6
STATEMENT OF CASH FLOWS
INTRODUCTION
IAS 7, Cash Flow Statements, became effective in 1994.
The purpose of the statement of cash flows is to provide information on how the entity generates and spends cash. In doing so, the statement of cash flows presents cash flows which are free from other non‐cash accounting items, such as depreciation and impairment charges, for example.
- By focusing on cash flows the statement provides a useful basis for users of financial statements to assess the ability of the entity to generate cash (and cash equivalents) and to obtain a clearer view on how the entity uses and expends its cash balances including its ability to distribute cash to investors.
Source of IFRS IAS 7
SCOPE
The statement of cash flows is prepared in accordance with the requirements of IAS 7 and must be presented as an integral part of the financial statements for each period for which financial statements are presented.
DEFINITIONS OF TERMS
Cash. Cash on hand and demand deposits.
Cash equivalents. Short‐term highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.
Cash flows. Inflows and outflows of cash and cash equivalents.
Direct method. A method that derives the net cash provided by or used in operating activities from major components of operating cash receipts and payments.
Financing activities. Activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.
Indirect (reconciliation) method. A method that derives the net cash provided by or used in operating activities by adjusting profit (loss) for the effects of transactions of a non‐cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing activities.
Investing activities. The acquisition and disposal of long‐term assets and other investments not included in cash equivalents.
Operating activities. The transactions and other events not classified as financing or investing activities. In general, operating activities are the principal revenue‐producing activities of an entity.
BACKGROUND
Benefits of Statement of Cash Flows
The perceived benefits of presenting the statement of cash flows in conjunction with the statement of financial position and the statement of profit or loss and comprehensive income have been highlighted by IAS 7 to be as follows:
- The statement of cash flows provides the user with further insight into the entity's performance and position, and more information relevant to an estimate of the entity's future results, than can be determined directly from the information presented in the statement of financial position and statement of profit or loss and comprehensive income and the related disclosure notes.
- It provides additional information to the users of financial statements for evaluating changes in the entity's assets, liabilities, debt and equity. In order to distinguish the effect of cash movements from year to year on an entity's assets and liability, and on debt and equity, in the absence of a statement of cash flows a user may not necessarily have sufficient information to derive an accurate assessment on the impact of the entity's cash payments and receipts. It would require the user to apply judgement to approximate reasons for movements in these balances. The challenge in such an exercise would increase with the entity's complexity: the level of complexity would increase the likelihood that the entity’s financial statements are impacted by a wider range of non‐cash accounting adjustments, such as fair value gains and losses, impairment adjustments, amortization, provisions for accounting estimates and the impact of business combinations. The presentation of a statement of cash flow reduces the need for the user to determine their own explanations in this regard and it provides them with a much clearer level of understanding on the effect of cash payments and receipts on the carrying value of net assets during the reporting period.
- It enhances the comparability of reporting of operating performance by different entities because it eliminates the effects of using different accounting treatments for the same transactions and events.
There was considerable debate even as early as the 1960s and 1970s over accounting standardisation, which led to the emergence of cash flow accounting. The principal argument in support of cash flow accounting by its earliest proponents was that it avoids the difficult‐to‐understand and sometimes seemingly arbitrary allocations inherent in accrual accounting and accounting for provisions. For example, cash flows provided by or used in operating activities are derived, under the indirect method, by adjusting profit (or loss) for items such as depreciation and amortisation, which can be computed by different entities using a variety of accounting methods. More recently, the impact of other non‐cash accounting treatments (such as the impact of impairment and fair value gains and losses on financial instruments) can also affect comparability of entities' abilities to generate cash. Clear and consistent reporting of cash flows, in the statement of cash flows, can help address these challenges of comparability.
- The historic cash flow information presented in the statement of cash flows, is often used when considering the amount, timing and uncertainty an entity's future cash flows. An entity may find the information in a statement of cash flows is useful for the purpose of checking the accuracy of past cash flow projections. It can also be used in examining relationships between profitability, margins and net cash flow and how these might vary due to changing prices.
