International Research Journal of Applied and Basic Sciences 2014 Available online at www.irjabs.com ISSN 2251-838X / Vol, 8 (2): 246-252 Science Explorer Publications The Preferable Presentation Method of Models of the Cash Flow Statement Yadollah Tariverdi (PH.D) 1, Maryam Rostami 2 Corresponding Author email: tariverdi2012ir@yahoo.com ABSTRACT: In most countries, the statement of cash flows contains three sections; though, it has five sections in Iran. Also, for the first time, we have presented four-way classification of the cash flow statement along with the respective reasoning. This article presents a cross-sectional pattern, viewpoints of different groups about the presentation methods of the cash flow statement have been considered. The result of the cross-sectional pattern shows that five-way classification of the cash flow statement is better than two models of three and four-way as well as four-way classification is better than three-way model. Keywords: Cash flow statement; Five-way classification model; Four-way classification model; Threeway classification model. INTRODUCTION With due attention to the aim of financial reporting, that is presentation of useful information to facilitate economic judgments and decisions of the users of financial statements or that the needs of these users could be standard quality of financial statements, this research tries to have a comparative study of different models of the cash flows statement. Financial Accounting Standards Board (FASB) believes that decisions of investors and creditors and their use of information are wider than the decision of other users of financial statements and so their decisions have significant impact on the allocation of economic resources of every country. In the USA, under FASB statement No. 95 (SFAS-95 1987) and at global level (international accounting standards board) based on accounting standard No. 7 of International Accounting Standards Committee Foundation (IASCF 2004) and following to the most countries in the world, the statement of cash flows consists of three sections of operating, investing and financing activities. In Iran, from 1996 to the end of 1998, this financial statement was presented in accordance with the above. A question arises here is that why in Iran, after the abovementioned period, the statement of cash flows changed from three-way classification to five-way classification (Iranian Accounting Standard, No.2 2002). Also, we propound a new model of the statement of the cash flows for the first time in this research so that beside the recommended model for Iran and the existing model of the most countries in the world, it can be known in a cross-sectional pattern, which of them possess the superiority? Since the statement of cash flows arises out of the decisions of working capital (operating and financial), investment, financing and servicing of finance of a corporation, so each of the above decisions are assessed to be presented in a better way along with the other financial statements. Also, it must be searched out that the statement of cash flows plainly present all the information needed for the investors. Five, four and three-way classification models of the cash flow statement have arisen from different conceptual frameworks and thus they are studied according to the different hypotheses in the present research. The three-way classification model has been recommended for the Anglo-Saxon countries including America, Australia, Canada, New Zealand and Ireland except England, international standards board and most of the third world countries such as Egypt, Jamaica and South Africa. The aim of the current study is to show whether or not there is difference among presentation methods of the cash flow statement from the viewpoints of different groups (including university professors, accounting PH.D students, certified public accountants and professional investors) and if it is so, which of them is preferable. The result of this research will define that which method of presenting the cash flow statement is preferable and this result can contribute to better reporting of cash flows that is one of the main factors in decision-making of users.
