EITF Issue 15-F Issue Summary No. 1, Supplement No. 4 · Project EITF Issue No. 15-F, “Statement...

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Memo No. Issue Summary No. 1, Supplement No. 4

Memo Issue Date May 27, 2016

Meeting Date(s) EITF June 10, 2016

Contact(s) Jenifer Wyss Lead Author, Project Lead (203) 956-3479

Andrew McClaskey Co-Author (203) 956-3442

Jin Koo Co-Author (203) 956-5279

Mark Pollock EITF Coordinator (203) 956-3476

Robert Uhl EITF Liaison (203) 761-3152

Project EITF Issue No. 15-F, “Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments”

Project Stage Redeliberations

Dates previously discussed by EITF

May 14, 2015 (Educational Meeting), June 18, 2015, September 17, 2015, November 12, 2015

Previously distributed Memo Numbers

Issue Summary No. 1, dated June 4, 2015; Supplement No. 1, dated September 3, 2015; Supplement No. 2, dated October 29, 2015; Supplement No. 3, dated October 30, 2015

Background

1. At the November 12, 2015 EITF meeting, the Task Force reached consensuses-for-exposure

on the eight cash flow issues included in the scope of Issue 15-F, as follows:

Cash Flow Issue Consensus-for-Exposure Reached

Issue 1—Debt Prepayment or Debt

Extinguishment Costs

Cash payments for debt prepayment or debt extinguishment costs would be classified

as cash outflows for financing activities.

Issue 2—Settlement of Zero-Coupon

Bonds

At settlement, the portion of the cash payment attributable to the accreted interest

would be classified as cash outflows for operating activities, and the portion of the

cash payment attributable to the principal would be classified as cash outflows for

financing activities.

The alternative views presented in this Issue Summary Supplement are for purposes of

discussion by the EITF. No individual views are to be presumed to be acceptable or

unacceptable applications of Generally Accepted Accounting Principles until the Task Force

makes such a determination, exposes it for public comment, and it is ratified by the Board.

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Issue 3—Contingent Consideration

Payments Made after a Business

Combination

Cash payments made by an acquirer that are not paid soon after a business

combination for the settlement of a contingent consideration liability would be

separated and classified as cash outflows for financing activities and operating

activities. Cash payments up to the amount of the contingent consideration liability

recognized at the acquisition date would be classified as financing activities; any

excess would be classified as operating activities. Issue 4—Proceeds from the

Settlement of Insurance Claims

Cash proceeds received from the settlement of insurance claims would be

classified on the basis of the related insurance coverage (that is, the nature of the

loss). For insurance proceeds that are received in a lump-sum settlement, an entity

would be required to determine the classification on the basis of the nature of each

loss included in the settlement.

Issue 5—Proceeds from the

Settlement of Corporate-Owned Life

Insurance Policies, including Bank-

Owned Life Insurance Policies

Cash proceeds received from the settlement of corporate-owned life insurance

policies would be classified as cash inflows from investing activities.

The cash payments for premiums on corporate-owned life insurance policies may

be classified as cash outflows for investing activities, operating activities, or a

combination of investing and operating activities.

Issue 6—Distributions Received from

Equity Method Investees

Distributions received from an equity method investee would be presumed to be

returns on investment and classified as cash inflows from operating activities,

unless the investor’s cumulative distributions received less distributions received

in prior years that were determined to be returns of investment, exceed cumulative

equity in earnings recognized by the investor. When such an excess occurs, the

current period distribution up to this excess would be considered a return of

investment and would be classified as cash inflows from investing activities. This

consensus-for-exposure does not address equity method investments measured

using the fair value option.

Issue 7—Beneficial Interests in

Securitization Transactions

A transferor’s beneficial interest obtained in a securitization of financial assets

would be disclosed as a noncash activity, and cash receipts from payments on a

transferor’s beneficial interests in securitized trade receivables would be classified

as cash inflows from investing activities.

Issue 8—Separately Identifiable Cash

Flows and Application of the

Predominance Principle

Additional guidance would clarify when an entity should separate cash receipts

and cash payments and classify them into more than one class of cash flows

(including when reasonable judgment is required to estimate and allocate cash

flows) and when an entity should classify the aggregate of those cash receipts and

payments into one class of cash flows on the basis of predominance.

2. The Board ratified the consensuses-for-exposure on December 11, 2015, and a proposed

Update was issued on January 29, 2016, with a March 29, 2016 comment letter deadline.

3. At the June 10, 2016 EITF meeting, the Task Force will have the opportunity to consider the

feedback received through comment letters as it redeliberates the consensuses-for-exposure.

The Task Force will then be asked whether it wishes to affirm its consensuses-for-exposure

as a consensus. To assist the Task Force as it redeliberates, the staff has provided a summary

of the cash flow issues and staff recommendations in Appendix A of this memo.

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Summary of Comment Letters

4. Twenty-seven comment letters were received in response to the proposed Update. The

number of comment letters by type of respondent is included in the table below:

Stakeholder Type Number of Comment Letters

Accounting/Consulting Firm 4

Preparer 18

Professional Accounting Association 4

Industry Trade Group 1

Issue 1: Debt Prepayment or Debt Extinguishment Costs

5. The proposed Update included the following question about the cash flow classification of

cash payments made for debt prepayment or debt extinguishment costs, including third-party

costs, premiums paid, and other fees paid to lenders:

Question 1: Should cash payments for debt prepayment or extinguishment costs be

classified as cash outflows for financing activities? If not, what classification is more

appropriate and why?

6. Nineteen respondents agreed with the proposed amendments to resolve Issue 1. However,

one of those respondents noted that it is unclear whether the phrase “other fees paid to

lenders,” in the proposed amendments to paragraph 230-10-45-15, refers to the incremental

direct cost of the debt prepayment or debt extinguishment transaction or whether it includes

fees that are not directly related to the debt prepayment or debt extinguishment transaction.

The respondent recommended that the proposed amendments be clarified so that there is no

question that “other fees paid to lenders” means incremental direct costs of the debt

prepayment or debt extinguishment transaction.

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7. One respondent, a consulting firm, disagreed with the proposed amendments and stated that

cash payments for debt prepayment or debt extinguishment costs should be classified as cash

outflows for operating activities. The consulting firm noted that prepayment penalties are

typically an approximation of interest that will not be paid to the lender due to the early

extinguishment of debt, which represents an adjustment to the effective interest rate, and

does not represent repayments of amounts borrowed. Under existing guidance, cash

payments to lenders and other creditors for interest are classified as cash outflows for

operating activities whereas repayments of amounts borrowed are classified as cash outflows

for financing activities in the statement of cash flows.

8. Seven respondents did not respond to Question 1 of the proposed Update.

Question 1 for the Task Force

1. Does the Task Force want to affirm its consensus-for-exposure that cash

payments for debt prepayment or debt extinguishment costs be classified as cash

outflows for financing activities?

Staff Recommendation

9. The staff recommends that the Task Force affirm its consensus-for-exposure with the

following clarification that “other fees paid to lenders” are fees that were incurred as part of

the debt prepayment or debt extinguishment transaction:

230-10-45-15 All of the following are cash outflows for financing activities:

(e) Payments for debt issue costs and payments for debt prepayment or debt

extinguishment costs, including third-party costs, premiums paid, and other fees paid

to lenders that are directly related to the debt prepayment or debt extinguishment.

10. The staff acknowledges the concern of the consulting firm that stated that cash payments for

debt prepayment or debt extinguishment costs should be classified as cash outflows for

operating activities. The Task Force previously considered an operating activities

classification but decided that cash payments made for debt prepayment or debt

extinguishment costs are associated with the extinguishment of debt and should be classified

as financing activities. Some Task Force members noted that a financial statement user

would treat those cash payments as financing activities because they are costs related to

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financing transactions. Additionally, some Task Force members believe that those costs are

similar to debt issue costs, which are classified as cash outflows for financing activities.

Issue 2: Settlement of Zero-Coupon Bonds


the cash payment made by a bond issuer at the settlement of a zero-coupon bond:

Question 2: Should the cash payment made at the settlement of a zero-coupon bond be

separated and classified as follows: the portion of the cash payment attributable to the

accreted interest as cash outflows for operating activities, and the portion of the cash

payment attributable to the principal as cash outflows for financing activities? If not, what

classification is more appropriate and why?

12. Eighteen respondents agreed with the proposed amendments to resolve Issue 2. Those

respondents noted that the proposed amendments are consistent with existing guidance that

states that cash paid to lenders and other creditors for interest are cash outflows for operating

activities and that repayments of amounts borrowed are cash outflows for financing

activities. One public accounting firm noted that while separating the cash payment between

principal and interest is more complex than not separating the cash payment, there should

not be significant costs associated with doing so. Another preparer noted that while they

agree with the proposed amendments, they suggested that the Task Force provide

classification guidance for other types of bonds that are issued at a discount or a premium.

13. Two preparers disagreed with the proposed amendments and stated that the entire cash

payment be classified as a cash outflow for financing activities for the following reasons:

(a) There will be reduced comparability with the classification of cash payments

to settle coupon-paying bonds issued at an original discount. Similar to zero-

coupon bonds, an original issue discount associated with a coupon-paying bond

will be accreted to interest expense. The entire cash payment to settle a coupon-

paying bond, including the portion attributable to accreted interest (that is, the

amortization of the discount recognized as interest expense), is classified as a

cash outflow from financing activities. As a result, the conclusion reached in

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the proposed Update is inconsistent with the guidance for economically similar

activities.

(b) There will be reduced comparability with the classification of cash payments

for debt prepayment or extinguishment costs. Similar to accreted interest on

zero-coupon bonds, debt prepayment or extinguishment costs are generally

considered to be interest-related and may be classified as interest expense or

separately as a loss on debt extinguishment in the income statement. While both

cash flows enter into the determination of net income, the resulting cash

payments have aspects of both an operating activity and a financing activity.

However, if the proposed amendments are affirmed, the cash payments

attributable to debt prepayment or extinguishment costs will be classified as

cash outflows for financing activities and the portion of the cash payments

attributable to accreted interest on zero-coupon bonds will be classified as cash

outflows for operating activities. The classification of those similar cash flows

should be aligned and reported as financing activities.

(c) The cash payment made at the settlement of a zero-coupon bond is a legal

payment of principal. Although interest is accreted from an accounting

standpoint, legally the settlement of a zero-coupon bond provides solely for the

payment of principal (that is, the par value of the debt). In substance, interest

is refinanced and rolled into the principal of the debt instrument. Consistent

with the guidance in Topic 230, repayments of amounts borrowed should be

classified as financing activities.

(d) Lastly, disaggregation of the cash payment between the portion attributable to

accreted interest and the portion attributable to principal would result in

additional costs and complexity because changes would need to be

implemented to accounting systems or a manual process would need to be

implemented to apply the proposed amendments, without substantial benefit to

financial statement users. The cost of these required system enhancements is

not justified, particularly given that the resulting financial reporting produces

inconsistent results for economically similar transactions.

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14. One preparer who did not indicate whether they agreed with the proposed amendments stated

that it is not clear whether the proposed amendments are only narrowly focused on zero-

coupon bonds, on all debt instruments that do not have a contractual interest rate (for

example, commercial paper1 and structured notes that do not require periodic interest

payments), or on all debt issued with a significant discount. The preparer recommended that

the Task Force clarify which debt instruments are included in the proposed amendments and

whether debt instruments issued at a premium should be treated similarly.

15. Six respondents did not respond to Question 2 of the proposed Update.


2. Does the Task Force want to affirm its consensus-for-exposure that the cash

payment made at the settlement of a zero-coupon bond be separated and classified

as follows: the portion of the cash payment attributable to the accreted interest as

cash outflows for operating activities, and the portion of the cash payment

attributable to the principal as cash outflows for financing activities?