Exclusion of Non‐Cash Transactions
The statement of cash flows, as its name implies, includes only actual inflows and outflows of cash and cash equivalents. Accordingly, it excludes all transactions that do not directly affect cash receipts and payments. However, IAS 7 does require that the effects of investing and financial transactions not resulting in receipts or payments of cash be disclosed elsewhere in the financial statements in a way that provides all the relevant information about these investing and financing activities. Examples of investing and financing activities that do not have a direct impact on cash flow but which may affect the capital and asset structure of an entity include acquisition of assets either by assuming directly related liabilities or by means of a lease, acquisition of an entity by means of an equity issue, or the conversion of debt to equity.
Components of Cash and Cash Equivalents
Cash and cash equivalents include unrestricted cash (meaning cash actually on hand, or bank balances whose immediate use is determined by management), other demand deposits and short‐term investments whose maturities at the date of acquisition by the entity were three months or less. Equity investments do not qualify as cash equivalents unless they fit the definition above of short‐term maturities of three months or less, which would rarely, if ever, be true. Preference shares carrying mandatory redemption features, if acquired within three months of their predetermined redemption date, would meet the criteria above since they are, in substance, cash equivalents. These are very infrequently encountered circumstances, however.
Bank borrowings are normally considered as financing activities. However, in some countries, bank overdrafts play an integral part in the entity's cash management and, as such, overdrafts are to be included as a component of cash equivalents if the following conditions are met:
- The bank overdraft is repayable on demand; and
- The bank balance often fluctuates from positive to negative (overdraft).
Statutory (or reserve) deposits by banks (i.e., those held with the central bank for regulatory compliance purposes) are often included in the same position as cash in the statement of financial position. The financial statement treatment of these deposits is subject to some controversy in certain countries, which becomes fairly evident from scrutiny of published financial statements of banks, as these deposits are variously considered to be either a cash equivalent or an operating asset. If the latter, changes in amount would be presented in the operating activities section of the statement of cash flows, and the item could not then be combined with cash in the statement of financial position. Since the appendix to IAS 7, which illustrates the application of the standard to statements of cash flows of financial institutions, does not include statutory deposits with the central bank as a cash equivalent, the authors have concluded that there is little logic to support the alternative presentation of this item as a cash equivalent. Given the fact that deposits with central banks are more or less permanent (and in fact would be more likely to increase over time than to be diminished, given a going concern assumption about the reporting financial institution) the presumption must be that these are not cash equivalents in normal practice.
PRESENTATION
Classifications in the Statement of Cash Flows
The statement of cash flows prepared in accordance with IAS 7 requires classification into the following three categories:
- Operating activities, which can be presented under the direct method or the indirect method, include all transactions that are not investing and financing activities. IAS 7 encourages entities to apply the direct method. In general, cash flows arising from transactions and other events that enter into the determination of profit or loss are operating cash flows. Operating activities are principal revenue‐producing activities of an entity and include delivering or producing goods for sale and providing services.
- Investing activities include the acquisition and disposal of property, plant and equipment and other long‐term assets and debt and equity instruments of other entities that are not considered cash equivalents or held for dealing or trading purposes. Investing activities include cash advances and collections on loans made to other parties (other than advances and loans of a financial institution).
- Financing activities include obtaining resources from and returning resources to the owners. Also included are obtaining resources through borrowings (short term or long term) and repayments of the amounts borrowed.
The following are examples of the statement of cash flows classification under the provisions of IAS 7:
| Operating | Investing | Financing | |
|---|---|---|---|
| Cash inflows |
|
|
|
| Cash outflows |
|
|
|
* Unless held for trading purposes or considered to be cash equivalents.
