Current accounting rules are either unclear or silent on how to classify cash flows in certain instances, so the Financial Accounting Standards Board is proposing an update to the Accounting Standards Codification to fill the gaps.
The Emerging Issues Task Force of the Financial Accounting Standards Board researched reports of diversity in how companies classify cash flows for eight specific types of transactions. The EITF recommended new rules that FASB is now proposing as a formal Accounting Standards Update to revise ASC Topic 230 on the statement of cash flows.
The issues arise with transactions such as debt prepayments or debt extinguishment costs, settlement of zero-coupon bonds, payments of contingent consideration in a business combination, proceeds from the settlement of insurance claims (including corporate-owned and bank-owned life insurance policies), distributions from equity-method investees, and beneficial interests in securitization transactions. Questions also surround when to separate cash receipts and cash payments to classify them differently in the statement of cash flows.
FASB is proposing new guidance to address each specific cash flow classification issue raised by the EITF. For debt prepayments or extinguishment costs, for example, FASB is suggesting companies be required to classify them as cash outflows for financing activities. For settlement of zero-coupon bonds, FASB says entities should classify the portion of the cash payment that goes to the accreted interest as cash outflows from operating activities, while the portion associated with principal should be classified as cash outflows from financing activities.
For contingent consideration not paid soon after a business combination, FASB says payments should be classified as operating or financing cash flows. Payments up to the amount of the liability recognized on the acquisition date would be classified as financing activities, and any excess would be classified under operating activities. For insurance proceeds, FASB says the classification would depend on the nature of the loss; for corporate-owned life insurance proceeds, thoe would be classified as investing activities, but premium payments might be investing or operating activities.
FASB has not set a target effective date for the proposal, but has indicated companies will be required to apply it retrospectively to all prior periods presented. “If it is impracticable to apply the proposed amendments retrospectively for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date practicable,” FASB says. Comments are requested by March 29.