3.1 Form and Content of the Statement of Cash Flows

The statement of cash flows should report the cash effects of operations, investing transactions, and financing transactions during a period. An entity can use the indirect method1 or the direct method2 to present the operating section of the statement of cash flows. ASC 230 contains examples illustrating the preparation of the statement of cash flows under both methods. ASC 230-10-45-25 encourages entities to use the direct method in presenting the operating section of the statement of cash flows and to report major classes of gross cash receipts and gross cash payments for operating cash flows. Further, entities are encouraged to use the direct method to include a detailed breakdown of operating cash receipts and payments to the extent that providing such detail is feasible and financial statement users find it helpful.

Although use of the direct method is encouraged, many entities apply the indirect method to present operating cash flows. However, entities employing the indirect method should consider the direct method when evaluating proper classification of operating cash flows.

ASC 230-10

45-28 Entities that choose not to provide information about major classes of operating cash receipts and payments by the direct method as encouraged in paragraph 230-10-45-25 shall determine and report the same amount for net cash flow from operating activities indirectly by adjusting net income of a business entity or change in net assets of a not-for-profit entity (NFP) to reconcile it to net cash flow from operating activities (the indirect or reconciliation method). That requires adjusting net income of a business entity or change in net assets of an NFP to remove both of the following:

The effects of all deferrals of past operating cash receipts and payments, such as changes during the period in inventory, deferred income, and the like, and all accruals of expected future operating cash receipts and payments, such as changes during the period in receivables and payables. Adjustments to net income of a business entity or change in net assets of an NFP to determine net cash flow from operating activities shall reflect accruals for interest earned but not received and interest incurred but not paid. Those accruals may be reflected in the statement of financial position in changes in assets and liabilities that relate to investing or financing activities, such as loans or deposits. However, interest credited directly to a deposit account that has the general characteristics of cash is a cash outflow of the payor and a cash inflow of the payee when the entry is made.
All items that are included in net income of a business entity or change in net assets of an NFP that do not affect net cash provided from, or used for, operating activities such as depreciation of property, plant, and equipment and amortization of finite-life intangible assets. This includes all items whose cash effects are related to investing or financing cash flows, such as gains or losses on sales of property, plant, and equipment and discontinued operations (which relate to investing activities), and gains or losses on extinguishment of debt (which relate to financing activities).

Regardless of which method is used, an entity must present a reconciliation of net income (or changes in net assets for NFPs) to net cash flows from operating activities. All major classes of reconciling items must be separately reported; further breakdowns of categories are encouraged if doing so would result in more meaningful information for users.

ASC 230-10

45-29 The reconciliation of net income of a business entity to net cash flow from operating activities described in paragraph 230-10-45-28 shall be provided regardless of whether the direct or indirect method of reporting net cash flow from operating activities is used. However, NFPs that use the direct method of reporting net cash flows from operations are not required to provide a reconciliation of change in net assets to net cash flow from operating activities. Additional guidance for NFPs is found in Subtopic 958-230. The reconciliation shall separately report all major classes of reconciling items. For example, major classes of deferrals of past operating cash receipts and payments and accruals of expected future operating cash receipts and payments, including, at a minimum, changes during the period in receivables pertaining to operating activities, in inventory, and in payables pertaining to operating activities, shall be separately reported. Entities are encouraged to provide further breakdowns of those categories that they consider meaningful. For example, changes in receivables from customers for an entity’s sale of goods or services might be reported separately from changes in other operating receivables.

45-30 If an entity other than an NFP uses the direct method of reporting net cash flow from operating activities, the reconciliation of net income to net cash flow from operating activities shall be provided in a separate schedule.

45-31 If the indirect method is used, the reconciliation may be either reported within the statement of cash flows or provided in a separate schedule, with the statement of cash flows reporting only the net cash flow from operating activities.

45-32 If the reconciliation is presented in the statement of cash flows, all adjustments to net income of a business entity or change in net assets of an NFP to determine net cash flow from operating activities shall be clearly identified as reconciling items.

At the 2005 AICPA Conference on Current SEC and PCAOB Developments (the 2005 AICPA Conference), SEC Associate Chief Accountant Joel Levine suggested that it is not appropriate to reconcile an amount other than net income (e.g., income from continuing operations) to net cash flows from operating activities in the statement of cash flows.

ASC 230-10-55-7 through 55-21 contain examples illustrating the presentation of the statement of cash flows under both the direct method and the indirect method.

NFPs have the option of presenting their statement of cash flows by using either the direct method or the indirect method. However, an NFP that chooses to use the direct method of cash flow reporting is not required to present or disclose (e.g., in a separate schedule) the indirect method reconciliation.