Research Background The topic of the research is new and the research has not been conducted by anyone and also carried out researches are mainly about the benefits of the statement of cash flows. At global level, principally, theoretical researches have been conducted such as Nurnberg (1993), Nurnberg and Largay (1996) have critically highlighted the presentation method of the statement of cash flows. Under SFAS-95, Munter (1990) has also described the presentation method of the cash flow statement that damages the comparability. Three-way classification model of the cash flow statement Nurnberg (1993, p.60) has presented the inconsistencies especially in describing SFAS-95 with the aim of foregrounding; 'since amounts reported as cash flows from operating, investing and financing activities do not reflect all of the cash consequences of these activities and accordingly, they should not be used in decision models without adjustment.' Also, Nurnberg (1993, p.62) has emphasized: 'The three-way model of the statement of cash flows is unable to present suitable definitions for each of the sections.' In SFAS-95 has been defined: 'operating activities as a residual category to include all transactions and event other than investing and financing activities (para.21).' In SFAS-95 has been declared: 'Classification in financial statements facilitates analysis through classifying inherently (from the viewpoint of nature) Similar items and separating inherently different items (para.20).' In spite of this, Nurnberg (1993, p.61) declares in his article; 'Three-way classification of SFAS-95 results in reporting similar cash flows differently and different cash flows similarly, just the opposite of the desired characteristic of financial reporting to report similar items similarly and different items differently.' Under SFAS-95, other reason is positive answer of respondents to the draft of three-way classification, so that nearly all the respondents to the draft were in agreement with three-way classification (para.84). but the main question is that whether other models had been given to the respondents? In the follow-up of the recognition of the method presenting three-way classification of the cash flow statement, the existing inconsistencies in each kind of activities of the cash flow statements are dealt with. Interest and Dividends According to SFAS-95, Interest and dividends received as well as interest paid are presented in operating activities section (para.88). While these items are parts of financial activities of an entity and reporting them under the classification of operating activities is an evident inconsistency. FASB ( para.88) in explanation of this presentation resorts to inclusion concept and states: 'Cash flows from operating activities must include items that facilitates understanding of the reasons for differences between net income and net cash flows from operating activities as far as possible.' 'But FASB still does not totally adhere to this and contrary to 'inclusion concept' has removed gain or loss from disposal of fixed assets from operating activities (Nurnberg 1993, p.65).' Income Tax Presenting income tax paid in operating activities such as interest and dividends received as well as interest paid causes incompatibility between classification of income statement and cash flow statement. In this regard, Nurnberg states: 'Presenting income tax paid in operating activities contaminates reported operating cash flows with the tax effects of gain or loss related to investing and financing activities (1993, p.61).' 'But FASB in order to explain the presentation of income tax paid in operating activities resorts to 'inclusion concept'. Furthermore, FASB reasons that allocation of income tax paid to different sections is optional (para.92).' Five-way classification model of the cash flow statement Moradzadeh (2002) has critically argued about adding two sections to the statement of cash flows. He describes: 'Segregation of these two sections cannot be suitable.' Bozorg Asl (2002) rejects his criticisms and discusses about the segregation of the returns on investments and servicing of finance. 'In his opinion, firstly, there is absence of unanimity about the presentation of items in this section, and secondly, in the International Accounting Standard No. 7 (IASCF, 2004), various methods are proposed that damage the comparison. So, the attempt was made that the two cases of coordination between financial statements and comparison between corporations could be possible.' There are no debate about comparability, but the ambiguity that exists particularly explaining the actual basis is that whether this conformity is vital to the extent that it accords with our presented methods and it is not vital in the cases that it does not correspond to them? Either the reasoning of conformity between financial statements should be accepted in principal and welcomed both desired and undesired aspects or it should not be resorted to in principal. 247
