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6.8.1 Cash flows with aspects of more than one class

Certain cash receipts and payments may have aspects of more than one class of cash flow. ASC 230 recognizes that the most appropriate classification of an item may not always be clear. ASC 230 provides the following guidance for classifying cash flows that have aspects of more than one class of cash flows:
  • Apply specific US GAAP addressing the statement of cash flow classification (if any)

    A reporting entity should first apply specific guidance in US GAAP addressing statement of cash flow classification to classify a discrete cash flow. For example, specific guidance in ASC 230-10-45-21C requires settlements of corporate owned life insurance to be reflected entirely as investing cash flows. In addition, there is specific guidance in ASC 230-10-45-15(b) that states that the payment for settlement of a zero coupon bond should be bifurcated between financing and operating cash flows. Therefore, the cash flow classification of these items would follow this guidance.
  • Bifurcate

    Bifurcate discrete cash flows into separately identifiable sources or uses on the basis of the nature of the underlying cash flows, and then classify each separately identifiable source or use as either investing, financing, or operating. Judgment may be necessary to determine how and when cash flows should be bifurcated, as well as to estimate the amount of each separately identifiable source or use. In making these determinations, a reporting entity should look to the application of other US GAAP. For example, when a reporting entity makes a quarterly payment on amortizing debt, it uses ASC 835, Interest, to determine the portion of the payment that relates to interest expense (which enters into the determination of net income) and the portion related to principal. For purposes of the statement of cash flows, the different natures of these separately identifiable uses cause the interest expense portion to be classified as operating and the principal portion to be classified as financing. We generally believe the application of other US GAAP will be indicative of when and how cash flows should be bifurcated. See Example FSP 6-3 for an illustration of the bifurcation of a single cash flow.

  • Predominant activity

    When a discrete cash flow has aspects of more than one class of cash flows, but it cannot be further bifurcated (see Example FSP 6-4), the appropriate classification should depend on the nature of the expected predominant activity.


Example FSP 6-3 illustrates the cash flow presentation of payments for equipment when it is uncertain if they will be either sold or rented.
EXAMPLE FSP 6-3
Classification of equipment purchases when the equipment is either sold or rented to customers
FSP Corp recently developed a new patented process to detect certain chemicals in waste water. Starting nine months ago, FSP Corp began marketing their product to municipalities and corporate entities that manage waste water. FSP Corp charges a fee each time its patented process is used to analyze a sample. Its commercial process is dependent on a proprietary sampling device, installed at the customer’s location, which collects samples that are then sent to FSP Corp for analysis. FSP Corp sells or rents (under an operating lease) the sampling device at cost, as the economics of their business is based solely on the fee charged to analyze a sample. Said differently, FSP Corp is indifferent between selling and renting sampling devices, and will therefore accommodate a customer’s individual preference.
Since inception, of the 1,000 sampling devices acquired by municipalities, 500 have been rented and 500 have been sold. Of the 500 sampling devices acquired by corporate customers, 100 have been rented and 400 have been sold. In total, 40% of the devices have been rented and 60% have been sold. FSP Corp expects future sales/rentals to be consistent with their recent history. The sampling devices are manufactured and assembled for FSP Corp by a third party, which delivers new sampling devices once a month. FSP Corp usually keeps a three-month supply of sampling devices on hand.
What is the appropriate classification in the statement of cash flows for the purchase of 100 sampling devices from the third-party manufacturer?
Analysis
Based on the inception-to-date statistics for all customers and the fact that FSP Corp expects future sales/rentals to be consistent with their recent history, the cost of 40% of the devices should be classified as investing (representing the devices that will be carried as long-lived assets and rented to customers) and the cost of 60% of the devices should be classified as operating (representing the devices carried as inventory that will be sold to customers).
By analogy to ASC 230-10-45-12(e), if a sampling device that was originally considered a long-lived asset is instead sold to a customer (i.e., the transaction did not follow original expectations), the sales proceeds should be classified in the same manner as the original purchase, as an investing inflow. Correspondingly, if a sampling device that was originally considered inventory is transferred to long-lived assets and rented to customers, any salvage proceeds received at the end of the device’s productive life should be classified as operating, as an operating outflow was recorded upon the purchase of the item. These subsequent balance sheet reclassifications of carrying amounts between inventory and long-lived assets are noncash activities. As a result, it would be inappropriate to adjust the cash flow classification as a result of the balance sheet reclassifications. Going forward, FSP Corp should continue to analyze how sampling devices are deployed, and modify the allocations between operating and investing, as appropriate.

Example FSP 6-4 illustrates the predominance principle.
EXAMPLE FSP 6-4
Classification of equipment purchases when the equipment is rented and later sold
FSP Corp operates a chain of rent-to-own facilities offering household appliances. It purchases new appliances, rents the appliances to third parties for a period of time, and subsequently sells the used appliances.
What is the appropriate classification in the statement of cash flows for the purchase of the appliances?
Analysis
Cash flows associated with purchasing an appliance to be used to rent to customers would be classified as investing. Cash flows associated with purchasing an appliance to sell to customers would be classified as operating. Since FSP Corp plans to both rent and sell each appliance, the cash flow to purchase the appliance has aspects of both operating and investing activities. Accordingly, FSP Corp would need to determine the nature of the activity that is likely to be the predominant source of cash flows in order to determine how the cash flow for the purchase of the appliances should be classified.
For example, assume FSP Corp expects to rent the new appliances for only a short period of time before selling them. In this fact pattern, the amount of cash flows that it expects to receive from rental income is relatively small compared to the proceeds that it expects to receive from the sale of the appliances. In such circumstances, the appliances would appear to have the nature of an inventory item, and accordingly the cash flows related to the purchase and sale of the appliances should be classified as operating activities.
If, however, FSP Corp expects to rent the new appliances for a longer period of time before selling them, and the amount of cash flows that it expects to receive from rental income as compared to the proceeds received from the sale of the appliances is relatively large, then the appliances have the nature of a long-lived asset. In this case, the cash flows related to the purchase and sale of the appliances should be classified as investing activities.

Application of this predominance principle could have applicability to a wide range of fact patterns. For example, upon disposition of a business, a reporting entity may have historically classified the net proceeds (i.e., gross proceeds, net of transaction costs paid at closing) as an investing inflow. Given that there is no specific guidance related to the classification of transaction costs, application of ASC 230 seems to suggest that the gross proceeds should be classified as an investing inflow, while the transaction costs should be classified as an operating outflow. Accordingly, reporting entities should thoughtfully consider how this aspect of ASC 230 impacts their statement of cash flows.

6.8.2 Subsidiary cash flows when part of centralized treasury function

Many large entities use centralized treasury functions in which subsidiaries’ excess cash balances are swept into a cash pool. When the centralized account is under the parent’s name, it demonstrates that the parent has legal title to the funds. In addition, subsidiaries may need to notify or obtain permission from the parent when accessing the funds in the cash pool. This kind of arrangement results in due to/from parent in each subsidiary’s standalone financial statements. In such circumstances, the intercompany net due to/from parent is, in substance, the subsidiary’s cash account. As a result, changes in the due to/from parent account should be reflected as actual cash flows in the subsidiary’s standalone statement of cash flows.
  • If a subsidiary’s balance sheet shows a net due-from-parent, an appropriate classification in the subsidiary’s statement of cash flows would be investing, as this balance is akin to making a loan, as contemplated by ASC 230-10-45-12(a) and ASC 230-10-45-13(a).
  • If a subsidiary’s balance sheet reflects a net due-to-parent, the appropriate classification in the subsidiary’s statement of cash flows would be financing, as this balance is similar to issuing debt.
  • Alternatively, both a parent and its subsidiaries could classify the cash flow activity associated with due-from-parent and due-to-parent accounts as financing activities based on the consolidating statement of cash flows example included in ASC 830-230-55-2.

For a subsidiary to classify funds in the cash pool as cash and cash equivalents in its standalone financial statements, the subsidiary needs to have control over the funds through legal title and autonomy to access the funds.

6.8.3 Distributions from equity method investees

ASC 230 indicates that cash flows that represent a “return on investment” are operating and those representing a “return of investment” are investing, and ASC 230-10-45-21D requires that a reporting entity elect an accounting policy to classify distributions received from equity method investees using either the cumulative earnings approach or the nature of distributions approach. This election must be made on an entity-wide basis for all equity method investments. However, as explained below, certain facts and circumstances may require a reporting entity to utilize both methods for different investments.
As discussed in paragraph BC30 of the Basis for Conclusions of ASU 2016-15, Statement of Cash Flow Classification of Certain Cash Receipts and Cash Payments, neither method is appropriate for an equity method investment measured using the fair value option, but further guidance is not provided. By analogy to the inherent nature of a derivative (see FSP 6.8.5), we believe that all distributions received from an equity method investment measured using the fair value option should be classified as investing.
The methodologies to determine if a distribution, or a portion of a distribution, from an equity investee is a return on investment or a return of investment are as follows.
  • Cumulative earnings approach

    The cumulative earnings approach is predicated on the rebuttable presumption that distributions received from equity method investees represent “returns on investment,” which ASC 230 indicates are operating, and differentiates between returns on investment and returns of investment by comparing cumulative distributions received by a reporting entity, less distributions received in prior periods that were deemed returns of investment, to its cumulative share of equity earnings (as adjusted for basis differences). When cumulative distributions less distributions received in prior periods that were deemed returns of investment are in excess of cumulative equity earnings, such excess should be considered a return of investment and classified as investing cash flows.
  • Nature of the distribution approach

    Under the nature of distribution approach, distributions received are classified as either a return on investment or a return of investment on the basis of the nature of the activity or activities of the investee that generated the distribution, when such information is available.

