Classification of the Statement of Cash Flows

The statement of cash flows requires classification of cash flows into these three categories:

1. Investing activities. The transactions the organization engages in which affect its investments in assets (e.g., purchases and sales).
2. Financing activities. The transactions an organization engages in to acquire and repay capital (e.g., borrowings, repayments, etc.).
3. Operating activities. The transactions not classified as financing or investing activities, generally involving receiving contributions, producing and delivering goods, or providing services.

The statement of cash flows must show the net change in cash during the period and supplemental disclosure of noncash investing and financing activities. All cash receipts and payments should be classified as operating, investing, or financing activities. Noncash transactions involving investing and financing activities, such as acquiring assets by assuming liabilities, should be disclosed separately rather than within the body of the statement. When a cash receipt or cash payment qualifies for more than one classification, it should be included in the category that represents the predominant source of cash flows for the item. The net cash provided or used by each of these three categories of activities provides important information to readers of financial statements. Care should be taken to ensure that the operating activities category does not include cash flows from investing or financing activities. Exhibit 1 displays cash flow classifications for a not-for-profit organization.

Definition of Cash and Cash Equivalents

This chapter, and indeed the title of the statement of cash flows itself, focuses on “cash” flows. Included within the meaning of cash for purposes of preparing a statement of cash flows are:

1. Currency;
2. Demand deposits with banks and other financial institutions (or other accounts that have the characteristics of demand accounts);
3. Cash equivalents.

GAAP is specific as to the meaning of cash equivalents for purposes of preparing the cash flow statement. Cash equivalents are short-term, highly liquid investments that meet both of the following criteria:

1. Are readily convertible to known amounts of cash.
2. Are so near their maturity date 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 would qualify under this definition of cash equivalent.

In applying this test, original maturity means the original maturity to the not-for-profit organization that holds the investment.

In November 2016 the FASB issued ASU 2016-18 Statement of Cash Flows (Topic 230) Restricted Cash to address how restricted cash should be treated in the statement of cash flows. Without specific guidance there was a diversity in practice as to whether or not restricted cash should be included in the cash and cash equivalent amounts to which the statement of cash flows reconciled cash inflows and outflows.

ASU 2016-18 provides that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-­period and end-of-period total amounts shown on the statement of cash flows.

ASU 2016-18 is effective for fiscal years beginning after December 15, 2017, for public business entities. For all other entities, including not-for-profit organizations, it is effective for fiscal years beginning after December 15, 2018. Early implementation is permitted.

In August 2016 the FASB issued ASU 2016-15 Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Payments to provide specific guidance for classifying in the statement of cash flows certain types of transactions where current guidance is either unclear or being inconsistently applied. While most of these transactions are not common to not-for-profit organizations, the summary of the guidance from ASU 2016-15 is provided for the instances where they might apply.

The following are the types of transactions addressed by ASU 2016-15:

• Debt Prepayment or Debt Extinguishment Costs

  Cash payments for debt prepayment or debt extinguishment costs should be classified as cash outflows for financing activities.

• Settlement of Zero-Coupon Debt Instruments or Other Debt Instruments with Coupon Interest Rates That are Insignificant in Relation to the Effective Interest Rate of the Borrowing

  At the settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing, the issuer should classify the portion of the cash payment attributable to the accreted interest related to the debt discount as cash outflows for operating activities, and the portion of the cash payment attributable to the principal as cash outflows for financing activities.

• Contingent Consideration Payments Made after a Business Combination

  Cash payments not made soon after the acquisition date of a business combination by an acquirer to settle a contingent consideration liability should be separated and classified as cash outflows for financing activities and operating activities.

  Cash payments up to the amount of the contingent consideration liability recognized at the acquisition date (including measurement-period adjustments) should be classified as financing activities; any excess should be classified as operating activities.

  Cash payments made soon after the acquisition date of a business combination by an acquirer to settle a contingent consideration liability should be classified as cash outflows for investing activities.

• Proceeds from the Settlement of Insurance Claims

  Cash proceeds received from the settlement of insurance claims should be classified on the basis of the related insurance coverage (that is, the nature of the loss). For insurance proceeds that are received in a lump sum settlement, an entity should determine the classification on the basis of the nature of each loss included in the settlement.

• Proceeds from the Settlement of Corporate-Owned Life Insurance Policies, including Bank-Owned Life Insurance Policies

  Cash proceeds received from the settlement of corporate-owned life insurance policies should be classified as cash inflows from investing activities. The cash payments for premiums on corporate-owned policies may be classified as cash outflows for investing activities, operating activities, or a combination of investing and operating activities.

