What International Accounting Standard 7 Leaves Out

August 2003

What International Accounting Standard 7 Leaves Out

In the era of Regulation G, I agree with Hugo Nurnberg (“Income Taxes in the Cash Flow Statement,” June 2003) that the potential benefits of additional cash flow information would be very useful to investors and others, and would likely exceed the costs of preparing it.

Nurnberg argues for a revision to FAS 95 that would require income taxes be reported in the same sections as the transactions and events that give rise to the tax expense or benefit. The simplified exhibit shows a gain on the sale of plant assets of $30,000 and the related tax on the disposal ($12,000) allocated to “investing activities” in the statement of cash flows.

The article does not discuss the fact that some portion of the gain on sale resulted from depreciation expense recorded in prior years. This depreciation resulted in a tax benefit, which was reflected in the “operating activities” section of the cash flow statement.

Following the author’s proposal, in order to decontaminate “operating activities,” it would follow that either (a) the prior year’s tax benefits related to depreciation should have been added to investing activities in those prior years, or (b) the $12,000 reduction in investing activities should be decreased by the accumulated tax benefits related to prior year’s depreciation. Other transactions have additional ramifications. For example:

An FAS 144 impairment write-down would also reduce the basis of the plant assets increasing the possible gain on any later disposal. Again, the choices are either (a) reflect the tax benefit in “investing activities” in the year of the impairment charge, or (b) adjust the reduction for the tax benefit of the prior year’s write-down in the year of sale.
Investments carried on the equity method may be sold resulting in either gains or losses. Prior to the sale, the investor’s proportionate share of losses, income, and dividends adjust the carrying basis of these investments for accounting purposes. The question is, should the entire tax on the gain be included in “investing activities” without adjustment for the tax effects of having used the equity method in prior years?
The accretion of discount on issued debt, which directly impacts the gain or loss on its later extinguishment. Should the tax benefits of the accretion be an adjustment of “financing activities”? If so, when?

Also, while leaving deferred tax assets and liabilities out of the Exhibit helps focus the reader on the author’s proposal, by not dealing with deferred taxes the example glosses over certain added complexities in making the recommended allocation.

Last, it is interesting that International Accounting Standard (IAS) 7, Cash Flow Statements, requires that cash payments or refunds of income taxes that are specifically identified with financing and investing activities not be included in “operating activities.” In the pursuit of principles-based accounting standards, however, none of the examples given in IAS 7 illustrates this required allocation.

Robert N. Waxman, CPA
Corporate Finance Advisory,
New York, N.Y.
Chair, NYSSCPA International Accounting and Auditing Committee

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