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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. 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 (net of cash acquired). 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. 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.
  • 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:Debt extinguished in conjunction with a business combination
    • 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 6.9.9, 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.
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