Chapter 6 — Classification of Cash Flows

6.3 Operating Activities

ASC 230-10-20 defines operating activities as follows:

Operating activities include all transactions and other events that are not defined as investing or financing activities (see paragraphs 230-10-45-12 through 45-15). Operating activities generally involve producing and delivering goods and providing services. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income.

ASC 230-10

45-16 All of the following are cash inflows from operating activities:

Cash receipts from sales of goods or services, including receipts from collection or sale of accounts and both short- and long-term notes receivable from customers arising from those sales. The term goods includes certain loans and other debt and equity instruments of other entities that are acquired specifically for resale, as discussed in paragraph 230-10-45-21.
Cash receipts from returns on loans, other debt instruments of other entities, and equity securities — interest and dividends.
All other cash receipts that do not stem from transactions defined as investing or financing activities, such as amounts received to settle lawsuits and refunds from suppliers.

45-17 All of the following are cash outflows for operating activities:

a. Cash payments to acquire materials for manufacture or goods for resale, including principal payments on accounts and both short- and long-term notes payable to suppliers for those materials or goods. The term goods includes certain loans and other debt and equity instruments of other entities that are acquired specifically for resale, as discussed in paragraph 230-10-45-21.

b. Cash payments to other suppliers and employees for other goods or services.

c. Cash payments to governments for taxes, duties, fines, and other fees or penalties.[2]

d. Cash payments to lenders and other creditors for interest, 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. For all other debt instruments, an issuer shall not bifurcate cash payments to lenders and other creditors at settlement for amounts attributable to accreted interest related to the debt discount, nor classify such amounts as cash outflows for operating activities.

e. Cash payment made to settle an asset retirement obligation.

ee. Cash payments, or the portion of the payments, not made soon after the acquisition date of a business combination by an acquirer to settle a contingent consideration liability that exceed the amount of the contingent consideration liability recognized at the acquisition date, including measurement-period adjustments, less any amounts paid soon after the acquisition date to settle the contingent consideration liability. See also paragraph 230-10-45-15(f).

f. All other cash payments that do not stem from transactions defined as investing or financing activities, such as payments to settle lawsuits, cash contributions to charities, and cash refunds to customers.

45-18 Banks, brokers and dealers in securities, and other entities may carry securities and other assets in a trading account. Characteristics of trading account activities are described in Topics 255 and 940.

45-19 Cash receipts and cash payments resulting from purchases and sales of securities classified as trading debt securities accounted for in accordance with Topic 320 and equity securities accounted for in accordance with Topic 321 shall be classified pursuant to this Topic based on the nature and purpose for which the securities were acquired.

45-20 Cash receipts and cash payments resulting from purchases and sales of other securities and other assets shall be classified as operating cash flows if those assets are acquired specifically for resale and are carried at fair value in a trading account.

45-21 Some loans are similar to debt securities in a trading account in that they are originated or purchased specifically for resale and are held for short periods of time. Cash receipts and cash payments resulting from acquisitions and sales of loans also shall be classified as operating cash flows if those loans are acquired specifically for resale and are carried at fair value or at the lower of cost or fair value. For example, mortgage loans held for sale are required to be reported at the lower of cost or fair value in accordance with Topic 948.

Pending Content (Transition Guidance: ASC 326-10-65-1)

45-21 Some loans are similar to debt securities in a trading account in that they are originated or purchased specifically for resale and are held for short periods of time. Cash receipts and cash payments resulting from acquisitions and sales of loans also shall be classified as operating cash flows if those loans are acquired specifically for resale and are carried at fair value or at the lower of amortized cost basis or fair value. For example, mortgage loans held for sale are required to be reported at the lower of amortized cost basis or fair value in accordance with Topic 948.

45-21A Cash receipts resulting from the sale of donated financial assets (for example, donated debt or equity instruments) by NFPs that upon receipt were directed without any NFP-imposed limitations for sale and were converted nearly immediately into cash shall be classified as operating cash flows. If, however, the donor restricted the use of the contributed resource to a long-term purpose of the nature of those described in paragraph 230-10-45-14(c), then those cash receipts meeting all the conditions in this paragraph shall be classified as a financing activity.

Pending Content (Transition Guidance: ASC 350-60-65-1)

45-21A Cash receipts resulting from the sale of donated financial assets (for example, donated debt or equity instruments) or crypto assets accounted for in accordance with Subtopic 350-60 by NFPs that upon receipt were directed without any NFP-imposed limitations for sale and were converted nearly immediately into cash shall be classified as operating cash flows. If, however, the donor restricted the use of the contributed resource to a long-term purpose of the nature of those described in paragraph 230-10-45-14(c), then those cash receipts meeting all the conditions in this paragraph shall be classified as a financing activity.

The next sections address certain types of operating cash flows.

