CPA Summary Notes. Statement of Cash Flow. Objective of IAS 7

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1 CPA Summary Notes Statement of Cash Flow Objective of IAS 7 The objective of IAS 7 is to require the presentation of information about the historical changes in cash and cash equivalents of an entity by means of a statement of cash flows, which classifies cash flows during the period according to operating, investing, and financing activities. Fundamental principle in IAS 7 All entities that prepare financial statements in conformity with IFRSs are required to present a statement of cash flows. [IAS 7.1] The statement of cash flows analyses changes in cash and cash equivalents during a period. Cash and cash equivalents comprise cash on hand and demand deposits, together with short term, highly liquid investments that are readily convertible to a known amount of cash, and that are subject to an insignificant risk of changes in value. Guidance notes indicate that an investment normally meets the definition of a cash equivalent when it has a maturity of three months or less from the date of acquisition. Equity investments are normally excluded, unless they are in substance a cash equivalent (e.g. preferred shares acquired within three months of their specified redemption date). Bank overdrafts which are repayable on demand and which form an integral part of an entity's cash management are also included as a component of cash and cash equivalents. [IAS 7.7 8] Presentation of the Statement of Cash Flows Cash flows must be analysed between operating, investing and financing activities. [IAS 7.10] Key principles specified by IAS 7 for the preparation of a statement of cash flows are as follows: operating activities are the main revenue producing activities of the entity that are not investing or financing activities, so operating cash flows include cash received from customers and cash paid to suppliers and employees [IAS 7.14] investing activities are the acquisition and disposal of long term assets and other investments that are not considered to be cash equivalents [IAS 7.6] financing activities are activities that alter the equity capital and borrowing structure of the entity [IAS 7.6] interest and dividends received and paid may be classified as operating, investing, or financing cash flows, provided that they are classified consistently from period to period [IAS 7.31] cash flows arising from taxes on income are normally classified as operating, unless they can be specifically identified with financing or investing activities [IAS 7.35]

2 for operating cash flows, the direct method of presentation is encouraged, but the indirect method is acceptable [IAS 7.18] The direct method shows each major class of gross cash receipts and gross cash payments. The operating cash flows section of the statement of cash flows under the direct method would appear something like this: Cash receipts from customers Cash paid to suppliers Cash paid to employees Cash paid for other operating expenses Interest paid Income taxes paid Net cash from operating activities The indirect methodadjusts accrual basis net profit or loss for the effects of non cash transactions. The operating cash flows section of the statement of cash flows under the indirect method would appear something like this: Profit before interest and income taxes Add back depreciation Add back amortisation of goodwill Increase in receivables Decrease in inventories Increase in trade payables Interest expense Less Interest accrued but not yet paid Interest paid Income taxes paid Net cash from operating activities the exchange rate used for translation of transactions denominated in a foreign currency should be the rate in effect at the date of the cash flows [IAS 7.25] cash flows of foreign subsidiaries should be translated at the exchange rates prevailing when the cash flows took place [IAS 7.26] as regards the cash flows of associates and joint ventures, where the equity method is used, the statement of cash flows should report only cash flows between the investor and the investee; where proportionate consolidation is used, the cash flow statement should include the venturer's share of the cash flows of the investee [IAS ] aggregate cash flows relating to acquisitions and disposals of subsidiaries and other business units should be presented separately and classified as investing activities, with specified additional disclosures. [IAS 7.39] The aggregate cash paid or received as consideration should be reported net of cash and cash

