The article “The Cash Flow Statement: Problems with the current Rules” was published in 2007 in

the United States. The issues covered will be discussed in relation to our course’s Topic “Statement
of Cash Flows” (SCF) Chapter 24.

The Author states some of the limitations of the SCF that makes it less useful in its current
presentation. Theses will be classified by the three reporting activities: Operating, investing and
financing.

Reporting of Operating Activities

Companies may choose to classify interest paid as an operating activity while dividends paid may be
treated as a financing activity. The differing methods of financing create difficulty for comparability
of financial information across the board. This has led to analysts having to generate their own
measures to make such comparisons. However, even the analysts haven’t reached an agreement on
an industry standard.

Another issue posed is the financing of receivables where monies received were treated as a
financing activity. However, with the increasing pressure to lower the debt on the balance sheet and
no recourse from the accounting rules, these transactions were allowed to be treated also as an
operating activity. This process favors the company as it leaves out the borrowing off the balance
sheet while inflating cash from operations.

An additional issue arises when a company manipulates its ‘cash provided by operations’ by
increasing the dividends it receives from investments in associated companies. This will increase
operating cash flow and thus is a simple yet effective strategy utilized by many companies. This
technique may distort the investment strategy used by the business and therefore confuse users of
these statements.

Another concern is the reporting of capital leases and how this one transaction is broken down into
two components, the first component, the payment of principal is treated as a financing activity and
on the other hand the payment of interest is regarded as a operating activity, this makes the cash flow
statement less informative and divided as it losses it’s “wholeness”. The author’s judgment in this
instance seem to be accurate as one might agree that one transaction should not be broken down into
two components but rather the payment of interest and the payment of principal should be recorded
as financing activities.

The article also points out to the distortion in the payment of taxes and the rule that it should be
treated as operating activity even when the gain being taxed is included in investing activities. The
article gives an example of a company with a low operating profit, however has a substantial capital
gain from the sale of an asset, the bulk of the tax expense is from this sale, on SCF the gain is
removed from operating and included under investing activities But the income tax expense on that
gain remains in the operating activities sections, generating substantial negative cash from
operations, this method is misleading and violates the matching rule required on the income
statement. It relates to this subject as this issue deals with the required standards of the AASB learnt
in this subject.

Deferred employee compensation is also a major problem regarding the SCF, the payment of
compensation is paid by organizations in the form of a stock option which is part of the balance
sheet when issued, when later redeemed into cash, the move is treated as a financing activity
however this payment should be treated as an operating activity as it is purely part of the wages.

Reporting of Investing Activities

Some companies get involved in large volume of purchasing and selling marketable securities to
manage their cash flows. These transactions with large amounts will be included in their SCF. This
might wrongfully indicate that the company’s main activity is trading in financial markets. Their
additions will lead to a confusion and clutter up the statement.

Reporting only cash amounts in the investing and financing activities will not give a clear picture of
the company financial commitments. This could be illustrated by an investment that is settled partly
by cash and the rest with debt and equities. The statement will not reflect the exact cost and might be
misleading as there is no reflection of the complete transaction.
Reporting of Financing Activities

Most of the issues relating to the financing activities were discussed above, namely the failure to
treat the financing of receivables as financing activity and the omission of non-cash financing
instruments in the SCF.

In conclusion, the SCF is accompanied with footnotes for completeness and even if some changes
might be needed as suggested by the author. Our main response to the issues above, would be to
reiterate what we have learnt through our course is not to rely on one financial statement or one ratio
to analyze the company’s financial position or performance.