16. The staff recommends that the Task Force affirm its consensus-for-exposure. While a couple

of respondents suggested that the Task Force consider cash flow classification guidance for

other types of bonds that are issued at a discount or premium, the Task Force previously

discussed the scope of this issue and decided to limit it to zero-coupon bonds. A couple of

respondents expressed a concern that the cash payment made to settle a coupon-paying bond

issued at a discount, including the portion attributable to accretion of the discount that was

recognized as interest expense, is classified entirely as a cash outflow for financing activities,

which is inconsistent with the proposed amendments. The staff thinks that there could be

coupon-paying bonds structured with small coupon payments such that the bond would, in

essence, represent a zero-coupon bond. However, Topic 230 does not include specific

guidance on the cash flow classification of cash payments to settle coupon-paying bonds.

1 As stated in paragraph 815-20-05-6, commercial paper and similar instruments are issued on a fixed-rate discounted basis with relatively short contractual maturities (for example, from 7 to 270 days). That is, the issuer receives a single discounted amount as proceeds of the issuance and makes a single payment of the stated amount at maturity. There are no periodic interest payments; thus, those instruments are effectively zero-coupon instruments.

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Although the Task Force previously acknowledged that there could be cash flow

classification issues similar to zero-coupon bonds, it decided that only zero-coupon bonds

would be addressed and that no explicit statement would be made about analogous cash flow

issues. Therefore, the staff does not recommend any changes to the proposed amendments.

17. The staff notes that a respondent asserted that there will be reduced comparability if cash

payments for debt prepayment or debt extinguishment costs are classified entirely as

financing activities. The Task Force previously discussed the potential inconsistency

between the classification of debt prepayment or debt extinguishment costs and the

classification of the settlement of a zero-coupon bond and, ultimately, noted that payments

made for debt prepayment or debt extinguishment costs are associated with the

extinguishment of debt principal and should be classified as financing activities.

Furthermore, the Task Force noted that a user would treat those cash payments as financing

activities because they are directly related to financing activities and because those costs are

similar to debt issue costs, which are classified as financing activities.

18. The staff also notes that a respondent stated that the cash payment made at the settlement of

a zero-coupon bond is a legal payment of principal. The Task Force previously discussed

that view and only a minority of Task Force members believed that the lack of an interest

payment each period constitutes a refinancing of interest due and that, at settlement, the

entire cash payment on a zero-coupon bond should be classified as cash outflows for

financing activities. A majority of the Task Force members supported separating and

classifying the cash payment for the settlement of zero-coupon bonds into operating and

financing activities because that classification is most consistent with current guidance. That

is, payments related to interest are classified as operating activities and repayment of

amounts borrowed are classified as financing activities.

19. The staff notes that most respondents did not think the costs to separate the portion of a zero-

coupon bond attributable to interest would be significant.

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Issue 3: Contingent Consideration Payments Made after a Business Combination

20. The proposed Update included the following questions about the cash flow classification of

contingent consideration payments made after a business combination:

Question 3: Should cash payments made by an acquirer that are not paid soon after a

business combination for the settlement of a contingent consideration liability be separated

and classified as follows: the payments, or portion of the payments, up to the amount of the

contingent consideration liability recognized at the acquisition date as cash outflows for

financing activities, and the payments, or portion of the payments, that exceed the amount

of the contingent consideration liability recognized at the acquisition date as cash outflows

for operating activities? If not, what classification is more appropriate and why?

Question 4: Is cash flow classification guidance needed to address situations in which an

acquirer makes a cash payment for the settlement of a contingent consideration liability soon

after the business combination? If so, what classification is appropriate and why?

21. In response to Question 3, 15 respondents agreed with the proposed amendments to resolve

Issue 3. Several of those respondents suggested that in order to prevent diversity in practice,

certain revisions or clarifications be made to the proposed amendments. Those respondents

indicated that the wording “soon after the business combination occurred” in the proposed

amendments either should be removed or should be defined or supported by practical

examples. The respondents noted that “soon after” could be interpreted as beginning either

at the acquisition date or at the conclusion of the measurement period, and there also could

be varying interpretations of a timeframe (that is, three months, six months, one year, and so

forth). A few of the 15 respondents stated that the cash flow classification for contingent

consideration payments should not differ depending on whether the payments are made soon

after the business combination occurs.

22. Additionally, one preparer who agreed with the proposed amendments raised a concern that

the proposed amendments do not address the classification of cash payments made in a multi-

year contingent consideration arrangement, which is common in certain industries in which

the nature of the business acquired is long-term project-based, such as construction

engineering. In those arrangements, cash payments are made for the contingent consideration

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and fair value adjustments of the contingent consideration liability are recognized over

multiple reporting periods. The preparer noted that it is unclear whether (a) each earn-out

milestone should be treated as a separate tranche or (b) the entire arrangement should be

treated as one tranche, as described in the next two paragraphs.

23. If each earn-out milestone is treated as a separate tranche, the cash payment made for each

milestone would be separated and classified as follows: (a) the portion of the cash payment

equal to the fair value adjustment that was recognized in the income statement for the

respective earn-out tranche would be classified as operating activities and (b) the remaining

amount of the cash payment representing the fair value of the respective earn-out tranche

recognized as of the acquisition date, including measurement period adjustments, would be

classified as financing activities. Therefore, each cash payment made would be separated

and classified into both operating and financing activities, regardless of whether the

cumulative cash payments exceed the amount of the contingent consideration liability

recognized at the acquisition date, including measurement-period adjustments.

24. If the entire arrangement is treated as a single tranche, each cash payment would be classified

as financing activities until the cumulative cash payments equal the amount of the contingent

consideration liability recognized at the acquisition date, including measurement-period

adjustments. Each subsequent cash payment made, or portion thereof, that exceeds the

amount of the contingent consideration liability recognized at the acquisition date, including

measurement-period adjustments, would be classified as operating activities.

25. Five respondents, including four preparers and one public accounting firm, disagreed with

the proposed amendments. One preparer stated that all cash payments made after a business

combination to settle a contingent consideration liability should be classified as cash

outflows for investing activities consistent with the classification of amounts paid to acquire

a business. That preparer noted that contingent consideration typically occurs when there is

uncertainty by the acquirer as to the expected future performance of the business being

acquired. The preparer also noted that contingent consideration generally is not included in

the business combination as a method of financing the transaction. Therefore, if contingent

consideration is being paid, it means that the acquired business is outperforming the

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projections of the acquiring entity and, therefore, the payments are representative of

additional amounts paid to acquire the business.

26. Three of the preparers and the public accounting firm who disagreed with the proposed

amendments stated that all cash payments made after a business combination to settle a

contingent consideration liability should be classified as cash outflows for financing

activities. A public accounting firm noted that classifying the amounts paid in financing

activities will provide financial statement users with better information about the total cash

payments made to complete a business combination.

27. A preparer stated that payments of contingent consideration are deemed to be seller-financed

debt and, as such, it is appropriate to classify the cash payments as financing activities

consistent with paragraph 230-10-45-13, which states that incurring directly-related debt to

the seller for purchases of property, plant, equipment, and other productive assets is a

financing transaction, and subsequent payments of principal on that debt are financing cash

outflows. Furthermore, the preparer noted that Topic 805 states that contingent consideration

represents an obligation of the acquirer to transfer additional assets or equity interests to the

former owners of an acquiree as part of the exchange for control of the acquiree if specified

future events occur or conditions are met. The corresponding liability is recognized and

measured at acquisition date fair value with subsequent changes in fair value recognized in

net income. The guidance does not indicate that the nature of the obligation is affected by

either the changes in the amount of such obligation or the ultimate settlement. Rather, the

entire amount represents seller-financed debt.

28. Six respondents did not respond to Question 3 and one respondent, a professional accounting

association, was unable to reach a conclusion on the most appropriate cash flow

classification.

29. In response to Question 4, 13 respondents noted that cash flow classification guidance to

address situations in which an acquirer makes a cash payment for the settlement of a

contingent consideration liability soon after the business combination is needed to eliminate

any ambiguity about the classification and to help achieve consistency in practice. Five of

the 13 respondents also noted that cash payments made to settle a contingent consideration

liability soon after the business combination should be classified as cash outflows for

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investing activities because the timing of the payment is approximate to the initial payment

made in the business combination.

30. Two of the 13 respondents to Question 4 agreed that cash flow classification guidance should

be provided but did not provide feedback on an appropriate classification. Two other

respondents noted that cash flow classification guidance should be provided, however, if all

cash payments made for the settlement of a contingent consideration liability are classified

as financing activities, no additional guidance would be necessary.

31. Four of the 13 respondents, including two public accounting firms, one consulting firm, and

one professional accounting association, noted that the classification for cash payments made

after a business combination for the settlement of a contingent consideration liability should

not differ for payments made soon after and for payments not made soon after the business

combination occurs. Rather, the cash flow classification for all payments made for the

settlement of a contingent consideration liability should be separated and classified as

proposed by the amendments (that is, into both operating activities and financing activities).

One public accounting firm stated that the expectations about the timing of the payment is

incorporated into the acquisition-date fair value measurement of the contingent

consideration liability. Furthermore, that same public accounting firm recommended that if

the Task Force affirms the proposed amendments, the basis for conclusions should include

a discussion about why contingent consideration paid soon after the business combination

occurs should be treated differently from contingent consideration not paid soon after the

business combination occurs.

32. Three respondents noted that no additional guidance is necessary. Two of those respondents

stated that if all cash payments made for the settlement of a contingent consideration liability

were classified as financing activities regardless of the timing of the payment and the

accounting treatment, there would be no need for additional guidance on cash payments for

contingent consideration payments made soon after the business combination.

33. Eleven respondents did not respond to Question 4 of the proposed Update.

Questions 3 and 4 for the Task Force

3. Does the Task Force want to affirm its consensus-for-exposure that cash

payments made by an acquirer that are not paid soon after a business combination

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for the settlement of a contingent consideration liability be separated and classified

as follows: the payments, or portion of the payments, up to the amount of the

contingent consideration liability recognized at the acquisition date as cash outflows

for financing activities, and the payments, or portion of the payments, that exceed

the amount of the contingent consideration liability recognized at the acquisition

date as cash outflows for operating activities?

4. Does the Task Force want to provide guidance to address situations in which an

acquirer makes a cash payment for the settlement of a contingent consideration

liability soon after the business combination?


34. The staff recommends that the Task Force affirm its consensus-for-exposure, with the

following revisions:

230-10-45-15 All of the following are cash outflows for financing activities:

f. Payments, or the portion of the payments, made by the an acquirer after a business

combination to settle a contingent consideration liability up to the amount of the

contingent consideration liability recognized at the acquisition date, including

measurement-period adjustments, if the payment was not made soon after the business

combination occurred. See also paragraph 230-10-45-17(ee).

230-10-45-17 All of the following are cash outflows for operating activities:

ee. Cash payments, or the portion of the payments, made by the an acquirer after a

business combination to settle a contingent consideration liability that exceed the

amount of the contingent consideration liability recognized at the acquisition date,

including measurement-period adjustments, if the payment was not made soon after the

business combination occurred. See also paragraph 230-10-45-15(f).

35. Consistent with feedback provided by multiple respondents, the staff believes that diversity

in practice could result from differing interpretations of what constitutes a payment that was

“not made soon after the business combination occurred,” if such language is not defined or

clarified. The staff also agrees with the respondent who noted that because expectations

about the timing of the payment are incorporated into the acquisition-date fair value

measurement of the contingent consideration liability, the classification should not differ for

payments made soon after and for payments not made soon after the business combination

occurs.

36. Removing that language also alleviates the need to provide guidance to address situations in

which an acquirer makes a cash payment for the settlement of a contingent consideration

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liability soon after the business combination. The staff believes that removing such language

from the proposed amendments would result in clear guidance that entities could consistently

apply to the classification of cash payments made after a business combination for the

settlement of a contingent consideration liability, regardless of the timing of when those cash

payments were made.

