board memo guidelines - ey · pdf filememo discusses issue 4 – restricted cash, the...

of 25

Memo No. Issue Summary No. 1, Supplement No. 2

Memo Issue Date October 29, 2015

Meeting Date(s) EITF November 12, 2015

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

Jane Rizzuto Co-Author (203) 956-3442

Justin Gwizdala Co-Author (203) 956-3263

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 Initial Deliberations

Dates previously discussed by EITF

May 14, 2015 EITF Educational Meeting, June 18, 2015, September 17, 2015

Previously distributed Memo Numbers

Issue Summary No. 1, dated June 4, 2015, Supplement No. 1, dated September 3, 2015

Purpose of This Memo

1. The purpose of this memo is to assist Task Force members as they consider classification of

certain cash receipts and payments in the statement of cash flows.

2. This memo is structured as follows:

(a) Background Information

(b) Issue 4 – Restricted Cash

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.

of 25

(c) Next Steps

(d) Appendix A – Definitions of Financing, Investing, and Operating Activities

from the Master Glossary of the Codification

(e) Appendix B – Summary of Alternatives and Staff Recommendations

Background Information

3. There are nine specific cash flow classification issues to be addressed in Issue 15-F. To date,

the Task Force has discussed and reached tentative conclusions on eight of those issues. This

memo discusses Issue 4 – Restricted Cash, the issue for which tentative conclusions have

not yet been reached.

Issue 4: Restricted Cash

4. Significant diversity exists in the classification and presentation of changes in restricted cash

on the statement of cash flows. Entities classify the changes in operating, investing, or

financing activities, or in a combination thereof.

5. At the June 18, 2015 EITF meeting, several Task Force members expressed concerns about

the lack of a definition of restricted cash in GAAP. Those Task Force members commented

that restricted cash appears to be investment-like when it is contractually and/or legally

restricted. However, when restricted cash is self-designated as restricted and maintained in

the general cash account, it seems to be other than investment-like.

6. Additionally, several Task Force members questioned whether and when cash payments and

receipts can be made directly from and into restricted cash. Some Task Force members

observed that those cash payments and receipts may be noncash items under existing GAAP.

Others suggested that it may be appropriate to assume that the restriction lapses right before

a reporting entity makes a cash payment directly from restricted cash; therefore, the direct

cash payments would be presented in the body of the statement of cash flows as an inflow

and a corresponding outflow.

7. As a result, the following three subissues have been identified:

of 25

(a) Definition of restricted cash (Subissue 4a)

(b) Classification of changes in restricted cash (Subissue 4b)

(c) Presentation of cash payments and cash receipts that directly affect restricted

cash (Subissue 4c).

8. Since the June 18, 2015 meeting, the staff has performed additional outreach on Subissues

4a and 4c with five public accounting firms, two FASB advisory groups composed of

auditors, preparers, and users, and an accounting analyst. The outreach primarily focused on

issues that are common among all types of entities rather than just industry-specific issues.

Feedback received is included in the staff analysis section of each Subissue. The staff notes

that not-for-profit entities (NFP) have unique issues that are incremental to for-profit entities,

and additional time is needed for the staff to perform outreach with NFP stakeholders to

adequately address the NFP-specific issues and to provide the Task Force with a complete

analysis of the restricted cash issues. However, the staff thinks that it is appropriate for the

Task Force to discuss the analysis performed to date in the context of for-profit entities.

Subissue 4a – Definition of Restricted Cash

9. Stakeholders indicated that the lack of a definition of restricted cash in the Master Glossary

contributes to the diversity in the presentation and classification of changes in restricted cash

on the statement of cash flows and the balance sheet. Therefore, defining restricted cash is

intended to reduce the diversity in both statements. The Master Glossary includes definitions

of cash and cash equivalents, as follows:

Cash

Consistent with common usage, cash includes not only currency on hand

but demand deposits with banks or other financial institutions. Cash also

includes other kinds of accounts that have the general characteristics of

demand deposits in that the customer may deposit additional funds at any

time and also effectively may withdraw funds at any time without prior

notice or penalty. All charges and credits to those accounts are cash receipts

or payments to both the entity owning the account and the bank holding it.

For example, a bank's granting of a loan by crediting the proceeds to a

of 25

customer's demand deposit account is a cash payment by the bank and a

cash receipt of the customer when the entry is made.

Cash Equivalents

Cash equivalents are short-term, highly liquid investments that have both of

the following characteristics:

a. Readily convertible to known amounts of cash

b. So near their maturity that they present insignificant risk of changes in

value because of changes in interest rates.

Generally, only investments with original maturities of three months or less

qualify under that definition. Original maturity means original maturity to

the entity holding the investment. For example, both a three-month U.S.

Treasury bill and a three-year U.S. Treasury note purchased three months

from maturity qualify as cash equivalents. However, a Treasury note

purchased three years ago does not become a cash equivalent when its

remaining maturity is three months. Examples of items commonly

considered to be cash equivalents are Treasury bills, commercial paper,

money market funds, and federal funds sold (for an entity with banking

operations).

