Deloitte's Roadmap: Statement of Cash Flows
Preface
Preface
We are pleased to present the 2023 edition of Statement of Cash
Flows. This Roadmap provides Deloitte’s insights into and interpretations of
the accounting guidance on the statement of cash flows, primarily that in ASC
230.1
The accounting principles related to the statement of cash flows
have been in place for many years; however, errors in the statement of cash flows
continue to be causes of restatements and registrants continue to receive comments
from the SEC staff on cash flow presentation matters.
While ASC 230 provides some guidance on cash payments and receipts
that are classified as either operating, investing, or financing activities, it does
not provide consistent principles for evaluating the classification of certain cash
payments and receipts in the statement of cash flows, which has led to diversity in
practice. This Roadmap includes some of Deloitte’s interpretive views on them.
The 2023 edition of this Roadmap includes several new discussions as
well as clarifications of previously expressed views. Appendix H highlights all new content as well
as any substantive revisions to previous content.
Be sure to check out On the Radar (also available
as a stand-alone
publication), which briefly summarizes
emerging issues and trends related to the accounting and
financial reporting topics addressed in the Roadmap.
We hope that you find this publication a valuable resource when
considering the accounting guidance on the statement of cash flows.2
Footnotes
1
For the full titles of standards, topics, and regulations,
see Appendix F.
For the full forms of acronyms, see Appendix G.
2
Although this Roadmap is intended to be a helpful resource,
it is not a substitute for consulting with Deloitte professionals on complex
accounting questions and transactions.
Videos in This Roadmap
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Topics
Restricted Cash
Predominance
Constructive Receipt and Disbursement
On the Radar
On the Radar
Because ASC 230 is largely principles-based,
financial statement preparers must exercise significant
judgment when classifying certain cash receipts and payments
in their statement of cash flows. Given the lack of
prescriptive rules, cash flow presentation continues to
challenge financial statement preparers.
In addition, while the guidance on cash flow presentation of
derivative instruments is not new, an entity’s cash flow
presentation may be subject to additional scrutiny as a
result of rising interest rates. For example, in an
increasing interest rate environment, an entity may pay
higher costs to acquire an interest rate cap agreement that
is intended to limit the entity’s exposure to future
variability in interest rates.
Further, given the rise in digital asset transactions and
lack of explicit guidance in U.S. GAAP on the accounting for
digital assets, including classification in the statement of
cash flows, entities must apply judgment when classifying
cash flows associated with transactions involving such
assets.
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Examples of SEC Comments
Examples of SEC Comments1
Category Classification
-
Please tell us your basis for classifying the capitalization of contract costs as an investing cash flow activity as opposed to an operating activity.
-
We note that you present increases and decreases in book overdrafts as cash flows from financing activities. In this regard, please provide us with your basis for reporting changes in book overdrafts as cash flows from financing activities instead of cash flows from operating activities. Also, clarify whether the overdraft is with a bank.
-
Please explain why you classified your short-term investments as trading and why the corresponding cash flows have been classified as investing instead of as operating in your Statements of Cash Flows. See ASC 320 and ASC 230-10-45-20.
ASC 230 requires entities to classify cash receipts and cash
payments as operating, investing, or financing activities on the basis of the
nature of the cash flow. Many of the SEC staff’s comments are related to
understanding the classification or potential misclassification among these
three cash flow categories. In some cases, the SEC staff has raised questions
about the presentation of cash inflows resulting from a transaction in a manner
inconsistent with the underlying balance sheet classification.
Examples of SEC Comments
Gross Versus Net Classification
-
Please revise the other assets and liabilities, net line item to present changes in other assets separately from other liabilities and further breakout any material components. Refer to ASC paragraphs 230-10-45-7 and 45-29.
-
We note that you present the caption Investments in property and equipment, net. Please revise future filings to separately present the cash inflows and cash outflows for property and equipment on a gross basis as discussed in ASC 230-10-45-26.
The SEC staff may challenge whether it is appropriate to report the net amount of
certain cash receipts and cash payments on the face of the statement of cash
flows. Generally, cash payments should not be presented net of cash receipts in
the statement of cash flows. However, ASC 230-10-45-7 through 45-9 state that
although reporting gross cash receipts and gross cash payments provides more
relevant information, financial statement users sometimes may not need gross
reporting to understand certain activities. Further, the netting criteria in ASC
230-10-45-8 (turnover is quick, the amounts are large, and the maturities are
short) must be met for an entity to present investing and financing activity on
a net basis. Accordingly, the SEC staff may ask a registrant to revise the
presentation or to explain (in accordance with ASC 230) why it is appropriate to
report certain cash flows on a net basis rather than on a gross basis.
Example of an SEC Comment
Extended Vendor Payable Arrangements
We note your “Accounts Payable days” are [X] days as of
[the fiscal year-end]. We further note your Accounts
Payable days [have] increased substantially over the
past ten years . . . . Please tell us if you are
engaging in supply chain finance operations and
mechanisms, such as reverse factoring or similar methods
to increase your Accounts Payable days. Otherwise,
please explain how you have been able to achieve such
extended accounts payable terms with your suppliers.
The SEC staff has recently issued comments to registrants that
use extended vendor payable arrangements involving the participation of a paying
agent or other financial institution. Under such programs, the paying agent or
financial institution may settle the payment obligation directly with the
registrant’s supplier, for a fee, earlier than the extended payment term.
Because there is no explicit authoritative guidance on these arrangements, the
SEC staff has challenged registrants’ determinations of whether the payments (1)
constitute trade payables, which would represent operating activities, or (2)
are more akin to debt, which would represent financing activities. Before the
issuance of ASU 2022-04 (discussed below), which requires enhanced disclosures
about supplier finance programs, there were no explicit disclosure requirements
for such programs. Therefore, the staff has encouraged registrants to provide
enhanced disclosures in MD&A about their extended vendor payable
arrangements, such as the following:
-
A description of the program; the material and relevant terms of the program, including the risks along with the general benefits.
-
Amounts settled through the program; and impacts of the program on the registrant’s payment terms to suppliers, days payable outstanding, working capital, liquidity, and capital resources.
-
Amounts remaining in trade payables at year-end for which the registrant’s supplier has elected early payment (i.e., the balance sheet impact).
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.
For a discussion of SEC comment letters to registrants on additional topics, see
Deloitte’s Roadmap SEC Comment Letter
Considerations, Including Industry Insights.
Increasing Interest Rates
As a result of rising interest
rates in the current economic environment, entities may have entered into,
amended, or terminated interest rate derivative contracts (such as interest rate
swaps and interest rate caps). The table below summarizes common cash flow
classifications for various derivative transactions. The classifications are
discussed in more detail in Section
7.4.
Derivative Instrument
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Classification of the Derivative’s Cash Flows
|
---|---|
Derivatives with an
other-than-insignificant financing element at
inception
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Financing activities (for the deemed
borrower2) and generally investing activities (for the
deemed lender)
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Derivatives acquired or originated for trading
purposes
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Operating activities
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Hedging derivatives
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Investing activities
or
In the same category as the cash flows from the item being hedged
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Nonhedging derivatives
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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)
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Digital Assets
There is currently 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. As a result, an
entity must apply judgment when classifying cash flows associated with
transactions involving such assets. These transactions commonly include
purchases and sales of crypto assets, crypto asset safeguarding, and crypto
asset lending.
In March 2023, the FASB issued a proposed ASU on the accounting for and disclosure of
certain crypto assets, including the cash flow presentation related to the sale
of crypto assets received as noncash consideration in the ordinary course of
business. Entities should continue to monitor the FASB’s project for
developments related to the presentation of digital assets in the statement of
cash flows.
See Section 7.15 for more
information about the proposed ASU and the presentation of certain digital asset
transactions in the statement of cash flows.
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).
Because ASC 230 does not address constructive receipt and disbursement, an
entity will need to use judgment when determining the substance of the
arrangement to presenting the cash flows of the arrangement.
For example, a company may purchase real estate by taking out a mortgage with a
third-party financing entity. In some cases, the third-party lender will not
deposit cash into the company’s bank account but will electronically wire cash
directly to an escrow account at the closing of the transaction, which in turn
is wired directly to the seller. 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.
This Roadmap comprehensively discusses the accounting
guidance on the statement of cash flows, primarily that
in ASC 230.
Footnotes
1
These examples of SEC comments
have been reproduced from the SEC’s Web site.
Dollar amounts and information identifying
registrants or their businesses have been redacted
from the comments.
2
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.
Contacts
Contacts
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Managing Director
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Ashley Carpenter
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Deloitte & Touche
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Deloitte & Touche
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Tony Goncalves
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Dennis Howell
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Stephen McKinney
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Nick Roger
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For information about Deloitte’s service offerings related to the statement of cash
flows, please contact:
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Bryan Anderson
Partner
Deloitte & Touche
LLP
+ 1 512 226 4559
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Chapter 1 — Overview
Chapter 1 — Overview
ASC 230 contains guidance on reporting cash flows in an entity’s financial statements. The primary objective for presenting a statement of cash flows under ASC 230 is to provide details on the changes in an entity’s cash and cash equivalents during a period. In accordance with this objective, cash receipts and payments are classified as operating activities, investing activities, or financing activities in the statement of cash flows and noncash investing and financing activities are separately disclosed.
ASC 230-10
10-1 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.
10-2 The information provided in a statement of cash flows, if used with related disclosures and information in the other financial statements, should help investors, creditors, and others (including donors) to do all of the following:
- Assess the entity’s ability to generate positive future net cash flows
- Assess the entity’s ability to meet its obligations, its ability to pay dividends, and its needs for external financing
- Assess the reasons for differences between net income and associated cash receipts and payments
- Assess the effects on an entity’s financial position of both its cash and noncash investing and financing transactions during the period.
ASC 230 provides general guidance on the classification of cash receipts and
payments as operating, investing, or financing
activities. Under ASC 230, cash receipts and
payments that are not defined as financing or
investing should be classified as operating
activities. Although ASC 230 provides some
guidance on identifying cash flows from operating
activities, it points out that such cash flows are
generally the cash effects of transactions or
events that enter into the determination of net
income. Because ASC 230 may not contain clearly
defined principles for evaluating the
classification of all cash payments and receipts
in the statement of cash flows, some diversity in
practice exists with respect to the classification
of certain cash receipts and cash payments.
Chapter 2 — Scope
Chapter 2 — Scope
Although entities are required to present a statement of cash flows, there are certain exceptions (identified in ASC 230). ASC 230 also defines the periods for which an entity is required to present a statement of cash flows.
ASC 230-10
15-2 The guidance in the Statement of Cash Flows Topic applies to all entities, including both business entities and not-for-profit entities (NFPs), with specific exceptions noted below. The phrase investors, creditors, and others includes donors. The terms income statement and net income apply to a business entity; the terms statement of activities and change in net assets apply to an NFP.
15-3 A business entity or NFP that provides a set of financial statements that reports both financial position and results of operations shall also provide a statement of cash flows for each period for which results of operations are provided.
A statement of cash flows should be presented for each of the periods in which a
statement of operations (or statement of
activities for not-for-profit entities [NFPs]) is
provided. For example, if a statement of
operations is provided for the most recent three
periods, a statement of cash flows should also be
provided for the same three periods. However,
certain types of entities are exempt from the
requirement to present a statement of cash flows
under ASC 230 when they are presenting a complete
set of financial statements.
ASC 230-10
15-4 The guidance in this Topic does not apply to the following entities:
- A statement of cash flows is not required to be provided by a defined benefit pension plan that presents financial information in accordance with the provisions of Topic 960. Other employee benefit plans that present financial information similar to that required by Topic 960 (including the presentation of plan investments at fair value) also are not required to provide a statement of cash flows. Employee benefit plans are encouraged to include a statement of cash flows with their annual financial statements when that statement would provide relevant information about the ability of the plan to meet future obligations (for example, when the plan invests in assets that are not highly liquid or obtains financing for investments).
- Provided that the conditions in (c) are met, a statement of cash flows is not required to be provided by the following entities:
- An investment company within the scope of Topic 946 on investment companies
- Subparagraph superseded by Accounting Standards Update No. 2013-08.
- A common trust fund, variable annuity account, or similar fund maintained by a bank, insurance entity, or other entity in its capacity as a trustee, administrator, or guardian for the collective investment and reinvestment of funds.
- For an investment company specified in (b) to be exempt from the requirement to provide a statement of cash flows, all of the following conditions must be met:
- Subparagraph superseded by Accounting Standards Update No. 2013-08.
- During the period, substantially all of the entity’s investments were carried at fair value and classified in accordance with Topic 820 as Level 1 or Level 2 measurements or were measured using the practical expedient in paragraph 820-10-35-59 to determine their fair values and are redeemable in the near term at all times.
- The entity had little or no debt, based on the average debt outstanding during the period, in relation to average total assets. For the purpose of determining average debt outstanding, obligations resulting from redemptions of shares by the entity from unsettled purchases of securities or similar assets, or from covered options written generally may be excluded. However, any extension of credit by the seller that is not in accordance with standard industry practices for redeeming shares or for settling purchases of investments shall be included in average debt outstanding.
- The entity provides a statement of changes in net assets.
Entities that are not required to present a statement of cash flows include
defined benefit pension plans that prepare financial information in accordance with
ASC 960, certain investment companies within the scope of ASC 946 that meet all of
the conditions in ASC 230-10-15-4(c), and certain funds described in ASC
230-10-15-4(b)(3).
Chapter 3 — Format and Presentation
Chapter 3 — Format and Presentation
This chapter provides guidance on the format and
presentation of changes in cash and cash equivalents, focusing on
actual cash flows during the period.
3.1 Form and Content of the Statement of Cash Flows
The statement of cash flows should report the cash effects of operations,
investing transactions, and financing transactions during a period. An entity can
use the indirect method1 or the direct method2 to present the operating section of the statement of cash flows. ASC 230
contains examples illustrating the preparation of the statement of cash flows under
both methods. ASC 230-10-45-25 encourages entities to use the direct method in
presenting the operating section of the statement of cash flows and to report major
classes of gross cash receipts and gross cash payments for operating cash flows.
Further, entities are encouraged to use the direct method to include a detailed
breakdown of operating cash receipts and payments to the extent that providing such
detail is feasible and financial statement users find it helpful.
Although use of the direct method is encouraged, many entities apply the indirect method to present operating cash flows. However, entities employing the indirect method should consider the direct method when evaluating proper classification of operating cash flows.
ASC 230-10
45-28 Entities that choose not
to provide information about major classes of operating cash
receipts and payments by the direct method as encouraged in
paragraph 230-10-45-25 shall determine and report the same
amount for net cash flow from operating activities
indirectly by adjusting net income of a business entity or
change in net assets of a not-for-profit entity (NFP) to
reconcile it to net cash flow from operating activities (the
indirect or reconciliation method). That requires adjusting
net income of a business entity or change in net assets of
an NFP to remove both of the following:
-
The effects of all deferrals of past operating cash receipts and payments, such as changes during the period in inventory, deferred income, and the like, and all accruals of expected future operating cash receipts and payments, such as changes during the period in receivables and payables. Adjustments to net income of a business entity or change in net assets of an NFP to determine net cash flow from operating activities shall reflect accruals for interest earned but not received and interest incurred but not paid. Those accruals may be reflected in the statement of financial position in changes in assets and liabilities that relate to investing or financing activities, such as loans or deposits. However, interest credited directly to a deposit account that has the general characteristics of cash is a cash outflow of the payor and a cash inflow of the payee when the entry is made.
-
All items that are included in net income of a business entity or change in net assets of an NFP that do not affect net cash provided from, or used for, operating activities such as depreciation of property, plant, and equipment and amortization of finite-life intangible assets. This includes all items whose cash effects are related to investing or financing cash flows, such as gains or losses on sales of property, plant, and equipment and discontinued operations (which relate to investing activities), and gains or losses on extinguishment of debt (which relate to financing activities).
Regardless of which method is used, an entity must present a reconciliation of net income (or changes in net assets for NFPs) to net cash flows from operating activities. All major classes of reconciling items must be separately reported; further breakdowns of categories are encouraged if doing so would result in more meaningful information for users.
ASC 230-10
45-29 The reconciliation of net
income of a business entity to net cash flow from operating
activities described in paragraph 230-10-45-28 shall be
provided regardless of whether the direct or indirect method
of reporting net cash flow from operating activities is
used. However, NFPs that use the direct method of reporting
net cash flows from operations are not required to provide a
reconciliation of change in net assets to net cash flow from
operating activities. Additional guidance for NFPs is found
in Subtopic 958-230. The reconciliation shall separately
report all major classes of reconciling items. For example,
major classes of deferrals of past operating cash receipts
and payments and accruals of expected future operating cash
receipts and payments, including, at a minimum, changes
during the period in receivables pertaining to operating
activities, in inventory, and in payables pertaining to
operating activities, shall be separately reported. Entities
are encouraged to provide further breakdowns of those
categories that they consider meaningful. For example,
changes in receivables from customers for an entity’s sale
of goods or services might be reported separately from
changes in other operating receivables.
45-30 If an entity other than an
NFP uses the direct method of reporting net cash flow from
operating activities, the reconciliation of net income to
net cash flow from operating activities shall be provided in
a separate schedule.
45-31 If the indirect method is used, the reconciliation may be either reported within the statement of cash flows or provided in a separate schedule, with the statement of cash flows reporting only the net cash flow from operating activities.
45-32 If the reconciliation is presented in the statement of cash flows, all adjustments to net income of a business entity or change in net assets of an NFP to determine net cash flow from operating activities shall be clearly identified as reconciling items.
At the 2005 AICPA Conference on Current SEC and PCAOB Developments (the 2005
AICPA Conference), SEC Associate Chief Accountant Joel Levine suggested that it is
not appropriate to reconcile an amount other than net income (e.g., income from
continuing operations) to net cash flows from operating activities in the statement
of cash flows.
ASC 230-10-55-7 through 55-21 contain examples illustrating the presentation of
the statement of cash flows under both the direct method and the indirect
method.
NFPs have the option of presenting their statement of cash flows by using either
the direct method or the indirect method. However, an NFP that chooses to use the
direct method of cash flow reporting is not required to present or disclose (e.g.,
in a separate schedule) the indirect method reconciliation.
3.1.1 Supplemental Disclosure of Interest and Income Taxes Paid
The FASB requires an entity to provide supplemental disclosure of interest and income taxes paid. This is to ensure that entities provide operating cash flow information similarly regardless of whether they used the indirect method to present it. Paragraph 121 of the Basis for Conclusions of FASB Statement 95
states, in part:
To provide information about the gross amounts of at least
those operating cash flows that are likely to be readily available, this
Statement requires enterprises that use the indirect method of reporting net
cash flow from operating activities to disclose amounts of interest and
income taxes paid. The Board believes that that information usually will be
readily available.
Accordingly, if an entity uses the indirect method to present the operating
section of its statement of cash flows, ASC 230 requires it to disclose
supplemental information regarding the payments made for interest and income
taxes during the period. Specifically, ASC 230-10-50-2 states as follows:
If
the indirect method is used, amounts of interest paid (net of amounts
capitalized), including the portion of the payments made to settle
zero-coupon debt instruments that is attributable to accreted interest
related to the debt discount or the portion of the payments made to settle
other debt instruments with coupon interest rates that are insignificant in
relation to the effective interest rate of the borrowing that is
attributable to accreted interest related to the debt discount, and income
taxes paid during the period shall be disclosed.
Although ASC 230-10-50-2 does not explicitly state whether an entity should
provide this supplemental information on the face of the statement of cash flows
or in the footnotes to the financial statements, we believe that either
presentation is acceptable.
3.1.1.1 Interest Paid
While ASC 230-10-50-2 provides guidance on certain amounts
related to interest paid (e.g., payments for the settlement of zero-coupon
debt instruments), it does not explicitly address whether an entity should
include, in the interest paid amount, the cash flows associated with
derivative contracts in a cash flow hedge of forecasted interest payments.
We believe that if an entity classifies the cash flows resulting from
derivative contracts in operating cash flows consistently with the cash flow
classification of the item being hedged, it would be acceptable for the
entity to include the cash flows resulting from those derivative contracts
as part of its supplemental disclosure of interest paid. If an entity
presents operating interest paid in this manner, we believe that the entity
should explain that fact in its supplemental disclosure of interest
paid.
3.1.1.2 Income Taxes Paid
3.1.1.2.1 Scope of Disclosures
ASC 230 requires entities to present income taxes paid
as operating cash flows, other than remittances of minimum statutory
withholding on share-based payment awards (see Section 7.3.5). However, the guidance
does not directly address whether the supplemental disclosure of income
taxes paid should include only cash outflows associated with current
income taxes paid or if it should also include other items related to
income taxes. For example, it is unclear whether the supplemental
disclosure of income taxes paid should include (1) interest and
penalties paid that an entity presents as income tax expense under ASC
740, (2) refunds received from relevant income tax authorities, or (3)
proceeds received from the disposal to third parties of transferable
income tax credits (see Section 3.1.1.2.2). Given the lack
of explicit guidance on what information to provide, we believe that it
would be acceptable for an entity to choose which amounts related to
income taxes to include in its supplemental disclosure of income taxes
paid. If the entity chooses to present cash flows in the manner
described above, the entity should specify which amounts comprise the
income taxes paid.
3.1.1.2.2 Transferable Income Tax Credits
An entity may elect to account for transferable income tax credits
(including the gains or losses from the sale or purchase of such
credits) within the scope of ASC 740. We believe that such an entity may
reflect the cash flows that result from the sale or purchase of
transferable income tax credits within cash flows from operating
activities in a manner consistent with the presentation of the cash
flows that result from the settlement of other balances related to
income taxes. Further, subject to any additional forthcoming guidance
issued by the FASB in connection with its project on income tax
disclosure,3 we believe that it would be acceptable for an entity to present
the cash flows that result from the sale or purchase of transferable
income tax credits within the amount specified in its supplemental
disclosure of income taxes paid during the period. If an entity presents
these cash flows within its supplemental disclosure of income taxes paid
during the period, we believe that the entity should disclose that fact,
as described in Section
3.1.1.1.
Footnotes
1
Under the indirect method, net cash provided or used by
operating activities is determined by adding back or deducting from net
income those items that do not affect cash (e.g., noncash transactions).
2
Under the direct method, major classes of gross cash
receipts and payments and their arithmetic sum are reported to determine net
cash provided or used by operating activities.
3
In March 2023, the FASB issued a proposed ASU that would
modify or eliminate certain existing income tax disclosure
requirements in addition to establishing new requirements. For
more information on the FASB’s proposed ASU, see Deloitte’s
March 22, 2023, Heads Up.
3.2 Gross and Net Cash Flows
Generally, cash payments should not be presented net of cash receipts in the statement of cash flows. ASC 230-10-45 provides guidance on presenting gross and net cash flows in the statement of cash flows.
ASC 230-10
45-7 Generally, information
about the gross amounts of cash receipts and cash payments
during a period is more relevant than information about the
net amounts of cash receipts and payments. However, the net
amount of related receipts and payments provides sufficient
information not only for cash equivalents, as noted in
paragraph 230-10-45-5, but also for certain other classes of
cash flows specified in paragraphs 230-10-45-8 through 45-9
and paragraph 230-10-45-28.
45-8 For certain items, the turnover is quick, the amounts are large, and the maturities are short. For certain other items, such as demand deposits of a bank and customer accounts payable of a broker-dealer, the entity is substantively holding or disbursing cash on behalf of its customers. Only the net changes during the period in assets and liabilities with those characteristics need be reported because knowledge of the gross cash receipts and payments related to them may not be necessary to understand the entity’s operating, investing, and financing activities.
