Working Paper Series No.9707

1.Introduction: A Requirement for the Primary Financial Statement

The cash flows statement (CF as an abbreviation) is said to be the third primary financial statement. Indeed, it may be regarded as such from the perspective of reporting of CF (information use), but taking the perspective of recording (information production) into consideration, it seems that there is still room for examination. For example, the indirect method for CF which is widely used as a practical method is, as is well-known, drawn from BS (beginning and ending) and PL which are prepared systematically from the existing double-entry bookkeeping. Even if we prepare the CF by the journalizing procedure in a work sheet form, it can not be regarded as a primary financial statement directly led by the transaction records. In my opinion, double-entry bookkeeping for CF can not be accomplished without introducing the direct method.

In this paper, the following 3 points are examined. First, assuming that we have a double-entry bookkeeping system for cash flows recording/reporting, how and by which bookkeeping principles is it explained. Second, by comparing double-entry bookkeeping with that of income recording/reporting, we observe if they are different in nature. Third, taking these points into the consideration, we examine a recording and calculating system which leads PL, CF and BS .

2.The Bookkeeping for Cash Flows Recording/Reporting

(1)Types of Journal Entries

This section discusses bookkeeping for cash flows recording/reporting. First, we need to consider the principle of double-entry bookkeeping for cash flows recording/reporting, i.e., identifying the types of journal entries. Table 1 shows the types of journal entries for cash flows recording/reporting. Note that the signs used in this table are as follows: NC= non-cash assets, L= liability, K= paid-in capital, Π= retained earnings, C+= cash inflows, C-= cash outflows, △= flows.




Table 1 Types of Journal Entries







The points to be noticed here are that cash flows accounts are introduced as the explanatory accounts by the source of the flows (“flows account” in general terms), while, there are no income and loss accounts used in income recording/reporting. For example, the journal entry for a transaction that payroll expense 100 is paid by cash 100 is shown as: (Dr.) capital (or equity) 100 / (Cr.) payments of payroll 100 … (a). Note that the cash account does not appear in the journal entry due to the settlement of the cash flow accounts (see the dotted blank space in Table 11 in section 4), and the cash account remains as the beginning balance until all the flows accounts have been totaled and the sum has been transferred to the balance of cash account. In any case, there are 15 types of journal entries which form the foundation of double-entry journalizing for cash flows recording/reporting.

(2)The Structure of the Trial Balance

Now, we shall examine the structure of the trial balance (in terms of balance) of cash flows recording/reporting. Table 2 shows it by using the signs of accounts categories in Table 1. Other signs are as follows: C= cash, and suffix of b and e represent respectively beginning and ending balance.




Table 2 The Structure of the Trial Balance






If flow accounts C+ and C- are extracted from the table, it shows the direct method for CF (it includes not only operating activities but also financing and investing activities). Then, can it also be obtained from the stock accounts? As already mentioned, the balance of the cash account in table 2 is the beginning one, not the ending one. It is due to the property of the table where the difference of cash flow accounts (C+ − C- = △C) has yet to be transferred to the balance of the cash account. Thus, the calculation of net cash flows (△C) is also possible by using the stock accounts. It is indicated by the following equation: (L_e + K_e+ Π_e− NC_e)− C_b= C_e − C_b …(1). Note that equation (1) is obtained from the trial balance, namely, from the transaction records, the same as the direct method is. And the important point here is that net cash flows △C is calculated from two aspects; the flow account system (direct method) and the stock account system.