6.3.1 Long-Term Trade Receivables

As indicated above, ASC 230-10-45-16 states that cash collections from sales of goods or services on account are cash inflows from operating activities. Further, at the 2004 AICPA Conference on Current SEC and PCAOB Developments, Todd Hardiman, associate chief accountant in the SEC’s Division of Corporation Finance, emphasized that all cash collections stemming from the sale of inventory are operating cash flows, regardless of whether the cash flows represent:

Immediate cash collections from customers.
Collections of cash from receivables obtained in exchange for inventory (short-term or long-term).
The proceeds of the sale of customer receivables (originated in exchange for inventory) to third parties (e.g., in a securitization accounted for under ASC 860).

In addition, during the conference, Craig Olinger, deputy chief accountant in the SEC’s Division of Corporation Finance, indicated that this classification is required in situations in which the extension of credit is provided by a captive finance subsidiary.

Example 6-5

Company A sells a product for $500. The customer finances its purchase with a loan from Company B (a captive finance subsidiary of A). When B makes the loan to the customer, it remits $500 to its parent (A) on behalf of the customer.

For A, the initial transaction (sale of the product) is a noncash transaction. However, when B receives a payment on the loan from the customer, the payment should be treated as an operating cash flow in A’s consolidated financial statements because the payment is related to sales of A’s inventory.

6.3.2 Cash Proceeds From Insurance Claims

ASC 230-10-45-21B states that “[c]ash receipts resulting from the settlement of insurance claims, excluding proceeds received from [COLI] policies and [BOLI] policies, shall be classified on the basis of the related insurance coverage (that is, the nature of the loss).” In addition, for lump-sum settlements, “an entity shall determine the classification on the basis of the nature of each loss included in the settlement.” The purpose of such clarifications is to provide financial statement users with more relevant information.

For example, insurance settlement proceeds received as a result of a claim made in connection with the destruction of productive assets should be classified as cash inflows from investing activities because the settlement proceeds could be analogous to proceeds received on the sale of such assets. However, proceeds received as a result of claims related to a business interruption should be classified as operating activities.

6.3.3 Planned Major Maintenance

Transportation assets in certain industries (e.g., the airline and shipping industries) may be subject to major maintenance activities at specified intervals in accordance with regulations applicable to the industry. These activities are known as planned major maintenance activities. For example, vessels participating in the United States Coast Guard’s alternate compliance program with the American Bureau of Shipping must meet specified “seaworthiness” standards to maintain required operating certificates. To meet such standards, vessels must undergo regular inspection, monitoring, and maintenance, referred to as “dry-docking.” Typical dry-docking costs include costs for blasting and steel coating as well as steel replacement.

When determining an accounting policy for dry-docking costs, many shipping entities apply ASC 908 for analogous guidance on overhaul costs. ASC 908-360-25-2 provides three alternatives for accounting for overhaul costs:

Direct expensing method — Actual costs are expensed as incurred.
Built-in overhaul method — The costs of components subject to overhaul are segregated at purchase and are amortized to the date of the initial overhaul. The process is repeated thereafter.
Deferral method — Actual costs are capitalized and amortized to the next overhaul.

Informal discussions with the SEC staff have revealed that an entity should classify dry-docking expenditures in operating activities in the statement of cash flows, regardless of the method the entity uses to account for these expenditures.

However, classification of these expenditures as operating activities is not limited to dry-docking costs for shipping vessels and thus would apply to planned major maintenance activities in other industries.

6.3.4 Employee Benefit Plans

When an employer makes contributions (discretionary and nondiscretionary) to an employee benefit plan in connection with employee services rendered, such payments, although perhaps initially contributed to a trust, will ultimately be paid to employees. Therefore, the employer should classify those payments as cash flows for operating activities in the statement of cash flows, regardless of whether such payments are voluntary or are required by Employment Retirement Income Security Act of 1974.

Further, when an entity files for bankruptcy, it may enter into an agreement with the Pension Benefit Guaranty Corporation regarding its employee benefit plan liabilities. Typically, such an agreement requires the entity to make payments for its employee benefit plan liabilities at the time of, or after, its emergence from bankruptcy. Although these payments may extend over a number of years, they still ultimately concern employee services rendered and therefore should be classified as cash flows for operating activities in the statement of cash flows. This classification is required even if the entity is later required to apply “fresh-start” reporting under ASC 852. This classification is also consistent with views expressed by the SEC staff.

Footnotes

ASU 2016-09 removed from ASC 230-10-45-17(c) the notion that “the cash that would have been paid for income taxes if increases in the value of equity instruments issued under share-based payment arrangements that are not included in the cost of goods or services recognizable for financial reporting purposes also had not been deductible in determining taxable income. (This is the same amount reported as a financing cash inflow pursuant to paragraph 230-10-45-14(e).)”

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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.