From the IFRS Institute – December 2, 2022
The statement of cash flows is a central component of a company’s financial statements and provides key information about its financial health and capacity to generate cash flows. Despite similar objectives, IAS 71 and ASC 2302 have different requirements, such as the composition of cash, and the classification of interest, dividends and lease payments across cash flow categories. These differences can significantly impair comparability between IFRS Accounting Standards and US GAAP. Here we summarize our selection of Top 10 GAAP differences related to the statement of cash flows.
The statement of cash flows prepared under IAS 7
A company is required to present a statement of cash flows that shows how its cash and cash equivalents have changed during the period. Cash flows are classified as either operating, investing or financing activities, depending on their nature.
| Classification | Description |
|---|
| Operating activities | The company’s principal revenue-producing activities, and other activities that are not investing or financing activities. |
| Investing activities | Relate to the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Only expenditures that result in a recognized asset on the balance sheet are eligible for classification as investing activities. |
| Financing activities | Result in changes in the size and composition of the company’s contributed equity and borrowings. |
How is IAS 7 different from ASC 230?
IFRS Accounting Standards and US GAAP contain similar overarching principles in preparing the statement of cash flows, including:
- the requirement to classify cash flows by operating, investing and financing activities; and
- allowing companies to elect to present cash flows from operating activities using either the direct method (showing receipts from customers, payments to suppliers etc.) or the indirect method (profit or loss for the period reconciled to the total net cash flows from operating activities).
Under IFRS Accounting Standards, the primary principle is that cash flows are classified based on the nature of the activity to which they relate. Under US GAAP, the classification of an item on the balance sheet, and its related accounting, often informs the appropriate classification in the statement of cash flows. As such, different classification and accounting for an underlying item on the balance sheet under US GAAP may result in differences in the statement of cash flows. In addition, certain differences exist between the detailed requirements of IAS 7 and ASC 230, which could affect dual preparers. See KPMG Handbook, Statement of cash flows, to learn more about the US GAAP requirements.
Here we summarize our selection of Top 10 differences.
1. Statement of cash flows always required under IFRS Accounting Standards; exceptions exist under US GAAP
Under IFRS Accounting Standards, there are no scope exceptions and all companies must present a statement of cash flows in a complete set of financial statements.
Under US GAAP, defined benefit pension plans that present financial information under ASC 9603 and certain investments companies in the scope of ASC 9464 may be exempt from presenting a statement of cash flows.
2. The starting point of the statement of cash flows varies under IFRS Accounting Standards; net income is the starting point under US GAAP
Under IFRS Accounting Standards, companies may use different starting points for reporting operating cash flows under the indirect method – e.g. profit or loss, profit or loss from continuing operations, profit or loss before tax or operating profit or loss.
Diversity in practice may have developed because IAS 7 refers to ‘profit or loss’, but an example to the standard starts with a different figure (profit before taxation). We believe it is more appropriate to follow the standard (i.e. start with profit or loss), because the example is illustrative only and does not have the same status as the standard.
See the proposed amendments that would require the operating profit or loss subtotal as the starting point.
3. IFRS Accounting Standards provide options for classifying cash flows related to interest, dividends and income taxes; US GAAP does not
The table summarizes the classification differences.
Cash flow item
| IFRS Accounting Standards
| US GAAP
|
|---|
| Interest paid | Operating or financing
(generally operating for financial institutions)
| Operating (net of interest capitalized5) |
| Dividends paid | Operating or financing | Financing |
| Interest and dividends received | Operating or investing
(generally operating for financial institutions)
| Operating |
| Taxes paid | Generally operating activities, unless practicable to identify taxes with investing or financing activities | Operating |
See the proposed amendments that would affect these classifications under IFRS Accounting Standards.
4. Cash may be net of bank overdrafts under IFRS Accounting Standards; not under US GAAP
Under IFRS Accounting Standards, bank overdrafts are generally6 presented as liabilities on the balance sheet. However, in the statement of cash flows, bank overdrafts reduce the cash and cash equivalents balance if they are repayable on demand and form an integral part of the company’s cash management. Assessing whether a banking arrangement is an integral part of the entity’s cash management depends on the specific facts and circumstances and may require judgment. Components making up the total cash and cash equivalents opening and closing balances in the statement of cash flows are disclosed and reconciled to the appropriate balance sheet line items.
Under US GAAP, bank overdrafts are considered a form of short-term financing and are generally6 presented as liabilities, with changes therein classified as financing activities (draws separate from repayments) in the statement of cash flows.
5. Restricted amounts may be excluded from total cash and cash equivalents under IFRS Accounting Standards; included under US GAAP
IFRS Accounting Standards do not define ‘restricted’ amounts and do not address whether restricted amounts should be included in a company’s beginning or ending cash and cash equivalent balances in the statement of cash flows. This depends on whether these amounts, while restricted, still meet either the definition of cash or the definition of cash equivalents. This usually requires judgment as further explained below.
Asset
| IAS 7 definition and related guidance
| Observation
|
|---|
| Cash | Defined as comprising cash on hand and demand deposits.
Demand deposits are not defined in IFRS Accounting Standards, but we believe they should have the same level of liquidity as cash and therefore should be able to be withdrawn at any time without penalty.
| Demand deposits with restrictions on use arising from a contract with a third party are still considered cash, unless those restrictions change the nature of the deposit in a way that it would no longer meet the definition of cash in IAS 77.