Question for the Task Force

1. What should be the definition of restricted cash?

Staff Analysis and Outreach – Subissue 4a

10. All of the stakeholders indicated that self-designated cash should be excluded from the

definition of restricted cash because the self-designation could frequently change based on

decisions made by management. However, some of the stakeholders thought separate

consideration should be given to NFPs because of their unique characteristics (for example,

board-designated funds, donor-restricted contributions, and endowments).

11. The majority of the stakeholders stated that cash that has legal and/or contractual restrictions

imposed by a third party and cannot be withdrawn or used by the entity without approval

from that third party should be included in the definition of restricted cash. However, a

concern was raised by a couple of stakeholders about whether compensating balance

of 25

arrangements1 would fall under the definition of restricted cash because such arrangements

may or may not restrict the withdrawal or use of cash.

12. Some stakeholders also raised concerns about the interaction between a GAAP definition of

restricted cash and the disclosure requirements in SEC Regulation S-X, Reg. § 210.5-02,

which states that separate disclosure shall be made of the cash and cash items that are

restricted as to withdrawal or usage. The provisions of any restrictions are required to be

described in a note to the financial statements. Restrictions may include legally restricted

deposits held as compensating balances against short-term borrowing arrangements,

contracts entered into with others, or company statements of intention with regard to

particular deposits; however, time deposits and short-term certificates of deposit are not

generally included in legally restricted deposits.

13. Those stakeholders noted that because of the current lack of a definition of restricted cash,

the description in SEC Regulation S-X, Reg. § 210.5-02 is being used in practice by some

entities as a definition. While the majority of stakeholders indicated that self-designated cash

should be excluded from a GAAP definition of restricted cash, that exclusion could cause

confusion when applying Reg. § 210.5-02, which requires disclosures of company

statements of intentions with regard to particular deposits.

14. Some examples of general types of restrictions placed on cash include: financing obligations,

bankruptcy reorganizations, insurance claims, securitization transactions, litigation

purposes, escrowed funds for a business combination, and operational obligations.

15. The staff has identified the following alternatives to address Subissue 4a:

Alternative A – Restricted cash should be defined as cash that is subject to a legal or

contractual restriction by a third party for a specified purpose and is restricted as to

withdrawal or usage.

1 A compensating balance arrangement can be described as funds that a borrower is required to keep on deposit in a

financial institution in accordance with a loan agreement. For example, a corporation agrees to maintain $1 million

in its checking account at a bank in exchange for the bank agreeing to lend up to $10 million to the corporation at 1

percent below the prime lending rate.

of 25

Alternative B – Restricted cash should be defined as cash that includes amounts that are

self-designated by management, and cash that is subject to a legal or contractual restriction

by a third party for a specified purpose and is restricted as to withdrawal or usage.

Alternative A

16. Proponents of the definition of restricted cash in Alternative A think that it is likely broad

enough to encompass the most prevalent forms of restrictions that are placed on cash by a

third party. The Master Glossary defines contract as an agreement between two or more

parties that creates enforceable rights and obligations. Proponents indicate that the definition

of contract is used in a number of Topics and is generally understood in practice. While the

term contract is not specifically used in the definition of restricted cash proposed in

Alternative A, the staff thinks that the term contractual (undefined) should be interpreted as

an agreement between two parties that creates enforceable rights and obligations.

17. The definition of a contract emphasizes that a contract exists when there is agreement

between two or more parties. There are situations in which an entity’s cash is restricted by a

court of law for a specific purpose (for example, for claims filed in a bankruptcy

reorganization) and cannot be withdrawn or used by the entity for reasons other than that

specified purpose. It could be unclear in those circumstances whether a court order that

imposes cash restrictions would constitute “agreement” by both the entity and the court or

whether this is a decision that the court made unilaterally. However, because the definition

of restricted cash in Alternative A includes legal restrictions and restrictions related to

withdrawal or usage, proponents think that in situations in which an entity's cash is restricted

by a court order, it would be clear that such a restriction constitutes restricted cash.

18. Proponents of the definition in Alternative A think that it would segregate unavailable cash

from cash that is available for use in an entity’s operations. Those proponents believe that

making a distinction between unavailable and available cash would provide relevant

information to users about an entity’s liquidity and the amount of limitations on cash and

cash equivalents.

19. Proponents of the definition of restricted cash in Alternative A believe that it addresses the

issue about whether cash associated with compensating balance requirements would be

of 25

considered restricted cash. Those proponents note that when a compensating balance

arrangement exists but does not legally restrict the use of cash because there is no prohibition

on the withdrawal of funds, the cash would not be included in restricted cash as defined in

Alternative A. When a compensating balance arrangement restricts the withdrawal or usage

of funds, those proponents think that the cash would be included in restricted cash, as defined

in Alternative A. For example, a compensating balance arrangement that specifies an amount

of cash that must be on deposit at the end of each day would not be considered restricted

cash because the entity is able to use or withdrawal the cash at other times.

20. Opponents think that the definition of restricted cash in Alternative A is appropriate for

entities other than NFPs, but that it does not consider the unique aspects of NFPs. Therefore,

the definition of restricted cash in Alternative A may not be appropriate for all types of

entities. Under Alternative A, donor-restricted gifts of cash that are received by an NFP for

an endowment fund2 would likely be considered restricted cash. Opponents of Alternative

A think that those funds should be excluded from the definition of restricted cash. Opponents

note that the definition of endowment fund, which includes donor-restricted gifts of cash, is

clearly stated in GAAP and well understood in practice.

