Last year marked the 30th anniversary of the cash flow statement as a mandatory statement. The FASB's efforts to develop the then-new standard were strongly influenced by the goals and concepts set out in the Statement of Financial Accounting Concepts (SFAC) 1 .commercial company financial information purposes,is SFAC 5,Recognition and valuation in company accounts.Statement of Financial Accounting Standards (SFAS) 95,cash flow statement,intends to overcome the questioned usefulness of previously required reporting of changes in financial condition and inconsistencies in the definition of "fund" builders. SFAS 95, as amended, is now incorporated into Accounting Standards (ASC) Codified Topic 230, Statement of Cash Flows.
Despite its long history, the cash flow statement continues to present reporting challenges, as evidenced by recurring results reported under the AICPA peer review program and inconsistencies in the reporting of various cash flows. Similar flaws in cash flow reporting have been found in public company reporting, as evidenced by PCAOB inspection findings, SEC updates, and comment letters (Dana R. Hermanson, Richard W. Houston, and Zhongxia Ye, "Accounting Restatements Suring From PCAOB Inspections of Small audit companies",Die CPA-Zeitung,September 2010,http://bit.ly/2y611hw🇧🇷 PCAOB, „2015 Inspections Information“, Staff Inspection Document, Oktober 2015,http://bit.ly/2Oexn4r; Ernst,SEC Comments and Trends,September 2017).
This article highlights practical issues with the cash flow statement in relation to general reporting deficiencies, recent updates issued by the FASB, and possible future changes.
Prior to SFAS 95, Accounting Principles Board Statement 19 required reporting of changes in financial condition, most of which focused on working capital. different definitions of funds, cash and cash flow from operations and different forms of presentation in the financial statements (SFAS 95, Appendix A: Basic Information). In fact, many users of financial statements have abandoned calculating earnings before interest, taxes, depreciation and amortization (EBITDA) as a substitute for operating cash flows in order to meet their information needs. The root cause of these difficulties was a misunderstanding among users, creators, and many reviewers, a misunderstanding that persists with some to this day. In addition, the FASB considered that reporting changes in working capital was inconsistent with its later issued SFAC 1, which states that financial reporting should provide users with information to evaluate the amounts, timing and uncertainties of cash flows.
After a project of approximately six years that included discussion memoranda, drafts, hearings, working groups, and several comments, the FASB issued SFAS 95 in November 1987. The standard required that a statement of cash flows be included in a complete set of financial statements and encouraged, but did not require, the Using the direct method to report cash flows from operating activities. In 2016, the FASB issued three updates to the accounting standards (ASU 2016-14, ASU 2016-15, and ASU 2016-18) that modified cash flow reporting standards.
A cash flow statement is required whenever a company or non-profit organization (NFP) presents a set of financial statements that report financial condition and results of operations. A cash flow statement must be submitted for each period for which results of operations are reported. A common lack of information noted in peer reviews is the omission of a cash flow statement for each period covered by the income statement; This deficiency is particularly common in comparative interim financial statements of private companies, in which monthly and cumulative results are shown together. While SEC regulations still require a statement of cash flows, they allow for an abbreviated level of detailed reporting.
The AICPA Statements on Standards for Accounting and Audit Services (SSARS) permit compiled statements that omit substantially all disclosures or the cash flow statement when the omission is disclosed in the auditor's report. A common finding in peer reviews is the failure to include the required reporting language when the cash flow statement has been omitted. Another reporting deficiency concerns the incorrect inclusion of disclosure language in preparation reports of tax-based financial statements that are presented without a cash flow statement. This is clearly incorrect as a cash flow statement is not required in tax accounts.
definition of money
The original purpose of the cash flow statement was to explain the change in amounts at the beginning and end of the period referred to as “cash” or “cash and cash equivalents” in the financial statements. Cash equivalents have been defined “broadly” (the word used by the FASB) as highly liquid short-term investments that meet specified maturity, risk and convertibility criteria; however, not all investments with similar characteristics should be considered cash equivalents. Therefore, as a guideline, companies should define and disclose which short-term and highly liquid investments are treated as cash equivalents.
Companies generally have cash and cash equivalents that are restricted and reported elsewhere on the balance sheet. Over time, problems and differences in practice have arisen in classifying and reporting changes in restricted cash and transfers between amounts of restricted and unrestricted cash.
To improve cash flow reporting and eliminate inconsistencies in restricted cash flow reporting, FASB issued ASU 2016-18,Statement of Cash Flows (Item 230): Restricted Cash (FASB Emerging Issues Working Group Consensus)🇧🇷 The ASU added a requirement to explain the change in the entity's total cash during the period, which is defined as the sum of cash, cash equivalents and amounts of restricted cash and restricted cash equivalents. When amounts representing total cash are reported in more than one line item on the balance sheet, ASU has added a requirement to report on the statement or in the notes to the financial statements the line items and amounts of cash, cash equivalents, limited cash and cash equivalents Restricted cash equivalents that add up to the total amount of cash and cash equivalents reported in the cash flow statement at the beginning and end of each period (exhibition 1).
