University of Economics, Prague. Statement of Cash Flows (IAS 7)

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1 University of Economics, Prague Faculty of Finance and Accounting Department of Financial Accounting and Auditing Statement of Cash Flows (IAS 7) 1FU496 Intermediate Accounting (MiFA course) David Procházka

2 Agenda Why is the cash flow statement useful? IAS 7: Cash flow structure IAS 7: Treatment of special items IAS 7: Presentation of cash flows Recommended issues for the final exam

3 1 Why is the cash flow statement useful? IAS 7 Statement of Cash Flows Cash flow statement (CFS) is necessary, because: - profit cash - accounting choices may have impact on earnings, but not on flows of cash - balance sheet and income statement on accrual basis => not all useful information can be obtained (amount, timing, and risks of future cash flows) - expected cash flows are input parametr into models for valuation of businesses - investors protection - I invest money => I want money as the return from the investment CFS replenishes balance sheet and income statement by: - providing information on the liquidity and relation between profitability and solvency - assessing short-term and long-term adaptability and survival of companies (important for going concern assumption)

4 - overcoming disadvantages of accrual basis for the effective cash management (sales/purchases on credit; payments for non-current assets vs their usage) in order to pay all debts on timely basis and to ensure dividends for owners - saying, where cash is generated and where it is used Remember: - profits do not guarantee survival => profits have to be converted into cash - CFS shows, why profit cash Main features of CFS: - despite capturing past transactions, it s future-oriented - cash flows are objective => not as easily manipulated as earnings - conclusions have to be made by users (no guidance on the interpretation of numbers) - difficulties to prepare it (there are no accounts in software, from which to automatically generate CFS) => has to be done manually by a person with a deep professional knowledge of accounting and knowledge of company s accounting system

5 2 IAS 7: Cash flow structure IAS 7 Statement of Cash Flows The statement of cash flows shall report cash flows during the period classified by operating, investing and financing activities: - 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 - cash flows are inflows and outflows of cash and cash equivalents - operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities - investing activities are 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 02-E09; 02-E10; 02-E11

Operating CF cash receipts from the customers for sale of goods/services cash receipts from royalties, fees, commissions and other revenue cash payments to suppliers for goods and services cash

6 Operating CF cash receipts from the customers for sale of goods/services cash receipts from royalties, fees, commissions and other revenue cash payments to suppliers for goods and services cash payments to and on behalf of employees cash payments or refunds of income taxes cash receipts and payments from contracts held for dealing or trading purposes Investing CF cash payments to acquire non-current tangible and intangible assets cash receipts from sales of non-current tangible and intangible assets cash payments to acquire financial assets cash receipts from sales of financial assets loans made to other parties and repayments of such loans cash receipts from the repayment of advances and loans made to other parties Financing CF cash proceeds from issuing shares or other equity instruments cash payments to owners to acquire or redeem the entity s shares cash proceeds from short-term or long-term borrowings cash repayments of amounts borrowed cash payments by a lessee for the finance lease

7 3 IAS 7: Treatment of special items Cash flows relating to income taxes: IAS 7 Statement of Cash Flows - cash flows arising from taxes on income shall be separately disclosed - cash flows shall be classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities (knowledge of local corporate taxation is needed) Cash flows relating to interest and dividends: - cash flows from interest and dividends received and paid shall each be disclosed separately - each shall be classified in a consistent manner from period to period as either operating, investing or financing activities - the total amount of interest paid during a period has to be disclosed in CFS regardless whether it has been recognised as an expense in profit or loss or capitalised (IAS 23) - under operating CF for financial institutions, however, non-financial entities not straight-forward

8 Interest Dividends Received Paid Received Paid Operating CF Operating CF Operating CF Financing CF or Investing CF or Financing CF or Investing CF or operating CF

9 Cash flows relating to ownership interests in subsidiaries and other businesses: - the aggregate cash flows arising from obtaining or losing control of subsidiaries or other businesses shall be presented separately and classified as investing activities - an entity shall disclose (a) the total consideration paid or received; (b) the portion of the consideration consisting of cash and cash equivalents; (c) the amount of cash and cash equivalents in the subsidiaries or other businesses over which control is obtained or lost; (d) the amount of the assets and liabilities other than cash or cash equivalents in the subsidiaries or other businesses over which control is obtained or lost, summarised by each major category Non-cash transactions: - investing and financing transactions that do not require the use of cash or cash equivalents shall be excluded from a statement of cash flows - such transactions shall be disclosed elsewhere in the financial statements in a way that provides all the relevant information about these investing and financing activities

10 Components of cash and cash equivalents: IAS 7 Statement of Cash Flows - an entity shall disclose the components of cash and cash equivalents and shall present a reconciliation of the amounts in its statement of cash flows with the equivalent items reported in the statement of financial position - an entity shall disclose, together with a commentary by management, the amount of significant cash and cash equivalent balances held by the entity that are not available for use by the group

11 4 IAS 7: Presentation of cash flows IAS 7 requires: IAS 7 Statement of Cash Flows - presentation of cash flows from operating activities using either direct or indirect method; - presentation of cash flows from investing and financing activities using direct method Direct method vs indirect method: - under direct method, major classes of gross cash receipts and gross cash payments are presented (despite for cases, when net basis is permitted) - under indirect method, profit or loss is adjusted for the effects of transactions of a noncash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows 02-E08; 02-E12

12 Opening balance of cash Cash flow from operating activities (direct or indirect presentation) + Cash flow form investing activities (direct presentation) + Cash flow form financing activities (direct presentation) = Total cash flow for period Closing balance of cash

13 Direct presentation of cash flows: IAS 7 Statement of Cash Flows - means that only cash receipts and cash outlays (expenditures) are shown on the face of CFS - it is more intuitive for the accounting amateurs not possessing knowledge of accounting principles (the only statement, who is understandable to everyone) - more useful in predicting future cash flows due to the linkage between revenues and cash receipts, and expenses and cash outlays respectively - preferable by IAS 7, but not easy to prepare: direct method (from T-accounts containing cash movements) impossible => roundabout has to be used Indirect presentation of cash flows: - despite not showing any movement of cash on the face of CFS, the total amount informs about the net change in cash for period - transforms earnings on accrual basis into cash by elimination of non-cash transactions - explains, why a profitable company may be in lack of money, or loss-making company has no problems to survive (to pay debts)

14 Direct presentation Indirect presentation Opening cash balance Closing cash balance

15 5 Recommended issues for the final exam Covered by this Presentation - assess the usefulness and limitations of cash flow statement for users - explain the difference between direct and indirect presentation of cash flows and their decision-usefulness, incl. depiction of technical solutions to prepare CFS - discuss presentation of special items on the face of CFS as required by IAS 7 - calculations of the figures needed for CFS - preparation of CFS Not covered by this Presentation, but relevant for the topic - analyse main differences in the structure of CFS and comprehensive income statement - sketch the impact on CFS and the main differences, if an tangible asset is bought by (a) cash; (b) on credit; (c) by finance lease - interpret a statement of cash flows

16 David Procházka Department of Financial Accounting and Auditing Faculty of Finance and Accounting University of Economics, Prague W. Churchill Sq. 4 Prague, Czech Republic Web: <prochazd@vse.cz>

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