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6.7 Classification of cash flows
Publication date: 29 Nov 2020
us Financial statement presentation guide 6.7
ASC 230 identifies three classes of cash flows—investing, financing, and operating—and requires a reporting entity to classify each discrete cash receipt and cash payment (or identifiable sources or uses therein) in one of these three classes. The classification is based on the nature of the cash flow, without regard to whether a cash flow stems from another item (hereafter referred to as the Nature Principle). A cash flow is first evaluated to determine if it meets either the definition of an investing or financing cash flow. If a cash flow does not meet the definition of an investing activity or a financing activity, the cash flow is classified as an operating activity. Cash flows from operating activities are generally the cash effects of events that enter into the determination of net income (see FSP 6.7.3 for a discussion of events that enter into the determination of net income that are not classified as operating cash flows).
The definitions of the activity classes within ASC 230, combined with its waterfall model, results in a bias toward classifying cash flows as operating activities. When determining the appropriate classification, the FASB acknowledged that, in some situations, a reasonable case can be made for alternative classifications. As a result, we believe that a change in classification of a cash flow item represents a reclassification of information and not a change in accounting principle, if both the old and new classifications are acceptable under US GAAP. In such circumstances, all years presented must reflect the reclassification, and the reclassification should be disclosed in the footnotes.
6.7.1 Investing activities
Investing activities include making and collecting loans, purchasing and selling debt or equity instruments of other reporting entities, and acquiring and disposing of property, plant, and equipment and other productive assets used in the production of goods or services.
As discussed in ASC 230-10-45-12, the following items should be classified as investing activities:
- Cash flows from purchases and sales of property, plant, and equipment and other productive assets, including business combinations (see FSP 6.9.15 for further discussion) and successful sale-leaseback transactions. Note that even though the gain or loss associated with a disposition could theoretically represent a separately identifiable source or use of cash, ASC 230-10-45-12(c) precludes such bifurcation.
- Insurance proceeds directly attributable to casualty losses related to productive assets (see FSP 6.9.22 for further discussion)
- Gross cash receipts or cash payments resulting from the acquisition or sale of debt securities (classified as available-for-sale or held-to-maturity) or equity securities of other reporting entities. However, interest income or dividend income received in cash on such investment securities is an operating cash inflow. Investments accounted for as trading securities under ASC 320-10, when there is a stated intent to buy and sell securities with the objective of generating trading profits, should be classified as operating activities rather than investing activities.
- Distributions received from equity method investees that are deemed a return of investment (see FSP 6.9.4 for further discussion)
- The impact on cash and cash equivalents of either consolidating or deconsolidating a variable interest entity
- Cash outflows and inflows associated with reverse repurchase agreements
- Cash flows resulting from acquisitions and sales of loans originally classified as loans held for long-term investment should be investing activities. Cash flows should continue to be classified as cash flows from investing activities, even if the reporting entity subsequently reclassifies the loans as held for sale
- Proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies (see FSP 6.9.23 for further discussion)
- Cash collected subsequent to sales of financial assets from the seller/transferor's interest in sold trade receivables, commonly referred to as a holdback or deferred purchase price (see FSP 6.9.14 for further discussion)
6.7.2 Financing activities
Financing activities include borrowing money and repaying or settling the obligation, and obtaining equity from owners and providing owners with a return on, or return of, their investment.
As discussed in ASC 230-10-45-14 to ASC 230-10-45-15, the following items should be classified as financing activities:
- Payments for debt issue costs (i.e., third party costs)
- Payments for debt prepayment or debt extinguishment costs (see FSP 6.9.9 for further discussion)
- Proceeds from failed sale-leaseback transactions
- Proceeds received from issuing debt
- Payments on seller-financed debt related to the purchase of property, plant, and equipment and other productive assets. The incurrence of that debt is a noncash financing transaction.
- Stock issuance proceeds, net of stock issuance costs
- Cash dividends and purchases of treasury stock
- Cash activity related to stock subscriptions receivable
- If a reporting entity has a "bank overdraft" at year end, the change in bank overdrafts during the period (see FSP 6.5.1.1 for further discussion)
- Cash proceeds received as collateral under a securities lending program and subsequent repayment of the cash, because the cash received is considered a borrowing
- Cash inflows and outflows associated with repurchase agreements, including transactions accounted for as a securitized borrowing. Net presentation for these cash flows may be permitted
6.7.3 Operating activities
Cash flows that are not investing or financing activities are operating cash flows. Typically, operating cash flows are receipts and payments that enter into the determination of net income.
As discussed in ASC 230-10-45-16 to ASC 230-10-45-17, common examples of operating cash flows are:
- Receipts from customers for sales of goods and/or services, as well as receipts from short-term and long-term receivables under normal trade terms that arose from sales of goods and/or services
- Interest and dividend receipts related to investments in other reporting entities or deposits with financial institutions (i.e., returns on investment). Interest income is considered received when the bank posts the entry to a reporting entity’s account.
- Payments to vendors for inventory or services (including cash expenditures for advertising). Similarly, payments on short-term or long-term credit extended by the supplier or its affiliate finance subsidiary for the purchase of inventory or other goods and services would also qualify as operating. In contrast, payments on credit extended by an entity other than the supplier or its affiliate finance subsidiary are normally a financing activity (see FSP 6.9.12 for further details on this scenario).
- Payments to creditors for interest
- Insurance proceeds related to operating activities (e.g., inventory losses or business interruption). See FSP 6.9.22 for further details.
- Cash receipts or cash payments resulting from the acquisition or sale of debt or equity securities of other reporting entities classified as trading securities pursuant to ASC 320-10 that are part of an investment strategy to actively buy and sell securities with the objective of generating profits on short-term differences in market prices
- Payments of all income taxes
- Payments made to settle an asset retirement obligation
- Cash receipts and cash payments resulting from acquisitions and sales of loans originally classified as loans held for sale. Cash flows should continue to be classified as operating activities, even if the reporting entity subsequently reclassifies the loans to be held for long-term investment.
- Restructuring payments, including severance
- Cash contributions made to employee benefit plans
ASC 230 defines operating activities.
Excerpt from ASC 230-10-20
Cash flows from operating are generally the cash effects of transactions and other events that enter into the determination of net income.
Figure FSP 6-2 includes common transactions that enter into the determination of net income, but are not classified as operating cash flows.
Figure FSP 6-2
Common transactions that enter into the determination of net income, but are not classified as operating cash flows
Common transactions that enter into the determination of net income, but are not classified as operating cash flows
Description
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FSP section
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Foreign currency transactions
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Gains and losses on the disposal of property, plant, and equipment, and other productive assets
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Gains and losses on the sales of debt and equity investments
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Derivative transactions
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Debt extinguishment costs
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Discounts on debt instruments with coupon interest rates that are significant in relation to the effective interest rate of the debt
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Specified portions of contingent consideration settlements made soon after the acquisition
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