Chapter 2 — Financial Statement Accounting and Disclosure Topics

2.9 Financial Statement Classification, Including Other Comprehensive Income

The SEC staff frequently comments on registrants’ classification of items in the financial statements — namely, on whether their balance sheets, income statements, statements of cash flows, and statements of comprehensive income comply with the requirements of Regulation S-X and U.S. GAAP.

2.9.1 Balance Sheet Classification

2.9.1.1 Separate Presentation

Examples of SEC Comments

Please state separately, in your balance sheet or in a note thereto, any elements of prepaid expenses and other current assets in excess of five percent of your total current assets. Refer to Rule 5-02(8) of Regulation S-X. In addition, please separately state any elements of other current liabilities in excess of five percent of your total current liabilities. Refer to Rule 5-02(2) of Regulation S-X.
Your accrued and other current liabilities [amount] represented [A]% and [B]% of total current liabilities as of December 31, [year 2] and [year 1], respectively. Please separately disclose, either on your balance sheet or in a footnote, any item in excess of five percent of total current liabilities, or explain to us how you have complied with Rule 5-02.20 of Regulation S-X.
Please present accounts payable separately from accrued expenses. Also, tell us and disclose with quantification as of each balance sheet date any component of accrued expenses exceeding the disclosure threshold. Refer to Rules 5-02.19 and .20 of Regulation S-X.

Regulation S-X, Rule 5-02, provides that in annual filings, commercial and industrial registrants should include certain line items on the face of the balance sheet to the extent material. It also requires registrants to state separately on the face of the balance sheet or in a note to the financial statements (1) other current assets and other current liabilities in excess of 5 percent of total current assets and total current liabilities, respectively, and (2) other noncurrent assets and other noncurrent liabilities in excess of 5 percent of total assets and total liabilities, respectively. Consequently, the SEC staff may ask a registrant to confirm whether the reported balances of other current assets and other current liabilities (or other noncurrent assets and other noncurrent liabilities) include any items in excess of 5 percent of total current assets and total current liabilities (or total assets and total liabilities). If the registrant confirms that any such items are included, the SEC staff will ask the registrant to state those items individually on the face of the balance sheet or in the notes.

2.9.1.2 Restricted Cash

Examples of SEC Comments

We note you determined that the settlement and merchant reserve assets consist of restricted cash. Please disclose the nature of the restrictions applicable to the settlement and merchant reserve assets. Refer to ASC 230-10-50-7 and Rule 5-02(1) of Regulation S-X.
[Y]ou state that you held [$X] and [$Y] at [the end of fiscal year 2] and [the end of fiscal year 1], respectively, in cash on behalf of a customer which is included in other current liabilities on the Consolidated Balance Sheet. Referring to your basis in accounting literature, tell us why you believe it is appropriate to report your customer’s cash on your balance sheet. Also, tell us why you do not report this cash as restricted, in a separate balance sheet line-item.

Regulation S-X, Rule 5-02, includes a provision requiring commercial and industrial registrants to (1) separately disclose cash and cash items that are subject to restrictions on withdrawal or usage and (2) describe the provisions of those restrictions in a note to the financial statements. Consequently, the SEC staff has issued comments asking registrants to explain how they considered presenting or disclosing restricted cash in accordance with Rule 5-02.

2.9.2 Income Statement Classification

The SEC staff has frequently commented on registrants’ compliance with the technical requirements of Regulation S-X, Rule 5-03, which lists the captions and details that commercial and industrial registrants must present in their income statements.

At the 2021 AICPA Conference, Division Deputy Chief Accountant Sarah Lowe indicated that the Division staff continues to focus on income statement presentation and placement and that it considers consistency and relationships between the income statement presentation and other related disclosures in a registrant’s SEC filings (e.g., financial statement footnotes, business section, MD&A). As companies evolve, some business models may not clearly fit into the SEC’s financial statement presentation requirements in Regulation S-X, Article 5, Article 7, or Article 9. Therefore, the staff has accepted income statement presentations that represent a hybrid of Article 5 and either Article 7 or Article 9 if such presentation more appropriately fits the registrant’s facts and circumstances. For example, the staff has not objected when a registrant in the financial technology industry with material lending activity presented its financial statements by using a hybrid of Articles 5 and 9.

