Intermediate Accounting Reporting and Analysis 3rd Edition

How are Cash Flows for Operating Activities Reported

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ETHICAL DILEMMA 21-9

Kyma Inc. manufactures and sells a variety of high-end electronic devices. Its most popular product, a portable satellite radio receiver, hs been a market leader for years and has helped the company amass a large amount of cash. However, Kym a 's financial performance has been somewhat disappointing over the last 2 years. Specifically, Kyma's return on assets hs decreased by two percentage points and its stock price has been stagnant. As Kyma's account the CEO has asked you to provide an analysis of the causes of these disappointing results and a recommendation that would increase the company's performance measures. Your examination of the company's financial results reveals that Kyma's large cash blance may be a factor in its disappointing performance. While the large cash balance increases the company's liquidity, the majority of these funds are invested in short-term, risk free financial instruments that yield approximately 2%. This low return is a significant cause of the company's declining return on assets measure and has many investors calling for an increased dividend, which the CEO is adamantly against. Instead of paying a dividend, you suggest that Kyma use the excess cash to finance its customers' purchases of the company's products he interest rate charged to provide this financial assistance will be much higher than the rate earned by Kym a's current investment strategy and this increased return is expected to add at least one percentage point to the company's return on assets.

The CEO is very excited about this proposal, but he is concerned about how the increased receivables created by the loans to customers will affect the company's cash flow from operating activities. You state that while this is not specifically addressed by GAAP, you feel that because customer loans arise from the sale of Kyma's products, the associated cash outflow should be classified as an operating activity. The CEO disagrees and decides that the cash outflow associated with the lending transaction is an investing activity. He reasons that because GAAP does not specifically address this issue, he has an obligation to the shareholders to make the company's financial statements look as good as possible. If Kyma classifies the lending transaction as an operating activity, it would report declining cash flow from operations and send an incorrect signal to the market as to the company's future. Furthermore, the CEO states that because the matter is simply a classification issue that does not change the company's total cash flow, no one would be hurt by classifying the transaction as an investing activity. How do you respond to the CEO's statements?