Issue No. 15-F, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments EITF Educational Meeting

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1 Issue No. 15-F, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments EITF Educational Meeting May 14,

2 Project Background and Objective Diversity in practice in application of Topic 230, Statement of Cash Flows Reduce the diversity and improve financial reporting 2

3 Board Decisions to Date April 28, 2014 Agenda Prioritization Board Meeting - Added a limited-scope cash flows project to the technical agenda Scope: clarification of certain existing principles in Topic 230 on what should be considered in determining the classification of cash flows and how that determination should be made April 1, 2015 Board Meeting - Nine cash flow classification issues added to EITF agenda - Broad-based research project added to FASB agenda, focused on classification 3

4 Cash Flow Classification Issues Added to EITF Agenda June 18, 2015 EITF Meeting 1. Debt prepayment or extinguishment costs 2. Settlement of zero-coupon bonds 3. Contingent consideration payments made after a business combination 4. Restricted cash 5. Proceeds from the settlement of insurance claims 6. Proceeds from the settlement of corporate-owned life insurance policies September 17, 2015 EITF Meeting 7. Distributions received from equity method investees 8. Beneficial interests in securitization transactions 9. Application of the predominance principle 4

5 Issue 1: Debt Prepayment or Extinguishment Costs Issue Description Often, a borrower is contractually required to pay the lender a fee to prepay or extinguish debt The fee represents: - Approximation of the interest that will not be paid - Penalties and other lender costs No specific cash flow classification guidance currently exists Question: How should payments made for debt prepayment or extinguishment costs be classified in the statement of cash flows? 5

6 Debt Prepayment or Extinguishment Costs Predominant Views View A: As an operating activity - Represent an adjustment of the debt s effective interest rate - Do not represent repayments of amounts borrowed View B: As a financing activity - Analogize to payments of debt issue costs, which are cash flows from financing activities 6

7 Issue 2: Settlement of Zero Coupon Bonds Issue Description Issuer of a zero-coupon bond classifies the cash proceeds as a financing inflow The bond is accreted up to its redemption value through recognition of interest expense No interest payments are made until maturity At settlement, original proceeds plus accreted interest is paid Question: How should the cash payment for the settlement of a zerocoupon bond be classified in the statement of cash flows? 7

8 Settlement of Zero Coupon Bonds Predominant Views View A: As both an operating activity (that is, the cumulative interest expense) and a financing activity (that is, the repayment of principal) View B: As a financing activity (that is, only a repayment of principal) - Accrued interest is viewed as being effectively refinanced with additional principal due upon redemption of the bonds 8

9 Issue 3: Contingent Consideration Payments Made After a Business Combination Issue Description No specific cash flow classification guidance currently exists Accounting for contingent consideration liability - Recognized at acquisition-date fair value - Remeasured to fair value through earnings at each reporting date until the contingency is resolved Question: How should a cash payment made for a contingent consideration liability be classified in the statement of cash flows? 9

10 Contingent Consideration Payments Made After a Business Combination Predominant Views View A: As an investing activity - Payment is related to the acquisition of the business View B: As a financing activity - Payment represents a contractual obligation to pay the seller (seller-financed debt) View C: As both a financing and an operating activity - Financing activity, for portion of liability recognized at acquisition-date fair value - Operating activity, for portion of liability remeasured to fair value and recognized in earnings 10

11 Contingent Consideration Payments Made After a Business Combination - Example View A: $1,750,000 would be classified as an investing activity. View B: $1,750,000 would be classified as a financing activity. View C: $1,250,000 would be classified as financing and $500,000 as an operating activity. Fact Pattern: On December 31, 20X5, Entity A acquires Entity B. Entity A recognizes a provisional contingent consideration liability in the amount of $1,000,000 in its initial accounting for the business combination. Debit Credit Identifiable assets/goodwill $ 1,000,000 Contingent consideration liability $ 1,000,000 On April 30, 20X6, the final valuation indicates contingent consideration liability of $1,250,000 should have been recognized in the accounting for the business combination. Entity A increases the contingent consideration liability through a measurement period adjustment in the amount of $250,000. Debit Identifiable assets/goodwill $ 250,000 Credit Contingent consideration liability $ 250,000 There is a change in the facts and circumstances. The fair value of the contingent consideration liability at the end of December 31, 20X6, is $1,750,000. Entity A increases the contingent consideration liability through a subsequent accounting adjustment and recognizes $500,000 in the income statement. Debit Expense $ 500,000 Credit Contingent consideration liability $ 500,000 Payment: On February 28, 20X7, Entity A paid $1,750,000 to settle the contingent consideration liability. Debit Contingent consideration liability $ 1,750,000 Credit Cash $ 1,750,000 11

