Principle Method? Simplified Method? Direct Method? Indirect Method? Consolidated? Individual? New Methods for Cash Flow Statements

Hello! I am HORI, a Product Manager for Money Forward Cloud Consolidated Accounting (hereinafter referred to as "Cloud Consolidated Accounting").

I irregularly serialize articles mainly about the "background of specifications" for Cloud Consolidated Accounting. (Sometimes articles about camping or skiing are mixed in, but please enjoy them as an icebreaker between difficult articles.)

Specialized Specification Series Part 16

The 16th installment of the Cloud Consolidated Accounting specialized series will explain the "Consolidated Cash Flow Statement." While consolidated accounting has become part of the scope for the Bookkeeping Level 2 exam, the cash flow statement remains part of the Bookkeeping Level 1 curriculum, so it is no exaggeration to say that it is an area of the highest difficulty in terms of accounting knowledge.

Therefore, I assume that those reading this are accounting professionals to a certain extent. With that premise, I will omit some basic terminology explanations this time, but it still ended up being quite a long article. (This is an article for the brave who make it to the end. Please enjoy it as entertainment for accounting professionals.)

Overview of Money Forward Cloud Consolidated Accounting

Since it will be quite long from here on, I will first list the features (supported scope) of Money Forward Cloud Consolidated Accounting based on an overview.

Individual/Consolidated → 〇 Both individual and consolidated can be created simultaneously

Since it is a creation function for cash flow statements made by a consolidated accounting system, it is naturally designed to be able to create a "Consolidated Cash Flow Statement." However, since the cash flow statements of each company are also created in the process of creating the consolidated cash flow statement, the cash flow statements of each group company can also be created. Note that cash flows in foreign currencies are also converted at the average rate for the period, and the translation difference for cash and cash equivalents is also calculated automatically.

Indirect Method/Direct Method → 〇 Both can be created

Since the indirect method is common in disclosure practices for cash flow statements in securities reports, etc., we have focused on ease of creation using the indirect method, but it is also possible to create it using the direct method depending on master settings. Note that we have included an AI-based setting support function for cash flow settings using the indirect method, which is likely to be used frequently.

Simplified Method/Principle Method → 〇 The best of both worlds

This is the most difficult part of this function to explain, and also the part where we put in the most effort. It is a style that "reproduces the operational feel of the simplified method (operational feel in Excel) while using the principle method (created by accumulating each subsidiary)." It is a new style created by combining the respective strengths of the intuitive and easy-to-create simplified method and the direct method, which allows for accurate tracing and accumulation. (Patent pending)

What is a Cash Flow Statement?

Before proceeding directly to how to create a consolidated cash flow statement, let's first confirm what a "cash flow statement" is in the first place. According to the
Standards for Preparing Consolidated Cash Flow Statements, etc., it is defined as: - Something created to report the status of cash flows of a corporate group during a single accounting period. Other important definitions include: - The scope of funds covered by the cash flow statement shall be cash and cash equivalents. - Classifications for "cash flows from operating activities," "cash flows from investing activities," and "cash flows from financing activities" must be established. These are the fundamental structural definitions of a cash flow statement.

Basic Principles of Cash Flow Statements

A cash flow statement is not just about measuring and disclosing the movement of cash (= cash and cash equivalents) itself; it is created using an accounting technique that creates the impact that each activity will have on cash from the balance sheet and profit and loss statement at the beginning and end of the period. The applicable rules are as follows: - Increase in assets (other than cash) → Decrease in cash - Increase in liabilities → Increase in cash - Increase in capital → Increase in cash - Acquisition of revenue → Increase in cash - Occurrence of expenses → Decrease in cash (Many people may wonder why an increase in assets is a decrease, but please imagine transactions such as buying fixed assets with cash.) Note that in the case of a decrease rather than an increase, the impact on cash is also reversed, but I have omitted the decrease side as it is easy to get confused and is not the main subject this time. In this way, it can be thought that a cash flow statement explains the reasons for the increase or decrease in "cash" from "movements other than cash" and classifies those movements.

