IAS 7 Statement of Cash Flows–Classification of short-term loans

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STAFF PAPER

March 2018

IFRS Interpretations Committee Meeting

Project

IAS 7 Statement of Cash Flows–Classification of short-term

loans and credit facilities

Paper topic

Initial consideration

CONTACT(S)

Vincent Louis

Jawaid Dossani

vlouis@ifrs.org

jdossani@ifrs.org

+44 (0) 20 7246 6470

+44 (0) 20 7332 2742

This paper has been prepared for discussion at a public meeting of the IFRS Interpretations Committee

(Committee). Comments on the application IFRS Standards do not purport to set out acceptable or

unacceptable application of IFRS Standards—only the Committee or the International Accounting

Standards Board (Board) can make such a determination. Decisions made by the Committee are

reported in IFRIC

Update. The approval of a final Interpretation by the Board is reported in IASB

Update.

Introduction

1. The IFRS Interpretation Committee (Committee) received a request to clarify when an

entity includes particular short-term loans and credit facilities as a component of cash

and cash equivalents in its statement of cash flows.

2. The objective of this paper is to:

(a) provide the Committee with a summary of the matter;

(b) present our research and analysis; and

the matter to its standard-setting agenda.

Structure of the paper

3. This paper includes:

(a) background information;

(b) summary of outreach;

(d) staff recommendation.

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4. There are two appendices to this paper:

(a) Appendix A––proposed tentative agenda decision; and

(b) Appendix B––submission.

Background information

5. In the fact pattern described in the request:

(a) an entity has short-term loans and credit facilities (short-term arrangements)

that have a short contractual notice period (eg 14 days);

(b) the short-term arrangements form an integral part of the entity’s cash

management; and

does not often fluctuate from being negative to positive.

6. The request asks whether, applying paragraph 8 of IAS 7 Statement of Cash Flows, an

entity includes the short-term arrangements as a component of cash and cash

equivalents in the statement of cash flows. In particular, the request asks whether the

last sentence of paragraph 8 of IAS 7 is a requirement that must be met to include a

short-term arrangements as a component of cash and cash equivalents or an indicator

to be considered.

7. Paragraph 8 of IAS 7 is included below for ease of reference:

Bank borrowings are generally considered to be financing

activities. However, in some countries, bank overdrafts which

are repayable on demand form an integral part of an entity's

cash management. In these circumstances, bank overdrafts are

included as a component of cash and cash equivalents. A

characteristic of such banking arrangements is that the bank

balance often fluctuates from being positive to overdrawn.

8. If included as a component of cash and cash equivalents, the entity would incorporate

any changes in the short-term arrangements within the overall net increase or decrease

in cash and cash equivalents for the period. If not included as a component of cash

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and cash equivalents, the entity would consider the short-term arrangements to be

financing activities.

Summary of outreach

9. We sent information requests to members of the International Forum of Accounting

Standard-Setters, securities regulators and the large accounting firms.

10. In our request we asked whether, in their experience:

(a) entities have material short-term borrowings or other credit facilities

(including bank overdrafts) that are repayable on demand and are generally

drawn (ie consistently show a negative balance); and

(b) entities include any such balances as a component of cash and cash

equivalents in the statement of cash flows.

11. We received 12 responses—six from the large accounting firms, five from national

standard-setters and one from an organisation representing groups of regulators. The

views received represent informal opinions and do not represent the official views of

those respondents.

Findings

Prevalence

12. Most respondents said that it is relatively common for entities to have short-term

borrowings or other credit facilities that are repayable on demand and are generally

drawn. Two respondents said these arrangements are not widespread but are specific

to particular jurisdictions. Some respondents said these arrangements could be

material.

Accounting treatment observed

13. Many respondents said there is diversity in practice with some entities considering

such short-term borrowings or credit facilities to be financing activities and others

including these arrangements as a component of cash and cash equivalents.

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14. Some respondents commented on the application of paragraph 8 of IAS 7. Four

respondents specifically commented on whether the characteristic described in

paragraph 8 of IAS 7—that a bank balance often fluctuates from being positive to

overdrawn—is a requirement that must be met to include a banking arrangement as a

component of cash and cash equivalents or an indicator to be considered. Two

respondents said this characteristic is an indicator while the other two expressed

mixed views. One of these respondents said that while, in their view, this

characteristic was not a requirement, they considered it to be a particularly important

indicator.

15. One respondent said that although the balances on short-term borrowings or credit

facilities were drawn at the end of reporting periods, they were unable to ascertain

whether the balances fluctuated from positive to negative within reporting periods.

