Group statements of cash flows

Group statements of cash flows Topic list Syllabus reference 1 Cash flows D1 2 IAS 7 Statement of cash flows: Single company D1 3 Consolidated statements of cash flows D1 Introduction A statement of cash flows is an additional primary statement of great value to users of financial statements for the extra information it provides. You should be familiar with the basic principles, techniques and definitions relating to statements of cash flows from your earlier studies. This chapter develops the principles and preparation techniques to include consolidated financial statements. 477

Study guide D1 Group accounting including statements of cash flows Intellectual level (j) Prepare and discuss group statements of cash flows 3 Exam guide A group statement of cash flows could well appear in the case study question in compulsory Section A of the paper as it did in the Pilot Paper. 1 Cash flows 12/13 FAST FORWARD Statements of cash flows are a useful addition to the financial statements of companies because it is recognised that accounting profit is not the only indicator of a company's performance. Statements of cash flows concentrate on the sources and uses of cash and are a useful indicator of a company's liquidity and solvency. Cash flows are much easier to understand as a concept than accounting profits. The main advantages of using cash flow accounting (including both historical and forecast cash flows) are as follows: (a) (b) (c) (d) (e) Survival of a company depends on its ability to generate cash. Cash flow accounting directs attention towards this critical issue. Cash flow is more comprehensive than 'profit' which is dependent on accounting conventions and concepts. Creditors (long- and short-term) are more interested in an entity's ability to repay them than in its profitability. Whereas 'profits' might indicate that cash is likely to be available, cash flow accounting is more direct with its message. Cash flow reporting provides a better means of comparing the results of different companies than traditional profit reporting. Cash flow reporting satisfies the needs of all users better. (i) (ii) (iii) For management. It provides the sort of information on which decisions should be taken (in management accounting, 'relevant costs' to a decision are future cash flows). Traditional profit accounting does not help with decision-making. For shareholders and auditors. Cash flow accounting can provide a satisfactory basis for stewardship accounting. For creditors and employees. Their information needs will be better served by cash flow accounting. (f) (g) (h) (i) (j) Cash flow forecasts are easier to prepare, as well as more useful, than profit forecasts. Cash flow accounts can be audited more easily than accounts based on the accruals concept. The accruals concept is confusing, and cash flows are more easily understood. Cash flow accounting can be both retrospective, and also include a forecast for the future. This is of great information value to all users of accounting information. Forecasts can subsequently be monitored by the use of variance statements which compare actual cash flows against the forecast. 478 17: Group statements of cash flows Part C Group financial statements

Looking at the same question from a different angle, readers of accounts can be misled by the profit figure. (a) (b) (c) (d) (e) Shareholders might believe that if a company makes a profit after tax of, say $100,000 then this is the amount which it could afford to pay as a dividend. Unless the company has sufficient cash available to stay in business and also to pay a dividend, the shareholders' expectations would be wrong. Employees might believe that if a company makes profits, it can afford to pay higher wages next year. This opinion may not be correct: the ability to pay wages depends on the availability of cash. Creditors might consider that a profitable company is a going concern. (i) (ii) If a company builds up large amounts of unsold inventories of goods, their cost would not be chargeable against profits, but cash would have been used up in making them, thus weakening the company's liquid resources. A company might capitalise large development costs, having spent considerable amounts of money on R & D, but only charge small amounts against current profits. As a result, the company might show reasonable profits, but get into severe difficulties with its liquidity position. Management might suppose that if their company makes a historical cost profit, and reinvests some of those profits, then the company must be expanding. This is not the case: in a period of inflation, a company might have a historical cost profit but a current cost accounting loss, which means that the operating capability of the firm will be declining. Survival of a business entity depends not so much on profits as on its ability to pay its debts when they fall due. Such payments might include 'profit or loss' items such as material purchases, wages, interest and taxation etc, but also capital payments for new non-current assets and the repayment of loan capital when this falls due (eg on the redemption of debentures). 2 IAS 7 Statement of cash flows: Single company FAST FORWARD You need to be aware of the format of the statement as laid out in IAS 7. Setting out the format is an essential first stage in preparing the statement, so this format must be learnt. The aim of IAS 7 is to provide information to users of financial statements about the cash flows of an entity's ability to generate cash and cash equivalents, as well as indicating the cash needs of the entity. The statement of cash flows provides historical information about cash and cash equivalents, classifying cash flows between operating, investing and financing activities. 2.1 Scope A statement of cash flows should be presented as an integral part of an entity's financial statements. All types of entity can provide useful information about cash flows as the need for cash is universal, whatever the nature of their revenue-producing activities. Therefore all entities are required by the standard to produce a statement of cash flows. 2.2 Benefits of cash flow information The use of statements of cash flows is very much in conjunction with the rest of the financial statements. Users can gain further appreciation of the change in net assets, of the entity's financial position (liquidity and solvency) and the entity's ability to adapt to changing circumstances by affecting the amount and timing of cash flows. Statements of cash flows enhance comparability as they are not affected by differing accounting policies used for the same type of transactions or events. Cash flow information of a historical nature can be used as an indicator of the amount, timing and certainty of future cash flows. Past forecast cash flow information can be checked for accuracy as actual Part C Group financial statements 17: Group statements of cash flows 479

