Chapter 7 — Common Issues Related to Cash Flows
Chapter 7 — Common Issues Related to Cash Flows
The previous chapters of this Roadmap describe general
principles and provide certain examples related to the
classification of cash flows between operating, financing, and
investing activities. This chapter addresses common issues
associated with the classification of cash flows as operating,
investing, or financing.
7.1 Foreign Currency Cash Flows
ASC 830-230
45-1 A
statement of cash flows of an entity with foreign currency
transactions or foreign operations shall report the
reporting currency equivalent of foreign currency cash flows
using the exchange rates in effect at the time of the cash
flows. An appropriately weighted average exchange rate for
the period may be used for translation if the result is
substantially the same as if the rates at the dates of the
cash flows were used. (That is, paragraph 830-30-45-3
applies to cash receipts and cash payments.) The statement
of cash flows shall report the effect of exchange rate
changes on cash, cash equivalents, and amounts generally
described as restricted cash or restricted cash equivalents
held in foreign currencies as a separate part of the
reconciliation of the change in the total of cash, cash
equivalents, and amounts generally described as restricted
cash or restricted cash equivalents during the period. See
Example 1 (paragraph 830-230-55-1) for an illustration of
this guidance.
Entities may have transactions that are denominated in a foreign currency or businesses that operate in foreign currency environments. An entity should report the cash flow effect of transactions denominated in a foreign currency by using the exchange rates in effect on the date of such cash flows. As noted in ASC 830-230-45-1, instead of using the actual exchange rate on the date of a foreign currency transaction, an entity may use “an appropriately weighted average exchange rate” for translation “if the result is substantially the same as if the rates at the dates of the cash flows were used.”
A consolidated entity with operations whose functional currencies are foreign currencies may use the following approach when preparing its consolidated statement of cash flows:
- Prepare a separate statement of cash flows for each foreign operation by using the operation’s functional currency.
- Translate the stand-alone cash flow statement prepared in the functional currency of each foreign entity into the reporting currency of the parent entity.
- Consolidate the individual translated statements of cash flows.
The effects of exchange rate changes, or translation gains and losses, are not the same as the effects of transaction gains and losses and should not be presented or calculated in the same manner.
Effects of exchange rate changes may have a direct impact on cash receipts and payments but do not directly result in cash flows themselves.
Because unrealized transaction gains and losses arising from the remeasurement
of foreign-currency-denominated monetary assets and liabilities on the balance sheet
date are generally included in the determination of net income, such amounts should
be presented as a reconciling item between net income and net cash from operating
activities (either on the face of the statement under the indirect method or in a
separate schedule under the direct method).
Subsequently, any cash flows arising from the settlement of the foreign-currency-denominated asset and liability should be presented in the statement of cash flows as an operating, investing, or financing activity on the basis of the nature of such cash flows.
Translation gains and losses, however, are recognized in OCI and are not
included in the cash flows from operating, investing, or financing activities.
The effects of exchange rate changes on cash should be shown as a separate line item in the statement of cash flows as part of the reconciliation of beginning and ending cash balances. This issue was discussed in paragraph 101 of the Basis for Conclusions of FASB Statement 95, which stated, in part:
The effects of exchange rate changes on assets and liabilities denominated in foreign currencies, like those of other price changes, may affect the amount of a cash receipt or payment. But exchange rate changes do not themselves give rise to cash flows, and their effects on items other than cash thus have no place in a statement of cash flows. To achieve its objective, a statement of cash flows should reflect the reporting currency equivalent of cash receipts and payments that occur in a foreign currency. Because the effect of exchange rate changes on the reporting currency equivalent of cash held in foreign currencies affects the change in an enterprise’s cash balance during a period but is not a cash receipt or payment, the Board decided that the effect of exchange rate changes on cash should be reported as a separate item in the reconciliation of beginning and ending balances of cash. [Emphasis added]
In a manner consistent with the implementation guidance in ASC 830-230-55-15,
the effect of exchange rate changes on cash and cash equivalents is the sum of the
following two components:
-
For each foreign operation, the difference between the exchange rates used in translating functional currency cash flows and the exchange rate at year-end multiplied by the net cash flow activity for the period measured in the functional currency.
-
The fluctuation in the exchange rates from the beginning of the year to the end of the year multiplied by the beginning cash balance denominated in currencies other than the reporting currency.
Example 1 of ASC 830-230-55-1 through 55-15 (see Appendix A) illustrates the
computation of the effect of exchange rate changes on cash. The example below
illustrates the translation of a statement of cash flows that was prepared in a
functional currency into a reporting currency.
Example 7-1
Company B, a wholly owned foreign subsidiary
of Company A whose reporting currency is the U.S. dollar
(USD), is a calendar-year-end company and uses the euro
(EUR) as its functional currency. Company B issues 200,000
shares of common stock with a par value of EUR 1 on January
1, 20X0. On May 24, 20X1, B issues long-term debt of EUR
240,000, and on July 26, 20X1, B purchases equipment for EUR
200,000. Company A translates B’s statement of cash flows
into A’s reporting currency to prepare its consolidated
statement of cash flows.
The exchange rates between the EUR and the
USD are as follows:
Balance
Sheet
Statement of Income
as of December 31, 20X1
Statement of
Comprehensive Income as of December 31,
20X1
Statement of Cash
Flows as of December 31, 20X1
Notes to Table:
(a) Common stock was issued on January 1, 20X0,
when the exchange rate was 1 EUR to 1.05 USD.
(b) Retained earnings represents beginning retained
earnings plus current-period net income.
Accordingly, beginning retained earnings is
translated by using the historical rate as of
December 31, 20X0 (1.10), and current-period net
income is translated by using the 20X1
weighted-average rate (1.15). The resulting foreign
exchange rate is 1.126 but is rounded up to 1.13 for
simplicity.
(c) CTA adjustment:
(d) 20X1 weighted-average rate is used.
(e) Equipment was purchased on July 26, 20X1, when
the exchange rate was 1 EUR to 1.19 USD.
(f) A long-term debt was issued on May 4, 20X1,
when the exchange rate was 1 EUR to 1.12 USD.
(g) Effect of foreign exchange rate changes on
cash:
(h) Represents the difference between the exchange
rate on December 31, 20X0, and that on December 31,
20X1.
(i) Represents the difference between the exchange
rate on December 31, 20X1, and the 20X1
weighted-average rate.
For more information about foreign currency accounting and reporting matters,
see Deloitte’s Roadmap Foreign
Currency Matters.
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.
Footnotes
1
This issue was discussed by an SEC staff member at the 2005
AICPA Conference on Current SEC and PCAOB Developments.
7.3 Stock Compensation
Because the receipt of employee services in exchange for a share-based payment award is a noncash item, the granting of such awards is not presented in the statement of cash flows.
However, in presenting cash flows under the indirect method, an entity would present the compensation cost recognized in net income in each reporting period as a reconciling item in arriving at cash flows from operations. In addition, an entity must present any cash paid by employees (e.g., the exercise price) to the entity for such awards as cash inflows from financing activities.
However, the complexity of stock compensation arrangements often leads to
additional presentation issues related to an entity’s statement of cash flows. This
section discusses the following presentation issues:
-
Cash received upon early exercise of a share-based payment award.
-
Income tax effects of share-based payment awards.
-
Settlement of equity-classified share-based payment awards.
-
Settlement of liability-classified share-based payment awards.
-
Remittances of statutory withholding on share-based payment awards.
For more information about the accounting for share-based payment awards, see
Deloitte’s Roadmap Share-Based
Payment Awards.
7.3.1 Cash Received Upon Early Exercise of a Share-Based Payment Award
An early exercise refers to an employee’s ability to change his or her tax position by exercising a share-based payment award and receiving shares before the completion of the requisite service period (i.e., before the award is vested). The early exercise of an award results in the employee’s deemed ownership of the shares for U.S. federal income tax purposes, which in turn results in the commencement of the holding period (under the tax law), allowing any subsequent appreciation in the value of the shares received (and realized upon the sale of those shares) to be taxed at a capital gains rate rather than an ordinary income tax rate.
Under ASC 718, an early exercise of a share-based payment award is not
considered substantive for accounting purposes (see ASC 718-10-55-31(a)). That
is, the share is not considered “issued” because the employee is still required
to perform the requisite service to earn the share. Although the share is not
considered issued, the cash received from the early exercise represents proceeds
from the issuance of an equity instrument and would still be classified as a
financing activity. As a result, such cash would be recognized as a cash inflow
from financing activities under ASC 230-10-45-14(a).
In addition, as defined in ASC 230-10-20, cash flows from operating activities are “generally the cash effects of transactions and other events that enter into the determination of net income.” A transaction in which cash is received from an employee who elects to early exercise an option is not the type of transaction that enters into the determination of net income.
7.3.2 Income Tax Effects of Share-Based Payment Awards
Before the issuance of ASU 2016-09, entities were required to present any realized
excess or deficient tax deductions (“excess tax benefit” or “tax deficiency”) on
a gross basis as separate components of financing activities.2 However, ASU 2016-09 clarified that the income tax effect of any excess
tax benefit or tax deficiency is recognized in the income statement; therefore,
excess tax benefits or tax deficiencies represent operating activities in a
manner consistent with other cash flows related to income taxes.
7.3.3 Settlement of Equity-Classified Share-Based Payment Awards
When settling an equity-classified share-based payment award, an entity presents the settlement in its statement of cash flows on the basis of whether the amount paid to settle the award is greater than or less than the fair-value-based measure of the award on the settlement date:
- Amount paid to settle the award does not exceed the fair-value-based measure of the award on the settlement date — In accordance with ASC 718-20-35-7, if the cash paid to repurchase the equity-classified award does not exceed the fair-value-based measure of the award on the repurchase date, the cash paid to repurchase the award is charged to equity. That is, repurchase of the equity-classified award is viewed as reacquisition of the entity’s equity instruments. Accordingly, the cash paid to reacquire the entity’s equity instruments is presented as a cash outflow for financing activities under ASC 230-10-45-15(a), which indicates that payments of dividends or other distributions to owners, including outlays to reacquire the entity’s equity instruments, are cash outflows for financing activities.
- Amount paid to settle the award exceeds the fair-value-based measure of the award on the settlement date — If the cash paid to repurchase the equity-classified award exceeds the fair-value-based measure of the award on the repurchase date, the cash paid in excess of the fair-value-based measure of the award is viewed as compensation for additional employee services and is recognized as additional compensation cost. Accordingly, if the equity-classified award is repurchased for an amount in excess of the fair-value-based measure, the portion of the cash paid to reacquire the entity’s equity instruments that equals the fair-value-based measure of the award is presented as a cash outflow for financing activities under ASC 230-10-45-15(a). The portion of the cash paid in excess of the fair-value-based measure, for additional employee services, is presented as a cash outflow for operating activities under ASC 230-10-45-17(b), which notes that cash payments to employees for services are cash outflows for operating activities.
Example 7-2
Company A is making a tender offer to repurchase $20 million of common stock in
the aggregate (the stock was originally distributed as
share-based compensation awards) from its current
employees. On the basis of an independent third-party
valuation, A concludes that the purchase price paid to
the employees for the common stock exceeds the fair
value of the common stock by a total of $4.5 million. In
accordance with ASC 718-20-35-7, the amount paid to
employees up to the fair value of common stock acquired
should be recognized in equity as a treasury stock
transaction and should therefore be presented as a cash
outflow for financing activities. The $4.5 million that
was paid in excess of the fair value of the common stock
constitutes compensation expense and is therefore
presented as a cash outflow for operating
activities.
7.3.4 Settlement of Liability-Classified Share-Based Payment Awards
In accordance with ASC 718-30, the grant-date fair-value-based measure and any
subsequent changes in the fair-value-based measure of a liability-classified
award through the date of settlement are recognized as compensation cost.
Accordingly, the cash paid to settle the liability-classified award is
effectively payment for employee services and is presented as a cash outflow for
operating activities under ASC 230-10-45-17(b).
Note that an entity may enter into an agreement to repurchase (or offer to repurchase) an equity-classified award for cash. Depending on the facts and circumstances, the agreement to repurchase (or offer to repurchase) may be accounted for as either (1) a settlement of the equity-classified award or (2) a modification of the equity-classified award that changes the award’s classification from equity to liability, followed by a settlement of the now liability-classified award.
If the agreement to repurchase (or offer to repurchase) is considered a
settlement of an equity-classified award, the cash paid to reacquire the
entity’s equity instruments is presented in a manner consistent with the
discussion in the previous section. If the agreement to repurchase (or offer to
repurchase) is considered a modification of the equity-classified award that
changes the award’s classification from equity to liability, the cash paid to
settle the liability-classified award should be presented in the statement of
cash flows in a manner similar to the conclusion above. That is, under ASC
230-10-45-17(b), the cash paid to settle the liability-classified award is
effectively payment for employee services and is presented as a cash outflow for
operating activities.
7.3.5 Remittances of Statutory Withholding on Share-Based Payment Awards
Regardless of whether the employer meets the employee’s statutory tax
withholding requirement for liability-classified or equity-classified
share-based payment awards through either a net settlement feature or a
repurchase of shares upon exercise of an employee share option (or vesting of a
nonvested share), an entity must account for the withholding as two transactions
in the statement of cash flows. That is, in substance, this transaction is (1) a
gross issuance of shares and (2) a repurchase of the amount of shares needed to
satisfy the employee’s statutory tax withholding requirement. Therefore, the
presentation in the statement of cash flows must also reflect the two
transactions.
First, the gross issuance of shares is presented as a financing activity. For example, the cash received for an employee share option as payment for the exercise price of the award is classified as a financing cash inflow. In contrast, for a nonvested share award, because no cash is received from the employee, the gross issuance of shares is presented as a noncash financing activity.
In the second step, when an employee elects to have shares withheld to satisfy
its statutory withholding tax obligation, the employer is deemed to have
repurchased a portion of the shares that were received by the employee in the
first step. While the employee does not receive cash directly, the employer has,
in substance, repurchased shares from the employee and remitted the cash
consideration to the tax authority on the employee’s behalf. Because the cash
payment is related to a repurchase of stock, it is presented as a financing cash
outflow.
In some circumstances, an exercise of the award may occur in one reporting
period while the amount withheld for tax purposes may not be remitted to the tax
authority by an employer, on behalf of the employee, until a subsequent
reporting period. In these circumstances, for the second step of the
transaction, the financing cash outflow is reported in the period in which the
cash is paid to the tax authority. In the initial reporting period, the employer
has issued the gross amount of shares and is deemed to have repurchased the
requisite number of shares needed to satisfy the employee’s statutory tax
withholding requirement by issuing a note payable to the employee. The note
payable issued for the repurchase amount is viewed as a noncash event that has
no impact on the statement of cash flows. In the subsequent reporting period,
the employer remits the payment for the note payable; however, the employee
requests that the amount be remitted to the tax authority on the employee’s
behalf instead of directly to the employee. This results in the financing cash
outflow.
Example 7-3
An entity grants 1,000 nonvested shares to an employee. The plan allows the
employer to net-settle the award to cover the statutory
tax withholding requirement. Upon vesting, the entity
withholds 250 shares to cover the statutory withholding
requirement and issues the employee the remaining 750
shares. For cash flow purposes, the entity must account
for this transaction as (1) the gross issuance of 1,000
shares and (2) the repurchase of 250 shares to satisfy
the statutory withholding requirement. Because no cash
is received from the employee for the nonvested share
award, the gross issuance of the 1,000 shares is
classified as a noncash financing activity. The
“repurchase,” through the net settlement feature, of the
250 shares to satisfy the statutory withholding
requirement is classified as a financing cash outflow.
The contemporaneous “receipt of cash,” through the net
settlement feature, from the employee and the remittance
of cash by the entity to the tax authority have no net
impact on the statement of cash flows.