If a reporting entity that elected to apply the nature of the distribution approach is no longer able to obtain the information needed to apply that approach to distributions received from an individual equity method investee, the reporting entity should report a change in accounting principle on a retrospective basis by applying the cumulative earnings approach for that investee. In such situations, an entity should disclose that a change in accounting principle has occurred with respect to the affected investees due to the lack of available information.
Because the nature of distribution approach does not include a presumption that distributions are returns on investment, investors will need to understand the facts and circumstances for each distribution to determine the proper classification. This will require the investor to obtain information about the nature of distributions received from investees, but ASC 230 contains no description of the information needed to make such an assessment. What constitutes sufficient information to apply the nature of distribution approach is a matter of judgment. The process used by investors to determine classification should be systematic, rational, and applied consistently from period to period.
Example FSP 6-5 and Example FSP 6-6 demonstrate the determination of a return of investment versus return on investment using the cumulative earnings approach.
EXAMPLE FSP 6-5
Return of investment versus return on investment under the cumulative earnings approach
FSP Corp is a calendar year-end SEC registrant with a 20% equity investment in a joint venture, EM Company. The initial cash investment by FSP Corp on January 1, 20X1 for the 20% interest is $25,000. The investment is accounted for as an equity method investment, and there is no basis difference between FSP Corp’s equity investment and the underlying equity of EM Company.
FSP Corp’s share of EM Company’s income/loss) and the related share of dividend distributions for the last four years are as follows:
Share of net income/(loss)
Share of dividend distributions
12/31/20X1
$(2,000)
$1,000
12/31/20X2
$(1,000)
$1,000
12/31/20X3
$5,000
$3,000
12/31/20X4
$6,000
$3,000
How should the distributions be classified in the statement of cash flows for each of these periods?
Analysis
If the investor’s inception-to-date distributions are greater than the investor’s inception-to-date earnings, the presumption is that the equity method investee utilized a portion of the funds initially invested to pay all, or a portion of, the cash distributions. As noted above, FSP Corp received distributions of $1,000 for the years ended December 31, 20X1 and December 31, 20X2 when EM Company incurred net losses. As such, FSP Corp would conclude that EM Company paid the distributions from its capital balance, which would be considered a return of investment and classified as an investing inflow within FSP Corp’s statement of cash flows.
For the year ended December 31, 20X3, the distribution received by FSP Corp would be allocated between return on investment and return of investment because, even though FSP’s Corp inception-to-date distribution exceeded its inception-to-date earnings, for the first time FSP Corp’s inception-to-date earnings were positive and therefore eligible to be considered as a portion of the 20X3 distributions. For the year ended December 31, 20X4, FSP Corp’s inception-to-date earnings exceeded the inception-to-date distributions adjusted for prior period distributions that were previously deemed returns of investment, and therefore the entire 20X4 distribution would be considered a return on investment and classified as an operating activity within FSP Corp’s statement of cash flows.
EM Company’s historical retained earnings balance prior to FSP Corp’s investment of $25,000 is not relevant for purposes of determining the classification of the distribution in FSP Corp’s statement of cash flows. FSP Corp should only consider EM Company’s earnings for purposes of the cumulative earnings approach beginning when FSP Corp made its investment in EM Company.
The following table summarizes the impact to FSP Corp:
End of period
FSP Corp’s 20% share
of EM Company’s
annual net
income/(loss)
FSP Corp’s share of
EM Company’s
cumulative earnings
since investment
inception
FSP Corp’s 20%
share of
dividend
distribution
Statement of cash flows
classification
Operating
Investing
12/31/20X1
$(2,000)
$(2,000)
$1,000
$1,000
12/31/20X2
$(1,000)
$(3,000)
$1,000
$1,000
12/31/20X3
$ 5,000
$ 2,000
$3,000
$2,000
$1,000
12/31/20X4
$ 6,000
$ 8,000
$3,000
$3,000
EXAMPLE FSP 6-6
Return of investment versus return on investment during interim periods under the cumulative earnings approach
FSP Corp receives a dividend from its equity method investee during an interim period. Based upon an analysis of inception-to-date distributions compared to inception-to-date earnings, it would appear the dividend received in the interim period should be considered a return of investment and classified as an investing inflow by the reporting entity. However, when forecasted earnings for the entire fiscal year are considered, inception-to-date earnings are expected to be greater than inception-to-date distributions. Thus, the dividend exceeds the investee’s current quarterly earnings (and the inception-to-date earnings) but does not exceed forecasted annual earnings.
How should the reporting entity classify the cash dividend received in its interim period statement of cash flows?
Analysis
We believe that it is acceptable for a reporting entity to consider the investee’s forecasted annual earnings in classifying dividends as either a return on or return of investment under the cumulative earnings approach. We also believe it is acceptable to analyze dividends received on a quarter-by-quarter basis without consideration of the investee’s forecasted earnings. The approach followed should be disclosed and consistently applied in all periods for similar investments.

6.8.4 Contributions and advances to joint ventures

Initial and subsequent cash contributions by a reporting entity to a joint venture meet the ASC 230 definition of investing activities and should be reflected as such in the investor’s statement of cash flows. Contributions of other assets are noncash transactions, which require separate disclosure.
In many cases, a reporting entity will loan money to its joint ventures with the expectation of repayment. Such loans, and their subsequent repayment, should be reflected as investing activities in the reporting entity’s statement of cash flows.

6.8.5 Derivatives

Generally, cash flows related to a derivative, whether over-the-counter or centrally-cleared, should be classified according to their nature, which is that of an investing activity. However, ASC 230-10-45-27 indicates that a reporting entity may elect an accounting policy to classify the cash flows from derivatives designated in a qualifying fair value or cash flow hedging relationship in the same category as the cash flows from the hedged items, provided there is no other-than-insignificant financing element (see FSP 6.8.5.5), and this treatment is disclosed. Refer to FSP 6.8.5.3 and 6.8.5.4 for discussions of the cash flow classification of derivatives used in economic hedges and net investment hedges, respectively.
Even under a policy to classify the cash flows from derivatives designated in a qualifying hedging relationship in the same category as the cash flows from the hedged items, reporting entities may treat cash payments and receipts on collateral as investing cash flows when the collateral account is in an asset position, and as financing cash flows when the collateral account is in a liability position. Example FSP 6-7 illustrates this treatment in the statement of cash flows.
EXAMPLE FSP 6-7
Cash flows presentation on the movement of derivative collateral.
FSP Corp and its counterparty (broker) post and receive collateral each month for the entire fair value of an over-the-counter derivative contract. The derivative’s trade date is August 5, 20X1. At the end of the first month, the contract is a $100 liability to FSP Corp, and it posts collateral of $100 with the broker. The following month the derivative’s liability increases to $125, then in the subsequent month, the liability becomes smaller. In November the derivative contract becomes an asset of $25, and in December the asset falls in value to $15.
Below are the transactions on a monthly basis and the treatment of the corresponding cash flows related to collateral, based on the changes in fair value of the derivative.
Date
Fair value of the derivative asset or (liability)
Collateral cash received
Collateral cash paid
Collateral asset / Due from broker balance
Collateral liability / Due to broker balance
Investing or financing cash flow
8/05/X1
0
8/30/X1
($100)
($100)
$100
$100 Investing outflow
9/30/X1
($125)
($25)
$125
$25 Investing outflow
10/31/X1
($55)
$70
$55
$70 Investing inflow
11/30/X1
$25
$80
0
$25
$55 Investing inflow and $25 Financing inflow
12/31/X1
$15
($10)
$15
$10 Financing outflow

As highlighted above, in November, when the derivative moves from a liability to an asset, the collateral account moves from an asset to a liability, as the broker has repaid all $125 of collateral that had been paid by FSP Corp and paid an additional $25 to satisfy the collateral exposure FSP Corp has to the broker for the derivative asset. In November the $80 received is a combination of a $55 investing inflow and a $25 financing inflow representing the extinguishment of the collateral asset/due from broker and creation of a collateral liability/due to broker.

6.8.5.1 Centrally-cleared derivatives

Certain central clearing parties, including the London Clearing House (LCH) and Chicago Mercantile Exchange (CME), have implemented rules so that a variation margin payment is legally considered a settlement payment, as opposed to the posting of collateral. For these contracts (referred to as “settled-to-market” or STM contracts), the derivative contract, variation margin, and interest on the cumulative variation margin (referred to as “price alignment interest,” PAI, or “price alignment,” PA) are viewed as a single unit of account.
For STM contracts, if a derivative does not have an “other-than-insignificant” financing element, we understand that the SEC staff would not object to a registrant continuing to report variation margin payments and “derivative settlements” in different categories in the statement of cash flows. This is based on a view that ASC 230 would support concluding that variation margin payments are separately identifiable sources and uses of cash flows that are distinguishable from “other derivative cash flows.” This view acknowledges that in this circumstance, the unit of account for balance sheet purposes is not determinative of the presentation of separately identifiable cash flows. We also understand that the SEC staff would not object to classifying all of the payments related to an STM contract as a single unit of account reported within the same classification in the statement of cash flows.
Question FSP 6-5 addresses the classification of a qualifying hedging instrument in the statement of cash flows.
Question FSP 6-5
A reporting entity has a qualifying cash flow hedge related to the forecasted purchase of inventory. The forecasted purchase has occurred and the hedging instrument has been settled, but, at the reporting date, the inventory has not been sold. How should the reporting entity classify the cash flows related to the qualifying hedging instrument in the statement of cash flows?
PwC response
The reporting entity may present the cash flows from the hedging instrument as either an investing activity or an operating activity (as a change in working capital components because the hedged item in this example is the forecasted purchase of inventory). However, if the reporting entity presents the cash flows from the hedging instruments in the same category as the hedged items, it must disclose its accounting policy in the financial statements and apply it consistently.

6.8.5.2 After hedge termination

When an individual hedge relationship is discontinued because the hedged item has been settled, or will no longer occur, any cash flows from the derivative instrument subsequent to the date hedge accounting is discontinued should be classified in accordance with a derivative’s nature as an investing activity. The cash flows should be classified as an investing activity because there are no cash flows from the hedged item for the classification of the derivative’s cash flows to follow. If only the derivative is settled or closed out, and the hedged item will continue to be accounted for, the derivative settlement cash flows should be classified according to the reporting entity’s policy for derivative settlements (i.e., as either investing cash flows or by following the classification of the hedged item).
In some instances, a cash flow resulting from the termination of a hedging instrument may be viewed as occurring simultaneously with discontinuance and disposal of the hedged item – not subsequent to the discontinuance. In that case, the derivative settlement should also be classified according to the reporting entity’s policy for derivative settlement.

