5 Comprehensive cash flow accounting events

Here are 5 Comprehensive cash flow accounting events with special presentation and/or disclosure requirements under IAS 7. They are:

1 IFRS 9 Classification of cash flows arising from a derivative used in an economic hedge

Consequential amendments were not made to IAS 7 as a result of the introduction of, and subsequent changes to, IFRS 9 Financial Instruments.

A related issue which often arises in practice is the classification of cash flows that arise from a derivative that, although used economically to hedge exposures, is not designated in an IFRS 9 qualifying hedge relationship. The same issue arises under IAS 39, for those insurers that meet the criteria for, and have chosen to apply, the temporary exemption from the application of IFRS 9.

IAS 7.16(g) and (h) note that cash payments and receipts that relate to futures contracts, forward contracts, option contracts, and swap contracts should be classified as investing activities, unless the contracts are held for dealing or trading purposes, or the cash flows are classified as relating to financing activities.

IAS 7.16 also notes that when a derivative is accounted for as a hedge of an identifiable position, the cash flows of that contract are classified in the same manner as the cash flows of the position being hedged (e.g. if interest is classified as giving rise to operating cash flows, cash flows relating to a derivative to hedge those interest payments are also classified as operating cash flows).

A derivative that is used in an economic hedge, but is not designated as a hedging instrument in accordance with IFRS 9, does not technically fall within the guidance in IAS 7.16. Consequently, it could be argued that it would not be appropriate to present the cash flows in the financial statements as if such a designation had been made.

However, in our view, because IAS 7 is not clear about this point, it is acceptable to classify cash flows arising from economic hedges that are not designated as hedging instruments in accordance with IFRS 9 in the same way as if they had formed part of a qualifying hedging relationship for accounting purposes. This means that the cash flows from those economic hedging instruments could be classified as operating, investing or financing, depending on the nature of the item that is being hedged.

In addition to the cash flows discussed above that relate to derivatives used in an economic hedge, entities must also consider how to classify the cash flows from the early settlement or ‘close out’ of certain derivatives, such as interest rate swaps. For example, an entity that aims to manage its interest rate risk exposure by regularly reviewing its proportion of fixed to variable interest rate borrowings may adjust its exposure by entering into new interest rate swaps or by closing out existing interest rate swaps (in this case, assume that hedge accounting is not applied and interest cash flows are classified as operating activities).

This is typically more efficient and less costly than renegotiation or terminating the underlying borrowings themselves. In closing out existing swaps, entities are typically required to pay the fair value of the swap as at the time of cancellation to the counterparty, and there may be an additional fee charged for the cancellation.

In our view, cash flows arising from the close out of interest swaps as described above may be classified as operating cash flows, consistent with the classification of interest payments. This is because the payments required on close out of the swaps represent the present value of the payments that would have otherwise been required, adjusted for expectations concerning market interest rates. Such future payments would have been classified as operating cash flows, therefore, the payment required on close out may also be presented as an operating cash flow.

However, because IAS 7 is not specific, the payment could also be presented as a financing cash flow. The approach adopted should be applied consistently as an accounting policy choice.

2 IFRS 15 Revenue from Contracts with Customers

Cash flows arising from revenue within the scope of IFRS 15 Revenue from Contracts with Customers will be classified as an operating activity as it is clearly a ‘principal revenue-producing activity of the entity…’. Cash flows other than those giving rise to revenue itself, which still relate to transactions in the scope of IFRS 15 may occur, however, such as cash flows relating to incremental costs of obtaining a contract. Such costs may be capitalised in certain circumstances and amortised on a systematic basis.

Cash flows related to capitalised costs in the scope of IFRS 15 (e.g. incremental costs of obtaining contracts) may be classified as operating activities, as they relate to the principle revenue-producing activities of the entity. They may also be classified as investing activities as they relate to acquisition of long-term assets, assuming the amortisation period of the costs is greater than one year.

If incremental costs of obtaining a contract have a particularly long life (i.e. significantly longer than one year), then it would be more appropriate to classify them as investing activities. Entities should consider if local regulatory requirements exist concerning the classification requirements of such cash flows.

