STATEMENT OF CASH FLOWS (IAS 7)

Chapter 16

Learning outcomesDevelop your understanding of:

the objective and purpose of a statement of cash flowscash and cash equivalentscontrast between the direct and indirect methods of presenting net cash flows from operating activitiesprepare a cash flow statementdisclosures required by IAS 7

Objective of a cash flow statement

The overall objective of a statement of cash flows is to present information about the historical changes in cash and cash equivalents of an entity during the period of time classified by operating ,investing and financing activities.

Purpose of a statement of cash flowsThe statement of cash flows is a financial statement which reports on the flows of cash in and out of a business entity during an accounting period.Cash is a vital resource. Without cash a business cannot pay its employees, suppliers etc. and will eventually fail.Profit is not a reliable indicator of an entity's cash situation since profits are computed on the accruals basis, not the cash basis.The statement of cash flows focuses on the entity's cash flows and draws attention to any cash problems.

PurposeThe cash flow is particularly useful to its users in the evaluation of:an entitys ability to generate cash and cash equivalents and the timing and certainty of their generationthe entitys financial structure and ability to meet its obligations

Purpose (continued)The information is particularly useful to users to assist in:understanding the reasons for the difference between profit and loss for the period and the net cash flow from operating activitiesthe comparison of the operating performance of different entities

Cash and cash equivalentsIAS7 states that cash comprises "cash on hand and demand deposits". Bank overdrafts are generally treated as negative cash.Cash equivalents are "short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to insignificant risk of changes in value".The total of cash and cash equivalents could be negative if the business has a bank overdraft.

Classification of cash flows by activityCash flows should be classified by activity. IAS7 identifies three classes of activity:Operating activities are "the principal revenue-producing activities of the entity".Investing activities consist of "the acquisition and disposal of long-term assets and other investments not included in cash equivalents".Financing activities are "activities that result in changes in the size and composition of the contributed equity and borrowings of the entity".

Operating activities(a)cash receipts from the sale of goods and services(b)cash receipts from royalties, fees, commissions and other revenue(c)cash payments to suppliers for goods and services(d)cash payments to and on behalf of employees(e)cash payments or cash refunds of taxes unless specifically identified with investing or financing activities.Cash flows arising from operating activities include:

Investing activities (a)cash payments to acquire property, plant and equipment or other long-term assets(b)cash receipts from the sale of property, plant and equipment or other long-term assets(c)cash payments to acquire shares or debt instruments of other entities(d)cash receipts from the sale of equity or debt instruments of other entities(e)cash advances and loans made to other parties(f)cash receipts from the repayment of advances and loans made to other parties.Cash flows arising from investing activities include:

Financing activities(a)cash proceeds from issuing shares(b)cash payments to owners to acquire or redeem the entity's own shares(c)cash proceeds from issuing debentures, loans and other borrowings(d)cash repayments of amounts borrowed(e)cash payments by a lessee for the reduction of the outstanding liability relating to a finance lease.Cash flows arising from financing activities include:

Interest, dividends and taxes In general:Interest received and dividends received are treated as cash inflows from investing activities.Interest paid on a loan acquired for operating purposes is classified under operating activities. Alternatively, interest paid might be classified under financing activities.Dividends paid might be classified under operating activities or financing activities.Cash flows arising from taxes are classified under operating activities unless specifically associated with investing or financing activities.Interest, dividends and taxes should be classified consistently from period to period.

Reporting cash flows fromoperating activitiesthe DIRECT method, whereby major classes of receipts and payments arising from operating activities are disclosed individually, or

the INDIRECT method, which begins with the profit or loss for the period (before tax) and then makes a number of adjustments so as to calculate the total amount of cash generated from operations.Cash flows from operating activities may be reported using either:Obviously, both methods will give the same bottom-line result for cash generated from operations.The direct method is encouraged by IAS 7

The direct methodMajor classes of operating receipts and payments are disclosed individually and are then aggregated to give the total cash generated from operations.Typically, a statement of cash flows prepared using the direct method will disclose:total cash receipts from customerstotal cash paid to suppliers of goods and servicestotal cash paid to employees.

The indirect methodThis method begins with the profit or loss before tax and then makes the following adjustments:any non-cash expenses (e.g. depreciation, losses on disposal of plant) are added backany non-cash income (e.g. a decrease in the allowance for doubtful debts) is subtractedany increases or decreases in inventories, trade receivables/payables, accruals/prepayments are adjusted forany items of income or expense which are not derived from operating activities are adjusted for.