12 Issue 4: Restricted Cash Subissue 4a Description Changes in restricted cash occur when deposits and withdrawals are made Changes often are transfers between restricted cash and unrestricted cash (cash and cash equivalents) Transfers occur when: - Restricted cash account is established (cash transfer from unrestricted cash to restricted cash) - When restrictions are released (cash transfer from restricted cash to unrestricted cash) Question: How should the changes in restricted cash be classified in the statement of cash flows when unrestricted cash is affected? 12

13 Restricted Cash Predominant Views Subissue 4a View A: Cash flows from both establishment and release of a restricted cash account should be classified as an investing activity. - Investment in a restricted cash vehicle is similar to an investment in marketable securities - Deposits and withdrawals of principal balances in restricted cash accounts represent the creation or return of investment View B: Cash flows should be classified based on the future use (purpose) of cash for which the restricted cash account was established See examples (Slide 14) 13

14 Restricted Cash Subissue 4a Examples Example 1: An entity is required by its insurer to establish a restricted cash account for future payment of workers' compensation claims. The restricted cash is to be invested in an interest-bearing account until the restriction is released and cash payments are made for workers' compensation claims. View A View B Cash Flow #1: Set up the restricted cash account (move money from the unrestricted account to the restricted cash account) Investing outflow Operating outflow Cash Flow #2: Release from restriction occurs (move money from the restricted cash account to the unrestricted cash account) Investing inflow Operating inflow Example 2: An entity is required by its lender to establish a restricted cash account for the future payment of debt. The restricted cash is required to be invested in an interest-bearing account until the restriction is released and a cash payment is made to pay down debt. View A View B Cash Flow #1: Set up restricted cash account (move money from the unrestricted account to the restricted cash account) Investing outflow Financing outflow Cash Flow #2: Release from restriction occurs (move money from the restricted cash account to the unrestricted cash account) Investing inflow Financing inflow 14

15 Restricted Cash Subissue 4b Description There are changes in restricted cash when: - Cash payments are made directly from restricted cash - Cash receipts are deposited directly into restricted cash Cash and cash equivalents are not affected by the changes Question: How should the changes in restricted cash be presented in a statement of cash flows when cash is paid directly from restricted cash and when cash is deposited directly into restricted cash? 15

16 Restricted Cash Predominant Views Subissue 4b View A: As noncash disclosures - Direct changes in restricted cash do not affect cash and cash equivalents View B: Present cash payments and receipts in the body of the statement of cash flows - Direct changes in restricted cash are actual cash payments and receipts, which is different from typical noncash transactions - No guidance on disclosure of noncash operating activities currently exists 16

17 Issue 5: Proceeds from the Settlement of Insurance Claims Issue Description Topic 230 states that cash inflows from operating activities include proceeds of insurance settlements except those directly related investing or financing activities, such as from destruction of a building. Stakeholders are unclear about: - Whether classification should be based on the nature of the covered loss or the intended use of the proceeds - What directly related to investing or financing activities means - Whether proceeds received in a lump sum settlement should be classified into more than one class of cash flows using estimation 17

18 Proceeds from the Settlement of Insurance Claims Predominant Views View A: Classification should be based on the insurance coverage (that is, the nature of the insured event) View B: Classification should be based on the planned use of the insurance proceeds View C: Proceeds received should be classified as operating activities See example (Slide 19) 18

19 Proceeds from the Settlement of Insurance Claims - Example Fact Pattern A manufacturing entity sustained significant fire damage to its manufacturing facility that was covered by a property and casualty insurance policy with an insurer. In addition to the loss of manufacturing equipment and inventory at the facility, the entity shut down its operations for a period of time because it was unable to produce its products. The manufacturing entity plans to use all of the proceeds to re-build the facility. Question: How should the proceeds received from the settlement of the insurance claim be classified in the statement of cash flows? View A The cash proceeds would be classified based on the nature of the insurance coverage (nature of the loss). Nature of the Loss Manufacturing facility Manufacturing equipment Inventory Business interruption Classification Investing activity Investing activity Operating activity Operating activity View B The entire amount of cash proceeds received would be classified as an investing activity because the planned use of the insurance proceeds is to re-build the facility, a productive asset. View C The entire amount of cash proceeds received would be classified as an operating activity because maintaining an insurance policy is an operating function. 19

