IAS 7 Statement of cash flows PURPOSE & SCOPE Purpose Users needs Scope The fundamental purpose of being in business is to generate profit, as this will increase the owners' wealth. Profitability relates to the long term performance of the business and indicates that over the long term a business will generate cash. In the short term, the business' viability is determined by its ability to generate cash. However as an statement of profit or loss is prepared on an accruals basis, the profit for the year is unlikely to correlate with the movement in the company's bank balance. Items such as depreciation, provision movements and impairment of goodwill will mean that profits and cash flows may differ dramatically. Users need to know about the cash generating ability and financial adaptability of an entity, i.e. can the business generate cash and can it alter the timing of its cash flows. If the entity can answer positively, users will be confident about the entity's prospects. Therefore, IAS 7 requires that entities should prepare a statement of cash flows as an integral component of financial statements. DEFINITIONS Cash Cash equivalent Cash flows Operating activities Investing activities Financing activities comprises cash on hand and demand deposits. are short terms, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. are inflows and outflows of cash and cash equivalents. are the principal revenue producing activities of the entity and other activities that are not investing or financing activities. are the acquisition and disposal of long term assets and other investments not included in cash equivalents. are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity. CASH EQUIVALENT 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. Investment in Investments equity shares is not included in cash and cash equivalents, however, investment in redeemable shares may be included if specific redemption date is very close. If the balance of bank overdraft fluctuates normally from positive to negative or Bank vice versa, it is included in cash and cash equivalent. However, if in substance, the overdraft entity is using bank overdraft as short term loan, it should be included in financing activities. Movement Movement within cash and cash equivalent are not presented as cash flows. Page 1 of 14 (kashifadeel.com)
Calculate the cash and cash equivalents from the following information: $ Cash in hand 200,000 Cash at bank 140,000 Short term investments (1 month) in government 40,000 treasury bills Trade debts 40,000 Investment in prize bonds 80,000 Other receivables 40,000 Bank overdraft 20,000 EXAMPLE 7A What would be the effect on statement of cash flows of the following transactions? $ Cash deposited in bank account 100,000 Sale of prize bonds 500,000 Investment in treasury bills of government with 60 days 800,000 maturity EXAMPLE 7B Page 2 of 14 (kashifadeel.com)
PRESENTATION The statement of cash flows shall report cash flows during the period classified by operating, investing and financing activities. They generally result from the transactions and other events that enter into the determination of profit or loss. Examples of cash flows from operating activities are: (a) Cash receipts from the sale of goods and the rendering of services; (b) Cash receipts from royalties, fees, commissions and other revenue; (c) Cash payments of suppliers for goods and services; (d) Cash payments to and on behalf of employees; Operating (e) Cash receipts and cash payments of an insurance; Activities (f) Cash payments or refunds of income taxes unless they can be specially identified with financing and investing activities; and Investing Activities Financing Activities Some transactions, such as the sale of an item of plant, may give rise to a gain or loss which is included in the determination of profit or loss. However, the cash flows relating to such transactions are cash flows from investing activities. The separate disclosure of cash flows arising from investing activities is important because the cash flows represent the extent to which expenditures have been made for resources intended to generate future income and cash flows. Examples of cash flows arising from investing activities are: (a) Cash payments to acquire PPE, intangibles and other long-term assets including development costs and self-constructed PPE. (b) Cash receipts from sales of PPE, intangibles and other long-term assets; (c) Cash payments to acquire equity or debt instruments of other; (d) Cash receipts from sales of equity or debt instruments of other entities; (e) Cash advances and loans made to other parties. The separate discloser of cash flows arising from financing activities is important because it is useful in predicting claims on future cash flows by providers of capital to the entity. Examples of cash flows arising from financing activities are: (a) cash proceeds from issuing shares or other equity instruments; (b) cash payment to owners to acquire or redeem the entity s shares; (c) cash proceed from issuing debentures, loans, notes, bonds, and other short or long term borrowings; (d) cash repayment of amounts borrowed, and (e) cash payments by lessee for liability under finance lease. Page 3 of 14 (kashifadeel.com)