Now that this reasoning is relied on, is presenting gain or loss (such as gain or loss from the disposal of non - current assets) in investing activities of the cash flow statement- While disclosed in the income statement- not an evident inconsistency? The answer is affirmative, that is, the appropriate place for investing activities is in balance sheet, while the appropriate place for gain or loss is in income statement. Thus, it is logical to state that 'operating activities' and 'returns on investments and servicing of finance' categories should mainly conform to income statement. While both 'investing activities' and 'financing activities' categories should conform to balance sheet. Thus, it is a clear inaccuracy to transfer gain or loss (resulting from disposal of non -current assets) from operating activities to investing activities. That is, considering an expense as an asset by mistake. The reasoning of presentation method of income tax will be presented in next section (Four -way classification model of the cash flow statement). The Proposed Four-way classification model of the cash flow statement In the four-way classification model that derive from four main obligations of corporation, the section of 'financing activities' describes cash has been financed from which resources. While supplied cash has been spent on which investing activities is noted in 'investing activities'. On the other hand, the amounts of cash which has been produced through operation and other activities are set out in 'returns on investments' category. Finally, the amounts of cash which paid to suppliers of capital as dividend and interest payments (including income tax) are pointed out in 'servicing of finance' category. Briefly, legal entity finances by owners and others (such as creditors), Then, invests by carried out financing in order to obtain returns and eventually pays dividends and interest for financing through received returns. In other words, the activities of an entity and the consequences of them are as follows: 1) Financing activities 2) Investing activities 3) Consequences of investing activities 4) Consequences of financing activities. In defense of the presentation method of returns on investments section In this category, not only the cash from operating activities is reflected, but also interest and dividends received from financial activities are presented. Two kinds of investments are presented in investment activities; one of them is capital expenditures, such as investing in property, plant and equipment and intangible assets and the other one is financial investments, such as investing in debt or equity securities of individuals and other entities. By this way, returns on investments must also include returns on operating investments (non -financial) like investment in properties, plant and equipment, as well as returns on financial investments like investing in debt or equity security. Each of these two kinds of investments and their structure are the outcome of the direct decisions and performance of management of corporation. In defense of the presentation method of Servicing of Finance Not only dividends paid but also income tax paid is presented in this section. Apart from this, the cash payments for the interest are presented in this category. According to one of the statements of American Accounting Association; 'interest expense, income tax paid and dividend distribution are not considered as a part of determinants of the entity income. In other words, above-mentioned items rather than being considered in determining net income, they are regarded as a kind of dividend distribution.' Thus, it can be concluded that stockholders, long-term creditors and government benefit from the entity income. The advantage of this concept of net income is that it separates operating and financing aspects of a business enterprise from each other. That is, net income of the business enterprise is merely operating concept of net income. While interest gained by creditors and dividends acquired by stockholders have financial nature. 'Income tax lacks financial nature and is devoid of absolute operating nature, too (Shabahang 2002, p.201).' The analysis provided by America Accounting Association reveals that this reasoning more or less conforms to the reasoning which presents a distinct category under the title of 'servicing of finance' and verifies this category of four-way classification model of the cash flow statement. In defense of the presentation method of investing and financing activities Presentation method of investing and financing activities of the four-way classification model except three basic items of gain or loss from disposal of non-current assets, depreciation of non-current assets and employees' termination benefits are similar to the three and five-way classification models. Each of the above items will be explained separately in the following sub-sections. 248
Gain or loss from disposal of non-current assets In the three and five-way classification model of the cash flow statement, gain or loss from disposal of noncurrent assets has been classified against the inclusion concept. If the reasoning of inclusion concept is accepted, all its desired and undesired aspects should be welcomed. That is, when it is stated under inclusion concept, gain or loss from disposal of non-current assets should be presented in operating activities under this concept. Also, if the reasoning of conformity among financial statements is relied on, gain or loss from disposal of non-current assets should be presented in operating activities according to this reasoning. Since this gain or loss generally is related to the income statement but they are presented in the investing activities section. When elements of financial statements are defined under the conceptual framework of financial reporting, they must be applied to similar way in all the financial statements. Gain or loss from disposal of non-current assets is not considered as returns of non-current assets that are presented in the section of investing activities; rather, this is related to the operating activities section in the framework of financial statements. Depreciation of non-current assets One of the methods that introduced in epistemology to recognize a scientific topic is necessary to go beyond its framework and avoid any bias. Presenting depreciation in operating