Reclassification Work on Cash Flows Opens Eyes

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					 Accounting & Auditing

Reclassification Work on Cash Flows Opens Eyes
By Tammy Whitehouse                                As financial statements go, the cash-                 about cash-flow classifications, Mulford
                                                flow statement is still a youngster, first               contends. “If we can make ourselves look

C     ash flow and its proper represen-
      tation in financial statements has
gained a lot of respect in recent years, and
                                                required in its current format in the mid-
                                                1990s, Mulford explains. Companies are
                                                required to classify their cash flows as
                                                                                                         better than we really are and no one cares,
                                                                                                         why not? That may be an overstatement,
                                                                                                         but not by a lot.”
companies would be wise to give it more         arising from operating, investing, or fi-                   When Mulford took his deep dive into
than an afterthought going forward.             nancing activities, but the classifications              cash flow statements several years ago, he
    “Investors are looking for sustain-         didn’t get much attention or respect for a               found some concerns about how compa-
able, ongoing, renewable cash flows,” says      long time, he says. “The cash flow state-                nies were classifying cash flows arising
Chuck Mulford, director of the Financial        ment was a stepchild to all the financial                from customer financing plans. Many
Analysis Lab at Georgia Tech and a cham-        statements. It was prepared after every-                 companies, especially major auto makers,
pion of cash flow reporting. “It’s arguably     thing else was done.”                                    were classifying them as operating cash
the best measure we have of a company’s            Since capital markets were more fix-                  flows when they should have been classi-
ongoing financial health.”                      ated on earnings and earnings per share,
    Mulford led a charge in 2004 and 2005       “companies grew sloppy and complacent”
                                                                                                                                      Continued on Page 75
to get companies to pay more attention
to how they classify cash flows, which                  CASH FLOW EFFECTS
prompted SEC staff to dangle a carrot in
front of public companies in early 2006:          The following excerpts are from, “The Effects of Cash Flow Statement Reclassifications Pursuant to
they could correct sloppy or misleading           the Securities and Exchange Commissionrsquo;s One-Time Allowance,” by Dana Hollie, Curtis Nich-
classifications in their next filing period       olls, and Qiuhong Zhao:
without restating, or correct them later
with a restatement.                               IV. Summary and Conclusions
    That unusual offer—coming on the              Consistent with the SEC’s concerns, we find that firms generally misclassified cash flows that signifi-
heels of accounting scandals, corporate           cantly overstated their net operating cash flows, while significantly understating cash flows related
collapses, Sarbanes-Oxley and a spike in          to investing activities. These types of cash flow misclassifications do appear to distort the true opera-
restatements—set off a flurry of correc-          tional, financing, and investing activities of the firm. Frequently occurring line-item reclassifications
tion activity. Emerging research on the           within all cash flow statement categories validate the SEC’s concerns regarding the presentation of
filings that followed now suggests that           dealer floor discontinued operations and plan financing arrangements. However, insurance claim pro-
perhaps problems with cash flow report-           ceeds and beneficial interests in securitized loans do not appear to have impacted overall cash flows
ing were more dispersed across various            to the degree feared by the SEC.
items in the cash flow statement than pre-
viously believed.                                 Abstract
    “We weren’t expecting to see so many          The Securities and Exchange Commission (SEC) announced a one-time opportunity for firms with
things getting restated,” says Curtis Nich-       misclassified items within their cash flow statements to correct these e
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