Enhancing the statement of cash flows – in a few easy steps?

The minutes of a recent meeting of the IASB’s Capital Markets Advisory Committee and Global Preparers Forum record their thoughts on a draft discussion paper on the statement of cash flows, prepared by staff of the UK Financial Reporting Council.

These are some of the modifications suggested in the paper, along with some of the commentary noted in the minutes:

Classification (a) Cash flows from operating activities, which currently act as a default category, should be positively defined or described. Items that do not relate to operating activities should be reported separately. Although there was some support for this, the absence of any definition in IFRS of operating profit presents some challenges. IASB staff at the meeting noted that the Primary Financial Statements research project will examine whether to define operating profit.

(b) Cash outflows to acquire property, plant and equipment should be reported as a cash outflow from operating activities, rather than within investing activities as currently required. As such outflows are likely to change significantly from period to period, a sub-total of cash generated from operating activities before capital expenditure should be disclosed. Entities should be encouraged to disclose the extent to which expenditure on property, plant and equipment represents ‘replacement’ and ‘expansion’—as is currently the case under IAS 7. There wasn’t general support for the first suggestion. Among other things, group members noted that “the current structure of the statement of cash flows shows how a company raises funds through financing activities, invests these funds and then generates day-to-day operating cash flows. In their view, the suggested change would disrupt this logical flow of the cash flow statement.” There was more support in theory for the latter suggestion, but members noted the practical difficulties in distinguishing “replacement” from “expansion” expenditures.

(c) Cash flows related to financing liabilities (including the payment of interest) should be reported in financing activities. Cash received from customers (including any amount treated as interest income in the statement of profit or loss) should be reported within cash flows from operating activities; (d) Cash flows relating to tax should be reported in a separate section of the statement of cash flows. Views on these suggestions were mixed, with members emphasizing eliminating choice for preparers; and ensuring that cash flows arising from interest received, interest paid and tax are presented separately in the statement.

Cash equivalents and managing liquid resources The discussion paper suggests the statement of cash flows should report flows of cash, rather than flows of cash and cash equivalents, and that a separate section of the statement of cash flows should report cash flows relating to the management of liquid resources, limited to assets that are readily convertible into cash. The group generally didn’t support this, one member arguing that if anything the definition of cash should be broadened to reflect new methods of payment, such as cryptocurrencies.

Reconciliation of operating activities The paper suggests a requirement to reconcile an income statement subtotal for operating income/loss to cash flow from operating activities. As already noted though, the absence of any such defined subtotal causes practical difficulties in implementing this suggestion at present. Members “expressed their preference for a line-by-line reconciliation of the statement of financial position, the statement of profit or loss and other comprehensive income and the statement of cash flows.” (This isn’t a new suggestion either).

If nothing else, this all serves as a reminder, if one were needed, of the pitfalls of assuming the statement of cash flows possesses an objectivity missing from other parts of the financial statements (“cash is cash,” say people sometimes, as if no further elucidation were needed). As the discussion indicates, even the bottom line of the statement is sometimes subject to definitional issues (and if these seem merely academic, recall that some Canadian entities during the liquidity crisis of 2008 suffered credit losses on items they had previously recorded as “cash,” and that IAS 7 isn’t very clear on the appropriate treatment of cash and cash equivalents subject to various kind of restrictions), and the point about cryptocurrencies underlines that such matters may keep evolving over time.

Likewise, measures of operating cash flow may often seem “superior” (perhaps better rooted in business realities, less infected by accounting conventions, and so forth) to income statement-based measures, but as of the current time there’s no guarantee of comparability in this regard between different entities (and the point about the absence of reconciliations to other parts of the financial statements, and the ongoing existence of both direct and indirect methods of setting out such cash flows – which the draft discussion paper doesn’t propose eliminating – constitute potential barriers to understandability). And as the point about capital expenditures indicates, the meaningfulness of an operating cash flow measure as a predictive measure of performance depends heavily on the extent of the “investing” cash flow measures that are necessary on an ongoing basis to keep those operations flowing.

Anyway, the current intention is to revise the discussion paper and to publish it before the end of the year. After that, who knows…?

The opinions expressed are solely those of the author

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