6.8.5.3 Derivatives used in economic hedges

Reporting entities frequently enter into derivative transactions for hedging purposes, but do not elect to apply the hedge accounting rules in ASC 815. Such transactions are commonly referred to as “economic hedges.” The literature does not specifically afford reporting entities the ability to elect an accounting policy to reflect classification of the cash flows of the economic hedge with cash flow classification of the hedged items (as ASC 230-10-45-27 permits mimicking the classification of the hedged item for designated fair value and cash flow accounting hedges). We believe that a literal application of the nature principle (see FSP 6.8.1), combined with other guidance in ASC 230 pertaining to classifying cash flows related to derivatives, would lead a reporting entity to classify the cash flows related to an economic hedge as investing. However, we note that the predominant practice is to classify these derivative cash flows according to the classification of cash flows of the economic “hedged item” when the reporting entity has a policy to do so under ASC 230-10-45-27. We have also observed this practice when reporting entities only have economic hedges. This practice has been acknowledged by regulators. Accordingly, we do not object to a reporting entity electing a policy to classify cash flows related to economic hedges following the classification of cash flows of the economic hedged items consistent with their policy for derivatives designated in hedge accounting relationships, assuming the practice is consistently applied and clearly disclosed.
Example FSP 6-8 illustrates an economic hedge.
EXAMPLE FSP 6-8
Cash flows related to an economic hedge
FSP Corp, an oil and gas producing company, sells its daily oil production to third parties for cash based upon a floating spot price specific to the production’s location. To fix the cash proceeds for its anticipated oil production over the next twelve months, FSP Corp enters into a derivative (a price swap), which requires the derivative counterparty to pay FSP Corp a stated fixed price for a fixed volume of oil, while FSP Corp must pay the counterparty a stated index price (that is variable) for the same fixed volume of oil. The price swap is settled net, in cash, on a quarterly basis. Based on common practice in the industry, FSP Corp does not employ hedge accounting and instead records changes in the derivative’s fair value in net income (an “economic hedge”).
At the first settlement date, FSP Corp receives a cash payment from the derivative counterparty. How should the cash receipt be classified in the statement of cash flows?
Analysis
The cash flows from the economic hedged item (oil production) would be reflected in operating cash flows. We believe FSP Corp may also classify the derivatives’ cash flows as operating, if it has elected an accounting policy to classify hedging cash flows in the same category in the statement of cash flows as the category for the cash flows from hedged items. Absent such a policy decision, the nature of a derivative is an investing activity. The changes in fair value of the derivative from period-to-period that are recognized in earnings represent a noncash adjustment in the reconciliation of net income to operating cash flows under the indirect method. These adjustments are separate from the actual cash settlements, classified as investing or operating, discussed in this example.

6.8.5.4 Derivatives used in net investment hedges

Reporting entities with global operations frequently hedge the investment made in their foreign subsidiaries with net investment hedges. Example FSP 6-9 illustrates the classification of cash received from the settlement of derivatives accounted for as a net investment hedge.
EXAMPLE FSP 6-9
Classifying cash flows from settlement of a net investment hedge
FSP Corp, a US parent company, enters into a foreign currency forward exchange contract to sell British pounds (GBP) and receive US dollars, and designates the forward exchange contract as a net investment hedge of its British subsidiary whose functional currency is the British pound. Under the spot method for hedges of net investments, the portion of the changes in the fair value of the forward exchange contract attributable to changes in the prevailing USD/GBP spot rate, are recorded in the cumulative translation adjustment (CTA) account, which is a component of OCI, and will remain there until the investment in the subsidiary is sold or substantially liquidated in accordance with ASC 830, Foreign Currency Matters. Any change in fair value of the excluded component is recognized in earnings or is deferred to CTA and systematically amortized to earnings. At the expiration of the forward exchange contract, FSP Corp receives $2 million from the counterparty.
How should the cash received from the settlement of the derivative accounted for as a net investment hedge be classified on the statement of cash flows?
Analysis
The cash received from settlement of the net investment hedge should be classified as an investing activity in the statement of cash flows. Investing classification is appropriate as the hedged item is the investment in a foreign subsidiary and the cash paid or received from acquiring or selling the subsidiary would typically be classified as investing under ASC 230-10-45. Additionally, ASC 230-10-45-27 further supports an investing classification as the FASB believed that the purchase or sale of a forward contract is an investing activity. Therefore, the $2 million received from the settlement of the net investment hedge should be classified as an investing inflow.
If the hedging instrument in a net investment hedge is a non-derivative financial instrument, such as foreign-denominated debt, the cash flows related to the net investment hedge would be classified according to the nature of the non-derivative instrument. In the case of debt instruments, interest payments are operating activities and the principal repayments are financing activities.
When employing cross currency swaps rather than forward contracts, under the spot method, the periodic settlements of the swaps are frequently recorded as interest income or expense in the income statement representing the amortization to earnings of the derivative’s excluded component. Generally, cash flows on cross currency swaps used to hedge a net investment are classified (1) as investing cash flows, consistent with a derivative’s nature, or (2) consistent with the nature of the hedged item (depending on the entity’s policy election under ASC 230-10-45). However, in certain circumstances, reporting entities have presented periodic settlements of cross currency swaps (both outflows and inflows) as operating cash flows under the concept that a derivative that relates to a specified debt instrument approximates an economic interest in foreign-denominated debt. Under this view, the periodic settlements on the cross currency swap are reported with the interest on the related debt instrument as operating cash flows.
Notwithstanding the cash flow treatment of the periodic swap settlements, the cash flows from sales or liquidation of the subsidiary will be investing cash flows.

6.8.5.5 Derivatives with financing elements

Per ASC 230-10-45-14(d) and ASC 230-10-45-15(d), all cash flows associated with an instrument accounted for as a derivative (i.e., the normal purchases and normal sales assertion has not been elected) that at its inception includes an “other-than-insignificant financing element” should be classified as financing activities by the borrower (i.e., the counterparty with a derivative liability).
Derivatives with off-market terms at their acquisition dates and those that have upfront cash receipts often contain a financing element. ASC 815-10-45 does not establish bright lines for determining when an inherent financing element should be considered other-than-insignificant. Determining if a derivative contains an other-than-insignificant financing element requires judgment based on the facts and circumstances. We have interpreted the term “insignificant” in this guidance as denoting an amount that is less than 10% of the present value of an at-the-market derivative’s fully prepaid amount. The term “at inception” is generally interpreted within ASC 815 to mean when the reporting entity acquired the derivative position, not when the derivative instrument was originated. While the requirement to classify all cash flows related to a derivative with an other-than-insignificant financing element within the financing category was an attempt to add transparency to the practice of effectively creating a borrowing in the form of an off-market derivative, the interpretation of “at inception” combined with the lack of scoping attached to the guidance in ASC 230 potentially impacts derivative instruments that did not provide any direct financing.
When the financing element is considered to be other-than-insignificant at inception, all of the cash flows associated with the derivative (i.e., not just the cash flows associated with the portion that represents the financing element) should be included in financing activities by the borrower.
For STM contracts, since variation margin and interest received or paid on the cumulative variation margin amount are considered part of a single unit of account, if a derivative has an “other-than-insignificant” financing element, cash flows associated with variation margin, price alignment, and price alignment interest must also be reported as financing activities.
Example FSP 6-10 illustrates the classification of cash flows associated with acquired forward contracts.
EXAMPLE FSP 6-10
Classifying cash flows associated with acquired derivatives
FSP Corp uses its common stock to acquire another company in a transaction accounted for as a business combination under ASC 805. At the acquisition date, the acquired company held derivatives in the form of physically settled commodity forward contracts originated by the acquired company. Based on the difference between market prices at the date of the acquisition and the historical terms of the acquired forward contracts, all of the forward contracts are in a liability position, and they all are deemed to contain an “other-than-insignificant” financing element.
Upon acquisition, FSP Corp accounts for the acquired forward contracts as derivative instruments. Source documents obtained from the acquired company indicate that the fair value of all the acquired forward contracts were zero when originated by the acquired company.
How should FSP Corp classify the cash flows associated with the acquired forward contracts in its statement of cash flows?
Analysis
The inception of the physically settled forward contracts for FSP Corp is the date of the business combination, not the date the acquired company originated the derivative contracts. Because all of the forward contracts contain an other-than-insignificant financing element, a literal read of ASC 230 would suggest that all the cash flows associated with the physically settled forward contracts should be presented in the financing section of the statement of cash flows.
While FSP Corp did not receive an upfront payment related to the acquired forward contracts, one could argue that FSP Corp effectively received noncash “financing” from the forward contracts because the liability position of the derivative contract on the acquisition date effectively allowed FSP Corp to issue fewer shares to purchase the acquiree. Of course, FSP Corp also acquired all the acquiree’s accounts payable and accrued liabilities, and when FSP Corp settles those liabilities, ASC 230 requires those outflows to be classified as operating, not financing.
Given that facts like these appear inconsistent with the transactions that the other-than-insignificant financing element concept was intended to target (especially when the derivative results in the physical delivery of an item used for operating purposes), we rarely see the other-than-insignificant financing element guidance applied to derivatives acquired in a business combination.

6.8.6 Discounts and premiums on debt instruments

When a debt instrument is issued at a discount, the cash proceeds received (i.e., face value of the debt instrument less the discount) is classified as a financing inflow for the issuer. The classification of subsequent payments related to debt issued at a discount can vary.

