U.S. regulators and standard setters are pressuring U.S. companies regarding the filing of cash-flow statements meant to help investors assess the financial well-being of an entity.
A cash-flow statement is one of three statements that public companies are required to file with the Securities and Exchange Commission (“SEC”). They serve as a snapshot of a company’s cash during a specific reporting period. Armed with these disclosures, investors learn where a company is getting its money, how (and how fast) it is using that money, and whether it has enough cash to fund operations and sustain business. Despite their importance, some companies and auditors do not give as much attention to the cash flow statement as they do, for example, the balance sheet or income statement. When companies fail to dedicate rigor and attention to preparing cash flow statement, investors are left in the dark—an issue the SEC plans to address.
News of this heightened scrutiny first appeared when SEC Chief Accountant Paul Munter published a statement on “Improving the Quality of Cash Flow Information Provided to Investors,” noting:
Unfortunately, we have observed that preparers and auditors may not always apply the same rigor and attention to the statement of cash flows as they do to other financial statements, which may impede high quality financial reporting for the benefit of investors. This is evidenced by the statement of cash flows consistently being a leading area of financial statement restatements, and by our observations of material weaknesses in internal control over financial reporting (“ICFR”) around the preparation and presentation of the statement of cash flows.
SEC senior associate chief accountant, Anita Doutt, has described a main problem with the cash-flow statements by pointing to the two types of restatements companies can make to correct errors. While a “big R” correction involves a company reissuing financials where an error materially affects those statements, a “little r” revision allows a company to address minor errors in a filing through future financial statements. According to Doutt, companies have been routinely deeming their cash-flow statement errors immaterial, therefore consistently making “little r” revisions instead of reissuing past financials.
Munter also focused on presentation and disclosure, internal controls, and independent auditors. As a word of warning to issuers and auditors, Munter emphasized that “a materiality level is established for the financial statements as a whole and it would not be appropriate for auditors to establish a materiality level for the statement of cash flows that exceeds the materiality level for the financial statements as a whole.”
Separate from the SEC update, the Financial Accounting Standards Board (“FASB”)—which sets accounting rules for U.S. companies—recently voted to add a rulemaking project to its agenda regarding the reorganization of cash-flow statements to address items core to the operations of banks and other financial institutions.
“When you think about it, we don’t require a single format for balance sheets, we don’t make financial institutions do classified balance sheets, we don’t have a single format for income statements, but we’ve stuck with this over 30 years—a single format to the statement of cash flows as if ‘that one there’s no variance by industry,’ and I think at the end of the day there is,” FASB Chair Richard Jones said about the cash-flow statement filing process. “And I think we’ve heard that pretty loudly from our customers who say they don’t use our product in certain industries and so I think it’s incumbent upon us to see if there’s improvements we can make to the statement of cash flows.”
FASB’s actions could result in an amendment of the standard governing cash-flow statements, ASC 230. Where a cash-flow statement has three sections for operating activities, investing activities, and financing activities, FASB is looking into revising how financial institutions report under those categories. Specifically, as part of the project, FASB is looking to require financial institutions to expand cash-flow statements to include additional line items about operations and to reclassify certain activities into the “operating” section, rather the “investing” or “financing” section. FASB is also looking into whether financial firms should disclose the amount of cash interest income received in a given period.
“The statement of cash flows represents a critical piece of a complete picture of an issuer’s financial health and operations. Issuers and auditors have a responsibility, under securities laws and professional standards, to apply the same high level of care and professionalism to the preparation, review, and audit of the statement of cash flows as is required for the other financial statements. Investors should be provided with transparent, meaningful, and high-quality cash flow information that is subject to rigor in both preparation and auditing, consistent with the other components of the financial statements.
These steps from the SEC and FASB mark positive shifts in the regulatory and standard framework governing cash-flow statements, as increased quality in these filings allows for a more robust disclosure of a company’s financial position and is beneficial to all investors.