Statement of Cash Flows
Statement of cash flows General Principles Mandatory for most of the entities Direct and Indirect method Generally starts with PAT (Profit after tax) 2
Overview of AS 3 Requires presentation of a statement of cash flows as an integral part of financial statements Cash flows are defined as inflows and outflows of cash and cash equivalents and classified into: Operating activities Investing activities Financing activities Cash flows from operating activities are reported using either direct or indirect method. Cash flows from investing and financing activities are reported on gross basis with some exceptions. Requires disclosure of components of cash and cash equivalents and a reconciliation of the amounts in statement of cash flows with the equivalent items reported in the balance sheet. 3
Key Concepts Cash comprises cash on hand and demand deposits Cash equivalents Short-term (<3 months from date of acquisition) Highly liquid investments (readily convertible into known amounts of cash) Insignificant risk of changes in value Held for purpose of meeting short-term cash commitments rather than investment or other purposes 4
Key Concepts Question #1: An entity purchases a two-year bond in the market when the bond only has three months remaining before its redemption date. Does the bond qualify as a cash equivalent under AS 3? 5
Key Concepts Suggested Solution #1: Yes, provided that it is held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. 6
Key Concepts Question #2: An entity purchases a two-year bond in the market when the bond only has four months remaining before its redemption date. Does the bond qualify as a cash equivalent under AS 3? 7
Key Concepts Suggested Solution #2: No. AS 3 clarifies that an investment normally qualifies as a cash equivalent when it has a maturity of three months or less from the date of acquisition. Note: The classification is established at the date of acquisition and is not changed subsequently (e.g., when the bond has less than three months remaining to maturity). 8
Key Concepts Operating activities Principal revenue producing activities and other activities that are not investing or financing activities Investing activities Acquisition and disposal of long-term assets and other assets not included in cash equivalents Financing activities Activities that result in changes in the size and composition of equity and borrowings 9
Reporting Cash Flows Cash flows from operating activities Use direct or indirect method Cash flows from investing and financing activities Presented on gross basis except Items in which turnover is quick, the amounts are large and the maturities are short Cash receipts and payments on behalf of customers when the cash flows reflect the activities of the customer rather than those of the entity Foreign currency cash flows Effect of exchange rate changes on cash and cash equivalents presented separately 10
Reporting Cash Flows Reporting Cash Flows from Operating Activities Net cash flow from operating activities can be reported either as direct method or as indirect method. Direct method In this method, we take the gross receipts from sales, trade receivables and other operating inflows and subtract gross payments for purchases, creditors and other expenses ignoring all non-cash items like depreciation, provisions. Indirect method In this method we start from the net profit or loss, eliminate the effect of any non-cash items, investing items and financing items from such profit/ loss i.e. all such expenses like depreciation, provisions, interest paid, loss on sale of assets etc. are added and interest received etc. are deducted. Adjustment for changes in working capital items are also made ignoring cash and cash equivalent to reach to the figure of net cash flows. 11
Classification of certain cash flow items Interest/dividends paid (for non-financial entities) classified as financing activity Interest/dividends received (for non-financial entities) classified as investing activity Bank overdraft Financing activity Income taxes paid/refunded Operating activity unless they can be specifically identified with financing and investing activities. 12
Key Concepts Question #3: An entity purchases a two-year bond in the market when the bond only has two months remaining before its redemption date. The purchase is made for investment purposes Does the bond qualify as a cash equivalent under AS 3? 13
Key Concepts Suggested Solution #3: No. AS 3 specifies that, in order to qualify as a cash equivalent, the bond must be held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. Because the bond has been acquired for investment purposes, the acquisition should be recorded as an investing cash outflow. 14
Key Concepts Question #4: One of the entities in Group A, (e.g. Subsidiary B) operates in a country where exchange controls or other legal restrictions apply and the cash and cash equivalents in the subsidiary B are not available for use by other members of the group? How should such cash and cash equivalent balances be presented in the consolidated statement of cash flows presented by Group A? 15