16. Some respondents said that, in their view, the key principle in paragraph 8 of IAS 7 is

whether a particular type of short-term borrowing or credit facility forms an integral

part of an entity’s cash management. Some respondents said, in their view, a

consistent negative balance for such an arrangement provides evidence that it is not an

integral part of an entity’s cash management. For example, one respondent said that a

consistently negative balance would indicate that the likely purpose of the

arrangement is to finance the operations of the entity, rather than forming an integral

part of the entity’s cash management.

17. Some respondents commented on whether an entity applying paragraph 8 of IAS 7

could include only bank overdrafts as a component of cash and cash equivalents. One

respondent said that a bank overdraft is just an example of bank borrowings and hence

an entity can include other types of bank borrowings as a component of cash and cash

equivalents. Two other respondents said only bank overdrafts repayable on demand

could be included as a component of cash and cash equivalents.

Staff analysis

General presumption

18. In our view, paragraph 8 of IAS 7 sets out a general presumption that an entity

includes bank borrowings as part of financing activities. This is consistent with

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paragraph 17 of IAS 7, which lists cash proceeds from issuing short-term or long-term

borrowings as examples of cash flows arising from financing activities.

19. However, paragraph 8 of IAS 7 identifies circumstances in which a bank borrowing is

included in cash and cash equivalents. These are :

(a) the entity has a bank overdraft;

(b) the bank overdraft is repayable on demand; and

This paragraph then goes on to state that a characteristic of such a banking

arrangement is that the balance often fluctuates from being positive to overdrawn.

20. IAS 7 does not further elaborate on the requirements of paragraph 8 or some of the

key terms within this paragraph. The remainder of our analysis provides additional

commentary on paragraph 8.

Bank overdraft

21. IAS 7 does not define bank overdraft. A bank overdraft commonly refers to a facility

provided by a financial institution to allow customers to draw funds even if the

account has no funds in it.

22. Paragraph 8 of IAS 7 specifically identifies bank overdrafts as a possible component

of cash and cash equivalents. There is no discussion of other forms of bank

borrowings and we think this wording—which refers to bank overdrafts and not bank

borrowings more broadly—is intentional. Accordingly, in our view an entity cannot

include other banking arrangements as components of cash and cash equivalents.

Repayable on demand

23. Paragraph 8 of IAS 7 also requires that the bank overdraft be ‘repayable on demand’.

In our view, this means that the entity is required to repay any negative balance in the

bank overdraft as soon as the lender requests such repayment (ie ‘on demand’).

24. Accordingly, we think banking arrangements that have a short contractual notice

period (eg 14 days) are not ‘repayable on demand’ for the purpose of applying

paragraph 8 of IAS 7. In our view, IAS 7 does not specify what is meant by ‘on

demand’ because the term is self-explanatory.

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Integral part of cash management

25. Paragraph 8 of IAS 7 requires that the bank overdraft form an integral part of an

entity’s cash management. Assessing whether this overdraft forms an integral (ie an

essential) part of an entity’s cash management is a matter of facts and circumstances.

26. IAS 7 does not define cash management. Paragraph 7 of IAS 7 states that ‘cash

equivalents are held for the purpose of meeting short-term cash commitments rather

than for investment or other purposes’. Paragraph 9 of IAS 7 goes on to say that ‘cash

management includes the investment of excess cash in cash equivalents’.

Accordingly, we think cash management entails the management of cash and cash

equivalents for meeting short-term cash commitments rather than for longer-term

investment or financing arrangements.

27. One example of a situation in which a bank overdraft may be an integral part of an

entity’s cash management is one in which an entity (a) has a bank account with an

overdraft facility, and (b) uses that overdraft facility periodically to meet short-term

cash flow needs.

Bank balance often fluctuates from being positive to overdrawn

28. The final sentence of paragraph 8 of IAS 7 states that a characteristic of such banking

arrangements is that the bank balance often fluctuates from being positive to

overdrawn.

29. In our view, the last sentence of paragraph 8 of IAS 7 describes an expected attribute

of a bank overdraft that forms part of cash and cash equivalents. If the overdraft

frequently fluctuates from positive to overdrawn then this characteristic is consistent

with an assertion that the entity uses the overdraft as an integral part of its cash

management. Conversely, if the balance is always, or almost always, negative then

this would appear to indicate that the entity uses the overdraft for financing, arguably

on a relatively consistent basis.

30. In our view, it would be unusual for an entity to have a banking arrangement that is

always, or almost always negative and concurrently be able to support an assertion

that it should include the balance of the arrangement as a component of cash and cash

equivalents. Accordingly, we think that even if the wording of the last sentence is not

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read as being a strict requirement, it is still a strong indicator that the arrangement

does not form an integral part of the entity’s cash management.