45-9 Providing that the original maturity of the asset or liability is three months or less, cash receipts and payments pertaining to any of the following qualify for net reporting for the reasons stated in the preceding paragraph:
- Investments (other than cash equivalents)
- Loans receivable
- Debt.
For purposes of this paragraph, amounts due on demand are considered to have maturities of three months or less. For convenience, credit card receivables of financial services operations — generally, receivables resulting from cardholder charges that may, at the cardholder’s option, be paid in full when first billed, usually within one month, without incurring interest charges and that do not stem from the entity’s sale of goods or services — also are considered to be loans with original maturities of three months or less.
The netting criteria in ASC 230-10-45-8 (turnover is quick, the amounts are
large, and the maturities are short) must be met for an entity to present investing
and financing activity on a net basis, regardless of the classification of the asset
or liability in the balance sheet (i.e., current or noncurrent). For example, in
some cases, provided that certain conditions are met, it may be appropriate to
present debt-related activity (e.g., withdrawals and repayments) on a net basis in
the statement of cash flows even though the debt is presented as noncurrent in the
balance sheet. This could be the case, for example, if debt (1) meets all of the
conditions for net presentation in ASC 230-10-45-8 and 45-9 and (2) is appropriately
presented as noncurrent in the balance sheet because it meets the criteria in ASC
470-10-45-14.
3.2.1 Situations in Which Net Presentation May Be Appropriate
ASC 942-230-45-1 and 45-2 state:
45-1 Banks, savings
institutions, and credit unions are not required to report gross amounts
of cash receipts and cash payments for any of the following:
-
Deposits placed with other financial institutions and withdrawals of deposits
-
Time deposits accepted and repayments of deposits
-
Loans made to customers and principal collections of loans.
45-2 When those entities
constitute part of a consolidated entity, net amounts of cash receipts
and cash payments for deposit or lending activities of those entities
shall be reported separate from gross amounts of cash receipts and cash
payments for other investing and financing activities of the
consolidated entity, including those of a subsidiary of a bank, savings
institution, or credit union that is not itself a bank, savings
institution, or credit union.
Example 3-1
On January 1, 20X1, Entity A enters into a three-year revolving line of credit with a maximum borrowing capacity of $300 million. Under the terms of the line of credit, each borrowing or draw is considered due on demand. On June 30, 20X1, A borrows $150 million against the line of credit. On August 1, 20X1, A draws against the line of credit again, borrowing an additional $120 million. On August 31, 20X1, A borrows another $30 million from the line of credit. On September 30, 20X1, A pays $200 million of the outstanding balance. Assume that the turnover of borrowings and payments is quick and that the amounts borrowed and paid are large. Because the original (contractual) maturity of the borrowings is due on demand (i.e., three months or less), A may present the borrowings and payment on a net basis ($100 million) as a financing cash inflow in its statement of cash flows for the period ended December 31, 20X1.
Example 3-2
On January 1, 20X1, Entity A enters into a three-year revolving line of credit with a maximum borrowing capacity of $300 million. On June 30, 20X1, A borrows (1) $200 million from the line of credit and signs a note to pay the amount borrowed in three months and (2) $100 million from the line of credit and signs a note to pay the amount borrowed in four months. On September 30, 20X1, A pays $200 million related to the first note. On October 31, 20X1, A pays $100 million related to the second note. Assume that the turnover of borrowings and payments is quick and that the amounts borrowed and paid are large. In A’s statement of cash flows for the period ended December 31, 20X1, only the borrowing and payment related to the first note may be presented on a net basis within financing activities because the original (contractual) maturity of this note is three months or less. The borrowing and payment related to the second note should be presented on a gross basis (i.e., borrowing of $100 million as a financing cash inflow and payment of $100 million as a financing cash outflow).
Example 3-3
On January 1, 20X1, Entity A enters into a three-year revolving line of credit with a maximum borrowing capacity of $300 million. The agreement does not set maturity dates for each borrowing other than the expiration of the line of credit at the end of December 31, 20X3. In this case, all borrowings and repayments made before October 1, 20X3, should be presented on a gross basis because the original (contractual) maturity of each borrowing is not three months or less. Provided that the turnover of borrowings and payments is quick and that the amounts borrowed and paid are large, amounts borrowed or paid after October 1, 20X3, may be presented on a net basis because the original (contractual) maturity is within three months. It may, however, be impractical to separate the borrowings and repayments into those that must be presented on a gross basis and those that may be presented on a net basis. Accordingly, A could present all borrowings and repayments on a gross basis.
3.3 Presentation of Discontinued Operations
A disposal of a component or group of components of an entity must be reported in discontinued operations if the disposal meets the criteria in ASC 205-20. ASU 2014-08 changed the requirements for reporting a discontinued operation under ASC 205-20 and introduced new disclosure requirements for discontinued operations, including certain cash flow disclosure requirements.
ASC 205-20
50-5B An entity shall disclose, to the extent not presented on the face of the financial statements as part of discontinued operations, all of the following in the notes to financial statements: . . .
c. Either of the following:
1. The total operating and investing cash flows of the discontinued operation for the periods in which the results of operations of the discontinued operation are presented in the statement where net income is reported (or statement of activities for a not-for-profit entity)
2. The depreciation, amortization, capital expenditures, and significant operating and investing noncash items of the discontinued operation for the periods in which the results of operations of the discontinued operation are presented in the statement where net income is reported (or statement of activities for a not-for-profit entity). . . .
During deliberations of the guidance in ASU 2014-08, some Board members noted that disclosure of investing and operating cash flows is more meaningful than disclosure of depreciation and amortization, capital expenditures, and significant noncash items. However, the cash flow disclosures could present a significant challenge for entities that have a centralized cash management process (since these entities do not typically segregate their invoices or purchase orders at the business unit or operating unit level) and may be difficult to provide in a timely manner and without undue effort. Therefore, the Board decided to give entities the option of providing the above alternative disclosure in the notes to the financial statements. The Board also decided not to require entities to disclose the financing cash flows of a discontinued operation because financing transactions are often conducted at the parent level rather than within each subsidiary.
Before the adoption of ASU 2014-08, entities were not required to separately
disclose — in the statement of cash flows or in the notes to the financial
statements — cash flows pertaining to discontinued operations reflected in
operating, investing, and financing activities. However, in his 2005 AICPA
Conference speech, Mr. Levine stated that if an entity chooses to separately present
cash flows pertaining to discontinued operations in the statement of cash flows,
such presentation should be in line with the basic principle of ASC 230 (i.e., all
cash flows must be reported as operating, investing, or financing activities, as
applicable). Therefore, although they are not required to do so, some entities have
chosen to separately present the cash flows pertaining to discontinued operations on
the face of the cash flow statement or to disclose such information in the notes to
the financial statements, classifying cash flows pertaining to discontinued
operations within operating, investing, and financing activities.
Under ASU 2014-08, if an entity chooses to separately disclose cash flows
pertaining to discontinued operations in the notes
to the financial statements, the entity is only
required to provide the minimum disclosures
described in ASC 205-20-50-5B(c), including either
(1) total operating and investing cash flows of
the discontinued operation or (2) depreciation,
amortization, capital expenditures, and
significant operating and investing noncash items
of the discontinued operation.
However, ASU 2014-08 states that “[a]n entity shall disclose, to the extent not
presented on the face of the financial statements as part of discontinued
operations, all of the following in the notes to financial statements.” From this
wording, it is not clear whether, (1) if an entity elects to provide these minimum
disclosures on the face of the statement of cash flows (in particular the option to
only disclose depreciation, amortization, capital expenditures, and significant
operating and investing noncash items), such disclosures would represent the
required minimum cash flow information about the discontinued operation to present
in the statement of cash flows or (2) an entity would nonetheless be required to
comply with the principles of ASC 230 and provide total operating, investing, and
financing information for the discontinued operation to the extent applicable. On
the basis of informal discussions with the FASB staff, we do not believe that ASU
2014-08 amended the principles of ASC 230, specifically those related to providing
total operating and investing cash flows for a discontinued operation. We therefore
believe that if an entity elects to provide the ASU 2014-08 cash flow disclosures
pertaining to a discontinued operation on the face of the statement of cash flows,
the entity would need to comply with the principles of ASC 230. Given the lack of
clarity discussed above, entities are encouraged to consult with their accounting
advisers if they are considering an alternative presentation of cash flows related
to discontinued operations on the face of the cash flow statement.
The following table illustrates one acceptable
presentation for reporting cash flows from
discontinued operations on the face of the cash
flow statement:
Categories Related to the
Statement of Cash Flows
|
Presentation
|
---|---|
Operating
|
Continuing
|
Discontinued (in detail or
net)
| |
Total operating cash flows
| |
Investing
|
Continuing
|
Discontinued (in detail or
net)
| |
Total investing cash flows
| |
Financing
|
Continuing
Discontinued (in detail or
net)
Total financing cash flows
|
An alternative to the above presentation is to
disclose cash flows pertaining to discontinued
operations for each of the categories (either in
detail or net) below the section for cash flows
from financing activities pertaining to continuing
operations:
Categories Related to the
Statement of Cash Flows | Presentation |
---|---|
Operating | Continuing |
Investing | Continuing |
Financing | Continuing |
Operating | Discontinued (in detail or net) |
Investing | Discontinued (in detail or net) |
Financing | Discontinued (in detail or net) |
When using this presentation, preparers should be aware that the approach does not provide a total for
each of the three categories (although a user could compute these totals by adding the net cash flow
for continuing operations and discontinued operations for each category). Accordingly, when using this
alternative approach, captions related to any totals presented must clearly reflect the category to which
the total is related (continuing vs. discontinued).
Entities should provide separate disclosures consistently for cash flows pertaining to discontinued operations for all periods affected and should continue to do so until there are no longer material cash flows related to the discontinued operation. In addition, ASU 2014-08 requires entities that have significant continuing involvement with a discontinued operation after the disposal date to disclose the amount of any cash inflows or outflows to or from the discontinued operation and any revenues and expenses with the discontinued operation presented in continuing operations after the disposal transaction that were eliminated in the consolidated financial statements before the disposal. SEC registrants should also consider discussing in MD&A the impact of the discontinued operations on future cash flows.
The proceeds from the sale of discontinued operations should be presented as cash associated with investing activities of discontinued operations. Although neither ASC 230 nor ASC 360-10 provides explicit guidance on the presentation of proceeds from the sale of discontinued operations in the statement of cash flows, this presentation is consistent with the concepts in those standards.
ASC 230-10-10-1 states that “[t]he 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.” Some preparers have included the
proceeds from the sale of a discontinued operation
in cash flows from continuing operations since
these proceeds will be used to fund outflows of
continuing operations. However, in commenting on
the proper classification of insurance proceeds in
the statement of cash flows at the 2005 AICPA
Conference, Mr. Levine clarified that the SEC
staff does not believe that the classification
should be affected by how an entity intends to
spend such proceeds. Further, the SEC staff’s view
is consistent with ASC 230-10-45-21B, under which
entities are required to classify proceeds from
insurance settlements on the basis of the
underlying loss (see Section 6.3.2 for
additional information). This view would also
apply to reporting the proceeds from the sale of a
discontinued operation.
Although ASC 360-10 does not provide explicit guidance on the presentation of
discontinued operations in the statement of cash
flows, ASC 205-20-45-3A and 45-3B require that
gains or losses from discontinued operations be
presented separately from gains or losses from
continuing operations in the income statement.
Likewise, in the statement of cash flows, proceeds
from the sale of assets that are associated with
discontinued operations should be presented
separately as cash related to investing activities
of discontinued operations.
However, the allocation of taxes associated with the sale of a discontinued
operation to investing activities would not be
appropriate. ASC 230-10-45-17(c) requires that
cash flows associated with cash payments to
governments for taxes be included as a component
of operating cash flows. Further, in the background information in paragraph 92 of FASB Statement 95, the Board indicates the
following:
On the basis of this wording and the
guidance in ASC 230-10-45-17(c), the Board decided
not to permit the allocation of income taxes to
the various cash flow components.
[A]llocation of income taxes
paid to operating, investing, and financing
activities would be so complex and arbitrary that
the benefits, if any, would not justify the costs
involved. This Statement requires that the total
amount of income taxes paid be disclosed for
reasons discussed in paragraph 121.
Example 3-4
Company P sold its international business to Company J for $12 billion and will be required to pay
approximately $3 billion in taxes related to the gain on the sale. Company P has appropriately decided
to report the sale of the international business as a discontinued operation in its income statement. In addition, P has elected to present the discontinued operation separately in its statement of cash flows. The
proceeds from the sale of the business should be presented separately as cash related to investing activities
of discontinued operations. The taxes related to the gain on the sale of the international business should be
presented in operating activities in P’s statement of cash flows.
Chapter 4 — Cash and Cash Equivalents
Chapter 4 — Cash and Cash Equivalents
This chapter provides guidance on the determination and
presentation of cash and cash equivalents in the statement of cash
flows. In accordance with ASC 230-10-45-4, when the total amounts of
cash, cash equivalents, and amounts generally described as
restricted cash or restricted cash equivalents are presented in more
than one line item within the statement of financial position, an
entity must provide additional disclosures to reconcile (1) the
amounts disaggregated by line item, as reported in the statement of
financial position, to (2) what is shown in the statement of cash
flows.
4.1 Definition of Cash and Cash Equivalents
ASC Master Glossary
Cash
Consistent with common usage, cash includes not only currency on hand but demand deposits with banks or other financial institutions. Cash also includes other kinds of accounts that have the general characteristics of demand deposits in that the customer may deposit additional funds at any time and also effectively may withdraw funds at any time without prior notice or penalty. All charges and credits to those accounts are cash receipts or payments to both the entity owning the account and the bank holding it. For example, a bank’s granting of a loan by crediting the proceeds to a customer’s demand deposit account is a cash payment by the bank and a cash receipt of the customer when the entry is made.
While the definition of cash is fairly straightforward, the determination of
cash equivalents may not be as clear. The ASC master glossary defines cash
equivalents as follows:
ASC Master Glossary
Cash Equivalents
Cash equivalents are short-term, highly liquid investments that have both of the following characteristics:
- Readily convertible to known amounts of cash
- So near their maturity that they present insignificant risk of changes in value because of changes in interest rates.
Generally, only investments with original maturities of three months or less qualify under that definition. Original maturity means original maturity to the entity holding the investment. For example, both a three-month U.S. Treasury bill and a three-year U.S. Treasury note purchased three months from maturity qualify as cash equivalents. However, a Treasury note purchased three years ago does not become a cash equivalent when its remaining maturity is three months. Examples of items commonly considered to be cash equivalents are Treasury bills, commercial paper, money market funds, and federal funds sold (for an entity with banking operations).
Maturity is a critical component in the determination of whether short-term investments, such as certificates of deposit, time deposits, and other temporary investments, can be combined with cash and classified as cash equivalents or presented separately as short-term investments in an entity’s balance sheet and statement of cash flows.
Example 4-1
Entity A invests excess funds in short-term (less than three months) bank repurchase agreements. The underlying securities in the transaction may have maturities greater than three months. Entity A may classify these repurchase agreements as cash equivalents in its balance sheet and statement of cash flows. The investment (the repurchase agreement), in substance, meets the criteria in ASC 230. The critical factor is the maturity of the repurchase agreement itself, not the underlying securities that serve to secure the investment.
ASC 230-10
45-6 Not all investments that qualify are required to be treated as cash equivalents. An entity shall establish a policy concerning which short-term, highly liquid investments that satisfy the definition of cash equivalents are treated as cash equivalents. For example, an entity having banking operations might decide that all investments that qualify except for those purchased for its trading account will be treated as cash equivalents, while an entity whose operations consist largely of investing in short-term, highly liquid investments might decide that all those items will be treated as investments rather than cash equivalents.
In accordance with ASC 230-10-50-1, an entity should disclose its policy for
determining which items are treated as cash equivalents. Changes to an entity’s policy
represent changes in accounting principle for which preferability must be established in
accordance with ASC 250.
4.1.1 Restricted Cash
4.1.1.1 Balance Sheet Presentation of Restricted Cash
Cash available for general operations is distinguishable from cash restricted in accordance with third-party special-purpose agreements. When a cash account is restricted, the ability of the account’s owner to withdraw funds at any time is contractually or legally restricted. Since an entity cannot withdraw restricted cash without prior notice or penalty, the entity should not present such cash in cash and cash equivalents. While the terms “restricted cash” and “restricted cash equivalents” are not defined in U.S. GAAP, SEC Regulation S-X, Rule 5-02(1), requires registrants to separately disclose account balances whose withdrawal or usage is restricted. As a result, registrants typically present restricted cash and restricted cash equivalents separately from cash and cash equivalents on their balance sheet, and many nonpublic entities elect similar balance sheet presentation. However, entities may include restricted cash and restricted cash equivalents in other balance sheet line items. Accordingly, an entity’s definition of restricted cash and restricted cash equivalents is typically an accounting policy matter. Such a policy should be applied consistently and will need to take into account the nature of both the financial instruments and the restrictions.
Paragraph BC9 of ASU 2016-18 indicates that the Board’s clarifications related to presenting restricted cash and restricted cash equivalents in the statement of cash flows were not intended to change an entity’s practice for identifying and reporting restricted cash or restricted cash equivalents. Specifically, paragraph BC9 states:
Although the Master Glossary does not include specific definitions of restricted cash or restricted cash equivalents, some Task Force members believe that only those financial instruments that first meet the definition of cash or cash equivalents before considering the restrictions that exist in a separate provision outside those financial instruments should be included in the beginning-of-period and end-of-period reconciliation of the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents on the statement of cash flows. Other Task Force members believe that the nature of the restrictions on cash or cash equivalents should be considered and that in certain cases the restrictions could be so severe that the financial instrument would not meet the definition of cash or cash equivalents, thereby preventing those balances from being included in the beginning-of-period and end-of-period reconciliation of total cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents on the statement of cash flows. The Task Force considered defining restricted cash; however, it ultimately decided that the issue resulting in diversity in practice is the presentation of changes in restricted cash on the statement of cash flows. The Task Force’s intent is not to change practice for what an entity reports as restricted cash or restricted cash equivalents.
Further, paragraph BC19 of ASU 2016-18 notes that (1) an entity should apply the
guidance on a change in an accounting principle in ASC 250 “if [the] entity is
considering changing its accounting policy for determining restricted cash and
restricted cash equivalents” and (2) “[s]uch evaluation would be separate from adoption
of the amendments in this Update [ASU 2016-18].”
In addition, in accordance with ASC 230-10-50-7, an entity should “disclose
information about the nature of restrictions on its cash, cash equivalents, and amounts
generally described as restricted cash or restricted cash equivalents.” Further, when
cash, cash equivalents, and amounts generally described as restricted cash or restricted
cash equivalents are presented in more than one line item in the statement of financial
position, an entity should also apply the requirements in ASC 230-10-50-8, as discussed
below.
4.1.1.2 Presentation of Restricted Cash in the Statement of Cash Flows
ASC 230-10
45-4 A statement of cash
flows shall explain the change during the period
in the total of cash, cash equivalents, and
amounts generally described as restricted cash or
restricted cash equivalents. The statement shall
use descriptive terms such as cash or cash and
cash equivalents rather than ambiguous terms such
as funds. When cash, cash equivalents, and amounts
generally described as restricted cash or
restricted cash equivalents are presented in more
than one line item within the statement of
financial position, an entity shall provide the
disclosures required in paragraph 230-10-50-8.
45-5 Cash purchases and sales of items commonly
considered to be cash equivalents generally are part of the entity’s cash
management activities rather than part of its operating, investing, and
financing activities, and details of those transactions need not be reported
in a statement of cash flows. In addition, transfers between cash, cash
equivalents, and amounts generally described as restricted cash or
restricted cash equivalents are not part of the entity’s operating,
investing, and financing activities, and details of those transfers are not
reported as cash flow activities in the statement of cash flows.
50-8 When cash, cash equivalents, and amounts
generally described as restricted cash or restricted cash equivalents are
presented in more than one line item within the statement of financial
position, an entity shall, for each period that a statement of financial
position is presented, present on the face of the statement of cash flows or
disclose in the notes to the financial statements, the line items and
amounts of cash, cash equivalents, and amounts generally described as
restricted cash or restricted cash equivalents reported within the statement
of financial position. The amounts, disaggregated by the line item in which
they appear within the statement of financial position, shall sum to the
total amount of cash, cash equivalents, and amounts generally described as
restricted cash or restricted cash equivalents at the end of the
corresponding period shown in the statement of cash flows. This disclosure
may be provided in either a narrative or a tabular format. . . .
In a manner consistent with the guidance in ASC
230-10-45-4, an entity should include in the beginning and ending cash and
cash-equivalent balances of the statement of cash flows those amounts that
are generally described as restricted cash and restricted cash equivalents,
regardless of where such amounts may be included on an entity’s balance
sheet (e.g., cash, restricted cash, other assets, collections from
servicing). The concept of reconciling “total cash” in the statement of cash
flows is discussed in paragraph BC5 of ASU 2016-18, which states:
The Task Force reached a consensus that a statement of
cash flows should explain the change during the period in the total of cash, cash equivalents, and amounts generally
described as restricted cash or restricted cash equivalents. That
is, amounts generally described as restricted cash and restricted cash
equivalents should be included with cash and cash equivalents when
reconciling the beginning-of-period and end-of-period total amounts shown
on the statement of cash flows under the amendments in this Update. The
Task Force recognizes that some entities present cash and cash equivalents
with restrictions in multiple line items on the statement of financial
position and that in some cases those line items are titled something
other than restricted cash or restricted cash equivalents; therefore, the
phrase amounts generally described as restricted cash or restricted
cash equivalents is used throughout this Update. This consensus
requires that those amounts also be included in the beginning-of-period
and end-of-period total amounts shown on the statement of cash flows.
[Emphasis added] |
Example 4-2
Entity A is a mortgage servicer that collects mortgage payments from
debtors and remits the mortgage payments (net of authorized service fees) to
a creditor. Before remitting net mortgage payments to the creditor, A
classifies cash, which it has control over, under the caption “collections
from servicing” on its balance sheet. Because the amounts included in the
balance sheet under this caption represent cash, A presents these amounts in
the beginning-of-period and end-of-period cash, cash equivalents, and
restricted cash in the statement of cash flows rather than as part of the
cash flow activities reported for the period.
Changes in restricted cash and restricted cash equivalents that result from
transfers between cash, cash equivalents, and restricted cash and restricted cash
equivalents should not be presented as cash flow activities in an entity’s statement of
cash flows. This stipulation is consistent with paragraph BC8 of ASU 2016-18, which
states, in part:
The Task Force believes that internal transfers
between cash, cash equivalents, and amounts generally described as restricted cash or
restricted cash equivalents do not represent a cash inflow or outflow of the entity
because there is no cash receipt or cash payment with a source outside of the entity
that affects the sum of cash, cash equivalents, and amounts generally described as
restricted cash or restricted cash equivalents.
Example 4-3
Company A enters into an agreement with Company B under which A will operate and maintain a desalination
plant owned by B. In accordance with the contract:
- Company B will transfer a fixed amount of cash into an account in A’s name at the beginning of every month to fund the cost of repairing and maintaining the plant.
- The account is segregated from A’s general operating account.
- Company A obtains approval from B before performing any repair and maintenance work, and available account funds cannot be withdrawn without B’s approval.
- Any funds remaining upon the expiration or termination of the agreement will be returned to B.
Because of the contractual restrictions associated with the use of the cash deposited into A’s account,
whenever B funds the account, A immediately recognizes restricted cash and a contract liability (i.e., deferred
revenue).
In accordance with ASC 230-10-45-4, A includes the restricted cash balance with cash and cash equivalents
in the reconciliation of beginning and ending cash, cash equivalents, restricted cash, and restricted cash
equivalents, instead of separate cash flows (for each period for which the cash amounts are restricted).