Identify the following transactions as operating, investing, financing or otherwise: TRANSACTION 1. Cash received from customers 2. Cash sales 3. Cash proceeds from disposal of PPE 4. Right issue of shares 5. Repayment of loan 6. Dividend received by stock market broker 7. Dividend paid 8. Salaries paid to employees 9. Interest on debentures paid 10. Interest received by a trading entity on some investment 11. Interest received by a bank on loans advanced 12. Taxes paid 13. Purchase of a patent and software 14. Advance paid to supplier 15. Depreciation 16. Bonus issue of shares 17. Impairment loss on a plant EXAMPLE 7C ANSWER Page 4 of 14 (kashifadeel.com)
REPORTING CASH FLOWS OPERATING CASH FLOWS An entity shall report cash flows from operating activities using either: Direct whereby major classes of gross cash receipts and gross cash payments are method disclosed; or whereby profit or loss is adjusted for the effects of transactions of a non cash nature, Indirect any deferrals or accruals of past or future operating cash receipts or payments, and method items of income or expense associated with investing or financing cash flows. EXAMPLE 7D The following are extracts from the financial statements of Oxygen Limited for the year ended June 30, 2012 and 2011. 2012 2011 SFP (extracts) $ $ Inventories 230,000 185,000 Prepayments 14,000 16,000 Trade receivables 52,000 30,000 Cash 15,000 38,000 Trade payables 39,000 44,000 Income tax payable 5,000 4,000 SPL (extracts) Revenue 500,000 Cost of sales (includes depreciation of $ 6,000) (310,000) Gross profit 190,000 Operating expenses (includes depreciation of $ 6,000) (80,000) Finance costs (21,000) Profit before tax 89,000 Taxation (30,000) Profit after tax 59,000 Required: What will be the net cash flow from operating activities under: (a) Indirect method (b) Direct method Page 5 of 14 (kashifadeel.com)
Investing and Financing Cash Flows An entity shall report separately major classes of gross cash receipts and gross Generally cash payments arising from investing and financing activities, except to the extent that cash flows described as follows are reported on a net basis. Cash flows arising from the following operating, investing or financing activities may be reported on a net basis: On net basis (a) cash receipts and payments on behalf of customers when the cash flows reflect the activities of the customer rather than those of the entity; and (b) cash receipts and payments for items in which the turnover is quick, the amounts are large, and the maturities are short. EXAMPLE 7E The following are extracts from the financial statements of Nitrogen Limited for the year ended June 30, 2012 and 2011. 2012 2011 SFP (extracts) $ $ Property, plant and equipment 850,000 800,000 Intangible assets 0 200,000 Share capital 600,000 500,000 Share premium 200,000 150,000 Long term loans 500,000 0 Debentures 100,000 400,000 Additional information: During the year, right issue of shares was made. Depreciation for the year was $ 200,000. There was no disposal of PPE during the year Intangible asset (patent) was sold at beginning of the year equal to its carrying amount. Required: Present the above transactions in the statement of cash flows. Page 6 of 14 (kashifadeel.com)
EXAMPLE 7F The following information relates to running finance of ABC Limited. $ Balance at beginning of month 47,000 Payments 6 January 10,000 18 January 25,000 28 January 17,000 52,000 Receipts 2 January 7,000 14 January 18,000 26 January 30,000 55,000 Balance at end of month 44,000 Required: How the above transactions should be treated in statement of cash flows. Page 7 of 14 (kashifadeel.com)
