UNIT 2 PRIMARY FINANCIAL STATEMENTS IAS 1,7,8,14,18 & IFRS5:

UNIT 2 PRIMARY FINANCIAL STATEMENTS IAS 1,7,8,14,18 & IFRS5: 1

IAS 1 PRESENTATION OF FINANCIAL STATEMENTS OVERVIEW IAS 1 Presentation of Financial Statements sets out the overall requirements for financial statements, including how they should be structured, the minimum requirements for their content overriding concepts such as going concern, the accrual basis of accounting and the current/non-current distinction. 2

IAS 1 PRESENTATION OF FINANCIAL STATEMENTS OVERVIEW The standard requires a complete set of financial statements to comprise a a) A statement of financial position, b) A statement of profit or loss and other comprehensive income, c) A statement of changes in equity and d) a statement of cash flow e) Notes to the financial statements 3

HOW ITEMS ARE DISCLOSED IAS 1 specifies disclosures of certain items in certain ways: a) Some items must appear on the face of the statement of financial position or statement of comprehensive income. b) Other items can appear in a note to the financial statements instead. c) Recommended formats are given which entities may or may not follow, depending on their circumstances. Disclosures by IAS 1 and other standards must be made either on the face of the statement or in the notes. 4

NARRATIVE STATEMENTS REQUIRED IN PUBLISHED FINANCIAL STATEMENTS Annual reports of businesses also include several narrative reports. Many of these are required by the legislation of a particular country or by stock exchange requirements. These include the following: a) Audit report b) Director's reports c) Corporate governance report. 5

OBJECTIVE OF FINANCIAL STATEMENTS This information, along with other information in the notes, assists users of financial statements in predicting the entity's future cash flows and, in particular, their timing and certainty. 6

COMPONENTS OF FINANCIAL STATEMENTS A complete set of financial statements includes: a) a statement of financial position (balance sheet) at the end of the period b) a statement of profit or loss and other comprehensive income for the period (presented as a single statement, or by presenting the profit or loss section in a separate statement of profit or loss, immediately followed by a statement presenting comprehensive income beginning with profit or loss) c) a statement of changes in equity for the period d) a statement of cash flows for the period e) notes, comprising a summary of significant accounting policies and other explanatory notes f) comparative information prescribed by the standard. 7

FAIR PRESENTATION AND COMPLIANCE WITH IFRSS IAS 1 requires an entity whose financial statements comply with IFRSs to make an explicit and unreserved statement of such compliance in the notes. Financial statements cannot be described as complying with IFRSs unless they comply with all the requirements of IFRSs (which includes International Financial Reporting Standards, International Accounting Standards, IFRIC Interpretations and SIC Interpretations) 8

COMPARATIVE INFORMATIONn IAS 1 requires that comparative information to be disclosed in respect of the previous period for all amounts reported in the financial statements, both on the face of the financial statements and in the notes, unless another Standard requires otherwise. Comparative information is provided for narrative and descriptive where it is relevant to understanding the financial statements of the current period. 9

STRUCTURE AND CONTENT OF FINANCIAL STATEMENTS IN GENERAL IAS 1 requires an entity to clearly identify: the financial statements, which must be distinguished from other information in a published document each financial statement and the notes to the financial statements. In addition, the following information must be displayed prominently, and repeated as necessary: the name of the reporting entity and any change in the name whether the financial statements are a group of entities or an individual entity information about the reporting period the presentation currency the level of rounding used (e.g. thousands, millions). 10

REPORTING PERIOD There is a presumption that financial statements will be prepared at least annually. If the annual reporting period changes and financial statements are prepared for a different period, the entity must disclose the reason for the change and state that amounts are not entirely comparable. For practical purposes, some entities prefer to use a period which approximates to a year,e.g. 52 weeks. IAS 1 allows this approach as it produces statements not materially different from those produced on an annual basis. 11

STATEMENT OF FINANCIAL POSITION (BALANCE SHEET) An entity must normally present a classified statement of financial position, separating current and non-current assets and liabilities, unless presentation based on liquidity provides information that is reliable. Current assets are assets that are: expected to be realised in the entity's normal operating cycle held primarily for the purpose of trading expected to be realised within 12 months after the reporting period cash and cash equivalents (unless restricted). All other assets are non-current. 12

STATEMENT OF FINANCIAL POSITION (BALANCE SHEET) Current liabilities are those: expected to be settled within the entity's normal operating cycle held for purpose of trading due to be settled within 12 months for which the entity does not have an unconditional right to defer settlement beyond 12 months (settlement by the issue of equity instruments does not impact classification). Other liabilities are non-current. 13