6.8.6.1 Zero coupon debt instruments and other deeply-discounted debt instruments

The cash received upon issuance of a zero coupon debt instrument is classified as a financing inflow and the discount accretion in subsequent periods is included as a positive adjustment in the reconciliation of net income to operating cash flows under the indirect method of presentation. ASC 230 requires that cash payments for the settlement of zero-coupon debt instruments, or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing, be allocated between financing and operating as follows:
  • Operating: the portion of the cash payment attributable to accreted interest on the debt discount
  • Financing: the portion of the cash payment attributable to the proceeds received at issuance

ASU 2016-15 introduced the concept of an insignificant coupon when compared to the effective rate of the debt instrument. During deliberations of ASU 2016-15, the EITF was concerned that if the scope was not expanded beyond zero-coupon debt instruments, there could be reduced comparability with the classification of economically similar instruments, such as a deeply discounted debt instrument with a near zero-coupon interest rate. As such, ASC 230-10-45-17 includes debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing but does not define what is meant by “insignificant in relation to the effective interest rate of the borrowing” so preparers will need to apply judgment in making this determination. In practice, we have seen reporting entities define insignificant as amounts that are less than 10%. We would view a coupon rate to be insignificant if this rate was less than 10% of the effective rate on the instrument (e.g., a 0.25% coupon rate where the effective rate of the instrument was 2.501% or higher).
The guidance in ASC 230-10-45-17 for zero-coupon debt instruments or those with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing should not be applied to other debt instruments issued at a discount when the coupon is not insignificant. Therefore, the entire cash outflow associated with the settlement of debt issued at a discount should be reflected as a financing outflow.
Example FSP 6-11 illustrates the cash flow classification of repayment of a debt issued at a discount with an insignificant coupon and Example FSP 6-12 illustrates the cash flow classification of repayment of a debt with a bifurcated feature resulting in an insignificant coupon on the debt host.
EXAMPLE FSP 6-11
Statement of cash flow classification of repayment of debt issued at a discount and with an insignificant coupon
FSP Corp issued 0.5% debt with a par value of $1,000. Cash proceeds received at issuance were $780. The debt matures in seven years and is callable at par by FSP Corp after the fifth year. At the time of issuance, FSP Corp also issued term debt at par with a coupon and effective interest rate of a 5.68%. After comparing the contractual coupon rate of 0.5% to the effective rate of 5.68%, FSP Corp concluded that the coupon rate is insignificant in relation to the effective rate of the bond (0.5%/5.68% = 8.8%, which is less than 10% of the effective rate and is therefore considered insignificant).
Five years after issuance, FSP Corp exercised its call option to prepay the debt and paid the issuer $1,000.
How should FSP Corp classify the payments in its statement of cash flows?
Analysis
Since FSP Corp determined that the bond is deeply discounted with an insignificant coupon, it would classify an outflow of $780 as a financing activity (because that is the portion of the consideration paid to settle the amounts attributable to the proceeds received at issuance). The $220 difference between the $1,000 extinguishment price and the $780 initial proceeds would be classified as an operating activity because that is the amount associated with the cash paid for accreted interest on the debt discount.
EXAMPLE FSP 6-12
Statement of cash flow classification of repayment of debt with a bifurcated feature and an insignificant coupon
FSP Corp issued 6% debt with a par value of $1,000. FSP Corp determined that the debt included an embedded derivative that required bifurcation. Cash proceeds received at issuance were $1,000 and the debt matures in one year. At the time of issuance, FSP Corp allocated $400 to the bifurcated component and $600 ($1,000 par value less $400 discount) to the debt host liability, resulting in a 76.7% effective interest rate. After comparing the contractual coupon rate of 6% to the effective rate of 76.7%, FSP Corp concluded that the coupon rate is insignificant in relation to the effective rate of the bond (6%/76.7% = 7.8%, which is less than 10% of the effective rate and is therefore insignificant).
At the maturity date, the embedded feature had expired and FSP Corp repaid the debt for $1,000.
How should FSP Corp classify the payments in its statement of cash flows?
Analysis
Since FSP Corp determined that the bond is deeply discounted with an insignificant coupon, it would classify an outflow of $600 as a financing activity (because that is the portion of the consideration paid to settle the amounts attributable to the proceeds received at issuance). The $400 difference between the $1,000 allocated to the extinguishment price and the $600 would be classified as an operating activity because that is the amount associated with the cash paid for accreted interest on the debt discount.

6.8.6.2 Payment in kind interest (PIK notes)

The terms of debt instruments may permit or require the borrower to satisfy interest payments on the debt by issuing additional paid-in-kind (PIK) notes having identical terms as the original debt instead of paying in cash. We believe that a PIK note is in substance the same as a zero coupon bond. That is, in both a PIK note and a zero coupon bond, the interest due on the original principal amount of debt is accrued and added to the debt balance. Therefore, we believe the guidance for zero coupon bonds should be followed for payments made to extinguish PIK notes as well. For example, if debt with a $100 principal amount was issued at par and the issuer satisfied $15 of interest by issuing additional notes, the borrower would pay $115 at maturity. On the extinguishment date, when the borrower pays $115 in cash to settle the debt, the $100 representing the original amount of proceeds received at issuance would be classified as a financing outflow, and the remaining $15 attributable to accreted interest would be classified as an operating cash outflow.

6.8.6.3 Debt issued at a premium

Consistent with the conclusion in ASU 2016-15 concerning debt discounts associated with debt instruments with coupon interest rates that are not insignificant in relation to the effective interest rate of the debt, we believe that it would be acceptable for the proceeds from debt issued at a premium to be reflected as a financing inflow. Premium amortization in subsequent periods is included as a reduction of net income in the reconciliation of net income to operating cash flows. When the debt is repaid, it would be acceptable for the entire cash outflow to be classified as a financing outflow.
Alternatively, it would also be acceptable to treat the contractual coupon cash flows paid in excess of the effective rate recognized as a financing outflow representing the repayment of the initial proceeds of the debt in excess of the contractual principal. A third approach has also been observed in practice in which the issuer splits the initial proceeds into an operating inflow for the initial proceeds in excess of the contractual principal due (i.e., the premium on the debt) and classifies the contractual principal of the debt as an inflow from financing activities. Subsequently, all contractual cash coupon payments are classified as operating outflows. While this technique results in the same cash flow classifications as the alternative approach in the aggregate across all cash flow periods, it does so by having earlier operating cash flows in the period of debt issuance and less operating cash flows in the subsequent periods.
To illustrate, assume a debt issuance of $1,000 principal has a stated coupon of 4%. The effective market rate is 3% and the initial proceeds are $1,100. The three approaches for classification in the cash flow statement of the borrowing, interest, and repayment cash flows over the life of the debt are:
  • Approach 1: The initial proceeds of $1,100 would be classified as financing inflows. The $40 coupon payments would be classified as operating outflows (interest). Finally, the $1,000 payment to retire the debt at its maturity would be classified as a financing outflow.
  • Approach 2: The initial proceeds of $1,100 would be classified as financing inflows. The contractual coupons would be split into operating outflows for the effective rate of interest and financing outflows for the excess of the coupon paid above the recognized interest expense as partial repayments on the outstanding debt balance. Finally, the $1,000 payment to retire the debt at its maturity would be classified as a financing outflow.
  • Approach 3: The initial proceeds of $1,100 would be split into a $100 operating inflow as receipt of interest in exchange for agreeing to make coupon payments that are greater than market rates, and $1,000 for contractual principal due as a financing inflow. The entirety of the $40 coupon payments would be subsequently classified as operating outflows for interest. Finally, the $1,000 payment to retire the debt at its maturity would be classified as a financing outflow.

6.8.7 Debt extinguishment costs

ASC 230 requires that cash payments for debt prepayment or other debt extinguishment costs, including third-party costs, premiums paid, and other fees paid to lenders that are directly related to the debt prepayment or extinguishment, be classified as financing activities in the statement of cash flows. The Basis for Conclusions in ASU 2016-15 stated that some members of the EITF noted that this was appropriate because such costs are associated with the extinguishment of the debt principal and because many view these costs as being similar to debt issue costs, which are also classified as financing outflows.

6.8.8 Debt restructurings accounted for under ASC 470-50

A debt restructuring is accounted for as either a modification or as an extinguishment. The statement of cash flows classification of cash exchanged in a debt restructuring depends on the accounting for the restructuring, the counterparties involved, and the nature of the payments being made. See FG 3 for a detailed discussion of accounting for modifications and extinguishments as well as accounting for modifications to lines of credit and revolving debt arrangements.
The treatment of unamortized fees or principal that remains outstanding is not addressed, as there is no cash flow effect. If they are expensed in the period, however, they will be a reconciling item between net income and cash flow from operations.

6.8.8.1 Term debt modifications

In connection with a restructuring of term debt accounted for as a modification, companies may incur creditor fees and fees to other parties. Creditor fees incurred in these situations are capitalized as a debt discount and amortized. According to ASC 230-10-45-17(d), when a discount is repaid for debt instruments with coupon interest rates that are not insignificant in relation to the effective interest rate of the debt, the repayment of that discount should be a financing cash outflow. In a modification, the creditor fees paid on the modification date are capitalized as a debt discount. Therefore, the borrower is paying that portion of the discount on the modification date. By analogy to ASC 230-10-45-15(g), we believe that it is acceptable to classify all creditor fees incurred in conjunction with a debt restructuring accounted for as a modification as financing cash outflows.
Fees paid to third parties associated with a term debt restructuring accounted for as a modification are expensed. The payment, which has entered into the determination of net income, is not considered a debt issuance cost since there is no new issuance of debt. Therefore, the payment of these costs should be presented as an operating cash outflow.

6.8.8.2 Term debt extinguishments

As required in ASC 230-10-45-15(g), all fees incurred in conjunction with a debt restructuring that is accounted for as an extinguishment under ASC 470-50 (irrespective of whether the fees are paid to creditors or third parties) should follow the same classification as discussed in FSP 6.8.7 for debt extinguishment payments costs, which are financing outflows.

