Chapter 20

Statement of Cash Flows

Prepared by Kent Wilson

Objectives

1 Explain the purpose of a statement of cash flows and its usefulness

2 Explain the definition of cash and cash equivalents

3 Explain the classification of cash flow activities and classify cash inflows and outflows into operating, investing and financing activities

4 Contrast the direct and indirect methods of presenting net cash flows from operating activities

Objectives

5 Prepare a statement of cash flows

6 Prepare other disclosures required or encouraged by AASB 107

7 Use a worksheet to prepare a statement of cash flows with more complex transactions

8 Review financial statement disclosures by companies.

Purpose of a Statement of Cash Flows

To provide information about the historical changes in cash (and equivalents) during the period: Ability to generate cash: certainty and timing

Evaluating financial structure: staying liquid and solvent while meeting obligations and paying dividends

Understanding reasons for the difference between profit/(loss) and net cash flow from operations

Comparing differing entities Operating performance Present value of future cash flows

Concept of Cash

Cash Cash on hand and demand deposits Includes bank overdrafts

Cash equivalents Short-term, highly liquid investments readily

convertible into known amounts of cash and which are subject to an insignificant risk of changes in value

Held to meet cash commitments and have a short maturity (3 months or less)

(AABS 107 para 6 -7)

Classifying Cash Flow Activities

AABS 107 requires that all cash flows be classified into the following categories:

Operating activitiesInvesting activities Financing activities

Classifying Cash Flows

Interest and dividends AABS 107 does not prescribe how interest and dividends should be classified

Require them to be separately disclosed and classified consistently across periods

Note textbook approach as follows: Interest received > investing Interest paid > operating Dividends received > investing Dividends paid > financing

Income tax AABS 107 also requires separate disclosure of income tax as an operating activity

Format of the Statement of Cash Flows

Reporting Cash Flows From Operating Activities

Operating cash flows may be reported using one of two methods: Direct method - Discloses classes of gross cash receipts

and payments

Indirect method - Discloses: Classes of gross cash receipts and paymentsNon-cash items Items relating to investing or financial activities (non-operating

items)The effects of accruals

The direct method is encouraged by AABS 107

(AABS 107 para 18)

Preparing a Statement of Cash Flows

Unlike statements of financial position and comprehensive income, cash flow is NOT prepared from the trial balance

Comparative statements of financial position are often used, with supplementary information statement of comprehensive income and specific general ledger transactions

Cash flows can be calculated in a number of ways. Common methods include:

Spread sheet approachReconstruction (T-account) methodFormula method

Determining Cash Receipts From Customers

Sales revenue reflects sales made by the entity during the year irrespective of whether the customers have paid for the sale

Cash received in the current year includes sales made in the prior year that are not collected until the current year and excludes sales made in the current year where the cash will be received in a future year

Therefore the cash flows are determined with reference to the movement in Accounts Receivable

Other factors affecting the Accounts Receivable account include:Settlement discounts given to customersBad debts written off during the period

Calculating Cash Paid to Suppliers

Payments to suppliers reflects payments made during the year for:

Inventory purchases All other supplies and services purchased

Includes: Payments for prior year purchases Current year (pre)payments that will be expensed in future

years

Excludes: Current year purchases where the cash will be paid in a future

year Expenses recognised in the current year that were (pre)paid in

prior years

Calculating Cash Paid to Suppliers

Payments to suppliers is often calculated in two steps :

1.Payments for inventoryDetermined by reference to the movement in Accounts

PayableNeed to consider settlement discounts given by suppliers

2.Payments for all other supplies and servicesDetermined by identifying expenses in the Income

Statements and adjusting for the effect of movements in prepayment and accrual accounts during the year

Cash Flows From Investing & Financing

ActivitiesInvesting Activities

Requires identifying cash inflows and outflows relating to the acquisition and disposal of long term assets and other investments not included in cash equivalents

Financing activitiesRequires identification of cash flows that result

in changes in the size and composition of contributed equity and borrowings

Disclosures

AABS 107 prescribes additional disclosures in the notes of the financial statements: Components of cash and cash equivalents Changes in ownership interests of subsidiaries and other

businesses Non-cash investing or financing transactions

Disclosures that are encouraged but not required: Refer AABS 107 para 50