STATEMENT OF FINANCIAL POSITION (BALANCE SHEET) The line items to be included on the face of the statement of financial position are: a) property, plant and equipment b) investment property c) intangible assets d) financial assets (excluding amounts shown under (e), (h), and (i)) e) investments accounted for using the equity method f) inventories 14

STATEMENT OF FINANCIAL POSITION (BALANCE SHEET) g) trade and other receivables h) cash and cash equivalents i) assets held for sale j) trade and other payables k) Provisions l) financial liabilities (excluding amounts shown under (k) and (l)) m) current tax liabilities and current tax assets, n) deferred tax liabilities and deferred tax assets o) non-controlling interests, presented within equity p) Issued capital and reserves attributable to owners of the parent. 15

STATEMENT OF FINANCIAL POSITION (BALANCE SHEET) IAS 1 does not prescribe the format of the statement of financial position. Assets can be presented current then noncurrent, or vice versa, and liabilities and equity can be presented current then non-current then equity, or vice versa. A net asset presentation (assets minus liabilities) is allowed. The long-term financing approach used in UK and elsewhere fixed assets + current assets - short term payables = long-term debt plus equity is also acceptable. 16

PROFORMA STATEMENT OF FINANCIAL ABC CO 'S POSITION STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 2015 NOTE S 2015 2014 K'0 Assets K'000 K'000 K'000 00 Non-Current assets Property,Plant and Equipment 2 X X Intangible assets 3 X X Investment in associates X X Available for sales 17

PROFORMA STATEMENT OF FINANCIAL POSITION Current assets Notes K 000 K 000 K 000 K 000 Inventories 4 X X Trade receivables X X Other current assets X X Cash and cash equivalents X X X X Total assets X X 18

PROFORMA STATEMENT OF FINANCIAL POSITION Equity and liabilities K 000 K 000 K 000 K 000 Equity Share capital X X Share premium X X Revaluation reserve X X Retained earnings X X X X 19

PROFORMA STATEMENT OF FINANCIAL POSITION Non-current liabilities K 000 K 000 K 000 K 000 Long term borrowings X X Defferd tax X X Long-term provisions X X X X Current liabilities Trade and other payables X X Short term borrowings X X Current portion of long term borrowings X X Current tax payable X X X X Total equity and liabilities X X 20

NOTES TO THE STATEMENT OF FINANCIAL POSITION 1. CLASSIFICATION OF NON CURRENT ASSETS: Assets are classified as non-current assets if they are intended for use on an continuing basis in the company s activities. Non- Current assets are subdivided as follows: Intangible non-current assets: These are assets that have no physical form, such as patents and goodwill. Tangible assets (property, plant and equipment):these assets have physical form, such as buildings 21

NOTES TO THE STATEMENT OF FINANCIAL POSITION Investments: This relates to long term investments in other companies. it includes shares and loans made to other companies. 22

NOTES TO THE STATEMENT OF FINANCIAL POSITION 2. PROPERTY,PLANT AND EQUIPMENT The property,plant and equipment note analyses the total carrying value shown in statement of financial position by category,and by cost and cumulative depreciation. The movements for the year ( by category,cost and depreciation) are disclosed as follows: Openning balance Additions/changes for the year Effect of revaluations Disposals Closing balance 23

NOTES TO THE STATEMENT OF FINANCIAL POSITION Land Plant Fixtures Payments Total and and fittings on account buildings machinery tools and and assets of equipment contruction K'000 K'000 K'000 K'000 K'000 Cost or valuation At 1 January 2015 X X X X X Additions X X X X X Disposals (X) (X) (X) (X) (X) At 31 December 2015 X X X X X 24

NOTES TO THE STATEMENT OF FINANCIAL POSITION Accumulated depreciation: At 1 January 2015 X X X X X Provision for year X X X X X Disposals (X) (X) (X) (X) (X) At 31 December 2015 X X X X X Carrying value: At 31 December 2015 X X X X X Carrying value: At 31 December 2015 X X X X X 25

NOTES TO THE STATEMENT OF FINANCIAL POSITION 3. INTAGIBLE ASSETS The notes to the accounts will detail the total in the statement of financial position. The following intangible assets are in the syllabus: Development costs 2015 K'000 X Concessions,patents, licences and trade marks Goodwill X X X 26

NOTES TO THE STATEMENT OF FINANCIAL POSITION 4. CLASSIFICATION OF CURRENT ASSETS Current assets are assets that are expected to be converted into cash within twelve months. For example, inventories will be sold and converted into cash or receivables. Receivables in turn will settle their debts in cash. 27

