Insight

Statement of cash flows: IFRS® Standards vs. US GAAP

Top 10 differences related to the statement of cash flows.

Kevin Bogle

Kevin Bogle

IFRS Institute Advisory Leader, KPMG LLP

+1 212-872-5766

From the IFRS Institute – March 5, 2021

The statement of cash flows is a central component of a company’s financial statements and provides key information about its financial health and capacity to generate cash flows. Despite similar objectives, IAS 71 and ASC 2302 have different requirements, such as the composition of cash, and the classification of interest, dividends and lease payments across cash flow categories. These differences can significantly impair comparability between IFRS Standards and US GAAP preparers. Here we summarize our selection of Top 10 GAAP differences related to the statement of cash flows.

The statement of cash flows prepared under IAS 7

A company is required to present a statement of cash flows that shows how its cash and cash equivalents have changed during the period. Cash flows are classified as either operating, investing or financing activities, depending on their nature.

  Description

Operating activities

The company’s principal revenue-producing activities, and other activities that are not investing or financing activities.

Investing activities

Relate to the acquisition and disposal of long-term assets and other investments not included in cash equivalents.

Financing activities

Result in changes in the size and composition of the company’s contributed equity and borrowings.


How is IAS 7 different from ASC 230?

IFRS Standards and US GAAP contain similar overriding principles in preparing the statement of cash flows, including:

  • the requirement to classify cash flows by operating, financing or investing activities; and
  • allowing companies to elect to present cash flows from operating activities using either the direct method (showing receipts from customers, payments to suppliers, etc.) or indirect method (profit or loss for the period reconciled to the total net cash flows from operating activities).

Under IFRS Standards, the primary consideration for the classification of cash flows is the nature of the activity to which they relate. Under US GAAP, the classification of an item on the balance sheet, and its related accounting, often informs the appropriate classification in the statement of cash flows. As such, different classification and accounting for an underlying item on the balance sheet under US GAAP may result in differences in the statement of cash flows. In addition, certain differences exist between the detailed requirements of IAS 7 and ASC 230, which could affect dual preparers. See KPMG Handbook, Statement of cash flows, to learn more about the US GAAP requirements.

Here we summarize our selection of Top 10 differences.

1.  Statement of cash flows always required under IFRS Standards; exceptions exist under US GAAP

Under IFRS Standards, there are no scope exceptions and all companies must present a statement of cash flows in a complete set of financial statements.

Under US GAAP, defined benefit pension plans that present financial information under ASC 960and certain investments companies in the scope of ASC 9464 may be exempt from presenting a statement of cash flows.

2.  The starting point of the statement of cash flows varies under IFRS Standards; net income is the starting point under US GAAP

Under IFRS Standards, entities may use different starting points for reporting operating cash flows under the indirect method – e.g. profit or loss, profit or loss from continuing operations, profit or loss before tax or operating profit or loss.

Diversity in practice may have developed because IAS 7 refers to ‘profit or loss’, but an example to the standard starts with a different figure (profit before taxation). We believe it is more appropriate to follow the standard (i.e. start with profit or loss), because the example is illustrative only and does not have the same status as the standard.

See the Proposed amendments that would require the operating profit or loss as the starting point and align IFRS Standards with US GAAP.

3.  IFRS Standards provide options for classifying interest, dividends and income taxes; US GAAP does not

The table summarizes the classification differences.

 

IFRS Standards

US GAAP

Interest paid

Operating or financing

(generally operating for financial institutions)

Operating (net of interest capitalized5)

Dividends paid

Operating or financing

Financing

Interest and dividends received

Operating or investing

(generally operating for financial institutions)

Operating

Taxes paid

Generally operating activities, unless practicable to identify taxes with investing or financing activities

Operating


See the Proposed amendments that would affect these classifications under IFRS Standards.

4.  Cash may be net of bank overdrafts under IFRS Standards; not under US GAAP

Under IFRS Standards, bank overdrafts reduce the cash and cash equivalents balance in the statement of cash flows if they are repayable on demand and form an integral part of the company’s cash management. On the balance sheet, however, bank overdrafts are generally6 presented as liabilities. Components making up the total cash and cash equivalents opening and closing balances in the statement of cash flows are disclosed and reconciled to the appropriate balance sheet line items.

Under US GAAP, bank overdrafts are considered a form of short-term financing and are generally6 presented as liabilities, with changes therein classified as financing activities (draws separate from repayments) in the statement of cash flows.   