• Distributions Received from Equity Method Investees

  When an organization applies the equity method, it should make an accounting policy election to classify distributions received from equity method investees using either of the following approaches:

  1. Cumulative earnings approach: Distributions received are considered returns on investment and classified as cash inflows from operating activities, unless the investor's cumulative distributions received less distributions received in prior periods that were determined to be returns of investment exceed cumulative equity in earnings recognized by the investor. When such an excess occurs, the current-period distribution up to this excess should be considered a return of investment and classified as cash inflows from investing activities.
  2. Nature of the distribution approach: Distributions received should be classified on the basis of the nature of the activity or activities of the investee that generated the distribution as either a return on investment (classified as cash inflows from operating activities) or a return of investment (classified as cash inflows from investing activities) when such information is available to the investor.

If an entity elects to apply the nature of the distribution approach and the information to apply that approach to distributions received from an individual equity method investee is not available to the investor, the entity should report a change in accounting principle on a retrospective basis by applying the cumulative earnings approach in (1) for that investee.

- Beneficial Interests in Securitization Transactions

A transferor's beneficial interest obtained in a securitization of financial assets should be disclosed as a noncash activity, and cash receipts from payments on a transferor's beneficial interests in securitized trade receivables should be classified as cash inflows from investing activities.

- Separately Identifiable Cash Flows and Application of the Predominance Principle

The classification of cash receipts and payments that have aspects of more than one class of cash flows should be determined first by applying specific guidance in generally accepted accounting principles (GAAP). In the absence of specific guidance, an entity should determine each separately identifiable source or use within the cash receipts and cash payments on the basis of the nature of the underlying cash flows. An entity should then classify each separately identifiable source or use within the cash receipts and payments on the basis of their nature in financing, investing, or operating activities. In situations in which cash receipts and payments have aspects of more than one class of cash flows and cannot be separated by source or use, the appropriate classification should depend on the activity that is likely to be the predominant source or use of cash flows for the item.

ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, for public business entities. For all other entities, including not-for-profit organizations, it is effective for fiscal years beginning after December 15, 2018. Early implementation is permitted.

Operating Activities Presentation

The operating activities section of the statement of cash flows can be presented under the direct or indirect method. However, the FASB has expressed preference for the direct method of presenting net cash from operating activities.

In situations where the direct method is used one year and the indirect method the next year, the common practice is to restate prior year cash flows to conform to the current year presentation and disclose the fact that the prior year was restated.

Direct method presentation. The direct method is the method of presenting cash flows from operating activities that derives the net cash provided by operating activities from the components of operating cash receipts and payments as opposed to adjusting operating activities for items not affecting funds. The direct method presents the items that directly affected cash flow. The direct method requires, at a minimum, the following categories of cash receipts and cash payments to be presented:

1. Cash collected from customers, service recipients, grants, and contributions not donor-restricted for long-term purposes.
2. Interest and dividends received that are not donor-restricted for long-term purposes.
3. Cash paid to employees and suppliers.
4. Cash paid for programmatic purposes, such as grants to individuals or other organizations.
5. Other operating cash receipts, if any.
6. Interest and income taxes paid.
7. Other operating cash payments.

Since the direct method shows only cash receipts and payments, no adjustments are necessary for noncash expenses such as depreciation. The following displays how cash flows from operating activities would be presented using the direct method.

Note that when the direct method is used, a separate schedule reconciling the net change in net assets to net cash flows from operating activities must also be provided. FASB ASC 230-10-45-29 states that at a minimum, changes in receivables and payables related to operating activities and changes in inventory must be reconciled in the separate schedule.

Indirect method presentation. The indirect method is an alternative to the direct method of presenting cash flows from operating activities. It is a method that derives the net cash provided by operating activities by adjusting operating activities for revenue and expense items not resulting from cash transactions. Primarily because it is easier to prepare, the indirect method is the most widely used presentation of cash from operating activities, despite the FASB's stated preference for the direct method. Net change in net assets and cash flow differences become the focal point. The indirect format begins with the change in net assets and adjusts for:

1. Noncash items or items related to investing or financing activities such as depreciation and net realized and unrealized gains or losses on investments.
2. Changes during the period in operating assets and liabilities.

The statement of cash flows prepared using the indirect method emphasizes changes in all major classes of operating items including changes in receivables and payables and inventory.