activities may be either under inclusion concept or may follow this reasoning that the depreciation expense has not been prerequisite for spending cash. This kind of presentation is correct when cash outflow (cash outflow from acquisition of non-current assets) is also presented in the operating activities section. However, in the existing models, this does not observe. So, presentation of acquisition of these assets in the investing activities and presentation of depreciation in operating activities have logical contradictions. Depreciation presentation in the income statement is considered as returns of investments but its presentation in the operating activities is counted as cash returns on investments. If the presentation of depreciation here means the calculation of net income in cash basis, this argument is illogical since acquisition of non-current assets is presented in the investing activities section. So, by this kind of presentation, appraising the potential creating cash of the entity is damaged by the investors and the other users of the financial statements. One of the basic thoughts of accounting is primacy of substance over form concept. Based on this concept, financial statements must be presented faithfully. In other words, financial reporting must be based on primary of substance over form. It is correct that depreciation is a non-current expense but theoretically, depreciation process is believed to be a process of returns of investment. So, as acquisition of non-current asset is presented in the investing activity section, therefore, returns of investments must be presented in the same section. Employees' termination benefits Employees' termination benefits and depreciation have the same reasoning. Presentation method in both three and five-way models is correct when no cash as employees' termination benefits is paid. Presenting employees' termination benefits in operating activities either may be within the framework of allinclusion concept or may follow this reasoning that this expense has not been prerequisite for spending cash. Thus, it is added to net income (or operating income), so that net cash flows from operating activities are obtained. This method of presenting is only correct when cash flows are never paid to employees for employees' termination benefits. But should not long-term outstanding of employees be settled one day? The answer is definitely negative. That is, this claim should be settled one day. The users of the financial statement have a clear understanding of cash returns and long-term debt to employees. They clearly accept that employees' termination benefits are considered as the debts of the entity. Presenting employees' termination benefits in operating activities is reported as the returns on investments. So it damages the process of appraising the potential creating cash of the entity. As the purpose is that by presenting operating activities, net income is calculated based on cash basis, this reasoning is defective, since if any reasoning is accepted, all desired and undesired aspects should be welcomed. If an item is defined as a financing activity for financial statements, it cannot be classified in financing activity in balance sheet, while it is not classified in financing activity in the cash flow statement. This is considered an evident inconsistency. As the primacy of substance over form has been explained for the depreciation, this also applies to employees' termination benefits. It is correct that employees' termination benefits amount is non-cash expense and is not effective in the cash flows and must not reflect in the financing activities, but, essentially increase of reserve of this expense has been shown in the balance sheet. 249
Research Hypotheses H1. From the viewpoints of different groups, five-way classification model of the cash flow statement is better than three-way model of the cash flow statement. H2. From the viewpoints of different groups, four-way model of the cash flow statement is better than threeway model of the cash flow statement. H3. From the viewpoints of different groups, five-way model of the cash flow statement is better than fourway model of the cash flow statement. METHODOLOGY Data Collection With due attention to the aim of the research, the questionnaire containing 18 questions that was prepared fundamentally utilized the accounting literature on the theme of the cash flow statement, defined in SFAS-95 and Accounting Standard No.2 of Iran. For validity of the questionnaire, the viewpoints of accounting professors have been used and revised accordingly. Also, to check the reliability of the questionnaire, Alpha Cronbach coefficient was calculated 90% by using SPSS software that showed the high reliability of the questionnaire. Finally, it is worth mentioning that questionnaire accompanied by complementary information on three, four and five-way classification of the cash flow statement was presented to respondents. Statistical society to distribute the questionnaires of research consist of three actual groups: first group comprised of university professors and PH.D students of accounting from the Iranian universities, second group comprised of managers and experts from investment companies and agencies of stock in Tehran and third group comprised of the certified public accountants of Iran. With due attention to the statistical society of 1800 people, 91 samples were computed. RESULT OF THE RESEARCH HYPOTHESES TESTS The collected data based on questionnaires pave the way to test the research hypotheses. To test the research hypotheses, Wilcoxon test has been used and the results are given in Table 1. Table 1. Wilcoxon test results of each