Case 13-02 Buck’s Dilemma: Gross or Net? Buck’s Hunting Equipment Inc. (“Buck”)

Question

Case 13-02
Buck’s Dilemma: Gross or Net?
Buck’s Hunting Equipment Inc. (“Buck”) is a retailer of hunting equipment, hunting apparel, and outdoor accessories. Buck’s operations are based in Pittsburgh, PA, with retail stores located in the nearby suburbs and throughout southwestern Pennsylvania. Buck is actively developing opportunities to expand its operations in the surrounding region, including construction of several new retail stores in West Virginia and southern Ohio. Buck intends to complete construction and open each of the new stores over the next three years. Buck anticipates incurring significant expenses and making short-term cash outlays during the construction phase of the expansion. As a result of this growing need to obtain new, readily available capital, Buck entered into a three-year revolving line of credit (the “Facility”) with its bank on January 1, 2010. The line of credit has a maximum borrowing capacity of $100 million.
Since Buck has not previously used a revolving line of credit, it does not have knowledge of the relevant accounting literature and guidance on how to present the related cash flows in its financial statements. Accordingly, as Buck’s external auditor, management has asked for your assistance in determining the appropriate presentation of the borrowing and payment activity within its statement of cash flows for the year ended December 31, 2010.
Required:
1. Should Buck present the borrowing and payment activity related to its revolving line of credit as cash flows from operating, investing, or financing activities?
2. For each of the following scenarios, on the basis of the specific facts and circumstances, determine whether Buck should present its borrowing and payment activity under the Facility on a net or gross basis within the financing activities section of its statement of cash flows.
Scenario 1:
• The line of credit has a maximum borrowing capacity of $100 million, and under the terms of the agreement, all draws are considered to be due on demand.
• On July 15, 2010, Buck drew $60 million on the Facility.
• On August 30, 2010, Buck drew an additional $40 million on the Facility.
• On September 30, 2010, Buck paid down the draws by $50 million.
• Assume the turnover of transactions is considered to be quick.
Scenario 2:
• The line of credit has a maximum borrowing capacity of $100 million, and under the terms of the agreement, specific maturity terms will be negotiated by Buck and the bank after each draw on the Facility.
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Case 13-02c: Buck’s Dilemma: Gross or Net? Page 2
• On June 15, 2010, Buck drew $60 million, and signed a note to repay the full
amount borrowed by December 15, 2010.
• On September 30, 2010, Buck drew an additional $40 million, and signed a
note to repay the full amount borrowed by December 1, 2010.
• On December 1, 2010, Buck paid $40 million to the bank related to the second
draw.
• On December 15, 2010, Buck paid $60 million to the bank related to the first
draw.
• Assume the turnover of the transactions is considered to be quick.
Scenario 3:
• The line of credit has a maximum borrowing capacity of $100 million.
Individual draws on the Facility do not contain specific maturity dates, other
than the entire amount outstanding under the Facility becomes due at the end
of the three-year term.
• On June 30, 2010, Buck drew $70 million on the Facility.
• On September 30, 2010, Buck drew an additional $15 million on the Facility.
• On November 30, 2010, Buck drew the remaining $15 million available under
the Facility.
• On December 15, 2010, Buck made a payment of $50 million related to the
outstanding balance.
• Assume the turnover of the transactions is considered to be quick.
3. What international accounting standard (IFRSs) applies to cash flow statement
presentation? In general, how do those guidelines compare to U.S. GAAP?

PROFESSOR’S DISCUSSION MATERIALS Objectives of the Case

This case gives students an opportunity to apply the guidance in ASC 230 on how to present borrowings and payments under a revolving line of credit within the statement of cash flows.

Applicable Professional Pronouncements

ASC 230-10, Statement of Cash Flows: Overall (ASC 230-10) IAS 7, Statement of Cash Flows (IAS 7)

Background

Presentation guidance for the statement of cash flows in ASC 230-10-45-7 states that information about the gross amounts of cash receipts and cash payments during a period is generally more relevant than information about the net amounts of cash receipts and cash payments. However, net presentation may be appropriate and acceptable in certain situations, including the borrowing and payment activity under a revolving line of credit., If an entity qualifies for net reporting (see following discussion), such presentation is elective. That is, net presentation is not mandatory, even if the qualifying criteria are

met. Entities may consider presenting activity on revolving lines of credit on a net basis within the financing activities section when:

•    The volume of borrowings and payments under the revolving line of credit is high

(sometimes even involving daily transactions).

•    The amounts borrowed and paid are large.

In addition to meeting these criteria, entities may present borrowings and payments net only if the original maturity of the borrowings is three months or less, in accordance with ASC 230-10-45-9. In making the determination of whether a borrowing has an original maturity of three months or less, amounts that are due on demand are deemed to have such maturities.

