Defining ‘ROI’ Correctly; IMA Updates; More

You invest money, and eventually—if it was a good investment—you get money back. Do you call that return on investment, or return of investment?

A potentially huge difference exists for accounting purposes, and some companies apparently have been getting it wrong. That's according to a recent study, “The Cash Flow Classification of Distributions Received from Unconsolidated Entities,” published by the Georgia Tech Financial Analysis Lab.

Financial Accounting Statement No. 95, Statement of Cash Flows, provides a roadmap for what goes where on the statement of cash flows. According to Charles Mulford, director of the Georgia Tech lab, FAS No. 95 makes a clear distinction that money earned on an investment should be classified as operating cash flow; the return of the principal amount invested should be accounted for as investing cash flow.

Co-authored by Mulford and Eugene Comiskey, both accounting professors at Georgia Tech, the study of 107 companies revealed that 19 classified all distributions from investments into investing cash flow. Of those, 13 companies showed earnings exceeding distributions received, suggesting they were lumping returns on investment and returns of investment into the same category and calling the whole thing investing cash flow.

Those companies could be showing stronger operating cash flow, Mulford says, if they followed the strictures of FAS No. 95 more carefully.

Mulford

“What it means for users of financial statements is that companies are understating their operating cash flow and end up looking financially weaker than they really are,” he says. “Investors are being misled into thinking those companies aren’t do[ing] as well as they think they are. That can lead to lower assessments of credit quality and lower share price.”

Schnitzer Steel Industries, for example, could have doubled its reported operating cash flow, according to Mulford and Comiskey’s analysis. Schnitzer reported operating cash flow of $73.5 million when it could have reported $146.3 million, the study found.

Schnitzer reported in July that it would amend its 2005 10-K and its 2006 first quarter 10-Qs to reclassify cash received from joint ventures, according to a company statement. The company expects to delay its third-quarter 10-Q until it finishes the amendments. Mulford attributes the amendment plan to the study’s findings, but the company did not respond to a request for comment.

Mulford says no obvious ulterior motive to misclassify the cash exists, so he assumes companies are simply making a mistake on this particular point. “It’s a misunderstanding of how to apply this part of Statement 95,” he says, which raises a bigger concern about accounting rules in general. “Are accounting standards getting so difficult it’s getting harder and harder for companies to do it properly?”

The Georgia Tech Financial Analysis Lab's study and related resources can be found in the box above, right.

IFAC Advocates ‘Sustainability’ Approach To Business

The International Federation of Accountants is trying to help the accounting profession grasp the concept of “sustainability”—a broad view of a company’s long-range performance considering social, environmental and economic issues.

IFAC’s Professional Accountants in Business committee has published two papers that focus on how accountants are called to take a more active role in planning a company’s long-term viability considering those broad social factors.

The first paper, “Why Sustainability Counts for Professional Accountants in Business,” describes what sustainability means and makes a business case for addressing the risks and opportunities that a sustainability view exposes. It also addresses how accountants will be called on to measure, record and interpret related information, especially if they work in entities that have significant environmental or social impacts.

The second paper, “Professional Accountants in Business—At the Heart of Sustainability?” provides nearly a dozen cases of accountants in various enterprises around the world who are guided by a sustainability view and the challenges they face in promoting and implementing sustainable development strategies.

Connell

PAIB Chairman Bill Connell says the concept of sustainability is comparable to “social responsibility,” which also advocates an awareness of environmental and social concerns. Sustainability, however, focuses more fundamentally on a long-range view of an entity’s development, he says.

“Sustainability is focused on long-term rather than short-term,” he says. “It’s making sure that developments meet the needs of the present without compromising future needs.”

Connell says interest in sustainability is growing, and comes not just from special interest groups but from shareholders, customers, suppliers, government and the general public. “It’s a topic that’s been important, but not on the urgent list,” he says. “Now I see it’s moving up in importance very fast. Some companies are leaders in the field.”

The white papers, as well as recent sustainability coverage from Compliance Week, can be found in the box above, right.

IMA Plans Updates On Accounting Literature

The Institute of Management Accountants is looking to update its series of statements on management accounting, to give corporate decision-makers new guidance in strategic cost management, enterprise risk management, technology and leadership.

The IMA’s statements represent a comprehensive summary of certain strategic areas that define competency in management accounting. They neither add to nor elaborate on Generally Accepted Accounting Principles, which are under the umbrella of the Financial Accounting Standards Board.

“The SMAs really do not relate much, if at all, to FASB’s statements of accounting,” says Jeffrey Thomson, IMA’s vice president of research. “The SMAs are directed to decision-makers working inside firms to create value in the areas of decision support, planning and control.”

IMA last updated its series of statements in 2000, Thomson says. The group is currently writing a handful of new statements and is updating and republishing about 30 existing statements. In addition, the group is looking for suggestions for future topics it should address, as well as prospective authors and reviewers, he says.