High risk accounting and reporting areas, those most prone to problems and the risk of amendment or restatement, are discussed in all our conferences and workshops. We always encourage folks to be aware of these risks and to address them in their reporting processes.
Now that we are into August, is it fair to put some of these issues on the planning calendar for year-end? Yes, because many of them require significant amounts of time and work to address. (For example, have you ever tried to make improvements in your MD&A?) So, even though it is only August, we are going to start a series of posts with some considerations for year-end planning! We will also bring all of them together later in the fall.
Perhaps surprisingly, one of these frequent problem areas is preparation of the statement of cash flows. For a variety of reasons the statement of cash flows is the source of many SEC comments and even restatements. Perhaps this is because the statement of cash flows is usually prepared late in the reporting process, perhaps because it is sometimes viewed as a mechanical process, perhaps because it is sometimes prepared by less experienced professionals and/or perhaps controls are not effective in this area. There are likely many underlying causes for the statement of cash flows being a frequent problem area, but if we are forewarned there is no reason that we should have problems here.
As a starting point, here are some example SEC comments.
Statement of Cash Flows
We note your presentation on the statement of cash flows of sales and maturities of short- term investments as one combined line item. In light of the fact that short term investments represent a significant part of your balance sheet, please revise to present sales and maturities of these investments as separate line items within the investing section in accordance with ASC 320-10-45-11.
The comment above is a great example of where a seemingly logical combination of similar cash flows runs afoul of the codification guidance. The referenced paragraph is not even in the ASC section about the statement of cash flows! What it says is:
Cash flows from purchases, sales, and maturities of available-for-sale securities and held-to-maturity securities shall be classified as cash flows from investing activities and reported gross for each security classification in the statement of cash flows. Cash flows from purchases, sales, and maturities of trading securities shall be classified based on the nature and purpose for which the securities were acquired.
Here is another example:
Please tell us how you determined it was appropriate to classify restricted cash collateralizing your outstanding letter of credit and cash secured loans as investing activities in the statement of cash flows. Please reference the authoritative accounting literature management relied upon.
This is an area where there may be no clear guidance. The distinction between operating and investing seems like an easy question to ask here. And, as you will see below, this is a question that was taken to the EITF.
Here are a few more comments with similar issues. This first one is pretty darn long!
Consolidated Statements of Cash Flows, page F-8
Please tell us your basis for recording the deposit related to the acquisition of land use right as operating activities as opposed to investing activities. Refer to ASC 230.
We note your line item, advances to suppliers, in your balance sheets and other trade receivables included in Note 4 on page F-30 related to your lending provided to some of your suppliers. Please tell us the nature of your lending activities to your suppliers and the difference in amounts included in the two accounts. Additionally, please tell us your basis for recording amounts in operating activities as opposed to investing activities in your statements of cash flows. Refer to ASC 230.
Please reconcile for us the purchase of property and equipment for 2014 in the amount of $256,027,300 to the change of $301,716,262 derived from your disclosure in Note 7.
This one seems fairly straightforward:
We note cash flows from financing activities include non-cash transactions consisting of common shares issued for debt conversions and as compensation for services as well as losses on settlement of debt through equity issuances. Please refer to ASC 230 and revise to separately disclose non-cash financing transactions in supplemental disclosure of noncash investing and financing activities and to disclose losses on debt settlements in cash flows from operating activities. Please note that this comment also applies to Form 10-Q filed February 2, 2016.
The Need For Clarification – The EITF to the Rescue!
Because of the frequent nature of these issues and diversity in practice surrounding many of them the EITF has two projects that are at the Exposure Draft stage and should finish before year end:
EITF Issue 16-A: Restricted Cash would require the statement of cash flows to reconcile the total change in cash including restricted cash.
EITF Issue 15-F: Statement of Cash Flows: Classification of certain cash receipts and cash payments deals with a variety of issues in the cash flow statement, including:
Issue 1—Debt Prepayment or Debt Extinguishment Costs
Issue 2—Settlement of Zero-Coupon Bonds
Issue 3—Contingent Consideration Payments Made after a Business Combination
Issue 4—Proceeds from the Settlement of Insurance Claims
Issue 5—Proceeds from the Settlement of Corporate-Owned Life Insurance Policies, including
Bank-Owned Life Insurance Policies
Issue 6—Distributions Received from Equity Method Investees
Issue 7—Beneficial Interests in Securitization Transactions
Issue 8—Predominant Cash Receipts and Cash Payments
With all of this comment activity and related standard setting going on, it is advisable to “scrub” your process for preparing the statement of cash flows in your upcoming periodic filings.
As always your thoughts and comments are welcome!