Discussion 1 — Classification with the Statement of Cash Flows

Should Buck present the borrowing and payment activity related to its revolving line of credit as cash flows from operating, investing, or financing activities?

Solution 1 — Classification with the Statement of Cash Flows

Discussion 2 — Gross versus net presentation

For each of the following scenarios, on the basis of the specific facts and circumstances, determine whether Buck should present its borrowing and payment activity under the Facility on a net or gross basis within the financing section of its statement of cash flows.

Solution 2 — Gross versus net presentation

Scenario 1

Scenario 2

Scenario 3

Discussion 3 — IFRSs

What international accounting standard (IFRSs) applies to cash flow statement presentation? In general, how do those guidelines compare to U.S. GAAP?

Solution 3 — IFRSs

Explanation / Answer

Answer:1 Buck’s Hunting Equipment Inc. (“Buck”) should present the borrowing and payment activity from his line of credit in his statement of cash flows as a financing activity. According to ACS 230-10-45-14 in the FASB Accounting Standards Codification it states the requirements for cash flows to be considered financing activities. Subsection b states, “Proceeds from issuing bonds, mortgages, notes, and from other short- or long-term borrowing”. Section 230-10-45-15 1 subsection b classifies an outflow of financing activity as “Repayments of amounts borrowed.” For these reasons Buck should present the borrowing and payment activity related to its revolving line of credit as cash flows under financing activities.

Answer:2

Scenario 1:

I would recommend Buck to present its borrowing and payment activity under the Facility on a net basis within the financing activities section of its statement of cash flows based on the current scenario. According to ACS 230-10-45-9 in the FASB Accounting Standards Codification it states that “For purposes of this paragraph, amounts due on demand are considered to have maturities of three months or less”. In this scenario amounts are due on demand. Also to be classified under net basis “the turnover is quick, the amounts are large, and the maturities are short .” (Stated in section 230-10-45-8) In this situation the volume of transactions are large, turnover is quick, and the amount due is within 3 months. Based on these statements I would advise Buck to report financing activities with a net basis.

Scenario 2:

I would recommend Buck to present its borrowing and payment activity under the Facility on a net basis within the financing activities section of its statement of cash flows based on the current scenario. As an external auditor I see that the line of credit is due relatively short, the amounts are large and turnover is quick which is stated in section 230-10-45-8. Items with these characteristics need to the net amount to be stated because “knowledge of the gross cash receipts and payments related to them may not be necessary to understand the entity's operating, investing, and financing activities.” (Section 230-10- 45-8) 2

Scenario 3:

I would recommend Buck to present its borrowing and payment activity under the Facility on a gross basis within the financing activities section of the statement of cash flows. The draws on the Facility do not have any specific repayment provisions other than the overall expiration date of the Facility as of December 31, 2012. While the activity does have some of the factors needed to consider net presentation, including large dollar amounts in relation to the maximum borrowing capacity and large volumes of transactions (see notes in Scenarios 1 and 2 above), the draws do not have an original maturities of three months or less. Under the provisions of Scenario 3, the only activities that Buck could potentially present net within its statement of cash flows are transactions occurring on or after October 1, 2012. Said differently, only draws occurring within three months of the Facility’s expiration would be considered to have original maturities of three months or less.

Answer:3 Under IFRSs, IAS 7 is the primary source of guidance for determining how to present information about the cash flows of an entity within the financial statements. IFRSs and U.S. GAAP are broadly consistent regarding net versus gross presentation. Similar to U.S. GAAP, IFRSs generally require entities to present information about an entity’s amounts of cash receipts and cash payments during a period on a gross basis. However, in certain circumstances, IFRSs permit certain cash flow activities to be presented on a net basis.

Paragraph 22(b) of IAS 7 states that cash flows may be reported on a net basis when “cash receipts and payments for items in which the turnover is quick, the amounts are large, and the maturities are short.” This guidance is generally consistent with the provisions of ASC 230-10- 45-8. Further, paragraph 23A of IAS 7 provides the following examples of cash receipts and payments that may be presented net under the criteria set forth in paragraph 22(b): a. principal amounts relating to credit card customers;

b. the purchase and sale of investments; and

c. other short-term borrowings, for example, those which have a maturity period of three months or less.

Accordingly, under IFRSs, an entity’s cash inflows and outflows associated with a revolving line of credit may potentially be presented on a net basis within the financing activities section of the statement of cash flows, provided the aforementioned criteria are met. Therefore, the conclusions under IFRSs for each scenario in this case would be consistent with that reached under U.S. GAAP.

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