Update to cash flow guidance

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Thanks to his vast experience in corporate accounting, Mayank Gupta knows how important cash flow is to business. During his time working in finance and accounting for major corporations such as Deloitte, PWC, and General Motors, Mayank Gupta became an expert on the subject and would like to take a moment to share with others what he knows about the update to the cash flow guidance.

FASB finalizes guidance to simplify elements of cash flow classification

On August 26, 2016, the FASB issued Accounting Standard Update 2016­-15, Statement of Cash Flows (Topic 230), a consensus of the FASB’s Emerging Issues Task Force. The new guidance is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows.

Mayank Gupta reviews the issues addressed in the new guidance:

  1. Debt prepayment or debt extinguishment costs. ​Cash payments for debt prepayment or debt extinguishment costs should be classified as cash outflows for financing activities.
  2. Settlement of zero­coupon debt instruments. ​Cash payments for the settlement of zero­coupon debt instruments, including other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing, should be classified as cash outflows for operating activities for the portion attributable to interest and as cash outflows for financing activities for the portion attributable to principal.
  3. Contingent consideration payments made after a business combination. ​Cash payments made soon after an acquisition’s consummation date (i.e., approximately three months or less) should be classified as cash outflows for investing activities. Payments made thereafter should be classified as cash outflows for financing activities up to the amount of the original contingent consideration liability. Payments made in excess of the amount of the original contingent consideration liability should be classified as cash outflows for operating activities.
  4. Proceeds from the settlement of insurance claims. ​Cash payments received from the settlement of insurance claims should be classified on the basis of the nature of the loss (or each component loss, if an entity receives a lump­sum settlement).
  5. Proceeds from the settlement of corporate ­owned life insurance (COLI) policies, including bank­owned life insurance (BOLI) policies. Cash payments received from the settlement of COLI policies should be classified as cash inflows from investing activities. Cash payments for premiums on COLI policies may be classified as cash outflows for investing, operating, or a combination of investing and operating activities.
  6. Distributions received from equity method investments. ​The guidance provides an accounting policy election for classifying distributions received from equity method investments. Such amounts can be classified using a 1) cumulative earnings approach, or 2) nature of distribution approach. Under the cumulative earnings approach, an investor would compare the distributions received to its cumulative equity­ method earnings since inception. Any distributions received up to the amount of cumulative equity earnings would be considered a return on investment and classified in operating activities. Any excess distributions would be considered a return of investment and classified in investing activities. Alternatively, an investor can choose to classify the distributions based on the nature of activities of the investee that generated the distribution. If the necessary information is subsequently not available for an investee to determine the nature of the activities, the entity should use the cumulative earnings approach for that investee and report a change in accounting principle on a retrospective basis.
  7. Beneficial interests in securitization transactions. A​ transferor’s beneficial interest obtained in a securitization of financial assets should be disclosed as a noncash activity. Cash receipts from a transferor’s beneficial interests in securitized trade receivables should be classified as cash inflows from investing activities.
  8. Separately identifiable cash flows and application of the predominance principle. E​ntities should use reasonable judgement to separate cash flows. In the absence of specific guidance, an entity should classify each separately identifiable cash source and use on the basis of the nature of the underlying cash flows. For cash flows with aspects of more than one class that cannot be separated, the classification should be based on the activity that is likely to be the predominate source or use of cash flow.

The guidance is intended to reduce diversity in practice across all industries.

For public business entities, the standard is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. For all other entities, the standard is effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Early adoption is permitted, provided that all of the amendments are adopted in the same period. The guidance requires application using a retrospective transition method.

Thank you for taking the time to review this informative blog by Mayank Gupta. Visit our blog again soon for more financial and accounting advice from corporate finances guru Mayank Gupta.

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