IAS 7 permits some choices to the preparer of financial statements when presenting the statement of cash flows. For example, interest paid, and interest and dividends received may be classified as operating because they enter into the determination of profit or loss. Alternatively, IAS 7 permits that interest paid, and interest and dividends received may be classified as financing cash flows and investing cash flows respectively because they are costs of obtaining financial resources or returns on investments.
Similarly, dividends paid may be classified as a financing cash flow because they are a cost of obtaining financial resources. Alternatively, dividends paid may be classified as a component of cash flows from operating activities in order to assist users to determine the ability of an entity to pay dividends out of operating cash flows.
Reporting Cash Flows from Operating Activities
Direct vs. indirect methods
The operating activities section of the statement of cash flows can be presented under the direct or the indirect method, with IAS 7 encouraging entities to apply the direct method. In practice, many preparers of financial statements choose to ignore the preference of IAS 7, and the indirect method is commonly used within IFRS financial statements.
The direct method shows the items which affected cash flow and the magnitude of those cash flows. Cash received from, and cash paid to, specific sources (such as customers and suppliers) are presented, as opposed to the indirect method's conversion of accrual‐basis profit (or loss) to cash flow information by means of a series of add‐backs and deductions. Entities using the direct method are required by IAS 7 to report the following major classes of gross cash receipts and gross cash payments:
- Cash collected from customers;
- Interest and dividends receiveda;
- Cash paid to employees and other suppliers;
- Interest paidb;
- Income taxes paid;
- Other operating cash receipts and payments.
Given the availability of alternative modes of presentation of interest and dividends received, and of interest paid, it is particularly critical that the policy adopted be followed consistently. Since the face of the statement of cash flows will, often make it clear which approach has been selected, it may not be necessary for the accounting policy note to the financial statements to be explicit on this, although the preparer may determine that a policy to this effect might be a useful clarification for the users.
An important advantage of the direct method is that it assists the user's understanding of the relationships between the entity's profit or loss and its cash flows. For example, payments of expenses are shown as cash disbursements and are deducted from cash receipts. In this way, the user is able to recognise the cash receipts and cash payments for the period. Formulae for conversion of various statement of profit or loss and comprehensive income amounts for the direct method presentation from the accrual basis to the cash basis are summarised below.
| Accrual basis | Additions | Deductions | Cash basis |
|---|---|---|---|
| Net sales | + Beginning AR | − Ending AR; AR written off | = Cash received from customers |
| Cost of goods sold | + Ending inventory; beginning AP | − Depreciation* and amortisation*; beginning inventory; Ending AP | = Cash paid to suppliers |
| Operating expenses | + Ending prepaid expenses; beginning accrued expenses | − Depreciation and amortisation; beginning prepaid expenses; ending accrued expenses payable; bad debts expense | = Cash paid for operating expenses |
* Applies to a manufacturing entity only.
AR = accounts receivable.
AP = accounts payable.
From the foregoing, it can be appreciated that the amounts to be included in the operating section of the statement of cash flows, when the direct approach is utilised, are derived amounts which must be computed, although the computations are not necessarily onerous. They are not generally amounts which exist as account balances simply to be looked up and then placed in the statement. The extra effort needed to prepare the direct method operating cash flow data is typically a factor in why this method is less popular with preparers.
The indirect method (sometimes referred to as the reconciliation method) is the most widely used means of presentation of cash from operating activities, primarily because it is easier to prepare. The indirect format begins with the amount of profit or loss for the year, as reported in the statement of profit or loss and comprehensive income. Investing or financial cash flows and changes during the period in inventories and operating receivables and payables are adjusted. Revenue and expense items not affecting cash are also added or deducted to arrive at net cash provided by operating activities. For example, depreciation and amortisation are added back as they do not arise from cash movements.
Under the indirect method changes in inventory, accounts receivable, and other current accounts are used to determine the cash flow from operating activities. Although these adjustments are often straight forward to determine, some changes require more careful analysis. For example, determining cash collected from sales proceeds may involve the change in accounts receivable as well as changes in accounts receivables balances due to the impact of impairment on the carrying value of trade receivable balances.