3 IFRS 16 Leases

Payments made on inception of a lease

IAS 7.44(a) notes that many investing and financing activities do not have a direct effect on cash flows, although they do affect the capital and asset structure of an entity. Among the examples listed is the acquisition of an asset by means of a lease. This is because, in many cases, the initial recognition of a right-of-use asset acquired under a lease, and the corresponding liability, arise from the signature of a lease contract without there being any exchange of cash. 5 Comprehensive cash flow accounting events

In some cases, leases can involve the exchange of cash on inception because the terms of the lease may require a deposit to be paid and/or payments to be made prior to the commencement of the lease, which is prior to a lease liability and right-of-use asset being recognised. In those cases, amounts are included in the statement of cash flows and would often be classified as investing activities (because the lease gives rise to a recognised asset, the lease deposit).

This is because such cash flows do not meet the definition of ‘financing activities’ as the cash flow does not affect the ‘size and composition of the contributed equity and borrowings of the entity’, since a lease liability has yet to be recognised prior to the commencement date of the lease. The cash flow relates to the ‘acquisition… of long-term assets…’, therefore, it is an investing activity. 5 Comprehensive cash flow accounting events

This classification is required if all amounts due under a lease contract are contractually due on inception or on commencement of a lease.

However, in cases where there is a payment on inception or on commencement of a lease followed by periodic payments during the lease term, it could also be argued that, because the cash flows on inception arise from what, overall, is a financing arrangement, those cash flows should also be classified as arising from financing activities. Entities should apply a consistent policy for classification of such cash flows. 5 Comprehensive cash flow accounting events

Disaggregation of lease payments

In the same way as repayments of a conventional loan, lease payments that settle a lease liability are comprised of two components:

  • Repayment of the principal amount, and 5 Comprehensive cash flow accounting events
  • Payment of interest. 5 Comprehensive cash flow accounting events

As a result, for the purposes of the statement of cash flows, lease payments are required to be split into each component with repayments of principal and payments of interest being presented separately. The repayments of principal are classified within financing activities (IAS 7.17(e)), with the interest portion being aggregated with other interest outflows (for other borrowings) and presented as arising from either operating, investing or financing activities (IAS 7.31).

However, to the extent that lease interest is capitalised in accordance with IAS 23 Borrowing Costs, an entity has an accounting policy choice relating to how the interest is classified (see Interest and dividends).

Lease payments not included in the measurement of the lease liability

Lessees may make lease payments that are not included in the measurement of lease liabilities, either because:

  • The leases meet recognition exemptions to not be recognised in the statement of financial position (i.e. short-term and low-value lease exemptions); or
  • They are variable lease payments that are not dependent on an index or rate (e.g. a percentage of turnover in a leased retail location), and are therefore excluded from the measurement of the lease liability. 5 Comprehensive cash flow accounting events

These lease payments are excluded from financing activities, as they are not a component of the repayment of a liability recorded in the statement of financial position. Such payments are included in cash flows from operating activities, since they are included in the determination of profit or loss for the period.

Entities that elect to utilise the short-term and/or low-value lease exemptions will therefore have lower cash flows from operating activities and higher cash flows from financing activities than entities who elect to record such leases in the statement of financial position.

4 IFRS 3 Business combinations

Presentation and disclosure of cash paid / acquired in a business combination

When an entity acquires a business and part or all of the consideration is in cash or cash equivalents, part of the net assets acquired may include the acquiree’s existing cash balance. This results in different amounts being presented in the statement of cash flows and the notes to the financial statements.

IAS 7.39 and 42 require the net cash flows arising from gaining or losing control of a business, to be classified as arising from investing activities. Consequently, the statement of cash flows will not include the gross cash flows arising from the acquisition, and will instead show a single net amount. IAS 7 40 then requires the gross amounts to be disclosed in the notes.

The disclosures required by IFRS 3 Business Combinations include: 5 Comprehensive cash flow accounting events

  • The acquisition date fair value of total consideration transferred, analysed into each major class of consideration including the cash element (IFRS 3 B64(f)(i))
  • Major classes of assets and liabilities acquired, of which cash and cash equivalents would be a class (IFRS 3 B64(i)).

Transaction costs

IFRS 3 requires transaction costs incurred in connection with a business combination to be expensed, because they relate to the purchase of services and not to the acquisition of the business.

Only cash outflows that result in the recognition of an asset in the statement of financial position are classified as arising from investing activities in the statement of cash flows. Consequently, cash flows arising from transaction costs related to a business combination are classified as arising from operating activities in consolidated financial statements.

However, if an entity prepares separate financial statements in accordance with IFRS, transaction costs are included as part of the cost of the investment in a subsidiary. Consequently, in the separate (parent) entity’s statement of cash flows, cash flows arising from transaction costs will be classified as arising from investing activities.