37. The staff thinks that if classification guidance was provided for payments made soon after

the business combination and that guidance was established on the basis of existing guidance

that states that cash outflows for investing activities includes payments at the time of

purchase or soon before or after the purchase to acquire property, plant, and equipment, then

contingent consideration payments would be classified by entities in operating, investing,

and financing activities. That is, entities would classify contingent consideration payments

as: (a) investing activities for amounts paid soon after the business combination, (b)

financing activities for cash payments that are not paid soon after a business combination,

up to the amount of the contingent consideration liability recognized at the acquisition date,

and (c) operating activities for cash payments that are not paid soon after a business

combination, in excess of the contingent consideration liability recognized at the acquisition

date. The staff thinks that such guidance would add a layer of unnecessary complexity to

financial reporting. However, the staff acknowledges that removing the language “not made

soon after the business the combination occurred” from the proposed amendments would

result in classification differences between contingent consideration payments made soon

after a business combination and payments made at the time of purchase or soon before or

after purchase to acquire property, plant, and equipment and other productive assets.

38. The staff believes that the proposed guidance already addresses the concern about multi-year

arrangements. The staff thinks that whether there is a single cash payment or multiple cash

payments made to settle a contingent consideration liability, the cash payment or payments

will be classified as financing activities up to the amount of the contingent consideration

liability recognized at the acquisition date, including measurement-period adjustments (the

“single tranche” approach discussed in this memo). When the cash payments made in a

multi-year arrangement exceed the amount of the contingent consideration liability

recognized at the acquisition date, including measurement-period adjustments, the excess

would be classified as operating activities.

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39. The staff notes that a couple of respondents stated that cash payments made to settle a

contingent consideration liability should be classified as cash outflows for investing

activities and several other respondents stated that cash payments made to settle a contingent

consideration liability should be classified as cash outflows for financing activities. The Task

Force previously considered both an investing and financing activities classification.

However, the Task Force favored separating cash payments made to settle a contingent

consideration liability and classifying them as cash outflows for both financing activities and

operating activities because that approach is the one applied most often in practice today and

most closely aligns with the requirements in Topic 230.

Issue 4: Proceeds from the Settlement of Insurance Claims


proceeds received from the settlement of insurance claims:

Question 5: Should the proceeds received from the settlement of insurance claims be

classified on the basis of the insurance coverage (that is, the nature of the loss), including

those proceeds received in a lump-sum settlement for which an entity would be required to

determine the classification on the basis of the nature of each loss included in the settlement?

If not, what classification is more appropriate and why?

41. Twenty-one respondents agreed with the proposed amendments to resolve Issue 4. A public

accounting firm recommended that for insurance proceeds received in a lump-sum

settlement that necessitates classifying individual losses on the basis of their nature, this

should only be required to the extent practicable without undue cost and effort. Otherwise,

entities should be able to classify the insurance proceeds all in one cash flow category by

applying the proposed amendments on the predominance principle. A preparer noted that the

guidance should emphasize that in the case of a lump-sum settlement, only significant losses

should be required to be separated and classified in the various cash flow categories. The

preparer indicated that the workload involved in segregating the individual losses could be

onerous and that this level of detail is not relevant for users.

42. Six respondents did not respond to Question 5 of the proposed Update.

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5. Does the Task Force want to affirm its consensus-for-exposure that proceeds

received from the settlement of insurance claims be classified on the basis of the

insurance coverage (that is, the nature of the loss), including those proceeds received

in a lump-sum settlement for which an entity would be required to determine the

classification on the basis of the nature of each loss included in the settlement?


43. The staff recommends that the Task Force affirm its consensus-for-exposure.

44. The staff considered the recommendation made by a public accounting firm that when there

is undue cost and effort to separate proceeds received in a lump-sum settlement, the proceeds

be classified on the basis of the predominant source of loss. The staff does not think that the

predominance principle in the proposed Update is intended to alleviate the cost and

complexity of determining the classification of cash flows. Rather, the predominance

principle is intended to clarify when an entity should separate cash receipts and cash

payments and classify them into more than one class of cash flows (including when

reasonable judgment is required to estimate and allocate cash flows) and when an entity

should classify the aggregate of those cash receipts and payments into one class of cash flows

on the basis of predominance. Furthermore, the predominance principle is not applicable

when there is specific cash flow classification guidance available, and in that situation,

specific guidance would exist. However, even if specific guidance did not exist, under the

proposed amendments concerning separately identifiable cash flows and application of the

predominance principle, a reporting entity would determine each separately identifiable

source within the lump-sum insurance proceeds on the basis of the insurance coverage and

classify each separately identifiable source in the appropriate cash flow category.

Furthermore, although one respondent requested that the guidance emphasize that only

significant proceeds received in a lump-sum settlement should be required to be separated

and classified into the various cash flow categories based on the nature of the loss, the staff

did not address that request because determining what constitutes a significant amount of

proceeds is entity-specific.

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Issue 5: Proceeds from the Settlement of Corporate-Owned Life Insurance Policies, including Bank-Owned Life Insurance Policies

45. The proposed Update included the following questions about the cash flow classification of

proceeds received from the settlement of corporate-owned life insurance policies, including

bank-owned life insurance policies:

Question 6: Should cash proceeds received from the settlement of corporate-owned life

insurance policies, including bank-owned life insurance policies, be classified as cash

inflows from investing activities? If not, what classification is more appropriate and why?

Question 7: Should cash payments made for premiums of corporate-owned life insurance

policies, including bank-owned life insurance policies, be permitted to be classified as cash

outflows for investing activities, operating activities, or a combination of investing and

operating activities? If not, what classification is more appropriate and why?

46. In response to Question 6, 19 respondents agreed that cash proceeds received from the

settlement of corporate-owned life insurance policies, including bank-owned life insurance

policies, be classified as cash inflows from investing activities. Eight respondents did not

respond to Question 6.

47. In response to Question 7, nine respondents, including five preparers, one public accounting

firm, one consulting firm, and two professional accounting associations, agreed with the

proposed amendments on the classification of cash payments made for premiums of

corporate-owned life insurance policies, including bank-owned life insurance policies. One

of those respondents stated that entities should have the authority to choose the classification

regardless of the classification of proceeds, and that the cash flow classification of premiums

paid and proceeds received for other types of insurance policies are not required to be

aligned. Furthermore, the respondent also stated that they do not believe that the

classification of premiums, whether in operating or investing activities, would mislead

financial statement users because the premiums generally are insignificant to an entity versus

a policy settlement, which is often a significant event to the entity and its financial statement

users.

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48. Eight respondents to Question 7, including five preparers, one public accounting firm, one

consulting firm, and one professional accounting association, disagreed with the proposed

amendments and indicated that cash payments for premiums of corporate-owned life

insurance policies, including bank-owned life insurance policies, should be classified as cash

outflows for investing activities consistent with the classification of cash proceeds received

from such policies. Several of those respondents noted that permitting the premiums to be

classified as cash outflows for investing activities, operating activities, or a combination of

investing and operating activities, as proposed, will result in unnecessary complexity,

diversity in practice, and a lack of comparability. Additionally, a couple of those respondents

stated that such policies are commonly purchased as investment vehicles. Therefore, the

related premium payments should be classified as cash outflows for investing activities.

49. Another one of the eight respondents to Question 7, the public accounting firm, stated that,

theoretically, they believe that only the portion of the premium equal to the insurance cost

of the policy (that is, the term insurance component of the policy) should be included in

operating activities; however, there would be costs associated with obtaining the insurance

cost of the policy because that information may not be readily available. The public

accounting firm commented that while they understand the Task Force’s desire to offer

flexibility in the classification, in an effort to reduce the diversity in practice, the public

accounting firm recommended that the Task Force only allow the following two alternatives:

(a) classify the entire premium payments as investing activities or (b) classify the insurance

cost of the policy as operating activities and classify any excess of the premium payments

over the insurance cost as investing activities. Furthermore, the public accounting firm

recommended that entities should be required to disclose the cash flow statement

classification of cash payments for premiums on corporate-owned life insurance policies, if

material.

50. Nine respondents did not respond to Question 7 and one respondent, a professional

accounting association, stated that some members of their organization supported the

proposed amendments while other members preferred an approach that would require the

classification of premiums paid to be aligned with the classification of proceeds received.

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6. Does the Task Force want to affirm its consensus-for-exposure that cash proceeds

received from the settlement of corporate-owned life insurance policies, including

bank-owned life insurance policies be classified as cash inflows from investing

activities?

7. Does the Task Force want to affirm its consensus-for-exposure that payments

made for premiums of corporate-owned life insurance policies, including bank-

owned life insurance policies, be permitted to be classified as cash outflows for

investing activities, operating activities, or a combination of investing and operating

activities?


51. The staff recommends that the Task Force affirm its consensus-for-exposure that cash

proceeds received from the settlement of corporate-owned life insurance policies, including

bank-owned life insurance policies, be classified as cash inflows from investing activities.

52. While mixed feedback was received on the classification of cash payments made for

premiums, the staff recommends that the Task Force affirm its consensus-for-exposure that

cash payments made for premiums of corporate-owned life insurance policies, including

bank-owned life insurance policies, be permitted to be classified as cash outflows for

investing activities, operating activities, or a combination of investing and operating

activities. The staff notes that the cash flow classification of premiums paid and proceeds

received for other types of insurance policies are not required to be aligned. Furthermore,

premiums generally are insignificant to an entity when compared to a policy settlement,

which is often a more significant event.

53. The staff does not think that it is necessary to prescribe a specific disclosure about the cash

flow statement classification of cash payments for premiums on corporate-owned life

insurance policies because Topic 235, Notes to Financial Statements, requires an accounting

policies disclosure when such policies materially affect the determination of financial

position, cash flows, or results of operations and when accounting principles involve a

selection of existing acceptable alternatives.

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Issue 6: Distributions Received from Equity Method Investees


distributions received from equity method investees:

Question 8: Should distributions received from an equity method investee when an investor

applies the equity method be presumed to be returns on investment and classified as cash

inflows from operating activities unless the investor’s cumulative distributions received less

distributions received in prior periods that were determined to be returns of investment

exceed cumulative equity in earnings recognized by the investor? When such an excess

occurs, should the current-period distribution up to this excess be considered a return of

investment and classified as cash inflows from investing activities? If not, what approach is

more appropriate and why?

55. Eighteen respondents agreed with the proposed amendments to resolve Issue 6. Those

respondents noted that the proposed amendments (referred to as the “cumulative earnings

approach” in this memo) are consistent with current practice and allow a consistent and

comparative application across entities. One professional accounting association stated that

cumulative distributions in excess of the equity-based income represent liquidating

dividends or returns of capital. Accordingly, such excess should be classified as cash inflows

from investing activities. The professional accounting association also does not see any

conceptual difference between liquidating dividends and the investor selling a portion of its

investment, the proceeds of which would be classified as cash inflows from investing

activities under current guidance. A couple of other respondents noted that up to an

investor’s equity in earnings, distributions received represent returns on investment and

should be classified as operating activities consistent with current guidance that states that

cash flows from operating activities include cash receipts from interest and dividends.

56. Six respondents, including an industry trade group and five preparers, primarily representing

real estate investment trusts (REITs) and energy companies, disagreed with the proposed

amendments and noted that the cash flow classification should be based on the nature of the

distribution, which is an approach commonly referred to as the “look-through approach.”

Those respondents stated that they do not believe that the cumulative earnings approach

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provides financial statement users with the most useful information or that it accurately

reflects the nature of distributions received from equity method investees.