This fundamental principle is not only common to the direct method vs. indirect method and the simplified method vs. the principle method, but it also remains unchanged between non-consolidated and consolidated accounting.

Practical Preparation of Consolidated Cash Flow Statements

A characteristic of the current Japanese consolidated accounting industry is that the practical methods for preparing consolidated cash flow statements differ completely between Excel-based consolidation and consolidated accounting systems.
Because the preparation styles are so different, the hurdles for system migration are high, and it is often the case that only the cash flow statement preparation remains an Excel-based task.

In the case of Excel-based consolidation

If you prepare a cash flow statement for each subsidiary by comparing the previous fiscal year-end with the current fiscal year, you would need about three sheets per company, which becomes extremely cumbersome in terms of the number of sheets and formulas. (It is difficult even with just two or three companies.)
Therefore, it is common to prepare them by applying the above fundamental principle to the consolidated balance sheet and consolidated income statement of the previous fiscal year-end and the current fiscal year, calculating a simplified cash flow, and then adjusting the impact amounts on cash flow as if filling in a worksheet. (This is the so-called Excel simplified method.)

• Advantages of the Excel Simplified Method

  • The amount of data (number of Excel sheets) can be kept within an acceptable range.

  • It can be structured in an intuitively easy-to-understand way, where you obtain the changes and then record the impact amounts on the cash flow statement column by column.

  • By writing the worksheet preparation method into Excel, work handovers are possible to some extent (though a considerable skill level is required for both the preparer and the successor).

• Disadvantages of the Excel Simplified Method

  • Cash flow statements cannot be created for each individual company.

  • Since the necessity of adjustments depends on each company's transactions, it is necessary to grasp the transactions of each subsidiary and think about the adjustments themselves by breaking them down into company-specific transactions.

  • If there is foreign currency translation, cumbersome adjustments occur (foreign currency cash flows must be translated at the average rate: Paragraph 17 of the Practical Guidelines for Preparing Cash Flow Statements in Consolidated Financial Statements).
    In addition, it is necessary to calculate not only the translation differences for each BS account but also the translation differences for cash and cash equivalents (Paragraph 15 of the Practical Guidelines for Preparing Cash Flow Statements in Consolidated Financial Statements).

  • The amount of formulas becomes enormous (it is extremely difficult to discover formula errors. Formulas to detect errors are also built, but this makes the formulas even larger).

  • It is easy to become a black box.

  • Work cannot be shared.

When using a consolidated accounting system

When using a consolidated accounting system, there is no need to be conscious of the limitations on the number of Excel sheets caused by the aggregation and translation of each subsidiary.
Therefore, it is often the case that a cash flow statement is prepared for each subsidiary, those cash flow statements are aggregated, and the impact amounts of consolidated journal entries are added.
In addition, to meet the need of "wanting to automate as much as possible since it is being systemized," it is common in Japan to request the preparation of a table called a "Statement of Changes" in the consolidation package and then convert those changes into cash flow. (We will call this the Statement of Changes Method.)

• Advantages of the Change Detail Method

  • Cash flow statements can be checked for each subsidiary

  • Almost full automation is possible as long as the change detail table is entered correctly

  • Tasks like checking the change detail table can be shared

  • No risk of formula errors like in Excel

• Disadvantages of the Change Detail Method

  • Requires group companies to enter accurate changes (requires significant instruction effort)

  • Because conversion destinations must be specified for every account title × change detail, the number of rows in the conversion master becomes difficult to manage (e.g., 200 accounts × 5 changes requires 1,000 mappings)

  • To achieve full automation, one change may need to generate multiple cash flow impacts, requiring even more settings

  • As a result, even though it is a system, this method is prone to becoming a black box

A new method that combines the advantages of the two creation methods

While the consolidated cash flow statement creation methods mentioned above each have their own advantages, they both share the common challenge of being prone to becoming a "black box."
In Money Forward Cloud Consolidated Accounting, we have incorporated various effective measures to prevent this "black box" effect, enabling the creation of consolidated cash flow statements in a new style. (Patent pending)

Components of a consolidated cash flow statement

The basic principles of cash flow statements explained at the beginning remain the same even for consolidated cash flow statements.
And, based on the obvious fact that consolidated financial statements are the sum of individual financial statements and consolidated journal entries, it is possible to apply the CF creation style used in the Excel simplified method separately to individual financial statements and consolidated journal entries.