IAS 7 offers an alternative way of presenting the cash flows from operating activities, often referred to as the modified indirect method. Under this variant of the indirect method, the starting point is not profit or loss but rather revenues and expenses disclosed in the statement of comprehensive income. In essence, this approach is virtually the same as the regular indirect method, with two more details: revenues and expenses for the period.
The following summary, simply an expanded statement of financial position equation, may facilitate an understanding of the adjustments to profit or loss necessary for converting accrual‐basis profit or loss to cash‐basis profit or loss when using the indirect method.
| Current assets* | − | Fixed assets | = | Current liabilities | + | Long‐term liabilities | + | Profit or loss | Accrual profit adjustment to convert to cash flow | |
|---|---|---|---|---|---|---|---|---|---|---|
| 1. | Increase | = | Increase | Decrease | ||||||
| 2. | Decrease | = | Decrease | Increase | ||||||
| 3. | = | Increase | Decrease | Increase | ||||||
| 4. | = | Decrease | Increase | Decrease |
* Other than cash and cash equivalents.
For example, using Row 1 in the above chart, a credit sale would increase accounts receivable and accrual‐basis profit but would not affect cash. Therefore, its effect must be removed from the accrual profit to convert to cash profit. The last column indicates that the increase in a current asset balance must be deducted from profit to obtain cash flow.
Similarly, an increase in a current liability, Row 3, must be added to profit to obtain cash flows (e.g., accrued wages are in the statement of profit or loss and comprehensive income as an expense, but they do not require cash; the increase in wages payable must be added back to remove this non‐cash flow expense from accrual‐basis profit).
The major drawback to the indirect method involves the user's difficulty in comprehending the information presented. This method does not show from where the cash was received or to where the cash was paid. Only adjustments to accrual‐basis profit or loss are shown. In some cases, the adjustments can be confusing. For instance, the sale of equipment resulting in an accrual‐basis loss would require that the loss be added to profit to arrive at net cash from operating activities. (The loss was deducted in the computation of profit or loss, but because the sale will be shown as an investing activity, the loss must be added back to profit or loss.)
Although the indirect method is more commonly used in practice, the IASB encourages entities to use the direct method. As pointed out by IAS 7, a distinct advantage of the direct method is that it provides information that may be useful in estimating or projecting future cash flows, a benefit that is clearly not achieved when the indirect method is utilised instead. Both the direct and indirect methods are presented below.
| Direct method | |
|---|---|
| € | |
| Cash flows from operating activities: | |
| Cash received from sale of goods | X |
| Cash dividends received | X |
| Cash provided by operating activities | X |
| Cash paid to suppliers | (X) |
| Cash paid for operating expenses | (X) |
| Cash paid for income taxes* | (X) |
| Cash disbursed for operating activities | (X) |
| Net cash flows from operating activities | X |
* Alternatively, could be classified as investing cash flow.
| Indirect method | |
|---|---|
| Cash flows from operating activities: | |
| Profit before income taxes | X |
| Adjustments for: | |
| Depreciation | X |
| Unrealised loss on foreign exchange | X |
| Interest expense | X |
| Operating profit before working capital changes: | X |
| Increase in accounts receivable | (X) |
| Decrease in inventories | X |
| Increase in accounts payable | X |
| Cash generated from operations | X |
| Interest paid | (X) |
| Income taxes paid** | (X) |
| Net cash flows from operating activities | X |
** Taxes paid are usually classified as operating activities. However, when it is practical to identify the tax cash flow with an individual transaction that gives rise to cash flows that are classified as investing or financing activities, then the tax cash flow is classified as an investing or financing activity as appropriate.
OTHER REQUIREMENTS
Gross vs. Net Basis
The emphasis in the statement of cash flows is on gross cash receipts and cash payments. For instance, reporting the net change in bonds payable would obscure the financing activities of the entity by not disclosing separately cash inflows from issuing bonds and cash outflows from retiring bonds.