figures emerge. The relationship between profit and cash flows can be analysed as can changes in prices over time. 2.3 Definitions The standard gives the following definitions, the most important of which are cash and cash equivalents. Key terms 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 equity capital and borrowings of the entity. (IAS 7) 2.4 Cash and cash equivalents The standard expands on the definition of cash equivalents: they are not held for investment or other longterm purposes, but rather to meet short-term cash commitments. To fulfil the above definition, an investment's maturity date should normally be three months from its acquisition date. It would usually be the case then that equity investments (ie shares in other companies) are not cash equivalents. An exception would be where preferred shares were acquired with a very close maturity date. Loans and other borrowings from banks are classified as investing activities. In some countries, however, bank overdrafts are repayable on demand and are treated as part of an entity's total cash management system. In these circumstances an overdrawn balance will be included in cash and cash equivalents. Such banking arrangements are characterised by a balance which fluctuates between overdrawn and credit. Movements between different types of cash and cash equivalent are not included in cash flows. The investment of surplus cash in cash equivalents is part of cash management, not part of operating, investing or financing activities. 2.5 Presentation of a statement of cash flows IAS 7 requires statements of cash flows to report cash flows during the period classified by operating, investing and financing activities. The manner of presentation of cash flows from operating, investing and financing activities depends on the nature of the entity. By classifying cash flows between different activities in this way users can see the impact on cash and cash equivalents of each one, and their relationships with each other. We can look at each in more detail. 2.5.1 Operating activities This is perhaps the key part of the statement of cash flows because it shows whether, and to what extent, companies can generate cash from their operations. It is these operating cash flows which must, in the end pay for all cash outflows relating to other activities, ie paying loan interest, dividends and so on. Most of the components of cash flows from operating activities will be those items which determine the net profit or loss of the entity, ie they relate to the main revenue-producing activities of the entity. The standard gives the following as examples of cash flows from operating activities. 480 17: Group statements of cash flows Part C Group financial statements

Cash receipts from the sale of goods and the rendering of 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/refunds of income taxes unless they can be specifically identified with financing or investing activities Cash receipts and payments from contracts held for dealing or trading purposes Certain items may be included in the net profit or loss for the period which do not relate to operational cash flows, for example the profit or loss on the sale of a piece of plant will be included in net profit or loss, but the cash flows will be classed as financing. 2.5.2 Investing activities The cash flows classified under this heading show the extent of new investment in assets which will generate future profit and cash flows. The standard gives the following examples of cash flows arising from investing activities. Cash payments to acquire property, plant and equipment, intangibles and other long-term assets, including those relating to capitalised development costs and self-constructed property, plant and equipment Cash receipts from sales of property, plant and equipment, intangibles and other long-term assets Cash payments to acquire shares or debentures of other entities Cash receipts from sales of shares or debentures of other entities Cash advances and loans made to other parties Cash receipts from the repayment of advances and loans made to other parties Cash payments for or receipts from futures/forward/option/swap contracts except where the contracts are held for dealing purposes, or the payments/receipts are classified as financing activities 2.5.3 Financing activities This section of the statement of cash flows shows the share of cash which the entity's capital providers have claimed during the period. This is an indicator of likely future interest and dividend payments. The standard gives the following examples of cash flows which might arise under these headings: Cash proceeds from issuing shares Cash payments to owners to acquire or redeem the entity's shares Cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short or longterm borrowings Cash repayments of amounts borrowed Cash payments by a lessee for the reduction of the outstanding liability relating to a finance lease 2.6 Reporting cash flows from operating activities The standard offers a choice of method for this part of the statement of cash flows. (a) (b) Direct method: disclose major classes of gross cash receipts and gross cash payments. Indirect method: net profit or loss is adjusted for the effects of transactions of a non-cash 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. Part C Group financial statements 17: Group statements of cash flows 481