5.  Cash may exclude restricted cash under IFRS Standards; included under US GAAP

Under IFRS Standards, ‘restricted cash’ is not defined and there is no specific guidance on whether restricted amounts should be included in a company’s beginning or ending cash and cash equivalent balances in the statement of cash flows. However, to meet the definition of cash and cash equivalents, among other criteria the amounts should be either held on hand, available to be withdrawn at any time without penalty or readily convertible into known amounts of cash. An overriding test for ‘cash equivalents’ is that they are held for the purpose of meeting short-term cash commitments rather than for investing or other purposes. Where significant amounts are not available for use by the group, IAS 7 requires disclosure of the amount and commentary on the restriction.

Under US GAAP, while restricted amounts are presented separately from cash and cash equivalents on the balance sheet, the amounts are included in the total cash and cash equivalents in the statement of cash flows. The company then discloses a reconciliation between the two cash and cash equivalents totals.

Although neither GAAP provides a specific definition of restricted cash, under US GAAP it is commonly understood to include cash and cash equivalents whose withdrawal or usage is restricted for certain purposes – e.g. legally restricted deposits held as compensating balances on short-term borrowing arrangements, contracts entered into with others, statements of intention regarding particular deposits. This absence of definitions may lead to differences in practice between amounts reported as restricted cash under IFRS Standards and US GAAP.

6.  Operating lease payments are mostly financing activities under IFRS Standards; operating activities under US GAAP

Under IFRS 167, a lessee classifies cash payments for the principal portion of a lease liability as financing activities in the statement of cash flows. Payments for the interest portion are classified as operating or financing activities, in line with a company’s policy election for interest paid  (see Difference #3). (For lessees, IFRS 16 does not distinguish between operating and finance leases, unlike US GAAP.)

Under US GAAP, a lessee classifies operating lease payments as operating activities. Finance lease payments are classified in the same way as all lease payments under IFRS Standards.

Both GAAPs classify the following as operating cash flows: payments for short-term leases and leases of low-value assets, and variable lease payments not included in the lease liability (as measured under applicable GAAP).

7.  Classification of deferred or contingent consideration in a business combination may differ under IFRS Standards and US GAAP

Under IFRS Standards, cash payments for deferred and contingent consideration in a business combination require judgment to determine the appropriate classification based on the nature of the activity to which the cash flows relate. While US GAAP does not address the classification of payments for deferred consideration in a business combination, it does include prescriptive guidance on how to classify payments for contingent consideration.

The table summarizes the classification differences.

 

IFRS Standards

US GAAP

Deferred consideration

We believe it is generally appropriate to classify payments as follows.

  • Payment reflecting a finance expense, consistent with the policy election for interest paid (see Difference #3).
  • Payment reflecting settlement of the fair value of consideration recognized on initial recognition, within financing or investing activities.
    Judgment needs to be applied to determine whether the payment arises from obtaining control (an investing activity) or whether it is a settlement of financing provided by the seller.
    Factors that may be relevant include: (1) the time between initial recognition of the liability and settlement; (2) whether the settlement period reflects a normal credit period; and (3) whether the liability is discounted to reflect its deferred settlement (which would suggest a financing element to the arrangement).
  • Contingent consideration paid in excess of the fair value of consideration recognized on initial recognition either in operating activities, or consistent with the policy election for interest paid (see Difference #3).
  • No specific guidance.
Contingent consideration
  • Payments made ‘soon after’ the acquisition date are classified as investing activities; we believe that three months or less is an appropriate interpretation of ‘soon after’.
  • Payments not made ‘soon after’ the acquisition date are split between operating and financing activities; payments up to the fair value of consideration recognized on initial recognition are classified as financing activities, with any excess classified as operating activities.


8.  US GAAP prescribes classification of certain cash flows; IFRS Standards do not

Unlike IAS 7, US GAAP explicitly specifies the classification of certain cash flows:

  • cash payments for debt prepayments or extinguishment costs: financing activities;
  • cash payments for the settlement of a zero-coupon bond or a bond with an insignificant interest rate: operating activities (portion attributable to accreted interest) and financing activities (portion attributable to original principal);
  • proceeds from the settlement of an insurance claim: based on the nature of the loss;
  • distributions from equity method investees: accounting policy election between operating activities (to the extent distributions are not a return of capital) or based on facts and circumstances of the distribution; and
  • cash receipts from payments on a transferor’s beneficial interests in securitized trade receivables: investing activities.

Absent specific guidance in IAS 7, we believe that judgment is required, considering primarily the nature of the activity (rather than the classification of the related items on the balance sheet).

