6.2 Financing Activities

ASC 230-10-45-15(g) specifies that cash outflows for financing activities include “[p]ayments for debt prepayment or debt extinguishment costs, including third-party costs, premiums paid, and other fees paid to lenders that are directly related to the debt prepayment or debt extinguishment, excluding accrued interest.” Further, paragraph BC7 of ASU 2016-15 specifies that the EITF concluded that debt extinguishment costs “should include all costs for the prepayment or extinguishment of debt (that is, third-party costs, premiums paid to repurchase debt in an open-market transaction, and other fees paid to lenders).”

Although ASC 230 does not address debt modifications,1 we believe that when debt is restructured and is accounted for as a modification rather than as an extinguishment, an entity should follow the principles in ASC 230 and classify the fees paid to the creditor on the modification date as a financing cash outflow. Our view is based on the fact that, in accordance with ASC 470-50-40-17(b), fees paid to the creditor on the modification date are “associated with the . . . modified debt instrument” and (1) capitalized on the balance sheet as a reduction to the modified debt and (2) “amortized as an adjustment of interest expense over the remaining term of the . . . modified debt instrument using the interest method.” Since the fees paid to the creditor to modify the debt reduce the liability on the balance sheet, such fees are akin to the payment of principal (or a debt discount, which, on the balance sheet, is netted against the proceeds from the debt issued); accordingly, such payments would be presented as financing cash outflows in the statement of cash flows.

Further, we believe that any fees paid to a third party other than the creditor in connection with a debt modification, including those incurred in connection with a troubled debt restructuring (TDR), should generally be classified as operating cash outflows because, in accordance with ASC 470-50-40-18(b), the payment must be expensed. Therefore, since such fees enter into the determination of net income, they would be presented as operating activities. See Section 6.3 for further discussion of operating activities.

Direct costs of purchasing or selling NCIs in a subsidiary, when control is maintained, should generally be recorded as an adjustment to additional paid-in capital (APIC) and be classified as financing cash outflows in the statement of cash flows. However, indirect costs of purchasing or selling NCIs in a subsidiary, when control is maintained, should generally be reflected as an expense in the income statement and should be classified as operating cash outflows in the statement of cash flows. These conclusions are supported by analogies to ASC 810, SAB Topic 5.A, and the nonauthoritative guidance in AICPA Technical Q&As Section 4110.09.

SAB Topic 5.A provides guidance on accounting for costs related to the issuance of equity securities, stating that “[s]pecific incremental costs directly attributable to a proposed or actual offering of securities may properly be deferred and charged against the gross proceeds of the offering.” Therefore, direct costs of issuing equity securities are generally reflected as a reduction of the amount that would have otherwise been recorded in APIC. SAB Topic 5.A further states that “management salaries or other general and administrative expenses may not be allocated as costs of the offering and deferred costs of an aborted offering may not be deferred and charged against proceeds of a subsequent offering.” These indirect costs are generally reflected as an expense in the income statement.

In addition, the nonauthoritative guidance in AICPA Technical Q&As Section 4110.09 states that although there is no authoritative literature on costs entities incur to acquire their own stock, some “believe that costs associated with the acquisition of treasury stock should be treated in a manner similar to stock issue costs.” Under SAB Topic 5.A, direct costs associated with the acquisition of treasury stock may be added to the cost of the treasury stock.

Distributions to NCI holders (in their capacity as equity holders) are considered equity transactions and should be reflected as cash outflows for financing activities in accordance with ASC 230-10-45-15. Entities that determine that it is appropriate to classify the cash outflows associated with these distributions outside of financing activities in the statement of cash flows are encouraged to consult with their accounting advisers.

Although ASC 230-10-45-15(e) states that cash outflows for financing activities include debt issue costs, an entity may be able to classify such costs as operating cash flows in certain instances. Under ASC 470-50-40-21, when an entity modifies or exchanges a line-of-credit or revolving-debt arrangement with the same creditor, any costs and fees incurred in connection with a modification or exchange must “be deferred and amortized over the term of the new arrangement.” The cash flow classification of these costs may depend on whether the entity intends to immediately access the funds provided by the arrangement. If the entity intends to draw down on amounts provided by the line-of-credit or revolving-debt arrangement after the modification or exchange, the costs and fees associated with the modification or exchange would be classified as financing cash outflows in accordance with ASC 230-10-45-15(e). However, if the entity does not intend to draw down on amounts after the modification or exchange but has entered into the arrangement to have the ability to access cash in the future, we believe that it would be acceptable to present the costs and fees associated with the modification or exchange as operating cash flows.

When an entity receives advance payments from a third party in an agency relationship, which must be refunded to that same party or another third party, the cash receipts in these situations are akin to borrowings rather than for the provision of goods or services. The changes in those advance payments generally should be classified as financing activities in a manner consistent with our understanding of the SEC staff’s view that the holding of funds on behalf of others is analogous to proceeds received from borrowings. Under this view, an entity may conclude that, as with bank deposits, the predominant source of the related cash flows is the receipt of cash in a custodial or fiduciary capacity.

According to this view, the borrowings are considered outstanding until the custodial entity delivers the funds to satisfy its client obligations and such delivery is deemed a repayment of the borrowing. Therefore, the cash receipts should generally be presented as financing cash inflows, with the subsequent repayments classified as financing cash outflows.

We believe that an operating classification may also be acceptable. When a supplier receives up-front payments from a customer (i.e., the payment represents consideration for the goods or services that the supplier provides to the customer), the receipt of such advance payments should be presented as operating cash inflows in accordance with ASC 230-10-45-16(a). In addition, refunds of customer deposits represent operating cash outflows in accordance with ASC 230-10-45-17(f).

Entities that plan on presenting the cash flow activity from this type of arrangement within operating activities should consider consulting with their accounting and financial advisers. According to this view, an entity may conclude that the predominant source of the related cash flows is the receipt and disbursement of cash as part of the entity’s ordinary revenue-generating activities and an integral part of providing its service offering. See Section 4.1.3 for further discussion of the classification of funds held for others on the balance sheet.