In Money Forward Cloud Consolidated Accounting, we have improved the method for creating cash flow statements to be both easy to understand and efficient by applying the basic principles of cash flow to decomposed elements.

Step 1: Conversion mapping to cash flow accounts (Patent pending)

First, we set up the conversion from the balance sheet and income statement, which are the basic principles of cash flow, to cash flow accounts.
Considering that this is a part that easily becomes a black box if there are a large number of conversion settings, and that all accounts must be mapped without omission to maintain the consistency of the cash flow statement, we have adopted the following policy:

• Keep settings for cash flow accounts simple (only 1-to-1 conversion from account titles to cash flow accounts)

• Even so, for high-volume conversion tasks, we provide a bulk conversion setting function that utilizes AI (Patent pending)

Step 2: Conversion from balance sheet and income statement to cash flow accounts and adjustment input according to instructions (Patent pending)

Since a style that starts with the changes in balance sheet accounts and profit before tax, and adds adjustments column by column, is more familiar to users, the style is designed to complete the cash flow statement by adding adjustment columns for changes.
While meeting the expectations of users who want the ease of use of the simplified method with this layout, the granularity is such that the cash flow statement for each subsidiary is completed.
Also, since the content that used to be in cell comments or procedure sheets is critically important for proceeding with the work, we have made it possible to check it as instructions during input.
This makes it clear "why cash flow adjustments are necessary" and "which account titles should be reconciled." Not only can work be performed without omissions, but it also serves as important information for business handovers.
And, since adjustments are often made while looking at related accounts when creating an actual cash flow statement, we have devised the screen display so that adjustments can be made while checking the amounts of related account titles.

In the case of foreign currency, the cash flow statement is created in foreign currency up to the pre-conversion amount, and that amount is converted using the AR. The system also calculates and sets the theoretical value for the translation difference of cash and cash equivalents, so manual calculation is unnecessary.
Furthermore, since we believe that "maintaining consistency" is what requires the most care in creating cash flow statements, we have made it easy to see that the total cash flow of each activity matches the change in cash calculated from cash amounts, and adjustment inputs are always registered so that the cash flow impact does not deviate. (Cash flow amounts and changes in cash are calculated separately, and we have made it possible to always check for inconsistencies.)

Step 3: Consolidated cash flow adjustment

The basic principles of cash flow are also applied to consolidated journal entries. In other words, by comparing the consolidated journal entries from the end of the previous period with those of the current period, the differences in the balance sheet and the profit or loss for the current period are converted into cash flow impact amounts, just as they are in separate financial statements.

Note that consolidated journal entries that remain largely unchanged between the end of the previous period and the current period do not affect cash flow.
For example, in cases such as capital consolidation, if there is no change in the scope of consolidation, often only the amortization of goodwill changes.
Furthermore, regarding internal transactions, the structure is such that (1) the cash flow of each company is recorded at the gross amount, and (2) the impact of eliminating internal transactions is offset by consolidated cash flow adjustments, so the adjustments are completed without any special effort.

Step 4: Cash Flow Worksheet

Finally, by arranging the individual cash flows of each company and the cash flow adjustment amounts from the consolidated journal entries in a layout similar to a consolidated worksheet, the consolidated cash flow statement is completed.

Just like the consolidated worksheet, the specifications—such as (1) listing the totals on the left, (2) being able to expand and collapse simple aggregates and consolidated journal entries, and (3) being able to click on simple aggregates and consolidated journal entries to trace them—are the same as those of the consolidated worksheet, ensuring that the intuitive ease of verification remains unchanged.

Conclusion

What did you think?
In this article, I explained the consolidated cash flow statement creation function of Money Forward Cloud Consolidated Accounting.
I have provided a lengthy explanation, but this feature incorporates many other detailed improvements, making it a tool that can dramatically improve the work of creating cash flow statements.
If you are struggling with the task of creating cash flow statements, I would appreciate it if you could consult with us via the link below.