Connecting the Dots
In June 2018, the FASB issued ASU 2018-07,3 which simplifies the accounting for share-based payments granted
to nonemployees for goods and services. Under the ASU, most of the
guidance on share-based payments to nonemployees is aligned with the
requirements for share-based payments granted to employees. As a result,
much of the guidance in ASC 718, including most of its requirements
related to classification and measurement of share-based payment awards
to employees, will apply to nonemployee share-based payment
arrangements. The ASU also revises ASC 230-10-45-15(a) to extend the
requirement to classify, as a financing activity, a repurchase of shares
to satisfy an employee’s statutory tax withholding obligation related to
share-based payments granted to nonemployees.
Footnotes
2
ASU 2016-09 removed ASC 230-10-45-14(e), which stated
that the following was a cash inflow from financing activities: “Cash
retained as a result of the tax deductibility of increases in the value
of equity instruments issued under share-based payment arrangements that
are not included in the cost of goods or services that is recognizable
for financial reporting purposes. For this purpose, excess tax benefits
shall be determined on an individual award (or portion thereof) basis.”
Such excess tax benefits were the same amounts that an entity was
required to show as an operating cash outflow in accordance with ASC
230-10-45-17(c), which the ASU also removed.
3
The amendments in ASU 2018-07 are effective for
public business entities for fiscal years beginning after
December 15, 2018, including interim periods within those fiscal
years. For all other entities, the amendments are effective for
fiscal years beginning after December 15, 2019, and interim
periods within fiscal years beginning after December 15, 2020.
Early adoption is permitted, provided that the adoption date is
no earlier than the date on which an entity adopts ASC 606.
7.4 Derivatives
ASC 230-10
Cash Receipts and
Payments Related to Hedging Activities
45-27 Generally, each cash receipt or payment is to be classified according to its nature without regard to whether it stems from an item intended as a hedge of another item. For example, the proceeds of a borrowing are a financing cash inflow even though the debt is intended as a hedge of an investment, and the purchase or sale of a futures contract is an investing activity even though the contract is intended as a hedge of a firm commitment to purchase inventory. However, cash flows from a derivative instrument that is accounted for as a fair value hedge or cash flow hedge may be classified in the same category as the cash flows from the items being hedged provided that the derivative instrument does not include an other-than-insignificant financing element at inception, other than a financing element inherently included in an at-the-market derivative instrument with no prepayments (that is, the forward points in an at-the-money forward contract) and that the accounting policy is disclosed. If the derivative instrument includes an other-than-insignificant financing element at inception, all cash inflows and outflows of the derivative instrument shall be considered cash flows from financing activities by the borrower. If for any reason hedge accounting for an instrument that hedges an identifiable transaction or event is discontinued, then any cash flows after the date of discontinuance shall be classified consistent with the nature of the instrument.
In accordance with the general principle in ASC 230-10-45-27, the presentation of
cash flows associated with derivatives depends on the nature of the underlying
instrument. Such presentation would therefore be affected by whether the instrument
contains an other-than-insignificant financing element, regardless of whether the
derivative is a hedging instrument. In situations in which an arrangement contains
an other-than-insignificant financing element, the borrower and lender under the
derivative instrument classify cash flows related to the derivative instrument as
financing activities and investing activities, respectively.
The table below summarizes common cash flow classifications for various derivative
transactions. These classifications are discussed in more detail throughout this
section.
Derivative Instrument
|
Classification of the Derivative’s Cash
Flows
|
---|---|
Derivatives with an other-than-insignificant
financing element at inception
|
Financing activities (for the deemed
borrower4) and generally investing activities (for the deemed
lender)
|
Derivatives acquired or originated for
trading purposes
|
Operating activities
|
Hedging derivatives
|
Investing activities
or
In the same category as the cash flows from
the item being hedged
|
Nonhedging derivatives
|
Investing activities
or
In accordance with the nature of the
derivative instrument as it is used in the context of the
entity’s business (if an economic hedge)
|
7.4.1 Determining Whether an Other-Than-Insignificant Financing Element Exists
ASC 815-10
45-11 An instrument accounted
for as a derivative instrument under this Subtopic that,
at its inception, includes off-market terms, or requires
an up-front cash payment, or both often contains a
financing element. Identifying a financing element
within a derivative instrument is a matter of judgment
that depends on facts and circumstances.
45-12 If an
other-than-insignificant financing element is present at
inception — other than a financing element inherently
included in an at-the-market derivative instrument with
no prepayments (that is, the forward points in an
at-the-money forward contract) — then the borrower shall
report all cash inflows and outflows associated with
that derivative instrument in a manner consistent with
financing activities as described in paragraphs
230-10-45-14 through 45-15.
45-13 An at-the-money
plain-vanilla interest rate swap that involves no
payments between the parties at inception would not be
considered as having a financing element present at
inception even though, due to the implicit forward rates
derived from the yield curve, the parties to the
contract have an expectation that the comparison of the
fixed and variable legs will result in payments being
made by one party in the earlier periods and being made
by the counterparty in the later periods of the swap's
term.
45-14 If a derivative
instrument is an at-the-money or out-of-the-money option
contract or contains an at-the-money or out-of-the-money
option contract, a payment made at inception to the
writer of the option for the option's time value by the
counterparty shall not be viewed as evidence that the
derivative instrument contains a financing element.
45-15 In contrast, if the
contractual terms of a derivative instrument have been
structured to ensure that net payments will be made by
one party in the earlier periods and subsequently
returned by the counterparty in the later periods of the
derivative instrument's term, that derivative instrument
shall be viewed as containing a financing element even
if the derivative instrument has a fair value of zero at
inception.
ASC 815-10-45-12 requires the deemed borrower of a financing
element in a derivative instrument to classify cash flows associated with the
derivative instrument as financing activities in accordance with ASC
230-10-45-14 and 45-15 if “an other-than-insignificant financing element is
present at inception — other than a financing element inherently included in an
at-the-market derivative instrument with no prepayments (that is, the forward
points in an at-the-money forward contract).” For example, an up-front payment
that does not represent compensation for the initial time value associated with
an at-the-money or out-of-the-money option may represent a financing element. To
determine whether a financing element is other than insignificant, an entity
often needs to use judgment and consider its specific facts and circumstances.
We have observed in practice that when making this determination, some entities
have compared the financing element with a reference amount (e.g., a comparison
to the present value of an at-the-market derivative’s fully prepaid amount).
ASC 230-10-45-27 requires an entity to evaluate whether an
other-than-insignificant financing element exists “at inception,” which is
generally the date on which the entity entered into the derivative instrument.
However, a modification made to the terms of the derivative instrument that
changes the timing or amount of cash flows is in substance a new derivative
instrument. Accordingly, the modification date would represent a new inception
date, and an entity would need to evaluate whether an other-than-insignificant
financing element exists on such date, if applicable. However, in the context of
derivative instruments modified as a result of the elimination of a benchmark
interest rate reference, we believe that an entity would not need to use the
modification date as the inception date if the entity elects to apply the
contract modification practical expedient provided under ASC 848.5 Therefore, an entity that elects to apply such practical expedient would
not need to reassess whether an other-than-insignificant financing element
exists on the modification date and, as a result, no reassessment to the cash
flow classification would be necessary.
7.4.2 Derivatives With an Other-Than-Insignificant Financing Element at Inception
Under ASC 230-10-45-27, if a derivative includes “an
other-than-insignificant financing element at inception, other than a financing
element inherently included in an at-the-market derivative instrument with no
prepayments (that is, the forward points in an at-the-money forward contract),”
the deemed borrower classifies all cash flows associated with that derivative
instrument as financing activities. While ASC 230 addresses the deemed
borrower’s classification of cash flows on a derivative with an
other-than-insignificant financing element at inception, it does not explicitly
address the deemed lender’s classification of such cash flows. In a
manner consistent with the guidance in ASC 230-10-45-27, it is appropriate for a
deemed lender to classify cash flows related to a derivative with an
other-than-insignificant financing element at inception as investing activities;
however, that classification may not be required in all circumstances. The
example below illustrates the classification of cash flows related to an
interest rate swap that is not a hedging derivative and contains an
other-than-insignificant financing element.
Example 7-4
In year 1, Entity A issues a five-year, $100 million
variable-rate corporate bond for which A pays the
secured overnight financing rate (SOFR) annually. To
minimize its exposure to fluctuations in interest rates,
A also enters into an interest rate swap agreement with
Bank B. Under the terms of the agreement, the fixed leg
of the interest rate swap is 8 percent, while the
interest rate at the inception of the instrument is 5
percent. Therefore, B will pay a premium to A at
inception. That is, A is deemed to borrow the amount of
the premium that would be repaid through higher payments
under the derivative instrument. The interest rate swap
is not designated as a hedging derivative.
Entity A concludes that the premium received at inception
represents a financing element that is other than
insignificant. Because the interest rate swap is not
designated as a hedging derivative and contains an
other-than-insignificant financing element at inception,
A should generally classify the cash flows associated
with the interest rate swap as financing
activities in its statement of cash flows since
A is the deemed borrower of the premiums received for
the swap. By contrast, B is considered the deemed lender
since B is making the premium payment at inception.
Therefore, B should classify the cash flows associated
with the interest rate swap as investing
activities in its statement of cash flows.
Note that A’s classification of the cash flows related to
the interest rate swap in this example would not be
affected if A had concluded that the instrument were a
hedging derivative.
The example below illustrates the classification of cash flows related to an
interest rate swap that is not a hedging derivative and does not contain an
other-than-insignificant financing element.
Example 7-5
Assume the same facts as in Example
7-4, except that Entity A concludes that
the interest rate swap does not contain an
other-than-insignificant financing element at inception.
Accordingly, the cash flows associated with the interest
rate swap should, on the basis of the guidance discussed
in Section 7.4.5, be classified either as
investing activities or in a
manner consistent with the nature of the derivative
instrument as it is used in the context of the entity’s
business. The interest rate swap arrangement derives its
periodic cash flows from an interest rate underlying and
was entered into to alter the entity’s periodic interest
payments. Therefore, because the cash payments for
interest are classified as operating
activities, it would be acceptable for A to
classify the cash flows from the derivative as operating
activities given the nature of the derivative instrument
as it is used in the context of the entity’s
business.
7.4.3 Derivatives Acquired or Originated for Trading Purposes
In accordance with ASC 230-10-45-19 through 45-21, cash receipts and payments
resulting from purchases and sales of securities, loans, and other assets that
are acquired specifically for resale must be classified as operating activities.
Thus, a trading entity that acquires derivatives as part of its trading business
should classify the cash flows from those derivatives as operating activities
(provided that those derivatives do not contain an other-than-insignificant
financing element at inception).
7.4.4 Hedging Derivatives
Under ASC 230-10-45-27, a cash receipt or payment related to a hedging
derivative should generally “be classified according to its nature without
regard to whether it stems from an item intended as a hedge of another item. For
example, the proceeds of a borrowing are a financing cash inflow even though the
debt is intended as a hedge of an investment, and the purchase or sale of a
futures contract is an investing activity even though the contract is intended
as a hedge of a firm commitment to purchase inventory.”
However, an entity may classify the cash flows from a derivative instrument that
is accounted for as a fair value hedge or a cash flow hedge (and that does not
contain an other-than-insignificant financing element at inception) in the same
category as the cash flows from the items being hedged as long as the entity has
elected and disclosed such classification as its accounting policy. Otherwise,
the entity should classify the cash flows from the derivative as an investing
activity under ASC 230-10-45-27. If periodic settlement payments are required
for the hedging derivative in a fair value or cash flow hedging relationship,
the cash flow classification of any termination or settlement payment should
generally be consistent with the classification of the periodic settlements.
If a derivative instrument (that does not contain an other-than-insignificant
financing element at inception) is designated as a hedging instrument in a hedge
of the foreign currency exposure related to a net investment in a foreign
operation, the cash flows from the derivative, including the cash flows
associated with the forward elements of the derivative, should generally be
classified as cash flows related to investing activities. This classification is
consistent with both the nature of the derivative and the nature of the hedged
item. If, however, an entity assesses the effectiveness of the net investment
hedging relationship by using the spot method, it is also acceptable for the
entity to classify the cash flows associated with the excluded component (e.g.,
the periodic settlement payments in a cross-currency interest rate swap)
according to their nature (i.e., as operating activities consistent with the
classification of interest payments and receipts) provided that such
classification is applied consistently and disclosed. However, the cash flow
classification of any termination or settlement payment for the derivative
should be consistent with the nature of the hedged item (i.e., as an investing
activity, because sales or purchases of the net investment would be an investing
activity).
The examples below illustrate an entity’s classification approaches when its accounting policy is to classify cash flows in the same category as the cash flows from the items being hedged.
Example 7-6
Entity A designates a forward-starting swap as a hedge of the forecasted
issuance of fixed-rate debt. The entity plans to issue
debt at par at the then-current market interest rate
(i.e., the market interest rate as of the date the debt
is issued) and will therefore have no variability in
debt proceeds; however, each of the probable interest
payments resulting from the debt is exposed to
variability up until the date of issuance. Accordingly,
the forward-starting swap is a hedge of the interest
payments, and the related cash flows should be
classified as operating activities in the statement of
cash flows.
Example 7-7
Entity B designates a forward-starting swap as a hedge of the forecasted
issuance of fixed-rate debt. The entity plans to issue
debt at a stipulated, fixed interest rate (4 percent,
regardless of current market rates as of the date the
debt is issued). As a result, the debt proceeds will be
variable (i.e., the debt will be issued at a discount or
a premium) because market rates will change during the
period leading up to the actual debt issuance date. The
interest payments are not exposed to variability (since
the entity has already determined the coupon it intends
to pay). Therefore, the forward-starting swap is a hedge
of the forecasted debt proceeds, and the cash flows on
the derivative should be classified as financing
activities in the statement of cash flows.
7.4.5 Nonhedging Derivatives
If a nonhedging derivative (1) does not contain an
other-than-insignificant financing element at inception and (2) was not acquired
or originated for trading purposes, as addressed in Sections
7.4.1 and 7.4.3, respectively, an entity
should apply the guidance discussed below.
Cash flows pertaining to physically settled derivatives related
to the entity’s ongoing revenue-producing and cost-generating activities should
generally be classified as operating activities in accordance with ASC
230-10-45-16(a) and ASC 230-10-45-17(a). For all other nonhedging derivatives,
ASC 230 does not specifically require an entity to classify cash flows as
investing activities; thus, an entity can make an accounting policy election to
apply either of the following approaches to nonhedging derivatives:
-
Classify the cash flows related to all other nonhedging derivatives as investing activities.
-
Classify the cash flows related to all other nonhedging derivatives in accordance with the nature of the derivative instrument as it is used in the context of the entity’s business.
When the cash flows associated with nonhedging derivatives are
material, an entity should disclose its policy for classifying the cash flows
associated with such instruments.
The table below outlines acceptable classifications for
nonhedging derivatives in the statement of cash flows. Note that in the
examples, none of the derivatives contain an other-than-insignificant financing
element at inception. Furthermore, when alternative classifications are
acceptable, the entity’s accounting policy election regarding the classification
of cash flows related to other nonhedging derivatives will dictate the proper
classification.
Derivative Example
|
Classification of the Derivative’s Cash
Flows
|
---|---|
A manufacturing entity enters into a
receive-variable, pay-fixed interest rate swap in
conjunction with the issuance of a floating-rate debt
instrument. The term of the interest-rate swap coincides
with the term of the debt, and the variable leg on the
swap is the same as the floating-rate index on the debt.
The interest-rate swap was entered into to alter the
economic interest cost related to the entity’s
floating-rate debt.
|
Investing activities or operating
activities.
Classification as an investing activity
is consistent with ASC 230-10-45-27.
