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Statement of cash flows – Getting it right November 10, 2016

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Administrative matters

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To receive the full 1.5 CPE credits for today’s webcast, you must be active during the entire 90 minute webcast. You will be required to answer 6 polling questions during the webcast to verify attendance. You will have 2 minutes to answer each timed poll. CPE is not offered for audio only attendees or viewers of the replay.

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PwC | Statement of cash flows – Getting it right

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Welcome Maria Constantinou Director National Professional Services Group Mark Pollock Partner National Professional Services Group

Suzanne Stephani Director National Professional Services Group

Steve Halterman Director National Professional Services Group PwC | Statement of cash flows – Getting it right

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Today’s agenda

Basic concepts

Classification of cash flows

Direct vs. indirect presentation Common issues

New guidance

Q&A session

PwC | Statement of cash flows – Getting it right

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Why is the statement of cash flows important? • Shows liquidity • Focus of all stakeholders, including users • Timing • Restatements • Internal controls

PwC | Statement of cash flows – Getting it right

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Polling question# 1 Which of the following best describes your role or responsibilities within your organization?

A. CFO or Controller/Assistant Controller B. Financial Reporting Director/Manager C. Accounting or Finance Manager/Analyst

D. Tax Director/Manager E. Other or PwC staff

PwC | Statement of cash flows – Getting it right

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Cash equivalents • Highly-liquid investments • Readily convertible to known amounts of cash • So near 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

PwC | Statement of cash flows – Getting it right

Common cash equivalents • Treasury bills • Commercial paper • Money market funds Recently-effective SEC rule could impact the classification of money market funds as cash equivalents.

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Classification of cash flows – Nature principle Example of the nature principle • 3 classes of cash flows:

Facts

• INVESTING • FINANCING

• OPERATING • Each cash receipt or payment (or identifiable sources or uses in it) should be classified into these 3 classes based on nature of the cash flow, without regard to whether it stems from another item



PP&E purchased for $100,000



Buyer pays $50,000 in cash up-front



Buyer issues debt to the seller for the remaining $50,000



Buyer repays the debt in one year

How should the $50,000 repayment of debt be classified in the statement of cash flows? •

Investing

Financing

PwC | Statement of cash flows – Getting it right

Operating

Based on the nature principle, the debt repayment is classified as FINANCING

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Classification of cash flows – Waterfall approach Investing activities • Cash flows from purchases and sales of PP&E • Cash flow from sales/purchase of productive assets, including the acquisition or sale of a business, net of cash acquired or sold

Investing

• Restricted cash (today’s guidance) • Insurance proceeds directly attributable to casualty losses related to productive assets

Financing

• Gross cash receipts or cash payments resulting from the acquisition or sale of debt or equity securities of other reporting entities (classified as available-for-sale or held-to-maturity) • Distributions received from equity method investees that are deemed a return of investment

PwC | Statement of cash flows – Getting it right

Operating 10

Classification of cash flows – Waterfall approach Financing activities • Borrowing and repaying money, including issuance costs

Investing

• Issuing equity instruments • Paying dividends to equity holders

Financing

Operating PwC | Statement of cash flows – Getting it right

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Classification of cash flows – Waterfall approach Operating activities • All transactions and other events that are NOT defined as investing or financing

Investing

• Generally includes the cash effects of transactions and other events that enter into the determination of net income Examples of operating activities: • Receipts from sale of goods

Financing

• Cash paid to employees

• Interest and dividends received • Interest paid • Income taxes paid

PwC | Statement of cash flows – Getting it right

Operating 12

Classification of cash flows - symmetry principle

Inflows ⇔ Outflows • Generally, over time the cash inflows and cash outflows will be in the same classification category as opposite flows - More easily applied to investing and financing cash flows • Inflow amounts may or may not always equal the outflows

ASC 230-10-45-12(e) Loans NOT acquired for resale If loans were acquired as investments, cash receipts from sales of those loans shall be classified as investing cash inflows regardless of a change in the purpose for holding those loans.

