This column sends two important messages. The first advises the Financial Accounting Standards Board on the statement of cash flows. The second warns CPAs who are considering whether to remain CGMAs. This latter memo is extremely urgent because at least 130,000 members of the American Institute of CPAs will find that a CGMA fee has been added to their dues bill this month. If they're not paying attention and fail to remove it before paying the balance, they'll be the unwitting victims of a hoax. If they deliberately do not remove it, they'll become one of its perpetrators (see sidebar).
MEMO TO FASB
In April, we challenged FASB to unwind its alliance with the International Accounting Standards Board and regain control over its agenda so it can pursue overdue reforms in GAAP. Our June column addressed accounting for pension plans. This one goes after the statement of cash flows.
A FLAWED HISTORY
The SCF is supposed to describe how much cash moved in and out and explain why it did. Although it should be the most straightforward financial statement to prepare and understand, FASB's compromises in SFAS 95 perpetuated these four flaws:
• Operating cash flow is virtually always presented in the less preferable indirect format that is onerous to prepare and more onerous to decipher.
• Income taxes are not allocated among the cash flow categories.
• Interest paid is not reported as a financing outflow.
• Investment income received is not reported as an investing inflow.
• Reform seems likely because the board is poised to resume its financial statement presentation project that produced a 2008 preliminary views document.
That report candidly concludes that the indirect format doesn't get the job done because it fails to reveal gross receipts and disbursements. However, the document doesn't fully challenge the time-worn assumption that the difference between cash and income can be explained by simply adding and subtracting changes in working capital accounts. As we described 15 years ago in Accounting Horizons, that doesn't work because nonoperating events routinely impact those accounts.
The indirect method began as an improvisation by users many decades ago because companies did not provide SCFs. Although analysts could cobble together crude estimates from public data, their numbers lacked precision and completeness. Unfortunately, this expedient became rooted in practice long before FASB ever came along. It's well past time to uproot it.
As to managers' laments that they can't produce the direct presentation, we say, "Oh yes, you can!" The key is setting up a cash accounting sub-system to classify each cash flow when it occurs, just like expense sub-systems classify each cost when it happens. It's really that simple. There's no need for today's complex analyses of the non-cash accounts because the cash flow information for the operating, financing and investing sections is immediately available from the cash sub-accounts.
WHENCE THE INDIRECT?
The indirect format is often defended as providing insight about income. The 2008 discussion paper agreed, suggesting that a reconciliation should be provided in addition to the direct presentation. We're not wild about that recommendation but, because the reconciliation is about income, it should be designed to supplement the income statement without compromising the statement of cash flows' usefulness.
INTRASTATEMENT TAX ALLOCATION
Perhaps the least controversial tax accounting issue asks whether it's useful to apply intraperiod allocation to split total tax expense among the various income statement categories. Of course, that practice has been accepted forever. However, SFAS 95's requirement to report all tax payments as operating outflows suggests that FASB didn't see that it would be useful to do the same thing on the SCF.
Here's what FASB should declare: Because cash flows arise from operating, investing and financing activities, tax-related cash flows should be reported in those areas as well, such that payments and savings will be included in each of them, instead of throwing the whole ball of wax into operations.
FINANCING ACTIVITIES
Suppose a bank officer is assessing whether a borrower has sufficient cash flow to cover mortgage payments of, say, $1,500 per month, including interest of $1,300. The banker would definitely not consider the $200 principal repayment to be the only cash outflow for monthly debt service.
Thus, we recommend that FASB should require entities to report their full debt service payments (interest plus principal) among their financing cash outflows. Only then can users have useful information for judging whether a company can cover its debt service with its cash from operations. This approach will increase the usefulness of reported operating cash flow by removing the non-operating interest payments.
We note that using leases to concoct off-balance-sheet financing similarly creates non-useful information about both operating and financing cash flows. Specifically, reporting thinly disguised "rent" payments as cash expenses understates both net operating inflows and financing outflows. Management's misbegotten quest to keep real debt off the balance sheet ends up hurting them by misrepresenting reported operating cash flows. Hopefully, FASB's lease project will squelch this game soon.
INVESTING ACTIVITIES
The SCF investing section describes how management deploys cash to buy plant and equipment that generate operating income and cash inflows. This information is useful in many respects.
However, what about inflows from financial assets like debt and equity investments, including pension funds? We think FASB should put cash flows from all financial investments in the investing section (along with income taxes), instead of attributing some to operations.
WRAPPING UP
We have aimed important messages to two different parties.
First, to FASB: The statement of cash flows is the simplest statement of all because there are no issues concerning the cash flows' existence and amounts. They should make the statement more informative and comprehensible by following that idea to its logical conclusion. The outcome should be immensely positive.
Next, to CGMA holders and AICPA members: Strike that renewal fee from your AICPA dues bill (see sidebar at right). We believe they're urging you to sell out your integrity and they don't mind that they're deprecating the value of the best credential you already have, the Certified Public Accountant, just so they can rake in more money from the many thousands of CGMAs spawned overnight by the joint venture with the Chartered Institute of Management Accountants.
Don't kid yourself: This designation after your name will proclaim that you're either sufficiently gullible to fall for a hoax or, what's worse, sufficiently devious to join with its perpetrators. Why would you want to make either of those representations about yourself?
Paul B. W. Miller is a professor at the University of Colorado at Colorado Springs and Paul R. Bahnson is a professor at Boise State University. The authors' views are not necessarily those of their institutions. Reach them at