21. Additionally, an NFP is required under existing GAAP to disclose information to enable

users of its financial statements to understand the following about its endowment funds,

which includes both the NFP’s donor-restricted endowment fund3 and board-designated

endowment fund4: net asset classification, net asset composition, changes in net asset

composition, spending policies, and related investment policies. Opponents of Alternative A

think that these required disclosures clearly explain the type of restrictions on cash included

2 The Master Glossary defines endowment fund as an established fund of cash, securities, or other assets to provide

income for the maintenance of a not-for-profit. The use of the assets of the fund may be permanently restricted,

temporarily restricted, or unrestricted. Endowment funds generally are established by donor-restricted gifts and

bequests to provide either of the following:

a. A permanent endowment, which is to provide a permanent source of income

b. A term endowment, which is to provide income for a specified period. 3 The Master Glossary defines donor-restricted endowment fund as an endowment fund that is created by a donor

stipulation requiring investment of the gift in perpetuity or for a specified time. Some donors may require that a

portion of income or gains or both be added to the gift and invested subject to similar restrictions. The term does not

include a Board-Designated Endowment Fund. See Endowment Fund. 4 The Master Glossary defines board-designated endowment fund as an endowment fund created by an NFP’s

governing board by designating a portion of its unrestricted net assets to be invested to provide income for a long

but unspecified period (sometimes call funds functioning as endowment or quasi-endowment funds). See

Endowment Fund.

of 25

in endowment funds and therefore is unnecessary to include in the definition of restricted

cash.

22. Similar to gifts of cash for an endowment fund, opponents of Alternative A also believe that

gifts of cash that are received by an NFP that by donor stipulation are restricted for a

specified purpose should be excluded from the scope of the definition of restricted cash

because guidance already exists about the classification of certain gifts with donor-imposed

restrictions on the statement of financial position and classification of receipts from

contributions and investment income that are donor-restricted in the statement of cash flows.

Alternative B

23. The difference between Alternative A and Alternative B is that Alternative B includes cash

that is self-designated as restricted by an entity’s management as unavailable for use in an

entity’s current operations.

24. Proponents of Alternative B indicate that including cash that is self-designated by

management as unavailable for use in an entity’s current operations in the definition of

restricted cash would be more consistent with the description of the disclosures required in

SEC Regulation S-X, Reg. § 210.5-02. Therefore, better alignment would exist between the

GAAP definition and the disclosures required by the SEC.

25. Proponents of Alternative B acknowledge that self-designated cash restrictions are subject

to change. However, including self-designations in restricted cash could provide insight into

an entity’s plans for the cash and the amount of cash available to fund current operations.

26. Opponents of Alternative B observe that while information about self-designated restrictions

on an entity’s cash that makes it unavailable for current period operations might be useful to

financial statement users, the restrictions are subject to change based on decisions made by

management. Opponents of Alternative B believe that there is the potential for manipulation

and frequent changes to occur when entities have the ability to control what is reported as

restricted cash in the financial statements. Therefore, the opponents believe that only cash

that is restricted by a third party for a specified purpose and is restricted as to withdrawal or

usage should be included in the definition of restricted cash.

of 25

Staff Recommendation – Subissue 4a

27. The staff thinks that the definition of restricted cash in Alternative A is appropriate for cash

restrictions that are most common among all types of entities, but that additional outreach

and research should be performed with NFP stakeholders to determine whether or how the

definition of restricted cash should be modified to address NFP-specific characteristics.

Consistent with stakeholder feedback, the staff believes that self-designated restrictions on

cash should not be included in the definition of restricted cash because the restrictions are

subject to change based on management decisions.

Subissue 4b – Classification of Changes in Restricted Cash

28. Changes in restricted cash occur when restricted cash is established (for example, transfer of

cash from unrestricted cash to restricted cash) and when the restrictions are released (for

example, transfer of cash from restricted cash to unrestricted cash). For purposes of the staff

analysis, unrestricted cash is synonymous with cash and cash equivalents. As noted and

addressed in Subissue 4c, changes in restricted cash can also occur when cash payments are

made directly from restricted cash and cash receipts are deposited directly into restricted

cash from a source outside the entity.

29. Sometimes restricted cash is set aside in a separate bank account, and other times restricted

cash is maintained in the same bank account along with unrestricted cash. The fact that a

separate bank account is not established for restricted cash does not mean that the cash is

without restrictions. If the withdrawal or usage of the cash would create a consequence to

the entity that is a sufficiently large disincentive for non-performance, then the staff thinks

that the cash is restricted. When entities commingle restricted and unrestricted cash in the

same bank account, cash receipts and payments are tracked separately for financial reporting

purposes. Regardless of whether the transfers occur between separate bank accounts or

whether the restricted and unrestricted cash is maintained in the same bank account and

tracked separately for financial reporting purposes, the movement of cash between restricted

and unrestricted cash results in cash flows that should be classified in the statement of cash

flows because Topic 230 requires presentation of the changes during the period in cash and

cash equivalents.

of 25

30. Entities presently classify the changes in restricted cash in operating, investing, or financing

activities, or in a combination thereof. Stakeholders indicated that it is unclear whether the

classification should be based on the nature of the cash flows or the purpose of the restriction.