NOTES TO THE STATEMENT OF FINANCIAL POSITION If it becomes apparent that the amount of cash that will be received will be less than the book value of the asset, then the asset should be written down to its recoverable amount. This is the basis for valuing inventories at the lower of cost and net realizable value, and for making allowances for receivables 28

NOTES TO THE STATEMENT OF FINANCIAL POSITION 4.1 INVETORIES Inventories will be stated at the lower of cost and net realizable value. They will be analysed as follows: Raw material and consumables Work in progress Finished goods and goods for resale 2015 K'000 X X X X Long term contracts are also part of inventories 29

NOTES TO THE STATEMENT OF FINANCIAL POSITION 5. LIABILITIES Non-current liabilities do not have to be repaid within next 12 months. Current liabilities are payable within the next 12 months. Liabilities includes provisions. Provisions are made for liabilities of uncertain timing or amount. 30

NOTES TO THE STATEMENT OF FINANCIAL POSITION 6. Share capital Any movement in the share capital of the company should be disclosed. This is done in the statement of changes in equity. The authorized share capital should also be disclosed. 2015 K'000 Alloted and fully paid: Ordinary shares of $1 each X 6 % preference shares of 50 p each X X 31

NOTES TO THE STATEMENT OF FINANCIAL POSITION 6.1 Reserves The movement in reserves is analysed out in the statement of changes of equity. 32

STATEMENT OF COMPREHENSIVE INCOME The statement of comprehensive income shows total comprehensive income, being the profit or loss for the period as well as other comprehensive income. Profit or loss is defined as "the total of income less expenses, excluding the components of other comprehensive income". Other comprehensive income is defined as comprising "items of income and expense (including reclassification adjustments) that are not recognised in profit or loss as required or permitted by other IFRSs". 33

STATEMENT OF COMPREHENSIVE INCOME Total comprehensive income is defined as "the change in equity during a period resulting from transactions and other events, other than those changes resulting from transactions with owners in their capacity as owners". Comprehensive income for the period = Profit or loss + Other comprehensive income 34

STATEMENT OF COMPREHENSIVE INCOME FORMAT IAS 1 allows this information to be presented in two ways: a)as a single statement of comprehensive income or b)in two statements: an income statement and a second statement beginning with profit and loss and displaying components of other comprehensive income (statement of comprehensive income) 35

STATEMENT OF COMPREHENSIVE INCOME FORMAT A single statement of profit or loss and other comprehensive income, with profit or loss and other comprehensive income presented in two sections, or two statements: a separate statement of profit or loss a statement of comprehensive income, immediately following the statement of profit or loss and beginning with profit or loss 36

PROFORMA FOR A STATEMENT OF COMPREHENSIVE INCOME PRESENTED IN TWO STATEMENTS ABC Co INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2015 2015 2014 Notes K'000 K'000 Revenue X X Cost of sales (X) (X) Gross profit X X Other income X X Distribution costs (X) (X) Administrative expenses (X) (X) Other expenses (X) (X) Finance costs (X) (X) Profit before tax X X Income tax expense 7.4 (X) (X) Profit for the year X X 37

PROFORMA FOR A STATEMENT OF COMPREHENSIVE INCOME PRESENTED IN TWO STATEMENTS ABC Co STATEMENT OF COMPREHENSIVE INCOME 2015 2014 FOR THE YEAR ENDED 31 DECEMBER 2015 K'000 K'000 Profit for the year X X Gains / (losses) on property revaluation X (X) Total comprehensive income for the year X X 38

PROFORMA FOR A SINGLE STATEMENT OF COMPREHENSIVE INCOME ABC Co STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 2015 Notes 2015 2014 K'000 K'000 Revenue X X Cost of sales (X) (X) Gross profit X X Other income X X Distribution costs (X) (X) Administrative expenses (X) (X) Other expenses (X) (X) Finance costs (X) (X) Profit before tax X X Income tax expense 7.4 (X) (X) Profit for the year X X Other comprehensive income Gain on property revaluation X X Total comprehensive income for the year X X Earnings per share X X 39

PROFORMA FOR A SINGLE STATEMENT OF COMPREHENSIVE INCOME 7.4 INCOME TAX EXPENSE A note to the statement of comprehensive income is for income tax expense is calculated as follows: Taxation on the profit for the year: 2015 2014 K'000 K'000 Income tax X X Under (Over) provision in previous year X (X) Deferred tax X X X X 40