The direct method is the preferred method because it discloses information, not available elsewhere in the financial statements, which could be of use in estimating future cash flows. The example below shows both methods. 2.6.1 Using the direct method There are different ways in which the information about gross cash receipts and payments can be obtained. The most obvious way is simply to extract the information from the accounting records. This may be a laborious task, however, and the indirect method below may be easier. 2.6.2 Using the indirect method This method is undoubtedly easier from the point of view of the preparer of the statement of cash flows. The net profit or loss for the period is adjusted for the following. (a) (b) (c) Changes during the period in inventories, operating receivables and payables Non-cash items, eg depreciation, provisions, profits/losses on the sales of assets Other items, the cash flows from which should be classified under investing or financing activities A proforma of such a calculation is as follows and this method may be more common in the exam. Profit before taxation (statement of profit or loss and other comprehensive income) Add depreciation Loss (profit) on sale of non-current assets (Increase)/decrease in inventories (Increase)/decrease in receivables Increase/(decrease) in payables Cash generated from operations Interest (paid)/received Income taxes paid Net cash flows from operating activities $ X X X (X)/X (X)/X X/(X) X (X) (X) X It is important to understand why certain items are added and others subtracted. Note the following points. (a) (b) (c) (d) (e) Depreciation is not a cash expense, but is deducted in arriving at the profit figure in the statement of comprehensive income. It makes sense, therefore, to eliminate it by adding it back. By the same logic, a loss on a disposal of a non-current asset (arising through underprovision of depreciation) needs to be added back and a profit deducted. An increase in inventories means less cash you have spent cash on buying inventory. An increase in receivables means the company's credit customers have not paid as much, and therefore there is less cash. If we pay off payables, causing the figure to decrease, again we have less cash. 2.6.3 Indirect versus direct 12/10 The direct method is encouraged where the necessary information is not too costly to obtain, but IAS 7 does not require it, and favours the indirect method. In practice, therefore, the direct method is rarely used. It is not obvious that IAS 7 is right in favouring the indirect method. It could be argued that companies ought to monitor their cash flows carefully enough on an ongoing basis to be able to use the direct method at minimal extra cost. Exam focus point In December 2010 students were asked to discuss the ethical implications of favouring the indirect method over the direct method. 482 17: Group statements of cash flows Part C Group financial statements

2.7 Interest and dividends Cash flows from interest and dividends received and paid should each be disclosed separately. Each should be classified in a consistent manner from period to period as either operating, investing or financing activities. Dividends paid by the entity can be classified in one of two ways: (a) (b) As a financing cash flow, showing the cost of obtaining financial resources. As a component of cash flows from operating activities so that users can assess the entity's ability to pay dividends out of operating cash flows. 2.8 Taxes on income Cash flows arising from taxes on income should be separately disclosed and should be classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities. Taxation cash flows are often difficult to match to the originating underlying transaction, so most of the time all tax cash flows are classified as arising from operating activities. 2.9 Components of cash and cash equivalents The components of cash and cash equivalents should be disclosed and a reconciliation should be presented, showing the amounts in the statement of cash flows reconciled with the equivalent items reported in the statement of financial position. It is also necessary to disclose the accounting policy used in deciding the items included in cash and cash equivalents, in accordance with IAS 1, but also because of the wide range of cash management practices worldwide. 2.10 Other disclosures All entities should disclose, together with a commentary by management, any other information likely to be of importance. (a) (b) (c) Restrictions on the use of or access to any part of cash equivalents. The amount of undrawn borrowing facilities which are available. Cash flows which increased operating capacity compared to cash flows which merely maintained operating capacity. 2.11 Example of a statement of cash flows In the next section we will look at the procedures for preparing a statement of cash flows. First, look at this example, adapted from the example given in the standard. 2.11.1 Direct method STATEMENT OF CASH FLOWS (DIRECT METHOD) YEAR ENDED 20X7 $m $m Cash flows from operating activities Cash receipts from customers 30,150 Cash paid to suppliers and employees (27,600) Cash generated from operations 2,550 Interest paid (270) Income taxes paid (900) Net cash from operating activities c/fwd 1,380 Part C Group financial statements 17: Group statements of cash flows 483