2. How should the changes of the principal balances in restricted cash be classified

in the statement of cash flows when cash and cash equivalents have been affected?

Staff Analysis – Subissue 4b

31. The staff has identified the following potential alternatives to address Subissue 4b:

Alternative A – Changes of the principal balances in restricted cash that affect cash and

cash equivalents should be based on the nature of the cash flows and, therefore, classified

as investing activities in the statement of cash flows.

Alternative B – Changes of the principal balances in restricted cash that affect cash and

cash equivalents should be classified based on the purpose of the restricted cash.

Alternative C – Include restricted cash with cash and cash equivalents on the statement

of cash flows.

Alternative A

32. Under Alternative A, the classification of changes of the principal balances in restricted cash

that affect cash and cash equivalents would be based on the nature of the cash flows.

Proponents of Alternative A believe that Topic 230 requires that classification should be

based on the nature of the cash flows. That is, inherent in the definitions of financing,

investing, and operating activities, classification is based on the nature of the cash flow

without regard to whether it stems from another item such as a transaction. In other words,

the term “nature” in this context can be described as the characteristics or features that a cash

receipt or payment exhibits without regard to whether the cash receipt or payment is linked

to other transactions. For example, the nature of proceeds received by an entity from a debt

borrowing that will be used to construct a building are financing, which is consistent with

the guidance that states that financing activities include proceeds from borrowings.

of 25

Classification of the proceeds based on linking it to the use of the proceeds (that is,

constructing a building) would result in an investing activity classification, which is

inconsistent with the current guidance, as noted above.

33. In evaluating the nature of the cash flows related to restricted cash, the descriptions of

financing, operating, and investing activities in Topic 230 were considered (the actual

Glossary definitions are included in Appendix A):

Financing Activities - The definition of financing activities includes obtaining resources

from owners and providing them with a return, and borrowing money and repaying

amounts borrowed. The cash flows associated with both the establishment of and the

release of the principal balances in restricted cash that are simply transfers between

unrestricted and restricted cash are not representative of these activities. Therefore,

proponents of Alternative A think that the nature of the cash flows do not fit within

financing activities.

Operating Activities - While the definition of operating activities is a residual category,

meaning operating activities include all transactions and other events that are not defined

as investing or financing, Topic 230 does state that operating activities generally involve

producing and delivering goods and providing services. The cash flows associated with

both the establishment of and the release of the principal balances in restricted cash do not

directly relate to producing and delivering goods and providing services. Furthermore, cash

flows from operating activities are generally the cash effects of transactions and other

events that enter into the determination of net income. The cash flows associated with both

the establishment and release of restricted cash that are simply transfers between

unrestricted and restricted cash do not enter into the determination of net income. For those

reasons, proponents of Alternative A think that the nature of the cash flows do not fit within

operating activities.

Investing Activities – Cash flows from investing activities include the purchase and sales

of equity securities, debt securities, and property, plant and equipment. Restricted cash

generally results from a contractual requirement to commit money or to invest cash

balances for a particular purpose and the contractual requirement limits an entity’s ability

to withdraw funds at any time.

of 25

34. Based on their review of the descriptions of operating, investing, and financing, proponents

of Alternative A believe that a balance on deposit in a restricted cash account is most

analogous to an investment whose return of principal requires the satisfaction of conditions

rather than a mere withdrawal demand. Accordingly, deposits and withdrawals of principal

balances in restricted cash accounts represent the creation or return of investment. Therefore,

the nature of the cash flows associated with both the establishment and the release of the

principal balances in restricted cash most closely fits within the definition of investing

activities.

35. Proponents of Alternative A also observe that determining the classification of cash receipts

and payments based on the nature of the restriction results in a consistent cash flow

classification and provides more decision useful information to financial statement users.

36. Furthermore, FASB Concepts Statement No. 5, Recognition and Measurement in Financial

Statements of Business Enterprises, paragraph 24(c), states that statements of cash flows

commonly show a great deal about an entity’s current cash receipts and payments, but a cash

flow statement provides an incomplete basis for assessing prospects for future cash flows

because it cannot show interperiod relationships. Statements of earnings and comprehensive

income, especially if used in conjunction with statements of financial position, usually

provide a better basis for assessing future cash flow prospects of an entity than do cash flow

statements alone.

37. Generally, cash is restricted for a future purpose (for example, future cash flows for the

payment of litigation claims, self-insurance and workers’ compensation obligations, and

financing obligations). Because the cash flow statement provides an incomplete basis for

assessing prospects for future cash flows and cannot show interperiod relationships,

classifying the changes in restricted cash based on the purpose of the restriction is contrary

to the information that CON 5 intends the statement of cash flows to provide.

38. Proponents of Alternative A also highlight that classifying changes in restricted cash based

on the purpose of the restricted cash could result in reflecting a duplicate cash flow

classification, which some people may believe is inappropriate.

of 25

39. For those reasons, Alternative A was supported by the five public accounting firms in the

staff’s outreach, the majority of the FASB Advisory Group members who provided

feedback, and a preparer representing a large multi-national public business entity.