PROFORMA FOR A SINGLE STATEMENT OF COMPREHENSIVE INCOME In the exam if the statement of comprehensive income is referred to this will always relate to the single statement format. If an income statement is referred to this relates to the revenue to profit for the year sections of the statement. 41

STATEMENT OF CHANGES IN EQUITY IAS 1 requires an entity to present a separate statement of changes in equity. The statement must show: total comprehensive income for the period, showing separately amounts attributable to owners of the parent and to non-controlling interests the effects of any retrospective application of accounting policies or restatements made in accordance with IAS 8, separately for each component of other comprehensive income 42

STATEMENT OF CHANGES IN EQUITY reconciliations between the carrying amounts at the beginning and the end of the period for each component of equity, separately disclosing: profit or loss other comprehensive income transactions with owners, showing separately contributions by and distributions to owners and changes in ownership interests in subsidiaries that do not result in a loss of control 43

STATEMENT OF CHANGES IN EQUITY Shar e Share Retai ned Revalu ation Tota l capit al premiu m earni ngs surplus Equi ty K'00 0 K'000 K'00 0 K'000 Balance at 1 January 2015 X X X X X Changes in equity for 2015 Issue of share capital X X 0 0 X Dividends 0 0 (X) 0 (X) Total comprehensive income for the year 0 0 X X X Balance at 31 December 2015 X X X X X K'00 0 44

NOTES TO THE FINANCIAL STATEMENTS IAS 1 requires notes to the financial statements. Notes must : present information about the basis of preparation of the financial statements and the specific accounting policies used. disclose any information required by IFRSs that is not presented elsewhere in the financial statements and provide additional information that is not presented elsewhere in the financial statements but is relevant to an understanding of any of them 45

NOTES TO THE FINANCIAL STATEMENTS Notes are presented in a systematic manner and cross-referenced from the face of the financial statements to the relevant note. IAS 1 suggests that the notes should normally be presented in the following order: a statement of compliance with IFRSs a summary of significant accounting policies applied, including: the measurement basis (or bases) used in preparing the financial statements the other accounting policies used that are relevant to an understanding of the financial statements 46

NOTES TO THE FINANCIAL STATEMENTS Supporting information for items presented on the face of the statement of financial position (balance sheet), statement(s) of profit or loss and other comprehensive income, statement of changes in equity and statement of cash flows, in the order in which each statement and each line item is presented. other disclosures, including: contingent liabilities (see IAS 37) and unrecognised contractual commitments non-financial disclosures, such as the entity's financial risk management objectives and policies 47

EXAMPLE 1 :EXAM STANDRD QUESTION The trial balance of Mullion enterprise for the year ended 30 September 2015 is as follows: K'000s K'000s Debits Credits Purchases 5,200 Revenue 12,363 Trade receivables (debtors) 1,180 Trade payables (creditors) 550 Distribution costs 920 Administration costs 1,650 Inventory 1 October 2014 1,620 Bank interest 5 Bank overdraft 220 48

EXAMPLE 1 :EXAM STANDRD QUESTION Wages and salaries administration 420 Provision for bad debts 52 Bad debts written off 5 Property at cost 3,100 Plant and equipment at cost 2,200 Vehicles at cost 900 Property accumulated depreciation as at 1 October 2014 750 Plant and equipment accumulated depreciation as at 1 October 2014 520 Vehicles accumulated depreciation as at 1 October 2014 230 Retained earnings as at 1 October 2014 415 Ordinary share capital K1 shares 700 Other reserves 250 Long-term loan 6% redeemable 2020 1,500 Bank 350 Total 17,550 17,550 49

EXAMPLE 1 :EXAM STANDRD QUESTION The following information is also available: 1. The inventory (stock) as at 30th September 2015 has been valued at K1,570,000. 2. As at 30th September 2015 rent owing is K90,000, and K25,000 had been paid in advance for insurance. Both these expenses are chargeable 60% to distribution and 40% to administration. 3. The interest on the long-term loan needs accruing for the year. 4. Tax is to be provided at 20% of profit after charging all expenses and interest. 50

EXAMPLE 1 :EXAM STANDRD QUESTION 5. Depreciation is to be provided for the year at the following rates: Property 2% on cost, chargeable 50% distribution and 50% administration Plant and equipment 10% on cost, chargeable 60% distribution and 40% administration Vehicles 20% reducing balance, all chargeable to distribution. 6. Provision for doubtful debts is to be set at 5% of trade receivables as at 30th September 2015. 51

