Armanino Blog

Start Spring Cleaning with Your Statement of Cash Flows

by Matthew Perreault
March 21, 2016

On January 29, the Financial Accounting Standards Board (FASB) released a proposal to clarify eight parts of its guidance on cash flow statements. The proposal aims to clear up some of the most frequently asked questions about this complex area of accounting.

Diversity in practice
Cash flow statement reporting is a leading cause of company financial restatements. Proposed Accounting Standards Update No. EITF-15F, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a Consensus of the FASB Emerging Issues Task Force), attempts to solve some narrow-scope issues related to FASB Accounting Standards Codification Topic 230, Statement of Cash Flows.

Topic 230 provides guidance on classifying and presenting cash receipts and payments as operating, investing or financing activities. Critics say the guidance is confusing and even contradictory at times.

The FASB began its work on the statement of cash flows in April 2014. Originally, the board planned to come up with a broad principle for classifying the items in the statement. A year later, the focus shifted to a narrow list of specific problems, which it passed on to the Emerging Issues Task Force (EITF).

The assignment was considered unusual because the EITF typically handles questions that can be resolved in one or two meetings. But the cash flow project was a much larger undertaking. In November, the project was split into two parts:

  • Phase 1: Eight narrow clarification issues, and
  • Phase 2: Restricted cash classification and presentation.

The EITF is expected to start discussing the second phase later this year.

Details of the proposal
In the first phase, the EITF recommended that the FASB propose the following changes, which, if approved, would apply to both public and private businesses:

  1. Debt prepayment and debt extinguishment costs (penalties paid by borrowers to settle debts early) should be classified as cash outflows for financing activities.
  2. Cash payments attributable to accreted interest on zero-coupon bonds (a type of debt security that is issued or traded at significant discounts) should be classified as a cash outflow for operating activities. The portion of cash payments attributable to principal should be classified as a cash outflow for financing activities.
  3. Cash payments for the settlement of a contingent consideration liability made by a business after it buys another business should be separated from the purchase price and classified as cash outflows for either financing activities or operating activities. (Contingent consideration is typically an obligation to transfer additional assets or equity interests to the former owners of the acquired businesses if certain conditions are met.) Cash payments up to the amount of the contingent consideration liability recognized at the acquisition date would be classified as financing activities. Any excess would be classified as operating activities.
  4. The proceeds from the settlement of insurance claims should be classified based on the type of insurance coverage and the type of loss. For example, a claim to cover destruction of a building would be classified in investing activities, while a claim to cover loss of inventory would be classified in operating activities.
  5. Proceeds businesses receive from corporate-owned life insurance (the insurance policies they take out on employees) should be classified in investing activities.
  6. Distributions received from equity method investees should be presumed to be returns on the investment and classified as cash inflows from operating activities, unless the investor’s cumulative distributions received (less distributions received in prior periods that were determined to be returns of investment) exceed cumulative equity in earnings recognized by the investor. When such an excess occurs, the current-period distribution up to this excess would be classified as cash inflows from investing activities. No solution was provided for equity method investment measured using the fair value option, however.
  7. For beneficial interests in securitization transactions, the updated guidance proposes two changes: One would require disclosure of a transferor’s beneficial interest obtained in a securitization of financial assets as a noncash activity. The other calls for classifying the cash receipts from payments on the transferor’s beneficial interests in securitized trade receivables as cash inflows from investing activities. These types of transactions are common for financial companies, large retailers and credit card companies.
  8. Finally, the proposal addresses one of the most complicated parts of cash flow presentation, a concept accountants call the “predominance principle.” Topic 230 acknowledges that it’s not always clear how cash flows should be classified, especially when cash receipts and payments have characteristics of more than one type of activity. The proposal says the business should look at the activity that is likely to be the “predominant” source of cash flows for the item.

A work in progress
The proposal also calls for adding more guidance in the standard about how an organization should separate cash receipts and cash payments and when they should be separated into more than one cash flow stream. And it’s asking whether it’s practical for companies to apply the guidance retrospectively to all prior periods — or whether the guidance should be applied only prospectively. In order to most effectively address these open issues, the FASB is soliciting comments from auditors, investors and businesses by March 29.

New-and-improved lease rules are hot off the presses
On February 25, the Financial Accounting Standards Board (FASB) published its long-awaited standard on lease accounting. Accounting Standards Update No. 2016-02, Leases (Topic 842), concludes a project that has taken more than a decade to complete. It comes about six weeks after the International Accounting Standards Board issued its updated standard on lease accounting.

The new guidance on reporting leases under U.S. Generally Accepted Accounting Principles has been the subject of intense public scrutiny. It’s received significant opposition from businesses that expect to add many billions of dollars in assets and liabilities to their balance sheets once the lease accounting standard becomes effective.

In fact, the U.S. Chamber of Commerce and other business groups recently requested that the FASB give private companies an exemption from the standard’s requirements because of the costs they would bear and the operational difficulties they would face implementing the changes. The updated guidance, however, provides no such exception for private companies.

On the bright side, for public companies, the new standard goes into effect for annual periods that begin after December 15, 2018. In other words, compliance would start in 2019 for calendar-year public entities. Private companies would have an extra year to comply.

March 21, 2016

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