31. We think the wording also indicates that the banking arrangement would have, or be

capable of having, either as a starting point or at some time over its life cycle, a

positive bank balance. This is because the sentence states that the balance fluctuates

‘from positive to overdrawn’ (we note here that the request asks whether an item is

required to fluctuate from negative to positive). In our view, this paragraph is not

intended to capture banking arrangements such as loans or other borrowings, which,

by their nature, always have a negative balance and would not fluctuate from negative

to positive.

Applying the requirements to the short-term arrangements described in the

submission

32. The short-term arrangements described in the request have a contractual notice period

(eg 14 days). They are not bank overdrafts that are repayable on demand and as such,

like other borrowings, would be considered to part of financing activities.

33. Even if the short-term arrangements were repayable on demand, the fact that the

balance is almost always negative indicates that the short-term arrangements are a

form of financing rather than an integral part of the entity’s cash management.

Other considerations – relevant disclosure requirements

34. We think it is helpful to highlight relevant disclosure requirements in IAS 7 that an

entity with the short-term arrangements described in the submission applies. In

particular, paragraph 45 of IAS 7 states:

An entity shall disclose the components of cash and cash

equivalents and shall present a reconciliation of the amounts in

its statement of cash flows with the equivalent items reported in

the statement of financial position.

35. Paragraph 46 of IAS 7 states:

In view of the variety of cash management practices and

banking arrangements around the world and in order to comply

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with IAS 1 Presentation of Financial Statements, an entity

discloses the policy which it adopts in determining the

composition of cash and cash equivalents.

Conclusion

36. Based on our analysis, we think that:

(a) bank borrowings are generally considered to be financing activities. An

entity includes a bank borrowing as a component of cash and cash

equivalents only in the particular circumstances described in paragraph 8 of

IAS 7—ie the banking arrangement is a bank overdraft that is (i) repayable

on demand, and (ii) forms an integral part of an entity’s cash management.

(b) cash management includes managing cash and cash equivalents for the

purpose of meeting short-term commitments rather than for investment or

other purposes. Assessing whether a banking arrangement is an integral part

of an entity’s cash management is a matter of facts and circumstances.

contractual notice period is short (eg 14 days), are not repayable on demand

for the purpose of applying paragraph 8 of IAS 7.

(d) if the balance of a banking arrangement is always or almost always

negative, then this is a strong indicator that the arrangement does not form

an integral part of the entity’s cash management. A consistently negative

balance indicates that the arrangement is a form of financing.

Question 1 for the Committee

Does the Committee agree with our analysis of the requirements in IFRS

Standards, summarised in paragraph 36 of this paper?

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Should the Committee add this matter to its standard setting agenda?

Is it necessary to add to or change IFRS Standards to improve financial

reporting?

37. Based on our analysis, we think the requirements in IAS 7 provide an adequate basis

for an entity to assess whether to include the short-term arrangements described in the

submission as components of cash and cash equivalents in the statement of cash

flows.

Staff recommendation

38. On the basis of our assessment of the Committee’s agenda criteria in paragraphs 5.16–

5.17 of the Due Process Handbook we recommend the Committee does not add this

matter to its standard-setting agenda. Instead, we recommend publishing an agenda

decision that explains how an entity applies the requirements in paragraph 8 of IAS 7.

We also think it would be useful for the agenda decision to outline relevant disclosure

requirements for entities with these types of short-term arrangements.

39. Appendix A to this paper outlines the proposed wording of the tentative agenda

decision.

Questions 2 and 3 for the Committee

2. Does the Committee agree with the staff recommendation not to add this matter

to its standard-setting agenda?

3. Does the Committee have any comments on the proposed wording of the

tentative agenda decision outlined in Appendix A to this paper?

Paragraph 5.16(b) of the Due Process Handbook.

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Appendix A –– Proposed wording of the tentative agenda decision

IAS 7 Statement of Cash Flows—Classification of short-term loans and credit

facilities

The Committee received a request asking about the types of borrowings an entity can

include in its statement of cash flows as a component of cash and cash equivalents. In

the fact pattern described in the request:

(a) the entity has short-term loans and credit facilities (short-term arrangements) that

have a short contractual notice period (eg 14 days);

(b) the short-term arrangements form an integral part of the entity’s cash

management; and

negative to positive.

The Committee observed that:

(a) applying paragraph 8 of IAS 7, an entity generally considers bank borrowings to

be financing activities. An entity, however, includes a bank borrowing as a

component of cash and cash equivalents only in the particular circumstances

described in paragraph 8 of IAS 7—ie the banking arrangement is a bank overdraft

that is (i) repayable on demand, and (ii) forms an integral part of the entity’s cash

management.

(b) cash management includes managing cash and cash equivalents for the purpose of

meeting short-term cash commitments rather than for investment or other purposes.