$m $m Net cash from operating activities b/fwd 1,380 Cash flows from investing activities Purchase of property, plant and equipment (900) Proceeds from sale of equipment 20 Interest received 200 Dividends received 200 Net cash used in investing activities (480) Cash flows from financing activities Proceeds from issuance of share capital 250 Proceeds from long-term borrowings 250 Payment of finance lease liabilities (90) Dividends paid* (1,200) Net cash used in financing activities (790) Net increase in cash and cash equivalents 110 Cash and cash equivalents at beginning of period (Note) 120 Cash and cash equivalents at end of period (Note) 230 * This could also be shown as an operating cash flow 2.11.2 Indirect method STATEMENT OF CASH FLOWS (INDIRECT METHOD) YEAR ENDED 20X7 Cash flows from operating activities Profit before taxation 3,390 Adjustments for: Depreciation 450 Investment income (500) Interest expense 400 3,740 Increase in trade and other receivables (500) Decrease in inventories 1,050 Decrease in trade payables (1,740) Cash generated from operations 2,550 Interest paid (270) Income taxes paid (900) $m $m Net cash from operating activities 1,380 Cash flows from investing activities Purchase of property, plant and equipment (900) Proceeds from sale of equipment 20 Interest received 200 Dividends received 200 Net cash used in investing activities (480) Cash flows from financing activities Proceeds from issue of share capital 250 Proceeds from long-term borrowings 250 Payment of finance lease liabilities (90) Dividends paid* (1,200) Net cash used in financing activities (790) Net increase in cash and cash equivalents c/f 110 484 17: Group statements of cash flows Part C Group financial statements

$m Net increase in cash and cash equivalents b/f 110 Cash and cash equivalents at beginning of period (Note) 120 Cash and cash equivalents at end of period (Note) 230 * This could also be shown as an operating cash flow 20X7 20X6 $m $m Cash on hand and balances with banks 40 25 Short-term investments 190 95 Cash and cash equivalents 230 120 2.12 Criticisms of IAS 7 The main disadvantages of cash accounting are essentially the advantages of accruals accounting (proper matching of related items). There is also the practical problem that few businesses keep historical cash flow information in the form needed to prepare a historical statement of cash flows and so extra record keeping is likely to be necessary. The inclusion of cash equivalents has been criticised because it does not reflect the way in which businesses are managed: in particular, the requirement that to be a cash equivalent an investment has to be within three months of maturity is considered unrealistic. The management of assets similar to cash (ie 'cash equivalents') is not distinguished from other investment decisions. Further issues have been identified by the IASB include the following. (a) (b) (c) Volatility of cash flows. Under accruals accounting, by contrast, uneven inflows and outflows are assigned to the period in which they are earned or incurred. Exclusion of non-cash transactions, such as the acquisition of assets under leases and goods and services acquired in exchange for shares. While it may be possible to modify the cash flow statement to include such transactions, that undermine the purpose of the statement. It would also be difficult to determine which non-cash transactions should be included and which should not. There are many variants of free cash flow. It would probably be difficult to obtain agreement on what is the single measure that should be prescribed by an accounting standard. It would seem likely that no single measure would be the best for all purposes. These deficiencies have led the IASB to consider better disclosures as part of their Disclosure Initiative project. 2.13 ED Disclosure initiative: Proposed amendments to IAS 7 An overview of the IASB s disclosure initiative is given in Chapter 19 on current developments. In December 2014, the IASB published and exposure draft Proposed amendments to IAS 7, the aim of which is to improve information provided to users of financial statements about an entity's financing activities and liquidity. 2.13.1 Improved information about an entity's financing activities, excluding equity items The ED proposes to add a disclosure requirement to IAS 7 for a reconciliation of cash flows arising from financing activities (as reported in the statement of cash flows excluding contributed equity) to the corresponding liabilities in the opening and closing statement of financial position. Part C Group financial statements 17: Group statements of cash flows 485