Classification as an operating activity
is consistent with the nature of the derivative
instrument as it is used in the context of the entity’s
business. The derivative instrument derives its periodic
cash flows on the basis of an interest rate underlying
and was entered into to alter the entity’s interest
costs. Cash payments for interest are classified as
operating activities in accordance with ASC
230-10-45-17(d).
|
A real estate company enters into a
variable-rate debt agreement that requires it to make
interest payments indexed to SOFR and pay a spread
quarterly. To limit its exposure to interest rates above
8 percent, which is above the current SOFR plus the
spread, the company also enters into an interest rate
cap arrangement. The company pays a premium to enter
into the interest rate cap arrangement that is not
considered an other-than-insignificant financing
element.
|
Investing activities or operating activities.
Classification as an investing activity
is consistent with the guidance in ASC 230-10-45-27.
Classification as an operating activity
is consistent with the nature of the derivative
instrument as it is used in the context of the entity’s
business. The derivative instrument was entered into to
mitigate a potential increase in the entity’s interest
cost payments. Cash payments for interest costs are
classified as operating activities in accordance with
ASC 230-10-45-17(d).
|
A financial institution enters into a
foreign currency forward contract that requires it to
pay USD and receive EUR. The forward contract matures on
the same date as the maturity of the principal amount of
the institution’s EUR-denominated long-term debt. The
forward contract was entered into to alter the
USD-equivalent amount that must be paid at maturity of
the debt.
|
Investing activities or financing
activities.
Classification as an investing activity
is consistent with ASC 230-10-45-27.
Classification as a financing activity
is consistent with the nature of the derivative
instrument as it is used in the context of the entity’s
business. The derivative instrument derives its cash
flows on the basis of a currency underlying and was
entered into to alter the amount payable upon maturity
of the institution’s debt. Cash payments made to repay
amounts borrowed are classified as financing activities
in accordance with ASC 230-10-45-15(b).
|
A power generator that uses a gas-fired
plant to generate electricity enters into physically
settleable forward gas purchase contracts that are
within the scope of ASC 815. The gas purchased is used
to run the power plant.
|
Operating activities.
Since the derivative is physically
settled and the gas purchased is used to operate the
power plant, cash flows related to the derivative should
be classified as an operating activity. Otherwise, the
power generator could potentially reflect a significant
amount of its cost-generating activities as investing
activities.
|
A power generator that uses a gas-fired
plant to generate electricity enters into futures
contracts on gas to economically hedge its exposure to
gas prices. The power generator does not plan to take
delivery of the gas.
|
Investing activities or operating
activities.
Classification as an investing activity
is consistent with ASC 230-10-45-27.
Classification as an operating activity
is consistent with the nature of the derivative
instrument as it is used in the context of the entity’s
business. The derivative may be considered part of the
ongoing revenue-producing and cost-generating activities
of the power generator. Cash receipts and payments
related to sales and costs of goods sold are classified
as operating activities in accordance with ASC
230-10-45-16 and 45-17.
Note that since the derivative will be
net settled, the power generator is not required to
classify the cash flows as an operating activity.
|
An Internet advertising agency enters
into a one-year futures contract on crude oil. The
agency expects that crude oil prices will increase
between the trade date and maturity date of the futures
contract, resulting in a gain upon settlement. The
agency does not plan to take delivery of the crude oil.
The futures contract is not held for trading
purposes.
|
Investing activities.
Classification as an investing activity
is consistent with ASC 230-10-45-27. Such classification
is also consistent with the nature of the derivative
instrument as it is used in the context of the entity’s
business. The crude oil futures contract was entered
into for speculative or investment purposes.
|
In year 1, Entity D issues a 10-year, $400 million
variable-rate debt instrument. Entity D pays SOFR plus a
spread of 200 basis points annually. To hedge its
exposure to interest rate risk, D also enters into a
receive-variable, pay-fixed interest rate swap
agreement.
In year 3, D terminated the interest rate swap
arrangement.
|
Year 1:
Investing activities or operating
activities.
Classification as an investing activity is consistent
with the guidance in ASC 230-10-45-27.
Classification as an operating activity is consistent
with the nature of the derivative instrument as it is
used in the context of the entity’s business. The
derivative instrument derives its periodic cash flows on
the basis of an interest rate underlying and was entered
into to alter the entity’s interest costs. Cash payments
for interest are classified as operating activities in
accordance with ASC 230-10-45-17(d).
Year 3:
In a manner consistent with the classification of the
periodic settlements, D should classify cash flows
associated with the termination of the interest rate
swap as investing activities or operating
activities.
|
Footnotes
4
The “deemed borrower” refers to the
party that benefits from a financing element in a
derivative instrument in early periods of the
instrument’s term. For example, a party that
receives a premium upon entering into an arrangement
because of the arrangement’s off-market terms is
considered to be the deemed borrower.
5
See Section 8.2.2.2 of Deloitte’s Roadmap
Hedge Accounting for more
information about this practical expedient.
7.5 Business Combinations
Cash flows related to the purchases and sales of businesses, PP&E, and other
productive assets are presented as investing activities in the statement of cash
flows. In a business combination, all cash paid to purchase the business is
presented as a single line item in the statement of cash flows, net of any cash and
cash equivalents acquired (including acquired restricted cash and restricted cash
equivalents after the adoption of ASU 2016-18). That is, changes in the individual
assets acquired and liabilities assumed that occur on the acquisition date are no
longer reflected as separate line items in the statement of cash flows. After an
acquisition, the cash flows of the acquirer and acquiree are combined and presented
in a consolidated statement of cash flows.
An entity may also need to consider other financial reporting implications of a
business combination depending on the nature and terms of the transaction. For
example, any noncash effects of a business combination, such as an acquisition
involving noncash consideration (as described in Example
5-2), must be disclosed in a narrative format or summarized in a
schedule.
For additional considerations related to an entity’s accounting for a business
combination, see Deloitte’s Roadmap Business Combinations.
7.5.1 Presentation of Acquisition-Related Costs
When consummating a business combination, an acquirer frequently incurs acquisition-related costs such as advisory, legal, accounting, valuation, and professional and consulting fees. Except for certain debt and equity issuance costs, ASC 805 requires that an entity expense all such acquisition-related costs as incurred. The costs of issuing debt or equity securities as part of a business combination are recognized in accordance with other applicable accounting literature.
In the deliberations before the issuance of Statement 141(R) (codified in ASC 805), the FASB determined that acquisition-related costs are not considered part of the fair value exchange between the buyer and seller of the business; rather, they are separate transactions in which the buyer pays for services that it receives. Further, the definition of “operating activities” in the ASC master glossary states, in part, that “[c]ash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income.” Because acquisition-related costs accounted for under ASC 805 are expensed and affect net income, these costs should be reflected as operating cash outflows in the statement of cash flows.
7.5.2 Settlement of Acquired Liabilities After a Business Combination
After an acquisition, the acquirer may make payments to settle a liability legally assumed in a business combination. The cash outflow related to the settlement of the liability could be classified as an operating, investing, or financing activity depending on the nature of the payment. The payment should be classified as it would have been in the absence of the business combination. For example:
- If the payment was for inventory purchased on account, it would represent an operating cash outflow.
- If the payment was for PP&E that was purchased on account and was paid within three months of its original purchase date, it would represent an investing cash outflow.
- If the payment was in connection with a debt obligation legally assumed in an acquisition that remained outstanding after the acquisition, it would represent a financing cash outflow. However, as described below, if the payment is related to debt extinguished in conjunction with a business combination, the entity must consider certain facts and circumstances of the business combination to determine the appropriate presentation in its statement of cash flows.
7.5.3 Debt in a Business Combination
An acquirer may sometimes use cash to settle debt of the acquiree at or close to the acquisition date. In such cases, it is necessary to determine whether the cash distributed should be reported as consideration transferred to effect the acquisition or as cash paid to settle the debt assumed in the acquisition. While cash paid on the acquisition date to settle debt of the acquiree is generally reported as consideration transferred, cash paid close to the acquisition date to settle debt of the acquiree might also be reported as consideration transferred if the acquirer is deemed not to have assumed the risks inherent in the debt (e.g., when the separation of the payment from the acquisition date is more administrative).
The classification in the statement of cash flows of cash paid to settle the
acquiree’s debt in a business combination should be consistent with the
acquirer’s treatment of the debt in acquisition accounting (i.e., whether the
debt was treated as a liability assumed in acquisition accounting). If the
acquirer concludes that it assumes the acquiree’s debt as part of the business
combination, the acquirer will generally present the extinguishment as a
financing activity (in a manner consistent with how it would present the
repayment of a debt obligation outside of a business combination). Conversely,
if the acquirer concludes that it does not assume the acquiree’s debt as part of
the business combination that was subsequently extinguished, the acquirer will
generally present the extinguishment as an investing activity (in a manner
consistent with how it would present cash consideration paid in a business
combination). The example below illustrates an acquisition in which the acquirer
does not assume the acquiree's debt.
Example 7-8
Company A acquires Company B in a business combination. Before the acquisition, B had $1 million in outstanding debt owed to a third-party bank. Company A pays the seller $5 million in cash and repays the $1 million debt upon the closing of the business combination. Company A concludes that it did not assume B’s debt (i.e., that it repaid the debt on B’s behalf). As of the acquisition date, B’s net assets recognized in accordance with ASC 805 are $4 million. Company A calculates the goodwill resulting from the acquisition of B as follows:
Because A did not assume B’s debt, the total consideration transferred is $6 million in cash. Therefore, A should present the $6 million as an investing outflow in its statement of cash flows.
In the example below, the acquirer has assumed the acquiree's debt.
Example 7-9
Assume the same facts as in the example above, except that Company A concludes
that it assumed Company B’s debt. As a result, B’s net
assets recognized in accordance with ASC 805 are $3
million (i.e., $4 million less $1 million in debt).
Company A calculates the goodwill resulting from the
acquisition of B as follows:
Because A assumed B’s debt, the consideration transferred is $5 million in cash paid to the seller, and the $1 million to repay B’s debt is a liability assumed in the acquisition accounting. Therefore, A should present $5 million as an investing outflow and $1 million as a financing outflow in its statement of cash flows.
7.5.4 Contingent Consideration in a Business Combination
ASC 805 requires the acquirer to recognize the acquisition-date fair value of the contingent consideration arrangement as part of the consideration transferred in exchange for the acquiree. The contingent consideration arrangement is classified either as a liability or as equity in accordance with applicable U.S. GAAP.
7.5.4.1 Contingent Consideration Classified as a Liability
If the acquiring entity determines that the contingent consideration arrangement
should be classified as a liability, the initial fair value of the
contingent consideration as of the acquisition date should be reflected as a
noncash investing activity. In accordance with
ASC 230-10-50-3, this arrangement should be either disclosed narratively or
summarized in a schedule because no cash consideration is transferred on the
acquisition date. It should not be reflected in investing activities. In
subsequent periods, the contingent consideration liability must be
remeasured at fair value as of each reporting date until the contingency is
resolved, with the changes recognized as an expense in the determination of
earnings (unless the change is the result of a measurement-period adjustment
or the arrangement is a hedging instrument for which ASC 815 requires
changes to be recognized in OCI). Because the subsequent fair value
adjustment enters into the determination of the acquiring entity’s net
income and is a noncash item, it should be reflected as a reconciling item
between net income and cash flows from operating activities in the statement
of cash flows.
If the contingent consideration is satisfied in either cash or cash
equivalents upon resolution of the contingency, the classification of
payments made to settle the contingent consideration liability should be
determined on the basis of when such payments are made in relation to the
date of the business combination. Essentially, classification of the
payments depends on whether they are made soon after the acquisition in a
business combination transaction. While ASC 230 does not define the term
“soon after,” we generally believe that this term would apply to payments
made within three months or less of the acquisition date. This view is also
consistent with paragraph BC16 of ASU 2016-15, which states that “some Task
Force members believe that a payment for contingent consideration that was
made soon after a business combination is an extension of the cash paid for
the business acquisition (an investing activity), if that payment for
contingent consideration was made within a relatively short period of time
after the acquisition date (for example, three months or less).” Therefore,
because a payment made on or soon after the business combination date (to
settle the liability related to contingent consideration) is viewed as an
extension of the business combination, such payments made soon after the
date of the business combination are presented as investing activities in
the acquirer’s statement of cash flows in accordance with ASC
230-10-45-13(d).
Conversely, contingent consideration payments that are not made on the acquisition date or soon after the business combination are not viewed as an extension of the business combination. Therefore, such payments should be separated and presented as:
- Financing cash flows — The cash paid to settle the contingent consideration liability recognized at fair value as of the acquisition date (including measurement-period adjustments), less payments made soon after the business combination date, should be reflected as a cash outflow for financing activities in accordance with ASC 230-10-45-15(f).
- Operating cash flows — The cash payments not made soon after the business combination date that exceed those classified as financing activities should be reflected as a cash outflow for operating activities in accordance with ASC 230-10-45-17(ee).
As indicated in paragraph BC14 of ASU 2016-15, the separation of contingent consideration payments not made soon after the business combination date is consistent with the approach most entities used before the ASU was issued. Paragraph BC14 further notes that this approach is the one that is most closely aligned with certain principles in ASC 230.
These principles include:
- The cash paid to settle the contingent consideration liability recognized at fair value as of the acquisition date (including measurement-period adjustments) should be reflected as a cash outflow for financing activities in the statement of cash flows. Effectively, the acquiring entity financed the acquisition and the cash outflow therefore represents a subsequent payment of principal on the borrowing and should be reflected in accordance with ASC 230-10-45-15(f).
- The remaining portion of the amount received/paid (i.e., the changes in fair value of the contingent consideration liability after the acquisition date) should be reflected as a cash inflow/outflow from operating activities because the fair value adjustments were recognized in earnings. If the amount paid to settle the contingent consideration liability is less than the amount recorded on the acquisition date (i.e., the fair value of the contingent consideration decreased), the entity would only reflect the portion of the liability that was paid as a cash outflow for financing activities. The difference between the liability and the amount paid is a fair value adjustment. This adjustment enters into the determination of the acquiring entity’s net income and is a noncash item, so it should be reflected as a reconciling item between net income and cash flows from operating activities in the consolidated statement of cash flows.
Example 7-10
On December 1, 20X2, Company A (a calendar-year-end private company) acquires 100 percent of Company B for
$1 million. The purchase agreement includes a contingent consideration arrangement under which A agrees to pay additional cash consideration if the earnings of B (which will be operated as a separate subsidiary of A) exceed a specified target for the year ended December 31, 20X3. Company A classifies the contingent consideration arrangement as a liability and records the contingent consideration liability at its acquisition-date fair value amount, provisionally determined to be $500,000.
On April 15, 20X3, A finalizes its valuation of the contingent consideration liability. Therefore, A estimates the acquisition-date fair value of the contingent consideration liability to be $600,000 and records a measurement-period adjustment for $100,000 (the measurement-period adjustment related to facts and circumstances that existed as of the acquisition date), with an offsetting adjustment to goodwill.
Company B achieves the performance target for the year ended December 31, 20X3; accordingly, A determines that it must pay $750,000 to B’s former owners to settle the contingent consideration arrangement. For the year ended December 31, 20X3, A recognizes $150,000 ($750,000 – $600,000) in earnings to reflect the subsequent remeasurement of the contingent consideration liability to fair value. On January 31, 20X4, A settles the obligation.
No payments to settle the liability for contingent consideration were made soon after the business acquisition date.
Company A would present the following amounts in its statement of cash flows for the years ended:
- December 31, 20X2 — The provisional accrual of $500,000 would be reflected as a noncash investing activity and would be either disclosed narratively or summarized in a schedule.
- December 31, 20X3 — The adjustment to the provisional accrual of $100,000 would be reflected as a noncash investing activity and would be either disclosed narratively or summarized in a schedule. The subsequent remeasurement adjustment to the contingent consideration liability of $150,000 would be reflected as a reconciling item between net income and cash flows from operating activities.