6.8.8.3 Restructuring of a term loan syndication

Syndicated loans involve multiple lenders and a single borrower. While the terms of the loan may be identical or virtually identical with each lender, they are legally separate loans between the borrower and each syndicate lender. When determining the treatment in the statement of cash flows when the proceeds from a new term loan syndication are used to repay an existing term loan syndication and there are lenders that roll over from the existing loan syndicate to the new loan syndicate, each loan should be analyzed separately.
The reporting entity must assess each lender to determine if it is a new lender (i.e., did not hold debt in the original syndicate), exiting lender (i.e., does not hold debt in the new syndicate), or rollover lender (i.e., holds debt in both the original and new syndicate). Additionally, the reporting entity must assess whether the debt held by the rollover lenders is accounted for as an extinguishment or a modification of the debt on a lender-by-lender basis, as discussed in FG 3.6.
Amounts paid to or received from new and exiting lenders
In all cases, proceeds received from new lenders (net of lender fees) are financing inflows and amounts paid to exiting lenders (including any lender fees) are financing outflows (assuming the debt does not have an insignificant coupon, as discussed in FSP 6.8.6).
Amounts paid to or received from rollover lenders
The presentation for rollover lenders is more complicated and depends on the form of the transaction and the accounting for each lender.
  • Cash is exchanged on a gross basis

In certain circumstances, a reporting entity receives proceeds for the entire amount of the lending provided by the new debt syndicate and repays the entire amount owed to the existing debt syndicate. That is, each lender (including rollover lenders) gives the reporting entity cash equal to the lender’s entire portion of the new debt syndicate, and each lender receives full payment equal to the lender’s entire portion of the existing debt syndicate. In this scenario, we believe the reporting entity should follow the form of the transaction and reflect the entire amount repaid and the entire amount of new proceeds received separately as a cash outflow and inflow from financing activities, respectively.
Alternatively, if a particular lender’s restructuring was accounted for as a modification based on the guidance in ASC 470-50-40, the reporting entity can elect to present only the net change for that particular lender. In this case, only the net cash received or paid, representing the net change in principal balance of the debt for that lender, would be reflected in the cash flow statement. This alternative election is a policy choice that should be applied consistently. See Example FSP 6-13 for an illustration of this scenario. Such net presentation is not permitted if the lender’s restructuring is accounted for as an extinguishment based on the guidance in ASC 470-50-40.
  • Cash is exchanged only for principal balance changes less lender fees

In certain circumstances, the rollover lenders would give the reporting entity cash only if their principal balance less lender fees in the new syndicate increased and would receive money only if their principal in the new syndicate decreased or they are receiving a lender fee. In this scenario, the reporting entity must present the cash receipts or repayments as financing inflows or outflows, respectively, based on the actual cash exchanged with each lender.
Third-party fees
The cash flow presentation for third-party fees (e.g., legal fees) incurred in the transaction are assessed separately from cash flows exchanged with lenders because payments are made to different parties. As discussed in FG 3.6.1, third-party fees are allocated to each lender using a rational approach to determine the accounting for such fees. The cash flow classification for these fees depends on the type of lender as follows:
Lender type
Cash flow classification of third-party fees
New lender
Financing
Exiting lender
Financing
Rollover lender accounted for as a modification
Operating
Rollover lender accounted for as an extinguishment
Financing
  • Reporting entity uses a transfer agent to facilitate the cash flows

A reporting entity may engage a transfer agent (often an investment bank) to assist in a debt restructuring. In these cases, the transfer agent collects the proceeds from the new debt issuance and repays the original debt on the reporting entity’s behalf. Typically, the reporting entity receives only the net difference between the proceeds received and the amounts paid. In these circumstances, the reporting entity should apply the constructive receipts and disbursement guidance discussed in FSP 6.9.2.1. Therefore, all cash that the transfer agent receives or pays on behalf of the reporting entity should be reflected in the cash flow statement as if it was received or paid by the reporting entity.
Example FSP 6-13 illustrates classification of the restructuring of a term loan syndication on the statement of cash flows. This example uses the same facts as in Example FG 3-7 in PwC’s Financing transactions guide.

EXAMPLE FSP 6-13
Statement of cash flow classification of the restructuring of a term loan syndication
FG Corp had a syndicated loan arrangement aggregating to $52 million. FG Corp needs additional financing and replaces its original syndicated loan arrangement with a new syndicated loan arrangement aggregating to $100 million. There are $4 million dollars in lender fees. Therefore, the net proceeds received from the new debt are $96 million. There are also $1 million of third-party costs.
The transaction is structured such that FG Corp receives $96 million in cash proceeds from the new debt. FG Corp uses $52 million of those proceeds to immediately repay the entire amount of existing debt and uses $1 million to pay third-party costs.
There are three lenders in the original syndication that also are lenders in the new syndication. Each of the loans with these rollover lenders is accounted for as a modification.
The following table summarizes changes to the syndicated loan on a lender-by-lender basis as well as the fees and costs allocated to each lender.
Bank
Balance of
original
syndication
Balance of new syndication
Principal
change
Lender fees
Third-party
costs
A
$5,000,000
$5,000,000
-
$200,000
$50,000
B
$20,000,000
$30,000,000
$10,000,000
$1,200,000
$300,000
C
-
$60,000,000
$60,000,000
$2,400,000
$600,000
D
$12,000,000
$5,000,000
$(7,000,000)
$200,000
$50,000
E
$15,000,000
-
$(15,000,000)
-
-
Total
$52,000,000
$100,000,000
$48,000,000
$4,000,000
$1,000,000

How should the transaction be reflected on the statement of cash flows?
Analysis
Amounts paid to or received from lenders are analyzed separately from third-party costs because third-party costs are paid to parties other than the lender.
Amounts paid to or received from lenders
Since the structure of the transaction was such that FG Corp received proceeds of $96 million (new principal less lender fees) in cash and used $52 million of those proceeds to pay off the existing debt at the same time, the presentation depends on FG Corp’s policy election (as described above):
  • Follow the form of the transaction

Under this approach, FG Corp presents a financing inflow for $96 million (proceeds received) and a financing outflow for the $52 million used to repay the original debt. This presentation does not require a lender-by-lender assessment.
  • Present the net change by lender

FG Corp can follow this approach for all the rollover lenders because each is accounted for as a modification. Under this approach, FG Corp reviews the net change for each rollover lender.
If the rollover lender’s principal balance has increased, a financing inflow is reflected for the principal change less any lender fees paid.
If the rollover lender’s principal balance has decreased, a financing outflow is reflected for the principal decrease plus lender fees.
If the rollover lender’s principal balance has not changed but a lender fee was paid, we believe this fee should be a financing outflow.
Any new or exiting lender would reflect financing inflows and outflows based on amounts paid/received as illustrated in the table below.
Lender
Financing inflow
Financing outflow
A: Rollover lender (modification)
($200,000)
B: Rollover lender (modification)
$8,800,000
C: New lender
$57,600,000
D: Rollover lender (modification)
($7,200,000)
E: Exiting lender
($15,000,000)
Totals
$66,400,000
($22,400,000)

Third-party fees
Third-party fees are presented based on the accounting for each lender and the amounts allocated. These amounts are not netted against the amounts paid to or received from the lenders under either presentation above. This was assessed as follows.
Lender
Financing outflow
Operating outflow
A: Rollover lender (modification)
($50,000)
B: Rollover lender (modification)
($300,000)
C: New lender
($600,000)
-
D: Rollover lender (modification)
($50,000)
E. Exiting lender (no third-party costs were allocated to the original loan)
Total
($600,000)
($400,000)

6.8.8.4 Modifications to line of credit and revolving debt arrangements

Third-party and creditor fees incurred in connection with a modification to a line of credit or revolving debt arrangement are considered to be associated with the new arrangement and should therefore be capitalized. We believe the classification of these costs in the statement of cash flows depends on the purpose of the line of credit. Will it be drawn upon, or is it more like “insurance” that enables the entity to access cash should it be needed?
  • If the reporting entity does not intend to draw down on the line: All third-party and creditor fees should be classified as operating activities because the entity does not expect them to be related to a borrowing.
  • If the reporting entity intends to draw down on the line: The fees are costs to issue debt in the future and should be classified as financing outflows.

6.8.8.5 Troubled debt restructurings

A troubled debt restructuring (TDR) can occur in a variety of ways including delivering assets or equity to fully or partially settle the debt and modifying the debt terms. In certain situations, a gain is recognized, and if there are ongoing debt service payments, the carrying value of the debt is set at the undiscounted future cash flow amount. In these cases, all ongoing debt service payments reduce the carrying value of the debt, and no interest expense is recognized going forward. See FG 3.3 for further details on TDRs.
Some of the key cash flow considerations relating to TDRs include the following.
  • Any delivery of equity or assets to partially or fully settle debt should be reported as noncash investing or financing activities, as appropriate.
  • Costs incurred with third parties directly related to the restructuring (including legal fees) generally should be classified in operating; however, any direct costs associated with the issuance of equity securities in partial or full settlement of the debt should be reflected as financing outflows.
  • Any fees paid to the lender should be classified as a financing outflow.
  • When debt is modified in a troubled debt restructuring, presentation of the subsequent cash payments made post restructuring depends on whether there was a gain recorded from the modification of terms.
  • Gain recognized

All ongoing debt payments should be reflected as financing outflows. This includes any contractual interest payments since, for accounting purposes, all payments are treated as reductions to the carrying value of the debt instead of interest expense.
  • No gain recognized

Ongoing debt payments should be reflected in a manner consistent with non-troubled debt. Interest payments should be reflected as operating outflows while principal repayments should be reflected as financing outflows.

6.8.9 Structured payables

Under structured payable programs, the reporting entity arranges for its vendors to have the option to factor their receivables (i.e., the reporting entity’s payables) to a bank. The balance sheet classification of the reporting entity’s payable depends on the economic substance of the arrangement. See FSP 11.3.1.5 for additional discussion of balance sheet classification of structured payables arrangements, including related disclosure requirements.
If the economic substance of the trade payables has changed as a consequence of implementing a structured vendor payable program, an in-substance refinancing will be deemed to have occurred. As a result, the affected trade payable balances should be reclassified to debt on the reporting entity’s balance sheet. In this circumstance, the SEC staff’s position (which is consistent with the view expressed concerning floor plan financing programs discussed in FSP 6.8.10) is that a reporting entity’s statement of cash flows should reflect (impute) an operating cash outflow and financing cash inflow related to the affected trade payable balances. A financing cash outflow should be reflected upon payment to the bank and settlement of the obligation.