Deferred and contingent consideration

IAS 7.39 requires the aggregate cash flows arising from obtaining (or losing) control of a subsidiary or other business to be classified as being derived from investing activities.

This is consistent with the requirement of IAS 7.16 that only expenditure that results in an asset that is recognised in the statement of financial position can be classified as arising from investing activities. 5 Comprehensive cash flow accounting events

While this appears straightforward, issues arise when determining how cash outflows associated with deferred or contingent consideration should be presented in the statement of cash flows.

(i) Deferred consideration

Some business combinations may involve deferral of (a portion of) the purchase consideration to a future date. A key question is whether cash flows associated with deferred consideration should be classified as arising from investing activities (on the basis that they are in connection with the acquisition of net assets), or from financing activities (on the basis that the vendor is providing a form of finance). 5 Comprehensive cash flow accounting events

In our view, these cash flows should normally be classified as arising from investing activities on the basis that this is consistent with the nature of the original transaction which gave rise to the initial recognition of assets and liabilities in the statement of financial position. This would include any adjustments resulting from additional information about facts and circumstances that existed at the acquisition date. 5 Comprehensive cash flow accounting events

However, in limited cases deferred consideration may be similar in nature to a loan granted by the vendor, with the associated cash flows being classified as arising from financing activities. In our view, this may be the case when the period between the acquisition date and settlement of the deferred consideration is sufficiently long that the vendor would recognise imputed interest (see Interest and dividends or the classification of cash flows relating to interest). Classification as financing would be appropriate if the vendor accepted payment in the form of a long term loan note.

(ii) Contingent consideration

When a business combination involves an adjustment to consideration payable to the vendor that is contingent on future events, IFRS 3 requires the acquirer to recognise the acquisition date fair value of the contingent consideration with an associated adjustment to goodwill. 5 Comprehensive cash flow accounting events

The related obligation (which meets the definition of a financial instrument) is classified as a financial liability or within equity in accordance with the requirements of IAS 32 Financial Instruments: Presentation. 5 Comprehensive cash flow accounting events

For obligations that are to be settled in cash or cash equivalents, subsequent changes in the carrying amount of the liability are recorded in profit or loss.

The classification of the related cash flows is affected by this requirement, because IAS 7.16 only permits cash outflows that result in the recognition of an asset to be classified as arising from investing activities. 5 Comprehensive cash flow accounting events

This requirement of IAS 7 indicates that cash payments arising from any post acquisition date increase in the carrying amount of contingent consideration cannot be classified as arising from investing activities, because the incremental amount would be charged to profit or loss and would not result in the recognition of an asset (or an increase in carrying amount of an asset). This means that those excess cash flows would typically be classified as arising from operating activities (particularly if the increase arose from a formula linked to the operating performance of the acquired business). 5 Comprehensive cash flow accounting events

In limited cases, it may be appropriate to classify at least some of the cash flows as arising from financing activities (see deferred consideration above). However, it is necessary to look at the extent to which the amount of contingent consideration payable is affected by factors other than time value of money and, the more linkage there is to future business performance, the more difficult it will be to identify any financing component. 5 Comprehensive cash flow accounting events

5 IFRS 5 Discontinued operations

IAS 7 requires an entity to include all of its cash flows in the statement of cash flows, including those generated from both continuing and discontinued activities.

IFRS 5 Non-current Assets Held for Sale and Discontinued Operations requires an entity to disclose its net cash flows derived from operating, investing and financing activities in respect of discontinued operations. There are two ways in which this can be achieved: 5 Comprehensive cash flow accounting events

1) Presentation in the statement of cash flows

Net cash flows from each type of activity (operating, investing and financing) derived from discontinued operations are presented separately in the statement of cash flows.

2) Presentation in a note

Cash flows from discontinued operations are included together with cash flows from continuing operations in each line item in the statement of cash flows. The net cash flows relating to each type of activity (operating, investing and financing) derived from discontinued operations are then disclosed separately in a note to the financial statements.