Alternative B

40. Proponents of Alternative B observe that classifying the changes of the principal balances in

restricted cash based on the purpose for restriction is more understandable to a financial

statement user. Those proponents believe that classifying changes of the principal balances

in restricted cash based on its nature (that is, investing activities) does not provide the user

with information about the purpose of the restriction.

41. One member of an FASB advisory group indicated that he believes that Alternative B is

more appropriate because classifying the changes of the principal balances in restricted cash

based on its purpose is a logical approach to presenting information on the statement of cash

flows.

42. Proponents of Alternative B also indicate that because changes of the principal balances in

restricted cash do not precisely fall into the definitions of financing, investing, and operating

activities, the most reasonable way to classify these changes is based on the purpose of the

restriction.

Alternative C

43. In Alternative C, restricted cash would be included in the statement of cash flows along with

cash and cash equivalents. That is, transfers between cash and cash equivalents and restricted

cash would not be presented in the statement of cash flows; only the ultimate cash outflow

from the entity or deposits from third parties directly into a restricted cash account would be

presented within the statement of cash flows. The effect of this alternative on the statement

of cash flows as compared to current GAAP is that it would remove the line item that presents

changes in restricted cash, and it would increase the total of the statement of cash flows

because restricted cash would be included. This approach is similar to GASB Statement No.

9, Reporting Cash Flows of Proprietary and Nonexpendable Trust Funds and Governmental

Entities That Use Proprietary Fund Accounting, which states that a statement of cash flows

of 25

should explain the change during the period in cash and cash equivalents regardless of

whether there are restrictions on their use.

44. Proponents of Alternative C think that this approach would reduce diversity in practice and

resolve all of the classification and presentation issues related to restricted cash in the

statement of cash flows. That is, it would address the transparency concerns related to a

noncash disclosure alternative, alleviate concerns about reporting changes in restricted cash

as if they were changes of cash and cash equivalents when cash is not transferred to or from

a segregated account, and obviate the need to determine whether changes in restricted cash

should be classified based on the nature or the purpose of the restriction (that is, the ultimate

cash payments made directly from restricted cash to third parties and the cash receipts

directly deposited into restricted cash from third parties would be classified based on their

nature, consistent with the classification of other cash flows).

45. Proponents of Alternative C think that the most important information to provide financial

statement users with is the ultimate cash flows that affect the reporting entity. Furthermore,

the amount of cash that is restricted and the change in restricted cash during the period can

be gleaned from the statement of financial position.

46. Opponents think that Alternative C would diminish the value of the cash flow statement

because it would commingle restricted and unrestricted cash in the statement of cash flows,

which could reduce transparency of the cash flows specifically related to cash that is

restricted and cash that is unrestricted. Similar to an investment and its cash flows, which

are presented separately from cash and cash equivalents, proponents believe that the

restricted cash and its cash flows also should be presented separately from cash and cash

equivalents.

47. Opponents of Alternative C also note that such a change would represent a fundamental

change to Topic 230 because Topic 230 states that the primary objective of a statement of

cash flows is to provide relevant information about the cash (as defined) receipts and

payments of an entity during a period.

48. Subissue 4c addresses issues that arise when cash payments are made directly from restricted

cash and cash receipts are deposited directly into restricted cash. However, if the Task Force

of 25

reaches a tentative conclusion supporting Alternative C, Subissue 4c does not need to be

considered.

Comparison of Classifications – Alternative A versus Alternative B

49. As noted above, Alternative A would result in a consistent cash flow classification of

changes of the principal balances in restricted cash, while under Alternative B the cash flow

classification would vary based on the purpose of the restriction. In the following two

examples it is assumed that transfers of cash occur between restricted and unrestricted cash

in order to establish the restricted cash account and to release the restriction. The following

two examples illustrate the differences in the cash flow classification based on nature and

purpose:

Example 1:

Nature of the Cash

Flows

Purpose of the

Restriction

Cash Flow #1: Set up the restricted cash account

(transfer of cash from unrestricted cash to restricted

cash) Investing outflow Operating outflow

Cash Flow #2: Release from restriction occurs (transfer

of cash from restricted cash to unrestricted cash) Investing inflow Operating inflow

Cash Flow #3: Payment of workers' compensation

claims from unrestricted cash Operating outflow Operating outflow

Classification Based on:

However, an operating activities classification for cash flows #1 and #2 is contrary to the Master Glossary

definition of operating activities, which states, in part, cash flows from operating activities generally are the cash

effects of transactions and other events that enter into the determination of net income. Cash flows #1 and #2

do not enter into the determination of net income.

Nature of the cash flows: Cash flows #1 and #2 are classified as an investing activity because the cash flows

are similar to the purchase and sale of an investment.

Purpose of the restriction: Cash flows #1 and #2 are classified as an operating activity because the cash

flows are being linked to the future payment of workers' compensation claims, an operating activity.

An entity is required by its insurer to establish a restricted cash account for future payment of workers'

compensation claims. The restricted cash is to be invested in an interest-bearing account until the restriction is

released and cash payments are made for workers' compensation claims.

of 25

Staff Recommendation – Subissue 4b

50. Some staff members recommend Alternative A and other staff members recommend

Alternative C. Those who support Alternative A believe that:

(a) Inherent in the definitions of financing, investing, and operating activities,

Topic 230 describes the classification principle as being based on the nature of

the cash flows without regard to whether it stems from another item

(b) The nature of the changes of the principal balances in restricted cash that affect

cash and cash equivalents most closely fits within the definition of investing

activities

(c) It would not take significant effort or cost to apply.

