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1.2 OBJECTIVE OF IAS 7 AND DEFINITIONS
Users of an enterprise's financial statements are interested in how the enterprise generates and
usescash and cash equivalents. Therefore, the enterprise must identify the activites operating
activities, investing activities and financing activities - which cause both inflows and outflows of
cash during an accounting period.
The objective of International Accounting Standard 7 (IAS 7) is to provide information to users of
accounts about the entitys ability to generate cash and cash equivalents as well as indicating the
cash requirements of the entity. IAS 7 requires companies to classify cash flows during the period
from operating, investing and financing activities.
Definitions relevant to this section:
Cash comprises cash on hand and demand deposits.
Cash equivalents are 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. A classic
example of a highly liquid investment is treasury bills.
Cash equivalents are held for the purpose of meeting short-term cash commitments rather than
for investment or other purposes. An investment normally qualifies as a cash equivalent only when
it has a short maturity of, say, three months or less from the date of acquisition.
Bank overdrafts which are repayable on demand form an integral part of an enterprise's cash
management. In these circumstances, bank overdrafts are included as a component of cash and
cash equivalents.
Operating activities are the principal revenue-producing activities of the enterprise and other
activities that are not investing or financing activities.
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Investing activities are the acquisition and disposal of non-current assets and other investments
not included in cash equivalents.
1.3 BENEFITS OF CASH FLOW INFORMATION
1. A cash flow statement, when used in conjunction with the rest of the financial statements,
provides information that enables users to evaluate the changes in net assets of an enterprise,
its financial structure (including its liquidity and solvency) and its ability to affect the amountsand timing of cash flows in order to adapt to changing circumstances and opportunities.
2. Cash flow information is useful in assessing the ability of the enterprise to generate cash andcash equivalents and enables users to develop models to assess and compare the present value
of the future cash flows of different enterprises.
3. It is also useful in checking the accuracy of past assessments of future cash flows.
4. It gives an indication of the relationship between profitability and net cash flow andhighlights the quality of the profit earned. Earnings are of good quality if they are
represented by cash flows now or in the near future.
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1.4 PRESENTATION OF CASH FLOW STATEMENT PER IAS 7
Cash flow statement for the period ended
Cash flows from operating activities X
Net profit before tax
Adjustments for:Depreciation (note 1) X
Interest expense (note 2, 3) X
Investment income (X)Profit on disposal of Property, plant and equipment (note 4) (X)
Loss on disposal PPE X
X(Increase)/ decrease in inventories (note 5) (X)/X
(Increase)/ decrease in trade and other receivables (X)/X
Increase/ (decrease) in trade and other payables X/(X)
Cash generated from operations X
Interest paid (note 1) (X)Income tax paid (X)
Net cash from operating activities X
Cash flows from investing activities (note 6)
Acquisition of subsidiary net of cash acquired (X)
Purchase of property, plant and equipment (X)
Proceeds from sale of equipment XInterest received X
Dividend received X
Cash flows from investing activities X
Cash flows from financing activities (note 7)
Cash proceeds from issuing shares or other equity instruments XCash payments to owners to redeem the shares. (X)
Cash proceeds from issuing debentures, loan stock or bonds X
Cash repayments of amounts borrowed (X)Cash payments by a lessee for the reduction of the outstanding liability
relating to a finance lease (i.e. the capital element of the rental)
(X)
Dividends paid (X)
Cash flows from financing activities X
Increase/ (decrease) in cash and cash equivalent (note 8) X
Cash and cash equivalent at the start of the period X
Cash and cash equivalent at the end of the period X
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Hartington Ltd prepares accounts to 31 March each year. The company's balance sheets at 31March 2003 and 2004 were as follows:
Balance sheet as at Balance sheet as at
31 March 2003 31 March 2004000 000 000 000Tangible fixed assets:
Cost 430 400Depreciation to date 160 270 175 225
Current assets:Stocks 175 140Trade debtors 250 210Bank balance - 70
425 420
Current liabilities:
Trade creditors 80 70Corporation tax 75 -Proposed dividends 50 -Bank balance 130 -
335 70
Net current assets 90 350
360 57510% debentures 60 606% debentures - 60 100 160
300 415
Capital and reserves:
Ordinary shares 100 240Share premium account 20 45General reserve 140 100Profit and loss account 40 30
300 415
The following information is also available:
1 Tangible fixed assets which had cost 100,000 in 1997 were sold for 30,000 during theyear to 31 March 2004. The written down value of these assets at the time of disposal was25,000.
2 The 10% debentures were issued in 1998. The 6% debentures were issued on 1 October2003. In both cases, interest is due every six months on 31 March and 30 September andhas been paid on the due dates.
3 Bank overdraft interest paid in the year to 31 March 2004 was 4,000.
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4 No dividends were paid or proposed in relation to the year to 31 March 2004.
5 The corporation tax liability for the year to 31 March 2003 was underestimated by 2,000.
Requirement for question 4
(a) Deduce the companys operating profit or loss for the year to 31 March 2004. 4
(b) Prepare a cash flow statement for the company for the year to 31 March 2004 inaccordance with the requirements of accounting standard FRS1 (Revised) using the
indirect method. The reconciliation to movement in net debt is not required. 10
(c) Explain how and why the company's cash position has changed during the year to 31March 2004. 4
(d) Briefly explain why the preparation of a cash flow statement is in accordance with theStatement of Principles for Financial Reportingpublished by the UK Accounting StandardsBoard. 2
(20)
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(a) The following extract has been taken from the statement of cash flows of Grutyer plc:
Net profit before taxation 433,444
Adjustments for:
Depreciation 214,530
Surplus on sale of non-current assets (14,400)
Interest expense 32,120
Operating profit before working capital changes 665,694
Increase in inventories (18,500)
Decrease in trade receivables 22,600
Increase in trade payables 27,400
Cash generated from operations 697,194
Interest paid (32,120)
Corporation tax paid (39,820)
Net cash from operating activities 625,254
The following additional information is available:
Sales 12,133,014
Purchases 9,564,500
Corporation tax payable at end of year 158,600
Corporation tax payable at the start of the year 98,420
Wages and salaries 1,010,500
Other expenses excluding interest and depreciation 893,800
Discounts allowed 33,560
Discounts received 16,540
Requirement for question 2 (a)
Prepare a clear calculation of the cash from operating activities using the direct method.10
(b) You have received an email from a friend asking for your advice. Your friend is a
shareholder in Sodian plc. He is concerned about the safety of his investment and wants
to know how well Sodian plc is surviving the credit crunch.
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