Act Now, and Avoid a Restatement

The SEC extends an olive branch to companies that correct misstatements of cash flow from discontinued operations.

In an unusual move, the Securities and Exchange Commission issued a staff position allowing companies with certain cash-flow statement problems to fix their mistakes without classifying the adjustment as a restatement. Companies that take advantage of the SEC’s largess must do so before their next filing period following February 15, 2006 or lose the chance to avoid a restatement, according to the document.

The leniency is important because restatements tend to carry a stigma that weakens investor confidence, says Charles Mulford, an accounting professor in the DuPree College of Management at the Georgia Institute of Technology. Mulford adds that he’s glad the SEC is taking a second look at cash-flow-statement problems, especially ones that have been hanging around for nearly 20 years.

The amnesty program concerns FAS 95 (Statement of Cash Flow), a standard issued in 1987. The SEC’s recent move focuses on the section of the guidance dealing with discontinued operations, which refers specifically to the disposal of a company unit that contains its own clearly defined operations and cash-flow. Typically, that means a business group or a line of a business that’s shut down or sold.

The SEC reprieve is being offered to companies that misclassified cash flow from discontinued operations and are therefore noncompliant with FAS 95. Under the accounting rule, companies must separate cash flow into three categories: operations, financing, and investing. The separation gives readers of cash flow statements insight into how a company generates cash and enables them to compare results from one period to the next.

Further, FAS 95 gives companies a choice of reporting cash flow from continuing operations and discontinued operations together or treating the two separately. But the accounting treatment must be consistent from period to period. Some companies combine cash flows from continuing and discontinued operations in one period while listing them separately in the next period. That inconsistency is a breach of FAS 95.

Companies also run afoul of FAS 95 by not using the three category classifications, adds SEC officials. While some companies properly separate cash flow from continuing operations into the three categories, for example they mistakenly lump together all the cash flow from discontinued operations into a single line item. When that happens, anyone reading a financial statement can’t identify which of the three segments was affected by the one-time discontinued operations event.

The misclassification is a “presentation” issue, which probably explains why the SEC is giving companies the chance to make the adjustment without dubbing it a restatement, notes L. Charles Evans, a partner with the accounting principles group at Grant Thornton LLP. While such an adjustment doesn’t affect cash-flow totals or change income-statement tallies, it does increase transparency, he says.

Indeed, making sure investors get a fuller picture is the main reason the SEC wants companies to correct their presentation errors. “The correction will allow investors to better understand what contributes to ongoing sustainable cash flow,” Mulford comments.

To be sure, the SEC’s move won’t save companies very much time or money, as auditors and in-house accountants still have to make the correction and adjust affected periods. But for the companies involved, it may eliminate some of the reputational risk associated with restatements.

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