4.1.1.3 Reconciliation of Cash, Cash Equivalents, and Amounts Generally Described as Restricted Cash or Restricted Cash Equivalents for an Interim Reporting Period
ASC 230 requires the
reconciliation of (1) the ending cash, cash equivalents, and amounts generally described
as restricted cash or the restricted cash equivalents balance presented in the statement
of cash flows to (2) the statement of financial position when such amounts are presented
in more than one line item in the statement of financial position. Such information must
be provided on the face of the statement of cash flows or disclosed in the notes to the
financial statements and can be in narrative or tabular form. However, ASC 230 does not
specify how to apply this requirement to comparative periods when interim periods
presented in the statement of cash flows do not correspond to the periods presented in
the statement of financial position. Specifically, while ASC 230-10-50-8 states, in
part, that the reconciliation is required for “each period that a statement of financial position is presented” (e.g., as of March 31, 20X1, and
December 31, 20X0), ASC 230-10-50-8 then goes on to indicate that those amounts “shall
sum to the total amount of cash, cash equivalents, and amounts generally described as
restricted cash or restricted cash equivalents at the end of the corresponding period
shown in the statement of cash flows” (e.g., March 31, 20X1, and
March 31, 20X0). [Emphasis added]
The lack of specific guidance
on this matter has led to diversity in how entities have applied this reporting
requirement for interim reporting periods. We believe that it is acceptable for an
entity to use one of the following alternatives to meet ASC 230’s reconciliation
requirement for interim reporting periods (for illustrative purposes, we have assumed
that in the interim financial statements, the statements of financial position are as of
March 31, 20X1, and December 31, 20X0, and the three months ended March 31, 20X1, and
March 31, 20X0, for the statement of cash flows):
- Provide the reconciliation for each period presented in the statement of financial position (e.g., March 31, 20X1, and December 31, 20X0).
- Provide the reconciliation for each period presented in the statement of cash flows (e.g., March 31, 20X1, and March 31, 20X0).
- Provide the reconciliation for each period presented in the statement of financial position as well as each period presented in the statement of cash flows (e.g., March 31, 20X1; December 31, 20X0; and March 31, 20X0).
See Appendix D for other SEC interim reporting
considerations related to the statement of cash flows.
4.1.2 Classification of Interest Earned on Restricted Funds
As noted in Section 4.1.1, entities must include in their cash and cash-equivalent balances in the statement of cash flows those amounts that are generally described as restricted cash and restricted cash equivalents. Entities must also provide certain disclosures about the amounts and nature of restricted cash included in their cash and cash-equivalent balances. Under ASC 230, an entity should classify interest earned on restricted funds in the statement of cash flows in a manner consistent with cash and cash equivalents that are not restricted and should also include such amounts in disclosures about restricted cash.
4.1.3 Funds Held for Others
In certain situations, an entity may arrange for the transfer of cash on behalf of others
(e.g., an entity that provides payroll tax filing, payment processing services, or
escrow-related activities). Questions have arisen regarding when such an entity should
report — as its asset on the balance sheet and the associated cash flows in the cash flows
statement — the cash and cash equivalents or restricted cash and restricted cash
equivalents held with financial institutions for the benefit of its clients (the
“Funds”).
We believe that the entity’s determination of whether to report the
Funds held on behalf of others as its own cash, or restricted cash in its balance sheet,
should be based on whether the entity controls the Funds. This stipulation is consistent
with the nonauthoritative guidance in Section 1100.08 of the AICPA’s Technical Q&As,
which states, in part, that “[t]he balance sheet caption ‘cash’ should represent an amount
that is within the control of the reporting enterprise.”
The determination of whether the entity controls the Funds held on the behalf of others
can be complex. Criteria an entity should consider in making this determination may
include, but are not limited to, the following:
- Whether the entity has legal ownership over or title to the Funds.
- Whether the entity has the right to use the Funds before performing under the terms of the arrangement (e.g., whether the entity has the right to invest the Funds before disbursement).
- In the event of bankruptcy, whether the Funds would be considered part of the bankruptcy state of the entity, the client, or both.
- What happens if the entity fails to perform (e.g., whether the entity would be obligated to make payments using its own cash if it failed to make payroll-related payments to a client’s employees).
If the entity determines that it controls the Funds held on behalf of
others, it should report the Funds as cash in its balance sheet. Further, the changes in
those Funds held for others generally should be classified as financing activities in a
manner consistent with our understanding of the SEC staff’s view that the holding of Funds
on behalf of others is analogous to proceeds received from borrowings. According to this
view, the borrowings are considered outstanding until the custodial entity delivers the
Funds to satisfy its client obligations and such delivery is deemed a repayment of the
borrowing. However, if an entity concludes that it does not control the Funds, it should
not present the Funds as assets on the balance sheet or present those transactions in the
statement of cash flows. We believe that an operating classification may also be
acceptable. Entities that plan on presenting the cash flow activity from this type of
arrangement within operating activities should consider consulting with their accounting
and financial advisers.
We believe that entities that participate in such arrangements should
consider disclosing the criteria and judgments they used when determining whether they
control the Funds held on behalf of others.
4.2 Book and Bank Overdrafts
4.2.1 Balance Sheet Considerations
4.2.1.1 Book Overdrafts
A book overdraft represents the amount of outstanding checks in excess of funds on deposit for a particular bank account, resulting in a credit cash balance reported on an entity’s balance sheet as of a reporting date. For financial reporting purposes, an entity should reinstate a liability (e.g., accounts payable) to the extent of the book overdraft in such a way that the cash balance is reported as a zero balance.
When an entity maintains separate funding and disbursement accounts with the same bank, it may not be as easy to determine the amount of the book overdraft. For example, an entity may have a cash management arrangement with a bank in which checks written are issued from a dedicated disbursement account that is funded from a separate deposit account as the checks are presented for payment to the bank. In such a scenario, the disbursement account may be designed to maintain a zero balance. Further, it is not uncommon for a bank to have the contractual right and ability to automatically sweep cash from the funding account to cover checks presented for payment from the disbursement account. Because of timing differences between when checks are written by an entity and when they are funded by the bank, the disbursement account may reflect a book overdraft as of a reporting date, which by design would represent the entire population of outstanding checks.
In practice, questions have arisen regarding how an entity should determine the book overdraft in such an arrangement to reinstate accounts payable. Two alternative approaches to making this determination have emerged:
- The single account approach ― The deposit and disbursement accounts with the same bank would be viewed as a single account in the determination of the book overdraft.
- The liability extinguishment approach ― The book overdraft with the same bank would be determined independently from any funds held in the deposit account, resulting in the reinstatement of the entire population of outstanding checks.
4.2.1.1.1 The Single Account Approach
The balance sheet offsetting guidance in ASC 210-20 focuses on whether a “right of setoff” exists. A right of setoff is defined as “a debtor’s legal right . . . to discharge all or a portion of the debt owed to another party by applying against the debt an amount that the other party owes to the debtor.” However, ASC 210-20-55-18A states that “[c]ash on deposit at a financial institution shall be considered by the depositor as cash rather than as an amount owed to the depositor.” Because cash on deposit is held by the bank for the entity in a fiduciary capacity, the cash on deposit would not be considered an “amount owed” to the entity. Although the offsetting guidance in ASC 210-20 would not apply to the separate deposit and disbursement accounts in the above scenario, we nonetheless believe that it would be acceptable — to the extent that the following conditions are met — for entities to analogize to the offsetting guidance in deciding whether to view the disbursement and deposit accounts as a single bank account in the determination of the book overdraft:
- Under the terms of the depositor relationship, the financial institution has the right, ability, and intent to offset a positive balance in one account against an overdrawn amount in the other.
- Amounts in each of the accounts are unencumbered and unrestricted with respect to use.
Further, we believe that the single account
approach is also consistent with the nonauthoritative guidance in AICPA
Technical Q&As Section 1100.08, which states:
Inquiry — Should the amount of checks that have been issued and are out of the control of the payor but which have not cleared the bank by the balance sheet date be reported as a reduction of cash?
Reply — Yes. A check is out of the payor’s control after it has been mailed or delivered to the payee. The balance sheet caption “cash” should represent an amount that is within the control of the reporting enterprise, namely, the amount of cash in banks plus the amount of cash and checks on hand and deposits in transit minus the amount of outstanding checks. Cash is misrepresented if outstanding checks are classified as liabilities rather than a reduction of cash.
Under the single account approach, a book overdraft would not exist to the extent that the funding account has sufficient funds to cover the amount of outstanding checks. Therefore, to the extent that outstanding checks exceed the amount in the deposit account, this excess would be considered the book overdraft and should be presented as a liability for financial reporting purposes.
4.2.1.1.2 The Liability Extinguishment Approach
Under the liability extinguishment approach, the disbursement account is viewed independently from the deposit account in the determination of the amount of the book overdraft. The accounting basis for this approach is that the liability (e.g., accounts payable) that will be settled through the issuance of the outstanding checks has not been legally extinguished as of the reporting date in accordance with ASC 405-20. Therefore, under the liability extinguishment approach, a book overdraft represents what is, in substance, a payable to the original creditor.
Accordingly, the existence of a deposit account with the same financial institution is not relevant to the accounting analysis. Specifically, ASC 405-20 indicates that a liability is not extinguished until a creditor is paid. Under this view, payment to the creditor occurs when the counterparty presents the check to the bank for payment rather than when the entity issues the check from the disbursement account. In addition, proponents of the liability extinguishment approach note that even if one were to support the view that book overdrafts are within the scope of ASC 210-20, offsetting is not required when the right of setoff exits. Instead, as noted in ASC 210-20-45-2, offsetting is permitted, but not required, provided that the right of setoff exists.
Consequently, under the liability extinguishment approach, the entire population of outstanding checks (i.e., all checks written from the disbursement account) would represent the book overdraft as of the end of the reporting period. Therefore, although there may be funds in the deposit account, accounts payable would be reinstated for such an amount. Further, while the liability extinguishment approach is based on a situation in which the separate disbursement and funding accounts are maintained with a bank, we believe that an entity would reach the same view when it uses one bank account for deposits and disbursements. That is, if an entity’s policy is that the liability derecognition guidance in ASC 405-20 does not apply until the counterparty presents the check to the bank for payment, we think that such a policy should be neutral regarding whether there are separate accounts (that are linked) or whether a single account is used for both funding and disbursements.
Regardless of whether an entity elects the single account approach or the liability extinguishment approach, we believe that the entity should consistently apply and transparently disclose the approach it uses.
4.2.1.2 Bank Overdrafts
A bank overdraft represents the amount by which funds disbursed by a bank exceed funds held on deposit for a given bank account. Therefore, a bank overdraft represents a loan from the bank to an entity and, for financial reporting purposes, the bank overdraft should be classified as a liability. There may be situations in which an entity maintains several bank accounts held by its subsidiaries at the same financial institution. Such subsidiary bank accounts are contractually linked, and the bank will allow the subsidiary cash accounts to be in a bank overdraft position, as long as sufficient funds are held on deposit at other subsidiary bank accounts that are part of the linked arrangement. Although the offsetting guidance in ASC 210-20 would not apply to such an arrangement (for the same reasons noted in Section 4.2.1.1), we nonetheless believe that for financial reporting purposes at the consolidated/parent level, the parent would be permitted but not required to offset bank overdraft balances in subsidiary bank accounts against positive cash account balances maintained in other subsidiary bank accounts with the same bank that are part of the contractual arrangement. For such offsetting to be acceptable, however, the following conditions would need to be met:
- Under the terms of the depositor relationship, the financial institution has the right and ability to offset a positive balance in one account against an overdrawn amount in the other.
- Amounts in each of the accounts are unencumbered and unrestricted with respect to use.
In addition, when a subsidiary prepares financial statements on a stand-alone basis, the presentation of the subsidiary’s bank accounts in the stand-alone financial statements should reflect the individual subsidiary’s facts and circumstances (i.e., in presenting bank accounts with the same financial institution, the subsidiary should not consider how the bank accounts are presented in the parent company’s consolidated financial statements).
4.2.2 Considerations Related to the Statement of Cash Flows
The nonauthoritative guidance in AICPA Technical Q&As Section 1300.15
stipulates that a net change in overdrafts should
be classified as a financing activity in the
statement of cash flows. Because this guidance
appears to address only bank overdrafts, an entity
that is in a bank overdraft position must show the
net change in liability related to the bank
overdraft as a financing activity.
However, we believe that if an entity is in a book overdraft position, it is acceptable for the entity to show the net change in the liability related to the book overdraft as either an operating activity or a financing activity in the statement of cash flows. This position is supported by the fact that at the time of the book overdraft, the entity has no financing activity with the bank (i.e., the bank has not extended credit, as would be the case if the bank account were overdrawn). The presentation of book overdrafts as either operating or financing activities is an accounting policy decision that the entity should apply consistently.
4.3 Centralized Cash Management Arrangements (“Cash Pools”)
A parent company and its subsidiaries may have centralized cash management arrangements in which excess cash is invested in a cash pool. Subsidiary cash requirements are met through withdrawals or borrowings from the pool. The pool is invested in assets (e.g., deposits at banks) that are in the parent company’s name. Under this type of arrangement, the parent company and its subsidiaries have sweep arrangements with their respective banks in which cash is transferred between the parent’s and subsidiaries’ bank accounts daily. This arrangement reduces lending costs and yields higher rates of return on investments (by allowing an entity to invest larger “blocks” of cash).
Generally, funds deposited by a subsidiary in its parent company’s cash account under a centralized cash management arrangement should not be classified as cash or a cash equivalent in the subsidiary’s separate financial statements if the subsidiary does not have legal title to the cash on deposit. For a subsidiary to classify funds on deposit with its parent as cash and cash equivalents in the balance sheet, the deposit in the cash pool would need to meet the definition of cash or a cash equivalent.
Because the deposit in the cash pool is not a demand deposit in a bank or other financial institution, it would not meet the definition of cash. Generally, legal title in a cash account is demonstrated by the deposit of the cash or cash equivalent in a demand deposit account at a bank or other financial institution in the subsidiary’s name.
A deposit in the cash pool would also not be considered a cash equivalent under ASC 230. As defined in
ASC 230-10-20, cash equivalents are “short-term, highly liquid investments.” Such investments are made available to a broad group of independent investors and are commonly recognized in markets as vehicles for investing funds for future benefit. Accordingly, the deposit in the affiliate cash management pool is generally a receivable from an affiliate and not an investment as contemplated in ASC 230.
Receivables from an affiliate resulting from a cash pooling arrangement are
generally considered loans and, correspondingly, changes resulting from such
deposits should be presented as investing activities in the statement of cash flows.
ASC 230-10-45-12 and 45-13 state that cash flows from investing activities include
payments and receipts related to making and collecting loans. Payables due to an
affiliate in these situations are considered borrowings and, correspondingly,
changes should be presented as financing activities in the statement of cash flows.
ASC 230-10-45-14 and 45-15 state that cash flows from financing activities include
proceeds and payments related to borrowings and repayments of amounts borrowed.
Example 4-4
Parent A maintains a centralized cash management program in which Subsidiary B participates. Subsidiary B issues stand-alone financial statements that reflect a $100 receivable from A as of December 31, 20X6, in connection with cash deposited by B into the centralized cash management program. During 20X7, B withdraws $200 from A as part of the centralized cash management program, resulting in a $100 payable to A as of December 31, 20X7. The statement of cash flows in the stand-alone financial statements of B for the 12 months ended 20X7 would report a $100 investing cash inflow and a $100 financing cash inflow related to the activity associated with the centralized cash management program.
ASC 230-10-45-8 and 45-9 indicate that payments and receipts in these situations
should be presented in the statement of cash flows on a gross basis, except when
“the turnover is quick, the amounts are large, and the maturities are short.” In
addition, if the receivable from or payable to affiliates is due on demand, net
presentation of payments and receipts is acceptable. In most centralized cash
management arrangements in which funds are due on demand, the parent acts as a bank
to the subsidiary in that it holds and disburses cash on the subsidiary’s behalf;
correspondingly, such related transactions may be presented net in the statement of
cash flows. See Section
3.2 for further discussion of reporting cash flows on a gross or net
basis.
The principles above also apply to condensed consolidating information for guarantor subsidiaries under SEC Regulation S-X, Rule 3-10. In a manner consistent with cash pooling arrangements, intercompany transactions settled on a net basis between entities with cash flow information reported in different columns in the condensed consolidating information in a guarantor footnote should be recorded separately in each entity’s column as if the columns were reported on a stand-alone basis. Therefore, the classification of intercompany funding activity between entities whose cash flow information is separately reported in each column should reflect cash payments and receipts in investing and financing activities.
4.4 Money Market Funds
Money market funds (MMFs) are investment funds that maintain a constant per-share net asset value (NAV) by adjusting the periodic interest rates paid to investors. The NAV is usually set at $1 per share. Generally, investors can make withdrawals from MMFs on short notice without incurring a penalty. However, as a result of the most recent credit crisis, certain money market mutual funds incurred losses on their investments, causing some of the funds to “break the buck” when the NAV fell below the constant per-share amount. As the fair values of MMFs declined as a result of deterioration in the creditworthiness of their assets and general illiquidity conditions, redemptions by investors increased. Accordingly, some funds were forced to impose limits on redemptions, liquidate their assets, or obtain support from related entities.
In July 2014, the SEC issued a final
rule that amends the rules governing MMFs under the Investment
Company Act of 1940. The final rule requires certain MMFs to “sell and redeem shares
based on the current market-based value of the securities in their underlying
portfolios rounded to the fourth decimal place (e.g., $1.0000), i.e., transact at a
’floating’ NAV.”1 In addition, the final rule gives the boards of directors of MMFs the
“discretion to impose a liquidity fee [or] suspend redemptions temporarily” (i.e.,
gate) if a fund’s weekly liquidity falls below the required regulatory threshold.
Further, the rules require nongovernmental MMFs to impose a liquidity fee or gate if
a fund’s weekly liquidity deteriorates below a designated threshold.
The definition of “cash equivalents” in the ASC master glossary indicates that
MMFs are often included within its scope. Under normal circumstances, an investment
in an MMF that has the ability to impose a fee or gate does not prevent the MMF from
being classified as a cash equivalent. Further, the requirement for certain MMFs to
transact at a floating NAV does not prevent an investment from being classified as a
cash equivalent. However, if events occur that give rise to credit and liquidity
issues for an investment and result in the imposition of redemption restrictions
(e.g., liquidity fees or gates) or a planned liquidation, it would generally not be
appropriate to continue to classify the investment as a cash equivalent.
Example 4-5
An MMF imposes a restriction on redemption before the balance sheet date to prevent an investor from converting its investment into cash as of the balance sheet date. It would not be appropriate to classify the fund as a cash equivalent since it is no longer “[r]eadily convertible to known amounts of cash” in accordance with the definition of “cash equivalents” in ASC 230.
Implicit in the definition of a cash equivalent is the assertion that an MMF is, in substance, cash or near cash. Therefore, a restriction on an MMF would contradict the definition of cash and therefore the intent of classification as a cash equivalent. Further, when an MMF has imposed redemption restrictions or is liquidating its investments over a period and is distributing the proceeds, an investor should not record any portion of its investment as a cash equivalent unless the entire investment is considered a cash equivalent in accordance with ASC 230. It would not be appropriate to look through the investment to the underlying securities and classify a portion of the investment as a cash equivalent.
Example 4-6
An MMF imposes an “insignificant” penalty on redemption, and an investor concludes that the imposition of this penalty causes the fund’s fair value to fall below the investor’s cost/par. Therefore, the MMF no longer qualifies as a cash equivalent.
Example 4-7
A redemption restriction is imposed on an MMF on or before the balance sheet date but is lifted after the balance sheet date and before the financial statements are issued or available to be issued. As a result, an investor is able to withdraw funds from the MMF without prior notice or penalty. The subsequent change to lift the redemption restriction should be accounted for as a nonrecognized subsequent event.
If a redemption restriction is imposed on January 15 for a calendar-year-end entity, we would expect the entity to reconsider the classification of the MMF and evaluate whether credit and liquidity issues existed as of the balance sheet date. Even if the redemption restriction is not imposed until after the balance sheet date, it may be appropriate to reclassify the MMF in the prior period depending on whether such conditions existed as of the balance sheet date.
Footnotes
1
The requirement to transact at a floating NAV applies to
institutional prime MMFs but not to government or retail MMFs.
4.5 Variable-Rate Demand Notes
Variable-rate demand notes (VRDNs), also called “low floaters” or “seven-day
floaters,” generally are municipal securities that
have long-term stated maturities. However, they
also have certain economic characteristics of
short-term investments, such as their rate-setting
mechanism and their liquidity provisions. These
notes are normally secured by a letter of credit.
The rates on VRDNs are reset periodically (e.g.,
daily, weekly, monthly) through an auction
process. If there is a failed auction, the VRDNs
can be tendered (i.e., put) by the investor for
par plus accrued interest. The counterparty to the
put is typically the third party that provided a
letter of credit. However, in certain cases in
which no letter of credit is involved, the
counterparty may be the original issuer of the
VRDN itself (e.g., a state, municipality, county,
or other governmental entity).
In determining whether VRDNs may be classified as cash equivalents in an
entity’s balance sheet and statement of cash
flows, an entity should consider whether the
instruments are puttable back to the original
issuer (or to the issuer through the issuer’s
agent) within three months throughout the term of
the instrument. An entity should also consider the
creditworthiness of the issuer. In the limited
circumstances in which VRDNs are puttable back to
the original issuer within three months throughout
the term of the instrument and there is no
concern about the issuer’s creditworthiness (e.g.,
in the case of a highly rated state government),
an entity may classify VRDNs as cash
equivalents.
VRDNs that are puttable to parties other than the original issuer (e.g.,
insurer, remarketing agent, bank, dealer, or other
third party) should be accounted for under ASC
815-10-15-6, which states, in part, that a “put or
call option that is added or attached to a debt
instrument by a third party contemporaneously with
or after the issuance of the debt instrument shall
be separately accounted for as a derivative
instrument under this Subtopic by the investor
(that is, by the creditor).”
Therefore, if a VRDN is puttable to a party other than the original issuer, the put option should be accounted for separately from the note in accordance with ASC 815. The note would not be considered a cash equivalent unless it is acquired within three months of its maturity and there is no concern about the issuer’s creditworthiness.
4.6 Auction Rate Securities
Auction rate securities (ARSs) are distinct from other, more traditional securities. ARSs generally have long-term stated maturities; the issuer is not required to redeem the security until 20 to 30 years after issuance. However, for the investor, these securities have certain economic characteristics of short-term investments because of their rate-setting mechanism. The return on these securities is designed to track short-term interest rates through a “Dutch” auction process, which resets the coupon rate (or dividend rate).
Generally, ARSs cannot be classified as cash equivalents in an investor’s statement of cash flows. Because ARSs have stated maturities of more than three months, investments in ARSs do not meet the definition of a cash equivalent in ASC 230-10-20 unless the ARSs are purchased very near their contractual maturity (i.e., three months or less). This conclusion is consistent with the views expressed in Section II.H.3 of the SEC’s Current Accounting and Disclosure Issues in the Division of Corporation Finance (updated November 30, 2006).
4.7 Credit and Debit Card Receivables
We have observed diversity in practice in how entities classify
credit and debit card receivables on their balance sheets. Depending on their
specific facts and circumstances (see discussion below), some entities classify
these receivables as cash and cash equivalents while others classify them as
receivables. This balance sheet diversity affects the statement of cash flows. If
these items are classified as cash and cash equivalents, they are included in the
beginning and ending balances of cash and cash equivalents (i.e., recognition of the
receivable is the equivalent of collecting the cash). Otherwise, they are included
in the change in net assets in the reconciliation from net income to cash flows from
operating activities, provided that entities are using the indirect method of
presenting operating cash flows (i.e., they are presented as operating cash inflows
when the entity receives the cash in its bank account).