The reconciliation should include: (a) (b) (c) Opening balances in the statement of financial position Movements in the period Closing balances in the statement of financial position The proposed amendments also include an illustrative example. These proposals were a response to requests from investors for a requirement to be added to IAS 7 that entities should present a net debt reconciliation. Although some of the required information is already available elsewhere in the financial statements, the impact of foreign exchange movements, non-cash items, and business combinations is not always disclosed separately. 2.13.2 Improved disclosures about the liquidity of an entity The ED proposes to extend the disclosures by requiring disclosure of restrictions that affect the decisions of an entity to use cash and cash equivalents, including tax liabilities that would arise on the repatriation of foreign cash and cash equivalent balances. 2.13.3 Changes to the IFRS Taxonomy There ED also proposes changes to the IFRS Taxonomy that would reflect the above amendments. 2.14 Section summary FAST FORWARD Remember the step-by-step preparation procedure and use it for all the questions you practise. Remember the steps involved in preparation of a statement of cash flows. Step 1 Step 2 Step 3 Step 4 Step 5 Step 6 Set out the proforma leaving plenty of space. Complete the reconciliation of operating profit to net cash from operating activities, as far as possible. Calculate the following where appropriate. Tax paid Dividends paid Purchase and sale of non-current assets Issues of shares Repayment of loans Work out the profit if not already given using: opening and closing balances, tax charge and dividends. Complete the note of gross cash flows. Alternatively the information may go straight into the statement. Slot the figures into the statement and any notes required. 486 17: Group statements of cash flows Part C Group financial statements

Question Single company Kane Co's statement of profit or loss and other comprehensive income for the year ended 31 December 20X8 and statements of financial position at 31 December 20X7 and 31 December 20X8 were as follows. KANE CO STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20X8 Sales 720 Raw materials consumed 70 Staff costs 94 Depreciation 118 Loss on disposal of long-term asset 18 300 420 Interest payable 28 Profit before tax 392 Income tax expense 124 Profit for the year 268 KANE CO STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X8 20X7 Assets Property, plant and equipment Cost 1,596 1,560 Depreciation 318 224 1,278 1,336 Current assets Inventory 24 20 Trade receivables 76 58 Bank 48 56 148 134 Total assets 1,426 1,470 Equity and liabilities Equity Share capital 360 340 Share premium 36 24 Retained earnings 686 490 1,082 854 Non-current liabilities Long-term loans 200 500 Current liabilities Trade payables 42 30 Taxation 102 86 144 116 1,426 1,470 During the year, the company paid $90,000 for a new piece of machinery. Required Prepare a statement of cash flows for Kane Co for the year ended 31 December 20X8 in accordance with the requirements of IAS 7, using the indirect method. Part C Group financial statements 17: Group statements of cash flows 487

Answer KANE CO STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20X8 Net cash flow from operating activities Operating profit 420 Depreciation charges 118 Loss on sale of property, plant and equipment 18 Increase in inventories (W4) (4) Increase in receivables (W4) (18) Increase in payables(w4) 12 Cash generated from operations 546 Interest paid (28) Dividends paid (W2) (72) Tax paid (W3) (108) Net cash flow from operating activities 338 Cash flows from investing activities Payments to acquire tangible non-current assets (90) Receipts from sales of tangible non-current assets (W1) 12 Net cash outflow from investing activities (78) Cash flows from financing activities Issues of share capital (W2) 32 Long-term loans repaid (W3) (300) Net cash flows from financing (268) Decrease in cash and cash equivalents (8) Cash and cash equivalents at 1.1.X8 56 Cash and cash equivalents at 31.12.X8 48 1 Assets PPE $ 000 b/d 1,336 Depreciation (non-cash) (118) Disposals* (NBV) (30) Cash paid (given in question but working shown for clarity) 90 β c/d 1,278 *Property, plant and equipment disposals $ 000 Non-current asset cost c/d 1,560 Purchases 90 Disposals (balancing figure) (54) Non-current asset cost c/d 1,596 $ 000 Non-current asset depreciation b/d 224 Depreciation charge for year 118 Depreciation on disposals (balancing figure) (24) Non-current asset depreciation c/d 318 488 17: Group statements of cash flows Part C Group financial statements

NBV of disposals (54 24) 30 Net loss reported (18) Proceeds of disposals 12 2 Equity Share capital (incl premium) Retained earnings $ 000 $ 000 b/d (340 + 24) 364 490 Profit for the year 268 Acquisition of subsidiary Cash received/(paid) β 32 (72) c/d (360 + 36) 396 686 3 Liabilities Long-term borrowings Tax payable $ 000 $ 000 b/d 500 86 P/L 124 Cash (paid)/rec'd β (300) (108) c/d 200 102 4 Working capital changes Inventories Trade receivables Trade payables $m $m $m b/d 20 58 30 Increase 4 β 18 β 12 β c/d 24 76 42 3 Consolidated statements of cash flows Pilot paper, 12/08, 12/10, 12/13 FAST FORWARD Consolidated cash flows should not present a great problem if you understand how to deal with acquisitions and disposals of subsidiaries, non-controlling interest and dividends. Consolidated statements of cash flows follow the same principles as for single company statements, with some additional complications. Cash flows that are internal to the group should be eliminated in the preparation of a consolidated statement of cash flows. Where a subsidiary undertaking joins or leaves a group during a financial year the cash flows of the group should include the cash flows of the subsidiary undertaking concerned for the same period as that for which the group's statement of profit or loss and other comprehensive income includes the results of the subsidiary undertaking. 3.1 Acquisitions and disposals of subsidiaries and other business units An entity should present separately the aggregate cash flows arising from acquisitions and from disposals of subsidiaries or other business units and classify them as investing activities. Part C Group financial statements 17: Group statements of cash flows 489

