20.8 Specific Items
The comprehensive illustration above included many of the more complex accounting transactions from the intermediate accounting courses (e.g., investments involving OCI, bonds issued at a discount, conversion of bonds to shares, deferred income taxes, exercising stock options, and accrued pension liabilities with funding changes). Below, however, is a brief discussion of further items to consider:
Cash equivalents
Cash equivalents are short-term, highly liquid investments that are both readily convertible to cash and carry little risk. Treasury bills, and term deposits that mature within 90 days, are examples of financial instruments that meet these two criteria and, thus, can be treated as a cash equivalent and added to cash for purposes of a statement of cash flows. Other instruments, such as publicly traded stocks, do not meet both criteria. While they may be easily traded, they carry significant risk due to market price fluctuations. For this reason, they cannot be classified as a cash equivalent. However, companies can choose whether to include cash equivalents with cash when preparing a SCF. If they do not include them with cash, then they are to be treated the same as the other working capital accounts. In which case, the accounting policy is disclosed in the notes to the financial statements.
Unrestricted cash and cash equivalents are treated as one reporting line item in a SCF. This means that changes between them are netted and are, therefore, not itemized. Simply speaking, the cash and cash equivalents accounts are added together and reported as a single amount for both the opening and closing balance.
Restricted cash or cash equivalents
These are to be reported separately in the SCF.
Bank overdrafts
Bank overdrafts are generally included in the opening and closing cash balances, provided that they are an integral part of the overall cash management for the company. However, depending on local practice or other conditions, they may be excluded. Line of credit accounts that are payable on demand are examples of accounts that would be netted with cash.
Discontinued operations
The SCF begins with income before discontinued operations. Items from discontinued operations are shown separately in the operating, investing, or financing activities according to their nature. For companies following IFRS, they can also disclose cash flow information about discontinued operations in the notes to the financial statements.
Impairments of identifiable tangible or intangible assets
Any impairment write-downs reported in net income are adjusted out of net income in the operating activities as non-cash items. This is also the case with impairment reversals.
Investments in associates
The accounting treatment for investments in associates was discussed in the previous accounting courses. Companies that follow IFRS account for these investments using the equity method. With ASPE, a policy choice allows either the equity method or fair value through net income or cost, depending upon the type of investment. Since the SCF reports cash flows, the cash dividend income received would be included in the SCF. Any investment income accrued, or unrealized gains or losses included in net income, must be adjusted out of net income as a non-cash item in operating activities.
Comprehensive income
As discussed earlier in the chapter, only net income is relevant with regard to the SCF. Comprehensive income items are excluded since they are non-cash items. For example, investments classified as “available for sale,” have fair value adjustments every reporting period which are recorded to OCI rather than to net income. It is only when an AFS investment is sold that its respective accumulated unrealized gains are reclassified from OCI/AOCI to net income. When this occurs, an adjustment to net income is required in operating activities, since the gain or loss on the sale of the AFS investment is a non-cash item, the same way that a gain or loss on the sale of a building or an equipment asset is a non-cash item.
Liabilities
Netting old and new debt in the SCF is not permitted and each individual debt instrument is to be individually reported. Amortization of a discount or premium is a non-cash component of interest expense, and since interest expense is reported in net income, amortization amounts are adjusted out of net income in operating activities.
Leases
The increase in assets and liabilities due to a new finance lease is treated as a non-cash transaction and is excluded from the SCF, although supplementary disclosures are required. Cash payments made or received regarding a lease obligation are reported as a financing activity for the lessee.
Complex financial instruments
Upon issuance of a hybrid instrument such as a convertible bond, only one cash inflow is recorded in the SCF for both the debt and the equity portion of the instrument. For more details regarding hybrid instruments, refer to the earlier complex financial instruments chapter.
Stock splits and dividends
As these are non-cash transactions, they are excluded from the SCF, although supplementary disclosures are required.
Estimate for uncollectible accounts
In cases where the balance sheet shows accounts receivable as a gross amount with a separate AFDA contra account, the indirect method will net the two accounts together and reports this net change as a change in the accounts receivable working capital account. However, with the direct method, an analysis is done on the AFDA to determine the current period estimate for uncollectible accounts and adjusts this amount from sales to cash paid for goods and services. This is done because the estimate for uncollectible accounts is debited to bad debt expense, which is usually included as other expenses within the cash paid for goods and services category.
