Both balance sheet and the income statement have been the required financial statements over the years whereas, the statement cash flows has been accepted in U.S only since 1988. Therefore, the statement of cash flows has a long evolution in the United States. However, in the 1980s, the Institute of Financial Executives (FEI) decided to encourage its members the preparation of cash flow statements in their financial statements to make some changes in the balance sheet. Consequently, only about 10% of all Fortune Companies adopted the use of cash flows while over 90% of the companies made their financial reports of the net changes in the format of working capital. However, in 1985, the number of Fortune 500 companies who used the statement of cash flows increased to about 70%.
The FASB issued a Financial Accounting Concept No. 5 suggesting that the conceptual statement of cash flow should be part of the entire set of financial statements. Additionally, the statement of cash flows replaced the general statement of changes in the balance sheet. The required statement of cash flow is relatively young as compared to the system of double entry accounting that was 500 years old. Therefore, cash flows do not receive the emphasis that it deserves just like other financial statements (the balance sheet, and income statement).
FASB’S Conceptual Framework led companies to issue cash flow statements
The conceptual statements of FASB are projected to serve the interest of the members of the public since it sets the objective and some qualitative features of financial reports. It also provides other concepts that act as a guide to the selection of economic phenomena to be realized and measured for the purpose of financial reports. Moreover, the phenomena are displayed in the financial statements or any other related means of passing relevant financial information to the interested parties. Therefore, it is a requirement for companies to issue cash flow statements because the guide for the statements will assist the board members to develop comprehensive principles of accounting. It will also help the board members and the subsidiary companies to understand the appropriateness of the contents and inherent shortfalls of financial reporting. On the other hand, the statement of financial concepts does not create the generally accepted accounting standards.
According to No. 1 of the SFAC, financial statements should deliver information that can help the investors to make appropriate investment decisions (Schroeder, Clark and Cathey). Paragraph 37 states that financial reports should give relevant information to the users so that they can assess the company’s values, and the future uncertainty of the cash flows. In paragraph 43, the main focus of financial reports is to provide information about the performance of the company based on earnings and its basic measures. Therefore, it is required that companies should issue the cash flow statements.
The cash flow statements are considered as effective services to companies and should be measured from time to time. Similarly, the matching concept of accounting is emphasizing on the cash flows, and this has led to the direct measurement of cash flows as residuals of the process of matching concept. Therefore, companies should issue cash flow statements because the recent pronouncement of the FASB is consistent with the matching concept approach (Schroeder, Clark and Cathey). This shows that there is a shift in emphasis from the income statement to the statement of financial position to the measurement of net profit of companies.
Bibliography
Schroeder, Richard, Myrtle Clark, and Jack Cathey. Financial Accounting Theory and Analysis: Text and Cases. 11th ed. John Wiley & Sons, 2013. Print.