Disclosure requirements of IAS7the amount of any undrawn borrowing facilitiesan analysis of cash flows by segment (where a segment is a distinguishable component of a business entity).Entities must disclose the components of their cash and cash equivalents and present a reconciliation of these amounts in the statement of cash flows with the equivalent items reported in the statement of financial position.Entities are also encouraged (but not required) to supply further information, such as:

Preparing a cash flow statementUnlike the other financial statements the statement of cash flows is not prepared from an entitys trial balance. It is prepared by using comparative statement of financial positions to determine the net changes in assets, liabilities and equities over a period of timeThe comparative SoFP are supplemented by various statement of profit or loss data and additional information

Choice in presentation of certain itemsIAS7 does not precisely define the position in the statement of cash flows of the following:Interest paid - classified as operating Dividend paid - classified as financingInterest/Dividends received - classified as investing consistently applied

Format of cash flow statement Direct methodABC LTDSTATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20XXCash flows from operating activitiesCash received from customersxxxCash paid to suppliers(xx)Cash paid for expenses(xx)Cash paid for wages and salaries(xx)Cash generated from operationsxxxInterest paid(xx)Tax paid(xx)Net cash from operating activitiesxxx

Format Direct method (contd.)Cash flows from investing activitiesAcquisition of property, plant and equipment (xx)Proceeds of sale of property, plant and equipmentxxxInterest receivedxxxDividend received xxxNet cash used in investing activities(xx)Cash flows from financing activitiesProceeds from issue of sharesxxxProceeds from long-term borrowingxxxPayments of finance lease liabilities(xx)Payments of long-term borrowings(xx)Dividends paid(xx)Net cash used in financing activities(xx)Net increase in cash and cash equivalents xxxCash and cash equivalents at beginning of the period xxxCash and cash equivalents at end of the period XXX

Format Indirect method

ABC LTD STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20XXCash flows from operating activities:Net profit before taxxxxAdjustments for:Finance costsxxxInvestment income(xx)DepreciationxxxProfit on sale of non-current assets(xx)Provisions increase/decreasexxx/(xx)Increase/decrease in prepayments(xx)/xxxIncrease/decrease in accrualsxxx/(xx)Operating profit before working capital changesxxxIncrease/decrease in inventories(xx)/xxxIncrease/decrease in receivables(xx)/xxxIncrease/decrease in payablesxxx/(xx)Cash generated from operationsxxxFinance costs paid(xx)Income tax paid(xx)Net cash from operating activitiesxxx

Format: Indirect method (contd.)Cash flows from investing activities:Acquisitions of property, plant and equipment(xx)Proceeds of sale of property, plant and equipmentxxxInterest receivedxxxDividends receivedxxxNet cash used in investing activitiesxxxCash flows from financing activities:Proceeds from issue of sharesxxxProceeds from long-term borrowingsxxxPayment of finance lease liabilities(xx)Payment of long-term liabilities(xx)Dividends paid(xx)Net cash used in financing activities(xx)Net increase in cash and cash equivalentsxxxCash and cash equivalents at beginning of the periodxxxCash and cash equivalents at end of the periodXXX

Criticism of IAS 7(revised)

Options within IAS7 with regard to direct and indirect method and the presentation of dividends and interest Definition of cash and cash equivalentsStandard form not suitable for all users

ExamplesSee attached question:-

Workings 1

Receivables'000'000Balance b/f157Closing balance c/d140Sales752 Missing figure Bank769909909

Workings 2

To compute purchases:'000Opening inventory212Purchases (missing figure)406618Less closing inventory-231Cost of sales387

Workings 3

Trade payables and expense suppliers'000'000Depreciation expense70Balance b/f176Employee salaries148Purchases(W2)406Balance c/d182Admin /Dist expenses225Bank (missing figure)407807807

Workings 4

Interest paid'000'000Balance c/f3Balance b/f000Bank (missing figure)15Statement of P or L181818

Workings 5

Tax'000'000Balance c/f33Balance b/f55Bank (missing figure)55Statement of P or L338888

Workings 6

PPE'000'000Balance b/f470Depreciation70Bank (missing figure)88Balance c/d488558558

Workings 7

Share capital and share premium'000'000Balance c/dBalance b/fS. capital220S.capital200S. premium70S premium60Bank (missing figure)30290290

MMX LTDSTATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 MARCH 2013000000Cash flows from operating activitiesCash received from customers(W1) 769Cash paid to suppliers of goods and services (W3)(407)Cash paid to employees(148)Cash generated from operations 214Interest paid (W 4) (15)Tax paid (W5) (55)Net cash from operating activities144

000000Cash flows from investing activitiesAcquisition of property, plant and equipment (W6)(88)Dividend received 22Net cash used in investing activities(66)Cash flows from financing activitiesProceeds from issue of shares (W7) 30Repayment of long-term loan(40)Dividend paid(30)Net cash used in financing activities(40)Net increase in cash and cash equivalents 38Cash and cash equivalents at 1 April 2012(23)Cash and cash equivalents at 31 March 2013 15

(b) Cash flows from operating activities000000Profitbefore tax144Adjustments for:Depreciation 70Interest payable 18Dividend received (22)Operating profit before working capital changes210Increase in inventories (19)Decrease in trade receivables 17Increase in trade payables 6Cash generated from operations214

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