Inconsistencies and Ambiguities in Cash Flow Statements Under FASB Statement No. 95.

Abstract SYNOPSIS: Under FASB Statement No. 95 (SFAS-95), cash receipts and cash payments are classified in the cash flow statement as resulting from investing, financing, or operating activities. This three-way classification is loosely based on the finance literature, but important modifications result in inconsistent or ambiguous classifications of certain cash flows. For this reason, reported cash flow from operating activities frequently includes cash flows from investing and financing activities. Similarly, reported cash flows from investing activities and financing activities frequently exclude certain cash flows properly attributable to them. This paper examines the distinctions among operating, investing, and financing activities under SFAS-95, and compares them with similar distinctions in the finance literature. It identifies several inconsistencies and ambiguities in the three-way classification of cash flows under SFAS-95. More specifically, this paper demonstrates that the three-way classification and the ambiguous presentation of third-party financing transactions under SFAS-95 results in reporting similar cash flows differently and different cash flows similarly, just the opposite of the desired characteristic of financial reporting. Additionally, the required classification of interest and dividend collections and interest and income tax payments as operating cash flows is shown to result in contaminating operating cash flow with certain effects of investing and financing activities, and may result in a peculiar if not counterintuitive presentation of the retirement of bonded debt originally issued at a discount. Finally, this paper demonstrates that the disclosure requirements for noncash investing and financing transactions are ambiguous. By highlighting these inconsistencies and ambiguities of SFAS-95, it is hoped that readers will be more aware that the amounts reported as cash flow from operating, investing, and financing activities do not reflect...