7.2 Constructive Receipt and Disbursement
|
An entity may enter into arrangements in
which cash is received by or disbursed to another party on
behalf of the entity. Although these arrangements may not
result in a direct exchange of cash to or from the entity,
the same economic result is achieved if cash is received by
or disbursed to the entity directly (i.e., constructive
receipt and constructive disbursement, respectively).
Consequently, it is often difficult to determine whether the
entity should report these cash flows in its statement of
cash flows.
|
In some industries, the entity (e.g., an automobile dealer) may finance its
purchases of inventory through the supplier and, in many cases, the finance entity
is a subsidiary of the supplier. The finance subsidiary pays the supplier directly
on behalf of the automobile dealer and no cash is disbursed by the dealer until the
inventory is sold. As discussed in the nonauthoritative guidance in AICPA Technical Q&As Section 1300.16, the
dealer reports purchases as increases in inventory and trade loans (a noncash
transaction), with repayments of the trade loans presented within operating
activities in the statement of cash flows.
However, when the finance entity is not a subsidiary of a supplier (i.e., a
third party), the amounts financed are not trade loans; rather, they are third-party
loans.1 As a result, they should be reflected as cash transactions in the dealer’s
statement of cash flows as follows:
-
Unrelated finance entity remits proceeds to the supplier (on behalf of the dealer) — The dealer should present this transaction as a financing cash inflow (to reflect the amount “received” from the third-party loan) and an operating cash outflow (to reflect the amount “paid” to purchase inventory).
-
Dealer repays loan to finance company — The dealer should present this transaction as a financing cash outflow.
This principle is applicable in other industries that may not have inventory
financing arrangements. For example, a company may purchase real estate by taking
out a mortgage with a third-party financing entity. At the closing of the purchase
transaction, the third-party lender electronically wires cash directly to an escrow
account, which in turn is wired directly to the seller. The cash from the mortgage
does not get deposited into the company’s bank account (or get paid out of the
company’s bank accounts) since it is paid directly from the lender to the seller as
part of closing escrow. Since the third-party lender is acting as the buyer’s agent
and transfers the proceeds of the mortgage directly to the escrow agent on behalf of
the buyer, the substance of the transaction is that the buyer received the proceeds
of the mortgage as a financing cash inflow and disbursed the purchase price of the
real estate as an investing cash outflow. Accordingly, the transaction should be
presented in such a manner in the company’s statement of cash flows.
Example 7-2
On December 30, 20X4, Entity A purchases a 12-month insurance
policy that requires the payment of $5 million to the
insurer at inception of the policy. To finance the
transaction, A arranges for a third-party lender to pay the
$5 million premium directly to the insurer as of the
policy’s inception date (i.e., A does not receive any cash
from the lender). Entity A is required to pay the lender
$1.25 million at inception, with the remaining amount
payable in 12 monthly installments.
On December 30, 20X4, Entity A records the following journal
entry to account for the transaction:
Although this arrangement does not result in a direct
exchange of cash to or from A, the same economic result
would be achieved if the cash had been received by or
disbursed to A directly. Therefore, on December 31, 20X4, A
should apply the guidance on constructive receipts and
disbursements and should present an operating cash outflow
for the full premium paid to the insurer (e.g., $5 million),
with a corresponding financing cash inflow for the borrowing
from the lender.
The subsequent monthly payments, excluding financing costs
(interest), are presented as a cash outflow from financing
activities.
Footnotes
1
This issue was discussed by an SEC staff member at the 2005
AICPA Conference on Current SEC and PCAOB Developments.