Reconciliation of cash, cash equivalents and restricted cash on the balance sheet and total cash shown on the cash flow statement
Interestingly, ASU 2016-18 does not include a definition of restricted cash or restricted cash equivalents. The FASB concluded that its intention is not to change existing practices regarding what entities report as restricted cash or restricted cash equivalents, but rather to provide relevant information about the sources and uses of an entity's total cash flows.
The new requirements apply to public-law entities for fiscal years beginning after December 15, 2017 and for interim periods within those fiscal years. For all other companies, the changes are effective for fiscal years beginning after December 15, 2018 and for interim periods within fiscal years beginning after December 15, 2019.
It is worth noting that the FASB has challenged the concept of cash equivalents. In its 2010 draft ASU on the presentation of financial statements, the Board proposed deleting the concept, concluding at the time that cash equivalents do not have the same characteristics or risk as cash. The FASB recognized that cash equivalents can be critical to an entity's cash management, but their use does not justify aggregating different assets. As a result, there may be a future change by the FASB that excludes cash equivalents as part of cash.
For non-governmental entities, a statement of cash flows must disclose the net cash provided or used in operating, investing and financing activities and the net impact of those flows in a manner that reconciles opening and closing totals of cash and cash equivalents. However, the presentation of cash flow from operating activities has been controversial since the presentation was developed. The FASB and some constituents have always preferred to report operating activities using the direct method, which reports the major classes of cash receipts and payments. Some users believe that the direct method provides little or no useful information, and many creators have noted the difficulty and prohibitive cost of gathering the information.
The preparers have consistently supported the use of the indirect method to reconcile net income to total net operating cash flow. Current standards allow both reporting formats but also require companies using the direct method to reconcile net income to net cash flow from operating activities. However, the rules do not clarify whether such a vote should be included in the statement as usual or disclosed in the notes. SEC regulations allow companies to opt out of reconciling interim reports on Form 10-Q. Although the FASB has always encouraged the use of the direct method, the indirect method is the predominant reporting method.
To improve financial reporting for ESFLs, the FASB originally proposed eliminating the optional indirect reporting method. The FASB's reasoning was that the direct method provides more useful information (which is very controversial) and the indirect method contributes to underutilization of the cash flow statement. Additionally, through its outreach activities, the FASB determined that the cost of implementing the direct method in the first year was primarily in the nature of the training and mapping of the information available in existing systems, and no significant costs for significant new systems or costs included or running costs. complexities
ASU 2016-14,Non-profit organizations (topic 958): Presentation of the annual accounts of non-profit organizations, final changes in the presentation of financial statements for ESFLs and retention of the option to use the direct or indirect method of presenting operating cash flows; However, the new standard also removed the requirement to include reconciliation when using the direct method. The FASB concluded that differences between NFPs and business units and the interests of users of their financial statements no longer justify NFPs bearing the cost of providing an indirect reconciliation of operating cash flows to changes in net assets. The Board also concluded that removing the barrier to indirect matching could encourage more NFPs to opt for the direct method. The Board decided that it was useful to await further investigation into the costs of moving from NFPs to the direct method and issues related to corporate reporting.
The FASB's activities related to NFPs and ASU 2016-14 were not the first discussions about eliminating the indirect method of reporting operating cash flows. The FASB's 2010 draft presentation of financial statements (see above) proposed mandatory use of the direct method for reporting operating cash flows, with the level of cash flow disaggregation to be determined at a later date. To reduce the cost of using the direct method, companies can calculate cash flows indirectly from changes in asset and liability balances, rather than making changes to their information systems. The FASB's proposal also included the continued presentation of the reconciliation of net income to net operating cash flow. Again, the board's action points to the possibility of future cash flow statement changes that could affect all companies.
The cash flow statement classifies incoming and outgoing payments as the result of investments, financing or operating activities. The peer review findings often include misclassification of financing and investing activities specifically presented in the standard; For example, it is incorrect to report the proceeds of a new third-party loan as an investing activity, or the cash payment for the purchase of equipment as a financing activity.
However, not all cash flow situations are addressed in the standards. This has contributed to the diversity in the reporting classification of certain common but infrequent cash flows. To improve reporting consistency, the FASB issued ASU 2016-15,Statement of Cash Flows (Item 230): Classification of Certain Cash Receipts and Payments (A Consensus Working Group on Emerging Problems), which clarified the classification of cash flows related to eight specific issues and provided additional guidance for identifying and applying the overriding principle to reporting situations not addressed in the Standards (Annex 2🇧🇷 For example, cash payments for debt prepayments or debt service costs are classified as cash used in financing activities. When settling zero-coupon debt instruments (or similar low-coupon debt instruments), the preparer must account for the portion of the cash payment attributable to accrued interest related to debt discounting as a cash outflow from operating activities and the portion of the cash payment attributable thereto , classify capital as cash used in financing activities. Cash proceeds from the settlement of insurance claims should be classified based on the associated insurance coverage (ie the type of damage). To illustrate, the Cash Settlement Guidelines state:
Income related to equity-type losses should be reported as operating cash inflows, while income related to investment-type losses should be reported as cash inflows from investing activities. For insurance revenue received as part of a lump sum settlement, an entity determines the classification and allocates the revenue based on the nature of each loss included in the settlement. For distributions received from investees using the equity method, the reporting entity must elect an accounting policy to use a "retained earnings approach" or a "distribution type approach" and report the results as operating or operating profit Classify investment results in accordance with the chosen policy. .
