Academic journal article Management Accounting Quarterly

The Statement of Cash Flows and the Direct Method of Presentation

Academic journal article Management Accounting Quarterly

The Statement of Cash Flows and the Direct Method of Presentation

Article excerpt

The Financial Accounting Standards Board (FASB) has traditionally encouraged entities to report major classes of gross cash receipts and gross cash payments and their arithmetic sum-the net cash flow from operating activities (the direct method, DM). Very few financial statement preparers, however, adhere to the guidance because the indirect method (IM) continues to be the most favored presentation method for preparers of cash flow statements (Accounting Standards Codification® 230-10-45-25).

In 1987, the FASB published Statement of Financial Accounting Standards 95 (SFAS 95), "Statement of Cash Flows," which set the stage for the statement of cash flows as we know it today. Over the Statement's 29-year history, rulemaking bodies made two noteworthy attempts to require the DM, and another attempt is probably on the horizon. The first attempt occurred when the Statement was released. The second attempt occurred in 2008 when the FASB and the International Accounting Standards Board (IASB) issued a joint discussion paper titled "Preliminary Views on Financial Statement Presentation." The discussion paper proposed, among other things, a mandate for the DM. As part of an overall tightening of the cash flow activity classification rules, attempts continued in 2014 and 2015.

In this article, we provide a history of the cash flow state- ment, followed by an analysis of the public's response to the most recent attempt to mandate the direct method. Then we describe the FASB's current ongoing efforts regarding the direct method, and we close with an analysis of which method is preferable.


Prior to the release of SFAS 95, Accounting Principles Board Opinion 19 (APB 19), "Reporting Changes in Financial Position," allowed the reporting of cash flows, but it was not a requirement. SFAS 95 established the current rules for the statement of cash flows- classifying cash flows into operating, investing, or financing activities.

The guidance of SFAS 95 allowed a choice of either the DM or IM of presentation for cash flows from operating activities. Although SFAS 95 did not require the DM, it encouraged the DM in lieu of the IM. The FASB passed SFAS 95 by a four-to-three vote with two of the three dissenting members concerned that the statement would have reduced usefulness by not requiring the DM. Specifically, they argued that using the IM would fail to "provide relevant information about the cash receipts and cash payments of an enterprise during a period." Providing relevant information about a business entity's cash flows was the stated overall purpose of SFAS 95.

Ever since SFAS 95 was issued, it has become clear that businesses have largely disregarded the FASB's encouragement to use the DM. The FASB and the IASB said they issued the discussion paper in response to users' concerns that "existing requirements permit too many alternative types of presentation and information in financial statements is highly aggregated and inconsistently presented, making it difficult to fully understand the relationship between the financial statements and the financial results of an entity." The discussion paper raised the issue of making the DM mandatory and contained guidance concerning a detailed reconciliation of cash flows to comprehensive income.

Recent Attempts to Mandate the Direct Method

The most significant attempt to mandate the direct method began in 2001, when the FASB and the IASB separately initiated projects to review the presentation of each financial statement. As part of the international accounting standards convergence, the Boards agreed to consider two independent projects in 2004. The rulemaking bodies agreed the projects would have three distinct phases:

* Phase A would outline the required financial statements and the required reporting periods.

* Phase B would consider details of financial statement presentation, including whether the DM would be used for the presentation of cash flows from operating activities. …

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