3 equivalents acquired or disposed of [IAS 7.42] cash flows from investing and financing activities should be reported gross by major class of cash receipts and major class of cash payments except for the following cases, which may be reported on a net basis: [IAS ] cash receipts and payments on behalf of customers (for example, receipt and repayment of demand deposits by banks, and receipts collected on behalf of and paid over to the owner of a property) cash receipts and payments for items in which the turnover is quick, the amounts are large, and the maturities are short, generally less than three months (for example, charges and collections from credit card customers, and purchase and sale of investments) cash receipts and payments relating to deposits by financial institutions cash advances and loans made to customers and repayments thereof investing and financing transactions which do not require the use of cash should be excluded from the statement of cash flows, but they should be separately disclosed elsewhere in the financial statements [IAS 7.43] the components of cash and cash equivalents should be disclosed, and a reconciliation presented to amounts reported in the statement of financial position [IAS 7.45] the amount of cash and cash equivalents held by the entity that is not available for use by the group should be disclosed, together with a commentary by management [IAS 7.48] Provisions, Contingent Liabilities and Contingent Assets Objective The objective of IAS 37 is to ensure that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount. The key principle established by the Standard is that a provision should be recognized only when there is a liability i.e. a present obligation resulting from past events. The Standard thus aims to ensure that only genuine obligations are dealt with in the financial statements planned future expenditure, even where authorised by the board of directors or equivalent governing body, is excluded from recognition. Scope IAS 37 excludes obligations and contingencies arising from: [IAS ] financial instruments that are in the scope of IAS 39 Financial Instruments: Recognition and Measurement

4 (or IFRS 9 Financial Instruments) non onerous executory contracts insurance contracts (see IFRS 4 Insurance Contracts), but IAS 37 does apply to other provisions, contingent liabilities and contingent assets of an insurer items covered by another IFRS. For example, IAS 11 Construction Contracts applies to obligations arising under such contracts; IAS 12 Income Taxes applies to obligations for current or deferred income taxes; IAS 17 Leases applies to lease obligations; and IAS 19 Employee Benefits applies to pension and other employee benefit obligations; and. Key definitions [IAS 37.10] Provision: a liability of uncertain timing or amount. Liability: present obligation as a result of past events settlement is expected to result in an outflow of resources (payment) Contingent liability: a possible obligation depending on whether some uncertain future event occurs, or a present obligation but payment is not probable or the amount cannot be measured reliably Contingent asset: a possible asset that arises from past events, and whose existence will be confirmed only by the occurrence or non occurrence of one or more uncertain future events not wholly within the control of the entity. Recognition of a provision An entity must recognize a provision if, and only if: [IAS 37.14] a present obligation (legal or constructive) has arisen as a result of a past event (the obligating event), payment is probable ('more likely than not'), and the amount can be estimated reliably. An obligating event is an event that creates a legal or constructive obligation and, therefore, results in an entity having no realistic alternative but to settle the obligation. [IAS 37.10] A constructive obligation arises if past practice creates a valid expectation on the part of a third party, for example, a retail store that has a long standing policy of allowing customers to return merchandise within, say, a 30 day period. [IAS 37.10]

5 A possible obligation (a contingent liability) is disclosed but not accrued. However, disclosure is not required if payment is remote. [IAS 37.86] In rare cases, for example in a lawsuit, it may not be clear whether an entity has a present obligation. In those cases, a past event is deemed to give rise to a present obligation if, taking account of all available evidence, it is more likely than not that a present obligation exists at the balance sheet date. A provision should be recognized for that present obligation if the other recognition criteria described above are met. If it is more likely than not that no present obligation exists, the entity should disclose a contingent liability, unless the possibility of an outflow of resources is remote. [IAS 37.15] Measurement of provisions The amount recognized as a provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date, that is, the amount that an entity would rationally pay to settle the obligation at the balance sheet date or to transfer it to a third party. [IAS 37.36] This means: Provisions for one off events (restructuring, environmental clean up, settlement of a lawsuit) are measured at the most likely amount. [IAS 37.40] Provisions for large populations of events (warranties, customer refunds) are measured at a probabilityweighted expected value. [IAS 37.39] Both measurements are at discounted present value using a pre tax discount rate that reflects the current market assessments of the time value of money and the risks specific to the liability. [IAS and 37.47] In reaching its best estimate, the entity should take into account the risks and uncertainties that surround the underlying events. [IAS 37.42] If some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement should be recognized as a separate asset, and not as a reduction of the required provision, when, and only when, it is virtually certain that reimbursement will be received if the entity settles the obligation. The amount recognized should not exceed the amount of the provision. [IAS 37.53] In measuring a provision consider future events as follows: forecast reasonable changes in applying existing technology [IAS 37.49] ignore possible gains on sale of assets [IAS 37.51] consider changes in legislation only if virtually certain to be enacted [IAS 37.50] Remeasurement of provisions [IAS 37.59] Review and adjust provisions at each balance sheet date If an outflow no longer probable, provision is reversed. Circumstance Recognize a provision?