51. Staff members who support Alternative C acknowledge that including restricted cash with

cash and cash equivalents in the statement of cash flows would be a fundamental change to

Topic 230. However, they believe this alternative, coupled with a definition of restricted

cash, resolves all classification and presentation issues related to restricted cash in the

Example 2:

Nature of the Cash

Flows

Purpose of the

Restriction

Cash Flow #1: Set up the restricted cash account

(transfer of cash from unrestricted cash to restricted

cash) Investing outflow Financing outflow

Cash Flow #2: Release from restriction occurs (transfer

of cash from restricted cash to unrestricted cash) Investing inflow Financing inflow

Cash Flow #3: Payment of debt from the unrestricted

cash account Financing outflow Financing outflow

An entity is required by its lender to establish a restricted cash account for the future payment of debt. The

restricted cash is required to be invested in an interest-bearing account until the restriction is released and a

cash payment is made to pay down debt.

Classification Based on:

Nature of the cash flows: Cash flows #1 and #2 are classified as an investing activity because the cash flows

are similar to the purchase and sale of an investment.

Purpose of the restriction: Cash flows #1 and #2 are classified as a financing activity because the cash flows

are being linked to the future payment of debt, a financing activity. However, the nature of cash flows #1 and #2

do not fit into the Master Glossary definition of financing activities , which includes, in part, obtaining resources

from owners and providing them with a return and borrowing money and repaying amounts borrowed.

of 25

statement of cash flows. Additionally, Alternative C provides information about the ultimate

cash flows during the period, which is of primary importance to financial statement users.

Furthermore, these staff members note that existing disclosure requirements and the

statement of financial position will provide users with additional restricted cash information

to further facilitate analysis.

Subissue 4c – Presentation of Cash Payments and Cash Receipts That Directly Affect Restricted Cash

52. At its June 18, 2015 meeting, the Task Force requested that the FASB staff perform

additional research on cash payments made directly from restricted cash and cash receipts

deposited directly into restricted cash.

53. Sometimes, cash payments are made directly from restricted cash and cash receipts are

deposited directly into restricted cash from a source outside the entity (for example, an

investor or lender). Stakeholders indicated that they are unclear about how to present and

classify cash flows that directly affect restricted cash because restricted cash is not included

in the reconciliation of cash and cash equivalents on the statement of cash flows, and there

is no specific guidance in GAAP. Therefore, some entities present direct payments made

from restricted cash or direct deposits received into restricted cash as line items on the

statement of cash flows (that is, those entities gross-up the cash flows) and some entities

provide a noncash disclosure.

Examples of Cash Payments Made Directly from Restricted Cash

54. Cash payments made directly from restricted cash could relate to operating, investing, or

financing activities (for example, workers compensation claims, litigation claims, property

and equipment, and repayment of debt).

Example of Cash Deposited Directly into Restricted Cash

55. An example of cash that is directly deposited into restricted cash is as follows: an entity

issues debt in a bond offering and according to the bond agreement, the proceeds are

deposited into an escrow account that is restricted for a specified purpose. A portion of the

proceeds are restricted for the immediate payment of existing debt and the remaining portion

of 25

is restricted for future construction expenditures. The entity never received the funds from

the bond offering in its unrestricted cash account; rather, the proceeds were sent directly

from the investor to the trustee-controlled escrow (restricted) account.

56. If the Task Force reaches a tentative conclusion supporting Alternative C in Subissue 4b,

Subissue 4c does not need to be considered.


3. How should the changes in restricted cash be presented in the statement of cash

flows when cash payments are made directly from restricted cash and cash receipts

are deposited directly into restricted cash?

Staff Analysis – Subissue 4c

57. The staff has identified the following potential alternatives to address Subissue 4c:

Alternative A – Require noncash disclosures.

Alternative B – Present cash payments made directly from restricted cash and cash

receipts directly deposited into restricted cash in the body of the statement of cash flows.

Alternative A

58. Alternative A would provide explicit guidance that cash payments made directly from

restricted cash and cash receipts directly deposited into restricted cash should be disclosed

as noncash activities, including noncash financing, investing, and operating activities. The

staff recognizes that GAAP currently does not require disclosure of other noncash operating

activities.

59. Proponents of Alternative A note that Topic 230 states that a statement of cash flows should

explain the change during the period in cash and cash equivalents (as defined), and

information about all investing and financing activities of an entity during a period that affect

recognized assets or liabilities but that do not result in cash receipts or cash payments should

be disclosed. Therefore, because restricted cash is not a change in cash and cash equivalents,

direct changes in restricted cash that do not affect cash and cash equivalents should not be

of 25

presented in the body of the statement of cash flows. Rather, the information should be

disclosed.

60. Proponents of Alternative A also observe that presenting the direct changes in restricted cash

grossed up in the statement of cash flows when, by definition, they are not a change in cash

and cash equivalents, could set a precedent that similar types of transactions also should be

presented grossed up in the statement of cash flows.