Assessing whether a banking arrangement is an integral part of an entity’s cash

management is a matter of facts and circumstances.

often fluctuate from positive to negative, then this is a strong indicator that the

arrangement does not form an integral part of the entity’s cash management and,

instead, represents a form of financing.

In the fact pattern described in the request, the Committee concluded that an entity

cannot include the short-term arrangements as components of cash and cash

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equivalents. This is because these short-term arrangements are not repayable on

demand. Additionally, the fact that the balance is almost always negative indicates

that the short-term arrangements are a form of financing rather than an integral part of

the entity’s cash management.

The Committee also noted that paragraphs 45 and 46 of IAS 7 require an entity to

(a) disclose the components of cash and cash equivalents and present a reconciliation

of the amounts in its statement of cash flows with the equivalent items reported in its

statement of financial position; and (b) disclose the policy which it adopts in

determining the composition of cash and cash equivalents.

The Committee concluded that the principles and requirements in IFRS Standards

provide an adequate basis for an entity to assess whether to include in its statement of

cash flows the short-term arrangements described in the request as components of

cash and cash equivalents. Consequently, the Committee [decided] not to add this

matter to its standard-setting agenda.

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Appendix B –– Submission

We have reproduced the submission below. We have deleted details that would identify the

submitter of this request.

Enquiry to the Interpretations Committee

[We] would like to submit an issue to IFRS IC regarding the classification of cash and

cash equivalents in the cash flow statement.

…

Issue

… [We have] identified divergent application of requirements of IAS 7 regarding the

classification of short-term loans and credit facilities as cash and cash equivalents in

accordance with IAS 7 paragraph 8.

Specifically, we ask the IFRS IC to clarify whether short-term loans and credit

facilities that have a very short notice and form an integral part of an entity’s cash

management can be classified as cash and cash equivalents only when their balance

often fluctuates from being negative to positive. We also question whether any such

fluctuation shall be regarded only as an indicator that entities have to consider when

classifying such items as cash or cash equivalents, or whether this would be a

requirement.

Some entities may have, together with an overdraft facility with their banks, also

other short- term loans and credit facilities that are always drawn and therefore show a

negative balance. However, since payments from customers also reduce the negative

balances, in theory these facilities could show also positive balances. Nevertheless, in

some cases, they show negative balances over a period of several years.

In cases when it is contractually agreed with the banks that the facilities have a very

short notice (e.g. 14 days), it is a widespread practice to classify a part of an entity’s

short term debt as cash and cash equivalents in the statements of cash flows, even

though the debt does not often fluctuate from being positive to overdrawn and the

balance is often never positive.

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These credit facilities come in many forms - some are without a redemption date,

some have a redemption date within 3 months, and some take the form of a revolving

credit facility. The entities applying this practice often present the amount for ‘cash

and cash equivalents’ as a significant negative amount year after year.

Cash and cash equivalents are defined in paragraph 6 of IAS 7. Cash is defined as

cash on hand and demand deposits. Cash equivalents are defined as short-term, highly

liquid investments that are readily convertible to known amounts of cash and which

are subject to an insignificant risk of changes in value.

Paragraph 7 of IAS 7 states that an investment normally only qualifies as a cash

equivalent when it has a short maturity of, for example, three months or less from the

date of acquisition.

Paragraph 8 of IAS 7 states that when bank overdrafts are repayable on demand they

may form an integral part of an entity’s cash management. In these circumstances,

bank overdrafts can be included as a component of cash and cash equivalents. A

characteristic of such banking arrangements is that the bank balance often fluctuates

from being positive to overdrawn.

[In the submitter’s jurisdiction] entities often classify a part of their short-term debt as

cash and cash equivalents even though the short-term loans and credit facilities do not

regularly fluctuate between being positive and negative.

The alternative to this would be to classify only positive cash balances and bank

overdrafts (provided that they fluctuate between negative and positive balances) as

cash and cash equivalents in the statement of cash flows.

Paragraph 8 of IAS 7 seems to point to the fact that it is a requirement that bank

balances fluctuate between positive and negative balances in order to classify negative

bank balances as cash and cash equivalents. However, some issuers consider this not

to be a requirement but only an indication.

[We] seek clarification from the IFRS IC on which types of debt an entity can and

should classify as cash and cash equivalents in the statement of cash flows. In

particular, we would like to know whether, according to paragraph 8 of IAS 7, an

entity can classify short-term loans and credit facilities as cash and cash equivalents

when:

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(i) bank facilities have a very short notice (e.g. 14 days); and

(ii) they form an integral part of an entity’s cash management, even

though they do not often fluctuate from being negative to

positive.

Particularly, we seek elucidation from the IFRS IC as to whether fluctuation from

negative to positive is a requirement for classification as cash and cash equivalents or

just an indication.

…