Ms. Lowe also noted that some registrants may present on the income statement disaggregated revenue beyond the five subcaptions included in Article 5 and that the Division staff has not objected to such disaggregation as long as the revenues presented are consistent with U.S. GAAP. Similarly, registrants may present a level of disaggregation applied to the expense line items; however, it may not always be clear whether such expenses are a part of costs associated with revenue or represent other operating costs and expenses (e.g., selling, general, and administrative expenses). If it is not clear, the staff may inquire further about the nature and classification of the costs. For example, a technology platform company may include an expense line item for “technology costs,” which include expenses related to maintaining and enhancing the company’s platform technology. If the company discusses its technology platform elsewhere (e.g., MD&A, business section) as important to the growth of the business, the staff may ask why technology costs are not classified as costs of revenue. To the extent that a registrant’s technology cost line item includes a mix of expenses, the registrant should provide quantitative disclosure of (1) the technology cost amount related to the cost of revenue and (2) the technology cost amount related to other line items.

2.9.2.1 Separate Presentation of Revenues From Products and Services

Examples of SEC Comments

We note from your disclosure . . . that in addition to manufacturing custom-engineered products and systems, you recognize revenue from contracts to provide field service inspection, installation, commissioning, modification, and repair services, as well as retrofit and retrofill components for existing systems. We also note from some of the discussion during the [fiscal-year-end] earnings call, that this service revenue was a significant contributor to your business during [the fiscal year]. Please tell us the amount of revenue related to services as compared to products for the [fiscal year]. If the amount is greater than 10% of the consolidated revenue amount, please revise future filings to separately present revenue and cost of goods sold for products and services. See requirement in Rule 5-03(b)(1) and (b)(2) of Regulation S-X.
Please provide for us the amount of revenue recognized separately from the sale of [Product 1] and [Product 2], and tell us your consideration of quantifying such revenues separately on the face of your statements of operations or in the notes to your financial statements as required by ASC 280-10-50-40. Also tell us why you have not provided a breakout of cost of revenue by products and services as required by Item 5-03(b)(1) - (2) of Regulation S-X on the face of your statements of operations. Accordingly, please consider revising your presentation and provide us with the proposed presentation you intend to include in future filings. As a related matter, please enhance your disclosures in the results of operations under the MD&A to provide additional quantitative discussion about your revenue and cost of sales on a more disaggregated basis, as well as any impact from changes in prices or volumes. Refer to Item 303(b)(2) of Regulation S-K.

The SEC staff continues to comment when registrants omit certain captions required by Regulation S-X, Rule 5-03, from the face of their income statements. The staff has asked registrants to explain their consideration of Rule 5-03 and to revise their income statement presentation accordingly. For example, the staff has commented on the distinction between product and service revenue. If product or service revenue is greater than 10 percent of total revenue, the registrant must disclose such component as a separate line item on the face of the income statement. Costs and expenses related to these revenues should be presented in the same manner.

2.9.2.2 Cost of Sales

Examples of SEC Comments

We note you have elected to exclude depreciation and amortization from cost of sales. You may elect to exclude amortization and depreciation from cost of sales by reference to SAB Topic 11.B; however, you must also remove the measures of gross profit and gross margin or label the measures as non-GAAP and conform to Item 10(e)(1)(i) of Regulation S-K. Please clearly identify gross profit and gross margin as presented . . . as non-GAAP and present GAAP gross profit and gross margin with equal or greater prominence, revise your reconciliations . . . to begin with GAAP gross profit and if you continue to adjust gross profit for more than depreciation and amortization, please distinguish its title, such as adjusted gross profit. Please revise accordingly or explain.
We note on the statements of operations, that you present a measure of gross profit (loss) (exclusive of depreciation shown separately below). Please tell us how your presentation complies with the guidance in SAB Topic 11.B. In this regard, if you do not allocate any depreciation and amortization to cost of sales, you should remove the gross profit subtotal from your statements of operations and relabel the cost of sales line item to indicate that it excludes depreciation and amortization. Your disclosures in MD&A should be similarly revised. Additionally, we note that in your Form 10-Q . . . , it is not clear where depreciation is presented in the Statements of Comprehensive Income. Please advise and revise accordingly, if applicable.
Please tell us your consideration of presenting depreciation of equipment under lease as cost of sales in your Statements of Operations. Refer to Rule 5-03.2 of Regulation S-X.