- Zero coupon bond – Inflows and outflows are same amounts - PP&E – Inflow and outflows are not the same amounts PwC | Statement of cash flows – Getting it right

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Direct versus indirect methods

Direct

Indirect

The two presentations result in identical amounts for operating activities

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Example – Direct and indirect methods

Checkbook register (Payment)/deposit Purchase of equipment

Profit and loss Amount ($10,000)

Dividend payment

(50,000)

Sale of goods

550,000

Supplier costs

(325,000)

Net cash received

$165,000

Direct Operating activities

Financing activities Investing activities

$1,000,000 (400,000) (20,000) $580,000

Change in operating assets and liabilities Beg. End Balance Balance Change A/P $50,000 $125,000 $75,000 A/R 40,000 490,000 450,000 Indirect

Sale of goods Supplier costs

$550,000 (325,000)

Total operating cash flows Dividend payment

$225,000 ($50,000)

Purchase of equipment

($10,000)

PwC | Statement of cash flows – Getting it right

Revenue Supplier costs Depreciation Net income

Net income Depreciation Increase in A/P Increase in A/R Total operating cash flows

$580,000 20,000 75,000 (450,000) $225,000

Dividend payment

($50,000)

Purchase of equipment

($10,000)

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Polling question# 2 Does your company use the direct or indirect method for preparing the statement of cash flows?

PwC | Statement of cash flows – Getting it right

A. Direct B. Indirect C. Not sure or PwC staff

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Gross vs. net reporting Example of net reporting Basic concepts • Gross reporting generally provides more relevant information • However, netting is permitted for items that have quick turnover, large amounts, and short maturities (i.e., less than 90 days)

PwC | Statement of cash flows – Getting it right

Net borrowings under a revolving line of credit if the revolver requires the borrower to sign a series of notes each having a maturity of 90 days or less

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Noncash investing and financing transactions Examples of non-cash transactions Basic concepts • Generally - Cash flows should only be reflected on the statement when they occur - The statement should not reflect cash flows that could have happened or are expected to happen • All investing or financing activities that do not result in cash flows are required to be disclosed

• Settling debt with company shares • Purchases of PP&E with unpaid trade payables/debt • Obtaining an asset by entering into a capital lease • Acquiring a business through the issuance of stock

Exceptions • Floor plan financing: 2005 SEC speech • Constructive receipts and disbursements

PwC | Statement of cash flows – Getting it right

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Constructive receipts and disbursements Example: Whether to gross up the statement of cash flows to reflect a cash flow that did not pass through the company’s cash accounts • If non-involvement in a cash flow is for convenience, constructive receipt and disbursement may be appropriate • If non-involvement in a cash flow is by design, constructive receipt and disbursement is not appropriate

Facts Borrower issues new debt and immediately repays existing debt. The administrative agent directly obtains the proceeds from the new debt and directly repays the existing lenders. No cash flows pass through the borrower’s cash account. Is there a constructive receipt and disbursement? Yes, if the company’s lack of direct involvement was predicated on convenience rather than by design. The borrower would show a financing inflow for the proceeds of the new debt and a financing outflow for the repayment of existing debt.

PwC | Statement of cash flows – Getting it right

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Preparing the Statement of cash flows (“SoCF”) for a company with foreign operations “The fourth category” Foreign currency activities require specific presentation on the statement of cash flows as follows: • Unrealized foreign currency transaction gains/losses reported on income statement are a reconciling item from net income to cash flows from operations. • The effect of exchange rate changes on foreign currency cash and cash equivalents should be a separate line item in the reconciliation of the change in cash and cash equivalents.

PwC | Statement of cash flows – Getting it right

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Preparing the SoCF for a company with foreign operations 1. Prepare stand-alone SoCF for each distinct and separable operation in its functional currency 2. Translate each SoCF into the parent’s reporting currency - Use the exchange rate in effect at the time of the cash flow - Average exchange rate ok if the pattern of cash flows and exchange rates are consistent

3. Prepare a consolidating SoCF - Calculate FX effect for currencies different from the parent’s reporting currency for each foreign entity - 4th category is the difference between these FX effect amounts and amounts added at current spot rate