When a disposal group that meets the definition of a discontinued operation is classified as held for sale in the current period, and has not been realised/disposed of at the entity’s reporting date, the closing balance of cash and cash equivalents presented in the statement of cash flows will not reconcile to the cash and cash equivalents balances that are included in the statement of financial position at the reporting date. 5 Comprehensive cash flow accounting events

This is because the cash and cash equivalents related to the disposal group are subsumed into the assets and liabilities of the disposal group and presented within the single line item in the statement of financial position. 5 Comprehensive cash flow accounting events

Worked example – Discontinued operations not disposed of at the entity’s reporting date

Background information: 5 Comprehensive cash flow accounting events

  • Entity A operates in the food and beverage industry sectors 5 Comprehensive cash flow accounting events
  • Towards the end of the year ended 31 December 20X3, Entity A decides to dispose of the food sector
  • The planned disposal qualifies as a discontinued operation in accordance with IFRS 5, as at 31 December 20X3
  • The carrying amount of CU180 relating to Assets in disposal group classified as held for sale includes CU30 of cash and cash equivalents.

Information extracted from Entity A’s statement of financial position is as follows: 5 Comprehensive cash flow accounting events

5 Comprehensive cash flow accounting events

Additional information 5 Comprehensive cash flow accounting events

Assets and liabilities directly related to the food sector disposal group as at 31 December 20X2 were as follows: 5 Comprehensive cash flow accounting events

  • Entity A’s profit (including profit generated from discontinued operations) in 20X3 is CU390. 5 Comprehensive cash flow accounting events
  • The profit from discontinued operations in 20X3 is CU30 5 Comprehensive cash flow accounting events
  • Discontinued operations in 20X3 include a cash outflow of CU100 for operating activities and a cash inflow of CU120 from investing activities
  • In 20X3, Entity A acquired property, plant and equipment for CU400. This property, plant and equipment is used in activities within continuing operations
  • Entity A presents net cash flows relating to each type of activity (operating, investing and financing) generated from discontinued operations in the statement of cash flows
  • Depreciation expense in 20X3 was CU60 5 Comprehensive cash flow accounting events
  • The effects of tax have been ignored. 5 Comprehensive cash flow accounting events

As at 31 December 20X3, Entity A had met the requirements in IFRS 5 meaning that the food sector disposal group was classified as a discontinued operation. As a result, the assets and liabilities of the food sector disposal group were presented separately from the other assets and liabilities of entity A in its statement of financial position.

However, the assets and liabilities of the food sector disposal group were not presented separately in the statement of financial position for the comparative period (IFRS 5.40).

In order to present a statement of cash flows for the year ended 31 December 20X3, which separates the continuing operations and the discontinued operations (either in the primary statement or in the notes), Entity A needs the opening balances of assets and liabilities of the disposal group (which comprises the discontinued operation) as at 31 December 20X2.

Entity A – Statement of Cash Flows for the year ended 31 December 20X3

a) Depreciation of property, plant and equipment – continuing operations

The opening balance is calculated by deducting the amount of property, plant and equipment which relates to the discontinued operations on 31 December 20X2 (CU140) from the opening balance of entity A’s property, plant and equipment at that date (CU200). 5 Comprehensive cash flow accounting events

b) Profit from discontinued operations

The profit from discontinued operations is adjusted to avoid double counting. The cash movement of 100 is obtained from the additional information above.

c) Increase in inventories – continuing operations 5 Comprehensive cash flow accounting events

The opening balance at 1 January 20X3 (excluding discontinued operations) is calculated by deducting the amount of inventories relating to the discontinued operations as at 31 December 20X2 (CU50) from the opening balance of Entity A’s inventories (CU160) at the same date. 5 Comprehensive cash flow accounting events

d) Increase in trade payables – continuing operations 5 Comprehensive cash flow accounting events

The opening balance (excluding discontinued operations)is calculated by deducting the balance of trade payables which relates to the discontinued operations as at 31 December 20X2 (CU120) from the balance of total trade payables of Entity A as at the same date (CU280). 5 Comprehensive cash flow accounting events

Statement of cash flows vs. Statement of financial position 5 Comprehensive cash flow accounting events

The differences in the amounts for the net (decrease) in cash and cash equivalents, and in the closing balance of cash and cash equivalents, is because cash and cash equivalents of CU30 related to the food sector disposal group are included within the single line item Assets in disposal groups classified as held for sale in the statement of financial position.