The SEC staff often asks registrants to disclose the types of expenses that are included in or excluded from the cost-of-sales line item and to support their determination of the types of costs included in costs of goods sold in accordance with Regulation S-X, Rule 5-03(b)(2).

As a related matter, the SEC staff has also asked registrants to support their consideration of SAB Topic 11.B when they elect not to allocate depreciation and amortization to cost of sales. SAB Topic 11.B states, in part:

If cost of sales or operating expenses exclude charges for depreciation, depletion and amortization of property, plant and equipment, the description of the line item should read somewhat as follows: “Cost of goods sold (exclusive of items shown separately below)” or “Cost of goods sold (exclusive of depreciation shown separately below).” [D]epreciation, depletion and amortization should not be positioned in the income statement in a manner which results in reporting a figure for income before depreciation.

Under Rule 5-03, a subtotal line item for gross margin (or a similar measure, such as gross profit) is not required on the face of the income statement. However, if a registrant presents a subtotal for the measure, it should not exclude depreciation and amortization since such exclusion would result in the presentation of a “figure for income before depreciation.” Often, a registrant will not present a gross margin subtotal on the face of the income statement but will discuss such a measure in MD&A. In those circumstances, if the gross profit measure does not represent a “fully burdened” gross profit, inclusive of relevant depreciation and amortization, the SEC staff will ask registrants to disclose that the measures are non-GAAP financial measures and to consider the disclosure requirements in Regulation S-K, Item 10(e). Further, reporting cost of sales that excludes expenses, such as depreciation and amortization or stock compensation expense that is related to the revenue-producing activity, is not permitted in the financial statements since this would be reporting a non-GAAP financial measure.

For additional discussion of non-GAAP measures, see Section 3.4.

2.9.2.3 Presentation of Operating Expenses

Examples of SEC Comments

Please explain how your presentation of operating expenses complies with Rule 5-03 of Regulation S-X. In this regard, tell us what consideration was given to separately presenting costs and expenses applicable to revenues and explain why expenses related to employee compensation and benefits, or portions thereof, are not included within selling, general administrative expenses.
Please tell us what consideration you gave to disclosing the type of costs and expenses classified as cost of sales and selling, general and administrative expenses.
In regard to share-based compensation, please explain to us how excluding employee costs from cost of revenues, technology and development, and sales, general and administrative expenses complies with generally accepted accounting principles and Rule 5-03(b) of Regulation S-X.

Among the requirements of Regulation S-X, Rule 5-03, is separate presentation of certain material (1) other operating costs and expenses; (2) selling, general, and administrative expense; and (3) other general expenses. In comments to registrants, the SEC staff may challenge registrants’ disclosure of the classification of costs in the income statement. In certain instances, the staff has asked registrants to consider disaggregating the components of such line items on the face of the income statement or in the notes to the financial statements as well as disclosing the type of costs and expenses classified in either cost of sales or selling, general, and administrative expense.

2.9.2.4 Operating Versus Nonoperating Income

Examples of SEC Comments

We note your line item for transaction and integration costs appears to be classified as a non-operating expense and that $[X] million of such costs in [the prior fiscal year], $[Y] million of such costs in [the prior fiscal year], and $[Z] million of such costs for the [first nine months of the current fiscal year] relate to [your business acquisition] and integration related costs. In light of the [business acquisition] taking place in [a previous fiscal year], please clarify for us the nature of such expenses and tell us what consideration you gave to classifying these expenses as operating expenses. Please refer to Rule 5-03 of Regulation S-X.
Please revise to present “Loss on impairment of assets” as an operating expense in your calculation of “Operating loss.”
Income (loss) from operations before income taxes includes various non-operating income and expenses discussed in paragraphs 7 through 9 of Rule 5-03 of Regulation S-X. Accordingly, please retitle this line item here and in your other filings to better reflect what it actually represents.

The SEC staff has commented on items that registrants have included in, or excluded from, operating income. Under Regulation S-X, Rule 5-03, a subtotal line item for operating income is not required on the face of the income statement. However, if a registrant presents a subtotal for operating income, it should generally present the following items (which are sometimes incorrectly excluded) in operating income:

Gains or losses on the sale of long-lived assets (e.g., property, plant, and equipment that do not qualify as discontinued operations).
Litigation settlements.
Insurance proceeds.
Restructuring charges.