PwC | Statement of cash flows – Getting it right

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FX effects on cash

Operating

Applicable

Reporting

Currency

Rate

Currency

100

1.30

Investing

100

1.20

120

Financing

100

1.20

120

Change

£

Functional

£

Beg bal

300 100

$

$ 1.40*

130

370 140 510

Ending bal

£

400

FX effects on cash

1.25**

500 $

10

Spot rates at the balance sheet date current year** prior year *

PwC | Statement of cash flows – Getting it right

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FX effects on cash

Operating

Applicable

Reporting

Currency

Rate

Currency

100

1.30

Investing

100

1.20

120

Financing

100

1.20

120

Change

£

Functional

£

Beg bal

300 100

$

$ 1.40*

130

370 140 510

Ending bal

£

400

FX effects on cash

1.25**

500 $

10

Spot rates at the balance sheet date current year** prior year *

PwC | Statement of cash flows – Getting it right

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FX effects on cash

Operating

Applicable

Reporting

Currency

Rate

Currency

100

1.30

Investing

100

1.20

120

Financing

100

1.20

120

Change

£

Functional

£

Beg bal

300 100

$

$ 1.40*

130

370 140 510

Ending bal

£

400

FX effects on cash

1.25**

500 $

10

Spot rates at the balance sheet date current year** prior year *

PwC | Statement of cash flows – Getting it right

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FX effects on cash

Operating

Applicable

Reporting

Currency

Rate

Currency

100

1.30

Investing

100

1.20

120

Financing

100

1.20

120

Change

£

Functional

£

Beg bal

300 100

$

$ 1.40*

130

370 140 510

Ending bal

£

400

FX effects on cash

1.25**

500 $

10

Spot rates at the balance sheet date current year** prior year *

PwC | Statement of cash flows – Getting it right

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FX effects on cash

Operating

Applicable

Reporting

Currency

Rate

Currency

100

1.30

Investing

100

1.20

120

Financing

100

1.20

120

Change

£

Functional

£

Beg bal

300 100

$

$ 1.40*

130

370 140 510

Ending bal

£

400

FX effects on cash

1.25**

500 $

10

Spot rates at the balance sheet date current year** prior year *

PwC | Statement of cash flows – Getting it right

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FX effects on cash

Operating

Applicable

Reporting

Currency

Rate

Currency

100

1.30

Investing

100

1.20

120

Financing

100

1.20

120

Change

£

Functional

£

Beg bal

300 100

$

$ 1.40*

130

370 140 510

Ending bal

£

400

FX effects on cash

1.25**

500 $

10

Spot rates at the balance sheet date current year** prior year *

PwC | Statement of cash flows – Getting it right

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Polling question# 3 Does your company have foreign operations?

A. Yes B. No C. Not sure or PwC Staff

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New classification guidance

ASU 2016-15 was issued in August 2016

Reduces diversity in practice on 8 specific issues

Retrospective transition is required

Can be adopted early (but all must be adopted together)

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Issue 1 – Debt prepayment and extinguishment costs • Cash payments for debt prepayment or other debt extinguishment costs = FINANCING cash outflows* • These fees include: - 3rd party costs - Premiums paid - Any other directly related fees

*Could be a significant change from today: Some companies classify these payments as operating cash flows. PwC | Statement of cash flows – Getting it right

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Issue 2 – Settlement of debt instruments Zeros and bonds with insignificant coupons in relation to the effective rates • Applies to zero coupon debt instruments and those debt instruments with an insignificant coupon rate in relation to the effective rate • Settlement payments are classified as follows:

Example: Facts Zero coupon debt is issued with the following terms: • Par value: $100,000 • $100,000 balloon payment due at maturity

- OPERATING for the portion attributed to interest

• Original issue discount: $5,000

- FINANCING for the portion attributed to principal

How should the company classify the $100,000? Operating activities: ($5,000) Financing activities: ($95,000)

PwC | Statement of cash flows – Getting it right

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Issue 2 – Settlement of debt instruments All other debt instruments

Example: Facts

• Applies to debt instruments issued at a discount with coupon rates that are that are NOT insignificant in relation to the effective rate

Assume same terms as prior slide except the coupon rate is NOT insignificant in relation to its effective rate

• ASU precludes bifurcation of settlement payments between operating and financing for any other debt instruments

How should the company classify the $100,000 repayment?

• Settlement payments = FINANCING for the ENTIRE cash outflow*

Financing activities: ($100,000)

*Could be a significant change from today: Some companies bifurcate settlement payments for all debt instruments between financing and operating. PwC | Statement of cash flows – Getting it right

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Fees paid in a debt restructuring Is the SoCF classification impacted by the new ASU? Overview of fee accounting Model

Creditor fees

3rd party fees

Extinguishment

Expensed

Capitalized

Modification

Capitalized

Expensed

Statement of cash flow treatment

• Extinguishment for accounting purposes: • Creditor fees: FINANCING* • 3rd party fees: FINANCING • Modification for accounting purposes:

• Creditor fees: FINANCING* • 3rd party fees: OPERATING

*Could be a significant change from today: Some companies classify creditor fees as operating PwC | Statement of cash flows – Getting it right

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Polling question# 4 How familiar are you with the new statement of cash flows classification guidance (ASU 2016-15)?

PwC | Statement of cash flows – Getting it right

A. Very familiar B. Somewhat familiar C. Still getting up to speed

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Issue 3 – Contingent consideration in a business combination

Example: Facts

Payments made soon after: •

INVESTING for the entire amount

Payments NOT made soon after: • FINANCING up to the amount of the original contingent consideration liability (plus or minus measurement period adjustments)

• OPERATING for amounts in excess of the original contingent consideration liability (plus or minus measurement period adjustments)

• Contingent consideration liability established on January 1, 20x1: $100,000 • Settlement payment made on October 1, 20x1: $125,000 How should the repayment of the liability be classified?