Reporting discontinued operations. Cash flows from discontinued operations need not be separately disclosed in cash flow statements. Therefore, the criteria for classifying transactions and events as operating, investing, or financing would also apply to discontinued operations, and these items should be reported in those categories. (FASB ASC 230-10-45-24)

Reporting agency transactions. According to FASB ASC 230-10-45-8, agency transactions may be reported net on the statement of cash flows. It is acceptable to report only the net changes to assets and liabilities resulting from agency transactions. In situations whereby an organization receives significant resources from agency transactions, gross cash receipts and payments on the statement of cash flows may be reported.

Note that changes in certain current assets and liabilities do not affect the statement of activities and would not affect cash provided from operating activities. Since operating activities are defined as including “all transactions and other events that are not defined as investing or financing activities,” cash flows from operating activities are not limited to the cash effect of transactions and other events that are reported on an organization's statement of activities and would include, if applicable, agency transactions.

Other adjustments to arrive at net cash flows from operating activities. When the indirect method is used to present cash flows from operating activities, other adjustments to arrive at net cash flows from operating activities are necessary. Examples of these adjustments include:

1. Amortization of discount on unconditional promise to give;
2. Noncash entries to current operating assets and liabilities, such as recording a provision for uncollectible promises to give not restricted for long-term purposes or providing a reserve for inventory obsolescence;
3. Amortization of intangible assets or deferred charges such as copyrights, mailing lists, and trademarks;
4. Increases in the cash value of life insurance, net of any premiums paid;
5. Contributions donor-restricted for long-term purposes;
6. Deferred income taxes resulting from unrelated business taxable income or net investment income subject to excise taxes, if any;
7. Deferred revenue;
8. Depreciation;
9. Realized and unrealized gains and losses on investments;
10. Gains or losses associated with the disposal of noncurrent assets;
11. Earnings on long-term investments in common stock of a for-profit entity accounted for under the equity method;
12. Minority interest in consolidated for-profit subsidiaries;
13. Long-term installment sale receivables.

The adjustments should be reflected either in the statement itself or in a separate schedule. When the direct method is used, the items should be excluded from the statement of cash flows because the direct approach only reflects cash receipts and payments. However, the items would be shown in the reconciliation of the change in net assets to net cash provided by operating activities.

Cash Flows from Investing Activities

Investing activities include the following:

• Lending money and collecting on loans;
• Acquiring and selling, or disposing of, securities that are not cash equivalents;
• Acquiring and selling, or disposing of, productive assets that are expected to generate revenue over a long period of time;
• Receiving cash from contributions donor-restricted for long-term purposes for which the restrictions have not been satisfied and cash is still held.

According to FASB ASC 230-10-50-4, certain investing activities, such as acquiring assets by assuming liabilities or exchanging assets, are noncash transactions. Although they do not involve cash receipts or payments, they must still be reported separately.

Discussing Gross and Net Cash Flows

The emphasis in the statement of cash flows is on gross cash receipts and cash payments. For instance, reporting the net change in bonds payable would obscure the financing activities of the entity by not disclosing separately cash inflows from issuing bonds and cash outflows from retiring bonds. GAAP specifies a few exceptions from this general rule and states that cash flows can be reported net from the following activities: (FASB ASC 230-10-45-7,8,9)

1. Cash receipts and payments from purchasing and selling cash equivalents;
2. Cash receipts and payments related to investments that are not cash equivalents, loans receivable, and debt when the original maturity of the asset or liability is three months or less;
3. Cash receipts and payments from transactions for which the organization is holding or disbursing cash on behalf of its customers (such as the collection and payment of sales taxes).

Although GAAP permits reporting net cash flows from the preceding activities, netting is not required. Presenting gross cash flows for those activities may be preferable in some instances.

Purchases of long-term assets. Purchases of long-term assets should be reported as cash outflows from investing activities. The not-for-profit organization should report on the statement of cash flows, the dollar value of the assets purchased, and the down payment amounts associated with the purchase of the asset by assuming liabilities.

Investing cash flows should include advance payments and the initial down payment or amounts paid at the same time the assets are purchased, as well as the assumption of any payments made after that time, should be classified as financing activities since these payments would represent repayment of the debt assumed to purchase the asset. Liabilities should be disclosed separately.

Sales of long-term assets. Sales of long-term assets should be shown as cash inflows from investing activities. Interest, if any was collected, should be classified as cash flows from operating activities.