57. One preparer commented that, generally, it is not a good accounting practice to ignore the

known facts surrounding a specific transaction in order to align the accounting between two

otherwise different transactions (that is, a dividend versus a return of capital). The preparer

noted that the nature of the cash flows resulting from a specific transaction typically is

available from the investees’ board of directors and that an investor is required to know the

classification of the distribution in order to properly file a tax return. The preparer indicated

that the cumulative earnings approach has the potential to increase diversity among investors

in the same equity method investee. If one of the investors was involved from the initial

formation of the equity method investee but another investor acquired its interest at a later

time, then the application of the cumulative earnings approach could lead to different

classifications for the investors who receive a share of the same distribution. The preparer

also noted that the cumulative earnings approach would be more difficult to implement than

classifying distributions under the look-through approach because of the need to collect

information on the cumulative distributions and cumulative equity in earnings on an ongoing

basis. The preparer suggested that consideration be given to the look-through approach

because it allows investors to classify the distributions according to the nature of each

distribution and, if that information is unavailable, to apply the cumulative earnings approach

as a practical expedient.

58. An industry trade group representing REITs and publicly traded real estate companies who

disagreed with the proposed amendments provided the following feedback:

(a) The cumulative earnings approach would represent a fundamental change in

the way that investors classify distributions received from equity method

investees. Income recognized by investors from unconsolidated ventures is

reduced by significant noncash depreciation and amortization charges.

Therefore, a considerable amount of distributions received by a real estate

company from equity method investees would be a return of investment and

classified as investing activities because cumulative distributions would often

exceed cumulative equity in earnings. Classifying such distributions as a return

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of investment would not provide financial statement users with information that

reflects the economics of the distributions received and, in turn, the operating

cash flows reported by the real estate company.

(b) There should be a distinction between distributions that result from ongoing

operations (that is, a return on investment classified as operating activities) and

those that result from sales of assets (that is, a return of investment classified

as investing activities).

(c) Additionally, one of the criteria to maintain REIT status under the Internal

Revenue Code is a requirement to distribute 90 percent of its taxable income.

Given this requirement, cash flows from operations reported by REITs is an

important indicator of its ability to meet dividend requirements, and the

cumulative earnings approach would generally understate the investor’s cash

flows from operations.

(d) The Task Force should pursue an alternative approach (that is, the look-through

approach) by providing investors with the ability to classify distributions

received from an equity method investee on the basis of the nature of the

activity that generated the distribution at the investee level.

59. Another preparer who disagreed with the proposed amendments stated that the cumulative

earnings approach requires a formula-driven application for classifying distributions

received from equity method investees that does not take into account the nature of the

distribution. The preparer recommended that the Task Force provide two acceptable methods

in determining the appropriate classification of distributions from equity method investees,

that is, the look-through approach and the cumulative earnings approach. The preparer also

recommended that preparers be required to apply the method consistently and disclose which

method is being applied.

60. A third preparer, a REIT, stated that it may not always be feasible for an equity method

investor to apply the look-through approach due to a lack of information, and offered an

alternative solution to the proposed amendments. That is, cumulative equity in earnings

would be adjusted by adding back depreciation, amortization, and losses on sales of real

estate and subtracting gains on sales of real estate. Cumulative distributions would be

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compared to the adjusted cumulative equity in earnings. If cumulative distributions received

exceed adjusted cumulative equity in earnings, then the excess distributions would be

classified as cash inflows from investing activities. The preparer stated that this approach

would provide more meaningful information to financial statement users to evaluate the

operating cash flows of the entity compared to the proposed amendments.

61. Three respondents did not respond to Question 8 of the proposed Update.

Stakeholder Outreach

62. After the comment period for the proposed Update ended, the staff conducted outreach with

a couple of users who primarily analyze financial statements of REITs. While users

understood the feedback from the respondents who opposed the proposed amendments, the

users indicated that their financial statement analysis of a REIT is primarily based on

quarterly unaudited supplemental information filed with the Securities and Exchange

Commission. The users noted that information about the cash flows of equity method

investees presented on the statement of cash flows is not overly meaningful and REITs

generally provide sufficient detailed supplemental information about individual equity

method investments. Both users did not oppose an option to allow entities to apply either

the look-through approach or the cumulative earnings approach, but they indicated that the

look-through approach better represents the economics of a REIT.

63. The staff conducted outreach with professionals from one public accounting firm with

experience in the real estate industry. They indicated that when REITs manage their equity

method investees, there is a high level of visibility into the investee’s activities. Also,

identifying the nature of distributions received from equity method investees is simple for

REITs because the nature is often required to be communicated in accordance with stock

agreements or for tax reporting purposes. While the public accounting firm acknowledged

that the tax status of the distributions may not always equate to the nature of the distribution

for book purposes as a result of book-tax differences, this is one piece of information that an

entity could evaluate in determining the cash flow classification. However, the public

accounting firm noted that diversity exists among REITs in the approach used to classify

distributions from equity method investees in the statement of cash flows. They

acknowledged that other industries may not have the same level of visibility into equity

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method investments. They also noted that some confusion exists about how to apply the

look-through approach, in particular, the level of effort required by an investor to obtain

information about distributions and the type of information that should be obtained. The

professionals stated that both the cumulative earnings approach and the look-through

approach are acceptable, but that the look-through is preferable and that disclosures in this

area could be improved.

64. The staff conducted outreach with two preparers who submitted comment letters opposing

the proposed amendments. One of the preparers noted that in nearly all of their equity method

investments, information about distributions is known through active involvement with an

investee’s board of directors, the operations of the investee, or, in the case of a partnership,

the partnership agreement. They stated that there are differences in the granularity of

information obtained from their investees and, in particular, there is less granularity when

the equity method investment is a partnership, and that in some cases the entity applies

judgment in order to determine the cash flow classification of a distribution. However, they

questioned how an investor could assert that it has the ability to exercise significant influence

over the investee when it does not have the ability to obtain the information necessary to

apply those judgments.

65. The staff also conducted outreach with a preparer who did not formally respond to the

proposed Update with a written comment letter. The preparer noted that, generally,

information is available from their equity method investees about whether the distributions

received are a return of investment or a return on investment and, therefore, the cash flow

classification is based on that information. The preparer does not think that cash flow

classification based on specific information is misleading to financial statement users.


8. Does the Task Force want to affirm the consensus-for-exposure that distributions

received from an equity method investee when an investor applies the equity method

be presumed to be returns on investment and classified as cash inflows from

operating activities unless the investor’s cumulative distributions received less

distributions received in prior periods that were determined to be returns of

investment exceed cumulative equity in earnings recognized by the investor? When

such an excess occurs, should the current-period distribution up to this excess be

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considered a return of investment and classified as cash inflows from investing

activities?

Staff Analysis

66. While the majority of respondents agreed with the proposed amendments, the respondents

who disagreed provided incremental feedback on information that was previously discussed

by the Task Force. The Task Force supported the cumulative earnings approach because that

approach is applied most often in practice today, is well understood, and would increase

consistency in financial reporting.

67. Based on the feedback received on the proposed Update and through subsequent outreach,

the staff thinks that the Task Force could consider the following: (a) affirming the proposed

amendments to require the cumulative earnings approach, (b) requiring the look-through

approach, and (c) allowing an accounting policy election to use the cumulative earnings

approach or the look-through approach.

Cumulative Earnings Approach

68. The Task Force could affirm the proposed amendments to require the cumulative earnings

approach. The cumulative earnings approach is a book-based approach that supports the

notion that the amount of equity in earnings recognized after the initial investment drives the

classification of the distribution. Therefore, when cumulative distributions do not exceed an

investor’s cumulative equity in earnings (as adjusted for basis differences), the distributions

received from an equity method investee represent a return on investment and would be

classified as operating activities consistent with the classification of cash receipts of interest

and dividends. Likewise, when cumulative distributions exceed cumulative equity in

earnings recognized by the investor (as adjusted for basis differences), such amounts are a

return of capital. Therefore, the distributions received from an equity method investee that

represent a return of investment are classified as investing activities consistent with the

classification of returns of investment in equity instruments of other entities (other than

certain equity instruments carried in a trading account).

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69. The determination of the cash flow classification using the cumulative earnings approach is

analogous to paragraph 325-20-35-1, which states that dividends received from a cost

method investee in excess of earnings recognized subsequent to the date of the investment

are considered a return of investment and are recorded as reductions of cost of the

investment.

70. The cumulative earnings approach is an operable approach that could be applied to all equity

method investments, resulting in improved comparability and reduced diversity in practice.

Furthermore, the cumulative earnings approach is relatively simple to apply because an

entity would not be required to seek out information that would be necessary to apply the

look-through approach.

Limitations of the Cumulative Earnings Approach

71. The nature in which cash is generated by the investee to fund the distribution is not

considered by the investor when classifying the distribution in the statement of cash flows.

In other words, known facts and circumstances about distributions may be ignored in the

cumulative earnings approach, resulting in a classification that may not provide meaningful

information to a financial statement user.

72. For those entities whose operations require a significant investment in property and

equipment, such as those entities in the real estate industry, large noncash charges of

depreciation and amortization expense would reduce cumulative equity in earnings, thereby

potentially resulting in an increased amount of distributions classified in investing activities

because cumulative distributions often could exceed cumulative equity in earnings.

73. Requiring the cumulative earnings approach would eliminate diversity in the accounting

practices currently used to classify distributions in the statement of cash flows. However, it

would not eliminate diversity in practice altogether. Different entities could classify their

share of the same distribution received from the same equity method investee differently

depending on when the respective equity method investment was made. That is, the

cumulative earnings approach could result in a different accounting outcome for a

distribution that is economically the same, thus reducing comparability among entities.

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Look-through Approach

74. In the look-through approach, distributions received from equity method investees are

presumed to be a return on investment and classified as cash inflows from operating

activities. However, in the presence of specific facts and circumstances, that presumption

can be overcome for all or a portion of the distribution. This is consistent with the AICPA’s

Technical Practice Aid, Section 1300.18, “Presentation on the Statement of Cash Flows of

Distributions from Investees from Operating Losses,” which states the following:

Distributions to investors from investees should be presumed to be

returns on investments and be classified by the investor as cash inflows from

operating activities, similar to the receipt of dividends. That presumption

can be overcome based on the specific facts and circumstances. For

example, if the partnership sells assets, the distribution to investors of the

proceeds of that sale would be considered a return of the investment and be

classified by the investor as cash inflows from investing activities.

75. The look-through approach would result in cash flow classification that is consistent with

the economics of the distribution. It is reasonable to expect that an investor would either be

aware of or be able to identify distributions that are other-than operating in nature through

its ability to exercise significant influence over the investee, which is required in order to

apply to equity method. Unlike the cumulative earnings approach, the timing of the

investment would not have an impact on the cash flow classification of the distribution.

Limitations of the Look-through Approach

76. The staff thinks that the level of effort required by the investor to seek out information to

overcome the operating cash flow presumption could be unclear. For example, would the

investor be required to seek out information for each distribution, or could it rely solely on

the information provided by the investee?

77. The staff believes that in applying the look-through approach, an investor would need to

make a reasonable effort to obtain the necessary information to determine the cash flow

classification, whether that information is obtained through a contractual arrangement with

an equity method investee, the investee’s board of directors, tax information, or some other

means. While it would be difficult to provide guidance that precisely explains an investor’s

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level of responsibility in obtaining information, the staff thinks that the look-through

approach could be written in such a way that this limitation is overcome, as follows:

When an investor applies the equity method, all distributions received from an

equity method investee are presumed to be returns on investment and shall be

classified as cash inflows from operating activities. However, that presumption can

be overcome when the nature of the underlying cash flow of the investee represents

a return of investment, in which case, the distributions received shall be classified

as cash inflows from investing activities. An investor shall make a reasonable effort

to obtain those specific facts and circumstances that represent the nature of the

distribution.

