SEC Gives One-Time Break On Cash Flow Classifications

In an unusual move, regulators have opened a back door to allow companies with erroneous cash flow classifications to sneak into compliance—without restating.

What began as a trickle of interest in cash flow classifications is mounting into a full-scale movement to review cash flow statements across capital markets and to take advantage of a limited opportunity to correct, but not restate.

Via the accounting industry’s governing body—and not directly published guidance—the Securities and Exchange Commission has prescribed a method where companies whose cash flow classifications have not been consistent with FAS 95 Statement of Cash Flows can correct their next 10-K or 10-Q filed after Feb.15. If they don’t make the correction in that next filing, they’ll be expected to restate.

Evans

“This allows companies to correct their cash flow classifications without going through the full restatement process,” says Charles Evans, partner with the accounting principles group of Grant Thornton. “We’re advising all of our clients to go through their cash flow statements and take advantage of this.”

The flap began in December when Joel Levine of the SEC’s Division of Corporation Finance delivered a speech to a conference of the American Institute of Certified Public Accountants. He pointed out that many companies are not properly classifying cash flows related to discontinued operations.

Although the SEC provides the text of nearly a dozen other speeches delivered at that conference, the text of Levine’s speech is not available, according to an SEC spokesman. Evans says Levine described three acceptable ways to describe cash flow associated with discontinued operations “along with a few unacceptable ways.”

SEC spokesmen declined to comment directly for this story, but said the AICPA’s interpretation of SEC policy is accurate.

One of those unacceptable ways, Evans says, was to present a single line lumping all discontinued operations into one figure: “The SEC said companies were expected to change their classifications if they’d done it incorrectly.”

As a follow-up to Levine’s remarks, the AICPA’s Center for Public Company Audit Firms engaged the SEC staff in an exchange that led the center’s officials to publish an alert to members, not only reiterating the SEC’s position but also offering an alternative to restatement.

“While the staff believes issuers using any of those formats [described by Levine] should revise their presentation through restating prior periods as correction of an error, the staff further advised us they will not object to issuers retrospectively modifying their presentation similar to a change in accounting method (without referring to the correction of an error),” the CPCAF alert reads.

EXCERPT

The excerpt below is from "SEC Staff Position Regarding Changes to the Statement of Cash Flows Relating to

Discontinued Operations," published by the Center for Public Company Audit Firms, 15 Feb. 2006:

SEC Staff Position Explained

"The SEC staff has advised us that their views concerning classification of discontinued operations

within the statement of cash flows were discussed in Joel Levine’s December speech at the AICPA

Annual Conference on SEC and PCAOB Current Developments. In that speech, Mr. Levine identified

certain presentation formats considered to be inconsistent with Statement of Financial Accounting

Standard No. 95, Statement of Cash Flows (SFAS 95). While the staff believes issuers using any of

those formats should revise their presentation through restating prior periods as correction of an

error, the staff further advised us they will not object to issuers retrospectively modifying their

presentation similar to a change in accounting method (without referring to the correction of an error)...

"Issuers who choose to retrospectively modify their presentation must provide enhanced

disclosures such that readers are aware that the cash flow presentation has been modified...

"For example, if the previous presentation was to have a single line at the bottom of the statement of

cash flows containing the combined Operating, Investing and Financing cash flows of Discontinued

Operations and the registrant's choice is to disclose such cash flows by expanding the previous one

caption display, then the footnotes would need to clearly disclose the change, and the face of the

cash flow statement should indicate the change by labeling either the column or the marginal heading

as "revised" or "restated." However the SEC Staff has advised us that characterizing the modification

as “reclassified” in the column or marginal heading would not be acceptable..."

Source:

CPCAF Alert No. 90: SEC Staff Position Regarding Changes To The Statement Of Cash Flows Relating To

Discontinued Operations (15 Feb. 2006)

The alert describes how the SEC would expect companies to correct classifications—clearly disclosing that the new classifications are revised or restated, not simply reclassified—and that it must be done in the next periodic report filed after Feb. 15. “If the issue is discovered and corrected in a later interim or annual period, the SEC staff would expect the modification to be treated as a correction of an error, and would expect the prior filing(s) to be amended,” the alert warns.

Lillian Ceynowa, director of the CPCAF, says the alert reflects the normal course of facilitating communication between regulators and auditors to disseminate accurate information. In the alert, CPCAF says the SEC staff offered the restatement alternative after considering many factors, “including the usefulness of information currently depicted in those presentations and the long-standing practice of a large population of issuers.”

Clearing Up Misunderstandings

Evans says certain aspect of FAS 95 are somewhat unclear, which has led to diversity of interpretation and practice. Charles Mulford, director of the Georgia Tech Financial Analysis Lab, says it has created incomparable figures among companies with inadequate disclosures to comprehend cash flow fully.

Mulford

“Some are reporting operating cash flow for discontinued operations,” he says. “Some are reporting operating, investing and financing cash flow for discontinued operations. Some are disclosing discontinued operations but including that cash flow in the totals for operations, investing and financing cash flow. Some are breaking out separately discontinued operations, and not including them in the totals for operating, investing and financing. Basically, it's all over the place with no standard presentation format.”

Mulford has been planning to do some research into this topic, he says, because he finds reading reports frustrating. “How much cash is from discontinued operations? What’s going to be sustainable? I can’t tell because of the lack of disclosure.”

As a rule, Mulford says, larger companies tend to have better reporting in this area than smaller companies, but the diversity and noncompliance is widespread. He expects many companies will change their practices as the SEC spotlights the issue. The corrections should start appearing en masse with quarterly reports for periods ending March 31, he says.

Jack Ciesielski, owner of advisory firm R.G. Associates, recently highlighted three auto retailers that already have restated to correct cash flow classifications related to financing of auto inventory, probably as a result of Levine’s December speech, he suspects.

Group 1 Automotive, United Auto Group and Asbury Automotive Group are restating to clarify that third-party lending to finance auto inventory is part of financing cash flows, where auto manufacturing finance via trade payables is included in operating cash flows. As Ciesielski sees it, Levine made the case in his speech that financing from sellers belongs in operating cash flow but financing from third parties belongs in financing cash flow. The effect for all three is a reduction in operating cash flows, Ciesielski adds.

Those filings predate CPCAF’s alert prescribing SEC’s alternative to restatement. Group 1 said it was restating as a result of SEC staff comments following a “customary review” of its 10-K.

Ciesielski says there aren’t a great many auto dealers in the public domain, so there may not be an onslaught of similar filings, but the same cash flow reporting principles could apply to other companies.