- December 31, 20X4 — Of the $750,000 paid, $600,000 represents the amount to settle the contingent consideration liability recognized at fair value as of the acquisition date (including measurement-period adjustments) and should be reflected as a cash outflow for financing activities. The remaining portion of the $750,000 paid (i.e., the $150,000 change in fair value of the contingent consideration liability after the acquisition date) should be reflected as a cash outflow for operating activities because the fair value adjustments were recognized in earnings.
Example 7-11
Assume the same facts as in the example above except that when B achieves the
performance target for the year ended December 31,
20X3, A determines that it only needs to pay
$550,000 to B’s former owners to settle the
contingent consideration arrangement. For the year
ended December 31, 20X3, A recognizes a credit of
$50,000 ($550,000 – $600,000) in earnings to reflect
the subsequent remeasurement of the contingent
consideration liability to fair value.
Company A would present the same amounts as those in the example above in its
statement of cash flows for the year ended December
31, 20X2. Company A would then present the following
amounts for the years ended:
-
December 31, 20X3 — The adjustment to the provisional accrual of $100,000 would be reflected as a noncash investing activity and would be either disclosed narratively or summarized in a schedule. The subsequent remeasurement adjustment to the contingent consideration liability of $50,000 would be reflected as a reconciling item between net income and cash flows from operating activities.
-
December 31, 20X4 — The entire amount of the $550,000 paid represents the amount to settle the contingent consideration liability recognized at fair value as of the acquisition date (including measurement-period adjustments) and should be reflected as a cash outflow for financing activities.
7.5.4.2 Contingent Consideration Classified as Equity
If the acquiring entity determines that the contingent consideration arrangement
should be classified as equity, it is not required to remeasure the amount
recorded as of the acquisition date at fair value as of each reporting
period after the acquisition date. The initial recognition of the contingent
consideration arrangement as of the acquisition date (including
measurement-period adjustments), as well as the issuance of shares to settle
the contingent consideration arrangement on the date the contingency is
resolved, should be reflected as noncash investing and financing activities
and, in accordance with ASC 230-10-50-3, should be either disclosed
narratively or summarized in a schedule.
7.5.4.3 Unit-of-Account Considerations
Contingent consideration arrangements in a business
combination may contain multiple contingent payment triggers. With respect
to the statement of cash flows, neither ASC 230 nor ASC 805 provides
explicit guidance on the unit of account, including when multiple payments
are specified in a contingent consideration arrangement; that is, neither
contains authoritative guidance on whether such payment arrangements should
be viewed as a single unit of account or multiple units of account. This
determination could also affect whether the arrangement qualifies as equity
or a liability (in whole or in part) and, accordingly, the presentation in
the statement of cash flows (as discussed in Sections 7.5.4.1 and 7.5.4.2).
Given the lack of on-point guidance in ASC 230 and ASC 805, an entity may
need to use significant judgment in determining the unit of account. We
believe that for cash flow statement reporting, entities should use the same
unit-of-account determination as that used to determine the classification
of the contingent consideration arrangement as a liability or equity. This
determination is made on the basis of the following definition of a
freestanding financial instrument in the ASC master glossary:
A
financial instrument that meets either of the following conditions:
- It is entered into separately and apart from any of the entity’s other financial instruments or equity transactions.
- It is entered into in conjunction with some other transaction and is legally detachable and separately exercisable.
Note that in applying this definition to a contingent consideration
arrangement, an entity must use judgment and must consider both the form and
substance of the arrangement. The following matters may be relevant to consider:
-
Whether the counterparty to the arrangement has the ability to transfer its rights and, if so, whether these rights may be transferred in discrete denominations or the entire arrangement must be transferred in totality.
-
The interdependency of the risks and payment triggers — that is, whether there are shared or independent risks and triggers, which could include whether future triggers (and therefore payments of contingent consideration) may change prior payments in such a way that the acquirer can recover or “claw back” previous amounts paid.Connecting the DotsIn evaluating the interdependency of the risks and payment triggers, an entity should consider the duration of the measurement period for each contingent payment trigger to determine whether each measurement period represents a substantively discrete reporting period. Given the lack of other authoritative guidance defining what period would comprise a substantive discrete period, entities will need to carefully consider the relevant facts and circumstances. However, we believe that to have discrete periods, and therefore separate units of account, each discrete period needs to consist of a substantive period. For example, we believe that measurement periods of less than three months generally would not be substantive (on a basis consistent with interim reporting periods for an SEC registrant). Measurement periods of one year or more generally would be considered substantive. An entity must use judgment and consider the specific facts and circumstances in determining whether measurement periods between three months and one year are substantive.
-
Whether there is an economic need or a substantive business purpose for structuring payments of contingent consideration separately. Entities may find the guidance in ASC 815-10-15-8 and 15-9 useful in this evaluation.
Section
5.7.2.1 of Deloitte’s Roadmap Business Combinations provides
additional guidance on the unit of account for contingent consideration
arrangements and includes numerous examples. Because an entity may need to
use significant judgment in determining the unit of account when there is
more than one contingent payment trigger in a contingent consideration
arrangement, we encourage entities to consider consultation with their
accounting and financial advisers.
7.5.5 Acquired IPR&D Assets With No Alternative Future Use
In accordance with ASC 730, IPR&D assets acquired in an
asset acquisition rather than in a business combination should be expensed as of
the acquisition date unless such assets have an alternative future use, in which
case they should be capitalized. All IPR&D assets acquired in a business
combination should initially be capitalized regardless of whether they have an
alternative future use. For more information, see Chapter 4 of Deloitte’s
Life Sciences Industry Accounting Guide.
We have observed diversity in practice related to how cash
payments for IPR&D assets acquired in an asset acquisition are reported in
the statement of cash flows when such assets have no alternative future use.
While some entities classify the cash payments in operating activities, other
entities classify them in investing activities. Given the lack of authoritative
guidance on this matter and the diversity in practice, we believe that it is
acceptable for an entity to present cash payments related to the IPR&D
assets acquired in an asset acquisition that have no alternative use as either
operating or investing activities. This election is an accounting policy matter
that an entity should consistently apply to similar arrangements and disclose if
material.
Considerations related to the classification as operating or
investing activities include:
-
Operating activities — Classification in operating activities of cash outflows for IPR&D assets acquired in an asset acquisition that do not have an alternative future use is supported by the following:
-
ASC 230 does not specifically define such cash outflows as investing or financing activities.
-
Since such cash outflows are immediately expensed, they represent “the cash effects of transactions and other events that enter into the determination of net income” in a manner consistent with the definition of operating activities in the ASC master glossary.
-
-
Investing activities — Classification in investing activities of cash outflows for IPR&D assets acquired in an asset acquisition that do not have an alternative future use is supported by the following Q&A in paragraph 5.12 of the AICPA Accounting and Valuation Guide Assets Acquired to Be Used in Research and Development Activities:Question 1: How should an acquiring entity classify in its statement of cash flows an R&D charge associated with the costs of IPR&D projects acquired as part of an asset acquisition that have no alternative future use?Answer: Best practices suggest that an acquiring entity should report its cash acquisition of assets to be used in R&D activities as an investing outflow in its statement of cash flows. In this regard, an acquiring entity should treat assets acquired to be used in R&D activities similar to how it reports other acquired assets in the statement of cash flows. Although acquired IPR&D may lack an alternative future use and, therefore, would be expensed immediately, it is still an asset for cash flow statement purposes.When arriving at cash flows from operating activities under the indirect method of reporting cash flows, best practices suggest that an acquiring entity should add back to net income the costs of assets acquired to be used in R&D activities that are charged to expense. That adjustment is necessary to eliminate from operating cash flows those cash outflows of assets acquired to be used in R&D activities that are reflected in investing activities.In addition, if the cash outflows are treated as investing activities, the cash flow reporting of IPR&D assets acquired in a business combination would be aligned with that of IPR&D assets acquired in an asset acquisition.
7.5.6 Break-Up Fees Resulting From a Failed Business Combination
In a merger or other business combination, a terminating party
may be required to pay a “break-up” fee or termination payment to the other
party involved in the transaction. While ASC 230 does not address the
classification of break-up or termination payments, we believe that the guidance
in ASC 230-10-45-17(f) applies in such circumstances. ASC 230-10-45-17(f) states
that cash outflows for operating activities include “[a]ll 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.” As a result, amounts paid or received in connection with
a failed merger or business combination would be classified as operating cash
flows.
7.6 Leases
ASU
2016-02 (codified in ASC 842), which revised the leasing
guidance in U.S. GAAP, became effective for calendar-year-end public business
entities on January 1, 2019. In response to the global COVID-19 pandemic, the FASB
issued ASU
2020-05 in June 2020 to (1) delay the effective date of ASC 606
for certain nonpublic entities by one year and (2) defer the effective date of ASC
842 to fiscal years beginning after December 15, 2021, for certain public business
entities (e.g., NFPs) and all nonpublic entities.
An entity adopts ASC 842 by using a modified retrospective approach.
Under this approach, the standard is effectively implemented either (1) as of the
earliest period presented and through the comparative periods in the entity’s
financial statements or (2) as of the effective date of ASC 842, with a
cumulative-effect adjustment to equity. Upon transition to ASC 842, lessees will
bring most leases onto the balance sheet and will disclose them as noncash investing
and financing activities. For a more detailed understanding of the requirements of
ASC 842, see Deloitte’s Roadmap Leases.
7.6.1 Initial and Subsequent Recognition of Leases
Before the Adoption of ASC
842
7.6.1.1 Capital Leases
In accordance with ASC 840, for a capital lease, a lessee recognizes a lease asset and lease liability at lease commencement. Accordingly, the lessee would account for the capital lease transaction in its statement of cash flows at lease commencement as a noncash investing and financing transaction, as discussed in ASC 230-10-50-4, which states:
Examples of noncash investing and financing transactions are converting debt to equity; acquiring assets by assuming directly related liabilities, such as purchasing a building by incurring a mortgage to the seller; obtaining an asset by entering into a capital lease; obtaining a building or investment asset by receiving a gift; and exchanging noncash assets or liabilities for other noncash assets or liabilities. [Emphasis added]
In other words, the statement of cash flows would not be affected by the noncash
nature of a situation in which an entity enters into a capital lease.
Instead, the entity would only provide noncash investing and financing
disclosures (see Chapter
5 for more information). Subsequently, when the lessee makes
principal payments under a capital lease, the lessee should reflect the
principal payment as a cash outflow from a financing activity in the
statement of cash flows. The portion of the capital lease payment that
reflects the interest payment should be classified as a cash outflow from an
operating activity in the statement of cash flows.
7.6.1.2 Operating Leases
Under ASC 840, there is no balance sheet recognition at lease commencement for operating leases. Consequently, there is no accounting for the lessee’s operating lease transaction at lease commencement in the lessee’s statement of cash flows. Subsequently, lease payments are presented as cash outflows from operating activities in the lessee’s statement of cash flows in a manner consistent with how the lease expense is recognized in the lessee’s income statement.
After the Adoption of ASC
842
7.6.1.3 Lessee Presentation
In accordance with ASC 842, upon entering into operating and finance leases, a lessee records on its balance sheet a right-of-use (ROU) asset and lease liability as of lease commencement. Accordingly, upon initial recognition of an ROU asset and lease liability at lease commencement, the lessee would disclose the recognition of the ROU asset and lease liability as a noncash activity. Such presentation is consistent with ASC 230-10-50-4, which was amended in ASC 842 to remove the reference to capital leases and therefore make the guidance applicable to all leases. ASC 230-10-50-4, as amended, states:
Examples of noncash investing and financing transactions are converting debt to equity; acquiring assets by assuming directly related liabilities, such as purchasing a building by incurring a mortgage to the seller; obtaining a right-of-use asset in exchange for a lease liability; obtaining a beneficial interest as consideration for transferring financial assets (excluding cash), including the transferor’s trade receivables, in a securitization transaction; obtaining a building or investment asset by receiving a gift; and exchanging noncash assets or liabilities for other noncash assets or liabilities. [Emphasis added]
ASC 842-20
45-5 In the statement of
cash flows, a lessee shall classify all of the
following:
-
Repayments of the principal portion of the lease liability arising from finance leases within financing activities
-
Interest on the lease liability arising from finance leases in accordance with the requirements relating to interest paid in Topic 230 on cash flows
-
Payments arising from operating leases within operating activities, except to the extent that those payments represent costs to bring another asset to the condition and location necessary for its intended use, which should be classified within investing activities
-
Variable lease payments and short-term lease payments not included in the lease liability within operating activities.
In accordance with ASC 842-20-45-5(a) and (b), for lease payments made to repay
a finance lease liability, the lessee should present, in its statement of
cash flows, (1) the principal portion of the payments as cash outflows from
financing activities and (2) the interest portion of the payments as cash
outflows from operating activities. Presentation of cash outflows in the
statement of cash flows for finance leases in accordance with ASC 842 is (1)
comparable to how principal and interest payments are presented for other
financial liabilities6 and (2) consistent with how cash outflows for capital leases under ASC
840 are presented.
For operating leases under ASC 842, subsequent repayments of lease liabilities should be classified in operating activities in accordance with ASC 842-20-45-5(c) and (d). Further, a lessee should present, as cash outflows for operating activities, lease payments made that were not included in the lease liability on the lessee’s balance sheet. For example, lease payments not included in the lessee’s lease liability include (1) variable lease payments and (2) lease payments for leases in which the related lease terms are one year or less (i.e., short-term leases) and for which the lessee elects as a policy to treat such leases as executory contracts in a manner similar to operating leases under ASC 840. However, ASC 842-20-45-5(c) notes that there is an exception to presentation as operating activities when payments are made for costs of bringing another asset to the condition and location necessary for its intended use, in which case those payments should be classified as investing outflows.
Paragraph BC271 of ASU 2016-02 explains the Board’s rationale behind its
decision that cash flows from operating leases and variable lease payments
that are not included in the lease liability should be classified as
operating activities:
In addition, the Board decided
that cash flows from operating leases and variable lease payments that
are not included in the lease liability should be classified as
operating activities because the corresponding lease costs, if
recognized in the statement of comprehensive income, will be presented
in income from continuing operations. The previous sentence
notwithstanding, Topic 842 states that lease payments capitalized as
part of the cost of another asset (for example, inventory or a piece of
property, plant, or equipment) should be classified in the same manner
as other payments for that asset.
The example below illustrates the financial statement presentation for a finance lease and operating lease.
Example 7-12
A lessee enters into a three-year lease and agrees to make the following annual payments at the end of each year: $10,000 in year 1, $15,000 in year 2, and $20,000 in year 3. The initial measurement of the ROU asset and liability to make lease payments is $38,000 at a discount rate of 8 percent.
This table highlights the differences in accounting for the lease as a finance lease and an operating lease:
For the finance lease model, the interest expense calculated is a function of the lease liability balance and the discount rate (i.e., $38,000 multiplied by 8 percent in year 1). For the finance lease, the lessee includes amortization expense as a noncash add-back to the operating activities section of the statement of cash flows, which is calculated on a straight-line basis ($38,000 divided by 3). The principal portion of the cash payment is reflected in the financing section as principal paid. There is no need to separately add interest expense since it is already included in net income in the operating section. The supplemental section includes interest paid.
For the operating lease model, the lessee may include noncash lease expense as a noncash add-back to the operating section of the statement of cash flows ($15,000 – $3,038 = $11,962); this reflects the portion of the lease expense that amortized the ROU asset. While this presentation reflects a best practice, there may be other acceptable methods of presentation for the change in ROU assets; however, it would be inappropriate to present the change in ROU assets in amortization expense. Entities contemplating a different method of presentation are encouraged to discuss the method with their accounting advisers. The cash payment is reflected in the operating section as a change in operating liabilities. Because interest expense is not included in operating leases, there are no separate disclosures for this activity.