78. When entities make a reasonable effort but cannot obtain information about the nature of the

distributions, all distributions received would be classified as cash inflows from operating

activities, thereby potentially overstating operating cash flow results. Additionally, under the

look-through approach, some entities may be able to obtain information about the nature of

the distribution whereas other entities may not, despite making a reasonable effort. This

could result in different cash flow classifications of the same or similar distributions.

79. The look-through approach requires judgment, whereas the cumulative earnings approach

does not require judgment. Because of that limitation, consistency and comparability in

financial reporting may not be achieved.

80. With equity method investments, some investors exercise significant influence over

operating and financial policies of an investee; for example, when the investor has

representation on the board of directors. However, some investors have the ability to exercise

significant influence but do not exercise it. For an investor who does not elect to exercise

significant influence, it could require more effort to obtain the information to apply the look-

through approach.

Accounting Policy Election – Cumulative Earnings Approach or Look-through Approach

81. An entity would make an accounting policy election to classify the distributions received

from equity method investees using either the cumulative earnings approach or the look-

through approach. The Task Force would need to decide whether an entity would be required

to apply the elected approach to distributions received from all of its equity method investees

or whether an entity would be permitted to make an accounting policy election on an equity-

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method-investment-by-equity-method-investment basis. In either scenario, an entity also

would be required to comply with the applicable accounting policy guidance, including the

disclosure requirements in paragraphs 235-10-50-1 through 50-6.

82. If an entity is permitted to make an accounting policy election on an equity-method-

investment-by-equity-method-investment basis, the Task Force would need to consider

whether disclosures incremental to those in Topic 235 should be required, such as (a)

information to enable financial statement users to understand management’s reasons for

electing the cumulative earnings approach for some equity method investments and the look-

through approach for other equity method investments, (b) qualitative information to enable

users to understand how the different approaches elected could affect the statement of cash

flows classification, (c) quantitative information about the amounts that would have been

classified as operating and investing activities using the alternative approach, if the

alternative approach would dramatically affect the amounts classified as operating and

investing activities, (d) information to enable users to understand which approach is being

applied to each equity method investment, and (e) quantitative information that reconciles

distributions received from each equity method investment, by its elected approach, to total

distributions received for the period and how those total distributions relate to line items on

the statement of cash flows.

83. Allowing an entity to choose between the cumulative earnings approach and the look-

through approach would make authoritative the two approaches that are most commonly

used in practice. Requiring an entity to disclose an accounting policy election and potentially

other incremental disclosures would supplement the line items on the statement of cash flows

and provide relevant financial information to users.

Limitations of the Accounting Policy Election Approach

84. Diversity in practice would not be eliminated by allowing an entity to make an accounting

policy election. However, the staff thinks that overall diversity would be reduced because

there are varying interpretations and application of both approaches being used today. For

example, a current variation of the cumulative earnings approach is to compare only current

period equity in earnings to current period distributions rather than cumulative amounts.

Also, a current variation of the look-through approach is to presume that all distributions are

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returns on investment and classify them as operating activities rather than make a reasonable

effort to obtain those specific facts and circumstances that represent that nature of the

distribution. Providing specific guidance about how to apply the cumulative earnings

approach and the look-through approach would improve the consistency with which those

approaches are applied.

85. The staff thinks that permitting an entity to make an accounting policy election on an equity-

method-investment-by-equity-method-investment basis would not improve the quality of

financial reporting and would add an unnecessary layer of complexity to a financial

statement user’s analysis because economically similar distributions could be classified

differently depending on the approach applied to a particular equity method investment.

Also, the cost and complexity would increase for preparers because it may be necessary to

provide additional disclosures that would clearly indicate which approach was elected for

each equity method investment and the amount of distributions classified as operating and

investing activities under each approach. Without such disclosures, there could be a lack of

meaningful information provided to users. There also would be increased costs to audit that

information. While allowing an accounting policy election at an entity-level basis or on an

equity-method-investment-by-equity-method-investment basis could reduce comparability

among entities and within an entity, allowing the latter would likely lead to a greater lack of

comparability.

Prior Alternative Discussed and Rejected – Hybrid Approach

86. The Task Force previously discussed a hybrid approach under which distributions received

from equity method investees are classified using the cumulative earnings approach unless

specific facts and circumstances of a distribution or a portion of a distribution are known, in

which case a distribution that represents a return of investment should be classified as cash

inflows from investing activities. Because no respondents specifically provided feedback

about the hybrid approach, the staff does not think that the Task Force needs to reconsider

this approach.

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Additional Alternative Considered and Rejected

87. A preparer who did not agree with the proposed amendments suggested an alternative

approach that involves comparing cumulative distributions received to cumulative equity in

earnings before depreciation, amortization, and gains and losses on the sale of real estate.

The staff does not think that using an adjusted cumulative equity in earnings amount to

classify distributions received from equity method investees would increase comparability

or provide users with useful information; therefore, the staff rejected this alternative in its

analysis.


88. Based on the feedback received in comment letters and from supplemental stakeholder

outreach, the staff recommends allowing an accounting policy election to classify the

distributions received from equity method investees either using the cumulative earnings

approach or the look-through approach. The staff recommends that an entity apply the

elected approach to the classification of all distributions received from all of its equity

method investees. In other words, the staff recommends that an entity not be permitted to

make an accounting policy election on an equity-method-investment-by-equity-method-

investment basis. The staff recognizes that comparable financial reporting is better achieved

through consistent application of the same guidance by all entities and that the overall goal

of Issue 15-F is to reduce diversity in practice. However, the staff does not believe that all

types of diversity in practice can be eliminated under either of the two approaches.

89. The staff is concerned that for those entities (or industries) that apply the look-through

approach today, application of the proposed amendments (that is, the cumulative earnings

approach), might not provide financial statement users with the most useful information or

the most accurate reflection of the nature of distributions received. That concern would be

resolved by allowing an entity to use the look-through approach and consider those known

facts and circumstances when classifying distributions.

90. Also, the staff notes that some investors have the ability to exercise significant influence but

do not exercise it, and that the cumulative earnings approach is more operable if significant

influence is exercised. For example, the staff understands that some equity method investors

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actively manage equity method investments, so obtaining facts and circumstances about

distributions from the investee would be less burdensome than it would be for an investor

who does not exercise significant influence and does not obtain such facts and circumstances

during the normal course of business.

91. The staff also recognizes that if the Task Force were to require entities to apply the look-

through approach, it could be costly for some entities to obtain the necessary information,

resulting in a default classification of operating activities for all distributions received from

equity method investees. That concern could be resolved by allowing entities that determine

that the look-through approach would result in significant cost and effort to obtain specific

facts and circumstances to elect the cumulative earnings approach, which is simple and

operable.

92. During outreach, users and the public accounting firm indicated that both the cumulative

earnings approach and the look-through approach are acceptable methods and that an

accounting policy disclosure would provide useful information about how an entity is

classifying distributions from equity method investees.

Issue 7: Beneficial Interests in Securitization Transactions

93. The proposed Update included the following questions about beneficial interests obtained in

securitization transactions:

Question 9: Should a transferor’s beneficial interest obtained in a securitization of financial

assets be disclosed as a noncash activity? If not, what treatment is more appropriate and

why?

Question 10: Should cash receipts from payments on a transferor’s beneficial interests in

securitized trade receivables be classified as cash inflows from investing activities? If not,

what classification is more appropriate and why?

94. In response to Question 9, 16 respondents agreed with the proposed amendments that a

transferor’s beneficial interest obtained in a securitization of financial assets be disclosed as

a noncash activity. One preparer requested clarification of whether the proposed

amendments are intended to apply to securitization transactions in which a transferor uses a

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third-party as an agent and the transferor and third-party exchange cash flows on a gross

basis. Specifically, transferors in securitization transactions may use third parties to deposit

the transferred financial assets into a securitization trust and to market and/or sell the issued

beneficial interests, and the transferor and third-party may exchange gross cash flows as part

of the transaction. For example, a transferor sells $10 million of mortgage loans to an

unconsolidated securitization trust in exchange for $4 million of beneficial interests. The

transferor receives $10 million in cash for the securitized mortgage loans and pays $4 million

for beneficial interests in those same securitized mortgage loans. The preparer recommended

that beneficial interests obtained in a securitization of financial assets be disclosed as a

noncash activity, regardless of whether cash is exchanged on a gross basis.

95. One preparer disagreed with the proposed amendments and stated that the treatment of a

transferor’s beneficial interest obtained in a securitization transaction should depend on an

entity’s business model. The preparer noted that a beneficial interest obtained in a

securitization of financial assets could be part of a trading business. That is, when the

beneficial interest is obtained for operating purposes, it should not be required to be

disclosed. Ten respondents did not respond to Question 9.

96. In response to Question 10, 12 respondents agreed that cash receipts from payments on a

transferor’s beneficial interests in securitized trade receivables be classified as cash inflows

from investing activities. Several of those respondents stated that the investing activities

classification is consistent with the nature and accounting for the asset (that is, the investment

security) that was retained as part of the securitization, and that an investing activities

classification reflects the fact that the transferor does not retain legal ownership over the

transferred trade receivables. One public accounting firm recommended that the scope of the

proposed amendments be broadened to include securitizations of all types of financial assets.

The public accounting firm noted that changing the proposed amendments to be broader than

trade receivables would be consistent with the proposed amendments to disclose a

transferor’s beneficial interest obtained in a securitization of financial assets as a noncash

activity.

97. Six respondents, all of whom are preparers, disagreed with the proposed amendments.

Several of those preparers stated that the classification of the subsequent cash receipts from

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the beneficial interest should be based on the underlying asset trade receivables, which arose

from the sale transaction. Classifying the cash receipts from payments on a transferor’s

beneficial interests in securitized trade receivables in investing activities creates a lack of

symmetry between sales and operating cash flows. That is, the sale that created the trade

receivable that was securitized will never result in a subsequent operating cash flow.

Furthermore, one preparer stated that securitizing trade receivables is a vehicle for

monetizing those trade receivables and does not represent a true investment.

98. One preparer who disagreed with the proposed amendments noted that rather than collecting

cash receipts from payments on a transferor’s beneficial interests, beneficial interests

sometimes can be settled through the exercise of a cleanup call option,2 under which trade

receivables previously sold are repurchased. Once the trade receivables are repurchased, the

beneficial interest and all exposure to additional risks of the securitization entity are

eliminated. The preparer asserted that the proposed amendments to classify the cash receipts

from payments on a transferor’s beneficial interests as investing activities could be

misinterpreted and extended to the subsequent collections on repurchased trade receivables,

which would add complexity for preparers and create confusion for users because collections

from trade receivables repurchased through the exercise of a cleanup call option of a

beneficial interest are identical to collections on other trade receivables. However, if

collections on repurchased trade receivables are classified as investing activities, and

collections on other trade receivables are classified as operating activities, the same asset

will have differing cash flow classifications. The preparer recommended that if the Task

Force affirms the amendments as proposed, then specific cash flow classification guidance

also should be provided on the collections of repurchased trade receivables when beneficial

interests have been settled through the exercise of a cleanup call option.

99. Nine respondents did not respond to Question 10 of the proposed Update.

2 The master glossary of the Codification defines a cleanup call option as an option held by the servicer or its affiliate, which may be the transferor, to purchase the remaining transferred financial assets, or the remaining beneficial interests not held by the transferor, its affiliates, or its agents in an entity (or in a series of beneficial interests in transferred financial assets within an entity) if the amount of outstanding financial assets or beneficial interests falls to a level at which the cost of servicing those assets or beneficial interests becomes burdensome in relation to the benefits of servicing.

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9. Does the Task Force want to affirm its consensus-for-exposure that a transferor’s

beneficial interest obtained in a securitization of financial assets be disclosed as a

noncash activity?