6.8.10 Floor plan financing programs

Reporting entities often finance the purchase of their inventory by engaging in floor plan financing arrangements with lenders that are not affiliated with the manufacturer of the inventory. When these arrangements are with the manufacturer, the arrangements are long-term accounts payable that are operating cash flows when settled. In an arrangement that is not with the manufacturer, an unaffiliated lender pays the manufacturer of the inventory directly and is then repaid by the reporting entity according to the terms negotiated between the reporting entity and the lender, which are usually much longer than normal trade payables.
Application of the concepts of ASC 230 to such an arrangement results in the reporting entity disclosing a noncash financing transaction for the acquisition of the inventory, followed by a financing outflow when the reporting entity repays the lender. As a result, operating activities will be asymmetrical and significantly overstated in that they will never include an outflow for the purchase of inventory that, when sold, will produce an operating inflow. Such an outcome would appear consistent with paragraph 54 of FASB Concepts Statement No. 5, which indicates that cash payments are recognized when they occur, and ASC 230-10-50-5, which indicates that only the cash portion of a transaction should be reported in the statement of cash flows.
However, the SEC staff has expressed the view that the lack of symmetry in such floor financing programs does not depict the substance of the transaction because the lender effectively acts as the reporting entity’s agent. To remedy the asymmetry, the SEC staff believes that the reporting entity should report (impute) an operating cash outflow and a financing cash inflow upon receipt of the inventory, even though neither cash flow occurred. Application of this approach to other situations requires judgment. Reporting entities should scrutinize their non-cash operating activities for situations similar to those created by the use of third-party floor plan financing arrangements. See FSP 6.9.2.1 for a discussion of constructive receipt and constructive disbursement.

6.8.11 Liabilities settled through paying agents

In some circumstances, a reporting entity may engage a financial institution to operate solely as a paying agent by entering into arrangements that allow for the financial institution to make payments on its behalf, and in some instances, allow it to participate in a rebates or “rewards” programs for transaction volume generation. See FSP 11.3.1.6 for further discussion of these arrangements.
With regard to classification of this type of arrangement in the statement of cash flows, reporting entities should follow the guidance in FSP 6.8.9 for structured payables.

6.8.12 Sales of receivables

Reporting entities sometimes sell or factor trade receivables to banks or asset-backed commercial paper conduits, frequently under revolving financing arrangements, to accelerate cash inflows. Sellers may not receive the entire purchase price in cash at the transfer date. Rather, the seller may receive only a portion of the purchase price (which is classified as operating in the statement of cash flows), with the difference consisting of a receivable from the bank or conduit. The repayment of that receivable is typically contingent on the subsequent collections of the underlying trade receivables sold. This deferred payment arrangement, a receivable from the bank or facility representing a beneficial interest in the transferred trade receivables, is commonly referred to as the “deferred purchase price,” or “DPP.”
ASC 230 requires that a transferor’s beneficial interest obtained upon sale in a securitization of financial assets be disclosed as a noncash activity, and any subsequent cash receipts from payments on a transferor’s beneficial interests in securitized trade receivables to be classified as cash inflows from investing activities when the trade receivable is derecognized upon transfer. Subsequent cash receipts, occurring after receipt of proceeds of the initial sale of receivables, cannot be attributed to the receivable because the receivable is no longer on the balance sheet. Instead, the subsequent cash receipts are considered an investing relationship with the bank or conduit.
Pursuant to replacement or unwinding of these accounts receivable programs, or through other transactions, the original seller of the accounts receivable balances may reacquire some of its own previously sold receivables. Just as the subsequent collections on any sold receivables after the initial sale are treated as an investing cash flow, the subsequent collections on any receivables reacquired would continue to be of an investing nature and included as cash inflows from investing activities; they would not revert back to an operating activity. The nature of these collections on reacquired receivables do not change to that of an operating cash flow due to the repurchase transaction.
Entities regularly continue to provide account servicing of the sold receivables and collect cash on behalf of the purchaser. Sometimes this cash is deposited into the purchaser’s bank account and is not a cash flow of the seller of the receivables; other times this cash is collected and retained by the seller until remitted to further receivables are purchased.
  • When this cash is deposited into the accounts of the seller, if this cash collection is not used to satisfy DPP, then it represents cash collected on the behalf of another, and the cash flow is classified as a financing inflow.
  • When remitted to the seller at a later date, this is a financing outflow.
  • When used to purchase further receivables, we believe that the reporting entity should present a financing outflow and an operating inflow for the sale of new receivables, provided that the reduction of the liability is consummate with the sale of the new receivables.

Example FSP 6-14 illustrates the statement of cash flows classification of receivables sold.
EXAMPLE FSP 6-14
Cash flow classification of receivables sold
FSP Corp sells its trade receivables into a revolving structure with a 90% advance rate applied to each receivable transfer, with monthly payments out of the collections account to the conduit and the selling company on the 15th of each month (the Payment Date). The structure was set up in a prior period and receivables have been transferred previously and funded in accordance with the terms of the receivables purchase agreement. The conduit has reached its funding limit under the agreement; therefore, going forward, the only source of cash to pay for receivables sold each day are collections on receivables previously sold to the conduit. Collections received on a daily basis can be used to pay for receivables transferred that same day after withholding amounts needed to pay the conduit at the upcoming Payment Date. This set-side, and any amounts remaining after payment to the transferor for that day’s new receivables, is deposited into an off-balance sheet collections account and held in trust until the next Payment Date. Since trade receivables are non-interest bearing, the purchase price of each receivable under these programs typically incorporates a discount from the receivable’s face amount. For simplicity, this example assumes a purchase price equal to face.
The following table summarizes the activity during the 30-day period preceding a Payment Date:
Day
Cash collections
on prior A/R

a
New
transfers
(face)
b
Cash
consideration

c
DPP
consideration

b - c
Trust fund
collections
account
a - c
16
$0
$50,000
$0
$50,000
$0
17
$100,000
$120,000
$96,000
$24,000
$4,000 *
18
$200,000
$10,000
$9,000
$1,000
$191,000
19
$0
$140,000
$0
$140,000
$0
[for simplicity, assume no additional activity takes place between the 20  th of the month and the ensuing Payment Date on the 15  th]
Total
$300,000
$320,000
$105,000
$215,000
$195,000
[on the 15 th, the $195,000 in the collections account is disbursed and allocated as follows]
15
$0
$0
$191,000
($191,000)
($191,000)
Seller
($4,000)
Conduit
Grand total
$296,000
$24,000
$0
*$4,000 for estimated payments to fund interest and fees payable to the conduit for the monthly period preceding the Payment Date
How should these transactions be reflected on the statement of cash flows?
Analysis
In our view, an appropriate basis of presentation would treat each day’s collective activity as the unit of analysis. Under this approach, each day’s cash collections released to the seller (i.e., reinvested) would be allocated between operating and investing inflows. Cash received would first considered to be payment for that day’s transfers of new receivables (subject to the applicable “advance rate”) and would be considered an operating inflow. Any excess that day would be deemed to be a repayment of the DPP, and an investing inflow. Any increase in the DPP (representing the excess of the transferred receivables’ purchase price over cash received) would be recorded and disclosed as a non-cash investing activity based on the fair value of DPP received.
The following table illustrates the application of this approach, based on the stipulated daily activity. All amounts exclude consideration of discounts and anticipated losses.
Day
Operating inflow
Investing inflow
Noncash investing disclosure
16
$0
$0
$50,000
17
$96,000
$0
$24,000
18
$9,000
$0
$1,000
19
$0
$0
$140,000
Total Month 1
$105,000
$0
$215,000
15
$0
$191,000
$0
Total Month 2
$0
$191,000
$0
Grand total
$105,000
$191,000
$215,000
The presentation in the statement of cash flows aligns with the legal form of the exchanges that take place daily between the seller and the conduit, and at the monthly settlement date. Each day serves as the unit of analysis. In this example, a substantial portion of the cash received by the seller for the period consists of a payout from the collections account at the Payment Date ($191,000). Consistent with the terms of the receivables purchase agreement, this receipt represents a return of a portion of the seller’s DPP – an investing cash inflow.

6.8.13 Property, plant, and equipment

As discussed in ASC 230-10-45-13(c), payments made soon before, soon after, or at the time of purchase to acquire property, plant, and equipment and other productive assets should be classified as cash outflows for investing activities. Such amounts should include interest payments and sales taxes capitalized as part of the cost of the acquired assets. If a purchase of property, plant, and equipment and other productive assets is solely funded by issuing debt directly to the seller, it is a noncash financing transaction. Subsequent payments of principal on such debt are financing cash outflows.
Purchases of property, plant, and equipment that have not been paid for during the period (i.e., liabilities exist in accounts payable or accrued liabilities to pay for the purchase) represent noncash activities, as discussed in ASC 230-10-50-4. As such, they should generally be excluded from the relevant statement of cash flows line items (i.e., the change in accounts payable or accrued liabilities lines in the operating category, and purchases of property, plant, and equipment in the investing category). Such noncash activity should be separately disclosed as discussed in ASC 230-10-50-3. Refer to Example FSP 6-15 for more information.
ASC 230-10-45-14 indicates that donor contributions and investment income thereon, which are stipulated by the donor for the purposes of acquiring, constructing, or improving property, plant, and equipment, should be classified as financing activities.
Real estate is generally considered a productive asset and cash payments to acquire such real estate are classified as investing cash outflows. However, if real estate is purchased by a developer to be subdivided, improved, and sold in individual lots, the cash payments to purchase the real estate and the related cash receipts from sale of the real estate should be classified as operating activities. Thus, the nature of the cash flows is similar to inventory in other businesses.