(3) The Calculation of the Indirect Method

Then, how is the calculation of net cash flows from the stock account described in equation (1) related to the indirect method? As widely known, the indirect method is led by the difference between the ending BS and the beginning BS (the table of the difference can be referred to as the balance change sheet). In this sense, it is not directly led by the transaction record; it means “indirect”. Now, the equation of the balance change sheet (Table 3) can be described as △C + △NC = △L + △K + ΔΠ…(2). From this equation, net cash flows of △C can be indicated as △C =ΔΠ + △L − △NC + △K …(3). This is the equation of the indirect method (it includes not only operating activities but also financing and investing activities). As the right side of equation (1) is developed as C_e − C_b = (L_e + K_e + Π_e−NC_e) −(L_b + K_b + Π_b − NC_b) = △L + △K + ΔΠ − △NC …(4), equation (3) shows the same formula as equation (1) calculated by the stock accounts, except that equation (3) is not directly led by transactions. The trial balance in terms of net flows (Table 4) shows its structure. The point here is that the outcome of equation (4) led by the trial balance is same as that of equation (3) led by the balance change sheet under the indirect method. That is, same calculation has been done by the stock accounts, and the only difference here is whether the net cash flows △C totaled from the cash flows accounts has been transferred to the balance of the cash account or not.




Table 3 Balance Change Sheet






Table 4 The Structure of the Trial Balance (in terms of net flows)






3.Comparison with the Bookkeeping for Income Recording/Reporting

(1) The Types of Journal Entries and the Structure of the Trial Balance

Now, the types of journal entries and the trial balance for income recording/reporting are shown in Table 5 and 6 where Π+ = revenue and Π- = expense.




Table 5 The Types of Journal Entries






Table 6 The Structure of the Trial Balance






In Table 5, there are no cash flows accounts and all the transactions involving cash flows are directly recorded in the cash account. On the contrary, income/loss transactions, which are directly recorded in the accountΠ in the double-entry bookkeeping for the cash flows recording/reporting described in section 2, are recorded individually here by using income/loss accounts (see the dotted blank space under the account Π in Table 11 in section 4). Thus, the account Π in the trial balance (Table 6) remains at the beginning balance (suppose there is no capital transaction). For example, the transaction (a) exampled in the previous section is shown here as: (Dr.) payroll expense 100 / (Cr.) cash 100 …(b). Comparing the relationship between the account C and cash flows account in the journal entry (a) and with that of between the account Π and the income/loss accounts in the journal entry (b), you can see a structural similarity in both double-entry bookkeeping systems.

Furthermore, Table 6 implies that there is a structural similarity in the dual-calculation system with that of CF. That is, the calculation based on the flows accounts can be indicated as Π₊−Π- (flow-oriented method), while that based on the stock account can be indicated as (A_ee− K_e) − Π_b = Π_e − Π_b (stock-oriented method) …(5). Eventually, following equation is obtained: Π_e − Π_b = Π₊ − Π- …(6). Setting this “dual-calculation” structure as the fundamental equation (accounting equation) into a bookkeeping system in advance, a bookkeeping system regulated by this accounting equation can be established. Here, we see the relation between the accounting structure and the bookkeeping system, broadly speaking, the relation between bookkeeping and accounting.




(2)The Direct and the Indirect Methods for Income Recording /Reporting

As you can easily see, the right side of equation (6) is the same method as that used in the direct method of cash flows recording/reporting; they both take the difference between inflows and outflows by the flows accounts. In other words, the income statement is the statement led by the direct method of income determination. As for the indirect method, the right side of equation (5) can be developed as follows:Π_e − Π_b = (A_e − L_e − K_e) − (A_b − L_b − K_b) = △A − △L − △K = △C + △NC − △L − △K …(7). This equation can be also obtained from the trial balance (Table 7) as we did in the cash flows recording/reporting. It should be noted that this equation results in the same calculation led by the balance change sheet (Table 3) as we also did in the previous section. Therefore, the right side of equation (7), especially △C + △NC − △L − △K is the same as the indirect method of income determination starting from △C.




Table 7 The Structure of the Trial Balance






Here, it should be also noted that the indirect method for CF and for PL can be respectively derived from the balance change sheet (Table 3) by extracting the respective ΔC and ΔΠ in the sheet, and that each method is also derived from the respective trial balances (Table 4 and Table 7).