EXAMPLE 1 :EXAM STANDRD QUESTION 7. Administration costs include K350,000 in relation to spending on research and development in connection with a new product. The product is set to go on sale on 1st January 2016 and revenue from the product is expected to cover all costs of production. Required Prepare the Income Statement (profit and loss account) for the year ended 30th September 2007 and the Balance Sheet as at that date for Mullion enterprise in accordance with IASs. (Total 25 marks) 52

EXAMPLE EXAM STANDARD QUESTION The following trial balance relates to Candel at 30 September 2014: Leasehold property at valuation 1 October 2013 (note (i)) 50,000 K 000 K 000 Plant and equipment at cost (note (i)) 76,600 Plant and equipment accumulated depreciation at 1 October 2013 24,600 Capitalised development expenditure at 1 October 2013 (note (ii)) 20,000 Development expenditure accumulated amortisation at 1 October 2013 6,000 Closing inventory at 30 September 2014 20,000 Trade receivables 43,100 53

EXAMPLE EXAM STANDARD QUESTION Bank 1,300 Trade payables and provisions (note (iii)) 23,800 Revenue (note (i)) 300,000 Cost of sales 204,000 Distribution costs 14,500 Administrative expenses (note (iii)) 22,200 Preference dividend paid 800 Interest on bank borrowings 200 Equity dividend paid 6,000 Research and development costs (note (ii)) 8,600 Equity shares of 25 ngwee each 50,000 8% redeemable preference shares of K1 each (note (iv)) 20,000 Retained earnings at 1 October 2013 24,500 Deferred tax (note (v)) 5,800 Leasehold property revaluation reserve 10,000 Total 466,000 466,000 54

EXAMPLE EXAM STANDARD QUESTION The following notes are relevant: i. Non-current assets tangible: The leasehold property had a remaining life of 20 years at 1 October 2013. The company s policy is to revalue its property at each year end and at 30 September 2014 it was valued at K43 million. Ignore deferred tax on the revaluation. On 1 October 2013 an item of plant was disposed of for K2 5 million cash. The proceeds have been treated as sales revenue by Candel. 55

EXAMPLE EXAM STANDARD QUESTION The plant is still included in the above trial balance figures at its cost of K8 million and accumulated depreciation of K4 million (to the date of disposal). All plant is depreciated at 20% per annum using the reducing balance method. Depreciation and amortisation of all non-current assets is charged to cost of sales. ii. Non-current assets intangible: In addition to the capitalised development expenditure (of K20 million), further research and development costs were incurred on a new project which commenced on 1 October 2013. The research stage of the new project lasted until 31 December 2013 and incurred K1 4 million of costs. 56

EXAMPLE EXAM STANDARD QUESTION From that date the project incurred development costs of K800,000 per month. On 1 April 2014 the directors became confident that the project would be successful and yield a profit well in excess of its costs. The project is still in development at 30 September 2014. Capitalised development expenditure is amortised at 20% per annum using the straightline method. All expensed research and development is charged to cost of sales. 57

EXAMPLE EXAM STANDARD QUESTION iii. Candel is being sued by a customer for K2 million for breach of contract over a cancelled order.. Candel has obtained legal opinion that there is a 20% chance that Candel will lose the case. Accordingly Candel has provided K400,000 (K2 million x 20%) included in administrative expenses in respect of the claim The unrecoverable legal costs of defending the action are estimated at K100,000. These have not been provided for as the legal action will not go to court until next year 58

EXAMPLE EXAM STANDARD QUESTION iv. The directors have estimated the provision for income tax for the year ended 30 September 2015 at K11 4 million. The required deferred tax provision at 30 September 2015 is K6 million. Required: a) Prepare the statement of comprehensive income for the year ended 30 September 2015. (12 marks) b) Prepare the statement of changes in equity for the year ended 30 September 2015. (3 marks) c) Prepare the statement of financial position as at 30 September 2015. (10 marks) Note: notes to the financial statements are not required. (25 marks) 59

IAS 7 STATEMENT OF CASH FLOWS The statement of cash flows is the third primary financial statement and is required by IAS 7. It reports on a company s generation and use of cash, showing how the cash balance moved from its value at the start of the accounting period to its closing value, as shown on the statement of financial position. It identifies net cash flows from three broad areas of activity: operating, investing and financing. By definition, financial statements prepared under the accruals basis take no account of actual cash flow. 60

IAS 7 STATEMENT OF CASH FLOWS They focus on the economic reality of transactions, recognising income as and when it is generated and expenditure as and when it is incurred. The generation of profit alone does not guarantee success. It s essential, therefore, that managers and investors focus not only on profit but also on cash flow. This is why the statement of cash flows is required. 61