IAS 7 specifies two exceptions where netting of cash flows is allowed. First, cash receipts and payments for items in which the turnover is quick, the amounts are large, and the maturities are short. Secondly, cash receipts and payments on behalf of customers when the cash flows reflect the activities of the customers rather than those of the entity. Cash flows under either of these two scenarios may be reported on a net rather than a gross basis.
Foreign Currency Cash Flows
Foreign operations must prepare a separate statement of cash flows and translate the statement to the reporting currency using the exchange rate in effect at the time of the cash flow (a weighted‐average exchange rate may be used if the result is substantially the same). This translated statement is then used in the preparation of the consolidated statement of cash flows. Non‐cash exchange gains and losses recognised in the statement of profit or loss and other comprehensive income should be reported as a separate item when reconciling profit or loss and operating activities. For a more detailed discussion about the effects of exchange rates on the statement of cash flows, see Chapter 23.
Cash Flow per Share
There is no requirement under IFRS to disclose cash flow per share in the financial statements of an entity, unlike the requirement to report earnings per share. In fact, cash flow per share is a somewhat disreputable concept, since it was sometimes touted in an earlier era as being indicative of an entity's “real” performance, when of course it is not a meaningful alternative to earnings per share because, for example, entities that are self‐liquidating by selling productive assets can generate very positive total cash flows, and hence cash flows per share, while decimating the potential for future earnings. Since, unlike a comprehensive statement of cash flows, cash flow per share cannot reveal the components of cash flow (operating, investing and financing), its usage could be misleading.
While cash flow per share is not well regarded (it is specifically prohibited under US GAAP), it should be noted that in recent years a growing number of entities have resorted to displaying a wide range of pro forma amounts, some of which roughly correspond to cash‐based measures of operating performance. These non‐IFRS categories should be viewed with great caution, both because they convey the message that IFRS‐based measures of performance are somehow less meaningful, and also because there are no standard definitions of the non‐IFRS measures, opening the door to possible manipulation.
Net Reporting by Financial Institutions
IAS 7 permits financial institutions to report cash flows arising from certain activities on a net basis. These activities, and the related conditions under which net reporting would be acceptable, are as follows:
- Cash receipts and payments on behalf of customers when the cash flows reflect the activities of the customers rather than those of the bank, such as the acceptance and repayment of demand deposits;
- Cash flows relating to deposits with fixed maturity dates;
- Placements and withdrawals of deposits from other financial institutions; and
- Cash advances and loans to banks' customers and repayments thereon.
Reporting Futures, Forward Contracts, Options and Swaps
IAS 7 stipulates that cash payments for and cash receipts from futures contracts, forward contracts, option contracts and swap contracts are normally classified as investing activities, except:
- When such contracts are held for dealing or trading purposes and thus represent operating activities; or
- When the payments or receipts are considered by the entity as financing activities and are reported accordingly.
Further, when a contract is accounted for as a hedge of an identifiable position, the cash flows of the contract are classified in the same manner as the cash flows of the position being hedged.
Reporting Extraordinary Items in the Statement of Cash Flows
IFRS long ago eliminated the categorisation of gains or losses as being extraordinary in character, so this no longer impacts the presentation of the statement of cash flows under IFRS.
Reconciliation of Cash and Cash Equivalents
An entity should disclose the components of cash and cash equivalents and should present a reconciliation of the difference, if any, between the amounts reported in the statement of cash flows and equivalent items reported in the statement of financial position.
Acquisitions and Disposals of Subsidiaries and Other Business Units
IAS 7 requires that the aggregate cash flows from acquisitions and disposals of subsidiaries or other business units should be presented separately as part of the investing activities section of the statement of cash flows. The following disclosures are also prescribed by IAS 7 in respect of both acquisitions and disposals:
- The total consideration paid or received;
- The portion thereof discharged by cash and cash equivalents;
- The amount of cash and cash equivalents in the subsidiary or business unit acquired or disposed of; and
- The amount of assets and liabilities (other than cash and cash equivalents) acquired or disposed of, summarised by major category.