Disclosure is required of the following, in aggregate, in respect of both acquisitions and disposals of subsidiaries or other business units during the period. Total purchase/disposal consideration Portion of purchase/disposal consideration discharged by means of cash/cash equivalents Amount of cash/cash equivalents in the subsidiary or business unit disposed of Amount of assets and liabilities other than cash/cash equivalents in the subsidiary or business unit acquired or disposed of, summarised by major category The amounts shown in the statements of cash flows for purchase or disposal of subsidiaries or business units will be the amounts paid or received net of cash/cash equivalents acquired or disposed of. 3.2 Consolidation adjustments and non-controlling interest The group statement of cash flows should only deal with flows of cash and cash equivalents external to the group, so all intra-group cash flows should be eliminated. Dividends paid to non-controlling interest should be included under the heading 'cash flow from financing' and disclosed separately. 3.3 Example: Non-controlling interest The following are extracts of the consolidated results for Jarvis Co for the year ended 31 December 20X8. CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME (EXTRACT) Group profit before tax 90 Income tax expense (30) Profit for the year 60 Profit attributable to: Owners of the parent 45 Non-controlling interest 15 60 CONSOLIDATED STATEMENT OF FINANCIAL POSITION (EXTRACT) 20X7 20X8 Non-controlling interest 300 306 Calculate the dividends paid to the non-controlling interest during the year Solution The non-controlling interest share of profit after tax represents retained profit plus dividends paid. Dividends paid to non-controlling interests $ 000 b/d 300 TCI attributable to NCI 15 315 Dividends paid to NCI (balancing figure) (9) c/d 306 Points to note: (a) (b) In this example, there is no other comprehensive income so the total comprehensive income (TCI) here is equal to the profit for the year. On the statement of financial position, the NCI balance includes the NCI share of retained earnings (ie after deduction of dividends). Dividends are not deducted in the statement of profit or loss and 490 17: Group statements of cash flows Part C Group financial statements

other comprehensive income so the NCI share of total comprehensive income is stated before deduction of dividends. Therefore the balancing figure in this working must be the dividends paid to the NCI. 3.4 Associates and joint ventures An entity which that reports its interest in an associate or a joint venture using the equity method includes in its statement of cash flows the cash flows in respect of its investments in the associate or joint venture, and distributions and other payments or receipts between it and the associate or joint venture. Dividends should be included in operating or investing cash flows. 3.5 Example: Associate The following are extracts of the consolidated results of Pripon Co for the year ended 31 December 20X8. CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME (EXTRACT) Group profit before tax 150 Share of associate's profit after tax (60 30) 30 180 Tax (group) 75 Profit after tax 105 CONSOLIDATED STATEMENT OF FINANCIAL POSITION (EXTRACTS) 20X7 20X8 Investment in associate 264 276 Calculate the dividend received from the associate. Solution Investment in associate $ 000 b/d 264 Share of profit after tax (60 30) 30 Dividend received (β) (18) c/d 276 Note. In the statement of financial position, the investment in associate balance includes the group share of the associate s retained earnings (ie after deduction of dividends). Dividends are not deducted in the statement of comprehensive income so the group share of the associate s profit and other comprehensive income (if any) is stated before deduction of dividends. Therefore the balancing figure in this working must be the dividends received from the associate. 3.6 Finance lease transactions When rentals under a finance lease are paid, the interest and capital elements are split out and included under the net cash from operations (interest paid)' and 'financing activities headings respectively. Exam focus point Various complications may arise in a consolidated statement of cash flows in the exam, the most important of which are covered above. The question, given below, is comprehensive. You may also have a written element. The Pilot Paper asked for the preparation of a consolidated statement of cash flows and a report on the usefulness of group statements of cash flows, generally and specifically to the entity in the question. In December 2010 students were asked whether it was acceptable for the proceeds of a loan to be classified as operating cash flow. Part C Group financial statements 17: Group statements of cash flows 491

