15. Cash Flow Statement Disclosure You have been hired as a staff accountant by

Question

15. Cash Flow Statement Disclosure You have been hired as a staff accountant by a small company that recently completed an initial public offering (IPO) of its common stock. At its inception, the company had been nanced by Pegasus, an investment group. Pegasus had bought a signicant amount of the company’s debt (equal to a third of its total assets) in the form of convertible bonds. The stock price has appreciated signicantly since the IPO, and Pegasus has decided to convert its debt securities into equity, giving Pegasus a 28% stake in the company. Your CEO, Dane Hathaway, argues that this conversion should not be reported on the cash ow statement. ‘‘It didn’t involve any cash either way, and it’s not like the structure of our business has changed. We haven’t increased or changed our xed assets, and we haven’t given anything up.’’ Research the appropriate Codication and draft a memo to Dane explaining whether his reasoning is correct and citing your references.

Explanation / Answer

Cash flow statement should report only cash flows. However, certain non cash investing financing transactions should also be reported as footnotes to the financial statements.They are:

1) Conversion debt into equity

2) Coversion of preferred equity into common equity

3) Acquisition of assets through capital leases

4) Acquisition of long term assets issuing notes payable etc.

Hence CEO's intetion to exclude the transaction of converting debt into equity from cash flow statement is correct but it should be reported as foot note to the financial statements.

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