Key Concepts Suggested Solution #4: Restrictions on the use of cash or cash equivalents do not alter the classification of the restricted amounts in the balance sheet or statement of cash flows. For example, when there are restrictions on the transfer of amounts from foreign subsidiary B, the amounts are treated as part of Group A s cash and cash equivalents in the consolidated statement of cash flows presented by Group A if they meet the definition of cash and cash equivalents in the foreign subsidiary; disclosure is made in accordance with AS 3. 16
Other Presentation Matters Facts: Company P sold its international business to Company J for Rs.1,200 crores. As a result of the sale, Company P will be required to pay taxes related to the gain on the sale of approximately Rs.300 crores. Company P has appropriately determined to report the sale of the international business as a discontinued operation in its statement of profit and loss. In its statement of cash flows, Company P has proposed including the taxes on the gain as a component of cash flows from investing activities, below the net proceeds from the sale of the international business. Question: Is the proposed presentation in the cash flow statement appropriate? 17
Other Presentation Matters Suggested Solution: Yes. AS 3 states that taxes shall be classified as operating activities " unless they can be specifically identified with financing and investing activities". The disposal of non-current assets would be considered investing activities, and therefore, allocation of the tax effect of the sale to investing activities would be appropriate. 18
Reporting cash flows on a net basis Cash flows arising from the following operating, investing or financing activities may be reported on a 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. Examples of cash receipts and payments referred to in paragraph (a) above are: a. the acceptance and repayment of demand deposits of a bank; b. funds held for customers by an investment entity; and c. rents collected on behalf of, and paid over to, the owners of properties. Examples of cash receipts and payments referred to in paragraph (b) above are advances made for, and the repayment of: a. principal amounts relating to credit card customers; b. the purchase and sale of investments; and c. other short-term borrowings, for example, those which have a maturity period of three months or less.
General Foreign currency cash flows Cash flows arising from transactions in a foreign currency shall be recorded in an entity's local currency by applying to the foreign currency amount the exchange rate between the functional currency and the foreign currency at the date of the cash flows. 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. 20
General Investments in subsidiaries, associates and joint ventures When accounting for an investment in an associate or a subsidiary or a joint venture, an investor restricts its reporting in the statement of cash flows to the cash flows between itself and the investee, for example, cash flows relating to dividends and advances. 21
General Components of cash and cash equivalents 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 Balance Sheet. Other disclosures An entity should disclose, together with a commentary by the management, the amount of significant cash and cash equivalent balances held by the enterprise that are not available for use by it. Additional disclosures may be relevant to users, disclosure of following together with a commentary by management, is encouraged and may include: a) the amount of undrawn borrowing facilities that may be available for future operating activities and to settle capital commitments, indicating any restrictions on the use of these facilities; b) the aggregate amount of cash flows that represent increases in operating capacity separately from those cash flows that are required to maintain operating capacity. 22
Example Classify the following activities as per AS 3 Cash Flow Statement: 1. Interest paid by financial enterprise 2. Tax deducted at source on interest received from subsidiary company 3. Deposit with Bank for a term of two years 4. Insurance claim received towards loss of machinery by fire 5. Bad debts written off. Solution 1. Cash flows from operating activities 2. Cash flows from investing activities 3. Cash flows from investing activities 4. Extraordinary item to be shown as a separate heading under Cash flow from investing activities. 5. It is a non-cash item which is adjusted from net profit/loss under indirect method, to arrive at net cash flow from operating activity. 23
3.44 Reporting Cash Flows from Operating Activities Net cash flow from operating activities can be reported either as direct method or as indirect method. Direct method In this method, we take the gross receipts from sales, trade receivables and other operating inflows and subtract gross payments for purchases, creditors and other expenses ignoring all non-cash items like depreciation, provisions. Indirect method In this method we start from the net profit or loss, eliminate the effect of any noncash items, investing items and financing items from such profit/ loss i.e. all such expenses like depreciation, provisions, interest paid, loss on sale of assets etc. are added and interest received etc. are deducted. Adjustment for changes in working capital items are also made ignoring cash and cash equivalent to reach to the figure of net cash flows.
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