Consequently, the left side of equation (6), which is one aspect of the dual-calculation for income determination, resulted in the “indirect method” stated here. And the point to be emphasized here is that income determination is also made from two perspectives: the flow-oriented method (direct method) by the flow account systems and the stock-oriented method (indirect method) by the stock account systems. It is all the same as was examined in the cash flows recording/reporting in the previous section, and we find here the structural similarity of dual-calculation between them.

　




4.A Bookkeeping System for Three Primary Financial Statements

We shall now examine a bookkeeping system for the three primary financial statements that are prepared systematically from transaction records. As discussed in the former sections, it seems evident that there is a common structure, i.e., the dual-calculation, in the two double-entry bookkeeping systems for PL/BS and for CF/BS. Furthermore, both of them share the same stock accounts of BS. Therefore it is quite possible that a new bookkeeping system which leads to three primary financial statements would be produced by combining the two double-entry bookkeeping systems. Accordingly, we now examine the types of journal entries and the trial balance for this new bookkeeping system.

(1)The Types of Journal Entries

As shown in Table 8, this new bookkeeping system includes 21 types (5×5 − 4) of journal entries instead of the existing 13 types (4×4 − 3 as shown in Table 5). It includes a new type of journal entry which comprehends both the income/loss transactions and the cash flows transactions; the flow accounts have to be set in both debit and credit sides. Such a journal entry does not exist in the present bookkeeping system.




Table 8 The Types of Journal Entries






Dividing assets A into the cash C and non-cash assets NC, the final BS can be shown as Table 9 (where C₀ is cash inflows from the paid-in capital K₀). Note that there is neither NC or L in the BS. Under the premise of “going concern” there is NC and L in the BS, but the relationship between C and NC / L and also the relationship between the two flow calculations, i.e., C₊ − C- and Π₊ − Π- become evident by observing the final status of the entity. The point to be emphasized here is that the relationship between the debit and credit side of the final BS is the identical relationship between cash (as a “concrete”) and capital/ income (as an “abstract”) each of which is the start and the end of the cash-cycle; it can be shown as C₀≡ K₀, C₊ − ≡ Π₊ − Π- …(8). Cash is not very different from capital and income in nature. This is exactly the nature of the capital and income (credit side) from the cash-cycle viewpoint.




Table 9 The Final Balance Sheet






(2) The Structure of the Trial Balance

As to the trial balance shown as Table 10, both the account C and Π remain at their beginning balance because both cash flows accounts and income/loss accounts are simultaneously introduced. Accordingly, the difference between the debit and the credit side of the stock accounts as well as that of the flows accounts becomes meaningless (the outcome is the difference of net income and net cash flows: △K − △Π).




Table 10 The Structure of the Trial Balance






Therefore, we here combine three account systems (two flows account systems and one stock account system) in a spread sheet form as shown in Table 11 instead of combining the three account systems in one T-form (Table 10). In Table 11, you can see that the two double-entry bookkeeping systems for PL/BS and for CF/BS described in the former sections are combined by their common stock accounts and that the dual-calculation for respective cash flows and income determination and beginning and ending balances of BS are all included.

Furthermore, it also shows the same formula of the indirect method based on the balance change sheet, namely, (ii)− (a) ＋ (b) − (c) for CF and (i) ＋ (a) − (b) − (c) for PL respectively which are derived from the (net flows) trial balance sheet, not from the balance change sheet. Note that △П shown as (ii) and △C shown as (i) are derived from the flows accounts instead of stock accounts.

Finally, it should be pointed out that a recording method is changeable by a change of recording media. That is, under the recording medium of “magnetism” (electronic data), the recording method which is restricted under the medium of “paper” is changeable, or developable. From this viewpoint, if we are free from the usual recording methods such as debit and credit entry, T-form and posting etc., the traditional recording system can be more efficiently organized to be a part of the software which manipulates the spread sheet, a sample of which is shown in Table 11. Therefore, it is important to recognize whether or not some issues in a recording method originate from restrictions due to the particular recording medium such as paper.




Table 11 The Spread Sheet Bookkeeping for Three Primary Financial Statements