IAS 7 STATEMENT OF CASH FLOWS The distinction between revenue and capital is a fundamental accounting concept. While the profit for the year arising from revenue transactions is reported in the statement of comprehensive income, the statement of financial position reports, among other things, the effect of capital transactions. Both revenue and capital transactions may give rise to cash movements in or out. In effect, the statement of cash flows forms a bridge between the two statements, bringing together all transactions that have a cash implication, whether they relate to operating, investing or financing activities, and whether they are revenue or capital in nature. 62

IAS 7 STATEMENT OF CASH FLOWS Although the statements of comprehensive income and financial position and the ratios extracted from these are affected significantly by the choice of accounting policies, the statement of cash flows is not. It is not affected by the problems associated with the alternative approaches to profit measurement and asset valuation. Inter-company comparisons of statements of comprehensive income and financial position may be compromised by divergent accounting policies, but the statement of cash flows is, in essence, immune from these concerns, containing information that is consistent and neutral. 63

IAS 7 STATEMENT OF CASH FLOWS A non-accountant may struggle to make sense of the statements of comprehensive income and financial position, but can usually relate to the statement of cash flows since it deals with the simple concept of cash. 64

PRESENTATION OF THE STATEMENT OF CASH FLOWS Cash flows must be analysed between operating, investing and financing activities. a) operating activities are the main revenueproducing 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. b) investing activities are the acquisition and disposal of long-term assets and other investments that are not considered to be cash equivalents. 65

PRESENTATION OF THE STATEMENT OF CASH FLOWS c) financing activities are activities that alter the equity capital and borrowing structure of the entity. 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. Cash flows arising from taxes on income are normally classified as operating, unless they can be specifically identified with financing or investing activities 66

FORMAT OF THE YEAR-END STATEMENT OF CASH FLOWS Briefly, the overall presentation of a statement of cash flows is as follows: Cash flows from operating activities Cash flows from investing activities Cash flows from financing activities Increase/decrease in net cash and cash equivalents Cash and cash equivalents at start of year Cash and cash equivalents at end of year K X X X X X X 67

OPERATING ACTIVITIES Cash flows from operating activities are, in general, the cash effects of transactions and other events relating to operating or trading activities. This can be measured by a direct or indirect method, both of which are acceptable under IAS 7. 68

DIRECT METHOD The direct method picks up individual categories of cash flow including income from customers, cash paid to suppliers, cash paid to employees and cash paid to meet expenses. 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: 69

DIRECT METHOD 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 K xx,xxx xx,xxx xx,xxx xx,xxx xx,xxx xx,xxx xx,xxx 70

INDIRECT METHOD Many businesses will not readily have available cash-based records and may prefer the indirect method (which is accruals based) of dealing with operating activities. The indirect method adjusts 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: 71

INDIRECT METHOD Operating Activities Profit before tax X Adjustments for: Depreciation X Profit/loss on sale of assets X Interest X X Increase/decrease in inventory (stock) X Increase/decrease in debtors (trade receivables) X Increase/decrease in creditors (trade payables) X Cash generated from operations X Interest paid (X) Income taxes paid (X) Net cash inflow/outflow from operating activities X 72

INDIRECT METHOD Alternatively, you may well see in practice "Net cash inflow from operating activities" in the statement of cash flows with a separate reconciliation as a note to the statement. This reconciliation will be between the operating profit (for non-financial companies, normally profit before interest) reported in the income statement and the net cash flow from operating activities. This should, as above, disclose separately the movements in inventories, trade receivables and trade payables (stock, debtors and creditors) relating to operating activities and other differences between cash flows and profits (such as accruals and deferrals). 73

ILLUSTRATION Reconciliation of Operating Profit to Net Cash Inflow from Operating Activities K 000 Operating profit 100 Depreciation charged 10 Increase in inventory (90) Increase in debtors (15) Increase in creditors 5 Effect of other deferrals and accruals of operating activity cash flows (5) Net cash inflow from operating activities 5 74

INDIRECT METHOD Although the profit from the income statement is K100,000, this does not mean that the company has received that amount of cash during the year, as profit has been charged with non-cash items such as depreciation. Therefore, in order to arrive at the "cash flow from operating activities" we have to adjust the operating profit figure for any non-cash items depreciation, amortisation and profit/loss on the sale of fixed assets. Depreciation, in the above example, has been deducted in arriving at the profit figure of 100,000. Therefore, we need to add the 10,000 depreciation back as it was just a book entry and did not involve any cash payment. 75