61. For the reasons noted above, Alternative A was supported by one public accounting firm,

three members of an FASB advisory group (two auditors and one preparer), and three

members of another FASB advisory group (one preparer and two users) included in the

staff’s outreach.

62. Opponents of Alternative A indicate that cash payments made directly from and cash receipts

directly deposited into restricted cash represent actual cash flows of an entity and, therefore,

it would be misleading to disclose cash flows of an entity as a noncash activity.

63. Several stakeholders included in the staff’s outreach observed that applying the existing

guidance would lead to a noncash disclosure because the direct changes in restricted cash do

not affect cash and cash equivalents. However, those stakeholders expressed concerns that

noncash disclosures tend to get overlooked by users, and therefore it might provide better

transparency to present the direct changes in restricted cash grossed up in the body of the

statement of cash flows. Ultimately, those stakeholders were undecided about which

alternative would most effectively address Subissue 4c.

Alternative B

64. Alternative B would require that cash payments made directly from restricted cash and cash

receipts directly deposited into restricted cash be presented in the body of the statement of

cash flows. Alternative B does not address the classification of the cash flows because

classification would be determined by existing guidance for the specific cash flow in

question or by tentative conclusions reached by the Task Force on Subissue 4b. For example,

if a payment of principal on debt was made directly from restricted cash, the cash outflow

would be classified as a financing activity, consistent with the guidance that states that cash

outflows from financing activities includes repayments of amounts borrowed.

of 25

65. Proponents of Alternative B believe that the cash payments made directly from restricted

cash and cash receipts directly deposited into restricted cash are actual cash flows of an entity

and are different from the types of transactions described in the noncash investing and

financing activities guidance because those noncash investing and financing transactions

result in no cash receipts or cash payments. For example, a common noncash investing and

financing transaction involves capital expenditures that are financed. Often times, capital

expenditures are financed directly by the vendor or by a financial institution that sends the

proceeds of the borrowing directly to the seller. Therefore, in the capital expenditure

example, the cash proceeds from the financing are never received by the borrower, which is

different from the scenario discussed in Subissue 4b. Therefore, the cash payments made

directly from restricted cash should be grossed up and presented as a transfer to unrestricted

cash (cash inflow) and then as a cash outflow for the payments made directly from the

restricted cash account.

66. Proponents of Alternative B state that disclosure of direct cash payments and receipts as a

noncash activity could imply that the transactions did not result in actual cash receipts or

payments which would be misleading to users. Therefore, proponents indicate that

Alternative B would provide better information to financial statement users about an entity’s

cash transactions and would increase financial statement comparability.

67. Several proponents of Alternative B indicate that there are times when an entity, upon

approval from the third party who is restricting the cash, instructs that third party such as a

financial institution, to make a direct cash payment from the restricted cash account simply

for administrative convenience rather than transferring the funds back into the entity’s

unrestricted cash account prior to disbursement. Therefore, whether the funds are transferred

back to the entity’s unrestricted cash account prior to disbursement or the disbursement is

made directly from the restricted cash account, the economics are the same.

68. Some proponents of Alternative B analogize restricted cash to investments. Although certain

investments do not meet the definitions of and are not included in cash and cash equivalents,

their cash flows are an integral part of the statement of cash flows. Therefore, the cash flows

associated with the changes in restricted cash should be presented in the body of the

statement of cash flows in the same manner as the cash flows of investments.

of 25

69. For the reasons stated above, Alternative B was supported by three public accounting firms,

an auditor from an FASB advisory group, and a user.

70. Opponents of Alternative B note that presenting direct changes in restricted cash in the body

of the statement of cash flows would be misleading because the changes do not affect cash

and cash equivalents.

71. Some stakeholders highlight that, if Alternative B is selected for Subissue 4b (classifying

changes of the principal balances in restricted cash based on the purpose of the restricted

cash), gross presentation of cash flows made directly from restricted cash could result in

reflecting a duplicate cash flow classification, which some people may believe is

inappropriate. An example of this fact pattern is illustrated below:

Changes in Restricted Cash Account—Cash Payments Directly from Restricted Cash

Cash Flow #1: On January 1, 20X5, the restricted

cash account is established (move money from the

unrestricted account to the restricted cash account) in

the amount of $10m

Debit Credit

$ 10

$ 10

Cash Flow #2: On June 15, 20X5, cash payments

are made to plaintiffs in the class action lawsuit,

directly from restricted cash account in the amount of

$10m

(1) Debit Credit

$ 10

$ 10

$ 10

$ 10

LiabilityCash used in operating

activities

Cash provided by

operating activities

(1) The journal entries are provided in this example to assist the Task Force members in their analysis of this issue and

are not meant to suggest that entities need to record journal entries in order to present a gross up of the cash flows.

Fact Pattern: On January 1, 20X5, an entity is required to set up a restricted cash account (held in escrow) as a result of a court

proceeding related to a class action lawsuit. The restricted cash account is restricted for the potential future cash payments to the

plaintiffs of the class action lawsuit. The restricted cash account is established by transferring $10 million from the entity's general

cash account (unrestricted cash). On June 15, 20X5, the court-appointed trustee of the escrow account makes cash payments to

plaintiffs directly from the restricted cash account in the amount of $10 million. The fact pattern also assumes that the entity previously

recorded a litigation accrual and an expense, prior to cash payments made to the plaintiffs.

