Page 237 - DMGT202_COST_AND_MANAGEMENT_ACCOUNTING

Cost and Management Accounting

Notes AS-3 (Revised) is mandatory in nature in respect of accounting periods commencing on or after
1-4-2001 for the following:
1. Enterprises whose equity or debt securities are listed on a recognised stock exchange in
India, and enterprises that are in the process of issuing equity or debt securities that will
be listed on a recognised stock exchange in India as evidenced by the board of directors’
resolution in this regard.
2. All other commercial, industrial and business reporting enterprises, whose turnover for
the accounting period exceeds ` 50 crores.

There are two methods of converting net profit into net cash flows from operating activities:

(i) Direct method, and
(ii) Indirect method.

Direct Method

Under direct method, cash receipts from operating revenues and cash payments for operating
expenses are arranged and presented in the cash flow statement. The difference between cash

receipts and cash payments is the net cash flow from operating activities. It is in effect a cash

basis profit & loss account. In this case, each cash transaction is analysed separately and the total
cash receipts and payments for the period are determined. The summarised data for revenue
and expenses can be obtained from the financial statements and additional information. We may

convert accrual basis of revenue and expenses to equivalent cash receipts and payments. Make
sure that a uniform procedure is adopted for converting accrual base items to cash base items.
The following are some examples of usual cash receipts and cash payments resulting from
operating activities:
1. Cash sales of goods and services;
2. Cash collected from debtors (customers);
3. Cash receipts of interest or dividends;

4. Cash receipts of royalties, fees, commission and other revenues;
5. Cash payments to suppliers (creditors);
6. Cash payments for various operating expenses, i.e., rent, rates, power, etc.
7. Cash payments for wages and salaries to employees;
8. Cash payments for income tax, etc.

Indirect Method

In this method, the net profit (loss) is used as the base and converted to net cash provided by
(used in) operating activities. The indirect method adjusts net profit for items that affected net

profit but did not affect cash. Non-cash and non-operating charges in the profit & loss account are

added back to the net profit, while non-cash and non-operating credits are deducted to calculate

operating profit before working capital changes. It is a partial conversion of accrual basis profi t
to cash basis profit. Necessary adjustment are made for increase/decrease in current assets and

current liabilities to obtain net cash from operating activities.

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