INDIRECT METHOD Now look at the next three items under "operating activities" inventory, debtors and creditors. We are trying to establish the net increase/decrease in cash in our statement of cash flows and the first stage of this is finding our "cash flow from operating activities". However, some of the profit has not gone into the cash or bank balance, but has been ploughed back into stock. Therefore, we need to deduct any increase in inventory from the operating profit to arrive at the cash flow figure. Similarly with debtors if the trade receivables figure in the statement of financial position has increased then some of the sales made during the year have not yet generated cash. 76

INDIRECT METHOD Therefore, any increase in debtors has to be deducted to arrive at the cash flow figure. On the other hand, if the trade payables figure has increased, then cash has not yet been paid out for some of the purchases that have been deducted in arriving at the operating profit. Therefore, we need to add back any increase in creditors. Prepayments and accruals are treated in the same way as trade receivables and trade payables. 77

INDIRECT METHOD Note that we have started with the figure for profit before tax, i.e. we do not adjust for any provision for tax on this year's profit, as this does not involve the movement of cash. What we do have to do is to deduct any tax actually paid during the year(normally the tax on the previous year's profits), under the appropriate heading in operating activities, as this reduces our cash flow. Lastly, we need to adjust for interest expense, so we will need to add back the accrued interest paid and deduct the accrued interest received. The actual interest paid in cash terms will be shown as a separate line under cash flow from operating activities and the actual interest received in cash terms will be shown under investing activities. 78

INVESTING ACTIVITIES Cash inflows from investing activities include: 1. Interest received in cash terms 2. Dividends received in cash terms 3. Proceeds from the sale of property, plant and equipment remember that we have already added back the profit or loss on the sale of these when amending the profit figure, so under this heading we need to include the cash we actually received on the sale. Cash outflows from investing activities include: 1. Payments made for investments in or loans to other entities 2. Payments made for the purchase of non-current (fixed) assets such as property, plant and equipment 3. Payments made for the acquisition of subsidiaries. 79

FINANCING ACTIVITIES Financing cash inflows include: 1. Proceeds from the issue of share capital or other equity instruments 2. Proceeds from long term borrowings (such as issuing debentures or taking out loans). Financing cash outflows include: 1. Payments to owners to acquire or redeem shares 2. Repayments of amounts borrowed 3. Equity dividends paid. 80

EXAMPLE 1:SIMPLIFIED EXAMPLE The following information relates to CPS Ltd: 1. Operating profit for the year ended 31 December 2014 K295,000 2. Debentures issued by the company in 2010 with an interest rate of 6% K50,000 3. Interim dividend paid on ordinary shares in 2014 K8,000 4. List price of motor vehicle EY7 purchased in 2014 K10,000 5. Trade-in value of vehicle given in part exchange against EY7 K2,000 81

EXAMPLE 1:SIMPLIFIED EXAMPLE 6. Ordinary shares of K1 each in CPS Ltd issued at par and fully paid during 2014 K100,000. 7. Ordinary share dividend proposed in 2013 K50,000 8. Ordinary share dividend proposed in 2015 K60,000 9. Corporation Tax paid during the year ended 31 December 2015 K70,000 10. During the year ended 31 December 2015 :Debtors decreased by K12,000, Creditors increased by K25,000,Stock increased by K30,000 82

EXAMPLE 1:SIMPLIFIED EXAMPLE Required: a) Prepare for CPS Ltd for the year ended 31 December 2015: i. A reconciliation of Operating Profit before Tax to Net Cash Inflow from Operating Activities (7 marks) ii. A Cash Flow Statement (11 marks) b) Explain the term cash equivalents. (4 marks) c) Name three headings which would be used when calculating Net Cash Inflow from Operating Activities using the Direct Method. (3 marks) (Total 25 marks) 83

CASH AND CASH EQUIVALENTS Supplementary notes are essential to explain certain movements. Paramount in these notes are reconciliations of the movements in cash and cash equivalents. The terms "cash" and "cash equivalents" should perhaps be defined as they exclude overdrafts which are hardcore in nature. Cash is defined as cash in hand (including overdrafts) and deposits repayable on demand with any bank or other financial institution. 84

CASH AND CASH EQUIVALENTS Cash equivalents are short-term, highly liquid investments which are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value. 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. Cash equivalents include investments and advances denominated in foreign currencies provided that they fulfil the above criteria. 85