The following items should generally be excluded from operating income (but are sometimes incorrectly included):

Dividends.
Interest on securities.
Profits on securities (net of losses).
Interest and amortization of debt discount and expense.
Earnings from equity method investments (or unconsolidated affiliates).4
Noncontrolling interest in income of consolidated subsidiaries.

Changing Lanes

On July 31, 2023, the FASB issued a proposed ASU that would enhance interim and annual disclosures related to disaggregation of income statement expenses for public business entities (PBEs) by requiring those entities to further disaggregate certain expenses in the footnotes to their financial statements. However, the face of the income statement would not be expected to change. The objective of the proposed ASU is to “address requests from investors for more detailed information about the types of expenses (including employee compensation, depreciation, and amortization) in commonly presented expense captions (such as cost of sales, SG&A, and research and development).” Comments on the proposed ASU were due by October 30, 2023. For more information, see Deloitte’s August 8, 2023, Heads Up.

2.9.3 Cash Flow Statement Classification

2.9.3.1 Gross Versus Net Classification

Examples of SEC Comments

Please breakout the line items under the changes in operating assets and liabilities, net section of your cash flows from operating activities into smaller components. For example, changes in inventories should be presented separately from other assets. Refer to ASC 230-10-45-29.
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.

2.9.3.2 Category Classification

Examples of SEC Comments

Please explain the nature of your customer acquisition costs and residual commission buyouts within investing activities and explain to us how your classification within investing activities complies with ASC 230-10-45-13.
Tell us how you account for the gain on the sale of [business] customer assets in your consolidated statement of cash flows. Refer us to your basis in the accounting literature.
Please tell us why you classify capitalized cloud computing implementation costs as operating cash flows referencing authoritative literature that supports the classification.
We note in [your disclosures] that $[X] million of the [year 1] Notes were exchanged for $[Y] million of the [year 2] Notes. Please tell us why you report cash proceeds and cash payments from what appears to be a non-cash transaction, within financing activities in your statements 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. 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 when the cash inflows resulting from a transaction have been presented in the statement of cash flows in a manner inconsistent with the underlying balance sheet classification.

2.9.3.3 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 the classification of payments in 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).

In September 2022, the FASB issued ASU 2022-04 to enhance transparency about an entity’s use of supplier finance programs. The ASU does not change the presentation or classification of these programs. However, it requires the buyer in a supplier finance program 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. For more information, see Deloitte’s September 30, 2022, Heads Up.

2.9.4 Comprehensive Income — Disclosure

Examples of SEC Comments

Please present the amount of income tax expense or benefit allocated to each component of other comprehensive income, including reclassification adjustments. Refer to ASC 220-10-45-12.
We note your convertible redeemable preferred shares of [Investment X] were redeemed during [the fiscal year]. Please clarify for us if you had any unrealized gains or losses that were recorded in accumulated other comprehensive income prior to the redemption. To the extent you had unrealized gains or losses, please tell us how you determined it was not necessary to reflect a reclassification of these unrealized gains or losses in the amounts reclassified from accumulated other comprehensive income column in your table . . . . Please refer to ASC 220-10.

The SEC staff has commented when registrants have not provided information required by ASC 220 about the amounts reclassified out of accumulated OCI. For example, the staff frequently reminds registrants to comply with the requirement in ASC 220-10-45-12 to “present the amount of income tax expense or benefit allocated to each component of other comprehensive income, including reclassification adjustments,” for each reporting period either on the face of the statement where those items are presented or in the footnotes. Similarly, the staff reminds registrants to reclassify unrealized gains or losses from accumulated OCI to realized gains or losses in comprehensive income when an event that would trigger a reclassification adjustment occurs.

Other Deloitte Resources

Roadmap, Statement of Cash Flows

Footnotes

While it is rare for an entity to classify equity in earnings of an equity method investee as a component of operating income, the SEC staff may not object to such classification if the equity method investee’s operations are “integral” to the investor’s business. In this context, the staff’s definition of “integral” indicates more than that the investor and investee operate in the same line of business (see the highlights of the March 2003 AICPA SEC Regulations Committee joint meeting with the SEC staff).