6 Restructuring by sale of an operation Restructuring by closure or reorganization Warranty Land contamination Customer refunds Offshore oil rig must be removed and sea bed restored Abandoned leasehold, four years to run, no re letting possible CPA firm must staff training for recent changes in tax law Major overhaul or repairs Onerous (lossmaking) contract Future operating losses Only when the entity is committed to a sale, i.e. there is a binding sale agreement [IAS 37.78] Only when a detailed form plan is in place and the entity has started to implement the plan, or announced its main features to those affected. A Board decision is insufficient [IAS 37.72, Appendix C, Examples 5A & 5B] When an obligating event occurs (sale of product with a warranty and probable warranty claims will be made) [Appendix C, Example 1] A provision is recognized as contamination occurs for any legal obligations of clean up, or for constructive obligations if the company's published policy is to clean up even if there is no legal requirement to do so (past event is the contamination and public expectation created by the company's policy) [Appendix C, Examples 2B] Recognize a provision if the entity's established policy is to give refunds (past event is the sale of the product together with the customer's expectation, at time of purchase, that a refund would be available) [Appendix C, Example 4] Recognized a provision for removal costs arising from the construction of the the oil rig as it is constructed, and add to the cost of the asset. Obligations arising from the production of oil are recognized as the production occurs [Appendix C, Example 3] A provision is recognized for the unavoidable lease payments [Appendix C, Example 8] No provision is recognized (there is no obligation to provide the training, recognize a liability if and when the retraining occurs) [Appendix C, Example 7] No provision is recognized (no obligation) [Appendix C, Example 11] Recognize a provision [IAS 37.66] No provision is recognized (no liability) [IAS 37.63] Restructurings A restructuring is: [IAS 37.70] sale or termination of a line of business

7 closure of business locations changes in management structure fundamental reorganisations. Restructuring provisions should be recognized as follows: [IAS 37.72] Sale of operation: recognize a provision only after a binding sale agreement [IAS 37.78] Closure or reorganisation: recognize a provision only after a detailed formal plan is adopted and has started being implemented, or announced to those affected. A board decision of itself is insufficient. Future operating losses: provisions are not recognized for future operating losses, even in a restructuring Restructuring provision on acquisition: recognize a provision only if there is an obligation at acquisition date [IFRS 3.11] Restructuring provisions should include only direct expenditures necessarily entailed by the restructuring, not costs that associated with the ongoing activities of the entity. [IAS 37.80] What is the debit entry? When a provision (liability) is recognized, the debit entry for a provision is not always an expense. Sometimes the provision may form part of the cost of the asset. Examples: included in the cost of inventories, or an obligation for environmental cleanup when a new mine is opened or an offshore oil rig is installed. [IAS 37.8] Use of provisions Provisions should only be used for the purpose for which they were originally recognized. They should be reviewed at each balance sheet date and adjusted to reflect the current best estimate. If it is no longer probable that an outflow of resources will be required to settle the obligation, the provision should be reversed. [IAS 37.61] Contingent liabilities Since there is common ground as regards liabilities that are uncertain, IAS 37 also deals with contingencies. It requires that entities should not recognize contingent liabilities but should disclose them, unless the possibility of an outflow of economic resources is remote. [IAS 37.86] Contingent assets Contingent assets should not be recognized but should be disclosed where an inflow of economic benefits is probable. When the realisation of income is virtually certain, then the related asset is not a contingent asset and its recognition is appropriate. [IAS ] Disclosures Reconciliation for each class of provision: [IAS 37.84]

