A recent proposal to change the presentation of financial information for not-for-profit entities, especially cash flow classifications, could serve as a preview of what might be in store for public companies down the line.
The Financial Accounting Standards Board has issued a proposal meant to improve the presentation of net asset classifications presented in financial statements and footnotes around liquidity, financial performance, and cash flow. In addition to some new requirements around measuring and presenting operating performance, net asset classifications, and liquidity, the proposal seeks to make the statement of cash flows easier to understand. The proposal would require entities to present cash flows using a direct method of reporting rather than an indirect or reconciliation method, and to classify cash flows in ways that are more consistent with classifications in the statement of activities.
At an Ohio regional conference of the Institute of Management Accountants, FASB Vice Chairman Jim Kroeker said public companies should study that proposal and consider whether it might have merit for public companies as well, especially changes around cash flow classifications. “I’d challenge you to look at the changes we’re making for not-for-profits that would eliminate the use of the indirect method of cash flows,” he says. “There’s the idea that perhaps we would to extend that to business enterprises as well.”
FASB is in the midst of determining what it can do to cash flow classification guidance that would improve accounting for entities beyond not-for-profits. The board hoped to issues some high-level, principles-based guidance that would help address persistent issues with cash flow classifications -- one of the most common causes for restatements, according to recent analysis by Audit Analytics -- but determine it may need to look more deeply at the issues. The board recently referred nine specific issues to its Emerging Issues Task Force to see if it can recommend some targeted improvements to the accounting rules.
Kroeker said discussion of cash flow classification issues for not-for-profits led to a determination that the accounting would be better ultimately if entities were required to use a direct method of classification cash flows rather than the more common indirect method. The board has heard in its outreach with public companies that using a direct method makes sense intuitively, but would be more costly and difficult, especially for larger organizations, where cash is often managed by a central treasury.
“We’ve concluded the acquisition of PP&E (plant, property and equipment) is an operating use of cash, not investing, so we’re pursuing a cohesiveness principle,” Kroeker said. “We believe depreciation expense is an operating expense, then the acquisition of PP&E is an operating cash outflow.” That leads the board members to ponder whether the same concept should be extended to for-profit enterprises as well, he said.
FASB’s EITF agenda now includes looking into: classification of cash flows related to settlement of insurance claims, debt prepayment or extinguishment costs, restricted cash, settlement of zero coupon bonds, distributions received from equity method investees, settlement of life insurance contracts, contingent consideration payments made after a business combination, beneficial interests in securitization transactions, and application of the predominance principle.