In addition, ASC 842-20-50-1 states that the “objective of the disclosure requirements is to enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases.” As a result, entities are required to provide various other cash and noncash disclosures for lease transactions under ASC 842 to supplement the amounts recorded in the financial statements (in addition to the disclosures they are required to provide under ASC 230). Such disclosures include the following:
ASC 842-20
50-4 For each period
presented in the financial statements, a lessee
shall disclose the following amounts relating to a
lessee’s total lease cost, which includes both
amounts recognized in profit or loss during the
period and any amounts capitalized as part of the
cost of another asset in accordance with other
Topics, and the cash flows arising from lease
transactions: . . .
g. Amounts segregated between those for
finance and operating leases for the following
items:
1. Cash paid for amounts
included in the measurement of lease liabilities,
segregated between operating and financing cash
flows
2. Supplemental noncash
information on lease liabilities arising from
obtaining right-of-use assets. . . .
While ASC 230 does not explicitly require entities to provide these disclosures in the statement of cash flows, entities should ensure that they comply with the requirements in ASC 842-20-50 related to any incremental cash and noncash disclosures that must be included in the footnotes to the financial statements.
7.6.1.4 Lessor Presentation
ASC 842-30
Sales-Type and Direct Financing Leases
45-5 In the statement of
cash flows, a lessor shall classify cash receipts
from leases within operating activities. However, if
the lessor is within the scope of Topic 942 on
financial services — depository and lending, it
shall follow the guidance in paragraph 942-230-45-4
for the presentation of principal payments received
from leases.
Operating Leases
45-7 In the statement of
cash flows, a lessor shall classify cash receipts
from leases within operating activities.
With the exception of depository and lending lessors within the scope of ASC
942,7 a lessor’s classification of cash receipts from leases should be
classified as cash inflows from operating activities (regardless of whether
the lease is classified as a sales-type, direct financing, or operating
lease) because, as noted in paragraph BC335 of ASU 2016-02, “[t]he Board
decided that in the statement of cash flows, a lessor should classify lease
payments received on all leases within operating activities because leasing
is generally part of a lessor’s revenue-generating activities.”
7.6.2 Lease Incentives
A lessor may make payments to incentivize a lessee to enter into a lease
agreement. For example, a lessor may provide a lessee with a tenant improvement
allowance to fund the lessee’s expenditures related to improving the leased
space primarily for the lessee’s benefit. The next sections discuss how a lessee
would classify payments received for such cash incentives paid by a lessor.
Before the Adoption of ASC 842
When a lessee makes payments for leasehold improvements in an operating lease, the cash outflow should be presented as an investing activity in the statement of cash flows. When leasehold improvements made by a lessee are reimbursed by a landlord (i.e., the lessor pays the lessee an incentive, which in this case is related to the lessee’s leasehold improvements), the lessee should separately present the cash inflow from the lessor as an operating activity in the lessee’s statement of cash flows. The SEC staff supports this view, as discussed in its February 7, 2005, letter to the Center for Public Company Audit Firms, which states, in part:
Landlord/Tenant Incentives — The staff believes that: (a) leasehold improvements made by a lessee that are funded by landlord incentives or allowances under an operating lease should be recorded by the lessee as leasehold improvement assets and amortized over a term consistent with the guidance in item 1 above; (b) the incentives should be recorded as deferred rent and amortized as reductions to lease expense over the lease term in accordance with paragraph 15 of
SFAS 13 and the response to Question 2 of FASB Technical Bulletin 88-1 (“FTB 88-1”), Issues Relating to Accounting for Leases, and therefore, the staff believes it is inappropriate to net the deferred rent against the leasehold improvements; and (c) a registrant’s statement of cash flows should reflect cash received from the lessor that is accounted for as a lease incentive within operating activities and the acquisition of leasehold improvements for cash within investing activities. The staff recognizes that evaluating when improvements should be recorded as assets of the lessor or assets of the lessee may require significant judgment and factors in making that evaluation are not the subject of this letter. [Emphasis added]
After the Adoption of ASC 842
ASC 842 indicates that lease incentives paid or payable to the lessee at commencement should be accounted for as a reduction to the fixed payments in the initial measurement of the ROU asset. As a result, the receipt of a landlord incentive affects the initial recognition of the ROU asset and lease liability, which is disclosed as a noncash activity, as noted in Section 7.6.1.3. However, we believe that, because the receipt of the landlord incentive effectively reduces the lease payments made in future periods, the receipt of the cash incentive should be classified in a manner consistent with the related lease payment. In other words, a cash incentive received from a landlord in connection with an operating lease should be classified in the lessee’s statement of cash flows as an inflow from operating activities in a manner consistent with the cash flow presentation of an operating lease payment; on the other hand, an incentive received in connection with a finance lease should be classified as an inflow from financing activities.
7.6.3 Sale-Leaseback Transactions
Under both ASC 840 and ASC 842, the presentation of cash inflows resulting from a sale-leaseback transaction depends on whether the seller-lessee achieves sale accounting. If the transaction satisfies the conditions for sale accounting, the cash inflows resulting from the transaction are presented as an investing activity in the statement of cash flows in a manner consistent with the underlying balance sheet classification. If the transaction does not satisfy the conditions for sale accounting, the cash inflows resulting from the transaction should be classified as a financing activity in the statement of cash flows.
In addition, Example 1 in ASC 842-40-55-23 through 55-30
illustrates the accounting by both parties in a sale-leaseback transaction when
sale accounting is achieved and the sale is not at fair value (i.e., includes
“off-market terms”). ASC 842-40-55-24 indicates that the “amount of the excess
sale price [which is significantly in excess of fair value] . . . is recognized
as additional financing from Buyer to Seller.” Therefore, the cash flow for the
additional financing should be classified as a financing activity in the
statement of cash flows.
7.6.3.1 Sale or Transfer of a Purchase Option by a Lessee
Some leases give an entity that leases an asset the right to purchase the
underlying leased asset during or after the lease. In some instances,
instead of exercising this right, the entity may enter into a transaction in
which (1) the entity transfers the option to purchase the asset to an
unaffiliated third party for no consideration and (2) the third party is
required to exercise the option and lease back the asset to the entity.
An option that grants to the potential seller-lessee the right to purchase
the underlying asset may convey control of the asset before exercise.
Although certain risks and rewards of the asset may be transferred to an
entity when the option is first conveyed to the entity (e.g., a fixed-price
purchase option that conveys the right to participate in any future
appreciation in the asset’s value), we believe that the entity typically
does not control the underlying asset at that point. Rather, we think
that the entity controls the underlying asset at the point when it
effectively exercises the option by transferring it to an unaffiliated third
party (a buyer-lessor) and requiring that the third party exercise it. At
that point, the entity controls the underlying asset and what happens to it
by requiring someone else to exercise the option (the owner of the asset is
compelled to transfer the asset in accordance with the option) and requiring
the buyer to provide the entity with the right to use the asset. Therefore,
such a transaction would be subject to the sale-leaseback accounting
guidance in ASC 842-40.
If an entity transfers the purchase option for no
consideration and concludes that the transfer is a failed sale-leaseback
transaction, the entity must account for the transfer as a financing
arrangement in accordance with ASC 842-40. In a manner consistent with the
guidance in Section 7.6.3, the entity
must present cash flows resulting from a financing arrangement as financing
activities in the statement of cash flows. However, if a transfer of a
purchase option to a third party does not result in cash flows for the
entity, the guidance is less clear.
We do not believe that there are differences between the economics of (1)
transactions in which the entity transfers the option to purchase the asset
to an unaffiliated third party for no consideration and the third party is
required to exercise the option and lease back the asset to the entity and
(2) transactions in which the entity had exercised its option to purchase
the underlying asset itself. In the first instance, the third party is
acting as the entity’s agent and transfers cash to the original lessor on
the entity’s behalf. In the second, the entity would exercise its option to
purchase the asset and would pay cash directly to the lessor. We believe
that in both scenarios, the cash flow presentation should be the same. That
is, although the third party disbursed cash to the lessor, the substance of
the transaction is that the entity exercised its option to purchase the
asset and disbursed cash to the lessor and then transferred the asset to the
third party for cash. Accordingly, the entity should present the
transactions in its statement of cash flows in a manner consistent with the
constructive receipt and disbursement guidance in Section 7.2.
For a financing arrangement, the entity presents the constructive receipt of
cash that is recognized as a financial liability as a financing activity in
the statement of cash flows. The constructive disbursement to purchase the
underlying asset from the original lessor by exercising the purchase option
is presented in the statement of cash flows in accordance with the guidance
discussed in Section 7.6.6 on
purchasing the underlying asset to terminate the lease.
Given the absence of a direct exchange of cash for the entity, some believe
that it is acceptable to present the transfer of the purchase option to the
third party and the exercise of that option by the third party as noncash
transactions. Entities that determine that such presentation is appropriate
are encouraged to consult with their accounting advisers.
7.6.4 Termination Costs Received From the Lessor
In certain instances, a lessor might want to exit an operating lease before the end of the lease term. Motivating factors for an early lease termination may include an alternative use for the asset that is more economically beneficial, a more profitable lease agreement with a different lessee, or an intent to sell the leased asset. To facilitate an early lease termination, a lessor often will need to compensate a lessee to exit a lease early.
Under both ASC 840 and ASC 842, we view cash received from a lessor to early terminate a lease as similar to a cash incentive, which lessees generally receive from lessors at the onset of lease arrangements. Therefore, we believe that the timing of when a lessee receives cash from the lessor should not affect how the cash receipt is presented in the lessee’s statement of cash flows. As a result, as with the presentation of lease incentives (as discussed further in Section 7.6.2), the receipt of a termination payment should be presented in a manner consistent with the related lease payment. In other words, an early termination payment received from a landlord in connection with either an operating or a finance lease should be classified in the lessee’s statement of cash flows as an inflow from operating or financing activities, respectively.
7.6.5 Payments for Land-Use Rights
In some countries, such as China, most, if not all, land is government-owned, and government-imposed restrictions are placed on the transfer of legal title to real property. Rather than permitting titles of real property to be transferred, governments in such countries may grant land-use rights under which entities can use the property for a specified period (i.e., 50 years), with renewal options for similar terms. Such entities typically would be required to make an up-front payment in full for the right to use the land for the stated term and generally would not have the right to purchase the land at the end of the term.
There is no specific guidance addressing the classification of land-use rights, including up-front payments for such rights, in the statement of cash flows.
Before the Adoption of ASC 842
Under ASC 840, there are currently two acceptable alternatives that entities have applied in practice when classifying payments for land-use rights. The first of these alternatives is to classify the payments as cash outflows in operating activities because the arrangement either is or is akin to an operating lease in accordance with ASC 840-10. This view is based on the facts that real property is the sole item being leased, title to the land is not transferred to the entity, and the entity does not have an option to purchase the property. Entities that classify payments for land-use rights within operating activities believe that the payments, in substance, represent prepaid rent related to an operating lease.
The second of these alternatives is to classify the payments as cash outflows
for investing activities on the basis of the notion that the purpose of
purchasing land-use rights is to obtain the right to construct buildings or
other real property on that land, and payments to construct real property are
classified as investing activities in accordance with ASC 230-10-45-13. Entities
that classify payments for land-use rights within investing activities view both
the land-use rights payment and payments to construct the real property on the
land as part of their overall capital expenditure initiatives. Entities that
enter into agreements with more extensive terms also believe that, although
title to the underlying land is never transferred, the terms are economically
similar to those in which the title to the land is acquired, in part because of
the significant period of time afforded by the land-use right.
After the Adoption of ASC 842
The classification of payments for land-use rights depends on whether the agreement is or contains a lease in accordance with ASC 842. We believe that if the agreement meets the definition of a lease, the associated payments should be classified in a manner consistent with the guidance on classification of other lease payments (see Section 7.6.1).
If the agreement does not meet the definition of a lease, entities should consider other applicable GAAP in determining the appropriate cash flow presentation. In such cases, classification should be determined on the basis of the nature of the underlying cash flow in accordance with the principles in ASC 230. For example, if an entity were to conclude that the payment is capitalizable and meets the definition of an intangible asset under ASC 350, classification as an investing outflow may be appropriate.
Connecting the Dots
Because (1) ownership of the land is not generally transferred in these arrangements (rather, a right of use is granted for a period) and (2) land is an asset that is within the scope of ASC 840 and ASC 842, some believe that entities should evaluate land-use rights to determine whether they are leases. While views differed on whether, under ASC 840, a land-use right is akin to an operating lease or a right to construct buildings or other real property on that land, we believe that, under ASC 842, the parties to a land-use arrangement should assess whether the contract is or contains a lease before considering other applicable GAAP.
7.6.6 Payments to Purchase the Underlying Asset Subject to a Lease
A lessee may decide to purchase the underlying asset from the lessor and
terminate the lease by exercising a purchase option granted to the lessee at
lease commencement or by separately negotiating the purchase of the leased asset
with the lessor. The presentation of the cash flows resulting from the purchase
of the underlying asset depends on whether the lease is classified as a finance
lease or an operating lease.
7.6.6.1 Operating Lease
An operating lease does not transfer control of the entire underlying asset
to the lessee. Rather, the operating lease transfers control of the right
to use the underlying asset to the lessee for a particular period in
exchange for a lease liability. However, the right to use an asset
represents only one right associated with the entirety of the asset.
In situations in which control of the entire underlying asset has not been
transferred in an operating lease and the lessee purchases the underlying
asset before the end of the lease term, questions have arisen regarding how
an entity should classify its payment for such purchase in the statement of
cash flows. We believe that it is acceptable for the entity to use one of
the following approaches to classify the cash outflow to purchase the
underlying asset subject to an operating lease:
- Approach A: Extinguishment of the lease liability — The payment to purchase the underlying asset extinguishes the lease liability in a manner similar to the purchase of an asset subject to a finance lease and is classified consistently with other lease payments in an operating lease. Payments to settle the lease liability should be classified as operating activities under ASC 842-20-45-5(c). Because the cash outflow extinguishes the lease liability, the underlying asset is considered purchased through a noncash exchange of the ROU asset for the underlying leased asset. Any amount paid in excess of the lease liability recognized on the balance sheet as of the purchase date is classified as an investing activity to reflect the purchase of PP&E or other productive assets.
- Approach B: Purchase of the underlying asset — The cash outflow is considered payment to acquire the underlying asset, and the subsequent termination of the lease results in derecognition of the ROU asset and lease liability in a noncash transaction. If the lease liability exceeds the carrying amount of the ROU asset on the purchase date, the portion of the payment that extinguishes the remaining liability is classified as operating activities consistently with other lease payments for an operating lease. Any residual payment in excess of the extinguishment of the remaining lease liability is classified as investing activities to reflect the purchase of PP&E or other productive assets.
The example below illustrates the statement of cash flows presentation under
the two approaches for an operating lease.
Example 7-13
A lessee enters into a five-year operating lease of
specified machinery (an equipment asset). The
initial measurements of the ROU asset and lease
liability are $63,578 and $65,328, respectively.
At the end of year 4, the lessee reaches an agreement
with the lessor to purchase the machinery for
$17,000. At the time of purchase, the ROU asset and
lease liability balances are $15,419 and $15,547,
respectively.
For the purchase of the asset and termination of the
operating lease, the lessee classifies the payment
of $17,000 in its year 4 statement of cash flows as
follows:
7.6.6.2 Finance Lease
Paragraph BC352(b) of ASU 2016-02 states that when a lessor leases an
underlying asset to a lessee under a finance lease, “the lessee, in effect,
obtains the ability to direct the use of, and obtain substantially all the
remaining benefits from, the underlying asset.” That is, the lessee obtains
control of the entire underlying asset. Accordingly, a finance lease is
economically equivalent to a financed purchase of the underlying asset.