INTEREST, DIVIDENDS AND TAXES ON INCOME Classification Consistency Taxes Interest paid and interest and dividends received are usually classified as operating cash flows for a financial institution. However, there is no consensus on the classification of these cash flows for other entities. 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 operating, investing or financing activities. Cash flows arising from taxes on income shall be separately disclosed and shall be classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities. NON CASH TRANSACTIONS Requirement Examples Investing and financing transaction that do not require the use of cash or cash equivalent shall be excluded from a statement of cash flows. Such transaction shall be disclosed elsewhere in the financial statements in a way that provides all the relevant information about these investing and financing activities. Gain on revaluation Assets acquired under finance lease Depreciation, amortisation and impairment losses Bonus issue of shares Conversion of convertible bonds in shares DISCLOSURE Components of cash and cash equivalents Other disclosures 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 SFP. An entity shall disclose, together with a commentary by management, the amount of significant cash and cash equivalent balance held by the entity that are not available for use by the group. Page 8 of 14 (kashifadeel.com)
INTERPRETATION OF STATEMENT OF CASH FLOWS Cash generation from trading operations Dividends and interest payouts Capital expenditure and financial investment Management of financing Cash flow Cash return on capital employed Cash generated to total debt Operating cash to capital exp. The figure should be compared to the operating profit. The reconciliation note to the SCF is useful in this regard. Overtrading may be indicated by: High profits and low cash generation Large increases in inventory, receivables and payables These can be compared to cash generated from trading operations to see whether the normal operations can sustain such payments. In most years they should. The nature and scale of a company s investment in non current assets is clearly shown. A simple test may be to compare investment and depreciation. If investment is > depreciation, the company is investing at a greater rate than its current assets are wearing out this suggests expansion. If investment = depreciation, the company is investing in new assets as existing ones wear out. The company appears stable. If investment < depreciation, the non current asset base of the company is not being maintained. This is potentially worrying as non current assets are generators of profit. The changes in financing (in pure cash terms) are clearly shown. There may be a note to the statement of cash flows which links the inflows/outflows with the movement in the statement of financial position. There may be significant non cash flow changes in the capital structure of business. Gearing can be considered at this point. The statement clearly shows the end result in cash terms of the company s operations in the year. Do not overstate the importance of this figure alone, however. A decrease in cash in the year may be for very sound reasons (e.g. there were surplus cash last year) or may be mainly the result of timing (e.g. a new loan was raised just after the end of accounting period). To help in determining the future cash position, other areas of the published accounts should also be considered. Cash generated from operations x 100% Total assets less current liabilities Cash generated from operations Total debt Net cash from operating activities x 100% Net capital expenditure Page 9 of 14 (kashifadeel.com)
FORMAT AND GUIDANCE [Entity Name] Statement of cash flows For the year ended [date here] Cash flows from operating activities: <Direct method> $ 000 Cash receipts from customers Note 1 XXX Cash paid to suppliers, employees and for expenses Note 2 (XXX) Cash generated from operations XXX Interest paid Pension benefits paid Income tax paid Net cash from (used in) operating activities A XXX Cash flows from operating activities: <Indirect method> $ 000 Profit before tax Note 3 XXX Adjustments for: Note 4 [non-cash income and expenses included in SPL] XX/ [items of income and expenses relating to investing or financing activity but included in SPL] XX/ [post-employment benefit expense, finance income and expense] XX/ Operating profit before working capital changes XXX [increase on decrease in current assets and liabilities] Note 5 XX/ Cash generated from operations XXX Interest paid Pension benefits paid Income tax paid Net cash from (used in) operating activities A XXX Cash flows from investing activities: Purchase of non-current assets or short term investment (on cash basis) (XXX) Disposal of non-current assets or short term investment (on cash basis) XX Investment income (on cash basis) XX Net cash from (used in) investing activities B (XXX) Cash flows from financing activities: Cash proceeds from share issue, loan issue and borrowings XXX Cash paid for share re-purchase, loan and borrowings repayment Interest paid on borrowings/dividend paid Net cash from financing activities C XXX Net decrease in cash and cash equivalents A+B+C XXX Cash and cash equivalents at beginning of the year SFP XX Cash and cash equivalents at end of the year SFP XX Page 10 of 14 (kashifadeel.com)