8 opening balance additions used (amounts charged against the provision) unused amounts reversed unwinding of the discount, or changes in discount rate closing balance A prior year reconciliation is not required. [IAS 37.84] For each class of provision, a brief description of: [IAS 37.85] nature timing uncertainties assumptions reimbursement, if any IAS 18: REVENUE RECOGNITION Objective of IAS 18 The objective of IAS 18 is to prescribe the accounting treatment for revenue arising from certain types of transactions and events. Key definition Revenue: the gross inflow of economic benefits (cash, receivables, other assets) arising from the ordinary operating activities of an entity (such as sales of goods, sales of services, interest, royalties, and dividends). [IAS 18.7] Measurement of revenue Revenue should be measured at the fair value of the consideration received or receivable. [IAS 18.9] An exchange for goods or services of a similar nature and value is not regarded as a transaction that generates revenue. However, exchanges for dissimilar items are regarded as generating revenue. [IAS 18.12]

9 If the inflow of cash or cash equivalents is deferred, the fair value of the consideration receivable is less than the nominal amount of cash and cash equivalents to be received, and discounting is appropriate. This would occur, for instance, if the seller is providing interest free credit to the buyer or is charging a belowmarket rate of interest. Interest must be imputed based on market rates. [IAS 18.11] Recognition of revenue Recognition, as defined in the IASB Framework, means incorporating an item that meets the definition of revenue (above) in the income statement when it meets the following criteria: it is probable that any future economic benefit associated with the item of revenue will flow to the entity, and the amount of revenue can be measured with reliability IAS 18 provides guidance for recognising the following specific categories of revenue: Sale of goods Revenue arising from the sale of goods should be recognised when all of the following criteria have been satisfied: [IAS 18.14] the seller has transferred to the buyer the significant risks and rewards of ownership the seller retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold the amount of revenue can be measured reliably it is probable that the economic benefits associated with the transaction will flow to the seller, and the costs incurred or to be incurred in respect of the transaction can be measured reliably Rendering of services For revenue arising from the rendering of services, provided that all of the following criteria are met, revenue should be recognised by reference to the stage of completion of the transaction at the balance sheet date (the percentage of completion method): [IAS 18.20] the amount of revenue can be measured reliably; it is probable that the economic benefits will flow to the seller; the stage of completion at the balance sheet date can be measured reliably; and the costs incurred, or to be incurred, in respect of the transaction can be measured reliably. When the above criteria are not met, revenue arising from the rendering of services should be recognised only to the extent of the expenses recognised that are recoverable (a "cost recovery approach". [IAS 18.26] Interest, royalties, and dividends

10 For interest, royalties and dividends, provided that it is probable that the economic benefits will flow to the enterprise and the amount of revenue can be measured reliably, revenue should be recognised as follows: [IAS ] interest: using the effective interest method as set out in IAS 39 royalties: on an accruals basis in accordance with the substance of the relevant agreement dividends: when the shareholder's right to receive payment is established Disclosure [IAS 18.35] accounting policy for recognising revenue amount of each of the following types of revenue: 1 sale of goods 2 rendering of services 3 interest 4 royalties 5 dividends within each of the above categories, the amount of revenue from exchanges of goods or services IAS 2: INVENTORIES Objective of IAS 2 The objective of IAS 2 is to prescribe the accounting treatment for inventories. It provides guidance for determining the cost of inventories and for subsequently recognizing an expense, including any write down to net realizable value. It also provides guidance on the cost formulas that are used to assign costs to inventories. Scope Inventories include assets held for sale in the ordinary course of business (finished goods), assets in the production process for sale in the ordinary course of business (work in process), and materials and supplies

