An In-Depth Look at the FASB's Cash Flow ASU

It is no secret that the cash flow statement has long been a source of heartache for both preparers and regulators of public company financial statements.  In fact, Audit Analytics cited the cash flow statement as the cause for 16.7% of restatements in 2015.  That’s a total of 123 restatements which is down slightly from 179 and 178 in 2014 and 2013, respectively.  Nevertheless, cash flow statement errors have been the second most common cause for restatements in each of the past five years according to Audit Analytics.

In August, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.  The issuance of ASU 2016-15 was the culmination of a project starting in April 2014 that was aimed at eliminating diversity in the presentation of certain transactions in the cash flow statement and cutting down on the number of errors and restatements caused by the cash flow statement.  The FASB’s belief was that existing guidance was not specific enough, and as such, requested that the Emerging Issues Task Force (EITF) address nine issues.  The issues addressed by the EITF, and the clarifications provided by ASU 2016-15, are provided in the table below:  

Issue Transaction Exsisting Guidance / Diversity Issues New Guidance
1 Debt Prepayment or Debt Extinguishment Costs Treated as a financing activity, or an operating activity, based on the entity's belief in whetherthe payment represents forgone future interest or interest incurred All cash payments for the debt prepayment or debt extinguishment, including third-party costs, premiums paid to repurchase debt, and fees paid to lenders, should be classified as cash outflows from financing activities.
2 Settlement of Zero-Coupon Debt Instruments and Other Debt Instruments with Coupon Interest Rate That Are Insignificant in Relation to the Effective Interest Rate of the Borrowing Diversity in practice exists specifically for the portion of the cash payment attributable to accreted interest related to the debt discount.  Some entities believe this portion represents a cash outflow from operating activities while others believe this is a noncash transaction. At the settlement date, the portion of the payment attributable to accreted interest related to the debt discount should be classified as cash outflows for operating activities.  The portion attributable to principal should be classified as cash outflows for financing activities.
3 Contingent Consideration Payments Made After a Business Combination The existing guidance does not specify a treatment for payments of contingent consideration.  The lack of guidance led to various treatments including classifications as operating, investing, and financing activities. Cash payments made soon after the acquisition date should be classified as cash outflows for investing activities.  Cash payments not made soon after the acquisition date should be classified as financing activities to the extent they do not exceed the contingent consideration liability recognized on the date of the acquisition.  Any excess should be classified as operating activities.
4 Proceeds From the Settlement of Insurance Claims The existing guidance requires treatment as an operating activity unless directly related to investing or financing activities.  There is confusion regarding what is a direct relationship to investing or financing activities and whether that was intended to mean a relationship to the insurance coverage or the use of the proceeds.  Cash proceeds should be classified on the basis of the related insurance coverage and the nature of the loss.
5 Proceeds From the Settlement of Corporate-Owned Life Insurance Policies, including Bank-Owned Life Insurance Policies Treated as an operating activity or an investing activity depending on the entity’s intended objectives or purpose for acquiring the policy (providing employee benefits, protecting against loss of key employee, etc.) Cash proceeds should be classified as cash inflows from investing activities.
6 Distributions Received From Equity Method Investees Returns on investment are generally treated as an operating activity, while returns of investment are generally treated as an investing activity.  However, diversity in practice exists in the methodology for determining what is a return on investment, and what is a return of investment. A Company must make an accounting policy election to treat distributions under the Cumulative Earnings Approach or the Distribution Approach.  These approaches determine whether distributions represent returns on investment or returns of investment.  Consistent with existing concepts, returns on investment should be classified as cash inflows from operating activities, while returns of investment should be classified as cash inflows from investing activities.    
7 Beneficial Interests in Securitization Transactions The existing guidance does not specifically address beneficial interests obtained in securitization transactions.  The lack of guidance led to various treatments.  The existing guidance also does not specifically address subsequent cash receipts from payments on beneficial interests obtained by the transferor in a securitization of the transferor’s trade receivables.  As such, diversity in practice exists as some entities classify these payments as cash inflows from operating activities, while other entities classify these payments as cash inflows from investing activities. A transferor’s beneficial interest obtained in a securitization of financial assets should be disclosed as a noncash activity, and collections on a transferor’s beneficial interest in securitized trade receivables should be classified as cash inflows from investing activities.
8 Separately Identifiable Cash Flows and Application of the Predominance Principle In many cases, cash receipts and cash payments have aspects of more than one class of cash flows and should be classified based on the nature of the predominant source of the cash flow.  There is a lack of guidance in how to apply this “predominance principle” resulting in diversity in the interpretation and application of this concept. Classification should first be determined by applying specific guidance within existing generally accepted accounting principles.  When specific guidance does not exist, an entity should seek to determine each separately identifiable source/use within each receipt/payment and classify each portion of the receipt/payment based on the nature of the source/use.  When a receipt/payment cannot be bifurcated by source/use, the entire receipt/payment shall be classified based on the predominant source/use of the receipt/payment.  
9 Restricted Cash No action taken.  Restricted cash will be addressed separately.

This ASU is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years.  For all other entities, the ASU is effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019.  Early adoption is permitted.

For more information about this ASU, contact Schneider Downs or check out related Our Thoughts On articles.    

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