USE OF STATEMENTS OF CASH FLOWS It is felt that a statement of cash flows helps analysts in making judgments on the amount, timing and degree of certainty of future cash flows by giving an indication of the relationship between profitability and cash generating ability, and thus the "quality" of the profit earned. Looking at the statement of cash flows in conjunction with a statement of financial position provides information about liquidity, viability and financial adaptability. The statement of financial position provides information about an entity's financial position at a particular point in time including assets, liabilities and equity,and their interrelationship. 86

USE OF STATEMENTS OF CASH FLOWS The statement of financial position is regularly used to obtain information about liquidity, but as it is only the picture on one day, the liquidity information is incomplete. The statement of cash flows extends liquidity information over the accounting period. However, to give an indication of future cash flows, the statement of cash flows needs to be studied in conjunction with the statements of both comprehensive income and of financial position. 87

USE OF STATEMENTS OF CASH FLOWS The concentration on cash as opposed to working capital emphasises the pure liquidity of the reporting business. Organisations can have ample working capital, but run out of cash and fail. 88

REASONS FOR PREPARING CASHFLOW STATEMENTS It is required by accounting standards. It reconciles the cash balances between the start and end of a year. It provides information about liquidity when used in conjunction with a statement of financial position. It can be used to see how funds have been used during the year To some extent it indicates the quality of cash management of the business. 89

REASONS FOR PREPARING CASHFLOW STATEMENTS It shows how funds have been obtained during the year. It shows the relationship between profit and cash flow. It is more objective than a Statement of Financial Position or Income Statement. It is useful for budgeting. 90

EXAMPLE 2:EXAM STANDARD QUESTION Pinto is a publicly listed company. The following financial statements of Pinto are available: Statement of comprehensive income for the year ended 31 March 2014 91

EXAMPLE 2:EXAM STANDARD QUESTION K 000 Revenue 5,740 Cost of sales (4,840) Gross profit 900 Income from and gains on investment property 60 Distribution costs (120) Administrative expenses (note (ii)) (350) Finance costs (50) Profit before tax 440 Income tax expense (160) Profit for the year 280 Other comprehensive income Gains on property revaluation 100 Total comprehensive income 380 92

EXAMPLE 2:EXAM STANDARD QUESTION Statements of financial position as at 31 March 2014 31 March 2013 Assets K 000 K 000 K 000 K 000 Non-current assets (note (i)) Property, plant and equipment 2,880 1,860 Investment property 420 400 3,300 2,260 Current assets Inventory 1,210 810 Trade receivables 480 540 Income tax asset nil 50 Bank 10 nil 1,700 1,400 Total assets 5,000 3,660 93

EXAMPLE 2:EXAM STANDARD QUESTION Equity and liabilities Equity shares of 20 cents each (note (iii)) 1,000 600 Share premium 600 nil Revaluation reserve 150 50 Retained earnings 1,440 1,310 2,190 1,360 3,190 1,960 Non-current liabilities 6% loan notes (note (ii)) nil 400 Deferred tax 50 30 50 430 Current liabilities Trade payables 1,410 1,050 Bank overdraft nil 120 Warranty provision (note (iv)) 200 100 Current tax payable 150 nil 1,760 1,270 Total equity and liabilities 5,000 3,660 94

EXAMPLE 2:EXAM STANDARD QUESTION The following supporting information is available: i. An item of plant with a carrying amount of K240,000 was sold at a loss of K90,000 during the year. Depreciation of K280,000 was charged (to cost of sales) for property, plant and equipment in the year ended 31 March 2014. Pinto uses the fair value model in IAS 40 Investment Property. There were no purchases or sales of investment property during the year. 95

EXAMPLE 2:EXAM STANDARD QUESTION ii. The 6% loan notes were redeemed early incurring a penalty payment of K20,000 which has been charged as an administrative expense in the income statement. iii. There was an issue of shares for cash on 1 October 2013. There were no bonus issues of shares during the year. iv. Pinto gives a 12 month warranty on some of the products it sells. 96

EXAMPLE 2:EXAM STANDARD QUESTION The amounts shown in current liabilities as warranty provision are an accurate assessment, based on past experience, of the amount of claims likely to be made in respect of warranties outstanding at each year end. Warranty costs are included in cost of sales. v. A dividend of 3 cents per share was paid on 1 January 2014. 97

EXAMPLE 2:EXAM STANDARD QUESTION Required: a) Prepare a statement of cash flows for Pinto for the year to 31 March 2014 in accordance with IAS 7 Statement of cash flows. (15 marks) b) Comment on the cash flow management of Pinto as revealed by the statement of cash flows and the information provided by the above financial statements. Note: ratio analysis is not required, and will not be awarded any marks. (10 marks) (25 marks) 98