10. Does the Task Force want to affirm its consensus-for-exposure that cash receipts

from payments on a transferor’s beneficial interests in securitized trade receivables

be classified as cash inflows from investing activities?


100. The staff recommends that the Task Force affirm its consensus-for-exposure that a

transferor’s beneficial interest obtained in a securitization of financial assets be disclosed as

a noncash activity.

101. The staff acknowledges that a preparer requested that the Task Force clarify whether the

proposed amendments are intended to apply to securitizations in which a transferor uses a

third-party as an agent and the transferor and the third-party exchange cash flows on a gross

basis. The objective of this issue is to reduce diversity in practice in situations in which the

transferor does not receive in cash the full fair value of the financial assets transferred at the

inception of the securitization transaction. The Task Force supported the noncash activity

disclosure primarily because it reflects the actual form of the securitization transaction. That

is, the noncash disclosure would be consistent with the form of the securitization transaction

because there is no cash outflow by the transferor of the financial assets to obtain the

beneficial interest. The staff thinks that the issue raised by the preparer is beyond the scope

of this issue, and the staff does not recommend that the Task Force broaden the scope of the

proposed amendments because doing so could raise questions about the gross versus net

presentation of other types of transactions. However, the Task Force could clarify the scope

in the Basis for Conclusions section of the final Update.

102. The staff also acknowledges the concern raised by a preparer that securitization of financial

assets may be part of an entity’s trading business and, therefore, that beneficial interests

obtained in securitization transactions should not be disclosed as noncash investing

activities. However, the staff thinks that the primary objective of Issue 15-F is to improve

consistent application of the guidance and reduce diversity in practice.

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103. The staff recommends that the Task Force affirm its consensus-for-exposure that cash

receipts from payments on a transferor’s beneficial interests in securitized trade receivables

be classified as cash inflows from investing activities.

104. The staff does not think that it is necessary to broaden the scope of the proposed amendments

to the classification of cash receipts from beneficial interests in trade receivables to include

other financial assets because diversity in practice has not been identified for cash receipts

from beneficial interests involving financial assets other than trade receivables.

105. While the staff acknowledges the concerns raised by a number of preparers that the

classification of cash receipts from beneficial interests in trade receivables creates a lack of

symmetry between sales and operating cash flows, the staff thinks that those cash receipts

should be classified as investing activities for the following reasons:

(a) The transferor’s ability to receive cash from its beneficial interest is sometimes

linked to the performance of third-party trade receivables. That is, the

additional exposure to credit risk makes the transferor’s beneficial interest

more akin to an investment in the securitization entity than to an existing trade

receivable.

(b) Trade receivables are transferred to the securitization entity and, therefore, the

transferor does not retain ownership of those trade receivables.

(c) Classification of cash receipts from beneficial interests in trade receivables as

investing activities is consistent with existing guidance in Topic 230 when

considering the consensus-for-exposure reached to disclose the transferor’s

beneficial interest obtained in a securitization transaction as a noncash activity.

106. The staff notes that the Task Force previously discussed the issue about the lack of symmetry

and ultimately reached a consensus-for-exposure that the cash receipts from payments on a

transferor’s beneficial interests in securitized trade receivables be classified as cash inflows

from investing activities for the reasons indicated in the preceding paragraph of this memo.

107. The staff also acknowledges the concern raised by a preparer about the collections of

repurchased trade receivables that occur through a cleanup call option. The staff thinks that

when trade receivables are repurchased by the transferor, the ownership (beneficial) interest

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in the securitization entity ceases to exist, and that the repurchased trade receivables are no

different than other trade receivables. Therefore, consistent with existing guidance, the cash

receipts from the collections on the repurchased trade receivables should be classified as

cash inflows from operating activities. The staff is uncertain how the proposed amendments

could be interpreted to extend to collections on repurchased trade receivables because trade

receivables and beneficial interests are assets that are different in nature. Therefore, the staff

does not recommend that specific cash flow classification guidance be provided on the

collections of repurchased trade receivables when beneficial interests have been settled

through the exercise of a cleanup call option.

Issue 8: Separately Identifiable Cash Flows and Application of the Predominance Principle

108. The proposed Update included the following question about separately identifiable cash

flows and application of the predominance principle:

Question 11: Is the additional guidance that clarifies when an entity should separate cash

receipts and cash payments and classify them into more than one class of cash flows

(including when reasonable judgment is required to estimate and allocate cash flows) and

when an entity should classify the aggregate of those cash receipts and payments into one

class of cash flows on the basis of predominance understandable and operable? If not, please

explain why and what additional guidance would be more appropriate.

109. Seventeen respondents agreed with the proposed amendments to resolve Issue 8. One of

those respondents, a consulting firm, stated that the proposed amendments do not change

existing guidance but, rather, expand and clarify existing practice and reinforce the

application of guidance in Topic 230, as well as in other relevant topics. A professional

accounting association stated that although application of the guidance will still require

significant judgment by financial statement preparers, the guidance will assist in eliminating

inconsistencies and uncertainty in the application and interpretation of the predominance

principle. Furthermore, a preparer noted that clarifying when an entity should separate cash

receipts and payments and classify them into more than one class of cash flows will provide

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a greater level of detail about the nature of the cash flows and, therefore, provide better

information for financial statement users.

110. Additionally, a public accounting firm stated that the proposed amendments are

understandable and operable, but suggested that the proposed amendments be clarified to

indicate that aggregation into one class of cash flows on the basis of predominance is only

appropriate if the cash flows cannot be separated because it is impracticable to do so or

because doing so would require undue cost or effort. The public accounting firm also raised

a concern about the proposed amendments that remove the following example in paragraph

230-10-45-22 about when to apply the predominance principle:

For example, a cash payment may pertain to an item that could be

considered either inventory or a productive asset. For example, the acquisition

and sale of equipment to be used by the entity or rented to other generally are

investing activities. However, equipment sometimes is acquired or produced to

be used by the entity or rented to others for a short period and then sold. In those

circumstances, the acquisition or production and subsequent sale of those assets

shall be considered operating activities.

111. The public accounting firm presumed that the removal of the example indicates that the cash

flows related to the acquisition or production and subsequent sale of the assets should be

separated and classified into more than one class of cash flows based on the underlying

nature of those cash flows. The public accounting firm suggested that if that presumption is

correct, then the Task Force should retain and amend the example to explain how the new

guidance would be applied. However, if the example is not retained, the public accounting

firm suggested that the reasons for removing the example should be explained in the basis

for conclusions.

112. Five respondents either opposed portions of the proposed amendments or were unable to

reach a decision on whether they agreed with the proposed amendments. One preparer stated

that the additional guidance is understandable but not operable because, in the absence of

specific guidance, an entity should not be required to determine each separately identifiable

source or use based on the nature of the underlying cash flows. Similarly, a public accounting

firm noted that it does not object to the proposed amendments, but is not optimistic that the

guidance will be effective in mitigating diversity in transactions that are not specifically

addressed in Topic 230.

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113. One preparer stated that the proposed amendments are clear in stating that separately

identifiable cash flows should be classified separately. However, the proposed amendments

are unclear in communicating the Board’s intent related to the application of judgment in

separating cash flow amounts. Therefore, the proposed amendments are open to an

interpretation that says that if the cash flow amounts are not clearly separable, then the

predominance principle should be applied. A different preparer stated that the clarification

of this principle will be helpful in consistently determining the classification of cash flows;

however, the principle should be removed from the scope of the proposed amendments and

more appropriately added to the scope of the FASB’s Conceptual Framework project

because of the difficulty in applying the principle retrospectively.

114. One preparer stated that they were unable to reach a decision on whether they agreed with

the proposed amendments because the proposed amendments are unclear. To clarify the

guidance, the preparer suggested that implementation guidance and illustrative examples be

provided (for example, a decision tree and examples that include factors such as historical

cash flows or projected cash flows).

115. Five respondents did not respond to Question 11 of the proposed Update.


11. Does the Task Force want to affirm its consensus-for-exposure that additional

guidance be provided that clarifies when an entity should separate cash receipts

and payments and classify them into more than one class of cash flows and when

an entity should classify the aggregate of those cash receipts and payments into

one class of cash flows on the basis of predominance?


116. While a majority of respondents agreed with the proposed amendments, one preparer raised

a concern that the proposed amendments do not clearly articulate the intent related to the

application of judgment in separating cash flow amounts, resulting in an interpretation that

if the cash flow amounts are not clearly separable, then the predominance principle should

be applied. At the September 2015 EITF meeting, the staff communicated that while each

separately identifiable use or each separately identifiable source within a cash receipt or cash

payment on the basis of nature could be determined on a qualitative basis, the amount of

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each separately identifiable use or each separately identifiable source within a cash receipt

or cash payment may not be clear. The staff believes that based on management’s best

judgment, a reporting entity should apply estimation and allocation to determine the amount

of each separately identifiable source or use within cash receipts or cash payments, which is

consistent with the tentative Board decision made in the FASB’s Conceptual Framework

project that Concepts Statement No. 5, Recognition and Measurement in Financial

Statements of Business Enterprises, is not intended to preclude entities from classifying cash

receipts and payments through the use of estimation or allocation.

117. Paragraph BC32 in the proposed Update states that the Task Force reached a consensus-for-

exposure to provide additional guidance that clarifies when an entity should separate cash

receipts and cash payments and classify them into more than one class of cash flows,

including when reasonable judgment is required to estimate and allocate cash flows.

However, that notion about using judgment to estimate and allocate cash flows was not

included in the proposed amendments to the Codification. The staff thinks that to more

clearly articulate the guidance, it would be worthwhile to include similar language in the

final Update.

118. With the revisions noted above, the staff recommends that the Task Force affirm its

consensus-for-exposure that additional guidance be provided on separately identifiable cash

flows, as follows (revisions are underlined):

230-10-45-22 Certain cash receipts and payments may have aspects of more than one

class of cash flows. The classification of those cash receipts and payments shall be

determined first by applying specific guidance in this Topic and other applicable

Topics. In the absence of specific guidance, a reporting entity shall determine each

separately identifiable source or each separately identifiable use within the cash

receipts and cash payments on the basis of the nature of the underlying cash flows,

including when reasonable judgment is necessary to estimate the amount of each

separately identifiable source or use. A reporting entity shall then classify each

separately identifiable source or use within the cash receipts and payments on the basis

of their nature in financing, investing, or operating activities.

119. Furthermore, the staff acknowledges that a public accounting firm suggested that the

proposed amendments be clarified to indicate that aggregation is only appropriate if the cash

flows cannot be separated because it is impracticable to do so or because doing so would

require undue cost or effort. The staff does not think that the predominance principle only

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should be applied when it is impracticable to separate cash receipts or cash payments that

have aspects of more than one class of cash flows. Rather, the predominance principle should

be applied when every dollar of the cash receipt or payment exhibits aspects of more than

one class of cash flows, as opposed to a cash receipt or payment in which a portion of the

dollars exhibits one class of cash flows and the remaining portion of the dollars exhibits a

different class of cash flows. The staff thinks that revising the proposed amendments to

indicate that reasonable judgment can be used to estimate the amount of each separately

identifiable source or use will not eliminate but will alleviate some of the costs to determine

precise amounts of each separately identifiable source or use within the cash receipts and

payments.

120. The staff understands the concern raised by the public accounting firm about the proposed

removal of the example showing how to apply the predominance principle to cash flows

associated with the acquisition and sale of equipment to be used by the entity or rented to

others. The staff refers to this as the “short period example.” The Task Force previously

discussed and ultimately rejected providing implementation guidance and illustrations that

include the short period example and additional examples to assist a reporting entity in

determining the predominant cash flow. One of the reasons why the Task Force decided not

to provide implementation guidance and illustrative examples is because specific

classification guidance is being provided for cash flows for which stakeholders indicated the

predominance principle is being applied. Therefore, the need to provide illustrative examples

is lessened because fewer cash flow classifications will be determined as a result of applying

this guidance. However, the staff notes that specific guidance is not being provided for the

cash flows in the short period example.