Entities may have established a policy of classifying credit and
debit card receivables as cash equivalents if they consider them to be cash
equivalents as defined in the ASC master glossary. That is, credit and debit card
receivables are viewed as akin to short-term, highly liquid investments that are
both readily convertible to known amounts of cash and are so near their maturity
that they pose an insignificant risk of changes in value because of changes in
interest rates. (See Section
4.1 for additional discussion of cash equivalents.) These entities
consider how quickly the receivables are due (e.g., if they are due within five days
or less, and are thus subject to insignificant interest rate risk, the receivables
could be considered a cash equivalent).
Other entities may classify credit and debit card receivables within
trade accounts receivable because they are subject to the credit risk of the owing
financial institution and are not a significant part of the entities’ cash
management strategy (e.g., they are non-interest-bearing, and an entity does not
consider them when making decisions regarding dividends and share purchases).
After an entity establishes an appropriate policy, any change in
policy would represent a change in accounting principle for which preferability must
be established in accordance with ASC 250.
Chapter 5 — Noncash Investing and Financing Activities
Chapter 5 — Noncash Investing and Financing Activities
Investing and financing activities that affect
recognized assets or liabilities but that do not result in actual cash receipts or
payments should be disclosed as noncash investing and financing activities. Such
disclosures should be summarized in a schedule or in narrative form on the face of
the statement of cash flows or in another section of the financial statements that
refers to the statement of cash flows. Some examples of noncash investing and
financing activities include:
-
Converting debt to equity.
-
Acquiring long-lived assets through the assumption of directly related liabilities (e.g., purchasing a building by incurring a mortgage to the seller).
-
Obtaining an asset through a capital lease (under ASC 840) or a finance lease (under ASC 842) and sale-leaseback transactions, when less than the full amount of the consideration is paid/received as of the closing date. (See Sections 7.6.1.1, 7.6.1.3, and 7.6.3 for further discussion of seller financing and lease transactions.)
-
Receiving a building or other asset as a gift.
-
Exchanging noncash assets (e.g., inventory or accounts receivable) or liabilities for other noncash assets or liabilities.
-
A transferor’s beneficial interest obtained in a securitization of financial assets.
Example 5-1
Company A acquired 100 percent of the common stock of Company B in exchange for issuing 10,000 shares of A’s stock. Because the acquisition of B involved no cash consideration, the transaction should be disclosed as a noncash investing (acquisition of B) and noncash financing (issuance of A’s stock) transaction. Disclosure may consist of a narrative or be summarized in a schedule.
In addition, A would generally classify B’s acquired cash and cash equivalents, if any, as an investing activity in the statement of cash flows. In certain circumstances, however, the predominant source of cash acquired in a business combination may be more appropriately characterized as financing (e.g., if B had recently issued debt and the acquired cash balance largely comprised the proceeds from that borrowing). See Section 6.4 for a discussion of transactions with more than one class of cash flow.
To the extent that a transaction includes both cash and noncash components, an entity should disclose the noncash component of the transaction and present the cash component in the statement of cash flows.
As discussed above, acquisitions paid for by
stock that are accounted for as business combinations under ASC 805 are considered
noncash investing and financing activities and should be disclosed in a narrative or
summarized in a schedule in the financial statements. Correspondingly, acquisitions
paid for in part by cash and in part by stock are split between the cash and noncash
aspects of the transaction. Only the cash portion is reported as an investing
activity in the statement of cash flows. The stock portion is disclosed in a manner
consistent with that discussed above. The amount of cash paid, net of the acquiree’s
cash and cash equivalents, is presented as an investing cash outflow. Consider the
following examples:
Example 5-2
Company A acquires Company B for 10,000 shares of A’s stock (fair value of $100 per share) and $150,000 of cash. Company B’s net assets have a fair value of $1.15 million, which includes $50,000 of cash and cash equivalents. Company A reflects the transaction in its statement of cash flows and related disclosures as follows:
- Noncash investing and financing activity of $1 million.
- Investing cash outflow of $100,000 for cash paid in acquisition, net of cash acquired.
Example 5-3
Company A divests one of its subsidiaries (Subsidiary B) to Company C in
exchange for all shares that C owns in A. The fair value of
C’s shares owned in A is $300 million, and B’s fair value is
$150 million. Because the fair value of the treasury stock
reacquired is greater than the fair value of the disposed-of
business, A infuses an additional $150 million in cash into
B before ownership of B is transferred to C. When combined
with $10 million in cash already held by B, the total amount
of cash transferred as part of B’s divestiture is $160
million. The $10 million of cash held by B before the $150
million cash infusion represents a normal level of (or
regular) working capital cash used in B’s operations.
Therefore, the substance of this transaction essentially
consists of (1) an exchange of A’s shares held by C for the
$150 million in cash (i.e., the amount of the cash infusion)
and (2) the divestiture of B in exchange for the remaining
shares of A’s stock held by C.
As a result, A would generally reflect the transaction in its statement of cash flows and related disclosures as follows:
- The $150 million in cash that is infused into B is considered a share repurchase of A’s stock from C and thus should be classified as a financing activity.
- The $10 million in regular working capital cash held by B before the cash infusion and transferred to C in the divestiture should be classified as an investing activity.
- The remainder — namely the noncash net assets of B transferred to C in exchange for the remaining number of A’s shares owned and held by C — should be treated as a noncash investing and financing activity and disclosed.
Chapter 6 — Classification of Cash Flows
Chapter 6 — Classification of Cash Flows
ASC 230 requires entities to classify cash receipts and cash payments as operating, investing, or financing activities on the basis of the nature of the cash flow. Grouping cash flows into one of these three categories enables investors and creditors to evaluate significant relationships within and between those activities. Such presentation also links similar cash flows (e.g., cash proceeds from and repayments of borrowings), facilitating further analysis of the reporting entity’s activities.
The most appropriate classification of a particular cash flow may not always be
clear because, as indicated in ASC 230, “[c]ertain cash receipts and payments may
have aspects of more than one class of cash flows.” Paragraph BC39 of ASU 2016-15
states that, in such circumstances, entities must determine the appropriate
classification by considering when to (1) “separate cash receipts and cash payments
and classify them into more than one class of cash flows” and (2) “classify the
aggregate of those cash receipts and payments into one class of cash flows based on
predominance.” See Section 6.4
for more information about when cash payments and receipts have more than one class
of cash flows.
This chapter provides an overview of the three cash flow categories as well as guidance on how to apply the cash flow categorization principles in a number of situations.
6.1 Investing Activities
ASC 230-10-20 defines investing activities, in part, as follows:
Investing activities include making and collecting loans and acquiring and disposing of debt or equity instruments and property, plant, and equipment and other productive assets, that is, assets held for or used in the production of goods or services by the entity (other than materials that are part of the entity’s inventory). Investing activities exclude acquiring and disposing of certain loans or other debt or equity instruments that are acquired specifically for resale.
ASC 230-10
45-12 All of the following are
cash inflows from investing activities:
-
Receipts from collections or sales of loans made by the entity and of other entities’ debt instruments (other than cash equivalents, certain debt instruments that are acquired specifically for resale as discussed in paragraph 230-10-45-21, and certain donated debt instruments received by not-for-profit entities (NFPs) as discussed in paragraph 230-10-45-21A) and collections on a transferor’s beneficial interests in a securitization of the transferor’s trade receivables
-
Receipts from sales of equity instruments of other entities (other than certain equity instruments carried in a trading account as described in paragraph 230-10-45-18 and certain donated equity instruments received by NFPs as discussed in paragraph 230-10-45-21A) and from returns of investment in those instruments
-
Receipts from sales of property, plant, and equipment and other productive assets
-
Subparagraph not used
-
Receipts from sales of loans that were not specifically acquired for resale. That is, if loans were acquired as investments, cash receipts from sales of those loans shall be classified as investing cash inflows regardless of a change in the purpose for holding those loans.
For purposes of this paragraph, receipts from disposing of loans, debt or equity
instruments, or property, plant, and equipment include
directly related proceeds of insurance settlements, such as
the proceeds of insurance on a building that is damaged or
destroyed.
45-13 All of the following are cash
outflows for investing activities:
-
Disbursements for loans made by the entity and payments to acquire debt instruments of other entities (other than cash equivalents and certain debt instruments that are acquired specifically for resale as discussed in paragraph 230-10-45-21)
-
Payments to acquire equity instruments of other entities (other than certain equity instruments carried in a trading account as described in paragraph 230-10-45-18)
-
Payments at the time of purchase or soon before or after purchase to acquire property, plant, and equipment and other productive assets, including interest capitalized as part of the cost of those assets. Generally, only advance payments, the down payment, or other amounts paid at the time of purchase or soon before or after purchase of property, plant, and equipment and other productive assets are investing cash outflows. However, incurring directly related debt to the seller is a financing transaction (see paragraphs 230-10-45-14 through 45-15), and subsequent payments of principal on that debt thus are financing cash outflows.
-
Payments made soon after the acquisition date of a business combination by an acquirer to settle a contingent consideration liability.
6.1.1 Securities Lending
Many entities with significant investments in marketable securities engage in securities-lending transactions. In one form of securities-lending transaction, the transferor relinquishes securities and agrees to repurchase them for a fixed amount on a specified future date. The transferee, to secure its obligation to return the securities (or similar securities), posts cash collateral in an account that is inaccessible to the transferor unless the transferee fails to deliver the securities.
Assume that the transaction fails to satisfy the derecognition criteria of ASC
860 and that the transferor and the transferee record the transfer as a secured
borrowing. The transferor classifies the amount provided by the transferee as
“collateral received” or “restricted cash” rather than including it in “cash and
cash equivalents.” ASC 860-30-45-1 states that if the transferee “has the right
by contract or custom to sell or repledge” the transferred securities, the
transferor reports the transferred securities “in its statement of financial
position separately . . . from other assets not so encumbered.”
The transferor is entitled to earnings on the cash in the restricted account and is obligated to pay the transferee (i.e., the borrower of the securities) a rebate, representing a portion of those earnings.
The sale and repurchase of the securities are noncash transactions (i.e., an exchange of investments) unless the transferee fails to deliver the securities and the transferor obtains access to the cash in the account.
6.1.2 Distributions From Equity Method Investments
ASC 230 distinguishes between returns of investment, which should be classified
as cash inflows from investing activities (see ASC 230-10-45-12(b)), and returns
on investment, which should be classified as cash inflows from operating
activities (see ASC 230-10-45-16(b)). Accordingly, to make the appropriate
classification in the statement of cash flows, entities must determine whether
distributions received from an equity method investee represent a “return on” or
a “return of” the related investment.
ASC 230-10-45-21D indicates that there are two acceptable methods for
determining whether distributions from equity method investments are returns on
investment or returns of investment. Under the first method (the “cumulative
earnings” approach), distributions are presumed to be returns on investment.
When classifying the related cash flows under this approach, an entity should
compare cumulative (i.e., since inception) distributions received by the
investor, less distributions received in prior periods that were determined to
be returns of investment, with the investor’s cumulative equity in earnings.
Cumulative distributions received that do not exceed cumulative equity in
earnings represent returns on investment and should be classified as cash
inflows from operating activities. Cumulative distributions received in excess
of the investor’s cumulative equity in earnings represent returns of investment
and therefore should be classified as cash inflows from investing
activities.
Under the second method (the “nature-of-the-distribution” approach), an entity
evaluates the specific facts and circumstances of each distribution to determine
its nature. Unlike the cumulative earnings approach, the
nature-of-the-distribution approach does not presume that a distribution is a
return on investment; rather, an entity using this approach must conduct an
analysis to determine the nature of each distribution and may be required to use
significant judgment in making this determination. Examples of distributions
that may represent returns of investment include, but are not limited to,
liquidating dividends and dividends representing proceeds from the sale of
property, plant, and equipment (PP&E). These distributions should be
classified as cash inflows from investing activities to the extent that they are
considered to represent returns of investment.
An entity can elect to apply either of these approaches as an accounting policy
and must select a single method for all of its equity method investments. Under
either approach, an entity should comply with the disclosure requirements in ASC
235-10-50-1 through 50-6. However, if an entity selects the
nature-of-the-distribution approach for its equity method investments but cannot
obtain the information it needs to evaluate the nature of the distributions for
any individual equity method investment, the entity must report a change in
accounting principle retrospectively by applying the “cumulative earnings”
approach to any such equity method investment. In other words, an entity is not
required to apply the cumulative earnings approach to all of its equity method
investments when it is unable to obtain adequate information for certain equity
method investments; rather, this approach must only be applied to the equity
method investments for which the information could not be obtained.
Connecting the Dots
Although entities are permitted to elect the approach under which distributions may be evaluated, it does not remove the requirement for entities to evaluate whether each distribution from an equity method investment represents a return on investment or a return of investment, particularly when entities elect the nature-of-the-distribution approach. In other words, because the nature-of-the-distribution approach does not presume that a distribution is a return on investment, it requires that an entity analyze each distribution to determine its nature. Further, entities that elect the cumulative earnings approach may generally presume distributions to represent a return on investment, unless such distributions represent returns of investment (i.e., they exceed the investor’s cumulative equity in earnings).
In addition, because ASC 230 does not provide guidance on how much information
(e.g., the type and sufficiency of investee information) an entity needs
to determine the nature of a distribution, an entity that applies the
nature-of-the-distribution approach will most likely need to use
significant judgment in making this determination. We generally believe
that such information should be sufficiently reliable and that the
degree of reliability is likely to increase in proportion to the
materiality of the distribution.
Note that while the guidance in ASU 2016-15 clarified the cash flow
classification of distributions received from equity method investees, it did
not address the presentation of distributions that are received from equity
method investees and measured by using the fair value option. Accordingly, an
entity should apply ASC 825-10-45-3 when considering how to classify
distributions received from equity method investees. Under that guidance, an
entity classifies “cash receipts and cash payments related to items measured at
fair value according to their nature and purpose as required by Topic 230.”
We thus believe that it would be appropriate for an entity that
measures an equity method investment by using the fair value option to apply by
analogy the “nature-of-the-distribution” approach discussed above. Such an
entity would classify distributions received as operating activities or
investing activities in accordance with the nature and purpose of the
distribution.
Example 6-1
Company A is a calendar-year-end company that has a 20 percent equity investment
in Company B but no other equity investments. On January
1, 20X7, A made an initial $10,000 cash investment in B.
Company A accounts for its investment in B as an equity
method investment and has elected to use the cumulative
earnings approach to determine the classification of
distributions from B in its statement of cash flows.
Further, there are no basis differences between A’s
equity investment and the underlying assets in B.
Company A’s share of income or loss in the equity of B and A’s related share of dividend distributions for the last six and five years, respectively, are as follows:
Classification of B’s distributions in A’s respective annual statements of cash flows is as follows:
Under the cumulative earnings approach, because the distributions that A received for the years ended December 31, 20X8, and December 31, 20X9, are in excess of A’s cumulative share of earnings in the equity of B for these same years, such distributions received represent a return of A’s investment in B. Therefore, such distributions should be classified as investing inflows. In other words, the fact that A had cumulative deficits in B’s earnings for both of the first two years (ended December 31, 20X9) indicates that B was funding A’s share of each year’s dividend through A’s initial investment in B. Consequently, the dividends represent returns of A’s investment in B.
As of December 31, 20Y0, only a portion of the cumulative distributions received
(less prior-year distributions that were returns of A’s
investment) was in excess of the inception-to-date
cumulative earnings in B’s equity. The excess portion
was therefore classified as an investing activity (i.e.,
as a return of A’s investment in B), and the remaining
portion was classified as an operating activity (i.e.,
as a return on A’s investment in B).
As of December 31, 20Y1, A’s cumulative distributions received, less any
prior-year distributions that were returns of
investment, did not exceed the cumulative earnings in
equity; therefore, the entire amount of distributions
received is classified as an operating activity that
reflects a return on A’s equity method investment in B.
Conversely, on December 31, 20Y2, cumulative
distributions received, less any prior-year
distributions that were returns of investment, fully
exceeded the cumulative earnings in equity; therefore,
the entire amount of distributions received in 20Y2
should be classified as an investing activity that
reflects a return of A’s equity method investment in
B.
6.1.3 Property, Plant, and Equipment Acquired on Account
ASC 230-10-45-29 states that the reconciliation of net income to net cash flows
from operating activities must separately report all major classes of
reconciling items, “including, at a minimum, changes during the period . . . in
payables pertaining to operating activities.” Therefore, the change in accounts
payable included in this reconciliation should exclude changes in payables
related to investing or financing transactions (e.g., the change in payables
incurred in the current and previous reporting periods to acquire or construct
PP&E and other productive assets).
Furthermore, the noncash investing activity disclosed by an entity should be limited to the amount of the liability incurred for assets acquired during the current reporting period that remains unpaid as of the end of the reporting period; it should not merely be the period-to-period change in the liability account used to track productive assets purchased on account. Noncash activity should be disclosed separately in a schedule or described in a narrative disclosure.
In the period in which the liability is settled, the amount paid should be
classified as a cash outflow for investing activities or financing activities,
depending on the payment terms of the transaction. Specifically, ASC
230-10-45-13(c) characterizes payments “at the time of purchase or soon before
or after purchase to acquire property, plant, and equipment and other productive
assets” as cash outflows for investing activities. The SEC staff has informally
interpreted the term “soon” in this context as indicating a period of three
months or less, which is consistent with the period used for other ASC 230
considerations (e.g., the definition of cash equivalents in ASC 230-10-20 [see
Chapter 4], the
determination of net or gross presentation in ASC 230-10-45-9 [see Chapter 3], and
contingent consideration classified as a liability [see Chapter 7]).
Therefore, if an entity purchases PP&E and other productive assets and the
terms of the transaction require payment within three months of the transaction
date, the payment would be classified as an investing outflow. Generally, if the
payment terms of the transaction extend beyond three months, any payment made
after three months would be classified as a financing outflow. However, there
may be limited circumstances in which payments made after three months (but less
than one year) could be classified as investing outflows — for example, if
payment terms extend beyond three months but such terms are consistent with
standard industry practice as well as with terms that are customary for the
vendor. Entities are encouraged to discuss these circumstances with their
accounting advisers. Payments made in connection with terms that require
discounting under ASC 835 (i.e., generally of more than one year) should be
classified as financing outflows even if the payment terms are consistent with
industry practice and considered customary for the vendor.
Example 6-2
In December 20X4, Company A purchased equipment from a supplier on account for $500,000, which was included in the total year-end accounts payable balance of $4 million. Company A paid the $500,000 payable due to the supplier in January 20X5. In December 20X5, A purchased equipment from a supplier on account for $1 million, which was included in the total year-end accounts payable balance of $6 million. Company A paid the $1 million payable due to the supplier in January 20X6.
In preparing its 20X5 cash flow statement, A would (1) reduce the total $2 million increase in accounts payable by the $500,000 change in nonoperating accounts payable (which increased from $500,000 to $1 million) and report a total increase in operating accounts payable of $1.5 million; (2) present an investing cash outflow for the $500,000 payment made in January 20X5; and (3) disclose a noncash investing activity of $1 million, representing the unpaid liability that was incurred during 20X5 to acquire the equipment.
In preparing its 20X6 cash flow statement, A would reflect the $1 million decrease in accounts payable as an investing activity outflow for the acquisition of the equipment.
Example 6-3
Company A, a telecommunications company, enters into a contract with Vendor B to receive equipment, construction, and installation services for a network build-out with payment terms of 270 days for the equipment and 90 days for construction and installation services. These payment terms are consistent with industry practice for similar equipment and services and are customary for B. Vendor B bills A for the equipment, construction, and installation of the network build-out on January 31, 20X6. In accordance with the payment terms, A pays B for the construction and installation services at the end of April 20X6 and the equipment at the end of October 20X6. Because the payment terms are consistent with industry practice, are customary for B, and do not need to be discounted under ASC 835, it would be appropriate for A to classify both payments to B as investing outflows even though the payment terms for the equipment extend beyond three months. In determining whether a period of more than three months but less than a year is in accordance with ASC 230-10-45-13(c) — which indicates that “[p]ayments at the time of purchase or soon before or after purchase to acquire property, plant, and equipment and other productive assets” are investing activities — A must use judgment and consider its specific facts and circumstances.
6.1.4 Securities
ASC 320-10
45-11 Cash flows from
purchases, sales, and maturities of available-for-sale
securities and held-to-maturity securities shall be
classified as cash flows from investing activities and
reported gross for each security classification in the
statement of cash flows. Cash flows from purchases,
sales, and maturities of trading securities shall be
classified based on the nature and purpose for which the
securities were acquired.
ASC 321-10
45-1 An entity shall classify
cash flows from purchases and sales of equity securities
on the basis of the nature and purpose for which it
acquired the securities.
ASC 230-10
45-19 Cash receipts and cash
payments resulting from purchases and sales of
securities classified as trading debt securities
accounted for in accordance with Topic 320 and equity
securities accounted for in accordance with Topic 321
shall be classified pursuant to this Topic based on the
nature and purpose for which the securities were
acquired.
Debt securities are accounted for in accordance with ASC 320, while equity securities (with certain exceptions) are accounted for in accordance with ASC 321. In accordance with ASC 230-10-45-19, for trading debt securities and equity securities, an entity is required to present the related cash receipts and payments in the statement of cash flows in a manner consistent with the nature and purpose for which the entity acquired such securities.
6.1.4.1 Debt Securities
In accordance with ASC 320, an entity is required to initially recognize purchases of debt securities as trading, available for sale, or held to maturity. An entity that actively and frequently purchases, sells, or trades securities with the intent to sell them in the near term (e.g., hours or days) to generate short-term profits should classify such purchases as trading securities. However, ASC 320-10-25-1(a) indicates that “[c]lassification of a security as trading shall not be precluded simply because the entity does not intend to sell it in the near term.” In addition, as noted in ASC 320-10-25-1(b), a debt security that is not classified as trading or held to maturity must be classified as an available-for-sale security.
Investments in debt securities classified as trading and available for sale are
initially recognized at fair value in the statement of financial position,
with subsequent changes in fair value recognized in net income and other
comprehensive income (OCI), respectively, in each reporting period. Further,
cash flow activity associated with debt securities classified as available
for sale and held to maturity is classified as investing activities, while
cash flow activity associated with trading securities is classified on the
basis of the security’s nature and the entity’s intent to sell or hold the
security.
However, while an entity’s election to classify a debt security as trading results in income statement recognition of subsequent changes in the security’s fair value ― not unlike the recognition of financial assets and liabilities for which an entity elects the fair value option under ASC 825 — entities that elect to classify securities as trading have questioned whether cash activities related to such securities should be presented as operating or investing activities.
An entity’s election of the fair value option for financial assets and
liabilities under ASC 825 does not affect its cash flow statement
classification of receipts and payments associated with financial assets and
financial liabilities. Specifically, ASC 825-10-45-3 states, “Entities shall
classify cash receipts and cash payments related to items measured at fair
value according to their nature and purpose as required by Topic 230.”
Accordingly, we believe that an entity should assess why debt securities are classified as trading. In other words, an entity should assess whether it is required to classify debt securities as trading in accordance with ASC 320 (i.e., because the securities that are acquired are intended to be sold within hours or days). We believe that if an entity is required to classify debt securities as trading securities, the related cash flow activities should be presented as operating activities in the entity’s statement of cash flows. Our view is based on ASC 230-10-45-20, which contains a general principle under which cash flows pertaining to securities or other assets acquired principally for resale in the near term must be classified in operating activities.