However, not all cash flow situations are addressed in the standards. This has contributed to the diversity in the reporting classification of certain common but infrequent cash flows.
Other cash flow reporting issues addressed in the ASU include contingent consideration following a business combination, proceeds from the liquidation of captive life insurance policies and economic interests in securitization transactions. It also provides guidance for classifying cash receipts and payments that have aspects of more than one class of cash flow.
The amendments in ASU 2016-15 are effective for public corporations for fiscal years beginning after December 15, 2017 and for interim periods within those fiscal years. For all other companies, the changes are effective for fiscal years beginning after December 15, 2018 and for interim periods within fiscal years beginning after December 15, 2019. Earlier application is permitted. An entity that elects to apply early must apply all amendments in the same period. Changes must be applied using a retrospective transition method for each period presented; if it is impracticable to apply the amendments to any of the items retrospectively, the amendments to those items are applied prospectively at the earliest possible date.
The classification of cash flows related to interest and dividends received and interest paid as operating activities has been controversial since the introduction of the cash flow statement. Recent FASB activity related to NFP reporting indicates changes may occur in how cash flows are classified. Proposed changes in ASU 2016-14 included the reclassification of interest and dividends received as investing cash flows and the classification of interest paid as financing cash flows. In addition, cash flows from the purchase and sale of long-lived assets would be classified as operating cash flows rather than investing cash flows. These proposed classification changes were also included in the FASB's exposure draft of the 2010 financial statements discussed above. These repeated Board discussions indicate that classification changes will be made for all entities; the only question is when.
Gross and Net Cash Flows
The FASB has always believed that information about the gross amounts of cash receipts and payments during a period is more relevant than information about the net amounts (SFAS 95, paragraph 75). For example, it is more meaningful to report separately the total proceeds from the disposal of fixed assets and the cash payments for their acquisition than simply reporting the net change in fixed assets as cash flow. A common conclusion from peer reviews is to report net, rather than gross, changes in fixed assets or long-term debt as cash flows.
However, not all reporting situations are clearly defined. There is a common problem with providing what is known as a "constructed receipt" (e.g. when a lender or lessor pays loan proceeds directly to the seller when purchasing or leasing a financial asset). The buyer-lessee reports gross as cash inflows and outflows or net as non-cash investing and financing activities. The standard is silent on this issue and practice varies.
There are exceptions to the raw reporting obligation. Items with large volumes, fast turnover, and transit times of three months or less can be reported on a net change basis. While some exceptions are industry specific, such as balances at sight banks or brokerage customer accounts, revolving credit lines are a more common reporting situation. However, to be eligible for the net reporting option, the underlying credit agreement must be daily repayable or relate to a debt obligation with a maturity of less than three months. If, on the other hand, the loans and repayments have a contract with a term of more than three months, the cash flows are to be reported gross. Consequently, appropriate cash flow information depends on an understanding of the underlying debt contract.
The appropriate recognition of overdrafts or negative cash balances in the cash flow statement depends on the underlying nature of the reporting situation. Bank overdrafts, which are checks written with insufficient funds in the company's bank account that are cleared by the bank and create a liability for the company, are considered financing activities. On the other hand, overdrafts, which refer to a temporary surplus of checks written in excess of funds deposited in a particular bank account, are analogous to trade payables and can be viewed as an item of cash flow from operating activities. Therefore, proper reporting of cash flow as a financial or operational activity requires a clear understanding of the cause of the overdraft or negative cash balance.
More guides coming?
In 1979, the FASB replaced the statement of changes in financial position with the statement of cash flows as the required financial statements. In doing so, the FASB has continued to allow some flexibility in reporting formats and has made decisions about the classification of cash flows that some say are arbitrary. Since its inception, peer review results have identified areas where practitioners and preparers have encountered difficulties implementing or using the standard. To resolve reporting inconsistencies and expand the scope of cash flows included in the statement, the FASB recently issued guidance in the form of various ASUs. However, some problems remain unresolved (Annex 3), and the FASB's deliberative process indicates that other significant changes may be on the horizon.
Unsolved liquidity problems
James Schmutte, DBA, CPA is a professor at Ball State University, Muncie, Indiana.
James R. Duncan, PhD, CPA is an Associate Professor at Ball State University, Muncie, Indiana.