Worked example – Discontinued operations disposed of in full during the reporting period

Extracts from Entity B’s statement of financial position as at 31 December 20X2 and 20X3 are as follows: 5 Comprehensive cash flow accounting events

Additional information: 5 Comprehensive cash flow accounting events

  • During 20X3, Entity B acquired property, plant and equipment (PP&E) for CU420. The PP&E is not included in the discontinued operation
  • On 30 June 20X3 Entity B paid dividends of CU140 5 Comprehensive cash flow accounting events
  • On 1 August 20X3, Entity B disposed of all of the assets and liabilities of the discontinued operation for cash proceeds of CU1,300. The carrying amount of the discontinued operation’s net assets as at the disposal date was CU1,050 5 Comprehensive cash flow accounting events
  • The following transactions and events took place in the discontinued operation during 20X3, prior to the date on which it was disposed of:
  • Property, plant and equipment was sold for cash proceeds of CU440 5 Comprehensive cash flow accounting events
  • A loan of CU320 was repaid 5 Comprehensive cash flow accounting events
  • Accounts receivable of CU480 were settled in cash. 5 Comprehensive cash flow accounting events
  • As at 31 December 20X2, cash and cash equivalents were not included in non-current assets classified as held for sale
  • Entity B has adopted an accounting policy for the presentation of dividends received and dividends paid as cash flows derived from investing and financing activities, respectively (IAS 7.33)
  • The effects of tax have been ignored. 5 Comprehensive cash flow accounting events

Alternative 1 – presentation of discontinued operations in the statement of cash flows

a) Profit for the period 5 Comprehensive cash flow accounting events

The profit for the period is equal to the change in equity before distributions. This is calculated as equity as at 31 December 20X3 of CU4,550 plus dividends paid of CU140, less the opening balance of equity of CU3,170. 5 Comprehensive cash flow accounting events

b) Depreciation of property, plant and equipment (PP&E) 5 Comprehensive cash flow accounting events

c) Profit from discontinued operations 5 Comprehensive cash flow accounting events

(i) Consideration received of CU1,300 less the closing net assets of the discontinued operations of CU1,050 (see additional information above).

(ii) Equal to the change in net assets of the discontinued operation, calculated as closing net assets of CU1,050 less opening net assets (assets of CU900 less liabilities of CU490).

d) Net cash generated from discontinued operations

In this case, it has been assumed that all operating activities had ceased by 1 January 20X3.

Consequently, the only cash flows that would be expected to be received would be the collection of trade receivables and other receivable balances. The additional information above notes that cash receipts of CU480 were received from the settlement of trade receivables.

e) Net cash generated from investing activities – discontinued operations

These are comprised of proceeds from the disposal of operations (CU1,300) plus cash received from the sale of property, plant and equipment (CU440)

f) Net cash used in financing – discontinued operations

This relates to the repayment of the loan of CU320.

g) Increase in cash and cash equivalents attributable to the discontinued operations that have been disposed of

This comprises all cash flows attributable to the discontinued operation up to the point at which it was disposed of, but does not include cash flows attributable to cash receipts from the sale of the discontinued operation.

The amount is therefore the cash inflow from the decrease in accounts receivable (CU480) plus cash proceeds from the sale of property, plant and equipment (CU440) less the cash outflow associated with the repayment of the loan (CU320).

Statement of cash flows vs. Statement of financial position

The amounts included in both primary statements are the same, because at the reporting period end there is no discontinued operation to be presented separately in the statement of financial position.

Alternative 2 – presentation of discontinued operations in the notes

a) Profit for the period

The profit for the period is equal to the change in equity before distributions. This is calculated as equity as at 31 December 20X3 of CU4,550 plus dividends paid of CU140, less the opening balance of equity of CU3,170.

b) Depreciation of property, plant and equipment (PP&E)

c) Profit from discontinued operations

(i) Consideration received of CU1,300 less the closing net assets of the discontinued operations of CU1,050 (see additional information above).

(ii) Equal to the change in net assets of the discontinued operation, calculated as closing net assets of CU1,050 less opening net assets (assets of CU900 less liabilities of CU490).

d) Increase in cash and cash equivalents attributable to the discontinued operations that have been disposed of

This is comprised of all cash flow attributable to the discontinued operation up to the point at which it was disposed of, but does not include cash flows attributable to cash receipts from the sale of the discontinued operation.

The amount is therefore the cash inflow from the decrease in accounts receivable (CU480) plus cash proceeds from the sale of property, plant and equipment (CU440) less the cash outflow associated with the repayment of the loan (CU320).

Notes to the financial statements (extract)

Note [x] – Discontinued operations (extract)

The statement of cash flows includes the following amounts relating to discontinued operations:

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