Discuss arguments supporting the need for improving the Statement of Cash Flows (SCF). What suggestions do Broom and the authors of the text make regarding improvement?
What will be an ideal response?
ANSWER:
Broome states that SFAS No. 95’s flexibility in allowing either the direct or the indirect method on the SCF creates confusion.
Some arguments supporting the need for improving the SCF include:
1. The complicated adjustments required by the indirect method are hard for a reader to understand and provide managers more leeway for manipulation.
2. The flexibility in classification between the three sections of the SCF can affect the perception of the firm’s financial strength.
3. Flexibility in allowing either the direct or indirect method creates confusion.
Broom makes the following suggestions:
1. FASB require both the direct method and the associated reconciliation of net income to operating cash flow for the operating section.
2. FASB should provide more quittances on classification of cash flows for the three sections.
3. The supplementary reconciliation should begin with cash flow from operations and proceed to net income, the reverse of the current practice.
Wolk, Dodd, and Rozycki agree that the direct method should be required, but argue that firms should explain the source of any non-articulation that occurs in the operating section of the SCF. They suggest firms be required to provide a schedule showing the non-cash flow transactions that affect working capital accounts, allowing the user to understand the differences between balance sheet changes and the SCF. They also suggest that, in the case of mid-year acquisitions, firms should provide a schedule that reconciles the working capital adjustment in the operating section of the SCF with the respective balance sheet changes.
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