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Responding to the growing criticisms levelled against APB No. 19, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 95“Statement of Cash Flows”

which superseded APB No. 19, effective for all companies with financial years ending after July 1988 (FASB, 1987). The U.S. was one of the first countries to introduce a standard on cash flow disclosure.4 Although the standard was issued primarily to eliminate the ambiguities of APB No. 19, it also developed as a result of FASB completing their conceptual framework and issuing the Statement of Financial Accounting Concepts (SFAC) No. 5 “Recognition and Measurement in Financial Statements of Business Enterprises”. SFAC No. 5 saw the inclusion of cash flow statements as an integral part of a company’s annual accounts (Donleavy, 1994).

SFAS No. 95 clarified the definition of cash flows and purpose of the standard, requiring the classification of cash receipts and payments according to whether they arose from operating, investing or financing activities. The purpose of the standard was to provide relevant information about cash receipts and payments during the period in order for users to be able to:

“…assess the enterprises ability to generate positive future net cash flows...meet its obligations...assess the reasons for the differences between net income and associated cash receipts and payments...and assess the effects on an enterprise’s

4

Although the U.S. was the first country to pioneer the development of the funds flow statement, they were actually the second country to replace their funds flow statement with a cash flow statement, preceded by Canada. In 1985 the Canadian Institute of Chartered Accountants (CICA) issued The Standard no. 1540“Statement of Changes in Financial position”requiring the disclosure of a cash flow statement as part of a complete set of accounts for all businesses (Donleavy, 1992). Comparisons of these and other major cash flow reporting standards issued around the world has been summarised by Wallace

financial position of both its cash and non-cash investing and financing transactions during the period.”

(FASB, 1987, paragraphs 4-6)

This definition made it clear that FASB designed SFAS No. 95 with the main objective of providing users with information to better estimate future cash flows in order to determine the firm’s ability to meet their future obligations. FASB further anticipated the informational benefits from reporting actual cash receipts and payments, in addition to a reconciliation of operating profits to cash flows, which could be useful in assessing the persistence of historical earnings. This information could help measure the impact of accrual accounting on the underlying profitability and future cash generating capacity of the enterprise.

Standard setters, therefore, explicitly declared their preference for the direct disclosure of cash flows arising from operating activities through the presentation of gross cash receipts and payments on the face of the cash flow statement. This approach is commonly known as the direct method of cash flow presentation.5One of the most fiercely debated topics in cash flow reporting, has arisen from the standard setters’ preference for this approach over the indirect method. This essentially forms the core of the thesis, which aims to examine the usefulness of direct cash flow statements further.

5_{See Table 2-3 for an example of operating cash flows reported using both the direct method and indirect}

Table 2-3 Illustrative examples of the indirect and direct method of disclosure XYZ Holdings Limited

Cash flows from operating activities using the Indirect Method £ '000s

Profit for the year 27,049

Income tax expense recognised in profit or loss 14,724

Share of profits of associates (1,186)

Finance costs recognised in profit or loss 4,418

Investment revenue recognised in profit or loss (3,608)

Gain on disposal of property, plant and equipment (303)

Net cash inflow on disposal of subsidiary 13,664

54,758 Movements in working capital

Increase in trade and other receivables (3,046)

Increase in inventories (5,900)

Decrease in trade and other payables (446)

Cash generated from operations 45,366

Interest paid (4,493)

Income taxes paid (13,848)

Net cash generated by operating activities 27,025

Cash flows from operating activities using the Direct Method £ '000s

Receipts from customers 211,032

Payments to suppliers and employees (165,666)

Cash generated from operations 45,366

Interest paid (4,493)

Income taxes paid (13,848)

Net cash generated by operating activities 27,025 The above example has been adapted from the Deloitte Model Financial Statements 2009 (Deloitte, 2009)

Other notable issues arising from SFAS No. 95 were the classification of dividends paid as financing activities whilst dividends received, interest received and interest paid were all classified as operating activities. Disclosing “cash flow per share” was prohibited in the conclusion of the standard, based on the boards concern that this could

mislead shareholders in believing it to be an alternative measure of performance to earnings per share (FASB, 1987, paragraphs 122-125).

Both The Financial Reporting Council (FRC) in the U.K. and the Australian Accounting Standards Board (AASB) were quick to follow the U.S. by issuing their respective standards, Financial Reporting Standard (FRS) 1 in September 1991, and AASB 1026 in December 1991. Around the same time the International Accounting Standards Committee (IASC) issued IAS 7 (revised 1992) “Cash Flow Statements” which replaced IAS 7 (1977) “Statement of Changes in Financial Position” thereby aligning the IASC more closely with FASB. The next three sections of this chapter will therefore examine and discuss the development of cash flow reporting in the U.K., Australia and by the IASB.