6.8.14 Contributions in aid of construction agreements

Utilities and pipeline operators often enter into arrangements to provide a municipality or plant with a commodity, such as high voltage electricity or natural gas. This requires the construction of infrastructure to deliver the commodity to the entity’s location, such as a high tension lines or a pipeline extension. Arrangements known as contributions in aid of construction (CIAC) dictate the amount of funds to be provided by the customer to the utility. An AICPA task force described the arrangements as follows.
Contributions in aid of construction (CIAC) represents an amount of money or other property contributed to a regulated utility to ensure that the appropriate parties are paying for the costs of utility infrastructure and that the price of utility service is economical and fair for all customers, including those that are not parties to the requested additional infrastructure. Specifically, CIAC is contributed by a customer that requests an uneconomic connection based on projected consumption and regulator-established utility rates. The CIAC, which is computed using a methodology set by the regulator, is paid up-front and covers the uneconomic portion of the utility’s investment on a dollar-for-dollar basis (no margin for the utility). The amount of the CIAC payment is not subject to negotiation between the utility and the customer; rather, the amount is prescribed by regulation. The utility maintains ownership, has full control over and is responsible for operating and maintaining the connection along with the larger distribution network.
The activity under the CIAC will result in the utility having a productive asset albeit at a low cost basis since it was able to construct the asset using the customer’s funding. Therefore, the cash receipts from the customer should be presented in the statement of cash flows as inflows from investing activities and the expenditures to construct the asset should be presented as outflow from investing activities.
Alternatively, the cash receipts under the CIAC could be classified as cash inflows from financing activities as they are recognized as liabilities and the construction disbursements up to the amount of the recognized liability classified as cash outflows from financing activities, with any disbursements in excess of the liability classified as outflows from investing activities.
Question UP 12-2 describes how CIAC agreements are distinguished from construction advances. Unlike a CIAC agreement, construction advances must be repaid to the third party by the reporting entity. Construction advances are classified as cash flows from financing activities when received and repaid, while the disbursements for construction would be classified as cash flows from investing activities.

6.8.15 Planned major maintenance

There are two acceptable methods of accounting for planned major maintenance: direct expensing and deferral. While these methods impact the income statement and balance sheet differently, we believe that the nature of expenditures related to planned major maintenance requires these cash flows to be classified as operating in the statement of cash flows, regardless of which accounting method the entity uses. This view is consistent with comments issued by the SEC staff.

6.8.16 Presenting cash flows for changes in lease-related accounts - lessees

The following subsections address how a lessee should present cash payments for finance and operating leases in the statement of cash flows.

6.8.16.1 Finance leases

A lessee should classify cash payments with respect to finance leases as follows.
  • Cash payments for the principal portion of the lease liability arising from a finance lease should be classified as financing activities.
  • Cash payments for the interest portion of the lease liability arising from a finance lease should follow the guidance in ASC 230. These amounts would generally be classified as operating activities.
  • Variable lease payments and short-term lease payments not included in the lease liability should be classified as operating activities.
  • Payments for prepaid rent for a finance lease are investing activities because these payments are made to acquire a productive right-of-use asset and are made before any finance lease liability is recorded. However, given the lack of specific guidance in ASC 230 or ASC 842 related to lease prepayments, we believe that it is also acceptable to classify these payments in financing, similar to the payment of principal on a finance lease.

6.8.16.2 Operating leases

A lessee should generally classify cash payments arising from operating leases within operating activities. The exception to this relates to lease payments associated with the cost to bring another asset to the condition and location necessary for its intended use that are capitalized as part of the cost of the asset. For example, certain lease payments incurred while building property, plant, or equipment would be capitalized and should be classified as investing activities rather than operating.
Under ASC 842, if a lessee is using the indirect method, both a right-of-use asset and lease liability are recorded as separate line items on the balance sheet for operating leases. The combined change of the two accounts will generally equal the difference between the straight-line lease expense and the cash paid for leases. Questions have arisen as to whether a single line presentation in the reconciliation to net income is appropriate with the two line items on the balance sheet. ASC 842 does not explicitly address this question. Additionally, the general statement of cash flow guidance in ASC 230 provides limited guidance on applying the indirect method. However, ASC 230 does suggest that the reconciliation of net income to operating cash flows should separately report all major classes of reconciling items. Therefore, we believe that the changes in right-of-use assets and lease liabilities arising from lease expense should be reported separately. This is consistent with the balance sheet presentation. One way to present this is to separately present the amortization of the right-of-use asset as a non-cash adjustment from net income and the change in the lease liability due to cash payments as a change in operating assets and liabilities.
We are also aware of another view of presenting a single line item in the reconciliation similar to how it was presented under ASC 840. Given the lack of guidance in this area and that the leases standard does not require the separate presentation of the expense in the income statement, we believe a single-line presentation in the reconciliation would be acceptable.

6.8.16.3 Payments and reimbursements for leasehold improvements

As discussed in LG 3.3.4.2, when a lessee pays for an improvement to the leased property, it must determine whether the improvement is a lessee asset or a lessor asset.
In the statement of cash flows, payments made by a lessee for lessee assets are reflected as investing activities. If the lessor reimburses the lessee for lessee assets, the reimbursement is treated as a lease incentive and the statement of cash flow presentation is the same as any other lease payment. For example, a lease incentive received for an operating lease would be an operating activity.
If a lessee pays for a lessor asset, the payment is accounted for as prepaid rent. If the lessor reimburses the lessee for the lessor asset, it is recorded as a reduction to the prepaid rent. For payments made by a lessee that are accounted for as prepaid rent, we believe that the statement of cash flows presentation will depend on the expected lease classification at commencement. As discussed in FSP 6.8.16.1, if there is clear evidence that the lease would be classified as a finance lease, payments for prepaid rent may be investing activities because these payments are made to acquire a productive right-of-use asset and are made before any finance lease liability is recorded. Alternatively, given the lack of specific guidance in ASC 230 or ASC 842 related to lease prepayments, payments for prepaid rent may be financing activities, similar to the payment of principal on a finance lease. Otherwise, the prepayment should be reflected in the operating section of the statement of cash flows. After the commencement date, any payments made by a lessee and any subsequent reimbursement by the lessor should follow the classification of any other lease payments in the statement of cash flows

6.8.16.4 Noncash transactions

As discussed in FSP 14.2.4, ASC 842 requires certain quantitative disclosures. One such disclosure relates to supplemental noncash information on lease liabilities arising from obtaining right-of-use assets. Furthermore, ASC 230 requires disclosure of all non-cash investing and financing transactions. We believe that all noncash transactions related to adjustments to the lease liability or right-of-use asset should be disclosed as noncash transactions. This includes all noncash changes related to any modification or reassessment events (even when there is a decrease to the right-of-use asset). We believe that disclosing each type of noncash event is the most transparent disclosure, however, we would not object to presenting all changes in one non-cash line item.

6.8.17 Presenting cash flows – lessors

A lessor is required to classify cash receipts from all lease payments, regardless of lease classification, as operating activities unless the lessor is within the scope of ASC 942, Financial Services – Depository and Lending. A lessor within the scope of ASC 942 should follow the guidance in ASC 942-230-45-4, which requires classification of principal payments received under sales-type leases and direct financing leases within investing activities.

6.8.17.1 Payments for assets under construction

When a lessor constructs an asset that it will ultimately lease, questions arise as to how the cash payments for construction should be presented in the statement of cashflows. We believe the presentation depends on the expected lease classification at lease commencement. If there is clear evidence that the lease will be classified a sales-type lease, the lessor should accumulate the construction costs as inventory, and the cash outflows should be reflected in the operating section of the statement of cash flows. Otherwise, the lessor should accumulate the construction costs as property, plant, and equipment, and reflect the cash outflows in the investing section of the statement of cash flows. This cash flow model is consistent with the lessee model for payments and reimbursements for leasehold improvements in FSP 6.8.16.3.

6.8.18 Stock compensation

ASC 230 requires that upon the settlement or exercise of stock-based compensation awards, income taxes payable is reduced (or deferred taxes are adjusted, subject to normal valuation allowance considerations) for the tax effect of the deductions generated, and any windfalls or shortfalls are recorded in the income statement. Furthermore, ASC 230 requires that all tax-related cash flows resulting from share-based payments be reported as operating activities in the statement of cash flows.
When a reporting entity settles outstanding equity-classified stock awards with cash, the classification of the outflow in the statement of cash flows is dependent upon the amount of cash paid. If the cash paid to settle a stock award is less than or equal to the fair value of the award on the settlement date, then the amount of cash paid is charged to equity in the balance sheet and classified as financing activities in the statement of cash flows. However, if the amount paid to settle a stock award exceeds the fair value of the award on the settlement date, the amount paid in excess of fair value would be charged to compensation cost. As such, the cash payment to settle the stock award should be bifurcated in the statement of cash flows — a financing outflow equal to the settlement date fair value and an operating outflow for the amount paid in excess of the settlement date fair value.
If cash is paid to settle a liability-classified stock award, the amount of cash paid to repurchase the award would settle the liability, which would have already been charged to compensation expense. As such, a cash settlement of a liability-classified stock award should be classified as an operating cash outflow in the statement of cash flows.
Reporting entities/grantors may grant awards to employees/grantees that are exercisable prior to vesting so that the grantees’ holding period for the underlying stock begins at an earlier date to achieve a more favorable tax position. These awards have an “early exercise” feature. When grantees “early exercise” stock options, we believe that the cash received by the reporting entity/grantors should be presented as a cash inflow from financing activities. Although the underlying shares are not considered “issued” for accounting purposes when the cash is received (because the options are subject to vesting conditions), the cash represents proceeds in connection with awarding equity instruments that will not enter into the determination of net income.
Stock-based compensation plans may permit shares to be withheld by a reporting entity/grantor in exchange for agreeing to fund a grantee’s tax obligation. When the reporting entity/grantor pays the withholding taxes to the appropriate taxing jurisdiction, ASC 230 requires that the cash payment be presented as a financing outflow in the statement of cash flows.
The presentation as a financing activity follows the view that while the reporting entity made a cash payment to a taxing authority and not the grantee, in substance the reporting entity issued the gross number of shares to the grantee, and then repurchased from the grantee shares commensurate with the statutory tax withholding requirement. As a result, it would be appropriate to account for the “in substance” repurchase of shares as a purchase of treasury shares, which is a financing outflow.