Cash flows from purchases, sales, and insurance recoveries of unrecognized, noncapitalized collection items should be reported as investing activities on the statement of cash flows. (FASB ASC 958-230-55-5A)

Contributions. Receipts of contributions that are donor-restricted for long-term purposes are considered financing activities, not operating activities. For purposes of the statement of cash flows, restricted cash is excluded from cash and cash equivalents.

If a contribution restricted for long-term purposes has not been spent during the period designated by the donor, a cash inflow and a cash outflow must be presented on the statement of cash flows.

Investments. If an organization has amounts that do not meet the definition of cash, it must decide whether to account for them as cash equivalents (as described more fully in an earlier section of this chapter) or as other short-term investments. An organization is permitted to establish a policy concerning which short-term, highly liquid investments with original maturities of three months or less are considered cash equivalents and which are to be reported as short-term investments. Once established, the policy should be consistently followed. A change in the type of investments classified as cash equivalents is a change in accounting principle that requires prior period financial statements presented for comparative purposes to be restated.

Purchases and sales of investments that are classified as cash equivalents are part of an organization's cash management rather than part of its operating, investing, and financing activities. Thus, the net change in cash equivalents should be included in the net change in cash and cash equivalents shown in the statement of cash flows. Accordingly, purchases and sales of cash equivalents need not be reported separately.

Investments that are not cash equivalents. Purchases and sales of investments that are not cash equivalents should be classified as investing activities in the statement of cash flows.

Interest and dividend income. Receipts from interest and dividends not donor-restricted for long-term purposes should be classified as cash flows from operating activities rather than cash flows from investing activities.

Notes and loans receivable. Making loans is an investment activity. The principal amount of the loan should be shown as cash used for investing activities, and principal ­collected on the loans should be shown as cash provided by investing activities. Interest collected on the loans should be shown as an operating activity. Cash flows relating to investments or loans receivable with original maturities of three months or less may be reported net.

Purchase or sale of a subsidiary. When a subsidiary is purchased or sold, cash flow statements should report the cash paid to acquire the subsidiary (or cash proceeds from the sale) as an investing activity.

Cash Flows from Financing Activities

Financing activities include the following:

• 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;
• Obtaining and paying for other resources from creditors on long-term credit.

Restricted contributions and investment income. Receipts of contributions that are restricted for long-term purposes by the donor should be classified as financing activities. Examples of these types of contributions would include purchasing or constructing facilities, including property, equipment, or any other long-lived asset and establishing or adding to a permanent or term endowment. Investment income that is donor-restricted for long-term purposes should be classified as a financing activity, not an operating receipt.

Short-term and long-term debt. Cash receipts from both short-term and long-term borrowings are reported as cash inflows from financing activities. The payment of short-term and long-term obligations should be reported as a separate cash outflow from financing activities. Cash flows related to loans with original maturities of three months or less may be reported on a net basis.

Noncash Investing and Financing Activities

Some investing and financing activities do not involve cash receipts and payments during the period. These noncash activities are excluded from the cash flow statement, although they must be disclosed and reported separately. Two options for providing this disclosure are in a supplemental schedule on the face of the cash flows statement or in the notes to the financial statements.

Some examples of noncash investing and financing activities include the following:

• Acquiring assets by assuming liabilities;
• Obtaining assets by entering into a capital lease;
• Exchanging noncash assets or liabilities for other noncash assets or liabilities;
• Seller financing and third-party financing.

Not-for-profit organizations often receive gifts of marketable securities from donors. These should be reported as noncash investing activities. This is true even if the not-for-profit organization has a policy in place to immediately liquidate securities received from donors.

Gifts of long-lived assets. Not-for-profit organizations sometimes receive contributions of land, buildings, equipment, collection items, or other long-lived assets due to the tax advantages afforded donors on the contribution of appreciated property. Such asset contributions do not involve the receipt of cash and are, therefore, considered noncash investing and financing transactions. (FASB ASC 958-230-55)

Issuance of social or country club membership shares. Cash receipts from issuance of membership shares should be reported as cash inflows from financing activities.

The following transactions related to issuance of membership club capital shares do not affect cash flows and should be disclosed as noncash investing and financing activities:

• Capital shares issued for receivables or other noncash consideration such as property and equipment;
• Capital shares issued to settle debt.

Exhibit 4 illustrates a sample cash flow statement for a not-for-profit organization using the direct method. Exhibit 5 illustrates the indirect method.