121. Specific to the cash flows in the short period example, while the staff thinks that the

appropriate classification should depend on the activity that is likely to be the predominant

source or use of cash flows for the item because the cash receipts or payments have aspects

of more than one class of cash flows that cannot be separated by source or use (that is, in

applying either the current guidance or the proposed amendments), the staff is concerned

that the removal of such an example in its entirety could be presumed to mean that the cash

flows related to the acquisition or production and subsequent sale of the assets to be used by

an entity or rented to others and then sold should be separated and classified into more than

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one class of cash flows on the basis of the underlying nature of the cash flows. To prevent

that presumption, the staff thinks that a brief example could be included in the amendments

to the Codification.

122. With the underlined revisions as noted below, the staff recommends that the Task Force

affirm its consensus-for-exposure that additional guidance be provided on the application of

the predominance principle, as follows:

230-10-45-22A In situations in which cash receipts and payments have aspects of more

than one class of cash flows and cannot be separated by source or use (for example,

when a piece of equipment is acquired or produced to be used by the entity or rented to

others for a period of time and then sold), the appropriate classification shall depend

on the activity that is likely to be the predominant source or use of cash flows for the

item.

123. The staff acknowledges the concern raised by a couple of respondents that the clarification

of the guidance on separately identifiable cash flows and application of the predominance

principle may not be an effective substitute for the lack of guidance on specific cash flow

classification issues. As previously mentioned in this memo, specific classification guidance

is being provided for cash flows for which stakeholders indicated that the predominance

principle is being applied. While the staff recognizes that there are likely other specific cash

flow issues for which the guidance on separately identifiable cash flows and application of

the predominance principle is being applied, those specific issues have not yet been

identified.

Transition Method

124. The proposed Update included the following questions on transition method:

Question 12: Should the proposed amendments for all eight cash flow issues be applied

using a retrospective transition method? If not, what transition approach is more appropriate

and for which specific cash flow issues and why?

Question 13: Should the proposed amendments include a provision that if it is impracticable

for some of the amendments to be applied using a retrospective transition method, then those

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amendments would be applied prospectively as of the earliest date practicable? Why or why

not?

125. In response to Question 12, 17 respondents supported retrospective application of the

proposed amendments for all eight cash flow issues because it would enhance the interperiod

consistency and comparability of financial information.

126. Four preparers disagreed with the proposed transition method for some or all of the eight

cash flow issues. One preparer recommended a prospective transition method, with an option

to apply the proposed amendments on a retrospective basis for all eight cash flow issues.

Another preparer indicated that prospective transition for all eight cash flow issues is more

appropriate because it may be difficult for preparers to obtain the prior period information

necessary to apply the proposed amendments on a retrospective basis. The other two

preparers recommended prospective transition for Issue 8, Separately Identifiable Cash

Flows and Application of the Predominance Principle. Both preparers expressed concerns

that retrospective application of Issue 8 would require a significant amount of work to

evaluate all prior period cash flows for which specific cash flow classification guidance does

not exist to determine whether the cash receipts and cash payments are classified

appropriately.

127. Five respondents did not respond to Question 12 of the proposed Update.

128. Additionally, one preparer who did not explicitly state whether they agreed or disagreed with

retrospective transition, stated that additional guidance should be provided on how to apply

the classification guidance on Issue 6, Distributions Received from Equity Method Investees,

on a retrospective basis. Specifically, the preparer suggested that guidance be provided on

whether a reporting entity must identify cumulative distributions and cumulative equity in

earnings since the inception of the equity method investment because such information could

be difficult to obtain or whether a reporting entity may begin accumulating cumulative

distributions and cumulative equity in earnings as of the earliest period presented.

129. Furthermore, one preparer who did not formally respond to the proposed Update with a

written comment letter indicated that for entities that determine classification of distributions

received from equity method investees based on specific facts and circumstances, the costs

of applying the proposed amendments on a retrospective basis may not justify the benefits.

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The preparer indicated that retrospective transition would require changes to its accounting

practice and accounting systems to capture the required data. The preparer noted that there

would be a significant amount of operational effort to gather the necessary information,

particularly for equity method investments that have been held for a long period of time (for

example, 10 years or longer) and receive frequent distributions. The preparer indicated that

it would be unable to use the impracticability exception, as proposed, because it could apply

the proposed amendments on a retrospective basis, albeit at a significant cost.

130. That preparer recommended prospective application of the proposed amendments regardless

of whether the information required to apply the guidance on a retrospective basis is

available. Furthermore, the preparer recommended that in the period of adoption, an entity

be permitted to apply a practical expedient to determine the starting point to classify future

distributions. At the transition date, as a starting point to classify future distributions, an

entity would determine the equity method investment’s inception-to-date cumulative

distributions and the cumulative equity in earnings for each investee, but would ignore prior

year distributions that were determined to be returns of investment and classified as cash

flows from investing activities. The preparer noted that gathering information about prior

year distributions that were determined to be returns of investment would be a manual

process that could take a significant amount of time and would not result in an improvement

to financial reporting. Subsequent to the transition date, the cash flow classification would

be determined by applying the amendments in the proposed Update. The practical expedient

recommended by the preparer is illustrated in the example below:

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Transition Illustration

Assumptions: Transition date of the new guidance is January 1, 2018.

Period

Share of net

income/(loss)

ABC

Company's

share of XYZ

Company's

cumulative

earnings since

inception

Share of

distributions

ABC

Company's

cumulative

distributions

since

inception

12/31/2012 (1,000) (1,000) 2,000 2,000

12/31/2013 1,000 - 2,000 4,000

12/31/2014 3,000 3,000 2,500 6,500

12/31/2015 2,000 5,000 1,000 7,500

12/31/2016 3,000 8,000 2,000 9,500

12/31/2017 2,000 10,000 * 2,000 11,500 *

03/31/2018 3,000 13,000 4,000 15,500

Cumulative distributions 15,500$

Less: cumulative equity in earnings 13,000

2,500$

Distribution received - interim reporting period 4,000$

Classification in the Statement of Cash Flows

Operating

activities

Investing

activities

1,500$ 2,500$

Fact Pattern: ABC Company is a calendar year-end entity with a 20% equity investment in a joint

venture, XYZ Company. The initial cash investment by ABC Company on January 1, 2012 for the 20%

interest is $25,000. The investment is accounted for as an equity-method investment. There is no

basis difference between ABC Company's cost basis of the investment and the proportional

interest in the equity of XYZ Company.

ABC Company's share of XYZ Company's income/(loss) and the related share of distributions for

the last six years and during the current interim reporting period are as follows:

* Represents the starting amounts for determining the classification of all

future distributions received.

Excess of distributions over equity in

earnings (cumulative)

During the March 31, 2018 interim reporting period, ABC Company receives a $4,000

distribution from XYZ Company and ABC Company's share of net income is $3,000.

131. Fifteen respondents who answered Question 13 agreed with the proposed amendments to

include a provision that if it is impracticable for some of the amendments to be applied using

a retrospective transition method, then those amendments would be applied prospectively as

of the earliest date practicable. Two preparers disagreed with the inclusion of an

impracticability provision. One of those preparers noted that Topic 250 already provides

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relief if retrospective application is impracticable and, therefore, it is unnecessary to

explicitly include such a provision. The other preparer observed that the impracticability

provision may lead to diversity in application, impacting comparability of financial

information.

132. Ten respondents did not respond to Question 13 of the proposed Update.


12. Does the Task Force want to affirm that the proposed amendments should be

applied using the retrospective transition method for all eight cash flow issues?

13. Does the Task Force want to affirm that the proposed amendments include a

provision that if it is impracticable for some of the amendments to be applied using

a retrospective transition method, then those amendments would be applied

prospectively as of the earliest date practicable?

Staff Analysis and Recommendation

133. In reaching its consensus-for-exposure that the proposed amendments should be applied

retrospectively, the Task Force stated that there will be a significant benefit to retrospective

transition because it would enhance interperiod consistency and comparability of financial

information.

134. The staff recognizes that one preparer recommended a prospective transition method, with

an option to apply the proposed amendments on a retrospective basis for all eight cash flow

issues, and that another preparer recommended prospective transition for all eight cash flow

issues. The staff also notes that several respondents raised concerns about applying the

proposed amendments for two of the eight specific cash flow issues (Issues 6 and 8) on a

retrospective basis. The staff has analyzed the transition method for those two issues in the

following paragraphs. For the other six issues (that is, Issues 1 through 5, and Issue 7),

respondents did not raise concerns about applying the proposed amendments; therefore, the

staff does not think that it is necessary to perform further analysis.

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Transition on Issue 6 – Distributions Received from Equity Method Investees

135. One preparer suggested that the Task Force provide clarification on how to apply the

guidance in Issue 6 on a retrospective basis. Specifically, the preparer requested clarification

on whether an entity must identify cumulative distributions and cumulative equity in

earnings since the inception of the equity method investment or whether an entity may begin

accumulating cumulative distributions and cumulative equity in earnings as of the earliest

period presented. In reaching its consensus-for-exposure to require retrospective transition,

the Task Force specifically considered transition on this Issue because stakeholders indicated

that retrospective transition could be difficult to apply. The Task Force considered a practical

expedient to apply the amendments as of a specified date. For example, entities would apply

the amendments as of the beginning of the earliest period presented in the statement of cash

flows; therefore, the information to be gathered (that is, cumulative distributions and

cumulative equity in earnings) would be limited to several years as opposed to cumulative

information that is gathered from the inception of when the equity method investment was

made. However, the Task Force rejected the alternative for a practical expedient because it

would be based on an arbitrary date and would not result in information that is any better or

more relevant than using an impracticability provision consistent with that in Topic 250. The

staff thinks that it could be made clear in the transition guidance that an entity would need

to gather cumulative information (that is, cumulative distributions received, prior

distributions determined to be returns of investment, and cumulative equity in earnings) from

the inception of when the equity method investment was made, unless impracticable.

136. Another preparer suggested prospective application to classify distributions received after

the date of adoption and that a practical expedient be provided to determine a starting point

from which to classify those distributions. That is, the information to be gathered would be

the investment inception-to-date cumulative distributions and the cumulative equity in

earnings for each investee; however, an entity would not be required to determine the

classification of prior year distributions. The staff notes that applying this practical expedient

could result in a different classification than a starting point where cumulative distributions

would be reduced by prior year distributions that were determined to be returns of

investment. In fact, the classification of all future distributions could be different if the

starting point used was consistent with the cumulative earnings approach described in the

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proposed amendments. While the staff understands that gathering information could be

costly for some entities, the staff thinks that the potential effect of this practical expedient

on the classification of all future distributions is inconsistent with the application of the

cumulative earnings approach, as proposed.

Retrospective Transition – Cumulative Earnings Approach

137. The staff does not expect that most entities would incur significant costs to apply the

cumulative earnings approach on a retrospective basis because it is the most commonly

applied approach in practice today. For those entities transitioning to the cumulative earnings

approach, including entities transitioning from a variation of the cumulative earnings

approach, the staff recognizes that entities with multiple equity method investments that have

been held for many years could incur significant costs to collect information about all

cumulative distributions and cumulative equity in earnings to determine which prior period

distributions would have been classified as returns of investment if the cumulative earnings

approach had been applied from the inception of the equity method investment. However, if

the Task Force affirms its consensus-for-exposure to require the cumulative earnings

approach, the staff recommends retrospective transition because the staff thinks that the

increase in comparability justifies the costs.

Retrospective Transition – Look-through Approach

138. If the Task Force decides during its redeliberations to require the look-through approach, for

those entities transitioning to the look-through approach, including entities transitioning

from a variation of the look-through approach, reasonable efforts would need to be made to

obtain information on the distributions received from equity method investees for all periods

presented.