If the lessee purchases the underlying asset in a finance
lease before the end of the lease term, the cash outflow to terminate the
lease represents the extinguishment of the financial liability associated
with the financed purchase of the asset. As a result, the payment to
purchase the underlying asset extinguishes the lease liability and is
classified consistently with other lease payments in a finance lease. Under
ASC 842-20-45-5(a), payments to settle the lease liability should be
classified as financing activities. Because the cash outflow extinguishes
the lease liability, the underlying asset is considered purchased through a
noncash exchange of the ROU asset for the underlying leased asset. Any
amount paid in excess of the lease liability recognized on the balance sheet
as of the purchase date is classified as an investing activity to reflect
the purchase of PP&E or other productive assets.
While we believe that it is acceptable for entities to apply
the approach described above regarding the presentation of cash flows when a
lessee purchases an underlying asset in a finance lease, we understand that
some entities may wish to classify such cash flows in a manner consistent
with Approach B for operating leases discussed in Section 7.6.6.1. Entities that plan to
classify cash flows by using Approach B discussed in Section 7.6.6.1 are encouraged to consult
with their accounting and financial advisers.
The example below illustrates the statement of cash flows presentation for a
lessee’s purchase of an underlying asset subject to a finance lease.
However, we have observed that depending on the nature of activities
associated with the purchase and sale of crypto assets, entities have
classified the cash flows from such purchases and sales as operating
activities. Entities that plan to classify cash flow activity from this type
of arrangement within operating activities are encouraged to consult with
their accounting and financial advisers.
Example 7-14
A lessee enters into a five-year lease with a lessor
to lease specified machinery (an equipment asset).
The lease is classified as a finance lease, and
there is no purchase option granted to the lessee at
lease commencement. The initial measurements of the
ROU asset and lease liability are $63,578 and
$65,328, respectively.
At the end of year 4, the lessee reaches an agreement
with the lessor to purchase the machinery for
$17,000. At the time of purchase, the ROU asset and
lease liability balances are $12,715 and $15,547,
respectively.
For the purchase of the asset and termination of the
finance lease, the lessee classifies the payment of
$17,000 in its year 4 statement of cash flows as
follows:
Footnotes
6
See paragraph BC270 of ASU 2016-02.
7
To resolve a stakeholder-identified conflict between
the example in ASC 942-230-55-2 and the guidance in ASC 842-30-45-5,
the FASB issued ASU 2019-01, which clarifies that depository and
lending lessors within the scope of ASC 942 would be required to
classify principal payments received from sales-type and direct
financing leases within investing activities.
7.7 Deferred Costs
ASC 230 does not explicitly address the presentation of deferred costs (i.e.,
incurred costs that are deferred on the balance
sheet). However, when determining the appropriate
presentation in the statement of cash flows, an
entity should consider the underlying principle
described in ASC 230-10-10-1, which states that
the “primary objective of a statement of cash
flows is to provide relevant information about the
cash receipts and cash payments of an entity
during a period.” Accordingly, the cash flow
presentation should generally be in line with the
balance sheet treatment. That is, cash outflows
related to current assets or inventory that are
recognized as a period expense in an entity’s
income statement should generally be classified as
an operating activity in the statement of cash
flows. Cash outflows related to noncurrent
productive assets that are capitalized in an
entity’s balance sheet should generally be
classified as an investing activity in the
statement of cash flows.
Example 7-15
Company E is a provider of software services to the health care industry. Recently, E has developed new software to market to new and existing customers. In accordance with ASC 985-20, E capitalizes the costs of developing the new software and therefore classifies the software development costs as an investing activity in its statement of cash flows. The software development costs are costs of developing a productive asset for E.
In this example, the software development costs paid by E are similar to construction costs paid by a manufacturing company to construct a manufacturing facility. That is, E’s payments of costs incurred to develop new software create an asset that is used to generate future revenue in a manner similar to how a manufacturing facility generates future revenue for a manufacturer. In both cases, the cash outflows for costs of generating future revenue are presented as investing activities in the statement of cash flows.
See Section 7.12
for discussion of deferred costs associated with cloud computing arrangements
(CCAs).
Connecting the Dots
While the cash flow presentation of deferred costs should
generally be in line with the balance sheet treatment, an entity
should also consider the rationale supporting the capitalization of the
noncurrent productive asset. In other words, an entity should not
automatically conclude that cash outflows related to a nonproductive asset
should be presented as investing simply because the costs have been
deferred. For example, there may be situations in which an entity is
permitted by U.S. GAAP to capitalize certain operating costs incurred in the
period that are related to a noncurrent productive asset (e.g., planned
major maintenance, as discussed in Section 6.3.3). In those situations,
although the deferred costs are related to a noncurrent productive asset,
the entity would present the cash outflows as an operating activity because
the costs represent an expense that can be deferred under U.S. GAAP rather
than an investment in a noncurrent productive asset.
7.8 Government Grants
Government grants are a form of government assistance that may be granted to
entities, either to encourage those entities to fulfill certain objectives (e.g.,
providing a financial grant to an entity to fund cancer research) or to assist them
during times of crisis (e.g., the CARES Act). Generally, a recipient of a government
grant is not expected to repay the grant provided that the recipient complies with
the grant’s conditions.
Not all government assistance is provided to a recipient in the form of a cash payment. For example, a government grant could be in the form of tax credits. In these situations, an entity must determine whether the tax credits are refundable.
Refundable tax credits (e.g., qualifying research and development [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, allowing an entity to 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. This section discusses such tax
credits as well as other government grants. For more information on the accounting
for refundable tax credits, see Section 2.7 of Deloitte’s Roadmap Income Taxes.
Tax credits whose realization ultimately depends on taxable income (e.g., investment tax credits and R&D) are not refundable. Such tax credits are recognized as a reduction of income tax, should be accounted for in accordance with ASC 740, and are not discussed in this section. Entities are encouraged to consult with their accounting advisers when it is not clear whether tax credits are refundable.
In determining the appropriate cash flow presentation of government grants (that are
not tax credits recognized as a reduction of income tax and accounted for in
accordance with ASC 740), it is important to consider the nature of the grants since
government assistance can take many different forms. We consider government grants
related to long-lived assets to be capital grants and grants related to income to be
income grants, as discussed below. However, some government grants may have aspects
of both capital grants and income grants (i.e., the grant may be intended to
subsidize the purchase of long-lived assets and certain operating costs). Therefore,
entities subject to multiple conditions should carefully assess the grant received
and should consider the guidance in Section
6.4 of this Roadmap.
7.8.1 Capital Grant
The classification of a capital grant in the statement of cash flows depends on
the timing of the cash receipt compared with the timing of the associated costs
to which the grant is related. If an entity receives the cash from the grant
after it has incurred the capital costs, it would be appropriate to present the
cash inflow from the government in the same category (i.e., investing) as the
original payment for the associated long-lived asset.
However, if the grant funding is received before the
expenditures have been incurred, it would be appropriate for the entity to
present that cash inflow as a financing activity, because receiving the cash
before incurring the related cost would be similar to receiving a refundable
loan advance or to an NFP’s receipt of a contribution of a refundable advance
that, according to the donor’s stipulation, is restricted for capital
investment. ASC 230-10-45-14(c) requires that the following be classified as
cash inflows from financing activities:
Receipts from
contributions and investment income that by donor stipulation are restricted
for the purposes of acquiring, constructing, or improving property, plant,
equipment, or other long-lived assets or establishing or increasing a
donor-restricted endowment fund.
In addition, when the entity incurs the costs in accordance with the conditions
of the government grant, it should disclose the existence of a noncash financing
activity resulting from the fulfillment of the grant requirements.
Example 7-16
Entity C is entitled to receive $100 million in tax credits upon completing a new manufacturing facility and obtaining a certificate of occupancy from the local authority. Because C does not need to incur a tax liability to collect the tax credits, the tax credits are refundable and are not within the scope of ASC 740.
On December 31, 20X1, C starts the construction of the facility and presents the capital expenditures as an investing activity in its statement of cash flows. On December 31, 20X2, C completes the manufacturing facility and pays the remaining total construction costs. On January 1, 20X3, C obtains the certificate of occupancy and receives the $100 million in tax credits.
In this example, because the construction costs are classified as an investing activity in C’s statement of cash flows and the payments are made before the receipt of the grant, C would present the grant monies as an investing activity in its statement of cash flows for 20X3.
Example 7-17
Assume the same facts as in the example above except that the grant monies are
received before any capital expenditures are incurred.
Entity C would record the grant monies as an asset with
a corresponding liability on the balance sheet. The
receipt of the grant would be reflected as a financing
cash inflow in the statement of cash flows in accordance
with ASC 230-10-45-14(c).
Connecting the Dots
When a for-profit entity applies the IAS 20 framework,
the classification of cash flows associated with a capital grant is
generally determined on the basis of when the entity receives the grant.
The entity should classify cash received for a capital grant as a
financing cash inflow if the entity receives the cash before incurring
the cost of the long-term construction project to which the grant is
related. In contrast, the entity should classify the cash proceeds from
a capital grant as an investing cash inflow if the entity receives the
grant after incurring the cost of the project.
However, in accordance with ASC 958-605, an NFP must
recognize all government grants as contributions received. Therefore, we
believe that such an entity should apply the guidance in ASC
230-10-45-14(c), which states that the entity should present as a
financing cash inflow any “[r]eceipts from contributions and investment
income that by donor stipulation are restricted for the purposes of
acquiring, constructing, or improving property, plant, equipment, or
other long-lived assets or establishing or increasing a donor-restricted
endowment fund.” Accordingly, an NFP applying this guidance would
classify the cash received from a government grant contribution as a
financing cash inflow, without regard to the timing of when it receives
the grant proceeds.
Although NFPs are required to apply the guidance above,
for-profit entities can also apply the framework in ASC 958-605 — and,
accordingly, the guidance in ASC 230-10-45-14(c) — by analogy in
accounting for capital grants.
7.8.2 Income Grant
Similarly, if an entity receives an income grant as reimbursement for qualifying
operating expenses, the grant would be presented in the statement of cash flows
as an operating activity if it was received after the operating expenses were
incurred. However, some entities may believe that when cash is received before
the qualifying operating expenses are incurred, it would be appropriate to
present the cash inflow as a financing activity for the advance in a manner
consistent with the guidance for capital grants above. Alternatively, others may
believe that it is acceptable to present the cash inflow as an operating
activity if the entity expects to comply with the terms of the grant (e.g., an
advance on future payroll taxes credit) so that both the inflow and outflow are
presented in the operating category. Given the absence of explicit guidance, we
believe that either approach is acceptable. An entity’s election of one of the
above approaches is a matter of accounting policy that the entity should
disclose and apply consistently in similar arrangements.
Example 7-18
Entity P is awarded a government grant
to receive up to $50 million of aggregate funding for
certain R&D activities. The intent of the government
grant is for P to perform R&D activities to achieve
the grant’s stated objectives. Grant funding is provided
after qualifying R&D costs are incurred by P.
Entity P records R&D expenses as period expenses and
classifies the cash outflows for the R&D expenses as
an operating activity in its statement of cash flows.
Therefore, P should classify the cash inflows from
receipt of grant monies as an operating activity in its
statement of cash flows.
7.9 Classification of Cash Flows Related to Beneficial Interests in Trade Receivables
An entity may transfer/sell trade receivables to fund working capital and
liquidity needs. In such transactions, the seller/transferor of the trade
receivable, instead of receiving the entire consideration in cash, may agree to
receive part of the consideration in cash and the balance as a noncash beneficial
interest in the transferred/sold trade receivable. Such a beneficial interest may or
may not be in a certificated form and is generally subordinated to the performance
of the receivables transferred/sold.
In accordance with ASC 230-10-50-4, a transferor’s beneficial interest obtained
in a securitization of financial assets (excluding cash), including a securitization
of the transferor’s trade receivables, should be disclosed as a noncash activity.
Further, cash receipts from payments on a transferor’s beneficial interests in the
securitized trade receivables should be classified as cash inflows from investing
activities in accordance with ASC 230-10-45-12.
7.9.1 Application of ASU 2016-15 to the Sale of Trade Receivables to Multiseller Commercial Paper Conduit Structures
Questions arose regarding how to apply ASU 2016-15’s guidance on beneficial
interests in securitization transactions, particularly for entities that have
sold trade receivables to a multiseller commercial paper conduit structure. Such
questions stem from the fact that an entity that has sold trade receivables to a
multiseller commercial paper conduit structure must apply the amended guidance
in ASC 230-10-45-12(a) and ASC 230-10-50-4 as well as the requirements in ASC
230-10-45-16(a).8
While commercial paper conduit structures may differ, common features of such programs include the following:
- An entity (the “seller”) transfers trade receivables to a nonconsolidated securitization entity. Such transfers qualify as sales under ASC 860.
- The seller transfers trade receivables at the inception of its involvement with the securitization entity and continues to transfer trade receivables to the securitization entity as frequently as daily. The securitization entity also receives collections from the seller’s trade receivables previously sold as frequently as daily.
- The seller continues to service the trade receivables sold to the securitization entity.
- For each trade receivable transferred to the securitization entity, the seller has the right to receive cash at a maximum advance rate. The maximum advance rate, which is determined by a formula in the agreements related to the securitization, represents the maximum amount of cash the seller can receive upon the transfer of trade receivables to the securitization entity. If the amount of cash available from the securitization entity to purchase trade receivables from the seller on a particular day is less than the maximum advance rate, the seller is entitled to only the available cash upon transfers of trade receivables to the securitization entity.
- The amount of cash received by the seller upon each sale of trade receivables to the securitization entity is referred to as the cash purchase price (CPP), and the remaining consideration received for the transfer of trade receivables is represented by a deferred purchase price (DPP). The DPP represents a beneficial interest in the securitization entity.
- After the initial transfer of trade receivables at the inception of the seller’s involvement with the securitization entity, the cash available to pay the CPP related to transfers of trade receivables is generally limited to the amount of cash received from collections of trade receivables previously sold to the securitization entity. To the extent that there are insufficient “same day” collections to fund the maximum advance rate, the entity will legally receive an additional DPP interest.
- Any cash collections on previously transferred trade receivables that exceed the maximum advance rate for that same day’s trade receivables sold to the securitization entity are held in an escrow account until each periodic settlement date.
- The settlement period is monthly. At the end of each monthly settlement period, the amounts in the escrow account are disbursed to (or retained by) the seller, the administrative agent of the conduit and other service providers, and the conduit in accordance with the terms of the securitization entity. The amount of cash in the escrow account to which the seller is entitled represents repayments of DPP amounts and, to some extent, a deferred payment of CPP amounts related to days on which the cash available as CPP for transfers of trade receivables was less than the maximum advance rate because the collections on trade receivables previously sold on that particular day were insufficient to pay the maximum advance rate.
The guidance in ASU 2016-15 (codified in ASC 230) is not clear regarding the
unit of account for determining the portions of each transfer of trade
receivables to a securitization entity that represent CPP (i.e., operating
activities) and DPP (i.e., investing activities). However, on the basis of
discussions with the SEC staff, we believe that the unit of account is each
day’s transactional activity.
Accordingly, an entity should evaluate each day’s transactional activity to
determine the CPP and DPP portions of trade receivables transferred to the
securitization entity. Thus, if the cash available from a particular day’s
collections of previously sold trade receivables is not sufficient to fund the
maximum advance rate on that day’s trade receivables sold to the securitization
entity, that deficit will reflect a noncash investing activity, which, when
collected, will represent an investing activity.
Footnotes
8
ASC 230-10-45-16(a) states that cash inflows from
operating activities include “[c]ash 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.” In accordance with
this guidance, an entity presents the proceeds received upon a sale of
trade receivables as an operating activity. As discussed below, the
proceeds received on the sale of trade receivables to a securitization
entity is represented by the cash purchase price.
