The FASB released a proposal to clarify eight parts of its guidance on company cash flow statements. The proposal aims to clear up some of the most frequently asked questions about a complex area of accounting.
The FASB on January 29, 2016, released for public comment a proposal to clarify eight narrow pieces of guidance for reporting cash flows.
Comments on Proposed Accounting Standards Update (ASU) No. EITF-15F, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments — A Consensus of the FASB Emerging Issues Task Force, are due by March 29.
Cash flow statement reporting is a complex area of accounting and a leading cause of company financial restatements. The proposed changes, which were forwarded to the FASB from its Emerging Issues Task Force (EITF), attempt to settle some of the frequently asked questions on FASB ASC 230, Statement of Cash Flows,formerly SFAS No. 95.
Topic 230 provides guidance on classifying and presenting cash receipts and payments as either operating, investing, or financing activities, but critics say the guidance is confusing and, at times, contradictory. In 2012, company reporting errors about cash flow reporting were the third-highest cause of restatements, FASB research has shown.
“Current GAAP is either unclear or does not include specific guidance on the eight cash flow classification issues included in this proposed update,” the FASB wrote in the introduction to the proposal. “The amendments in this proposed update are an improvement to GAAP because the proposed amendments would provide guidance for each of the eight issues, thereby reducing the current and potential future diversity in practice.”
The FASB in April 2014 started work to clarify the most confusing parts of cash flow reporting by coming up with a broad principle for classifying the items in the cash flow statement. A year later, the board realized it would be a much bigger effort than it thought and decided instead to focus on a narrow list of specific problems, which it passed on to the EITF.
The task force’s assignment was considered unusual because the EITF typically handles questions that can be resolved in one meeting or maybe two, but the cash flow project was a much larger undertaking. The board in November agreed that it needed to split the endeavor into two parts, tackling eight narrow questions in phase one and a larger question in phase two. The second phase, to be discussed in 2016, will cover how to classify and present changes in restricted cash on the statement of cash flows.
The January 29 proposal covers several areas.
Debt prepayment or debt extinguishment costs — penalties paid by borrowers to settle a debt ahead of time — should be classified as cash outflows for financing activities.
The cash payment attributable to accreted interested on zero-coupon bonds, a type of debt security that is issued or traded at significant discounts, should be classified as a cash outflow for operating activities. The portion of the cash payment attributable to principal should be classified as a cash outflow for financing activities.
Cash payments for the settlement of a contingent consideration liability made by a business after it buys another business should be separated and classified as cash outflows for financing activities and operating activities. Contingent consideration is typically an obligation to transfer additional assets or equity interests to the former owners of the acquired businesses if certain conditions are met.
The proceeds from the settlement of insurance claims should be classified based on the type of insurance coverage and the type of loss. For example, a claim to cover destruction of a building would be classified in investing activities while a claim to cover loss of inventory would be classified in operating activities.
Proceeds businesses receive from corporate-owned life insurance (COLI), the insurance policies they take out on employees, should be classified in investing.
Distributions received from equity method investees should be presumed to be returns on the investment and classified as cash inflows from operating activities, unless the investor’s distributions received less distributions received in prior periods that were determined to be returns of investment, exceed cumulative equity in earnings recognized by the investor.
For beneficial interests in securitization transactions, which are common transactions for financial companies, large retailers, and credit card companies, the FASB is proposing two changes — one would require disclosure of a transferor’s beneficial interest obtained in a securitization of financial assets as a noncash activity, and the second calls for classifying the cash receipts from payments on the transferor’s beneficial interests in securitized trade receivables as cash inflows from investing.
Finally, the proposal addresses one of the most complicated parts of cash flow presentation, a concept accountants call the “predominance principle.”
Topic 230 acknowledges that it is not always clear how cash flows should be classified, especially when cash receipts and payments have characteristics of more than one type of activity. In these situations, the standard says the business should look at the activity that is likely to be the “predominant” source of cash flows for the item.
The proposal calls for adding more guidance in the standard about how an organization should separate cash receipts and cash payments and when they should be separated into more than one cash flow stream.
In a separate move, the IASB on January 29 published Disclosure Initiative: Amendments to IAS 7, to require companies to provide cash flow information about changes in their debt from borrowing. (See Cash Flow Disclosure Requirements Are Amended to Highlight Borrowing Activity in today’s edition of Accounting & Compliance Alert.)