two groups of total groups Null hypothesis Subjects Z Sig. Error level Result of null hypothesis H1 3,5 -way classification -7.182 0.000 5 percent Rejected H2 3, 4 -way classification -2.841 0.004 5 percent Rejected H3 4,5 way classification -5.018 0.000 5 percent Rejected With the study of Table 1, it is found that with due attention to the fact that significance level of z in each of the hypotheses is less than 0.05, so the alternative hypothesis is accepted. It can be stated with 95% assurance that from the view of different groups, five-way classification model is better than four and three-way classification model as well as four-way classification model is better than three-way classification model. Table 2. Friedman test results of total groups Groups K- square Sig. University professors, PH.D students of accounting 5.797 0.055 Professional investors 21.038 0.000 Certified public accountants 43.75 0.000 Total groups 64.799 0.000 Also, the results of testing the preference model of the cash flow statement among the received responses from total groups of university professors, PH.D students of accounting, professional investors, certified public accountants through Friedman test show that there are significant differences among models. 250
Table 3. Mann-Whitney U test results of each two groups of total groups Groups Five-way classification Four-way classification Three-way classification Z SIG Z SIG Z SIG University professors, PH.D students of -0.211 0.833-1.06 0.289-0.434 0.664 accounting Professional investors -1.022 0.307-0.484 0.628-1.402 0.161 certified public accountants -0.683 0.495-0.856 0.392-0.536 0.592 To test the monotony of the received responses from each of the three groups compared with another group has been used Mann-Whitney U Test. The result of test shows that there are no significant differences between each of two groups. Table 4. Kruskal-Wallis test results of total groups Model of cash flow statement K square Sig. Five- way classification 2.061 0.56 Four - way classification 2.807 0.422 Three - way classification 3.084 0.379 Also, on the basis of Kruskal-Wallis test, no specific differences were observed among the responses from total groups of university professors, PH.D students of accounting, professional investors, certified public accountants. CONCLUSIONS & SUGGUSTIONS The aim of the research was to study the preferable method of presenting the cash flow statement from the viewpoints of university professors, PH.D students of accounting, professional investors, and certified public accountants. The research indicates important preference of five-way model of the cash flow statement compared to four and three-way models, and also important preference of four-way model over three-way model. One of the reasons of tendency of different groups of present research is the increase in the number of sections of four and five-way models in comparison to three-way model. Segregation of interest and dividends is one of the issues that all groups have emphasized. It can be described that one of the basic reasons of first place being assigned to the five-way model and second place to four-way model is the segregation of these items and income tax paid from the operating activities section. Further, it is suggested that this research will be assessed and compared with market researches. In other words, market reactions to the cash flow information should be considered. Further, it is also suggested that with regard to the executed and identified patterns of this research and by use of other groups like creditors, financial managers and managers of the corporation, a research can be conducted and its findings will be compared to this result. In the scope of academic education, it is suggested that with due attention to the identified four-way model of the present research and with respect to its importance among two other models, it can be explained and analyzed for the students and people along with the two other models. In the scope of standard setting, it is necessary to be mentioned that a model of the cash flow statement has been suggested for the first time with the help of the authors. Results of this model according to the present research have been similar to the results of the recommended model for Iran. Thus, it is suggested that this model also should be considered as standard making in the work statute to pave the ground for the presentation method of the statement of cash flows. REFERENCES Bozorg Asl M. 2002. The Process of Setting National Accounting Standards and the Difference between National Standards and International Standards with the Emphasis on the Standard of the Cash Flow Statement. Hesabdar Monthly, 148. Financial Accounting Standards Board (FASB). 1987. Statement of Financial Accounting Standards No. 95: Statement of Cash Flows, Stamford. International Accounting Standards Committee Foundation (IASCF). 2004. International Accounting Standard No.7: Cash Flow Statement. Moradzadeh fard M. 2002. Cash Flow Statement, Iranian Standard Versus International Standard. Hesabdar Monthly,147. Munter P. 1990. Form over Substance, Another Look at: The Statement of Cash Flows. CPA Journal, September, 54-56. 251
Nurnberg H, Largay JA. 1996. More Concerns over Cash Flow Reporting under FASB Statement No. 95. Accounting Horizons, December, 123-136. Nurnberg H. 1993. In Consistencies and Ambiguities in Cash Flow Statement under FASB Statement No.95. Accounting Horizons, June, 60-75. Shabahang R. 2002. Accounting Theory, 1 & 2th volume, Audit Organization, Tehran. Technical Committee of Audit Organization. 2003. Iranian Accounting Standards (Scientific Journal No.160), first edition, Audit Organization. 252