7.10 Classification of Cash Flows for Repurchase Agreements and Reverse Repurchase Agreements
The ASC master glossary defines a “repurchase agreement” and “reverse repurchase agreement,” in part,
as follows:
- Repurchase agreement — An “agreement under which the transferor (repo party) transfers a financial asset to a transferee (repo counterparty or reverse party) in exchange for cash and concurrently agrees to reacquire that financial asset at a future date for an amount equal to the cash exchanged plus or minus a stipulated interest factor.”
- Reverse repurchase agreement accounted for as a collateralized borrowing — A “transaction that is accounted for as a collateralized lending in which a buyer-lender buys securities with an agreement to resell them to the seller-borrower at a stated price plus interest at a specified date or in specified circumstances.”
Most repurchase and reverse repurchase agreements are accounted for as secured borrowing and lending arrangements under ASC 860 because the transferor usually has retained effective control over the transferred securities. Because a repurchase agreement represents a collateralized borrowing (for the cash recipient) and a reverse repurchase agreement represents a collateralized lending (for the transferee of the security), the related cash flows should be classified as financing and investing activities, respectively.
On the basis of discussions with the FASB staff, another acceptable method for determining the appropriate classification of the cash flows related to repurchase and reverse repurchase agreements is to evaluate the specific facts and circumstances and the reasons for entering into each agreement to determine its nature and the entity’s intent. As a result, both repurchase agreements and reverse repurchase agreements could be classified in the same section of the statement of cash flows (i.e., operating, investing, or financing). For example:
- It is acceptable to classify the cash flows related to repurchase agreements
and reverse repurchase agreements as operating activities if the
transactions are entered into in connection with the entity’s principal
activities (e.g., broker-dealers or other entities with similar operations).
Such classification is further supported by a note in Exhibit 6-7 of the
AICPA Audit and Accounting Guide Brokers and Dealers in Securities,
which states:Depending on the nature of the activity, securities purchased under agreements to resell can be classified as operating or investing; likewise, securities sold under agreements to repurchase can be classified as operating or financing.
- It is acceptable to classify cash flows related to both repurchase agreements and reverse repurchase agreements as investing cash flows when the primary intent of entering into the transactions is to increase the return on an entity’s investment portfolio. For example, an entity may enter into a repurchase agreement to reinvest the cash proceeds in another investment because the entity believes it can earn a higher return than the spread on the repurchase side of the repurchase agreement. Therefore, even though funds were essentially a secured borrowing in the first leg of the repurchase agreement, the business purpose and substance of the transaction were to generate a higher yield on the investment portfolio and, accordingly, “both legs” could be classified as an investing activity.
- It is acceptable to classify the cash flows related to both repurchase agreements and reverse repurchase agreements as financing activities if the primary purpose of the arrangement is to provide funds to finance operations or raise working capital.
7.11 Assets Held for Sale
Cash and cash equivalents may be included in a
disposal group or component that is classified as an asset held for sale, regardless
of whether such an asset meets the definition of a discontinued operation (see
Section 3.3 for
additional considerations related to the presentation of discontinued operations in
the statement of cash flows). Accordingly, the “cash and cash equivalents” line item
on the balance sheet may exclude some of the entity’s cash and cash equivalents
(i.e., the portion that is included in the “assets held for sale” line item). As a
result, an entity will need to modify its normal presentation of such amounts in the
statement of cash flows. The following two methods are acceptable ways to adjust the
statement of cash flows for cash and cash equivalents included in assets held for
sale:
-
Method 1 — First, (1) cash and cash equivalents included in the “assets held for sale” line item on the balance sheet at the beginning of the period are added to beginning cash presented in the statement of cash flows and (2) the corresponding amount at the end of the period is added to ending cash and cash equivalents in the statement of cash flows. Next, the adjusted amounts in the statement of cash flows are reconciled to the amounts presented on the balance sheet in a footnote.
-
Method 2 — A reconciling line item is presented that shows the change in cash balances included in the assets held for sale caption after financing activities and before beginning cash balances. An entity may present the following under Method 2:
7.12 Cloud Computing Arrangements
In August 2018, the FASB issued ASU 2018-15, which amends ASC 350-40 to address a customer’s accounting for implementation costs incurred in a CCA that is a service contract. ASU 2018-15 aligns the accounting for costs incurred to implement a CCA that is a service arrangement with the guidance on capitalizing costs associated with developing or obtaining internal-use software. Specifically, the ASU amends ASC 350 to include in its scope implementation costs of a CCA that is a service contract and clarifies that a customer should apply ASC 350-40 to determine which implementation costs should be capitalized in a CCA that is considered a service contract.
In accordance with ASC 350-40-45-3, cash flows to implement a CCA that is a
service contract and that meet the capitalization criteria in ASC 350-40 must be
presented in an entity’s statement of cash flows “in the same manner as the cash
flows for the fees for the associated hosting arrangement.” The FASB gives a
rationale for this requirement in paragraph BC12 of ASU 2018-15:
This is because the asset recognized for the implementation
costs is recognized only as a result of enhancing the value of the hosting
service, which itself is not recognized as an asset. Thus, although the
implementation costs are recognized as a standalone asset, the future benefit
derived from that asset is linked to the benefit derived from the hosting
service, which is expensed as incurred.
For additional considerations related to ASU 2018-15, see Deloitte’s September 11, 2018, Heads Up.
Connecting the Dots
Capitalized implementation costs related to a CCA that is a service contract differ from capitalized costs associated with developing or obtaining internal-use software. Internal-use software is, by its nature, a recognizable intangible asset. Accordingly, any incurred and capitalized costs associated with developing or obtaining internal-use software form part of the acquired asset and would generally also be considered an intangible asset. Furthermore, and as discussed in Section 7.7, the cash flow presentation should generally be in line with the balance sheet treatment. That is, cash outflows related to noncurrent productive assets that are capitalized in an entity’s balance sheet should generally be classified as an investing activity in the statement of cash flows.
However, a CCA that is a service contract does not give rise to a recognizable intangible asset because it is an executory service contract. Consequently, any costs incurred to implement a CCA that is a service contract would not be capitalized as an intangible asset (since they do not form part of an intangible asset); rather, such costs would be characterized in a company’s financial statements in the same manner as other service costs and assets related to service contracts (e.g., prepaid expense). That is, these costs would be capitalized as part of the service contract, and financial statement presentation of the cash flows, the resulting asset, and related amortization would be consistent with the ongoing periodic costs of the underlying CCA.
7.13 Supplier Finance Programs
An entity may work with a bank or other intermediary to arrange a supplier finance
program (also referred to as structured trade payables, reverse factoring, vendor
payable, supply-chain financing, and extended vendor payables programs). Under the
terms of the program, the intermediary typically pays the amount owed to an entity’s
supplier of goods or services before the due date of the related supplier (trade)
payable. Then, the entity settles with the intermediary on a later date.
An entity’s use of such a program could result in recharacterization of the trade
payable as debt (i.e., a borrowing) on the balance sheet. The balance sheet
classification generally dictates the classification in the statement of cash flows
as follows:
- Trade payables balance sheet classification — The payment by the bank or intermediary to the supplier has no effect on the entity’s statement of cash flows. The entity should present the cash payment to the bank or intermediary as an operating cash outflow.
- Debt balance sheet classification — If the entity recharacterizes the trade payable to borrowings (e.g., upon payment of the supplier by the bank or intermediary), the entity generally would record a financing cash inflow (for the amounts borrowed from the bank or intermediary) and an operating cash outflow (for the payment to the supplier by the bank or intermediary). This presentation in the statement of cash flows is consistent with the concept of constructive receipt and disbursement, which is discussed further in Section 7.2. The subsequent cash payment to the bank or intermediary is a financing cash outflow.
See Appendix
C for an example of an SEC comment letter on this topic that also
addresses considerations related to financial statement disclosures.
Changing Lanes
In September 2022, the FASB issued ASU 2022-04 to enhance transparency
about an entity’s use of supplier finance programs. Under the ASU, the buyer
in a supplier finance program is required to disclose information about the
key terms of the program, outstanding amounts as of the end of the period
that the buyer has confirmed as valid in accordance with the supplier
finance program, a rollforward of such amounts during each annual period,
and a description of where in the financial statements outstanding amounts
are presented. The ASU does not affect the recognition, measurement, or
presentation of supplier finance program obligations on the face of the
balance sheet or in the cash flow statement.
7.14 Tax Receivable Agreements
A common method for partnerships or limited liability companies
(LLCs) to raise capital via an initial public offering (IPO) or through a
special-purpose acquisition company (SPAC) is by using the umbrella partnership C
corporation (“Up-C”) structure. An Up-C structure involves (1) the formation of a
new corporation (often referred to as “PubCo”) for the purpose of completing a
public offering and (2) the restructure of transactions to carry on the business of
an operating entity (often referred to as “OpCo”) that is usually structured as an
LLC or a limited partnership.
To become a public company and complete the Up-C structure, PubCo typically executes
a series of reorganization steps that allow it to take advantage of certain tax
benefits for pass-through entities. Shares of PubCo are issued and sold to the
public in an IPO; PubCo then uses the proceeds from the IPO or newly issued stock to
acquire an ownership interest in the existing OpCo. As a result of the IPO and the
reorganization steps, PubCo becomes a holding company whose sole asset is its equity
interest in OpCo, which generally represents a controlling financial interest in
OpCo that must be consolidated in accordance with ASC 810. In the absence of
substantive operations before the reorganization steps and IPO, PubCo would not meet
the definition of a business, and its legal acquisition of OpCo would therefore not
be considered a business combination under ASC 805. Alternatively, the
reorganization steps and IPO represent transactions that are under common control
(e.g., an equity transaction) and the OpCo units that continue to be held by
existing owners are accounted for as an NCI within equity on PubCo’s consolidated
balance sheet.
An Up-C structure can benefit the pre-public-offering owners (existing owners) of
OpCo by allowing them to maintain ownership for U.S. federal income tax purposes
through an LLC or partnership, which would continue to receive the advantages of a
single taxation level until the existing owners sell their interests.
An Up-C structure also gives the existing owners the right to exchange their OpCo
interests for cash or newly issued shares of PubCo on a one-for-one basis. If they
exercise this right, PubCo will be entitled to certain future tax benefits from
adjustments under the Internal Revenue Code related to the assets of OpCo.
Specifically, PubCo would receive a step-up in the tax basis of the net assets
resulting from the exchange with existing owners, which in turn would provide
additional tax amortization and depreciation expense in future periods (i.e., a
deferred tax asset).
To incentivize existing owners to exchange their LLC or partnership units, PubCo may
negotiate and execute a tax receivable agreement (TRA) with them. A TRA gives
existing owners that have exchanged their units the right to receive a percentage
(usually 85 percent) of the net cash savings, if any, in U.S. federal, state, and
local income tax that PubCo realizes or is deemed to realize. The TRA payments
capture the value of the future tax benefits transferred to PubCo that would have
otherwise been forgone in a traditional IPO.
Under the terms of a TRA, PubCo accounts for the exchange of LLC or partnership units
by existing owners as an equity reorganization through which:
-
A deferred tax asset is recognized as a result of the increase in the tax basis of the net assets. The deferred tax asset is recognized directly in equity as part of the equity transaction.
-
The corresponding TRA contingent obligation (usually 85 percent of the net cash savings to be realized) is recognized as a reduction of equity on the same date the initial deferred tax asset is recognized.
-
After initial recognition, any increase or decrease in both the deferred tax asset and the TRA obligation would be recognized in the income statement.
To compute the amount of the TRA obligation, PubCo calculates realized tax benefits
by comparing its actual tax liability to the amount that it would have been required
to pay in the absence of the future tax benefits from the step-up in tax basis.
PubCo then measures the payment obligation under the TRA as the negotiated
percentage (e.g., 85 percent) of the realized tax benefits.
When assessing how to classify the TRA payments in the statement of cash flows, PubCo
would apply ASC 230-10-45-10, which requires entities to “classify cash receipts and
cash payments as resulting from investing, financing, or operating activities” on
the basis of the nature of the cash flow. However, certain cash payments may
resemble more than one type of cash flow. ASC 230-10-45-22 states:
Certain cash receipts and payments may have aspects of more than one class of
cash flows. The classification of those cash receipts and payments shall be
determined first by applying specific guidance in this Topic and other
applicable Topics. In the absence of specific guidance, a reporting
entity shall determine each separately identifiable source or each
separately identifiable use within the cash receipts and cash payments
on the basis of the nature of the underlying cash flows, including when
judgment is necessary to estimate the amount of each separately
identifiable source or use. A reporting entity shall then classify
each separately identifiable source or use within the cash receipts and
payments on the basis of their nature in financing, investing, or operating
activities. [Emphasis added]
Currently, there is no authoritative accounting guidance on the classification in the
statement of cash flows of TRA payments. We believe that the classification and
presentation of such payments should be evaluated on the basis of the substance or
nature of the transaction.
When assessing the nature of a TRA, PubCo would consider whether the
payments represent cash outflows to noncontrolling interest (NCI) holders that are
equal to a percentage (e.g., 85 percent) of the cash tax savings realized by PubCo
as a result of increases in the tax basis derived from the existing owners’
exchanges of OpCo units for shares of PubCo. ASC 810-10-45-23 addresses
distributions to NCI holders and states, in part:
Changes in a parent’s ownership interest while the parent
retains its controlling financial interest in its subsidiary shall be
accounted for as equity transactions (investments by owners and
distributions to owners acting in their capacity as owners).
Since the reorganization steps and IPO represent transactions under
common control and the authoritative guidance in ASC 810-10-45-23 concludes that
payments to acquire NCIs would be considered “distributions to owners acting in
their capacity as owners,” payments under the TRA to NCI holders to settle a TRA
obligation can be considered payments related to an equity transaction. This is
further clarified in Section
6.2.2, which states that “[d]istributions to noncontrolling interest
holders (in their capacity as equity holders) are considered equity
transactions.”
ASC 230-10-45-15(a) suggests that TRA payments should be classified as cash outflows
for financing activities because such payments are a settlement of an obligation
established through an equity transaction. However, remeasurement of the TRA
liability is recognized in the income statement; consequently, the definition of
“operating activities” in ASC 230-10-20 suggests that TRA payments could be
classified as cash outflows for operating activities because “[c]ash flows from
operating activities are generally the cash effects of transactions and other events
that enter into the determination of net income.” TRA payments therefore have
aspects of more than one class of cash flows.
In the absence of guidance on this topic (i.e., on the attribution of TRA payments to
the equity transaction or on the cash effect of a transaction included in the
determination of net income when both aspects are present), we believe that it is
reasonable to apply by analogy the cash flow guidance on contingent consideration
payments made after a business combination and on the settlement of zero-coupon debt
instruments.
As discussed in Section 7.5.4, an entity is
required to classify as financing activities payments made up to the amount of the
contingent consideration liability recognized on the acquisition date; any payments
made in excess of the initial contingent consideration liability must be classified
as operating activities. Note that ASC 230-10-45-15 refers to “payments” to indicate
that cumulative payments to date that are related to a contingent consideration
liability should first be classified as financing activities up to the amount of the
initial liability and that cumulative payments in excess of that initial liability
should be classified as operating activities. In addition, Section 6.4.2 discusses the cash flow presentation
of zero-coupon debt instruments, which is similar to the presentation of payments
made on contingent consideration liabilities. Specifically, an entity is required to
classify payments made up to the amount of the principal of the zero-coupon debt
instrument (initially recognized on the balance sheet) as financing activities and
classify payments made to settle zero-coupon debt instruments related to accreted
interest for the debt discount (recognized in earnings) as operating activities.
