FASB’s proposal also included the continued presentation of the reconciliation of net income to net operating cash flows
This contributed to the diversity in reporting classification of certain common but infrequent cash flows
In efforts to improve financial reporting for NFPs, FASB initially proposed the elimination of the optional indirect presentation method. FASB’s rationale was that the direct method provides more useful information (which is highly debatable) and the indirect method contributes to the underutilization of the statement of cash flows. In addition, through its outreach activities, FASB learned that the direct method first-year implementation costs were primarily in the nature of training and mapping information available from existing systems and did not involve significant costs for new systems or significant ongoing costs or complexities.
ASU 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, finalized the changes in the presentation of financial statements of NFPs and continued the option of using either the direct or indirect method of presenting operating cash flows; however, the new standard also removed the requirement to include the reconciliation when using the direct method. The board also concluded that removing the impediment of the indirect reconciliation might encourage more NFPs to choose the direct method. The board decided that there is sufficient merit in waiting for further study of the costs of those NFPs that switch to using the direct method as well as of the related issues for reporting by business entities.
FASB’s activities related to NFPs and ASU 2016-14 were not the first discussions concerning the elimination of the indirect method of reporting operating cash flows. FASB’s 2010 draft on financial statement presentation (discussed above) proposed the required use of the direct method to report operating cash flows, with the level of disaggregation of cash flows to be determined at a later date. To reduce the cost of implementing the direct method, entities could compute the cash flows indirectly from changes in asset and liability balances in lieu of making changes in their information systems. Again, the board’s action suggests the possibility of future changes in the statement of cash flows that may affect all entities.
The statement of cash flows classifies cash receipts and cash payments as resulting from investing, financing, or operating activities. Peer review findings commonly include the misclassification of the financing and investing activities that are specifically illustrated in the standard; for example, it is incorrect to report the proceeds of a new debt borrowing as an investing activity or the cash payment for equipment acquisitions as a financing activity.
Not all cash flow situations, however, are addressed in the standards. To improve the consistency of reporting, FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force), which clarified the classification of cash flows related to eight specific issues and provided additional guidance to identify and apply the predominant principle for reporting situations not addressed in the standards (Exhibit 2). For example, cash payments for debt prepayment or debt extinguishment costs should be classified as cash outflows from financing activities. At the settlement of zero-coupon debt instruments (or similar low coupon interest debt instruments), a preparer should classify the portion of the cash payment attributable to the accreted interest related to the debt discount as a cash outflow from operating activities, and the portion of the cash payment attributable to principal as a cash outflow from financing activities. 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). To illustrate, the guidance for cash settlements states: