In Accounting Standards Update (ASU) No. 2016-15, Statement of Cash Flows, the Financial Accounting Standards Board (FASB) provides companies with guidance on how to classify certain cash payments and receipts in their cash flow statements. For public companies, the update applies to financial statements for fiscal years beginning after December 15, 2017, and includes interim periods within those fiscal years.

Rodney Dangerfield of statements

The newest of the three basic financial statements, the statement of cash flows hasn’t enjoyed the same respect as the balance sheet and income statement. The FASB introduced it in 1987 to provide financial statement users with information about how a company receives and uses its cash. Unfortunately, a scarcity of guiding principles for evaluating and presenting this information has led to inconsistent practices.

Generally, companies can classify payments and receipts as operating activities, financing activities or investing activities. But if one company includes an item in operating activities while another company includes the same item in financing activities, comparing the two entities’ statements can be challenging.

The FASB’s update offers welcome consistency and is intended to reduce the diversity that currently exists in practice. It sets basic rules for classifying certain payments and receipts.

8 cash-flow issues

The ASU provides classification rules for eight types of cash flow:

  1. Debt prepayment or extinguishment. You must classify cash payments for debt prepayment or extinguishment costs as cash outflows for financing activities.
  2. Settlement of zero-coupon debt instruments. For cash payments to settle zero-coupon debt instruments — as well as other instruments with coupon interest rates that are insignificant relative to the borrowing’s effective interest rate — the ASU distinguishes between interest and principal. You’ll need to classify the portion attributable to interest as cash outflows for operating activities, and the portion attributable to principal as cash outflows for financing activities. While some companies currently use this approach, many companies classify the entire payment under financing activities.
  3. Post-merger contingent consideration payments. How cash payments to settle contingent consideration liability after a merger or other business combination (“earnouts,” for example) are classified depends on their timing. If you make payments “soon after” completing the transaction (the FASB suggests three months or less), you must classify them as cash outflows for investing activities. After that, classify them as cash outflows for financing activities up to the acquisition-date contingent consideration liability, and classify any excess as cash outflows for operating activities.
  4. Proceeds from the settlement of insurance claims. Classify cash receipts from the settlement of insurance claims on the basis of the nature of the loss. In the case of a lump-sum settlement, classify on the basis of the nature of each loss included in the settlement.
  5. COLI proceeds. You will need to classify cash receipts from the settlement of corporate-owned life insurance (COLI) policies as cash inflows from investing activities. You’ll then classify COLI premium payments as cash outflows for either operating activities, investing activities or a combination of the two.
  6. Distributions received from equity method investees (investments in other companies). Generally, you’ll classify distributions that represent returns on investment as cash inflows from operating activities, while classifying distributions that represent returns of investment as cash inflows from investing activities. The ASU requires you to elect an accounting policy — the cumulative earnings or distribution approach — to distinguish between the two.
  7. Beneficial interests in securitization transactions. A transferor’s beneficial interest obtained in a securitization of financial assets should be classified as a noncash activity. But, you’ll classify cash receipts from payments on a transferor’s beneficial interests in securitized trade receivables as cash inflows from investing activities. Currently, many companies classify receipts from securitized trade receivables under operating activities, so this change may have a significant impact.
  8. Separately identifiable cash flows. It’s not unusual for cash inflows or outflows to have characteristics of more than one of the three cash-flow classes. Under those circumstances, you must apply any specific guidance in Generally Accepted Accounting Principles. In the absence of such guidance, you should classify each separately identifiable source or use within cash receipts or payments based on the nature of the underlying cash flows. You should classify cash flows with characteristics of more than one class that can’t be separated by source or use based on the activity that’s likely to be the predominant source or use for that item.

Go with the flow

In preparation for these new cash-flow classification rules, your company should review the ASU and evaluate its potential impact on cash-flow statements. Then determine whether you need to revise your accounting policies and procedures. The ASU permits early adoption, so get started now. 

Rich Bellucci

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