reconciliation, which is basically the indirect method as well and so Therefore the direct method is is probably something less seen although more intuitive meaning The direct method makes a lot of sense when you just think about it You can probably explain the direct method to someone more easily meaning The direct method is just going to take The income statement in essence and convert each line item revenues and expenses To more of a cash basis from an accrual basis So how would we construct the The operating section under a direct method of the statement of cash flows We can kind of take the income statement and just say well revenue Is revenue on an accrual basis on a cash basis will convert it To a cash basis and call it you know cash received from customers The cost of goods sold expenses on the income statement on an accrual basis are on the income statement We'll convert it to say something like cash paid for inventory Any other expenses we have on the income statement are going to be on an accrual basis We're going to record it to reverse it to just cash paid for expenses or something like that And and that makes intuitive sense. I think to most people Well, we're just going to take the income statement and convert it From an accrual basis that's driven by accrual principles revenue recognition and matching And convert it to basically an income statement that's driven by Recognizing revenue and expenses when cash happens or similar to that. We're recognizing cash flows Based on these activities And so that's just basically what the direct method will be now you could compare and contrast that to the indirect method just to give more detail The indirect method is going to start with net income and reconcile to cash flows from operating activities and So it's kind of like starting at the at net income and then reconciling reversing out everything to get to a net income on a cash basis cash from operating activities And the reason that's nice to have is because it gives that reconciliation It tells us the difference between cash flow from an operating and cash flows from an investing So, uh, that's why one reason is why sometimes it's it's required to have the indirect method even though We're using a direct method even though the direct method is probably more intuitive It's probably easier for us to explain the direct method To people and it's also important to note that the direct method And the indirect method only differ in the operating section So explain when it when we ask the question here Explain how it how the two methods differ in terms of creating the operating activities It's not like they're they would differ on the financing or the investing activities Those two will remain the same Whether we use a direct method or indirect method the direct method and indirect method in other words only apply to the operating activities