Just got a note from Georgia Institute of Technology accounting professor (and cash flow guru) Chuck Mulford in response to my blog post of yesterday. I added it as a comment to that post, but it's worth posting it into a fresh item today. Here are his thoughts on requiring the direct method:
Calls for a direct-method statement of cash flows are laudable. A direct-method statement would go a long ways towards increasing consistency in the classification of cash flows into operating, investing and financing activities. However, even with a direct-method statement, there would remain much flexibility for reporting companies in the classification of cash flow. That reporting flexibility and its use in classifying similar transactions in different ways can affect the perception of users as to the cash flow performance of a company. Standard setters should consider revisiting, clarifying and standardizing cash flow classification.
Examples where different reporting practices have been noted include such items as:
- The proceeds received from sales of investments. Depending on whether how an investment is classified, the related sales proceeds may be reported as operating or investing cash flow.
- The proceeds received from an insurance policy for damage sustained by property, plant and equipment. While GAAP seems clear on the classification of these proceeds as investing cash flow, some companies report such proceeds as operating cash flow.
- Interest paid on zero coupon bonds. While interest is an operating item, many companies classify interest on zero coupon bonds as financing cash flow.
- Cash proceeds from increases in book overdrafts. While most companies report such proceeds as financing cash flow, many report it as operating cash flow.
- Proceeds from sale and leaseback transactions involving operating leasebacks. Companies are generally evenly split on reporting such proceeds as investing and financing cash flow.
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