Accounting Today - July 2012

By PAul B. W. Miller AnD PAul r. BAhnSon
Dual memos:
To FASB on cash flows,
and to targets of the CGMA

This column sends two important mes sages. The first advises the Financial Accounting Standards Board on the statement of cash flows. The second warns CPAs who are considering whether to re main 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 atten tion 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 “Memo 2” on page 24).

Although the SCF should be the most straightforward financial statement to prepare and understand, FASB’s compromises in SFAS 95 perpetuated four flaws.

“
”
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 account ing 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 straight forward 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 finan cing outflow.

;Investment income received is not re ported 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 be
cause it fails to reveal gross receipts and dis
bursements. However, the document doesn’t
fully challenge the timeworn assumption
that the difference between cash and in
come can be explained by simply adding and
subtracting changes in working capital ac
counts. As we described 15 years ago in
Accounting Horizons, that doesn’t work be
cause nonoperating events routinely impact
those accounts.

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, taxrelated 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.

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 addi tion 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 state ment without compromising the statement of cash flows’ usefulness.

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 prin cipal repayment to be the only cash outflow for monthly debt service.

Thus, we recommend that FASB should re quire entities to report their full debt service payments (interest plus principal) among their financing cash outflows. Only then can users have useful information for judg ing whether a company can cover its debt service with its cash from operations. This approach will increase the usefulness of re ported operating cash flow by removing the nonoperating interest payments.

We note that using leases to concoct off balancesheet financing similarly creates nonuseful information about both operat ing and financing cash flows. Specifically, reporting thinly disguised “rent” payments as cash expenses understates both net oper ating inflows and financing outflows. Man agement’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.

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 paulandpaul@qfr.biz.

INTRASTATEMENT TAX ALLOCATION Perhaps the least controversial tax account ing issue asks whether it’s useful to apply intraperiod allocation to split total tax ex pense among the various income statement categories. Of course, that practice has been accepted forever. However, SFAS 95’s require ment to report all tax payments as operating

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.