9.  No predominance principle in IFRS Standards; exists in US GAAP

Under IFRS Standards, a company classifies each of the separate components of a single transaction as operating, investing or financing because IAS 7 does not allow a transaction to be classified based on its predominant characteristic. IAS 7 includes specific guidance related to purchase and sale of equipment held for rental to others.

US GAAP includes similar principles, but when a transaction has characteristics of more than one class of cash flows – and each separately identifiable source or use of cash cannot reasonably be separated – then a company applies the predominance principle to determine the appropriate classification for the related cash flows.

Example: Company A routinely purchases equipment to be rented to others then sold.

Under IFRS Standards, payments to purchase the equipment, as well as the proceeds from rentals and ultimate sale, are classified as operating activities. This classification is prescribed by the specific guidance in IAS 7 related to the purchase and sale of equipment held for rental to others.

Under US GAAP, the rental proceeds are also classified as operating activities. However, the classification of the cash flows from the purchase and sale of equipment depends on which activity is predominant – rental or sale.

  • If the rental is for a substantial period and the sales price modest, the rental activity is likely to be the predominant source of cash flows. In that case, the cash flows from the purchase and sale of equipment are classified as investing activities, consistent with other purchases and sales of productive assets.
  • If the rental is for a short period and the sales price substantial, the sale activity is likely to be the predominant source of cash flows. In that case, the cash flows from the purchase and sale of equipment are classified as operating activities, consistent with purchases and sales of inventory.


10.  IFRS Standards and US GAAP have different disclosure requirements

The following are key disclosure differences between IFRS Standards and US GAAP.

  • Under both IFRS Standards and US GAAP, a company is required to disclose cash flow information for discontinued operations. US GAAP, however, allows a company to disclose depreciation, amortization, capital expenditure and significant operating and investing noncash items from discontinued operations, instead of disclosing total operating and investing cash flows.
  • Cash flow per share may be presented under IFRS Standards, but not under US GAAP.
  • Additional disclosures are required by IAS 7 for changes in liabilities arising from financing activities; US GAAP has no such requirement.

Proposed amendments

In December 2019, the International Accounting Standards Board issued its exposure draft, General Presentation and Disclosures – Primary Financial Statements, which proposed a new standard on the presentation of financial statements with an aim to improve their usefulness and relevance. While the key proposals focused on the income statement, the following targeted improvements to reduce diversity in the classification and presentation of cash flows and improve comparability between companies were also proposed:

  • Use operating profit or loss as the starting point when presenting operating cash flows under the indirect method (see Difference #2).
  • Present cash flows from investments in ‘integral’ versus ‘non-integral’ associates and joint ventures separately.
  • Eliminate the options for classifying interest and dividends for most companies (see Difference #3).

Our article, IFRS Perspectives: Proposed changes to IFRS Standards financial statements, provides an overview of the key proposals. Further discussion about the exposure draft, including more on the impact to the statement of cash flows, can be found in the KPMG publication, New on the Horizon: Presentation and disclosures.

The takeaway

The statement of cash flows is a central component of a company’s financial statements and provides users with key information to evaluate a company’s financial performance for investing or other decisions. However, cash flows can be classified differently under IFRS Standards and US GAAP – due to differences in accounting for the underlying item to which a cash flow relates, as well as differing requirements in IAS 7 and ASC 230. Therefore, financial statement preparers and users should develop a clear understanding of these classification differences when analyzing and using statements of cash flows prepared under IFRS Standards or US GAAP.

For further discussion on the differences between IFRS Standards and US GAAP, see our publication IFRS Compared to US GAAP.

Contributing authors

Valerie Boissou

Valerie Boissou

Partner, Dept. of Professional Practice, KPMG US

+1 212-954-1723
Ashley L. Peters

Ashley L. Peters

Director Advisory, Accounting Advisory Services, KPMG US

+1 917-438-3963

Footnotes

  1. IAS 7, Statement of Cash Flows
  2. ASC 230, Statement of Cash Flows
  3. ASC 960, Plan Accounting—Defined Benefit Pension Plans
  4. ASC 946, Financial Services—Investment Companies
  5. See our IFRS Perspectives article Borrowing costs: Top 10 differences between IFRS Standards and US GAAP
  6. The right to offset between bank accounts is considered when determining if an account is overdrawn. This assessment considers criteria in IAS 32, Financial Instruments: Presentation under IFRS Standards; and ASC 210, Balance Sheet, under US GAAP.
  7. IFRS 16, Leases

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