3.7 Section summary The preparation of consolidated statements of cash flows will, in many respects, be the same as those for single companies, with the following additional complications. Acquisitions and disposals of subsidiary undertaking Cancellation of intra-group transactions Non-controlling interest Associates and joint ventures Finance leases Question Consolidated cash flow 1 Topiary Co is a 40 year old company producing garden statues carved from marble. 22 years ago it acquired a 100% interest in a marble importing company, Hardstuff Co. In 20W9 it acquired a 40% interest in a competitor, Landscapes Co and on 1 January 20X7 it acquired a 75% interest in Garden Furniture Designs. The draft consolidated accounts for the Topiary Group are as follows. DRAFT CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20X7 Operating profit 4,455 Share of profit after tax of associate 1,050 Income from long-term investment 465 Interest payable (450) Profit before taxation 5,520 Tax on profit Income tax 1,173 Deferred taxation 312 (1,485) Profit for the year 4,035 Attributable to: owners of the parent 3,735 non-controlling interest 300 4,035 DRAFT CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X6 20X7 Assets Non-current assets Tangible assets Buildings at net book value 6,600 6,225 Machinery: cost 4,200 9,000 aggregate depreciation (3,300) (3,600) net book value 900 5,400 7,500 11,625 Goodwill 300 Investments in associates 3,000 3,300 Long-term investments 1,230 1,230 11,730 16,455 Current assets Inventories 3,000 5,925 Receivables 3,825 5,550 Cash 5,460 13,545 12,285 25,020 24,015 41,475 492 17: Group statements of cash flows Part C Group financial statements

20X6 20X7 Equity and liabilities Equity Share capital: 25c shares 6,000 11,820 Share premium account 6,285 8,649 Retained earnings 7,500 10,335 19,785 30,804 Non-controlling interest 345 Total equity c/f 19,785 31,149 Total equity b/f 19,785 31,149 Non-current liabilities Obligations under finance leases 510 2,130 Loans 1,500 4,380 Deferred tax 39 90 2,049 6,600 Current liabilities Trade payables 840 1,500 Obligations under finance leases 600 720 Income tax 651 1,386 Accrued interest and finance charges 90 120 2,181 3,726 24,015 41,475 Note 1 There had been no acquisitions or disposals of buildings during the year. Machinery costing $1.5m was sold for $1.5m resulting in a profit of $300,000. New machinery was acquired in 20X7 including additions of $2.55m acquired under finance leases. 2 Information relating to the acquisition of Garden Furniture Designs Machinery 495 Inventories 96 Trade receivables 84 Cash 336 Trade payables (204) Income tax (51) 756 Non-controlling interest (189) 567 Goodwill 300 867 2,640,000 shares issued as part consideration 825 Balance of consideration paid in cash 42 867 3 Loans were issued at a discount in 20X7 and the carrying amount of the loans at 31 December 20X7 included $120,000 representing the finance cost attributable to the discount and allocated in respect of the current reporting period. Required Prepare a consolidated statement of cash flows for the Topiary Group for the year ended 31 December 20X7 as required by IAS 7, using the indirect method. There is no need to provide notes to the statement of cash flows. Part C Group financial statements 17: Group statements of cash flows 493

Answer TOPIARY CO CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20X7 Cash flows from operating activities Net profit before tax 5,520 Adjustments for: Depreciation (W1) 975 Profit on sale of plant (300) Share of associate's profits (1,050) Investment income (465) Interest payable 450 Operating profit before working capital changes 5,130 Increase in trade and other receivables (W4) (1,641) Increase in inventories (W4) (2,829) Increase in trade payables (W4) 456 Cash generated from operations 1,116 Interest paid (W5) (300) Income taxes paid (W3) (750) Net cash from operating activities 66 Cash flows from investing activities Purchase of subsidiary undertaking (W6) 294 Purchase of property, plant and equipment (W1) (3,255) Proceeds from sale of plant 1,500 Dividends from investment 465 Dividends from associate (W1) 750 Dividends paid to non-controlling interest (W2) (144) Net cash used in investing activities (390) Cash flows from financing activities Issue of ordinary share capital (W2) 7,359 Issue of loan notes (W3) 2,760 Capital payments under finance leases (W3) (810) Dividends paid (W2) (900) Net cash flows from financing activities 8,409 Net increase in cash and cash equivalents 8,085 Cash and cash equivalents at 1.1.X7 5,460 Cash and cash equivalents at 31.12.X7 13,545 Workings 1 Assets Buildings Plant and machinery Goodwill Associate Long-term investment b/d 6,600 900-3,000 1,230 P/L 1,050 Dep'n*/ Amort'n/ - β Impairment (375) β (600) Acquisition of sub/assoc - 495 300 Non-cash additions (W3) - 2,550 - Disposals - (1,200) - Cash paid/(rec'd) β - 3,255 β - (750) β c/d 6,225 5,400 300 3,300 1,230 494 17: Group statements of cash flows Part C Group financial statements