A deposit that fails to be classified as cash may still meet the definition of cash equivalents if specific criteria are met.
|
| Cash equivalents | Defined as short-term, highly liquid investments that are readily convertible to known amounts of cash and that are subject to an insignificant risk of changes in value.
An overriding test for cash equivalents is that they are held for the purpose of meeting short-term cash commitments rather than for investing or other purposes – i.e. the ‘purpose test’.
| Judgment is required to assess whether restrictions on use of amounts that otherwise meet the definition of cash equivalents prevent the ‘purpose test’ from being met, in which case these amounts would not be cash equivalents. |
Under US GAAP, while restricted amounts of cash and cash equivalents are presented separately from unrestricted amounts on the balance sheet, restricted amounts are included in the total cash and cash equivalents in the statement of cash flows. The company then discloses a reconciliation between the two cash and cash equivalents totals.
Although neither GAAP provides a specific definition of restricted cash, under US GAAP it is commonly understood to include cash and cash equivalents whose withdrawal or usage is restricted for certain purposes – e.g. legally restricted deposits held as compensating balances on short-term borrowing arrangements, contracts entered into with others, statements of intention regarding particular deposits. This absence of definitions may lead to differences in practice between amounts reported as restricted cash under IFRS Accounting Standards and US GAAP.
6. IFRS Accounting Standards do not distinguish between operating and finance leases; Classification of lease payments for lessees depends on lease classification under US GAAP
Under IFRS 168, a lessee classifies cash payments for the principal portion of a lease liability as financing activities in the statement of cash flows. Payments for the interest portion are classified as operating or financing activities, in line with a company’s policy election for interest paid (see Difference #3). (For lessees, IFRS 16 does not distinguish between operating and finance leases, unlike US GAAP.)
Under US GAAP, a lessee classifies operating lease payments as operating activities. Finance lease payments are classified in the same way as all lease payments under IFRS Accounting Standards.
Both GAAPs classify the following as operating cash flows: payments for short-term leases , and variable lease payments not included in the lease liability (as measured under the applicable GAAP).
7. Classification of deferred or contingent consideration payments in a business combination may differ under IFRS Accounting Standards and US GAAP
Under IFRS Accounting Standards, cash payments for deferred and contingent consideration in a business combination require judgment to determine the appropriate classification based on the nature of the activity to which the cash flows relate. We believe it is generally appropriate to classify payments as shown in the following table.
Payment reflecting a finance expense
| Consistent with the policy election for interest paid (see Difference #3).
|
| Payment reflecting settlement of the fair value of consideration recognized on initial recognition | Financing or investing activities.
Judgment needs to be applied when determining whether the payment arises from obtaining control (an investing activity) or whether it is a settlement of financing provided by the seller.
Factors that may be relevant include: (1) the time between initial recognition of the liability and settlement; (2) whether the settlement period reflects a normal credit period; and (3) whether the liability is discounted to reflect its deferred settlement (which would suggest a financing element to the arrangement).
|
| Contingent consideration paid in excess of the fair value of consideration recognized on initial recognition | Operating activities, or consistent with the policy election for interest paid (see Difference #3). |
US GAAP includes prescriptive guidance on how to classify payments for contingent consideration, which we believe applies equally to deferred fixed consideration payments as follows:
| Payments made ‘soon after’ the acquisition date | Investing activities.
We believe that three months or less is an appropriate interpretation of ‘soon after’.
|
| Payments not made ‘soon after’ the acquisition date | Payments up to the fair value of consideration recognized at acquisition are classified as financing activities
Any excess is classified as operating activities.
|
8. IFRS Accounting Standards do not prescribe classification of certain cash flows; US GAAP does
Unlike IAS 7, US GAAP explicitly specifies the classification of the following cash flows:
- cash payments for debt prepayments or extinguishment costs: financing activities;
- cash payments for the settlement of a zero-coupon bond or a bond with an insignificant interest rate: operating activities (portion attributable to accreted interest) and financing activities (portion attributable to original principal);
- proceeds from the settlement of an insurance claim: based on the nature of the loss;
- distributions from equity method investees: accounting policy election between operating activities (to the extent distributions are not a return of capital) and investing activities or based on facts and circumstances of the distribution; and
- cash receipts from payments on a transferor’s beneficial interests in securitized trade receivables: investing activities.
Absent specific guidance in IAS 7, we believe that judgment is required in determining the classification of these items. Such judgment should primarily consider the nature of the activity (rather than the classification of the related items on the balance sheet), as mentioned above. Unlike US GAAP, this principles-based approach may lead to more diverse classification outcomes.
9. No predominance principle in IFRS Accounting Standards; exists in US GAAP
Under IFRS Accounting Standards, a company classifies each of the separate components of a single transaction as operating, investing or financing because IAS 7 does not allow a transaction to be classified based on its predominant characteristic. IAS 7 includes specific guidance related to purchases and sales of equipment held for rental to others.
US GAAP includes similar principles, but when a transaction has characteristics of more than one class of cash flows – and each separately identifiable source or use of cash cannot reasonably be separated – then a company applies the predominance principle to determine the appropriate classification for the related cash flows.
