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  • Writer's pictureDaniel Goelzer

Audit Committees Should Pay Attention to the Statement of Cash Flows

Updated: Dec 18, 2023

SEC Chief Accountant Paul Munter has issued The Statement of Cash Flows: Improving the Quality of Cash Flow Information Provided to Investors, as a reminder of the importance of the statement of cash flows.  According to Mr. Munter, the “statement of cash flows is integral to a complete set of financial statements, and it should therefore be subject to the same level of due professional care, effective internal controls, and robust, high-quality audit as other financial statements.” However, “preparers and auditors may not always apply the same rigor and attention to the statement of cash flows as they do to other financial statements.”  This failure “may impede high quality financial reporting for the benefit of investors.”

 

Mr. Munter’s statement makes several points that audit committees should bear in mind as part of their financial reporting oversight:

 

  • Statements of cash flow are a leading source of restatements.  Cash flows statement errors are frequently corrected by “little r” restatements, indicating that the company believes that the misstatement was immaterial.  (For a description of little r restatements, see After a SPAC-Driven Surge, Restatements Returned to “Normal” in this Update.)  In some instances, the SEC staff disagrees with this conclusion.  “We remind issuers, auditors, and others of the importance of performing an objective analysis from the perspective of a reasonable investor when evaluating the materiality of both the financial statement and ICFR impacts of an error in the statement of cash flows.” (footnotes omitted)  See SEC Acting Chief Accountant Warns Against Bias in Restatement Materiality Decisions, March  2022 Update which discusses Mr. Munter’s comments on audit committee oversight of restatement decisions.

 

  • Disclosures related to the statement of cash flows are critical to investors.  “We remind issuers that the requirement to disclose significant accounting policies includes those policies that materially affect the determination of cash flow classification.”

 

  • Establishing and maintaining effective internal control over financial reporting includes controls to facilitate the preparation and presentation of the statement of cash flows.

 

  • Companies should carefully consider how to best present cash and noncash information and what disclosures facilitate investor understanding of the statement of cash flows and the financial statements as a whole. In particular, companies should consider reporting operating cash flows under the “direct method.” The direct method of preparing a statement of cash flows involves presenting the specific cash amounts associated with each item that affects cash flow.  In contrast, the more common indirect method involves adjusting net income with changes in balance sheet accounts to arrive at the amount of cash generated by operating activities.

 

As to additional disclosure and the choice between the direct and indirect methods, Mr. Munter explicitly refers to the audit committee’s responsibilities: 

 

“We encourage audit committees, as part of their important oversight role, to discuss with management and the independent auditor the potential use of the direct method or additional disclosures of gross cash receipts and payments, with an emphasis on investor needs. We also note that independent auditors can use their communications with the audit committee around alternative accounting treatments to facilitate this dialogue.”

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