We believe that when an entity elects to classify debt securities as trading, the frequency of purchases and sales of securities should be assessed as a basis for determining an entity’s intent. For example, we believe that daily trading is analogous to trading securities under ASC 320 and that the related cash flows therefore should be presented as operating cash flows. Conversely, and in the absence of the intent to trade to generate short-term profits, nondaily trading may not reflect trading activities and, therefore, presentation of related cash flows as investing activities would be required in such cases.
6.1.4.2 Equity Securities
In accordance with ASC 321, equity securities (except those accounted for under the equity method or those that result in consolidation of the investee) are measured at fair value, with changes in fair value recognized through net income.
As with debt securities classified as trading, an entity needs to consider the nature of the equity securities, and why they were acquired, to determine the appropriate presentation in the statement of cash flows. That is, an entity that actively and frequently purchases, sells, or trades equity securities, intending to sell them in the near term (e.g., hours or days) to generate short-term profits, would generally present such cash flow activity as operating activities; otherwise, presentation within investing activities would generally be required.
6.1.5 Company- and Bank-Owned Life Insurance Policies
ASC 230-10
45-21C Cash receipts
resulting from the settlement of corporate-owned life
insurance policies, including bank-owned life insurance
policies, shall be classified as cash inflows from
investing activities. Cash payments for premiums on
corporate-owned life insurance policies, including
bank-owned life insurance policies, may be classified as
cash outflows for investing activities, operating
activities, or a combination of cash outflows for
investing and operating activities.
Entities purchase life insurance policies for various reasons (e.g., to fund employee benefit costs and protect against the loss of key persons). Such policies are typically described as company-owned life insurance (COLI). ASC 230 addresses cash receipts (and premium payments) related to COLI, including bank-owned life insurance (BOLI) policies. The guidance in ASC 230-10-45-21C, which is predicated on a notion that COLI policies, including BOLI policies, are purchased primarily as investment vehicles, requires that an entity classify cash proceeds received from the settlement of COLI policies, including BOLI policies, as cash flows from investing activities.
In addition, entities are permitted, but not required, to align the classification of premiums paid with the classification of proceeds received. Therefore, cash payments for premiums may be classified as cash outflows for investing activities, operating activities, or a combination of cash flows for investing and operating activities.
6.2 Financing Activities
ASC 230-10-20 defines financing activities as follows:
Financing activities include obtaining resources from owners and providing them with a return on, and a return of, their investment; receiving restricted resources that by donor stipulation must be used for long-term purposes; borrowing money and repaying amounts borrowed, or otherwise settling the obligation; and obtaining and paying for other resources obtained from creditors on long-term credit.
ASC 230-10
45-14 All of the following
are cash inflows from financing activities:
-
Proceeds from issuing equity instruments
-
Proceeds from issuing bonds, mortgages, notes, and from other short- or long-term borrowing
-
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
-
Proceeds received from derivative instruments that include financing elements at inception, whether the proceeds were received at inception or over the term of the derivative instrument, other than a financing element inherently included in an at-the-market derivative instrument with no prepayments
-
Subparagraph superseded by Accounting Standards Update No. 2016-09.
45-15 All of the following
are cash outflows for financing activities:
-
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.
-
Repayments of amounts borrowed, including the portion of the repayments made to settle zero-coupon debt instruments that is attributable to the principal or the portion of the repayments made to settle other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing that is attributable to the principal.
-
Other principal payments to creditors who have extended long-term credit. See paragraph 230-10-45-13(c), which indicates that most principal payments on seller-financed debt directly related to a purchase of property, plant, and equipment or other productive assets are financing cash outflows.
-
Distributions to counterparties of derivative instruments that include financing elements at inception, other than a financing element inherently included in an at-the-market derivative instrument with no prepayments. The distributions may be either at inception or over the term of the derivative instrument.
-
Payments for debt issue costs.
-
Payments, or the portion of the payments, not made soon after the acquisition date of a business combination by an acquirer to settle a contingent consideration liability up to the amount of the contingent consideration liability recognized at the acquisition date, including measurement-period adjustments, less any amounts paid soon after the acquisition date to settle the contingent consideration liability. See also paragraph 230-10-45-17(ee).
-
Payments for debt prepayment or debt extinguishment costs, including third-party costs, premiums paid, and other fees paid to lenders that are directly related to the debt prepayment or debt extinguishment, excluding accrued interest.
The next sections discuss certain types of financing cash flows.
6.2.1 Debt Extinguishments and Modifications
If a borrower settles a debt financing arrangement before the maturity date, a lender may include a prepayment penalty in the financing agreement, often on the basis of a number of factors, such as an approximation of remaining interest that will not be paid given the early extinguishment.
ASC 230-10-45-15(g) specifies that cash outflows for financing activities
include “[p]ayments for debt prepayment or debt
extinguishment costs, including third-party costs,
premiums paid, and other fees paid to lenders that
are directly related to the debt prepayment or
debt extinguishment, excluding accrued interest.”
Further, paragraph BC7 of ASU 2016-15 specifies
that the EITF concluded that debt extinguishment
costs “should include all costs for the prepayment
or extinguishment of debt (that is, third-party
costs, premiums paid to repurchase debt in an
open-market transaction, and other fees paid to
lenders).”
Although ASC 230 does not address debt modifications,1 we believe that when debt is restructured
and is accounted for as a modification rather than
as an extinguishment, an entity should follow the
principles in ASC 230 and classify the fees paid
to the creditor on the modification date as a
financing cash outflow. Our view is based on the
fact that, in accordance with ASC 470-50-40-17(b),
fees paid to the creditor on the modification date
are “associated with the . . . modified debt
instrument” and (1) capitalized on the balance
sheet as a reduction to the modified debt and (2)
“amortized as an adjustment of interest expense
over the remaining term of the . . . modified debt
instrument using the interest method.” Since the
fees paid to the creditor to modify the debt
reduce the liability on the balance sheet, such
fees are akin to the payment of principal (or a
debt discount, which, on the balance sheet, is
netted against the proceeds from the debt issued);
accordingly, such payments would be presented as
financing cash outflows in the statement of cash
flows.
Further, we believe that any fees paid to a third party other than the creditor
in connection with a debt modification, including
those incurred in connection with a troubled debt
restructuring (TDR), should generally be
classified as operating cash outflows because, in
accordance with ASC 470-50-40-18(b), the payment
must be expensed. Therefore, since such fees enter
into the determination of net income, they would
be presented as operating activities. See
Section 6.3 for further discussion of
operating activities.
6.2.1.1 Troubled Debt Restructurings
As part of a TDR, an entity may recognize a
gain because the carrying amount of the debt is
greater than the total future cash payments
specified by the modified terms. In such a case,
the entity should present cash payments made after
the TDR as financing cash outflows, including
interest payments. In accordance with ASC
470-60-35-5, all payments are treated as
reductions to the carrying value of the debt
instead of interest expense for accounting
purposes.
If an entity does not
recognize a gain as part of a TDR because the
carrying amount of the debt is equal to or lower
than the total future cash payments specified by
the modified terms, the entity should present any
debt payments made after the TDR in a manner
consistent with the presentation of payments made
on nontroubled debt. Consequently, an entity
should present interest payments as operating
outflows in accordance with ASC 230-10-45-17(d)
and principal repayments as financing outflows in
accordance with ASC 230-10-45-15(b).
For additional discussion of TDRs, see
Chapter 11
of Deloitte’s Roadmap Issuer’s Accounting for
Debt.
6.2.2 Transactions With Noncontrolling Interest Holders
ASC 810-10-45-23 indicates that “[c]hanges 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).” Accordingly, payments to acquire
noncontrolling interests in a subsidiary, or those
associated with the sale of noncontrolling
interests in a subsidiary, should be classified as
financing activities in the statement of cash
flows.
Direct costs of purchasing or selling noncontrolling interests in a subsidiary,
when control is maintained, should generally be
recorded as an adjustment to additional paid-in
capital (APIC) and be classified as financing cash
outflows in the statement of cash flows. However,
indirect costs of purchasing or selling
noncontrolling interests in a subsidiary, when
control is maintained, should generally be
reflected as an expense in the income statement
and should be classified as operating cash
outflows in the statement of cash flows. These
conclusions are supported by analogies to ASC 810,
SAB Topic
5.A, and the nonauthoritative
guidance in AICPA Technical Q&As Section
4110.09.
SAB Topic 5.A provides guidance on accounting for costs related to the issuance of equity securities,
stating that “[s]pecific incremental costs directly attributable to a proposed or actual offering of
securities may properly be deferred and charged against the gross proceeds of the offering.” Therefore, direct costs of issuing equity securities are generally reflected as a reduction of the amount that would
have otherwise been recorded in APIC. SAB Topic 5.A further states that “management salaries or other
general and administrative expenses may not be allocated as costs of the offering and deferred costs of
an aborted offering may not be deferred and charged against proceeds of a subsequent offering.” These
indirect costs are generally reflected as an expense in the income statement.
In addition, the nonauthoritative guidance in AICPA Technical Q&As Section
4110.09 states that although there is no
authoritative literature on costs entities incur
to acquire their own stock, some “believe that
costs associated with the acquisition of treasury
stock should be treated in a manner similar to
stock issue costs.” Under SAB Topic 5.A, direct
costs associated with the acquisition of treasury
stock may be added to the cost of the treasury
stock.
Distributions to noncontrolling interest holders (in their capacity as equity
holders) are considered equity transactions and
should be reflected as cash outflows for financing
activities in accordance with ASC 230-10-45-15.
Entities that determine that it is appropriate to
classify the cash outflows associated with these
distributions outside of financing activities in
the statement of cash flows are encouraged to
consult with their accounting advisers.
6.2.3 Debt Issue Costs
ASC 230-10-45-15(e) notes that
cash outflows for financing activities include
“[p]ayments for debt issue costs.” To the extent
that debt issue costs are paid to the lender, they
should be presented net in the statement of cash
flows, since such a transaction effectively
represents a reduction of borrowed amounts.
However, any debt issue costs paid to other
parties should be presented separately in the
statement of cash flows and should not be
presented net against the proceeds received. In
other words, such fees should be presented
separately as financing activities (i.e., on a
gross basis), regardless of whether the borrower
pays the debt issue costs to the other party
directly or the lender retains the borrowing costs
from the debt proceeds and remits them to the
other party. Importantly, the balance sheet
classification of debt issue costs (as a reduction
of the related debt liability rather than as an
asset) does not depend on the party to whom the
debt issue costs are paid and therefore does not
change if the fees are paid to the lender or to
other parties. For additional considerations
related to debt extinguishments and modifications,
see Section
6.2.1.
6.2.4 Advance Payments Received From Customers or Other Third Parties
When a supplier receives
up-front payments from a customer (i.e., the
payment represents consideration for the goods or
services that the supplier provides to the
customer), the receipt of such advance payments
should be presented as operating cash inflows in
accordance with ASC 230-10-45-16(a). In addition,
refunds of customer deposits represent operating
cash outflows in accordance with ASC
230-10-45-17(f).
When an entity receives
advance payments from a third party in an agency
relationship, which must be refunded to that same
party or another third party, the cash receipts in
these situations are akin to borrowings rather
than for the provision of goods or services.
Therefore the cash receipts should generally be
presented as financing cash inflows, with the
subsequent repayments classified as financing cash
outflows.
Example 6-4
Company M is a payroll processor that
receives funds from clients in advance before it
remits those funds to the client’s employees. The
cash flows from the funds received from, and paid
on behalf of, M’s clients are reported as
financing activities in the statement of cash
flows.
Footnotes
1
While ASU 2016-15 clarified
the presentation of certain payments related to
debt extinguishments in the statement of cash
flows, it did not address the cash flow
presentation related to fees a debtor pays to the
creditor when the debt is modified in accordance
with ASC 470-50.
6.3 Operating Activities
ASC 230-10-20 defines operating activities as follows:
Operating activities include all transactions and other events that are not
defined as investing or financing activities (see paragraphs 230-10-45-12
through 45-15). Operating activities generally involve producing and delivering
goods and providing services. Cash flows from operating activities are generally
the cash effects of transactions and other events that enter into the
determination of net income.
ASC 230-10
45-16 All of the following are
cash inflows from operating activities:
-
Cash receipts from sales of goods or services, including receipts from collection or sale of accounts and both short- and long-term notes receivable from customers arising from those sales. The term goods includes certain loans and other debt and equity instruments of other entities that are acquired specifically for resale, as discussed in paragraph 230-10-45-21.
-
Cash receipts from returns on loans, other debt instruments of other entities, and equity securities — interest and dividends.
-
All other cash receipts that do not stem from transactions defined as investing or financing activities, such as amounts received to settle lawsuits and refunds from suppliers.
45-17 All of the following are
cash outflows for operating activities:
a. Cash payments to acquire materials for
manufacture or goods for resale, including principal
payments on accounts and both short- and long-term
notes payable to suppliers for those materials or
goods. The term goods includes certain loans
and other debt and equity instruments of other
entities that are acquired specifically for resale,
as discussed in paragraph 230-10-45-21.
b. Cash payments to other suppliers and employees
for other goods or services.
d. Cash payments to lenders and other creditors for
interest, including the portion of the payments made
to settle zero-coupon debt instruments that is
attributable to accreted interest related to the
debt discount or the portion of the payments made to
settle other debt instruments with coupon interest
rates that are insignificant in relation to the
effective interest rate of the borrowing that is
attributable to accreted interest related to the
debt discount. For all other debt instruments, an
issuer shall not bifurcate cash payments to lenders
and other creditors at settlement for amounts
attributable to accreted interest related to the
debt discount, nor classify such amounts as cash
outflows for operating activities.
e. Cash payment made to settle an asset retirement
obligation.
ee. Cash payments, or the portion of the payments,
not made soon after the acquisition date of a
business combination by an acquirer to settle a
contingent consideration liability that exceed the
amount of the contingent consideration liability
recognized at the acquisition date, including
measurement-period adjustments, less any amounts
paid soon after the acquisition date to settle the
contingent consideration liability. See also
paragraph 230-10-45-15(f).
f. All other cash payments that do not stem from
transactions defined as investing or financing
activities, such as payments to settle lawsuits,
cash contributions to charities, and cash refunds to
customers.
45-18 Banks, brokers and dealers in securities, and other entities may carry securities and other assets in a trading account. Characteristics of trading account activities are described in Topics 255 and 940.
45-19 Cash receipts and cash
payments resulting from purchases and sales of securities
classified as trading debt securities accounted for in
accordance with Topic 320 and equity securities accounted
for in accordance with Topic 321 shall be classified
pursuant to this Topic based on the nature and purpose for
which the securities were acquired.
45-20 Cash receipts and cash
payments resulting from purchases and sales of other
securities and other assets shall be classified as operating
cash flows if those assets are acquired specifically for
resale and are carried at fair value in a trading
account.
45-21 Some loans are similar to
debt securities in a trading account in that they are
originated or purchased specifically for resale and are held
for short periods of time. Cash receipts and cash payments
resulting from acquisitions and sales of loans also shall be
classified as operating cash flows if those loans are
acquired specifically for resale and are carried at fair
value or at the lower of cost or fair value. For example,
mortgage loans held for sale are required to be reported at
the lower of cost or fair value in accordance with Topic
948.
Pending Content (Transition Guidance: ASC 326-10-65-1)
45-21 Some loans are similar to debt securities in a trading account in that they are originated or
purchased specifically for resale and are held for short periods of time. Cash receipts and cash payments
resulting from acquisitions and sales of loans also shall be classified as operating cash flows if those loans
are acquired specifically for resale and are carried at fair value or at the lower of amortized cost basis or
fair value. For example, mortgage loans held for sale are required to be reported at the lower of amortized
cost basis or fair value in accordance with Topic 948.
45-21A Cash receipts resulting
from the sale of donated financial assets (for example,
donated debt or equity instruments) by NFPs that upon
receipt were directed without any NFP-imposed limitations
for sale and were converted nearly immediately into cash
shall be classified as operating cash flows. If, however,
the donor restricted the use of the contributed resource to
a long-term purpose of the nature of those described in
paragraph 230-10-45-14(c), then those cash receipts meeting
all the conditions in this paragraph shall be classified as
a financing activity.
The next sections address certain types of operating cash flows.
6.3.1 Long-Term Trade Receivables
As indicated above, ASC 230-10-45-16 states that cash collections from sales of
goods or services on account are cash inflows from operating activities.
Further, at the 2004 AICPA Conference on Current SEC and PCAOB Developments,
Todd Hardiman, associate chief accountant in the SEC’s Division of Corporation
Finance, emphasized that all cash collections stemming from the sale of
inventory are operating cash flows, regardless of whether the cash flows
represent:
-
Immediate cash collections from customers.
-
Collections of cash from receivables obtained in exchange for inventory (short-term or long-term).
-
The proceeds of the sale of customer receivables (originated in exchange for inventory) to third parties (e.g., in a securitization accounted for under ASC 860).
Example 6-5
Company A sells a product for $500. The customer finances its purchase with a loan from Company B (a captive finance subsidiary of A). When B makes the loan to the customer, it remits $500 to its parent (A) on behalf of the customer.
For A, the initial transaction (sale of the product) is a noncash transaction. However, when B receives a payment on the loan from the customer, the payment should be treated as an operating cash flow in A’s consolidated financial statements because the payment is related to sales of A’s inventory.
Connecting the Dots
ASC 230-10-50-4 notes that the transferor’s initial receipt of the beneficial
interest in a securitization of trade receivables should be disclosed as
a noncash activity. In addition, ASC 230-10-45-12(a) (as amended by ASU
2016-15) clarifies that subsequent cash receipts from payments on such
beneficial interests should be classified as investing activities.
Entities that may have classified subsequent receipts of the beneficial
interest as operating activities will need to be mindful of the amended
guidance in ASC 230-10-45-12(a). As a result, the ASU has resulted in a
change in practice for some entities.
6.3.2 Cash Proceeds From Insurance Claims
ASC 230-10-45-21B states that “[c]ash receipts resulting from the settlement of
insurance claims, excluding proceeds received from [COLI] policies and [BOLI]
policies, shall be classified on the basis of the related insurance coverage
(that is, the nature of the loss).” In addition, for lump-sum settlements, “an
entity shall determine the classification on the basis of the nature of each
loss included in the settlement.” The purpose of such clarifications is to
provide financial statement users with more relevant information.
For example, insurance settlement proceeds received as a result of a claim made in connection with the destruction of productive assets should be classified as cash inflows from investing activities because the settlement proceeds could be analogous to proceeds received on the sale of such assets. However, proceeds received as a result of claims related to a business interruption should be classified as operating activities.
6.3.3 Planned Major Maintenance
Transportation assets in certain industries (e.g., the airline and shipping industries) may be subject
to major maintenance activities at specified intervals in accordance with regulations applicable to the
industry. These activities are known as planned major maintenance activities. For example, vessels
participating in the United States Coast Guard’s alternate compliance program with the American
Bureau of Shipping must meet specified “seaworthiness” standards to maintain required operating
certificates. To meet such standards, vessels must undergo regular inspection, monitoring, and
maintenance, referred to as “dry-docking.” Typical dry-docking costs include costs for blasting and steel
coating as well as steel replacement.
When determining an accounting policy for dry-docking costs, many shipping
entities apply ASC 908 for analogous guidance on overhaul costs. ASC
908-360-25-2 provides three alternatives for accounting for overhaul costs:
-
Direct expensing method — Actual costs are expensed as incurred.
-
Built-in overhaul method — The costs of components subject to overhaul are segregated at purchase and are amortized to the date of the initial overhaul. The process is repeated thereafter.
-
Deferral method — Actual costs are capitalized and amortized to the next overhaul.
Informal discussions with the SEC staff have revealed that an entity should classify dry-docking expenditures in operating activities in the statement of cash flows, regardless of the method the entity uses to account for these expenditures.
However, classification of these expenditures as operating activities is not limited to dry-docking costs
for shipping vessels and thus would apply to planned major maintenance activities in other industries.
6.3.4 Employee Benefit Plans
When an employer makes contributions (discretionary and nondiscretionary) to an employee benefit plan in connection with employee services rendered, such payments, although perhaps initially contributed to a trust, will ultimately be paid to employees. Therefore, the employer should classify those payments as cash flows for operating activities in the statement of cash flows, regardless of whether such payments are voluntary or are required by ERISA.
Further, when an entity files for bankruptcy, it may enter into an agreement with the Pension Benefit Guaranty Corporation regarding its employee benefit plan liabilities. Typically, such an agreement requires the entity to make payments for its employee benefit plan liabilities at the time of, or after, its emergence from bankruptcy. Although these payments may extend over a number of years, they still ultimately concern employee services rendered and therefore should be classified as cash flows for operating activities in the statement of cash flows. This classification is required even if the entity is later required to apply “fresh-start” reporting under ASC 852. This classification is also consistent with views expressed by the SEC staff.
Footnotes
2
ASU 2016-09
removed from ASC 230-10-45-17(c) the notion that
“the cash that would have been paid for income
taxes if increases in the value of equity
instruments issued under share-based payment
arrangements that are not included in the cost of
goods or services recognizable for financial
reporting purposes also had not been deductible in
determining taxable income. (This is the same
amount reported as a financing cash inflow
pursuant to paragraph 230-10-45-14(e).)”
6.4 More Than One Class of Cash Flows
ASC 230-10
45-22 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.
45-22A In situations in which cash receipts and payments
have aspects of more than one class of cash flows and cannot be separated by
source or use (for example, when a piece of equipment is acquired or produced by
an entity to be rented to others for a period of time and then sold), the
appropriate classification shall depend on the activity that is likely to be the
predominant source or use of cash flows for the item.
45-23 Another example where cash receipts and payments include more than one class of cash flows involves a derivative instrument that includes a financing element at inception, other than a financing element inherently included in an at-the-market derivative instrument with no prepayments, because the borrower’s cash flows are associated with both the financing element and the derivative instrument. For that derivative instrument, all cash inflows and outflows shall be considered cash flows from financing activities by the borrower.
Certain cash receipts and payments may have aspects of more
than one class of cash flows. Paragraph BC39 of ASU 2016-15 provides guidance on
“when an entity should separate cash receipts and cash payments and classify
them into more than one class of cash flows . . . and when an entity should
classify the aggregate of those cash receipts and payments into one class of
cash flows based on predominance.” The classification of cash receipts and
payments that have aspects of more than one class of cash flows should be
determined by first applying specific guidance in U.S. GAAP. When such guidance
is not available, financial statement preparers should separate each
identifiable source or use of cash flows within the cash receipts and cash
payments on the basis of the nature of the underlying cash flows. Each
separately identified source or use of cash receipts or payments should then be
classified on the basis of its nature. Classification based on the activity that
is most likely to be the predominant source or use of cash flows is only
appropriate when the source or use of cash receipts and payments has multiple
characteristics and is not separately identifiable.
|
In accordance with ASC 230, the classification of cash flows with characteristics of more than one class of cash flows is a three-step process and, as noted above, an entity should not default to classification based on predominance. Unless an entity can conclude that sources or uses of cash payments or receipts are not separately identifiable, the entity must first allocate amounts of each cash receipt or payment that has aspects of more than one class of cash flows on the basis of the nature of the underlying cash flows for each separately identifiable source or use of cash. However, because the guidance does not define the term “separately identifiable,” entities must use judgment when applying the guidance.
The first step in the process is to determine whether there is explicit guidance
in ASC 230 or other U.S. GAAP regarding the classification of the related cash flows. The
example below illustrates guidance from ASC 230 that would address the portion of the
payment for long-lived assets used in operations (i.e., as investing activities) and the
portion for the inventory (i.e., as operating activities).