NOTE 1 Revenue (Cash + Credit) (Increase)/decrease in trade receivables $ XXX XX/ XXX NOTE 2 All expenses and incomes in SPL for profit before tax excluding revenue [non-cash income and expenses included in SPL] [items of income and expenses relating to investing or financing activity but included in SPL] [post-employment benefit expense, finance income and expense] [increase on decrease in current assets and liabilities excluding trade receivables] $ (XXX) XX/ XX/ XX/ XX/(XXX) (XXX) NOTE 3 If profit in not given in the question (for indirect method), it is usually determined by reconciling retained earnings. Profit before tax is to be taken for starting statement of cash flows under indirect method. NOTE 4 Expenses add back in profit Incomes less back from profit NOTE 5 Include increase/decrease in inventory, prepayments, advances, receivables, trade payables, Accrued expenses. Exclude Cash, Investment, borrowings, interest payable, tax payable, and bank overdraft. Cash inflow increase in liability, decrease in asset Cash outflow increase in asset, decrease in liability ADDITIONAL NOTE 6 Some T accounts should be combined like: Share capital and Share premium Liabilities classified under current and non-current elements Deferred tax and current tax Page 11 of 14 (kashifadeel.com)
ANSWER 7A $ Cash in hand 200,000 Cash at bank 140,000 Short term investments (1 month) in government 40,000 treasury bills Investment in prize bond 80,000 Bank overdraft (20,000) 440,000 ANSWER 7B There will be no particular effect on statement of cash flows because these are movements within the statement of cash flows. ANSWER 7C Identify the following transactions as operating, investing, financing or otherwise: TRANSACTION ANSWER 1. Cash received from customers Operating 2. Cash sales Operating 3. Cash proceeds from disposal of PPE Investing 4. Right issue of shares Financing 5. Repayment of loan Financing 6. Dividend received by stock market broker Operating 7. Dividend paid Financing 8. Salaries paid to employees Operating 9. Interest on debentures paid Financing 10. Interest received by a trading entity on some investment Investing 11. Interest received by a bank on loans advanced Operating 12. Taxes paid Operating 13. Purchase of a patent and software Investing 14. Advance paid to supplier Operating 15. Depreciation Non-cash 16. Bonus issue of shares Non-cash 17. Impairment loss on a plant Non-cash Page 12 of 14 (kashifadeel.com)
ANSWER 7D Part (a) Oxygen Limited Statement of cash flows For the year ended June 30, 2012 Cash flows from operating activities $ Profit before tax 89,000 Adjustments: Depreciation 12,000 Finance costs 21,000 Operating capital before working capital changes 122,000 Increase in inventory (230,000 185,000) (45,000) Decrease in prepayments (14,000 16,000) 2,000 Increase in trade receivables (52,000 30,000) (22,000) Increase in trade payables (39,000 44,000) (5,000) Cash generated from operations 52,000 Interest paid (21,000) Income tax paid (b/f 4,000 + PL 30,000 c/f 5,000) (29,000) Net cash from operating activities 2,000 Part (b) Oxygen Limited Statement of cash flows For the year ended June 30, 2012 Cash flows from operating activities $ Cash received from customers (500,000 revenue 22,000 increase in 478,000 receivables) Cash paid to suppliers and employees (W1) (426,000) Cash generated from operations 52,000 Interest paid (21,000) Income tax paid (b/f 4,000 + PL 30,000 c/f 5,000) (29,000) Net cash from operating activities 2,000 W1 $ Cost of sales (310,000) Operating expenses (80,000) Finance costs (21,000) (411,000) Adjustments: Depreciation 12,000 Finance costs 21,000 Operating capital before working capital changes (378,000) Increase in inventory (230,000 185,000) (45,000) Decrease in prepayments (14,000 16,000) 2,000 Increase in trade payables (39,000 44,000) (5,000) Cash paid to suppliers and employees (426,000) Page 13 of 14 (kashifadeel.com)
ANSWER 7E Nitrogen Limited Statement of cash flows For the year ended June 30, 2012 Cash flows from investing activities $ Cash paid to acquire PPE (b/f 800,000 200,000 dep. c/f 850,000) (250,000) Sale proceeds of intangible assets 200,000 Net cash used in investing activities (50,000) Cash flows from financing activities Issue of shares (b/f 500,000 + 150,000 c/f 600,000 + 200,000) 250,000 Long term loan obtained 500,000 Redemption of debentures (100,000 400,000) (300,000) Net cash from financing activities 450,000 ANSWER 7F The repayment of running finance of $ 3,000 (i.e. 47,000 44,000) should be presented in financing activities. Dated: 13 August 2016 Page 14 of 14 (kashifadeel.com)