139. The staff acknowledges that requiring an entity to obtain specific information about

distributions received from equity method investees could result in incremental costs.

However, because an entity only would obtain information about distributions received

dating back to the earliest period presented, as opposed to cumulative distributions received

since the inception of the equity method investment, applying the guidance retrospectively

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would be less onerous. Therefore, if the Task Force decides to require the look-through

approach, the staff recommends retrospective transition.

Retrospective Transition – Accounting Policy Election

140. The staff thinks that if the Task Force decides during its redeliberations to allow entities to

make an accounting policy election to apply either the cumulative earnings approach or the

look-through approach, that decision could relieve some of the pressure on applying the

guidance retrospectively because it would be expected that many entities will make an

accounting policy election to apply the same approach as they currently use. The staff

acknowledges that entities could be applying either of those approaches in a slightly different

manner compared to proposed amendments, but the staff does not think that it would

significantly affect an entity’s ability to apply the guidance on a retrospective basis.

Therefore, if the Task Force decides to allow an entity to apply either the cumulative earnings

approach or the look-through approach to classify distributions received from equity method

investees, the staff recommends retrospective transition.

Transition on Issue 8 – Separately Identifiable Cash Flows and Application of the Predominance Principle

141. A couple of respondents noted that retrospective transition could be difficult to apply on

Issue 8 because entities would need to reevaluate certain cash flows for which specific

guidance does not exist to determine whether changes in classification should be made to

prior periods presented. In reaching its consensus-for-exposure to require retrospective

transition, the Task Force specifically considered transition on Issue 8 because stakeholders

indicated that retrospective transition could be difficult to apply. However, those

stakeholders indicated that if sufficient transition time was provided, Issue 8 could be applied

on a retrospective basis. Because the Task Force reached a consensus-for-exposure on

specific cash flow classification issues for which stakeholders indicated that the

predominance principle is being applied, the staff thinks that fewer cash flow classifications

will be determined by applying the guidance in Issue 8. Furthermore, if the Task Force

affirms its consensus-for-exposure to include an impracticability provision, cost and

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complexity would be alleviated for those entities that lack the information to apply Issue 8

on a retrospective basis. Therefore, the staff recommends retrospective transition on Issue 8.

Impracticability Provision

142. The staff recommends that the Task Force affirm its consensus-for-exposure to include a

provision that if it is impracticable for some of the amendments to be applied using a

retrospective transition method, then those amendments would be applied prospectively as

of the earliest date practicable. The staff thinks that the impracticability provision could

alleviate the cost and complexity for those entities that lack the information to apply the

proposed amendments or portions of the proposed amendments retrospectively.

143. The staff acknowledges that a preparer observed that the impracticability provision may lead

to diversity in application, impacting comparability of financial information. However, the

staff thinks that there will be limited circumstances in which it is impracticable for an entity

to apply the proposed amendments.

Overall Staff Recommendation

144. The staff recommends the Task Force affirm its consensus-for-exposure to require

retrospective transition on all eight cash flows issues with a provision for impracticability.

The staff recognizes the concerns raised about transition for distributions received from

equity method investees and separately identifiable cash flows and application of the

predominance principle, but believes that the benefits justify the costs of requiring

retrospective transition. In conclusion, the staff thinks that there is a significant benefit to

retrospective transition because it would enhance interperiod consistency and comparability

of financial information.

Transition Disclosures

145. The proposed Update included the following question on transition disclosures:

Question 14: Should an entity be required to provide the transition disclosures specified in

the proposed Update? Should any other transition disclosures be required? If yes, please

explain what transition disclosures should be required and why.

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146. The proposed Update stated that an entity would provide the disclosures in paragraphs 250-

10-50-1(a) and (b)(1) and 250-10-50-2, as applicable, in the first interim and annual period

of adoption. Those paragraphs disclose the nature of and reason for the change in accounting

principle and a description of the prior period information that has been retrospectively

adjusted. Furthermore, if retrospective application to all prior periods is impracticable, then

an entity would provide a disclosure of the reasons therefore, and a description of the

alternative method used to report the change (paragraph 250-10-50-1(b)(4)).

147. Fifteen respondents who answered Question 14 agreed with the transition disclosures in the

proposed Update. Two respondents, a preparer and a professional accounting association,

indicated that the effect of the change on applicable financial statement line items also should

be required (paragraph 250-10-50-1(b)(2)). Eleven respondents did not respond to Question

14 of the proposed Update.

Question for the Task Force – Transition Disclosures

14. Does the Task Force want to affirm its consensus-for-exposure that (a) the

transition disclosures in paragraphs 250-10-50-1(a) and (b)(1) and 250-10-50-2, as

applicable, in the first interim and annual period of adoption, be required and (b) if

retrospective application to any prior period is impracticable, transition disclosures in

paragraph 250-10-50-1(b)(4) be required?


148. The staff recommends that the Task Force affirm its consensuses-for-exposure that (a) the

transition disclosures of paragraphs 250-10-50-1(a) and (b)(1) and 250-10-50-2, as

applicable, in the first interim and annual period of adoption, be required and (b) if

retrospective application to any prior period is impracticable, transition disclosures in

paragraph 250-10-50-1(b)(4) be required. The staff believes that those disclosure

requirements would sufficiently explain the change in accounting principle, and, therefore,

no additional disclosures should be required.

Effective Date and Early Adoption

149. The proposed Update included the following questions on effective date and early adoption:

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Question 15: How much time will be necessary to implement the proposed amendments?

Do entities other than public business entities that are required to present a statement of cash

flows under Topic 230 (that is, private companies and not-for-profit entities, but not

employee benefit plans) need additional time to apply the proposed amendments? Why or

why not?

Question 16: Should early adoption be allowed?

150. Eight respondents stated that the amount of time needed to implement the amendments as

described in the proposed Update would not be significant. A couple of those eight

respondents indicated that a minimum of six months should be provided to implement the

proposed guidance. Four additional respondents indicated that a minimum of one year should

be provided between the issuance of a final standard and the effective date to implement the

proposed guidance. One additional respondent was unable to estimate the time needed to

implement the amendments.

151. Four respondents recommended the same effective date for all entities. Five respondents

stated that entities other-than-public business entities should be permitted an additional year

to implement the proposed amendments. Twelve respondents did not respond to Question

15 of the proposed Update.

152. Fourteen of the 15 respondents who answered Question 16 agreed that early adoption should

be allowed. Several of those respondents noted that early adoption should be allowed

because the proposed amendments would promote consistency in financial reporting and

reduce diversity in practice.

153. One of the 15 respondents who answered Question 16 does not think that early adoption

should be allowed because it may reduce comparability of different entities’ statements of

cash flows.


15. What should the effective date be?

16. Should early adoption be permitted?

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154. Based on comment letter feedback, the staff believes that the time required to implement the

amendments in the proposed Update would be minimal. Therefore, the staff recommends

that for public business entities, the amendments in the proposed Update should be effective

for fiscal periods, and interim periods within those fiscal periods, beginning after December

15, 2017.

155. Because the respondents were about evenly split on whether the effective date should be the

same for all entities or different for other-than-public business entities, the staff considered

the Private Company Decision-Making Framework. It recommends that, generally, (a) the

amendments in an Accounting Standards Update should be effective for other-than-public

business entities one year after the first fiscal period for which public business entities are

required to adopt them and (b) other-than-public business entities should not be required to

adopt amendments during an interim period within the initial fiscal year of adoption. The

additional one-year transition period will allow a complete training cycle to occur, which

will enable other-than-public business entities to become aware of the changes. For entities

other-than-public business entities, the staff recommends that the amendments in the

proposed Update should be effective for fiscal periods beginning after December 15, 2018,

and interim periods within fiscal periods beginning after December 15, 2019.

156. The staff recommends that all entities should be permitted to early adopt the amendments in

the proposed Update. Specifically, entities would be permitted to apply the proposed

amendments for any annual or interim period for which the entity’s financial statements have

not yet been issued or made available for issuance; however, application would be as of the

beginning of the annual period.

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Appendix A: Summary of Cash Flow Issues and Staff Recommendations

Cash Flow Issue Consensus-For-Exposure Staff Recommendation

Issue 1—Debt Prepayment or Debt

Extinguishment Costs Cash payments for debt prepayment or extinguishment costs would be classified as cash outflows for financing activities.

Affirm the consensus-for-exposure, with minor revisions

Issue 2—Settlement of Zero-

Coupon Bonds At settlement, the portion of the cash payment attributable to the accreted interest would be classified as cash outflows for operating activities, and the portion of the cash payment attributable to the principal would be classified as cash outflows for financing activities.

Affirm the consensus-for-exposure

Issue 3—Contingent Consideration

Payments Made After a Business Combination

Cash payments made by an acquirer that are not paid soon after a business combination for the settlement of a contingent consideration liability would be separated and classified as cash outflows for financing activities and operating activities. Cash payments up to the amount of the contingent consideration liability recognized at the acquisition date would be classified as financing activities; any excess would be classified as operating activities.



Settlement of Insurance Claims Cash proceeds received from the settlement of insurance claims would be classified on the basis of the related insurance coverage (that is, the nature of the loss). For insurance proceeds that are received in a lump-sum settlement, an entity would be required to determine the classification on the basis of the nature of each loss included in the settlement.



Settlement of Corporate-Owned Life Insurance Policies, including Bank-Owned Life Insurance Policies

Cash proceeds received from the settlement of corporate-owned life insurance policies would be classified as cash inflows from investing activities.

The cash payments for premiums on corporate-owned life insurance policies may be classified as cash outflows for investing activities, operating activities, or a combination of investing and operating activities.

Cash Proceeds:


Premiums Paid: Affirm the consensus-for-exposure

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Issue 6—Distributions Received

from Equity Method Investees Distributions received from an equity method investee would be presumed to be returns on investment and classified as cash inflows from operating activities, unless the investor’s cumulative distributions received less distributions received in prior years that were determined to be returns of investment, exceed cumulative equity in earnings recognized by the investor. When such as excess occurs, the current period distribution up to this excess would be considered a return of investment and would be classified as cash inflows from investing activities. This consensus-for-exposure does not address equity method investments measured using the fair value option.

Require an accounting policy election to use either the cumulative earnings approach or the look-through approach

Issue 7—Beneficial Interests in

Securitization Transactions A transferor’s beneficial interest obtained in a securitization of financial assets would be disclosed as a noncash activity, and cash receipts from payments on a transferor’s beneficial interests in securitized trade receivables would be classified as cash inflows from investing activities.

Transferor’s Beneficial Interests Obtained in Securitized Financial Assets at the Inception of the Securitization: Affirm the consensus-for-exposure

Receipts from Collections on a Transferor’s Beneficial Interests: Affirm the consensus-for-exposure

Issue 8—Separately Identifiable

Cash Flows and Application of the Predominance Principle

Additional guidance would clarify when an entity should separate cash receipts and cash payments and classify them into more than one class of cash flows (including when reasonable judgment is required to estimate and allocate cash flows) and when an entity should classify the aggregate of those cash receipts and payments into one class of cash flows on the basis of predominance.


Transition Method Retrospective transition for all prior periods presented.


Transition Disclosures

Provide the disclosures in paragraphs 250-10-50-1(a) and (b)(1) and 250-10-50-2, as applicable, and if retrospective application to all prior periods is impracticable, the disclosure in paragraph 250-10-50-1(b)(4).


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Effective Date

Not applicable. Public Business Entities: Fiscal periods, and interim periods within those fiscal periods, beginning after December 15, 2017

Other-than-Public Business Entities:

Fiscal periods beginning after December 15, 2018, and interim periods within fiscal periods beginning after December 15, 2019

Early Adoption Not applicable. All entities should be permitted to early adopt

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