Example 6-6
Entity A rents office equipment to customers and separately sells supplies such
as paper and ink cartridges. In 20X6, A enters into an asset purchase agreement
with Entity B to purchase printers and related ink cartridges for $1.5 million.
The transaction does not represent the acquisition of a business; therefore, A
accounts for the transaction as an asset acquisition. On the basis of their
relative fair values, A records $1.2 million for the purchase of the printers as
investing cash outflows because the printers will be used in A’s operations as
rentals (i.e., equipment under operating leases). Entity A records $300,000 for
the purchase of the ink cartridges as operating cash outflows because they
represent inventory that A will sell.
If no guidance explicitly addresses classification, the second step is to determine whether cash flows are
separately identifiable. ASC 230-10-45-22 notes that entities should identify each separate source and
use of cash on the basis of the nature of the underlying cash flows and states “including when judgment
is necessary to estimate the amount of each separately identifiable source or use.” Consider the
following example:
Example 6-7
Entity A’s primary operations consist of sales and rentals of commercial trucks. In 20X6, A enters into
a transaction to purchase 100 trucks of the same make and model from Entity B for $10 million. At the time
of the purchase, A does not know precisely how many of the trucks will be sold and how many will be rented;
however, A is able to reasonably estimate that 60 trucks will be sold (i.e., inventory) and that the remaining 40
will be rented (i.e., long-lived depreciable assets). Accordingly, on the basis of its estimate of the nature of the
underlying cash flows, A classifies $6 million as operating outflows for its estimate of inventory purchases and
$4 million as investing outflows for its estimate of purchases of depreciable long-lived assets.
In the example above, the entity purchases trucks (which are similar assets)
that it regularly uses in its operations as rentals and for resale. When the entity
purchased the trucks, it did not know exactly how many units would be rented and how many
would be sold; however, the entity used judgment and estimated the cash flows for each
category (operating and investing). In other words, at the time of purchase, the entity
estimated the cash flows for each category on the basis of how it planned to use each truck.
The third step is to determine classification of cash flows on the basis of
predominance in situations in which cash receipts and payments have aspects of more than one
class of cash flow and the entity is unable to separately identify sources and uses of cash
flows (note that this is not the case in Example 6-7 because the entity could estimate the category, which in that case
was based on the entity’s intent at the time the original cash flow occurred). Such
scenarios may occur when the same piece of equipment is sold but, at the time of purchase,
the asset will be used in the entity’s operations for a short period before resale. In such
situations, an entity may need to classify all of the cash outflows in the same category on
the basis of the activity that is likely to be the predominant use of the cash flows (i.e.,
the investing outflows in the example below are based on predominance).
Example 6-8
A company provides health care equipment to patients for a monthly rental fee. At times, the company may
also sell the rental equipment to patients. In other words, the entity sells the same asset that it uses in its
operations as rentals and classifies the cash outflows for asset purchases on the basis of the predominant
source of cash flows (i.e., the entity’s use of the assets as rentals). Therefore, because the purchases of health
care equipment are presented as a cash outflow from investing activities upon acquisition, proceeds from the
sale of the health care equipment should be presented as a cash inflow from investing activities.
Note that an entity should apply the same three-step process when the disposition of assets may have
aspects of more than one class of cash flows. Consider the following example:
Example 6-9
Assume the same facts as in Example 6-6, except that, rather than purchasing printers and
related ink cartridges, Entity A is selling these items in a single transaction
for $1.5 million. Entity A accounts for the transaction as an asset disposition.
On the basis of their relative fair values, A records $1.2 million for the sale
of the printers as investing cash inflows because the printers have been used in
A’s operations as rentals (and the presentation is consistent with the cash
outflows when the printers were originally acquired). Entity A records $300,000
for the sale of the ink cartridges as operating cash inflows because they
represent inventory that A was holding for sale as part of its normal operations
(and the presentation is consistent with the cash outflows when the ink
cartridges were originally acquired).
In addition, an entity’s intended use of an asset may change when compared with
its intended use at the time the asset was acquired. Such changes in an asset’s intended use
may also make it challenging to determine how to classify cash inflows and outflows.
Consider Example 6-7, in which
the entity purchases assets, intending to use some of the assets purchased in its operations
(as rentals) and resell others. The entity may purchase a piece of equipment to rent to
customers but may later decide to sell the asset rather than rent it to customers. Because
the entity purchased the asset while intending to use it in its operations, the cash
outflows were classified as investing activities. However, because the entity also regularly
resells equipment (representing a revenue transaction for the entity), a question arises
regarding whether the cash inflows from the sale of the asset should be classified as
operating activities. Therefore, classifying the cash outflows and inflows on the basis of
the intent that existed when the respective cash flows occurred would result in the
differing classification of inflows and outflows for the same asset (i.e., investing
activities for the purchases of equipment to be rented and operating activities for revenue
from their sales). Conversely, if cash flows for the asset’s purchase and sale are
classified consistently (e.g., both are presented on the basis of original intent
representing an investing activity and therefore the subsequent sale would also be investing
rather than operating), the cash flow presentation may not be consistent (i.e., not
symmetrical) with how balances are presented in the other financial statements because
presentation in other financial statements reflects the entity’s change in intent.
In a manner consistent with the SEC staff’s remarks at the 2006 AICPA Conference on Current SEC and
PCAOB Developments and comment letters to registrants, we believe that an entity should be consistent
in how it classifies cash outflows and inflows related to an asset’s purchase and sale. Further, cash
flow classification should be consistent even if doing so creates asymmetry with how the transaction is
presented in the balance sheet and income statement. When such asymmetry exists, an entity should
include appropriate disclosures that explain such differences.
6.4.1 Classification of Cash Flows for Emission Allowances and Related Transactions
Emission trading (or “cap-and-trade”) programs are administered by governing bodies (i.e., governments or governmental agencies) to control or reduce the emission of pollutants or greenhouse gases. The most common programs in the United States cover emissions of sulfur dioxide and nitrogen oxide. Outside the United States, there are similar programs to control the emission of greenhouse gases (e.g., carbon dioxide). In the current U.S. cap-and-trade programs, governing bodies typically issue rights (allowances) to participating entities to emit a specified level of pollutants. Each individual emission allowance (EA) has a vintage year designation (i.e., the year the allowance may be used). EAs with the same vintage year designation are fungible and can be used by any party to satisfy pollution control obligations for emissions from any source within the governing bodies’ associated control area during the vintage year or, potentially, subsequent years (i.e., many EA programs permit carryforward to subsequent years). EAs are generally granted several years in advance. For example, sulfur dioxide allowances in the United States have already been allocated and delivered to participating entities for the next 30 years.
Entities can choose to buy EAs from, and sell EAs to, other entities, which is typically initiated through a broker. Entities can also enter into nonmonetary exchanges of EAs of one vintage (e.g., use in 2020) for EAs of another vintage (e.g., use in 2030) — commonly referred to as vintage year swaps. At the end of a compliance period, a participating entity must either (1) deliver to the governing bodies EAs sufficient to offset the entity’s actual emissions or (2) pay a fine.
Markets to buy and sell EAs in the United States continue to develop. The extent of development depends on the type of EA and whether the EA is related to a national, regional, or state program.
Discussions with the FASB and SEC staffs have indicated that two methods of accounting for EAs are acceptable: (1) the inventory model and (2) the intangible asset model. While both are permitted, the intangible asset model is preferable. Although the FASB added a project to its agenda to address the accounting for EAs, the project was removed from the Board’s agenda in January 2014. Therefore, entities should choose one method and apply it consistently to a given category of EA. For example, an entity could hold two categories of EA, “held for use” and “held for sale,” each with its own accounting method. However, within a category, the method must be consistently applied.
Under the intangible asset model, cash inflows and outflows from sales and
purchases of EAs are generally classified as investing activities in the statement of cash
flows; however, under the inventory model, they are classified as operating activities in
the statement of cash flows.
6.4.2 Classification of Cash Flows of Repayments of Zero-Coupon Bonds and Other Debt Instruments With Coupon Interest Rates That Are Insignificant in Relation to the Effective Interest Rate of the Borrowing
ASC 230-10
45-15 All of the following are cash outflows for
financing activities:
-
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.
-
Repayments of amounts borrowed, including the portion of the repayments made to settle zero-coupon debt instruments that is attributable to the principal or the portion of the repayments made to settle other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing that is attributable to the principal.
-
Other principal payments to creditors who have extended long-term credit. See paragraph 230-10-45-13(c), which indicates that most principal payments on seller-financed debt directly related to a purchase of property, plant, and equipment or other productive assets are financing cash outflows.
-
Distributions to counterparties of derivative instruments that include financing elements at inception, other than a financing element inherently included in an at-the-market derivative instrument with no prepayments. The distributions may be either at inception or over the term of the derivative instrument.
-
Payments for debt issue costs.
-
Payments, or the portion of the payments, not made soon after the acquisition date of a business combination by an acquirer to settle a contingent consideration liability up to the amount of the contingent consideration liability recognized at the acquisition date, including measurement-period adjustments, less any amounts paid soon after the acquisition date to settle the contingent consideration liability. See also paragraph 230-10-45-17(ee).
-
Payments for debt prepayment or debt extinguishment costs, including third-party costs, premiums paid, and other fees paid to lenders that are directly related to the debt prepayment or debt extinguishment, excluding accrued interest.
45-17
All of the following are cash outflows for operating activities:
a. Cash payments to acquire materials for manufacture or goods for
resale, including principal payments on accounts and both short- and
long-term notes payable to suppliers for those materials or goods. The
term goods includes certain loans and other debt and equity
instruments of other entities that are acquired specifically for resale,
as discussed in paragraph 230-10-45-21.
b. Cash payments to other suppliers and employees for other goods or
services.
d. Cash payments to lenders and other creditors for interest, including
the portion of the payments made to settle zero-coupon debt instruments
that is attributable to accreted interest related to the debt discount or
the portion of the payments made to settle other debt instruments with
coupon interest rates that are insignificant in relation to the effective
interest rate of the borrowing that is attributable to accreted interest
related to the debt discount. For all other debt instruments, an issuer
shall not bifurcate cash payments to lenders and other creditors at
settlement for amounts attributable to accreted interest related to the
debt discount, nor classify such amounts as cash outflows for operating
activities.
e. Cash payment made to settle an asset retirement obligation.
ee. Cash payments, or the portion of the payments, not made soon after
the acquisition date of a business combination by an acquirer to settle a
contingent consideration liability that exceed the amount of the
contingent consideration liability recognized at the acquisition date,
including measurement-period adjustments, less any amounts paid soon after
the acquisition date to settle the contingent consideration liability. See
also paragraph 230-10-45-15(f).
f. All other cash payments that do not stem from transactions defined
as investing or financing activities, such as payments to settle lawsuits,
cash contributions to charities, and cash refunds to customers.
45-25 In reporting cash flows from operating
activities, entities are encouraged to report major classes of gross cash
receipts and gross cash payments and their arithmetic sum — the net cash flow
from operating activities (the direct method). (Paragraphs 230-10-55-1 through
55-4 and paragraph 230-10-55-21, respectively, discuss and illustrate a method
by which those major classes of gross operating cash receipts and payments
generally may be determined indirectly.) Entities that do so shall, at a
minimum, separately report the following classes of operating cash receipts
and payments:
-
Cash collected from customers, including lessees, licensees, and the like
-
Interest and dividends received. Interest and dividends that are donor restricted for long-term purposes as included in the list of financing activities and paragraph 230-10-45-14(c) are not part of operating cash receipts.
-
Other operating cash receipts, if any
-
Cash paid to employees and other suppliers of goods or services, including suppliers of insurance, advertising, and the like
-
Interest paid, including the portion of the payments made to settle zero-coupon debt instruments that is attributable to accreted interest related to the debt discount or the portion of the payments made to settle other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing that is attributable to accreted interest related to the debt discount
-
Income taxes paid
-
Other operating cash payments, if any.
Entities are encouraged to provide further breakdowns of operating cash
receipts and payments that they consider meaningful and feasible. For example,
a retailer or manufacturer might decide to further divide cash paid to
employees and suppliers (category (d) in the preceding paragraph) into
payments for costs of inventory and payments for selling, general, and
administrative expenses.
An entity that issues zero-coupon bonds to an investor records the proceeds from
the bonds’ issuance as a financing cash inflow. The bonds are accreted to their redemption
value in accordance with the “interest” method,4 as described in ASC 835 (i.e., the carrying amount of the bonds increases from
issuance until maturity [or earlier if prepayment is allowed] for the accrued interest to
arrive at the bonds’ redemption value). On the maturity date (or earlier if prepayment is
allowed), the entity repays (1) the original proceeds (the principal amount of the bonds)
and (2) the accrued interest from the date of issuance. Before the bonds’ maturity (or the
date of prepayment, if earlier), the interest expense is presented in the statement of
cash flows as a reconciling item between net income and cash flows from operating
activities, since no interim cash payments are made for the periodic accrual of
interest.
At redemption, the cash paid to settle the interest component is reflected as a cash outflow from operating activities in the statement of cash flows in accordance with ASC 230-10-45-17 and ASC 230-10-45-25
as the accrued interest is recognized in earnings. The cash paid to settle the principal is reflected as a cash outflow from financing activities in the statement of cash flows in accordance with ASC 230-10-45-15.
Example 6-10
On January 1, 20X2, Company A issues 1,000 zero-coupon bonds, each with a face amount of $1,000, and A
receives proceeds of $600,000 upon issuance. The zero-coupon bonds mature in five years (on December 31,
20X6).
In fiscal years 20X2–20X6, A records annual interest expense of $80,000, which
is calculated as ($1,000,000 redemption value – $600,000 proceeds received) ÷
5 years, to accrete the zero-coupon bonds to their redemption value. Company A
has determined that the amount of the interest expense accrued annually on a
straight-line basis ($80,000) would not materially differ from the amount of
interest expense accrued under the interest method.
On December 31, 20X6, A redeems the zero-coupon bonds for $1 million. Amounts
that A would present in its statement of cash flows for specific years are as
follows:
-
December 31, 20X2:
-
The initial cash proceeds of $600,000 received upon issuance of the zero-coupon bonds would be reflected as a cash inflow from financing activities.
-
The interest expense of $80,000 recorded to accrete the zero-coupon bonds to their redemption value would be reflected as a reconciling item between net income and cash flows from operating activities.
-
-
December 31, 20X3–20X5:
-
The interest expense of $80,000 recorded to accrete the zero-coupon bonds to their redemption value would be reflected as a reconciling item between net income and cash flows from operating activities.
-
-
December 31, 20X6:
-
Of the $1 million of cash paid, $600,000 represents the amount paid to settle the principal amount of the zero-coupon bonds and would be reflected as a cash outflow from financing activities.
-
The remaining $400,000 of cash paid (i.e., the interest expense of $80,000 recorded in each of the five fiscal years) would be reflected as a cash outflow from operating activities because the interest was recognized in earnings.
-
In addition to zero-coupon bonds, the guidance in ASC 230-10-45-15, ASC
230-10-45-17, and ASC 230-10-45-25 also applies to other debt instruments “with coupon
interest rates that are insignificant in relation to the effective interest rate of the
borrowing that is attributable to the principal.” The objective of including these other
debt instruments (rather than all debt instruments) is to improve comparability related to
entities’ presentation of economically similar transactions.
Connecting the Dots
ASC 230 does not define the term “insignificant” or otherwise provide guidance
on what would constitute insignificant coupon rates. Consequently, entities that issue
other debt instruments with coupon rates that are insignificant in relation to the
effective interest rate attributable to the principal will most likely need to
exercise greater judgment in evaluating the portion of the rates that is
insignificant. We generally believe that an entity should determine whether an
interest rate is insignificant by looking to the market. For example, a 1 percent
coupon rate may not be insignificant if the market rate is 2 percent. However, an
entity may conclude that a 1 percent coupon rate is insignificant compared with a
market rate of 10 percent and that the 1 percent rate is therefore within the scope of
ASC 230-10-45-15, ASC 230-10-45-17, and ASC 230-10-45-25.
6.4.3 Debt Instruments That Contain Interest Payable in Kind
Entities may issue debt instruments that require or permit the payment of the periodic interest coupons in kind. The ASC master glossary defines payment-in-kind bonds as follows:
Bonds in which the issuer has the option at each interest payment date of making interest payments in cash or in additional debt securities. Those additional debt securities are referred to as baby or bunny bonds. Baby bonds generally have the same terms, including maturity dates and interest rates, as the original bonds (parent payment-in-kind bonds). Interest on baby bonds may also be paid in cash or in additional like-kind debt securities at the option of the issuer.
On the basis of the EITF’s deliberations leading up to the issuance of ASU
2016-15 (codified in ASC 230), we understand that the requirements discussed in the
previous section apply to all debt instruments that are economically similar to
zero-coupon bonds (including debt instruments that contain periodic interest coupons that
are payable in kind).5 Therefore, we believe that the guidance in ASC 230-10-45-15, ASC 230-10-45-17, and
ASC 230-10-45-25 should be considered for debt instruments that:
-
Require periodic interest coupons to be paid in kind through an addition to the contractual principal amount of the original debt instrument.
-
Permit the debtor to pay each periodic interest coupon in cash or in kind, with any payments made in kind added to the contractual principal amount of the original debt instrument.
-
Require periodic interest coupons to be paid in kind through the issuance of a new debt instrument that has the same terms as the original debt instrument.
-
Permit the debtor to pay each periodic interest coupon in cash or in kind, with any payments in kind paid through the issuance of a new debt instrument that has the same terms as the original debt instrument.
While the guidance in ASC 230-10-45-15, ASC 230-10-45-17, and ASC 230-10-45-25 specifically addresses only the debtor’s cash flow statement classification, we believe that it is also relevant to the investor’s cash flow statement classification. Therefore, we think that the following payments should be classified as operating activities: (1) the portion of payments received upon settlement of zero-coupon debt instruments that is attributable to accreted interest and (2) the portion of payments received upon settlement of other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing that is attributable to accreted interest (including debt instruments that contain periodic interest coupons that are payable in kind). The principal portion received on these debt instruments would continue to be classified as investing activities.
The guidance discussed above (and in Section 6.4.2) should not affect the classification of cash
flows for the following types of financial instruments that contain periodic coupons that are
payable in kind:
-
Convertible debt instruments or convertible preferred stock instruments that are settled through the issuance of common stock — The settlement of convertible securities for common stock is treated as a noncash investing or financing activity.
-
Preferred stock instruments that are classified in equity — The issuer of preferred stock classifies payments of dividends on, and redemptions of, equity-classified preferred stock instruments as financing activities. Therefore, the ASU’s guidance does not apply to the issuer; however, it does apply to the investor. Under this guidance, the investor would be required to classify (1) dividends received on equity-classified preferred stock instruments as operating activities and (2) redemptions of equity-classified preferred stock instruments as investing activities.
Footnotes
3
See footnote 2.
4
ASC 835-30-35-4 states that “[o]ther methods of amortization may be
used if the results obtained are not materially different from those that would result
from the interest method.”
5
We generally believe that when ASU 2016-15 is applied, debt
instruments that contain periodic interest coupons that are payable in kind are
economically similar to zero-coupon bonds.
6.5 Changes to Historical Classification
In certain instances, an entity may elect to change its historical classification of certain items in the statement of cash flows. We do not believe that such a change in classification would represent a change in accounting principle as defined in ASC 250 if the entity is able to conclude that both the previous classification and the new classification are acceptable under GAAP. Instead, the change should be viewed as a change from one acceptable presentation to another acceptable presentation in accordance with ASC 230. Further, an entity should retrospectively apply the revised classification for each year presented in the financial statements and include appropriate disclosure of the change.
Conversely, a change to an entity’s policy for determining which items are treated as cash equivalents represents a change in accounting principle for which the entity must demonstrate preferability in accordance with ASC 250 (see Section 4.1 regarding the definition of cash and cash equivalents).
Example 6-11
Entity A has decided to change the approach it uses for presentation in its statement of cash flows in the current year from the direct method to the indirect method, since management considers presentation under the indirect method to be more informative and readily understandable by financial statement users.
Both the direct method and the indirect method are acceptable under U.S. GAAP, and the change is considered to be a change in presentation, which is analogous to a reclassification. Entity A will retroactively reclassify the statement of cash flows presented and disclose the reclassification in the notes to the financial statements.
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.
Appendix A — Implementation Guidance and Illustrations
Appendix A — Implementation Guidance and Illustrations
ASC 830-230
Illustrations
Example 1: Statement of Cash Flows for Manufacturing
Entity With Foreign Operations
55-1 This Example illustrates a statement of cash flows under the direct method for a manufacturing entity with foreign operations. The illustrations of the reconciliation of net income to net cash provided by operating activities may provide detailed information in excess of that required for a meaningful presentation. Other formats or levels of detail may be appropriate for particular circumstances.
55-2 The following is a consolidating statement of cash flows for the year ended December 31, 19X1, for Entity F, a multinational U.S. corporation engaged principally in manufacturing activities, which has two wholly owned foreign subsidiaries — Subsidiary A and Subsidiary B. For Subsidiary A, the local currency is the functional currency. For Subsidiary B, which operates in a highly inflationary economy, the U.S. dollar is the functional currency.
Reconciliation of net income to net cash provided by operating activities:
55-3 The entity would make the following disclosure.
Cash in excess of daily requirements is invested in marketable securities consisting of U.S. Treasury bills with maturities of three months or less. Such investments are deemed to be cash equivalents for purposes of the statement of cash flows.
55-4 Summarized in the
following tables is financial information for the current
year for Entity F, which provides the basis for the
statement of cash flows presented in paragraph
830-230-55-2.
55-5 The U.S. dollar equivalents of one unit of local currency applicable to Subsidiary A and to Subsidiary B are as follows.
55-6 The computation of the
weighted-average exchange rate for Subsidiary A excludes the
effect of Subsidiary A’s sale of inventory to the parent
entity at the beginning of the year discussed in paragraph
830-230-55-10(a).
55-7 Comparative statements of financial position for the parent entity and for each of the foreign subsidiaries are as follows.
55-8 Statements of income in local currency and U.S. dollars for each of the foreign subsidiaries are as follows.
55-9 All of the following transactions were entered into during the year by the parent entity and are reflected in the preceding financial statements:
- The parent entity invested cash in excess of daily requirements in U.S. Treasury bills. Interest earned on such investments totaled USD 35.
- The parent entity sold excess property with a net book value of USD 35 for USD 150.
- The parent entity’s capital expenditures totaled USD 450.
- The parent entity wrote down to its estimated net realizable value of USD 25 a facility with a net book value of USD 75.
- The parent entity’s short-term debt consisted of commercial paper with maturities not exceeding 60 days.
- The parent entity repaid long-term notes of USD 200.
- The parent entity’s depreciation totaled USD 340, and amortization of intangible assets totaled USD 10.
- The parent entity’s provision for income taxes included deferred taxes of USD 90.
- Because of a change in product design, the parent entity purchased all of Subsidiary A’s beginning inventory for its book value of USD 160. All of the inventory was subsequently sold by the parent entity.
- The parent entity received a dividend of USD 22 from Subsidiary A. The dividend was credited to the parent entity’s income.
- The parent entity purchased from Subsidiary B USD 270 of merchandise of which USD 45 remained in the parent entity’s inventory at year-end. Intra-entity profit on the remaining inventory totaled USD 15.
- The parent entity loaned USD 15, payable in U.S. dollars, to Subsidiary B.
- Entity F paid dividends totaling USD 120 to shareholders.
55-10 All of the following transactions were entered into during the year by Subsidiary A and are reflected in the above financial statements. The U.S. dollar equivalent of the local currency amount based on the exchange rate at the date of each transaction is included. Except for the sale of inventory to the parent entity (the transaction in [a]), Subsidiary A’s sales and purchases and operating cash receipts and payments occurred evenly throughout the year.