DISCLOSURE AND EXAMPLES
Certain additional information may be relevant to the users of financial statements in gaining an insight into the liquidity or solvency of an entity. With this objective in mind, IAS 7 sets out other disclosures which are required or, in some cases, recommended.
- Required disclosure—The amount of significant cash and cash equivalent balances held by an entity which are not available for use by the group should be disclosed along with a commentary by management.
- Recommended disclosures—The disclosures which are recommended are as follows:
- The amount of undrawn borrowing facilities, indicating restrictions on their use, if any;
- The aggregate amount of cash flows that are attributable to the increase in operating capacity separately from those cash flows that are required to maintain operating capacity; and
- The amount of the cash flows arising from the operating, investing and financing activities of each reportable segment determined in accordance with IFRS 8. (See Chapter 28.)
The above disclosures recommended by IAS 7, although difficult to present, are useful in enabling the users of financial statements to better understand the entity's financial position.
Changes in Liabilities Arising from Financing Activities
An entity shall provide disclosures that enable users of financial statements to evaluate changes in liabilities arising from financing activities, including both changes arising from cash flows and non‐cash changes.
To the extent necessary to satisfy the requirement above, an entity shall disclose the following changes in liabilities arising from financing activities:
- Changes from financing cash flows;
- Changes arising from obtaining or losing control of subsidiaries or other businesses;
- The effect of changes in foreign exchange rates;
- Changes in fair values; and
- Other changes.
Liabilities arising from financing activities are liabilities for which cash flows were, or future cash flows will be, classified in the statement of cash flows as cash flows from financing activities. In addition, the disclosure requirement also applies to changes in financial assets (for example, assets that hedge liabilities arising from financing activities) if cash flows from those financial assets were, or future cash flows will be, included in cash flows from financing activities.
One way to fulfil this disclosure requirement is by providing a reconciliation between the opening and closing balances in the statement of financial position for liabilities arising from financing activities. Where an entity discloses such a reconciliation, it shall provide sufficient information to enable users of the financial statements to link items included in the reconciliation to the statement of financial position and the statement of cash flows.
If an entity provides the disclosure required in combination with disclosures of changes in other assets and liabilities, it shall disclose the changes in liabilities arising from financing activities separately from changes in those other assets and liabilities.
This example illustrates one possible way of providing the disclosures required. The example shows only current period amounts. Corresponding amounts for the preceding period are required to be presented in accordance with IAS 1, Presentation of Financial Statements.
| Non‐cash changes | ||||||
|---|---|---|---|---|---|---|
| 202X‐1 | Cash flows | Acquisitions | Foreign exchange movement | Fair value changes | 202X | |
| Long‐term loans | 10,000 | (5,175) | – | – | – | 4,825 |
| Short‐term loans | 12,000 | (1,500) | – | 2,000 | – | 12,500 |
| Lease liabilities | 4,000 | (800) | 1,500 | – | – | 4,700 |
| Total liabilities from financing activities | 26,000 | (7,475) | 1,500 | 2,500 | – | 22,025 |
CONSOLIDATED STATEMENT OF CASH FLOWS
A consolidated statement of cash flows must be presented when a complete set of consolidated financial statements is issued. The consolidated statement of cash flows would be the last statement to be prepared, as the information to prepare it will come from the other consolidated statements (consolidated statement of financial position, statement of profit or loss and comprehensive income and statement of changes in equity). The preparation of these other consolidated statements is discussed in Chapter 1.
The preparation of a consolidated statement of cash flows involves the same analysis and procedures as the statement for an individual entity, with a few additional items. The direct or indirect method of presentation may be used. When the indirect method is used, the additional non‐cash transactions relating to any business combination, such as the differential amortisation at group level, must also be reversed. Furthermore, all transfers to subsidiaries must be eliminated, as they do not represent a cash inflow or outflow of the consolidated entity.