6.8.19 Cash flows related to noncontrolling interests

Pursuant to ASC 810, noncontrolling interest holders are viewed as owners. ASC 230 indicates that financing activities include the provision of resources by owners and the return on, and return of, their investment. Therefore, dividends paid to noncontrolling interest holders should be classified as financing activities.
Cash paid to acquire a noncontrolling interest, or cash received from the sale of a noncontrolling interest, should be presented as a financing activity when the parent maintains control of the subsidiary. Cash received for the sale of an interest in a subsidiary should be classified as an investing activity in the consolidated statement of cash flows when the parent loses control of the subsidiary as a result of the transaction.
Because there is no guidance regarding transaction costs related to purchases and sales of noncontrolling interests, reporting entities may elect a policy to report such costs as either an expense in the income statement, or as a direct charge to equity. The classification of transaction costs in the cash flow statement should be consistent with that accounting. Therefore, if a reporting entity reflects transaction costs in its income statement, the related cash flows should be classified as an operating activity. If a reporting entity instead reflects the transaction costs as a direct charge to equity, the related cash flows should be classified as a financing activity.

6.8.20 Business combinations and asset acquisitions

Business combinations may generate multiple types of cash flows. Their classification can vary depending on the nature and source of the cash flows.
  • Business combinations

    Cash flows from sales and for purchases of productive assets, including the acquisition or sale of a business, are presented as investing activities if made soon before (e.g., within three months), soon after (e.g., within three months), or at the acquisition date. Payments not made soon after the acquisition date in a business combination are akin to seller-provided financing and therefore should be classified as a financing outflow in the statement of cash flows.

    In an acquisition, the unit of account is the acquired business, and therefore the individual changes in assets and liabilities that occur on the acquisition date in the consolidated financial statements are not reflected on the individual line items in the statement of cash flows. Rather, the statement of cash flows should reflect, as a single line item, cash paid to purchase a business. This line item should be net of any cash acquired. Occasionally, the cash acquired can be greater than the cash paid and can result in a net cash inflow. Since the nature of the transaction is the acquisition of a business, we believe that a net cash inflow would still be presented within the investing section.

    The noncash effects of a business combination, including any noncash consideration included in the purchase consideration and the significant assets and liabilities of the acquirer, are required to be disclosed. Consideration that is not expected to be paid soon after the acquisition date would be considered a noncash financing activity at the acquisition date and a cash outflow from financing activities when paid (see FSP 6.9.2). Subsequent to the acquisition of a business, cash flows of the newly acquired business are combined with those of the consolidated entity and presented within operating, investing, and financing activities as appropriate.
  • Transaction costs

    Cash paid by the buyer for transaction costs incurred in a business combination would be classified as operating activities in the statement of cash flows. ASC 805-10-25-23 requires transaction costs to be expensed as incurred, thus establishing that the nature of transaction costs is that of an operating activity.
  • Contingent consideration

    Contingent consideration arrangements will often be settled at an amount different than the amount initially included in the measurement of the consideration transferred. Contingent consideration classified as a liability is remeasured to fair value at each reporting date until the contingency is resolved. Changes in fair value that are not measurement period adjustments are recognized in earnings. These subsequent changes in the fair value of the contingent consideration arrangement should be recorded as an adjustment to reconcile net income to cash flows from operating activities under the indirect method of presentation.

    ASC 230-10-45-13 through ASC 230-10-45-17 indicates that the classification of contingent consideration in the statement of cash flows depends on the timing and amount of the payment and should be reflected as follows:

    Timing of payment after the acquisition date
    Amount
    Classification
    Soon after the acquisition date (e.g., within three months)
    All payments related to contingent consideration made soon after the acquisition date, including amounts related to fair value remeasurements
    All payments should be classified as investing cash outflows.
    Three or more months after the acquisition date
    Liability is settled at an amount equal to or less than the acquisition date fair value (plus or minus measurement period adjustments)
    The cash payment is akin to seller-provided financing and therefore should be classified as a financing outflow in the statement of cash flows.
    Liability is settled at an amount greater than the acquisition date fair value (plus or minus measurement period adjustments)
    The portion of the payment in excess of the acquisition date fair value (plus or minus measurement period adjustments) should be classified as an operating outflow, because this portion of the payment impacts net income. The remaining amount should be classified as a financing outflow.
    When determining whether a liability is settled at an amount greater than the acquisition date fair value, reporting entities should include all payments made to satisfy the contingent consideration, including payments made soon after the acquisition and classified as investing cash outflows.
    While the suggested threshold of three months or less is not included in the codification, it was the period suggested by some members of the EITF (referenced in the Basis for Conclusions of ASU 2016-15).
  • Working capital adjustments

    A working capital adjustment is typically included in a purchase and sale agreement as a means of agreeing on the amount of working capital that existed, and was thus acquired, as of the acquisition date. The subsequent determination of working capital that existed as of the acquisition date does not relate to future events or conditions. Accordingly, payments or receipts for changes in provisional amounts for working capital are recognized as an adjustment of consideration transferred by the acquirer in its acquisition accounting if the changes occur during the measurement period. Payments or receipts for changes in provisional amounts for working capital that occur outside of the measurement period should be recognized in current period earnings.
  • Pushdown accounting

    When pushdown accounting is not applied to the financial statements of a subsidiary as a result of a business combination, cash flows should only be reported by the entity actually involved in the cash transactions. When pushdown accounting has been elected, there may be alternatives in how to present the cash flows in the financial statements of the subsidiary. In all cases, appropriate disclosure of the form of the transaction and the resulting cash flows should be made.
  • Acquired IPR&D in an asset acquisition

    In accordance with ASC 730-10-25-2(c), intangible assets used in research and developmental activities that are acquired in an asset acquisition should be expensed at the acquisition date if there is no alternative future use in other R&D projects or otherwise. Cash flows related to the acquisition of such in-process research and development (IPR&D) assets require consideration of the nature of the underlying cash flow in determining its classification. In general, a reporting entity should classify the cash outflow based on what is likely to be the predominant use of cash in accordance with ASC 230-10-45-22A. On the one hand, such assets are considered intangible assets (productive assets) that have no useful life. On the other hand, expenditures for such assets are immediately recognized as research and development expenses in the income statement. Given that the nature of this cash flow has aspects of more than one class of cash flows as well as the lack of authoritative guidance in this area, we believe that classification in either operating or investing activities is acceptable. Reporting entities should consistently apply their classification conclusion to similar transactions.
  • Debt extinguished in conjunction with a business combination

    Debt extinguished by the acquirer in connection with a business combination requires careful evaluation of the facts and circumstances of the arrangement to determine how the cash flows should be presented. We believe the presentation of cash flows should be based upon whether the acquirer legally assumed the debt.

    When determining whether the acquirer legally assumed the debt, consideration should be given to all relevant factors, which may include the following:
    • If repayment of an acquiree's debt is required by the terms of the acquisition agreement, it is important to understand the reasons for including this provision as well as the timing and method of settlement.
    • If the lender provides a concession that allows the acquiree's debt to be assumed by the acquirer or settled after the acquisition date, such concession indicates that the acquirer has assumed the debt. Therefore, it is important to understand the specific terms of any change in control provisions, and whether the lender was required to grant consent to allow the acquirer to assume the debt.
    • If the debt is settled after the acquisition date, it indicates the debt was assumed by the acquirer in the acquisition. Therefore, understanding the timing of extinguishment in relation to the acquisition date is also important.

    If an acquirer legally assumes debt, we believe it is appropriate to record the debt at fair value on the acquirer's balance sheet as a liability assumed in the acquisition. The debt would therefore be included net in the "acquisition of a business, net of cash acquired" line in investing activities, rather than as a financing inflow. Any subsequent payments related to the debt would be classified as a financing cash outflow, as discussed in FSP 6.8.7, since the debt is the legal obligation of the acquirer at the time the debt is extinguished.

    If an acquirer does not legally assume debt as part of an acquisition and the debt is extinguished on the acquisition date, we believe any funds provided by the acquirer to extinguish the acquiree's debt should be reflected by the acquirer as consideration transferred in the acquisition and classified as an investing cash outflow.

    In limited circumstances, it may be appropriate to consider debt that has been legally assumed and extinguished by the acquirer to be acquisition consideration transferred and an investing cash outflow. This should only occur when the acquirer extinguishes the assumed debt as an integrated part of closing the acquisition, and it is accomplished in close proximity to the acquisition date (i.e., within approximately 1 day), such that it is clear that the acquirer did not substantively assume the risks inherent in the borrowing. In these circumstances, if a cash payment to extinguish acquiree debt is considered part of the acquisition consideration and therefore classified as an investing outflow, the extinguished debt should not be disclosed elsewhere as a liability assumed in the business combination.

6.8.20.1 Carve-out financial statements

Preparing the statement of cash flows for a carve-out reporting entity can be challenging. CO 6.4 explains some of the specific considerations, such as distinguishing the bank accounts and intercompany accounts that form the basis for the transactions in the statement of cash flows of the carve-out reporting entity. Determining the equity amounts requires judgment. As discussed in CO 4.4, the parent investment shown in the statement of changes in equity should be reconcilable to the financing section of the cash flow statement for the carve-out reporting entity.

6.8.21 Cash flow presentation of insurance claim proceeds

ASC 230 requires that cash proceeds received from the settlement of insurance claims (with the exception of proceeds received from corporate-owned life insurance policies and bank-owned life insurance policies, discussed in FSP 6.8.22) be classified on the basis of the related insurance coverage. In other words, the classification should be made based on the nature of the loss. For example, insurance proceeds related to damage of equipment are investing inflows while proceeds related to business interruption are operating inflows.

6.8.22 Cash flow presentation of life insurance proceeds

Life insurance policies are purchased for a variety of purposes, including funding the cost of providing employee benefits and protecting against the financial consequences of the loss of key persons. These types of policies are generally known as corporate-owned life insurance and bank-owned life insurance. ASC 230-10-45-21C requires that cash proceeds received from the settlement of corporate-owned life insurance policies and bank-owned life insurance policies be classified as investing cash inflows. Payments for premiums on corporate-owned policies may be classified as cash outflows for investing activities, operating activities, or a combination of investing and operating activities.
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