Simplifying a FASB 95 procedure.

SIMPLIFYING A FASB 95 PROCEDURE

Many practitioners believe the direct format of the newly required statement of cash flows can better fill clients' information needs because of its breakdown of operating activities into major classes of cash inflows and outflows. Unfortunately, however, there are problems in preparing the direct format. This article describes a worksheet that helps solve some of these difficulties.

IMPLEMENTATION PROBLEMS

The two major disadvantages in using the direct format are lack of familiarity and the cost of preparation. CPAs often are less familiar with the process and the information necessary to prepare operating activities in the direct format. If this format is used, Financial Accounting Standards Board Statement no. 95, Statement of Cash Flows, also requires preparation and presentation of operating activities in the indirect format as a supplemental disclosure. This requirement can add to the cost of preparation.

THE SIMULTANEOUS WORKSHEET

A worksheet that prepares the statement in both formats simultaneously can help solve these difficulties. It uses a format and procedures familiar to practitioners.

For merchandising or service-oriented clients, the information needed to prepare both methods simultaneously generally is the same as that used in the indirect format. For manufacturing clients, the simultaneous worksheet can be used if a breakdown of the costs capitalized in the work-in-progress account is available.

The simultaneous worksheet also presents the income statement and the direct and indirect formats side by side. This permits straightforward comparisons, which can be quite beneficial in explaining the differences to clients, users and staff. The worksheet thus can help solve the major problems associated with the direct method. Finally, the worksheet format can be easily used in any spreadsheet program.

The simultaneous worksheet for a merchandising company, shown in exhibit 1 at left, is based on the 1988 and 1987 balance sheet (exhibit 2 on page 126), the 1988 statement of income (exhibit 3 on page 127) and other information (exhibit 4 on page 127).

Note that the worksheet's analysis of transactions section is identical to the top section of the worksheet used to prepare a statement of changes in financial position. The procedures used to analyze the changes between the beginning- and end-of-the-year account balances also are the same as were used for that worksheet.

Two adaptations to the adjustments section of the old worksheet permit simultaneous determination of the direct and indirect formats. First, the format is changed to include two additional columns for operating activities. The accrual basis column lists line-item revenue, gain, expense and loss components of net income. The cash basis column contains estimates of major classes of cash flows from operating activities that are analogous to the line-item income components.

The second adaptation is procedural. When a change in an asset or liability account's balance is used to remove the effect of an accrual, deferral or nonoperating activity from net income (the indirect format), the change must be recorded on the same line of the worksheet as the revenue, gain, expense or loss for that particular asset or liability. Thus, while net income is being reconciled with cash flows from operating activities through a vertical adjustment, the major classes of operating cash flows can be estimated simultaneously through a horizontal adjustment.

As illustrated on the worksheet, customer cash receipts are estimated by adjusting net sales (sales revenue less bad debt expense) for the changes in both accounts receivable and bad debts. Cash received from interest is equal to interest revenue adjusted for the change in interest receivable.

Similar adjustments are made to estimate the major classes of cash disbursements. Cash paid to suppliers is estimated by adjusting sales for the changes in both inventory and accounts payable. Interest paid is equal to interest expense adjusted for the account balance changes in prepaid interest and interest payable. Taxes paid is equal to the current tax provision minus the increase in the current taxes payable account. And payments to employees are equal to salary and wages expense, since the related liability account balance did not change.

The final adjustments reduce to zero the depreciation expense, loss on the sale of machinery and the provision for deferred taxes. The first two are investing activities, while the third is an operating activity with no cash consequences.

Since the direct and indirect formats relate only to the presentation of operating cash flows, the determination of investing and financing cash flows as well as significant noncash financing and investing activities is the same in either format.

STATEMENT OF CASH FLOWS

The worksheet then provides side-by-side comparisons of the income statement and the two formats of the cash flow statement. This information can easily be lifted and presented as a statement of cash flows under the direct method with the required supplemental reconciliation of net income and cash flows from operating activities.

MANUFACTURING COMPANIES

The worksheet also can be used for companies that capitalize certain costs, if those costs are known. For a manufacturing company, the analysis of transactions worksheet procedures would be modified to debit a net inventory account (raw materials, work-in-progress plus finished goods) and credit the appropriate asset or liability accounts for the costs capitalized. The line-item components of net income would then be adjusted as before for changes in the appropriate account balances to determine the line-item operating cash activities.

A VALUABLE TOOL

The simultaneous worksheet is an adaption of the familiar statement of changes in financial position worksheet. It can be used for most companies, although the information requirements are greater for manufacturers.

The worksheet provides readily understandable comparisons of the income statement and the direct and indirect formats. It can be a valuable tool that CPAs can take advantage of to assist them in a number of practical applications.

EXHIBIT 2

Balance sheet as of December 31, 1988 and 1987

12/31/88 12/31/87

Assets

Cash                                          $70,000    $10,000
Accounts receivable                            80,000    100,000
Less: allowance for bad debts                  (5,000)   (10,000)
Interest receivable                                 0      5,000
Merchandise inventory                         120,000     80,000
Prepaid interest                                5,000          0
Property, plant and equipment                 550,000    650,000
Less: accumulated depreciation               (145,000)  (160,000)
Long-term certificates of deposit             200,000    125,000
Total assets                                 $875,000   $800,000

Liabilities and shareholders' equity Liabilities

Accounts payable                              $50,000    $85,000
Salary and wages payable                       20,000     20,000
Interest payable                               18,000     10,000
Current taxes payable                           7,000      5,000
Deferred taxes                                 35,000     25,000
Long-term bonds payable                       150,000    150,000
Total liabilities                            $280,000   $295,000

Shareholders' equity Common stock, $4 par, 100,000 shares

  authorized; 50,000 shares issued           $200,000   $200,000
Additional paid-in-capital                    100,000    100,000
Retained earnings                             295,000    205,000
Total shareholders' equity                    595,000    505,000
Total liabilities and shareholders' equity   $875,000   $800,000

EXHIBIT 3

Statement of income for the year ending December 31, 1988 Revenues

Sales                                    $1,100,000
Interest                                     15,000
Total revenues                                        $1,115,000

Expenses and losses

Bad debt                                     25,000
Cost of sales                               600,000
Salary and wages                            275,000
Depreciation                                 45,000
Interest                                     12,000
Loss on sale of machinery                    18,000
Total expenses and losses                               $975,000
Income before a provision for taxes                      140,000

Income taxes

Current                                      25,000
Deferred                                     10,000       35,000
Net income                                              $105,000

EXHIBIT 4

Other information 1. Machinery with an original cost of $100,000 and a

net carrying value of $40,000 was sold for

$22,000. 2. $75,000 was invested in a 24-month CD.

3. Cash dividends of $15,000 were declared and paid. [Exhibit 1 Omitted]