Cash Flow Statement (IAS 7): Direct vs Indirect Method (Which to Choose?)
Cash Flow Statement (IAS 7): Direct vs Indirect Method (Which to Choose?)
Financial statements show “How much,” but the Notes explain “How” and “Why”. Without these disclosures, the numbers in the Balance Sheet and Income Statement are just vague data. The Notes turn them into useful information by clarifying accounting policies, breakdown of large balances, and revealing hidden risks like lawsuits. This guide shows you how to read (and write) them professionally—Digital Salla.
- Why the “Notes” are an inseparable part of the financial report.
- Structure of the Notes: From General Information to Specific Breakdowns.
- Understanding Accounting Policies (Depreciation, Inventory Valuation).
- How to disclose Contingent Liabilities (Lawsuits, Guarantees).
- Interactive Tool to check required disclosures for specific items.
1) What are the Notes? (The Fine Print)
The Notes to Financial Statements (or Footnotes) are the narrative section of the annual report. They provide the details that cannot fit into the rigid columns of the Balance Sheet or Income Statement. They tell the reader how the numbers were calculated and what risks might affect them in the future.
2) Why are they Essential? (Transparency)
Without notes, a number like “$1,000,000 Inventory” is meaningless. Is it raw material? Is it old stock? Is it valued at cost or market price?
- Comparability: Helps investors compare companies using different accounting methods (e.g., FIFO vs. Weighted Average).
- Risk Assessment: Reveals hidden dangers like pending litigation or debt covenants.
3) Standard Structure (IAS 1 Requirements)
International standards organize the notes in a logical order:
Indirect/Direct Cash Flow Model - Excel File
- Statement of Compliance: Declaration that the report follows IFRS or local GAAP.
- Significant Accounting Policies: The rules used (e.g., Depreciation method, Revenue recognition).
- Supporting Information: Detailed tables breaking down the numbers in the main statements (e.g., PPE schedule).
- Other Disclosures: Contingencies, Events after the reporting period, Related party transactions.
4) The Connection Map: Linking Statements to Notes (SVG)
Visualizing how the “Summary” connects to the “Detail”.
5) Disclosure of Accounting Policies
This is usually Note 2. It defines the “Rules of the Game” used by the company:
- Revenue Recognition: When is a sale considered final? (e.g., upon delivery or upon payment?).
- Depreciation: Is it Straight-Line or Double Declining? What are the useful lives?.
- Inventory: Is it valued at FIFO or Weighted Average? Is NRV applied?.
6) Breakdown of Line Items (Numerical Detail)
If the Balance Sheet says “Trade Payables: $50,000”, the Note might show:
| Component | Amount ($) |
|---|---|
| Suppliers (Local) | 30,000 |
| Suppliers (International) | 15,000 |
| Accrued Expenses | 5,000 |
| Total | 50,000 |
7) Interactive Disclosure Checker
Select an item to see what MUST be disclosed in the notes.
8) Frequently Asked Questions
Do small companies need full notes?
SMEs often follow a simplified standard (IFRS for SMEs) which requires fewer disclosures, but core policies and breakdowns are still mandatory.
What is ‘Going Concern’ disclosure?
If management has significant doubt about the company’s ability to continue operating next year, this MUST be explicitly stated in the notes.
Are related party transactions disclosed?
Yes. Transactions with owners, directors, or sister companies must be detailed to ensure transparency about potential conflicts of interest.
9) Summary & Final Word
The Notes to Financial Statements are not just “extra text”; they are the narrative that makes the numbers credible. Whether identifying accounting methods or revealing hidden liabilities, the Notes protect both the company (by being transparent) and the investor (by being informed)—Digital Salla.