11 that are consumed in production (raw materials). [IAS 2.6] However, IAS 2 excludes certain inventories from its scope: [IAS 2.2] work in process arising under construction contracts (see IAS 11 Construction Contracts) financial instruments (see IAS 39 Financial Instruments: Recognition and Measurement) biological assets related to agricultural activity and agricultural produce at the point of harvest (see IAS 41 Agriculture). Also, while the following are within the scope of the standard, IAS 2 does not apply to the measurement of inventories held by: [IAS 2.3] producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products, to the extent that they are measured at net realisable value (above or below cost) in accordance with well established practices in those industries. When such inventories are measured at net realisable value, changes in that value are recognised in profit or loss in the period of the change. commodity brokers and dealers who measure their inventories at fair value less costs to sell. When such inventories are measured at fair value less costs to sell, changes in fair value less costs to sell are recognised in profit or loss in the period of the change. Fundamental principle of IAS 2 Inventories are required to be stated at the lower of cost and net realisable value (NRV). [IAS 2.9] Measurement of inventories Cost should include all: [IAS 2.10] costs of purchase (including taxes, transport, and handling) net of trade discounts received costs of conversion (including fixed and variable manufacturing overheads) and other costs incurred in bringing the inventories to their present location and condition IAS 23 Borrowing Costs identifies some limited circumstances where borrowing costs (interest) can be included in cost of inventories that meet the definition of a qualifying asset. [IAS 2.17 and IAS 23.4] Inventory cost should not include: [IAS 2.16 and 2.18] abnormal waste storage costs administrative overheads unrelated to production selling costs foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign

12 currency interest cost when inventories are purchased with deferred settlement terms. The standard cost and retail methods may be used for the measurement of cost, provided that the results approximate actual cost. [IAS ] For inventory items that are not interchangeable, specific costs are attributed to the specific individual items of inventory. [IAS 2.23] For items that are interchangeable, IAS 2 allows the FIFO or weighted average cost formulas. [IAS 2.25] The LIFO formula, which had been allowed prior to the 2003 revision of IAS 2, is no longer allowed. The same cost formula should be used for all inventories with similar characteristics as to their nature and use to the entity. For groups of inventories that have different characteristics, different cost formulas may be justified. [IAS 2.25] Write down to net realizable value NRV is the estimated selling price in the ordinary course of business, less the estimated cost of completion and the estimated costs necessary to make the sale. [IAS 2.6] Any write down to NRV should be recognized as an expense in the period in which the write down occurs. Any reversal should be recognized in the income statement in the period in which the reversal occurs. [IAS 2.34] Expense recognition IAS 18 Revenue addresses revenue recognition for the sale of goods. When inventories are sold and revenue is recognised, the carrying amount of those inventories is recognised as an expense (often called cost ofgoods sold). Any write down to NRV and any inventory losses are also recognised as an expense when they occur. [IAS 2.34] Disclosure Required disclosures: [IAS 2.36] accounting policy for inventories carrying amount, generally classified as merchandise, supplies, materials, work in progress, and finished goods. The classifications depend on what is appropriate for the entity carrying amount of any inventories carried at fair value less costs to sell amount of any write down of inventories recognized as an expense in the period amount of any reversal of a write down to NRV and the circumstances that led to such reversal carrying amount of inventories pledged as security for liabilities cost of inventories recognized as expense (cost of goods sold). IAS 2 acknowledges that some enterprises classify income statement expenses by nature (materials, labour, and so on) rather than by function (cost of

13 goods sold, selling expense, and so on). Accordingly, as an alternative to disclosing cost of goods sold expense, IAS 2 allows an entity to disclose operating costs recognized during the period by nature of the cost (raw materials and consumables, labour costs, other operating costs) and the amount of the net change in inventories for the period). [IAS 2.39] This is consistent with IAS 1 Presentation of Financial Statements, which allows presentation of expenses by function or nature. SS