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.65 Statement of cash flows
Publication date: 27 Jul 2018
us Investment companies ARM 9652.65
Amendments to ASC 230-10-15-4 exempted the following from providing a statement of cash flows, provided certain conditions are met:
1. | an investment company subject to the registration and regulatory requirements of the 1940 Act, or |
2. | an investment enterprise that has essentially the same characteristics as those subject to the 1940 Act, or |
3. | a common trust fund, variable annuity account, or similar fund maintained by a bank, insurance company, or other enterprise in its capacity as a trustee, administrator, or guardian for the collective investment and reinvestment of moneys. |
To qualify for the exemption, the following conditions must be met:
1. | During the period, substantially all of the entity's investments were carried at fair value and classified as Level 1 or Level 2 measurements in accordance with ASC 820; |
2. | The enterprise had little or no debt, based on average debt outstanding during the period, in relation to average total assets; |
3. | The enterprise provides a statement of changes in net assets. |
The SEC has taken no position on what should constitute little or no debt regarding condition (2), but, if a fund's debt was more than 10 percent of its total assets, a statement of cash flows is typically presented. The 10 percent threshold is based on average assets during the year, not simply the period end balances, and is not a "bright-line" test (i.e., 9.9 percent "passes" while 10.1 percent "fails"). This matter was discussed most recently at the AICPA Investment Company Expert Panel meeting on November 8, 2012.
The determination of leverage or debt can often be complex and must be evaluated by each type of liability. For example, short sales may be considered a form of debt or leverage to the extent the cash proceeds from the sale are used to finance other transactions while repayment (or the cover of the short) does not occur immediately. On the other hand, dollar roll transactions in which "To Be Announced" (TBA) pass through certificates underlie the transaction, may not be considered leverage if there is no actual delivery of cash and securities but merely paper movement of a series of short and long transactions (i.e., if the TBAs are being used as equivalents to forward or futures contracts). TIS Section 6910.25 indicates that liabilities recorded for the return of collateral from securities loans will not be considered "debt" under this criterion if the lending proceeds are not used for actual leverage. See ARM section 9652.18 for further discussion.
ASC 230-10 uses the term debt rather than senior securities. Accordingly, whether redeemable preferred stock is considered debt for purposes of criterion (c) would depend on who has the option to redeem that stock (in effect, whether the stock is a liability under ASC 480). If the holder has the option to redeem it, it should be considered debt. Preferred stock that is mandatorily redeemable after a fixed period has elapsed, such as six to seven years, should also normally be considered debt.
For those investment companies that are not exempt from including a statement of cash flows as part of their financial statements, see the Audit Guide for an example of a cash flow statement. A different format may be used because of a fund's unique circumstances or because of client preferences, provided the following key elements of this statement are followed:
1. | Two activities, Financing and Operations, are presented. Investment activities are considered part of an investment company's operations and are not separately disclosed in a third caption as suggested by ASC 230. (Amendments to ASC 230-10-45-18 through 45-21 clarified that investments in "trading" securities should be classified as an operating activity). |
2. | Cash is defined as the amount presented in the Statement of Assets and Liabilities and does not include short-term investments. |
3. | Capital share sales and repurchases are presented gross, including equalization credits and debits, as financing activities. |
4. | Dividends and distributions paid is the net cash disbursement after the reinvestment of dividends and distributions. |
5. | Investment activities, on a cash basis, are presented gross; short-term investments are included net. Net cash purchases of short-term investments may be included with cash purchases of portfolio securities. If the net cash proceeds from short-term investments exceed cash purchases, that amount may be included in cash proceeds from sale of portfolio securities |
For those investment companies with futures and options activity, it will be necessary to identify the associated cash flows as part of the portfolio purchases or sales. For such activity, separate reporting may be appropriate where amounts are material. | |
For money market funds, it would be appropriate to present the net of purchases and sales/proceeds on maturities of investments as one amount. | |
6. | Net increase or decrease in net assets from operations is the amount reported in the Statement of Operations. This presentation would not necessarily require a reconciliation of the changes in net assets from operations to the cash used for operations as (a) the major reconciling items, realized gains on investments sold and net change in unrealized appreciation or depreciation, appear in the Statement of Operations, and (b) any accrual/cash basis timing differences are normally not material. However, if non-cash income items such as the amortization of discounts or premiums are significant and not disclosed elsewhere in the financial statements, the aforementioned reconciliation should be presented. |
7. | Net change in receivables/payables related to operations may be used when the individual accrual/cash basis timing differences are not material. This presentation should be available to a majority of investment companies. |
8. | Investment companies that use (a) leverage (borrowing) including reverse repurchase agreements and "dollar rolls" and (b) securities lending or short sales should present the cash flows provided from these activities as (a) from financing and (b) from operations, respectively. |
9. | The Statement of Cash Flows would be presented for the same periods for which the Statement of Operations is presented. |
The Statement of Changes in Net Assets will continue to be presented even if the Statement of Cash Flows is presented, because it presents the changes in shareholders' equity required by generally accepted accounting principles. If presentation of a Statement of Cash Flows is required, disclosure is required of the cash amount of interest and taxes paid.
Occasionally, we receive inquiries from clients regarding whether an activity may be classified as both an operating activity and an investment activity on the statement of cash flows. We generally do not believe that such activities within the same reporting entity may be split between the two sections unless the nature of the two activities can be sufficiently distinguished from each other. In such cases where the nature of the activities are distinct and the entity classifies the activities in two separate sections of the cash flow statement, we believe that the entity should disclose in the financial statements the nature of the two different activities and explain the distinction between them.
Additionally, TIS Section 6910.26 clarified that the investment company's trading style, investment objectives stated in its offering memorandum, and portfolio turnover should be the primary determinants of net vs. gross reporting. Where the investment company's overall activities comport with trading, as discussed in ASC 230-10 and ASC 320-10, netting is permissible; otherwise, gross reporting of purchases and sales/maturities is required.
Regardless of whether net or gross reporting is appropriate based on the stated criteria, an entity should separately report its activity related to long positions from activity related to short positions; that is, changes/activity in account balances reported as assets should not be netted against changes/activity in account balances reported as liabilities. As such, proceeds and costs reported for transactions in short positions are reflected separately from proceeds and costs associated with long positions.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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