- Because of a change in product design, Subsidiary A sold all of its beginning inventory to the parent entity for its book value of LC 400 (USD 160).
- Subsidiary A sold equipment for its book value of LC 275 (USD 116) and purchased new equipment at a cost of LC 600 (USD 258).
- Subsidiary A issued an additional LC 175 (USD 75) of 30-day notes and renewed the notes at each maturity date.
- Subsidiary A issued long-term debt of LC 400 (USD 165) and repaid long-term debt of LC 250 (USD 105).
- Subsidiary A paid a dividend to the parent entity of LC 50 (USD 22).
55-11 The following transactions were entered into during the year by Subsidiary B and are reflected in the preceding financial statements. The U.S. dollar equivalent of the local currency amount based on the exchange rate at the date of each transaction is included. Subsidiary B’s sales and operating cash receipts and payments occurred evenly throughout the year. For convenience, all purchases of inventory were based on the weighted-average exchange rate for the year. Subsidiary B uses the first-in, first-out (FIFO) method of inventory valuation.
- Subsidiary B had sales to the parent entity as follows.
- Subsidiary B sold equipment with a net book value of LC 200 (USD 39) for LC 350 (USD 14). New equipment was purchased at a cost of LC 500 (USD 15).
- Subsidiary B borrowed USD 15 (LC 500), payable in U.S. dollars, from the parent entity.
- Subsidiary B repaid LC 1,000 (USD 35) of long-term debt.
55-12 Statements of cash flows in the local currency and in U.S. dollars for Subsidiary A and Subsidiary B are as follows.
55-13 A reconciliation of net income to net cash provided by operating activities follows.
55-14 The following is the
computation of cash received from customers and cash paid to
suppliers and employees as reported in the consolidating
statement of cash flows for Entity F appearing in paragraph
830-230-55-2.
55-15 The following is the computation of the effect of exchange rate changes on cash for Subsidiary A and Subsidiary B.
Appendix B — Glossary of Selected Terms
Appendix B — Glossary of Selected Terms
Selected terms from the ASC master glossary are included below.
ASC
Master Glossary
Acquiree
The
business or businesses that the acquirer obtains control of
in a business combination. This term also includes a
nonprofit activity or business that a not-for-profit
acquirer obtains control of in an acquisition by a
not-for-profit entity.
Acquirer
The
entity that obtains control of the acquiree. However, in a
business combination in which a variable interest entity
(VIE) is acquired, the primary beneficiary of that entity
always is the acquirer.
Acquisition Date
The date on which the acquirer obtains
control of the acquiree.
Amortization
The process of reducing a recognized liability
systematically by recognizing gains or by reducing a
recognized asset systematically by recognizing losses. In
accounting for pension benefits or other postretirement
benefits, amortization also means the systematic recognition
in net periodic pension cost or other postretirement benefit
cost over several periods of amounts previously recognized
in other comprehensive income, that is, gains or losses,
prior service cost or credits, and any transition obligation
or asset.
Available-for-Sale Securities
Investments not classified as either
trading securities or as held-to-maturity
securities.
Award
The
collective noun for multiple instruments with the same terms
and conditions granted at the same time either to a single
grantee or to a group of grantees. An award may specify
multiple vesting dates, referred to as graded vesting, and
different parts of an award may have different expected
terms. References to an award also apply to a portion of an
award.
Beneficial Interests
Rights to receive all or portions of
specified cash inflows received by a trust or other entity,
including, but not limited to, all of the following:
- Senior and subordinated shares of interest, principal, or other cash inflows to be passed-through or paid-through
- Premiums due to guarantors
- Commercial paper obligations
- Residual interests, whether in the form of debt or equity.
Business Combination
A transaction or other event in which an acquirer obtains control of one or more
businesses. Transactions sometimes referred to as true
mergers or mergers of equals also are business combinations.
. . .
Capital Lease
From the perspective of a lessee, a lease
that meets any of the four lease classification criteria in
paragraph 840-10-25-1.
Note: The following definition is
Pending Content; see Transition Guidance in
842-10-65-1.
Glossary term superseded
by Accounting Standards Update No. 2016-02.
Cash
Consistent with common usage, cash includes not only
currency on hand but demand deposits with banks or other
financial institutions. Cash also includes other kinds of
accounts that have the general characteristics of demand
deposits in that the customer may deposit additional funds
at any time and also effectively may withdraw funds at any
time without prior notice or penalty. All charges and
credits to those accounts are cash receipts or payments to
both the entity owning the account and the bank holding it.
For example, a bank’s granting of a loan by crediting the
proceeds to a customer’s demand deposit account is a cash
payment by the bank and a cash receipt of the customer when
the entry is made.
Cash Equivalents
Cash equivalents are short-term, highly
liquid investments that have both of the following
characteristics:
- Readily convertible to known amounts of cash
- So near their maturity that they present insignificant risk of changes in value because of changes in interest rates.
Generally, only investments
with original maturities of three months or less qualify
under that definition. Original maturity means original
maturity to the entity holding the investment. For example,
both a three-month U.S. Treasury bill and a three-year U.S.
Treasury note purchased three months from maturity qualify
as cash equivalents. However, a Treasury note purchased
three years ago does not become a cash equivalent when its
remaining maturity is three months. Examples of items
commonly considered to be cash equivalents are Treasury
bills, commercial paper, money market funds, and federal
funds sold (for an entity with banking
operations).
Cash Flow Hedge
A hedge of the exposure to variability in
the cash flows of a recognized asset or liability, or of a
forecasted transaction, that is attributable to a particular
risk.
Contingent Consideration
Usually an obligation of the acquirer to
transfer additional assets or equity interests to the former
owners of an acquiree as part of the exchange for control of
the acquiree if specified future events occur or conditions
are met. However, contingent consideration also may give the
acquirer the right to the return of previously transferred
consideration if specified conditions are met.
Dividends
Dividends paid or payable in cash, other assets, or another
class of stock and does not include stock dividends or stock
splits.
Exchange Rate
The ratio between a unit of one currency
and the amount of another currency for which that unit can
be exchanged at a particular time.
Fair Value
The price that would be received to sell an
asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement
date.
Fair Value Hedge
A hedge of the exposure to changes in the
fair value of a recognized asset or liability, or of an
unrecognized firm commitment, that are attributable to a
particular risk.
Finance Lease
Note: The following
definition is Pending Content; see Transition Guidance in
842-10-65-1.
From the perspective of a lessee, a lease
that meets one or more of the criteria in paragraph
842-10-25-2.
Financial Asset
Cash, evidence of an ownership interest in
an entity, or a contract that conveys to one entity a right
to do either of the following:
- Receive cash or another financial instrument from a second entity
- Exchange other financial instruments on potentially favorable terms with the second entity.
Financing Activities
Financing activities include obtaining
resources from owners and providing them with a return on,
and a return of, their investment; receiving restricted
resources that by donor stipulation must be used for
long-term purposes; borrowing money and repaying amounts
borrowed, or otherwise settling the obligation; and
obtaining and paying for other resources obtained from
creditors on long-term credit.
Foreign Currency
A currency other than the functional
currency of the entity being referred to (for example, the
dollar could be a foreign currency for a foreign entity).
Composites of currencies, such as the Special Drawing
Rights, used to set prices or denominate amounts of loans,
and so forth, have the characteristics of foreign
currency.
Foreign Currency Translation
The process of expressing in the reporting
currency of the reporting entity those amounts that are
denominated or measured in a different currency.
Foreign Entity
An operation (for example, subsidiary,
division, branch, joint venture, and so forth) whose
financial statements are both:
- Prepared in a currency other than the reporting currency of the reporting entity
- Combined or consolidated with or accounted for on the equity basis in the financial statements of the reporting entity.
Functional Currency
An entity’s functional currency is the currency of the primary economic
environment in which the entity operates; normally, that is
the currency of the environment in which an entity primarily
generates and expends cash. (See paragraphs 830-10-45-2
through 830-10-45-6 and 830-10-55-3 through
830-10-55-7.)
Grant Date
The date at which a grantor and a grantee
reach a mutual understanding of the key terms and conditions
of a share-based payment award. The grantor becomes
contingently obligated on the grant date to issue equity
instruments or transfer assets to a grantee who delivers
goods or renders services or purchases goods or services as
a customer. Awards made under an arrangement that is subject
to shareholder approval are not deemed to be granted until
that approval is obtained unless approval is essentially a
formality (or perfunctory), for example, if management and
the members of the board of directors control enough votes
to approve the arrangement. Similarly, individual awards
that are subject to approval by the board of directors,
management, or both are not deemed to be granted until all
such approvals are obtained. The grant date for an award of
equity instruments is the date that a grantee begins to
benefit from, or be adversely affected by, subsequent
changes in the price of the grantor’s equity shares.
Paragraph 718-10-25-5 provides guidance on determining the
grant date. See Service Inception Date.
Inventory
The aggregate of those items of tangible personal property
that have any of the following characteristics:
- Held for sale in the ordinary course of business
- In process of production for such sale
- To be currently consumed in the production of goods or services to be available for sale.
The term inventory embraces
goods awaiting sale (the merchandise of a trading concern
and the finished goods of a manufacturer), goods in the
course of production (work in process), and goods to be
consumed directly or indirectly in production (raw materials
and supplies). This definition of inventories excludes
long-term assets subject to depreciation accounting, or
goods which, when put into use, will be so classified. The
fact that a depreciable asset is retired from regular use
and held for sale does not indicate that the item should be
classified as part of the inventory. Raw materials and
supplies purchased for production may be used or consumed
for the construction of long-term assets or other purposes
not related to production, but the fact that inventory items
representing a small portion of the total may not be
absorbed ultimately in the production process does not
require separate classification. By trade practice,
operating materials and supplies of certain types of
entities such as oil producers are usually treated as
inventory.
Investing Activities
Investing activities include making and collecting loans and acquiring and
disposing of debt or equity instruments and property, plant,
and equipment and other productive assets, that is, assets
held for or used in the production of goods or services by
the entity (other than materials that are part of the
entity’s inventory). Investing activities exclude acquiring
and disposing of certain loans or other debt or equity
instruments that are acquired specifically for resale, as
discussed in paragraphs 230-10-45-12 and 230-10-45-21.
Lease
An
agreement conveying the right to use property, plant, or
equipment (land and/or depreciable assets) usually for a
stated period of time.
Note: The following definition is
Pending Content; see Transition Guidance in
842-10-65-1.
A contract, or part of a
contract, that conveys the right to control the use of
identified property, plant, or equipment (an identified
asset) for a period of time in exchange for
consideration.
Lease Liability
Note: The following
definition is Pending Content; see Transition Guidance in
842-10-65-1.
A lessee’s obligation to
make the lease payments arising from a lease, measured on a
discounted basis.
Net Asset Value per Share
Net asset value per share is the amount of
net assets attributable to each share of capital stock
(other than senior equity securities, that is, preferred
stock) outstanding at the close of the period. It excludes
the effects of assuming conversion of outstanding
convertible securities, whether or not their conversion
would have a diluting effect.
Net Share Settlement
A form of settling a financial
instrument under which the entity with a loss delivers to
the entity with a gain shares of stock with a current fair
value equal to the gain.
Nonvested Shares
Shares that an entity has not yet
issued because the agreed-upon consideration, such as the
delivery of specified goods or services and any other
conditions necessary to earn the right to benefit from the
instruments, has not yet been satisfied. Nonvested shares
cannot be sold. The restriction on sale of nonvested shares
is due to the forfeitability of the shares if specified
events occur (or do not occur).
Not-for-Profit Entity
An entity that possesses the following
characteristics, in varying degrees, that distinguish it
from a business entity:
- Contributions of significant amounts of resources from resource providers who do not expect commensurate or proportionate pecuniary return
- Operating purposes other than to provide goods or services at a profit
- Absence of ownership interests like those of business entities.
Entities that clearly fall
outside this definition include the following:
- All investor-owned entities
- Entities that provide dividends, lower costs, or other economic benefits directly and proportionately to their owners, members, or participants, such as mutual insurance entities, credit unions, farm and rural electric cooperatives, and employee benefit plans.
Operating Activities
Operating activities include all transactions and other events that are not
defined as investing or financing activities (see paragraphs
230-10-45-12 through 45-15). Operating activities generally
involve producing and delivering goods and providing
services. Cash flows from operating activities are generally
the cash effects of transactions and other events that enter
into the determination of net income.
Operating Lease
From the perspective of a lessee, any lease other than a capital lease. From the
perspective of a lessor, a lease that meets the conditions
in paragraph 840-10-25-43(d).
Note: The following definition
is Pending Content; see Transition Guidance in
842-10-65-1.
From the perspective of
a lessee, any lease other than a finance lease.
From the perspective of a lessor, any lease
other than a sales-type lease or a direct financing
lease.
Other Comprehensive Income
Revenues, expenses, gains, and losses that
under generally accepted accounting principles (GAAP) are
included in comprehensive income but excluded from net
income.
Physical Settlement
The party designated in the
contract as the buyer delivers the full stated amount of
cash to the seller, and the seller delivers the full stated
number of shares to the buyer.
Readily Convertible to Cash
Assets that are readily convertible to cash
have both of the following:
- Interchangeable (fungible) units
- Quoted prices available in an active market that can rapidly absorb the quantity held by the entity without significantly affecting the price. . . .
Reporting Currency
The currency in which a reporting entity
prepares its financial statements.
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. Instead of cash,
other securities or letters of credit sometimes are
exchanged. Some repurchase agreements call for repurchase of
financial assets that need not be identical to the financial
assets transferred.
Requisite Service Period
The period or periods during which an
employee is required to provide service in exchange for an
award under a share-based payment arrangement. The service
that an employee is required to render during that period is
referred to as the requisite service. The requisite service
period for an award that has only a service condition is
presumed to be the vesting period, unless there is clear
evidence to the contrary. If an award requires future
service for vesting, the entity cannot define a prior period
as the requisite service period. Requisite service periods
may be explicit, implicit, or derived, depending on the
terms of the share-based payment award.
Research and Development
Research is planned search or critical
investigation aimed at discovery of new knowledge with the
hope that such knowledge will be useful in developing a new
product or service (referred to as product) or a new process
or technique (referred to as process) or in bringing about a
significant improvement to an existing product or process.
Development is the translation of
research findings or other knowledge into a plan or design
for a new product or process or for a significant
improvement to an existing product or process whether
intended for sale or use. It includes the conceptual
formulation, design, and testing of product alternatives,
construction of prototypes, and operation of pilot
plants.
Reverse Repurchase Agreement Accounted
for as a Collateralized Borrowing
A reverse repurchase agreement accounted
for as a collateralized borrowing (also known as a reverse
repo) refers to 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. The receivable
under a reverse repurchase agreement accounted for as a
collateralized borrowing refers to the amount due from the
seller-borrower for the repurchase of the securities from
the buyer-lender. In certain industries, the terminology is
reversed; that is, entities in those industries refer to
this type of agreement as a repo.
Right of Setoff
A right of setoff is a debtor’s legal
right, by contract or otherwise, to discharge all or a
portion of the debt owed to another party by applying
against the debt an amount that the other party owes to the
debtor.
Right-of-Use Asset
Note: The following
definition is Pending Content; see Transition Guidance in
842-10-65-1.
An asset that represents
a lessee’s right to use an underlying asset for the lease
term.
Sale-Leaseback Accounting
A method of accounting for a sale-leaseback
transaction in which the seller-lessee records the sale,
removes all property and related liabilities from its
balance sheet, recognizes gain or loss from the sale, and
classifies the leaseback in accordance with the Lessees
Subsections of Subtopic 840-40.
Note: The following definition is
Pending Content; see Transition Guidance in
842-10-65-1.
Glossary term superseded
by Accounting Standards Update No. 2016-02.
Service Inception Date
The date at which the employee’s
requisite service period or the nonemployee’s vesting period
begins. The service inception date usually is the grant
date, but the service inception date may differ from the
grant date (see Example 6 [see paragraph 718-10-55-107] for
an illustration of the application of this term to an
employee award).
Settlement of an Award
An action or event that irrevocably
extinguishes the issuing entity’s obligation under a
share-based payment award. Transactions and events that
constitute settlements include the following:
- Exercise of a share option or lapse of an option at the end of its contractual term
- Vesting of shares
- Forfeiture of shares or share options due to failure to satisfy a vesting condition
- An entity’s repurchase of instruments in exchange for assets or for fully vested and transferable equity instruments.
The vesting of a share option
is not a settlement because the entity remains obligated to
issue shares upon exercise of the option.
Share Option
A contract that gives
the holder the right, but not the obligation, either to
purchase (to call) or to sell (to put) a certain number of
shares at a predetermined price for a specified period of
time.
Subsequent Events
Events or transactions that occur after the
balance sheet date but before financial statements are
issued or are available to be issued. There are two types of
subsequent events:
- The first type consists of events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements (that is, recognized subsequent events).
- The second type consists of events that provide evidence about conditions that did not exist at the date of the balance sheet but arose subsequent to that date (that is, nonrecognized subsequent events).
Subsidiary
An entity, including an unincorporated entity such as a
partnership or trust, in which another entity, known as its
parent, holds a controlling financial interest. (Also, a
variable interest entity that is consolidated by a primary
beneficiary.)
Trading Securities
Securities that are bought and held
principally for the purpose of selling them in the near term
and therefore held for only a short period of time. Trading
generally reflects active and frequent buying and selling,
and trading securities are generally used with the objective
of generating profits on short-term differences in
price.
Transaction Gain or Loss
Transaction gains or losses result from a
change in exchange rates between the functional currency and
the currency in which a foreign currency transaction is
denominated. They represent an increase or decrease in both
of the following:
- The actual functional currency cash flows realized upon settlement of foreign currency transactions
- The expected functional currency cash flows on unsettled foreign currency transactions.
Transferee
An entity that receives a financial asset, an interest in a
financial asset, or a group of financial assets from a
transferor.
Transferor
An entity that transfers a financial asset, an interest in
a financial asset, or a group of financial assets that it
controls to another entity.
Appendix C — SEC Staff Review Process and Sample SEC Comments Related to the Statement of Cash Flows
Appendix C — SEC Staff Review Process and Sample SEC Comments Related to the Statement of Cash Flows
SEC Staff Review Process
The SEC’s Division of Corporation Finance (the “Division”) conducts selective
and required reviews of filings made under the Securities Act and the Exchange
Act. In 2019, the Division established a new organizational structure for its
disclosure program. The new structure consists of the following four groups:
- Disclosure Review Program — Performs most of the
selective and required reviews. Reviews are conducted by the following
seven review offices:
- Energy & Transportation.
- Finance.
- Life Sciences.
- Manufacturing.
- Real Estate & Construction.
- Technology.
- Trade & Services.
Registrants are assigned to a specific review office on the basis of their industry, and each office is staffed by professionals with specialized industry, accounting, and disclosure review expertise. Before the organizational change, each registrant subject to a disclosure review was assigned to one of 11 assistant director offices. - Specialized Policy and Disclosure — Handles matters related to international corporate finance, mergers and acquisitions, structured finance, and corporate governance.
- Office of Risk and Strategy — Provides guidance to Division staff on emerging risks and related disclosures.
- Office of Assessment and Continuous Improvement — Evaluates the effectiveness of the Disclosure Review Program.
For more information on the new organizational structure, including the name of
the chief and the senior adviser of each review office, see the Division’s
announcement.
The SEC’s Web site includes an overview that explains the Division’s filing review and
comment letter process. The overview aims to increase transparency in the review
process and expresses the staff’s willingness to discuss issues with
registrants. The overview indicates that the Division focuses “on critical
disclosures that appear to conflict with Commission rules or applicable
accounting standards and on disclosure that appears to be materially deficient
in explanation or clarity.” In addition, the overview notes that the “Division
completes many filing reviews without issuing comments.”
The overview encourages registrants to view the comment letter process as a
dialogue and states that “[i]f a company does not understand a comment or the
staff’s purpose in issuing it,” the company may “seek clarification [first] from
the examiner” and then from “the staff member who approved the comment.”1 In addition, registrants may request “[a]t any time during the filing
review process . . . that the staff reconsider either a previously-issued
comment or its view of the company’s response to a comment.” Although the
Division does not require registrants to follow a formal protocol for seeking
reconsideration, such a request should be directed to the chief of the office
conducting the review. Further, registrants “should feel free to involve the
Disclosure Program Director, the Division’s Deputy Director or Director at any
stage in the filing review process.”
Registrants may also involve the SEC’s Office of the Chief Accountant (OCA)
during any stage of the review process. Unlike the Division’s role, which is to
address matters related to the age, form, and content of registrants’ financial
statements that are required to be filed, the OCA’s role is to address questions
concerning a registrant’s application of GAAP. Guidance on consulting with the OCA is
available on the SEC’s Web site.
A registrant that receives an SEC comment letter should generally respond within
the time frame indicated in the letter or proactively communicate with the SEC
staff regarding expected timing. See Appendix B of Deloitte’s Roadmap SEC Comment Letter
Considerations, Including Industry Insights for more
information about responding to SEC comment letters. The registrant should
continue to respond to any requests for more information until it receives a
letter from the Division stating that the Division has no further comments. A
registrant that does not receive a completion letter within a reasonable amount
of time after submitting a response letter should call its SEC staff reviewer
(named in the letter) to ask about the status of the review. If the review is
complete, the registrant should request a completion letter.
To increase the transparency of the Division’s review process, comment letters
and company responses to those letters are made public, via the SEC’s Web site,
at least 20 business days after the Division has completed its review of a
periodic or current report or declared a registration statement effective. See
Appendix C of
Deloitte’s Roadmap SEC
Comment Letter Considerations, Including Industry
Insights for tips on searching the SEC’s comment letter
database.
In certain instances, the SEC staff may conclude that a registration statement
or offering document is so deficient that the staff will defer review until such
filing is amended to address the deficiencies. Historically, the staff has
communicated this to registrants on a confidential basis. Since 2018, however,
in a manner consistent with the SEC’s effort to improve transparency, letters
requiring registrants to amend their filings to resolve the deficiencies before
the staff commences its review have been made public via the SEC’s Web site
within 10 days of issuance. Thus far, the issuance of such letters has been
limited.
Examples of SEC Comments
The extracts in this publication are specifically related to the statement of
cash flows and have been reproduced from comments published on the SEC’s Web
site. Dollar amounts and information identifying registrants or their businesses
have been redacted from the comments.
For a discussion of SEC comment letters to registrants on
additional topics, see Deloitte’s Roadmap SEC Comment Letter Considerations, Including
Industry Insights.
Category Classification
Examples of SEC Comments
- Please tell us your basis for classifying the capitalization of contract costs as an investing cash flow activity as opposed to an operating activity.
- We note that you present increases and decreases in book overdrafts as cash flows from financing activities. In this regard, please provide us with your basis for reporting changes in book overdrafts as cash flows from financing activities instead of cash flows from operating activities. Also, clarify whether the overdraft is with a bank.
- Please explain why you classified your short-term investments as trading and why the corresponding cash flows have been classified as investing instead of as operating in your Statements of Cash Flows. See ASC 320 and ASC 230-10-45-20.
ASC 230 requires entities to classify cash receipts and cash payments as
operating, investing, or financing activities on the basis of the nature of
the cash flow. Many of the SEC staff’s comments are related to understanding
the classification or potential misclassification among these three cash
flow categories. In some cases, the SEC staff has raised questions about the
presentation of cash inflows resulting from a transaction in a manner
inconsistent with the underlying balance sheet classification.
Net Versus Gross Presentation
Examples of SEC Comments
- Please revise the other assets and liabilities, net line item to present changes in other assets separately from other liabilities and further breakout any material components. Refer to ASC paragraphs 230-10-45-7 and 45-29.