Financing activities: $100,000 Operating activities: $25,000

PwC | Statement of cash flows – Getting it right

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Insurance cash flows

Issue 4 – Proceeds from insurance claims

Issue 5 – Corporate-owned life insurance policies

• Classify based on the nature of the loss

• Proceeds from claims = INVESTING

• Lump sum settlements: classification determined based on the nature of each loss included in the settlement

• Payments for premiums may be INVESTING, OPERATING, or a combination of INVESTING/OPERATING

PwC | Statement of cash flows – Getting it right

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Issue 6 – Distributions received from equity method investments General premise • Return ON investment = OPERATING • Return OF investment = INVESTING

Entity-wide accounting policy election Cumulative earnings approach • Classify distribution by comparing cumulative distributions to cumulative earnings: • If cumulative distributions (less prior period returns OF investment) exceed cumulative earnings, excess is INVESTING • Otherwise, OPERATING Nature of distribution approach • Classify distribution based on the nature of activities of the investee that generated the distribution

PwC | Statement of cash flows – Getting it right

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Polling question# 5 Which method do you expect your company to choose for classifying distributions from equity method investments?

A. Cumulative earnings B. Nature of distribution C. Still assessing

D. N/A or PwC staff

PwC | Statement of cash flows – Getting it right

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Issue 7 – Beneficial interests in securitization transactions • Disclose as a noncash activity • All cash receipts from beneficial interests in securitized trade accounts receivable = INVESTING**

Example: • Company sells trade receivables of $100 for $85 of cash and a beneficial interest of $15 • Initial $85 is an operating inflow • $15 beneficial interest is a noncash investing cash flow • Any subsequent cash receipts from the beneficial interest = investing inflow**

**Could be a significant change from today: Many companies classify the subsequent cash receipts on the beneficial interest as OPERATING cash flows. PwC | Statement of cash flows – Getting it right

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Issue 8 – More than one class of cash flows Separately identifiable cash flows and the predominance principle Our suggested three step approach to application 1. Apply specific GAAP addressing the statement of cash flow classification (if any)

or

2. Bifurcate cash flows into separately-identifiable sources or uses on the basis of the nature of the underlying cash flows, and then classify each separately-identifiable source or use 3. Predominant activity – When cash flows can no longer be bifurcated, classification depends on the nature of the expected predominant activity

PwC | Statement of cash flows – Getting it right

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Predominance principle – Example Facts: Company operates a chain of rent-to-own facilities offering household appliances. It purchases new appliances, rents the appliances, and subsequently sells the used appliances.

Classification of cash flows for initial appliance purchase OPERATING • If company expects to rent the new appliances for only a short period of time and therefore expects cash flows from the rental stream to be relatively small compared to expected cash flows from selling the appliances

INVESTING • If company expects to rent new appliances for a longer period of time and therefore expects cash flows from the rental stream to be relatively large compared to expected cash flows from selling appliances.

PwC | Statement of cash flows – Getting it right

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Polling question# 6 Will the new guidance related to more than one class of cash flows significantly impact your statement of cash flows?

A. Yes B. No C. Still evaluating

D. PwC staff

PwC | Statement of cash flows – Getting it right

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Restricted cash • Final guidance expected imminently from the FASB to reduce diversity in practice related to the presentation of changes in restricted cash on the statement of cash flows • Present restricted cash/restricted cash equivalents with cash and cash equivalents • Reconcile amounts on the balance sheet to the statement of cash flows • Disclose the nature of the restrictions • Guidance will be applied retrospectively

PwC | Statement of cash flows – Getting it right

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Effective date and transition

Permitted, provided that all of the amendments are adopted in the same period. Consider adopting classification guidance and restricted cash guidance together.

Financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years.

Financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Retrospective transition is required PwC | Statement of cash flows – Getting it right

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Where to go for more information

PwC’s Financial Statement Presentation Guide – Chapter 6

PwC | Statement of cash flows – Getting it right

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Polling question# 7 Will your company early adopt the new guidance?

A. Yes – classification guidance only B. Yes – restricted cash guidance only C. Yes to both

D. No E. Still assessing or PwC staff

PwC | Statement of cash flows – Getting it right

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Q&A session

PwC | Statement of cash flows – Getting it right

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PwC | Statement of cash flows – Getting it right

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PwC | Statement of cash flows – Getting it right

November 16 November 17 November 30 December 6 December 14

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