3.1.1 Supplemental Disclosure of Interest and Income Taxes Paid

The FASB requires an entity to provide supplemental disclosure of interest and income taxes paid. This is to ensure that entities provide operating cash flow information similarly regardless of whether they used the indirect method to present it. Paragraph 121 of the Basis for Conclusions of FASB Statement 95 states, in part:

To provide information about the gross amounts of at least those operating cash flows that are likely to be readily available, this Statement requires enterprises that use the indirect method of reporting net cash flow from operating activities to disclose amounts of interest and income taxes paid. The Board believes that that information usually will be readily available.

Accordingly, if an entity uses the indirect method to present the operating section of its statement of cash flows, ASC 230 requires it to disclose supplemental information regarding the payments made for interest and income taxes during the period. Specifically, ASC 230-10-50-2 states:

If the indirect method is used, amounts of interest paid (net of amounts capitalized), including the portion of the payments made to settle zero-coupon debt instruments that is attributable to accreted interest related to the debt discount or the portion of the payments made to settle other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing that is attributable to accreted interest related to the debt discount, and income taxes paid during the period shall be disclosed.

Although ASC 230-10-50-2 does not explicitly state whether an entity should provide this supplemental information on the face of the statement of cash flows or in the footnotes to the financial statements, we believe that either presentation is acceptable.

Changing Lanes

In December 2023, the FASB issued ASU 2023-09, which amends, among other things, the disclosure requirement in ASC 230-10-50-2 related to income taxes paid. Specifically, the amendments require an entity to disclose income taxes paid, disaggregated by foreign, domestic, and state taxes, with further disaggregation by jurisdiction on the basis of a quantitative threshold of 5 percent “of total income taxes paid (net of refunds received).” Further, comparative information for all periods presented is not required for the disclosures related to income taxes paid in an individual jurisdiction under ASC 740-10-50-23.

The ASU’s amendments are effective for public business entities for fiscal years beginning after December 15, 2024 (2025 for calendar-year-end public business entities). Entities other than public business entities have an additional year to adopt the guidance. Early adoption of the ASU is permitted.

3.1.1.1 Interest Paid

While ASC 230-10-50-2 provides guidance on certain amounts related to interest paid (e.g., payments for the settlement of zero-coupon debt instruments), it does not explicitly address whether an entity should include, in the interest paid amount, the cash flows associated with derivative contracts in a cash flow hedge of forecasted interest payments. We believe that if an entity classifies the cash flows resulting from derivative contracts in operating cash flows consistently with the cash flow classification of the item being hedged, it would be acceptable for the entity to include the cash flows resulting from those derivative contracts as part of its supplemental disclosure of interest paid. If an entity presents operating interest paid in this manner, we believe that the entity should explain that fact in its supplemental disclosure of interest paid.

3.1.1.2 Income Taxes Paid

3.1.1.2.1 Scope of Disclosures

ASC 230 requires entities to present income taxes paid as operating cash flows, other than remittances of minimum statutory withholding on share-based payment awards (see Section 7.3.5). However, the guidance does not directly address whether the supplemental disclosure of income taxes paid should include only cash outflows associated with current income taxes paid or whether it should also include other items related to income taxes. For example, it is unclear whether the supplemental disclosure of income taxes paid should include (1) interest and penalties paid that an entity presents as income tax expense under ASC 740, (2) refunds received from relevant income tax authorities, or (3) proceeds received from the disposal to third parties of transferable income tax credits (see Section 3.1.1.2.2). Given the lack of explicit guidance on what information to provide, we believe that it would be acceptable for an entity to choose which amounts related to income taxes to include in its supplemental disclosure of income taxes paid. If the entity chooses to present cash flows in the manner described above, the entity should specify which amounts comprise the income taxes paid.

3.1.1.2.2 Transferable Income Tax Credits

An entity may elect to account for transferable income tax credits (including the gains or losses from the sale or purchase of such credits) within the scope of ASC 740. We believe that such an entity may reflect the cash flows that result from the sale or purchase of transferable income tax credits within cash flows from operating activities in a manner consistent with the presentation of the cash flows that result from the settlement of other balances related to income taxes. In addition, we believe that it would be acceptable for an entity to present the cash flows that result from the sale or purchase of transferable income tax credits within the amount specified in its supplemental disclosure of income taxes paid during the period. Further, we think that an entity that presents these cash flows within its supplemental disclosure of income taxes paid during the period should disclose that fact, as described in Section 3.1.1.1.

Refundable tax credits (e.g., qualifying R&D credits in certain countries and state jurisdictions and alternative fuel tax credits for U.S. federal income tax) do not depend on an entity’s ongoing tax status or tax position; as a result, an entity could receive a refund despite being in a taxable loss position. Consequently, the refundable tax credits are similar to government grants and are generally accounted for similarly. For more information, see Section 7.8.

Footnotes

Under the indirect method, net cash provided or used by operating activities is determined by adding back or deducting from net income those items that do not affect cash (e.g., noncash transactions).

Under the direct method, major classes of gross cash receipts and payments and their arithmetic sum are reported to determine net cash provided or used by operating activities.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.