- We note that you present the caption Investments in property and equipment, net. Please revise future filings to separately present the cash inflows and cash outflows for property and equipment on a gross basis as discussed in ASC 230-10-45-26.
The SEC staff may challenge whether it is appropriate to
report the net amount of certain cash receipts and cash payments on the face
of the statement of cash flows. Generally, cash payments should not be
presented net of cash receipts in the statement of cash flows. However, ASC
230-10-45-7 through 45-9 state that although reporting gross cash receipts
and gross cash payments provides more relevant information, financial
statement users sometimes may not need gross reporting to understand certain
activities. Further, the netting criteria in ASC 230-10-45-8 (turnover is
quick, the amounts are large, and the maturities are short) must be met for
an entity to present investing and financing activity on a net basis.
Accordingly, the SEC staff may ask a registrant to revise the presentation
or to explain (in accordance with ASC 230) why it is appropriate to report
certain cash flows on a net basis rather than on a gross basis.
Extended Vendor Payable Arrangements
Example of an SEC Comment
We note your “Accounts Payable days”
are [X] days as of [the fiscal year-end]. We further
note your Accounts Payable days [have] increased
substantially over the past ten years . . . . Please
tell us if you are engaging in supply chain finance
operations and mechanisms, such as reverse factoring
or similar methods to increase your Accounts Payable
days. Otherwise, please explain how you have been
able to achieve such extended accounts payable terms
with your suppliers.
The SEC staff has recently issued comments to registrants that use extended
vendor-payable arrangements involving the participation of a paying agent or
other financial institution. Under such programs, the paying agent or
financial institution may settle the payment obligation directly with the
registrant’s supplier, for a fee, earlier than the extended payment term.
Because there is no explicit authoritative guidance on these arrangements,
the SEC staff has challenged registrants’ determinations of whether the
payments under such programs (1) constitute trade payables, which would
represent operating activities, or (2) are more akin to debt, which would
represent financing activities. In addition, the staff has encouraged
registrants to provide enhanced disclosures about their extended vendor
payable arrangements, such as the following:
- A description of the program, including relevant terms, related risks, and impacts on the registrant’s working capital, liquidity, and capital resources.
- Amounts settled through the program, including relevant terms, related risks, and impacts on the registrant’s working capital, liquidity, and capital resources.
- Amounts remaining in trade payables at year-end for which the registrant’s supplier has elected early payment (i.e., the balance sheet impact).
See Section 7.13 for interpretive views on how supplier finance
programs (also referred to herein as extended vendor-payable arrangements)
are presented in the statement of cash flows.
Footnotes
1
Contact information is provided in the concluding paragraph of a comment
letter.
Appendix D — SEC Interim Reporting Considerations
Appendix D — SEC Interim Reporting Considerations
Regulation S-X, Article 10, outlines the financial statement
requirements for interim financial reporting. Such requirements include:
- “Interim statements of cash flows . . . for the period between the end of the preceding fiscal year and the end of the most recent fiscal quarter [year-to-date statements], and for the corresponding period of the preceding fiscal year” (Regulation S-X, Article 10-01(c)(3)).1
- Issuers, although required to present year-to-date
statements as described above, may present additional periods,
specifically:
- “[T]he cumulative twelve month period ended during the most recent fiscal quarter and for the corresponding preceding period” in accordance with Regulation S-X, Article 10-01(c)(3).
- A statement of cash flows for the most recent fiscal quarter, and for the corresponding period of the preceding fiscal year, is not prohibited.
- Interim statements of cash flows and related footnotes may be presented on a condensed basis in a level of detail permitted by Article 10 but will need to be supplemented by disclosure of any material matters that were not disclosed in the most recently issued annual financial statements.
- Regulation S-X, Article 10-01(a)(4), states that “[t]he statement of cash flows may be abbreviated starting with a single figure of net cash flows from operating activities and showing cash changes from investing and financing activities individually only when they exceed 10% of the average of net cash flows from operating activities for the most recent three years. Notwithstanding this test, § 210.4-02 applies and de minimis amounts therefore need not be shown separately.”
In addition, while ASC 230 requires disclosure of noncash investing
and financing items and that the amount of interest (net of amounts capitalized) and
income taxes paid (for entities reporting under the indirect method) be disclosed
during the “period,” the guidance is not clear on whether “period” was intended to
include interim reporting periods. Further, while Regulation S-X, Article 10, does
not provide for similar disclosure requirements regarding noncash items and amounts
paid for interest and income taxes, many registrants provide one or more of these
when such information (1) represents a material change from the preceding
comparative period; (2) exceeds the 10 percent threshold discussed in Regulation
S-X, Article 10-01(a)(4) (as noted above); or (3) is believed to be informative to
users of the interim financial statements.
Footnotes
1
Regulation S-X, Article 10-01(c)(4), notes that
“registrants engaged in seasonal production and sale of a
single-crop agricultural commodity may provide interim statements of
. . . cash flows for the twelve month period ended during the most
recent fiscal quarter and for the corresponding preceding period in
lieu of the year-to-date statements specified in paragraphs (c)(2)
and [(c)(3) of Article 10].”
Appendix E — Differences Between U.S. GAAP and IFRS Accounting Standards
Appendix E — Differences Between U.S. GAAP and IFRS Accounting Standards
U.S. GAAP and IFRS® Accounting Standards contain similar
guidance on presentation in the statement of cash flows, including the requirement
to separate cash flows into operating, investing, and financing activities. Both
also allow the use of the direct or indirect method of presenting cash flows from
operating activities. However, as shown in the table below, there are a number of
differences between the two sets of standards regarding presentation in the
statement of cash flows.
Subject | U.S. GAAP (ASC 230-10) | IFRS Accounting Standards (IAS 1, IAS 7) |
---|---|---|
Scope | Although all entities are required to
present a statement of cash flows, there are certain
exceptions. Entities that are not required to present a
statement of cash flows include defined benefit pension
plans that prepare financial information in accordance with
ASC 960, certain investment companies within the scope of
ASC 946 that meet all of the conditions in ASC
230-10-15-4(c), and certain funds described in ASC
230-10-15-4(b)(3). | Under paragraph 7 of IAS 7, all entities
are required to present a statement of cash flows (i.e.,
there are no scope exceptions). |
Method of reporting cash flows from operating
activities
|
Under ASC 230-10-45-25, an entity is allowed to
use the direct or indirect method. Under both
methods, net income must be reconciled to net cash
flows from operating activities.
|
Under paragraph 18 of IAS 7, an entity is
allowed to use the direct or indirect method. Net
income must be reconciled to net cash flows from
operating activities only under the indirect
method.
|
Presentation of bank overdrafts
|
Bank overdrafts cannot be presented in cash and
cash equivalents.
|
Bank overdrafts may be included as components
of cash and cash equivalents in certain situations
if they are an “integral part of an entity’s cash
management,” even though such overdrafts are not
presented in cash and cash equivalents on the
balance sheet unless the offsetting criteria in
IAS 32 are met. An entity that classifies bank
overdrafts as cash and cash equivalents in the
statement of cash flows will need to disclose this
policy.
|
Presentation of restricted cash | Amounts generally described as restricted cash or restricted cash equivalents must be included in an entity’s beginning and ending balances of cash and cash equivalents as presented in the statement of cash flows regardless of whether they are included in cash and cash equivalents on the balance sheet. | There is no specific guidance on whether amounts generally described as
restricted cash or restricted cash equivalents
should be included in an entity’s beginning and
ending balances of cash and cash equivalents as
presented in the statement of cash flows. However,
amounts generally described as restricted cash or
restricted cash equivalents are not included in
these balances in the statement of cash flows
unless an entity classifies these amounts as cash
and cash equivalents on its balance sheet. |
Classification in the statement of cash flows | ASC 230-10-45-10 requires that cash flows be classified and presented in one of
three categories: operating, investing, or financing. ASC
230 provides more specific guidance than IFRS Accounting
Standards on items to be included in each category. | Paragraph 10 of IAS 7 requires that cash flows be classified and presented in
one of three categories: operating, investing, or
financing. IAS 7 is more flexible than U.S. GAAP
regarding which items are to be included in each
category. |
Presentation of components of transactions
with characteristics of more than one category of cash
flows |
Under ASC 230-10-45-22, ASC
230-10-45-22A, and ASC 230-10-45-23, an entity first needs
to determine whether there are separately identifiable cash
flows within a specific transaction. If so, the entity
presents such cash flows on the basis of their nature in
operating, investing, and financing . In the absence of
separately identifiable cash flows, the entity would present
such cash flows collectively on the basis of the predominant
source or use of the cash flows.
| Paragraph 12 of IAS 7 requires that an entity classify individual components of
a single transaction separately as operating, investing, or
financing depending on the nature of the transaction. IFRS
Accounting Standards do not provide guidance on situations
in which individual components of a single transaction
cannot be separately identified. |
Disclosure of cash flows pertaining to
discontinued operations | An entity must disclose either of the
following if it is not already presented on the face of the
cash flows statement:
| In accordance with paragraph 33(c) of IFRS 5, an entity must disclose cash flows
from discontinued operations under each category either on
the face of the cash flow statement or in the notes. |
Presentation of cash flow per share on the
face of the financial statements | In accordance with ASC 230-10-45-3, an entity is prohibited from reporting cash flow per share. | Under IFRS Accounting Standards (including IAS 7, which does not mention this
metric), an entity is not explicitly prohibited from
disclosing cash flow per share. |
Taxes paid | Under ASC 230-10-45-25, taxes paid are
classified as operating activities. | Under paragraph 14(f) of IAS 7, taxes paid
are classified as operating activities unless they can be
specifically identified within financing and investing
activities. |
Interest and dividends paid and
received | Under ASC 230, interest paid and received should be classified as operating
activities.
Cash flows from interest paid must be disclosed
separately if the indirect method is used. Dividends received are classified as operating activities because these are
generally considered to be returns on an entity’s investment. However, a dividend from
an equity method investment may be investing if the
distribution is a return of
investment. That is, for distributions from equity method
investments, an entity is required to determine whether the
distribution is a return on or a return of the entity’s
investment. See Section
6.1.2 for specific guidance on distributions
from equity method investments. Dividends
paid are classified as financing activities. | Under IAS 7,
entities should elect accounting policies for
presenting interest and dividends paid as either
operating or financing activities. In addition,
entities should elect accounting policies for
presenting interest and dividends received as
either operating or investing activities. Cash flows from interest and
dividends received and paid must be disclosed
separately. Note that IAS 7
does not include a requirement to determine
whether a distribution from an equity method
investment is a return on, or a return of, the
entity’s investment. |
Remittances of statutory withholdings on
share-based payment awards
|
For U.S. GAAP guidance, see
Section 7.3.5.
|
Under IAS 7, an entity should assess the nature
of the transaction on the basis of the general
principles of classification of the cash flows as
operating or financing, as well as the applicable
noncash activity disclosures.
|
Leases
|
After the adoption of ASC 842, a lessee should
present payments associated with its leases in the
statement of cash flows as follows:
See Section
7.6 for more information.
|
The lessee should present payments associated
with its leases in the statement of cash flows as follows:
|
Settlement of zero-coupon debt instruments
or other debt instruments that are insignificant in relation
to the effective interest rate of the borrowing | As bonds are accreted from issuance to
maturity, the interest expense is presented as a reconciling
item between net income and cash flows from operating
activities. At redemption, the cash paid to settle the
interest component is classified as an operating activity
and the cash paid to settle the principal is classified as a
financing activity. See Sections 6.4.2 and 6.4.3. | Rather than including specific guidance as is done in U.S. GAAP, IFRS Accounting
Standards include principles related to assessing the
classification of the cash flows as operating, investing, or
financing activities. |
Contingent consideration payments made
after the date of a business combination | Contingent consideration payments that are not made soon after the acquisition
date must be classified as financing activities;
any excess cash payments (that are in excess of
the fair value of the consideration recorded after
the business combination) will be classified as
operating activities. Cash payments made soon
after the acquisition date in a business
combination transaction must be classified as
investing activities (see Section
7.5.4.1). | IFRS Accounting Standards do not provide guidance similar to that in U.S. GAAP
(under U.S. GAAP, such guidance is based on when contingent
consideration payments are made in relation to the date of a
business combination). Instead, an entity should assess the
nature of the transaction on the basis of the general
principle of classification of the cash flows as operating
or financing activities. |
Proceeds from the settlement of insurance
claims | Proceeds from the settlement of insurance
claims should generally be classified on the basis of the
nature of the loss (see Section
6.3.2). | Rather than including specific guidance as is done in U.S. GAAP, IFRS Accounting
Standards include principles related to assessing the
classification of the cash flows as operating, investing, or
financing activities. |
Proceeds from the settlement of company-owned or BOLI policies | ASC 230-10-45-21C indicates that proceeds from the settlement of company-owned
or BOLI policies should be classified as investing
activities (see Section 6.1.5). | Rather than including specific guidance as is done in U.S. GAAP, IFRS Accounting
Standards include principles related to assessing the
classification of the cash flows as operating, investing, or
financing activities. |
Beneficial interests in a securitization
transaction | For U.S. GAAP guidance, see Sections 7.9 and 7.9.1. | Rather than including specific guidance as is done in U.S. GAAP, IFRS Accounting
Standards include principles related to assessing the
classification of the cash flows as operating, investing, or
financing activities. |
Income tax effects of share-based payment
awards | Excess tax benefits or tax deficiencies
represent operating activities (see Section
7.3.2). | IFRS Accounting Standards do not include explicit guidance on classifying excess
tax benefits related to share-based payment awards. |
Comparative periods | Under ASC
230, presentation of comparative periods is not
required. However, SEC Regulation S-X, Rule
3-02, requires that an audited cash flow statement
be presented for the previous three fiscal
years. | Under
paragraph 36 of IAS 7, the most recent two years
must be presented. Under the general
requirements of paragraphs 38 and 38A of IAS 1,
comparative information related to the preceding
period should be presented for all amounts
reported in the current-period statement of cash
flows and the supporting notes. Consequently, an
entity should present, at a minimum, two
statements of cash flows. |
Cash flows from hedging instruments | A company may classify cash flows from hedging activities in the same category
as the cash flows from the hedged item provided
that the requirements in ASC 230-10-45-27 are met
(i.e., regarding the financing element at
inception and disclosure of the accounting
policy). | Paragraph 16 of IAS 7 requires entities to classify cash flows from hedging activities in the same category as the cash flows from the item being hedged. |
Appendix F — Titles of Standards and Other Literature
Appendix F — Titles of Standards and Other Literature
AICPA Literature
Accounting and Valuation Guide
Assets Acquired to Be Used in Research and Development
Activities
Audit and Accounting Guide
Brokers and Dealers in Securities
Practice Aid
Accounting for and Auditing of Digital
Assets
Technical Questions and Answers
Section 1100.08,
“Classification of Outstanding Checks”
Section 1300.15,
“Presentation of Cash Overdraft on Statement of Cash Flows”
Section 1300.16, “Purchase
of Inventory Through Direct Financing”
Section 4110.09, “Costs
Incurred to Acquire Treasury Stock”
FASB Literature
ASC Topics
ASC 205, Presentation of Financial Statements
ASC 210, Balance Sheet
ASC 230, Statement of Cash Flows
ASC 235, Notes to Financial Statements
ASC 250, Accounting Changes and Error Corrections
ASC 255, Changing Prices
ASC 305, Cash and Cash Equivalents
ASC 320, Investments —
Debt Securities
ASC 321, Investments — Equity Securities
ASC 326, Financial Instruments — Credit Losses
ASC 350, Intangibles — Goodwill and Other
ASC 360, Property, Plant, and Equipment
ASC 405, Liabilities
ASC 470, Debt
ASC 606, Revenue From Contracts With
Customers
ASC 718, Compensation — Stock Compensation
ASC 730, Research and Development
ASC 740, Income Taxes
ASC 805, Business Combinations
ASC 810, Consolidation
ASC 815, Derivatives and Hedging
ASC 820, Fair Value
Measurement
ASC 825, Financial Instruments
ASC 830, Foreign Currency Matters
ASC 835, Interest
ASC 840, Leases
ASC 842, Leases
ASC 848, Reference Rate Reform
ASC 852,
Reorganizations
ASC 860, Transfers and
Servicing
ASC 908, Airlines
ASC 940, Financial
Services — Brokers and Dealers
ASC 942, Financial Services — Depository and
Lending
ASC 946, Financial Services — Investment
Companies
ASC 948, Financial Services — Mortgage Banking
ASC 958, Not-for-Profit Entities
ASC 960, Plan Accounting — Defined Benefit Pension
Plans
ASC 985, Software
ASUs
ASU 2013-08, Financial
Services — Investment Companies (Topic 946): Amendments to the Scope,
Measurement, and Disclosure Requirements
ASU 2014-08, Presentation
of Financial Statements (Topic 205) and Property, Plant, and Equipment
(Topic 360): Reporting Discontinued Operations and Disclosures of
Disposals of Components of an Entity
ASU 2016-01, Financial
Instruments — Overall (Subtopic 825-10): Recognition and Measurement of
Financial Assets and Financial Liabilities
ASU 2016-02, Leases
(Topic 842)
ASU 2016-04, Liabilities — Extinguishments
of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain
Prepaid Stored-Value Products — a consensus of the FASB Emerging
Issues Task Force
ASU 2016-09, Compensation
— Stock Compensation (Topic 718): Improvements to Employee Share-Based
Payment Accounting
ASU 2016-15, Statement of
Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash
Payments — a consensus of the FASB Emerging Issues Task Force
ASU 2016-18, Statement of
Cash Flows (Topic 230): Restricted Cash — a consensus of the FASB
Emerging Issues Task Force
ASU 2018-07, Compensation
— Stock Compensation (Topic 718): Improvements to Nonemployee
Share-Based Payment Accounting
ASU 2018-15, Intangibles
— Goodwill and Other — Internal-Use Software (Subtopic 350-40):
Customer’s Accounting for Implementation Costs Incurred in a Cloud
Computing Arrangement That Is a Service Contract
ASU 2019-01, Leases
(Topic 842) — Codification Improvements
ASU 2020-05, Revenue From Contracts With
Customers (Topic 606) and Leases (Topic 842): Effective Dates for
Certain Entities
ASU 2022-04, Liabilities
— Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier
Finance Program Obligations
Proposed ASU
Proposed ASU 2023-ED200,
Intangibles — Goodwill and Other — Crypto Assets (Subtopic 350-60):
Accounting for and Disclosure of Crypto Assets
Federal Regulation
Internal Revenue Code
Section 4501, “Repurchase of
Corporate Stock”
IFRS Literature
IAS 1, Presentation of
Financial Statements
IAS 7, Statement of Cash
Flows
IAS 20, Accounting for Government Grants and
Disclosure of Government Assistance
IAS 32, Financial
Instruments: Presentation
IFRS 5, Non-Current Assets Held for Sale and Discontinued
Operations
SEC Literature
Final Rule Release
No. 33-9616, Money Market Reform; Amendments to Form
PF
Regulation S-X
Rule 3-02, “Consolidated Statements of
Comprehensive Income and Cash Flows”
Rule 3-10, “Financial Statements of Guarantors and Issuers
of Guaranteed Securities Registered or Being Registered”
Article 10, “Interim
Financial Statements”
-
Rule 10-01, “Interim Financial Statements”
-
Rule 10-01(a), “Condensed Statements”
-
Rule 10-01(c), “Periods to Be Covered”
-
Rule 5-02(1), “Balance Sheets; Cash and Cash
Items”
SAB Topic
No. 5.A, “Miscellaneous
Accounting; Expenses of Offering”
Superseded Literature
FASB Statements
No. 13, Accounting for Leases
No. 95, Statement of Cash Flows
No. 141(R), Business Combinations
FASB Technical Bulletin
No. 88-1, Issues Relating to Accounting for
Leases
Appendix G — Abbreviations
Appendix G — Abbreviations
Abbreviation
|
Description
|
---|---|
AICPA
|
American Institute of Certified Public
Accountants
|
APIC
|
additional paid-in capital
|
ARS
|
auction rate security
|
ASC
|
FASB Accounting Standards Codification
|
ASU
|
FASB Accounting Standards Update
|
BOLI
|
bank-owned life insurance
|
CCA
|
cloud computing arrangement
|
COLI
|
company-owned life insurance
|
CPP
|
cash purchase price
|
DPP
|
deferred purchase price
|
EA
|
emission allowance
|
EITF
|
Emerging Issues Task Force
|
ERISA
|
Employee Retirement Income Security Act of
1974
|
EUR
|
euro
|
FASB
|
Financial Accounting Standards Board
|
GAAP
|
generally accepted accounting principles
|
IAS
|
International Accounting Standard
|
IFRIC
|
IFRS Interpretations Committee
|
IFRS
|
International Financial Reporting
Standard
|
IPO
|
initial public offering
|
IPR&D
|
in-process research and development
|
LC
|
local currency
|
LLC
|
limited liability company
|
MD&A
|
Management’s Discussion and Analysis
|
MMF
|
money market fund
|
NAV
|
net asset value
|
NFP
|
not-for-profit (entity)
|
OCA
|
SEC’s Office of the Chief Accountant
|
OCI
|
other comprehensive income
|
PCAOB
|
Public Company Accounting Oversight
Board
|
PP&E
|
property, plant, and equipment
|
R&D
|
research and development
|
ROU
|
right of use
|
SAB
|
SEC Staff Accounting Bulletin
|
SEC
|
Securities and Exchange Commission
|
SFAS
|
Statement of Financial Accounting
Standards
|
SOFR
|
secured overnight financing rate
|
SPAC
|
special-purpose acquisition company
|
TDR
|
troubled debt restructuring
|
TRA
|
tax receivable agreement
|
VRDN
|
variable-rate demand note
|
USD
|
U.S. dollar
|
Appendix H — Roadmap Updates for 2023
Appendix H — Roadmap Updates for 2023
The tables below summarize the
substantive changes made in the 2023 edition of this Roadmap.
New Content
Section
|
Title
|
Description
|
---|---|---|
Supplemental Disclosure of Interest and Income Taxes
Paid
|
Added guidance on disclosures related to interest and
income taxes paid.
| |
Troubled Debt Restructurings
|
Added guidance on the presentation of
cash flows related to TDRs.
| |
Sale or Transfer of a Purchase Option by
a Lessee
|
Added guidance on the presentation of
cash flows related to the sale or transfer of a purchase
option by a lessee.
| |
Payments to Purchase the Underlying
Asset Subject to a Lease
|
Added guidance on an entity’s
presentation of cash flows related to the purchase of an
underlying asset that was subject to a lease
agreement.
| |
Tax Receivable Agreements
|
Added guidance on the presentation of
cash flows from TRAs.
| |
Digital Assets
|
Added guidance on how to present cash
flows associated with purchases and sales of crypto
assets, safeguarding requirements, and crypto asset
lending.
| |
Excise Taxes Paid
|
Added guidance on the classification of cash outflows for
payment of the excise tax under the Inflation Reduction
Act of 2022.
|
Amended Content
Section
|
Title
|
Description
|
---|---|---|
Updated to reflect considerations related to the cash
flow presentation of derivative instruments, digital
assets, and the FASB's issuance of ASU 2022-04.
| ||
Distributions From Equity Method
Investments
|
Clarified the guidance on cash flow
presentation related to distributions received from
equity method investees measured by using the fair value
option.
| |
Derivatives
|
Expanded guidance on how to determine
whether an other-than-insignificant financing element
exists in derivative instruments.
Added new subsections, examples, and a
table that lists the cash flow classification
conclusions for each type of derivative instrument.
| |
Supplier Finance Programs
|
Updated to reflect the issuance of ASU 2022-04.
|