Cash Flow

Classification

Restricted Cash

(in millions)

Cash used in operating

activities (in millions)

Journal Entry:

Unrestricted Cash

Unrestricted Cash

Restricted Cash

Unrestricted Cash

Journal Entries:

of 25

Staff Recommendation – Subissue 4c

72. The staff thinks that there is merit to both Alternatives A and B because of the reasons

provided in previous paragraphs. However, the staff recommends Alternative A primarily

because it most closely applies the existing guidance in Topic 230 that states that (a) a

statement of cash flows explains the changes during the period in cash and cash equivalents

(as defined in the Master Glossary) and (b) information about all investing and financing

activities of an entity during a period that affect recognized assets and liabilities but that do

not result in cash receipts or cash payments in the period shall be disclosed. The staff

recognizes that there is a lack of existing guidance about disclosures of noncash operating

activities. However, this alternative would provide explicit guidance that cash flows that

directly affect restricted cash should be disclosed as noncash activities, including noncash

financing, investing, and operating activities. The staff also has some concern that requiring

a “gross up” of this cash activity could set a precedent and result in entities reaching

conclusions that other noncash transactions should be “grossed up” in the cash flow

statement.

Consistency Between Subissue 4b and Subissue 4c

73. In Subissue 4b, changes in restricted cash typically occur when restricted cash is established

(transfer of cash from unrestricted cash to restricted cash) and when the restrictions are

released (transfer of cash from restricted cash to unrestricted cash). Subissue 4c discusses

changes in restricted cash that occur when cash payments are made directly from restricted

cash and cash receipts are deposited directly into restricted cash from a source outside the

entity.

74. The staff recognizes that it may be unclear to stakeholders why the cash flow classification

for changes in restricted cash in Subissue 4b could be different from the cash flow

classification in Subissue 4c. In Subissue 4b, the changes in restricted cash are simply

transfers from one account to another (unrestricted cash to/from restricted cash). In Subissue

4c, the deposits into and disbursements from restricted cash are cash flows with an outside

entity. Because the nature of the cash flows in the two subissues are different, it is reasonable

to expect that the cash flow classification also would be different.

of 25

Next Steps

75. At a future meeting, the staff will bring the following for the Task Force’s consideration:

(a) Further analysis of Issue 4 – Restricted Cash

(b) Transition alternatives for Issue 4 – Restricted Cash

of 25

Appendix A: Definitions of Financing, Investing, and Operating Activities from the Master Glossary of the Codification

Financing Activities:

Financing activities include obtaining resources from owners and providing them with a return

on, and a return of, their investment; receiving restricted resources that by donor stipulation must

be used for long-term purposes; borrowing money and repaying amounts borrowed, or otherwise

settling the obligation; and obtaining and paying for other resources obtained from creditors on

long-term credit.

Investing Activities:

Investing activities include making and collecting loans and acquiring and disposing of debt or

equity instruments and property, plant, and equipment and other productive assets, that is, assets

held for or used in the production of goods or services by the entity (other than materials that are

part of the entity's inventory). Investing activities exclude acquiring and disposing of certain

loans or other debt or equity instruments that are acquired specifically for resale, as discussed in

paragraphs 230-10-45-12 and 230-10-45-21.

Operating Activities:

Operating activities include all transactions and other events that are not defined as investing or

financing activities (see paragraphs 230-10-45-12 through 45-15). Operating activities generally

involve producing and delivering goods and providing services. Cash flows from operating

activities are generally the cash effects of transactions and other events that enter into the

determination of net income.

https://asc.fasb.org/link&sourceid=SL2193397-108755&objid=6516133



of 25

Appendix B: Summary of Alternatives and Staff Recommendations

Issue Alternatives Staff

Recommendation

Issue 4—Restricted Cash

Subissue 4a—Definition of

Restricted Cash

Alternative A – Restricted cash should be defined as

cash that is subject to a legally enforceable agreement

with a third party for a specified purpose and is

restricted as to withdrawal or usage.

Alternative C – Restricted cash should be defined as

cash that includes deposits that are self-designated by

management, and cash that is subject to a legally

enforceable agreement with a third party for a specified

purpose and is restricted as to withdrawal or usage.

Alternative A,

pending additional

outreach and research

on NFP-specific

issues

Subissue 4b—Classification of

Changes in Restricted Cash

Alternative A – Changes of the principal balances

in restricted cash that affect cash and cash

equivalents should be based on the nature of the

cash flows and, therefore, classified as investing

activities on the statement of cash flows.

Alternative B – Changes of the principal balances

in restricted cash that affect cash and cash

equivalents should be classified based on the

purpose of the restricted cash.

Alternative C – Include restricted cash with cash

and cash equivalents on the statement of cash

flows.

Split

Recommendation:

Alternative A

and

Alternative C

Subissue 4c— Cash Payments

and Cash Receipts That Directly

Affect Restricted Cash

Alternative A – Require noncash disclosures.

Alternative B – Present cash payments made

directly from restricted cash and cash receipts

directly deposited into restricted cash in the body of

the statement of cash flows.

Alternative A

board memo guidelines - ey · pdf filememo discusses issue 4 – restricted cash, the...

Documents