All unrealised intragroup profits should have been eliminated in preparation of the other statements; thus, no additional entry of this sort should be required. Any profit allocated to non‐controlling parties would need to be added back, as it would have been eliminated in computing consolidated profit but does not represent a true cash outflow. Finally, any dividend payments should be recorded as cash outflows in the financing activities section.
In preparing the operating activities section of the statement by the indirect method following a purchase business combination, the changes in assets and liabilities related to operations since acquisition should be derived by comparing the consolidated statement of financial position as at the date of acquisition with the year‐end consolidated statement of financial position. These changes will be combined with those for the acquiring company up to the date of acquisition as adjustments to profit. The effects due to the acquisition of these assets and liabilities are reported under investing activities.
FUTURE DEVELOPMENTS
In November 2021, the IASB published for public comment proposed changes in disclosure requirements to enhance the transparency of supplier finance arrangements and their effects on a company's liabilities and cash flows.
Supplier finance arrangements are often referred to as supply chain finance, payables finance or reverse factoring arrangements.
The proposed targeted amendments to the current disclosure requirements are designed to meet investors' demands for more detailed information to help them analyse and understand the effects of such arrangements.
Under the IASB's proposals, a company would be required to disclose information that enables investors to assess the effects of the company's supplier finance arrangements on its liabilities and cash flows. These proposals would amend IAS 7 Statement of Cash Flows and IFRS 7 Financial Instruments: Disclosures.
The proposed amendments would affect a company that, as a buyer, enters into one or more supplier finance arrangements, under which the company, or its suppliers, can access financing for amounts the company owes its suppliers.
The Exposure Draft Supplier Finance Arrangements was open for comment until 28 March 2022.
US GAAP COMPARISON
Under US GAAP, bank overdrafts are classified as financing activities.
Under US GAAP, dividends received and interest paid or received are always included in operating cash flows. Dividends paid are always classified as financing activities.
Taxes paid are generally classified as operating cash flows, with specific rules for tax benefits associated with share‐based compensation arrangements.
Under US GAAP, cash equivalents are short‐term, highly liquid investments that are readily convertible to known amounts of cash and so near their maturity that they present insignificant risk of changes in value because of changes in interest rates. Generally, only investments with original maturities of three months or less qualify under that definition.
Not all investments that qualify are required to be treated as cash equivalents. An entity shall establish a policy concerning which short‐term, highly liquid investments that satisfy the definition of cash equivalents are treated as cash equivalents.
If a derivative instrument includes a non‐trivial financing element at inception, all cash inflows and outflows of the derivative instrument shall be considered cash flows from financing activities by the borrower.
US GAAP provides specific guidance about the cash flow classification of cash payments for debt prepayment or extinguishment costs, proceeds received from the settlement of insurance claims, proceeds received from the settlement of corporate‐owned life insurance policies, including bank‐owned life insurance policies, beneficial interests in securitisation transactions, cash payments for the settlement of a zero‐coupon debt instrument, contingent consideration payments made after a business combination and distributions received from an equity method investee.
Unlike IFRS, US GAAP does not have specific guidance requiring that cash payments to manufacture or acquire assets held for rental to others and subsequently held for sale are cash flows from operating activities and that the cash receipts from rents and subsequent sales also are cash flows from operating activities.
Also, US GAAP, as amended by ASU Update 2016‐18, set out specific requirements on the presentation of changes in restricted cash and restricted cash equivalents on the statement of cash flows, in that they are included in total cash, cash equivalents and restricted cash beginning and ending on the statement of cash flows where restricted cash exits on the balance sheet. ASU Update 2016‐18 is now effective and part of ASC No. 230 Statement of Cash Flows.
NOTES
- a Alternatively, interest and dividends received may be classified as investing cash flows rather than as operating cash flows because they are returns on investments.
- b Alternatively, IAS 7 permits interest paid to be classified as a financing cash flow, because this is the cost of obtaining financing.