20 Issue 6: Proceeds from the Settlement of Corporate Owned Life Insurance Policies Issue Description Cash receipts and payments related to life settlement contracts are classified based on the nature and purpose for which the contracts were acquired (Paragraph ) Policies are purchased for a variety of purposes Nature and purpose can result in competing or multiple classifications Question: How should the proceeds from the settlement of corporateowned life insurance policies be classified in the statement of cash flows? 20

21 Proceeds from the Settlement of Corporate Owned Life Insurance Policies Predominant Views View A: As an operating activity - Funds the cost of employee benefits, nature of operations View B: As an investing activity - Investment income accumulated tax-free through the buildup of the cash surrender value (CSV) View C: As both an investing activity and an operating activity - Investing activity, for portion of proceeds equal to amount of CSV - Operating activity, for portion of proceeds in excess of CSV 21

22 Issue 7: Distributions Received from Equity Method Investees Issue Description How to determine whether the cash receipts from an equity method investee represent a return on investment (operating activity) or a return of investment (investing activity) Question: How should the classification of distributions received from an equity method investee in the statement of cash flows be determined? 22

23 Distributions Received from Equity Method Investees Predominant Views View A: Cash flow classification depends on whether the distributions exceed cumulative equity earnings - Cumulative distributions < cumulative equity in earnings = return on investment - Cumulative distributions > cumulative equity in earnings = return of investment View B: Specific facts and circumstances of each cash distribution are evaluated to determine whether the nature is a return on or return of investment View C: All distributions received are cash inflows from investing activities 23

24 Issue 8: Beneficial Interests in Securitization Transactions Subissue 8a Description When an entity initially sells receivables in a securitization transaction, it typically retains an interest in the receivables. Question: How should the retained interest obtained at the inception of a securitization transaction be classified in the statement of cash flows? 24

25 Beneficial Interests in Securitization Transactions Predominant Views Subissue 8a View A: Classify the retained beneficial interest on a gross basis - Cash inflow from the sale of trade receivables, including retained beneficial interest - Cash outflow for the purchase of the retained beneficial interest in the securitization View B: Disclose the retained beneficial interest as a noncash activity - No cash inflow occurred for the retained benefit interest at the inception of the securitization transaction 25

26 Beneficial Interests in Securitization Transactions Subissue 8b Description The holder of the retained interest will receive a share of the collections of principal payments from the securitized assets. Question: How should the cash received from principal payments of the securitized assets be classified in the statement of cash flows? 26

27 Beneficial Interests in Securitization Transactions Predominant Views Subissue 8b View A: Principal payments received are similar to cash proceeds from the sale of a security - Classify principal payments received as investing activities View B: Retained interests are considered a securitization of customerrelated receivables instead of a re-characterization as securities - Classify principal payments received as operating activities 27

28 Issue 9: Application of the Predominance Principle Issue Description Topic 230 recognizes that the most appropriate classification will not always be clear Some cash receipts and payments have aspects of more than one class of cash flows - In those situations, the appropriate classification depends on the activity that is likely to be the predominant source of cash flows. Some stakeholders have said it is unclear which factors to use to assist in determining predominant cash flow It is not often apparent when classification is based on predominance Questions: What factors can or should be used to determine the predominant source of cash flows? What disclosures should be provided to improve financial reporting when classification is based on predominance? 28

29 Application of the Predominance Principle Predominant Views View A: Include guidance on additional factors to be used in determining predominant cash flow - Ex: Historical cash flows, projected cash flows, short period View B: When classification is determined using the predominant cash flow, require disclosure of: - A description of the transaction giving rise to the cash flows - The classification of cash receipts and disbursements in the statement of cash flows - The amount of cash flows, if not presented on its own line item on the face of the statement of cash flows View C: Includes both View A and View B 29

30 Questions or Comments? 30

EITF Issue No. 15-F, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments Private Company Council Meeting

EITF Issue No. 15-F, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments Private Company Council Meeting July 21, 2015 1 EITF Issue No. 15-F Background and Objective Background