By analogy, the cumulative TRA payments should be classified as cash outflows for
financing activities up to the amount of the TRA liability initially recognized on
the date of the existing owner share/unit exchange (initially recognized in equity
on the balance sheet), and cumulative TRA payments in excess of those amounts should
be classified as cash outflows for operating activities (settlement of amounts
recognized in earnings).
The examples below illustrate the classification of TRA payments.
Example 7-19
On October 1, 20X1, Company A, a newly
formed corporation, files a Form S-1 registration statement
with the SEC to indicate its intent to publicly issue shares
(i.e., undertake an IPO). As part of becoming a public
company, A executes a series of reorganization steps to take
advantage of certain tax benefits for pass-through entities
that use an Up-C structure. Company A’s IPO closes on
November 1, 20X1, and 10 million shares of A are issued and
sold to public investors at $15 per share for proceeds of
$150 million. Company A then uses the proceeds from the IPO
to contribute $100 million to Company B, a limited
partnership operating entity, in exchange for 8,333,333
units of B as well as to purchase 4,166,667 units of B from
B’s existing owners for $50 million. Through the Up-C
structure, the continuing existing owners of B are granted
the right to exchange their B units for cash or newly issued
shares of A on a one-for-one basis.
Upon the reorganization and IPO, A is a holding company whose
sole asset is its equity interest in B, which represents 60
percent of the economic interests in B. Assume that the
reorganization and IPO represent common-control equity
transactions under ASC 805-50 and that A has a controlling
financial interest in B under ASC 810-10 and therefore
consolidates B. The remaining 40 percent of the economic
interests in B is classified as an NCI within equity on A’s
consolidated balance sheet.
As part of the negotiations for the transactions, A enters
into a TRA with the existing owners of B. The TRA provides
for the payment of cash by A to the existing owners of B in
exchange for their units of B, which is equal to 85 percent
of the net cash savings, if any, in U.S. federal, state, and
local income tax that A realizes, or is deemed to realize,
from the step-up in the tax basis of the net assets
resulting from the exchange with existing owners of B.
Immediately after the closing of the IPO on
November 1, 20X1, certain existing owners of B exercise
their exchange rights and exchange 5 million units of B for
5 million newly issued shares of A, which accounts for the
exchange as an equity reorganization. Company A records the
following journal entries:
During the fiscal year ending December 31,
20X1, no payments are made to the existing owners of B under
the TRA. However, A is able to use certain tax benefits
subject to the TRA to reduce cash taxes paid to IRS so that
$2 million is paid to the existing owners of B (that
exercised their exchange rights) on December 1, 20X2. No
remeasurement adjustments are recorded to the deferred tax
asset or TRA liability between November 1, 20X1, and
December 1, 20X2. In this example, the TRA liability is
initially recognized as equity on the balance sheet, with no
adjustments recorded as earnings. The entire amount of the
$2 million paid is presented as a financing activity in the
statement of cash flows.
Example 7-20
Assume the same facts as in Example
7-19 except that as of the date of the
unit/share exchanges by the existing owners of Company B
(November 1, 20X1), Company A has a full valuation allowance
against its net deferred tax asset on the basis of
projections of future taxable income. Because of the full
valuation allowance, A does not recognize an initial net
deferred tax asset or an initial TRA liability on November
1, 20X1 (i.e., it is more likely than not that A will not
realize the future tax benefits, so the initial net deferred
tax asset is $0, which results in a TRA obligation of $0).
Company A records the following journal entries:
On December 31, 20X2, on the basis of a reassessment of
projected future taxable income, A releases its full
valuation allowance because management believes that it is
more likely than not that the future tax benefits will be
used. Company A records the adjustment to the net deferred
tax asset and TRA liability as follows:
Company A is able to use certain tax
benefits subject to the TRA to reduce cash taxes remitted to
the IRS so that $3 million is paid to the existing owners of
B (that exercised their exchange rights) on December 1,
20X4. No subsequent remeasurement adjustments are recorded
to the deferred tax asset or TRA liability between December
31, 20X2, and December 1, 20X4. In this example, the TRA
liability is initially recognized through net income or loss
in the income statement. The entire amount of the $3 million
paid is presented as an operating activity in the statement
of cash flows.
Example 7-21
Assume the same facts as in Example
7-19 except that during the fiscal year
ending December 31, 20X1, Company A records an increase in
the deferred tax asset of $5 million as follows because of
changes in the geographic mix of A’s earnings that affect
A’s tax savings:
Company A is able to use certain tax
benefits subject to the TRA to reduce cash taxes remitted to
the IRS so that $12 million is paid to the existing owners
of Company B (that exercised their exchange rights) in each
of the fiscal years ending December 31, 20X2, 20X3, and
20X4. Assume in this example that A does not record any
additional remeasurement adjustments after December 31,
20X1.
Before the TRA payments, a portion of the
TRA obligation is initially recognized through equity
(offsetting entry to APIC) and another portion of it is
recognized through earnings. The cumulative TRA payments
should be classified as cash outflows for financing
activities up to the amount of the TRA liability initially
recognized on the date of the existing owner share/unit
exchange (initially recognized through equity on the balance
sheet), and cumulative TRA payments in excess of those
amounts should be classified as cash outflows for operating
activities (settlement of amounts recognized through
earnings). Accordingly, the entire amount of the $12 million
paid in the fiscal years ending December 31, 20X2, and
December 31, 20X3, is presented as a financing activity in
the statement of cash flows because the cumulative payments
of $24 million (2 × $12,000,000) are less than the initial
TRA liability recorded in equity. For the $12 million paid
during the fiscal year ending December 31, 20X4, only $10
million remains [$34,000,000 – (2 × $12,000,000)] from the
initial TRA liability recorded in equity. The $10 million is
presented as a financing activity in the statement of cash
flows, and the $2 million in excess of the initial TRA
liability recorded in equity [(3 × $12,000,000) –
$34,000,000] is presented as an operating activity in the
statement of cash flows.
7.15 Digital Assets
There is no explicit guidance in U.S. GAAP on the accounting for
digital assets, including how an entity classifies its receipts of and payments for
such assets in the statement of cash flows. While the AICPA’s updated practice aid provides nonauthoritative guidance on the
accounting for digital assets (see Deloitte’s April 25, 2023, Heads Up), it does not address issues related
to the presentation of digital assets in the statement of cash flows. As a result,
an entity must apply judgment when classifying the cash flows associated with
transactions involving such assets.
The guidance discussed in the sections below applies to crypto
assets that are classified as intangible assets. In accordance with the AICPA’s
updated practice aid, crypto assets are types of digital assets that:
-
[F]unction as a medium of exchange and
-
[H]ave all of the following characteristics:
-
They are not issued by a jurisdictional authority (for example, a sovereign government).
-
They do not give rise to a contract between the holder and another party.
-
They are not considered a security under the Securities Act of 1933 or the Securities Exchange Act of 1934.
-
The practice aid further states that the above characteristics “are
not all-inclusive, and other facts and circumstances may need to be considered.
Examples of crypto assets meeting these characteristics include bitcoin, bitcoin
cash, and ether.”
Changing Lanes
In March 2023, the FASB issued a proposed ASU on the accounting for and
disclosure of certain crypto assets. The proposed ASU addresses, among other
things, cash flow presentation related to the sale of crypto assets received
as noncash consideration in the ordinary course of business. The proposed
amendments would require entities to present, as operating cash inflows, the
cash receipts from the nearly immediate sale of crypto assets that were
received as noncash consideration in the ordinary course of business. In
this situation, an entity would, in the normal course of business, receive
crypto assets as noncash consideration for a revenue-generating activity
(e.g., mining). According to the proposed ASU, the phrase “nearly
immediately” means “a short period of time that is expected to be within
hours or a few days, rather than weeks.” See Deloitte’s March 27, 2023,
Heads
Up for additional information about the proposed ASU. We
encourage entities to continue to monitor the FASB’s project on crypto
assets for developments related to the presentation of digital assets in the
cash flow statement.
7.15.1 Purchases and Sales of Crypto Assets
We generally believe that because crypto assets are classified
as intangible assets, an entity should classify cash flows resulting from the
purchases or sales of such assets as investing activities in accordance with ASC
230-10-45-13(c) and ASC 230-10-45-12(c), respectively. However, we have observed
that depending on the nature of activities associated with the purchase and sale
of crypto assets, entities have classified cash flows from such purchases and
sales as operating activities. Entities that plan to classify the cash flow
activity from this type of arrangement within operating activities are
encouraged to consult with their accounting and financial advisers.
7.15.2 Safeguarding Requirements
In March 2022, the SEC issued SAB 121, in which the SEC staff provided
its view that an entity that has an obligation to safeguard crypto assets should
record a liability and corresponding asset on its balance sheet at the fair
value of the crypto assets. See Deloitte’s April 6, 2022 (updated July 28,
2022), Financial Reporting
Alert for more information about SAB 121.
Since the initial recognition of a safeguarding liability and
safeguarding asset is a noncash transaction whose nature is generally
categorized as operating (e.g., cash flows resulting from custodial services
provided by an asset manager enter into the determination of the asset manager’s
net income), such recognition would not be presented in the statement of cash
flows or disclosed in accordance with ASC 230. If, in subsequent periods, a
difference arises between the remeasurement of the safeguarding liability and
the safeguarding asset (e.g., because of a loss event9), we believe that it is acceptable for an entity to present this
difference on a net basis as a reconciling item within its net cash flows from
operating activities.
Example 7-22
Entity A is a broker-dealer that is required to record a
safeguarding liability and safeguarding asset on its
balance sheet in accordance with SAB 121. At initial
recognition, the safeguarding liability and safeguarding
asset were both $100 million. Since they are both part
of A’s operations, A would not present their initial
recognition in its statement of cash flows.
In year 2, A remeasured the safeguarding liability and
safeguarding asset. As a result of a loss event, the
safeguarding asset was remeasured at $80 million while
the safeguarding liability remained at $100 million. The
$20 million loss would be presented as a reconciling
item within the reconciliation of net income to net cash
flows from operating activities in year 2.
7.15.3 Crypto Asset Lending
At the 2022 AICPA & CIMA Conference on Current SEC and PCAOB
Developments,10 the SEC staff indicated that it generally believes that in crypto asset
lending transactions, the lender transfers control of the crypto asset and
should therefore derecognize it if the transfer meets the requirements for
derecognition.11 In such a case, the lender would derecognize the crypto asset and
recognize an asset (i.e., loan receivable) that reflects its right to receive
the crypto asset from the borrower at the end of the loan period. The lender
would also recognize an allowance for credit losses related to the asset
recognized from the exchange at the inception of the loan and at the end of each
subsequent reporting period. In addition, the lender may earn a fee during the
loan period that is commonly paid in the form of crypto assets.
We believe that it would be acceptable to present the exchange
of the loaned crypto asset for the loan receivable as a noncash investing
activity since it is analogous to making and collecting loans. Any gain or loss
on the exchange12 related to the recognized asset should be presented as a noncash
reconciling item in the reconciliation of net income to net cash flows from
operating activities. In addition, since lender fees received in the form of
crypto assets reflect noncash income, we believe that it is acceptable for a
lender to present the crypto assets received as a noncash reconciling item in
the reconciliation of net income to net cash flows from operating
activities.
Example 7-23
Entity A entered into an agreement with Entity B in which
A will lend B 200 units of bitcoin that is due one year
from the loan commencement date. Entity A concludes that
it should derecognize the bitcoin assets from its
financial statements. Upon such derecognition, A
simultaneously recognizes a loan receivable that
reflects the fair value of the bitcoin assets lent,
adjusted by an allowance for credit losses, and presents
this noncash exchange as a noncash investing
activity.
In connection with the loan, A charges B a fee of 2
percent per month and requires B to pay A 4 units of
bitcoin each month for the 12-month duration of the
loan. The bitcoin received by A related to the fees
earned on the loan represents noncash consideration
received and may be presented as a noncash reconciling
item in the reconciliation of net income to net cash
flows from operating activities.
In addition, A determines that the allowance for credit
losses is $200,000. This allowance would be presented as
a noncash reconciling item in the reconciliation of net
income to net cash flows from operating activities.
Footnotes
9
The entity would factor in potential loss events (e.g.,
theft, loss of the private key, loss of the crypto asset, cybersecurity
hacks) that could affect the measurement of the safeguarding asset. The
occurrence of such a loss event could result in a difference between the
safeguarding asset and the safeguarding liability.
11
Entities need to consider various indicators of control
and elements of asset derecognition when making this determination. For
more information, see Deloitte’s April 25, 2023, Heads
Up.
12
A gain or loss may be recognized as a result of (1) the
difference between the carrying value of the lent assets and the fair
value of the crypto asset loan receivable or (2) the initial and
subsequent measurement of the allowance for credit losses on the crypto
asset loan receivable.
7.16 Excise Taxes Paid on Treasury Stock Transactions
The Inflation Reduction Act of 2022 adds a new Internal Revenue Code
section, Section 4501, that imposes a 1 percent excise tax on own-stock repurchases
by publicly traded companies that occur after December 31, 2022. Specifically, under
Section 4501, a covered corporation is subject to a tax equal to 1 percent of (1)
the fair market value of any stock of the corporation that is repurchased by this
corporation (or certain affiliates) during any taxable year, with limited
exceptions, less (2) the fair market value of any stock issued by the covered
corporation (or certain affiliates) during the taxable year (including compensatory
stock issuances). The 1 percent excise tax may also be imposed on acquisitions of
stock in certain mergers or acquisitions involving covered corporations.
Because the tax is not based on a measure of income, the excise tax
is not an income tax and, therefore, is not within the scope of ASC 740. The
accounting for taxes paid in connection with the repurchase of stock is not
specifically addressed in U.S. GAAP. However, AICPA Technical Q&As Section
4110.09 indicates that direct and incremental legal and accounting costs associated
with the acquisition of treasury stock may be added to the cost of the treasury
stock. Therefore, it is acceptable to account for the Section 4501 excise tax
obligation that results from the repurchase of common stock classified within
permanent equity as a cost of the treasury stock transaction. Any reductions in the
excise tax obligation associated with share issuances would also be recognized as
part of the original treasury stock transaction even if the share issuance is a
different type of instrument than the share that was repurchased.
Additional considerations are necessary when the excise tax obligation is related to
redemptions of preferred stock. Such an excise tax obligation would be recognized as
a cost of redeeming the preferred stock. The accounting for redemptions of preferred
stock differs depending on the classification of the preferred stock as permanent
equity, temporary equity, or a liability. An entity would need to use a systematic
and rational allocation approach to account for the effect of share issuances on the
excise tax obligation when the entity has repurchases of both common stock and
preferred stock during a taxable period.
ASC 230 does not specifically address the classification of cash outflows for payment
of the excise tax. Therefore, either of the following two classifications is
acceptable:
- Net cash paid for excise taxes is reported in operating activities. This classification is consistent with ASC 230-10-45-17(c), which indicates that “[c]ash payments to governments for taxes, duties, fines, and other fees or penalties” are cash outflows for operating activities.
- Net cash paid for excise taxes is reported in financing activities. This classification is
consistent with ASC 230-10-45-15(a), which states that cash outflows for
financing activities include: Payments of dividends or other distributions to owners, including outlays to reacquire the entity’s equity instruments. Cash paid to a tax authority by a grantor when withholding shares from a grantee’s award for tax-withholding purposes shall be considered an outlay to reacquire the entity’s equity instruments.
An entity should elect one of the two approaches as an accounting policy and report
the net cash paid for excise taxes in either operating or financing activities. An
entity is not permitted to report amounts in both operating activities and financing
activities.
Note that only actual cash payments for excise taxes will affect an entity’s
statement of cash flows. If an entity has recognized an excise tax payable, it
should report that transaction as a noncash financing activity if it elects to
report cash amounts paid within financing activities.