*Depreciation charges Accumulated depreciation b/d 3,300 Depreciation on disposal (1,500 1,200*) (300) Depreciation charge (balancing figure) 600 Accumulated depreciation c/d 3,600 *Disposal Proceeds 1,500 Net book value (balancing figure) (1,200) Profit on disposal 300 Freehold buildings ($6,600,000 $6,225,000) = $375,000 Total depreciation charge: ($375,000 + $600,000) = $975,000 Note. The share of the associate s profit, recognised in the consolidated statement of profit or loss and other comprehensive income, is not a cash item so is added back on the face of the statement of cash flows in the section that calculates the cash generated from operations. The dividend received from the associate is the cash item and appears in the investing activities section. 2 Equity Share capital Share premium Retained earnings NCI b/d 6,000 6,285 7,500 - P/L 3,735 300 Acquisition of subsidiary 660 165 189 Cash (paid)/rec'd β 5160 2,199 (900) (144) c/d 11.820 8,649 10,335 345 3 Liabilities Loans Finance lease Tax payable (600 + 510) (651 + 39) b/d 1,500 1,110 690 P/L (W5)120 (1,173 + 312) 1,485 New lease commitment (machinery) 2,550 Acquisition of subsidiary 51 Cash (paid)/rec'd β 2,760 (810) (750) c/d 4 Working capital changes 4,380 2,850 (720 + 2.130) Inventories Receivables 1,476 (1,386 + 90) Payables Balance b/d 3,000 3,825 840 Acquisition of subsidiary 96 84 204 3,096 3,909 1,044 Increase/(decrease) (balancing figure) 2,829 1,641 456 Balance c/d 5,925 5,550 1,500 Part C Group financial statements 17: Group statements of cash flows 495

5 Interest Balance b/d 90 SPLOCI (450 120) (excluding the discount credited to the 330 carrying value of loans) Interest paid in cash (balancing figure) (300) Balance c/d 120 6 Purchase of subsidiary Cash received on acquisition of subsidiary 336 Less cash consideration (42) Cash inflow 294 Note. Only the cash consideration is included in the figure reported in the statement of cash flows. The shares issued as part of the consideration are reflected in the share capital working (W2) above. Question Consolidated cash flow 2 The following are extracts from the financial statements of Tastydesserts and one of its wholly owned subsidiaries, Custardpowders, the shares in which were acquired on 31 October 20X2. STATEMENTS OF FINANCIAL POSITION Tastydesserts Custardpowders and subsidiaries 31 December 31 December 31 October 20X2 20X1 20X2 Non-current assets Property, plant & equipment 4,764 3,685 694 Goodwill 42 Investment in associates 2,195 2,175 7,001 5,860 694 Current assets Inventories 1,735 1,388 306 Receivables 2,658 2,436 185 Bank balances and cash 43 77 7 4,436 3,901 498 11,437 9,761 1,192 Equity Share capital 4,896 4,776 400 Share premium 216 Retained earnings 2,540 2,063 644 7,652 6,839 1,044 Non-current liabilities Loans 1,348 653 Deferred tax 111 180 1,459 833 Current liabilities Payables 1,915 1,546 148 Bank overdrafts 176 343 Current tax payable 235 200 2,326 2,089 148 11,437 9,761 1,192 496 17: Group statements of cash flows Part C Group financial statements

CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20X2 Profit before interest and tax 546 Finance costs Share of profit of associates 120 Profit before tax 666 Income tax expense 126 PROFIT/TOTAL COMPREHENSIVE INCOME FOR THE YEAR 540 Attributable to: Owners of the parent 540 Non-controlling interests 0 540 The following information is also given: (a) (b) (c) (d) The consolidated figures at 31 December 20X2 include Custardpowders. The amount of depreciation on property, plant and equipment during the year was $78,000. There were no disposals. The cost on 31 October 20X2 of the shares in Custardpowders was $1,086,000 comprising the issue of $695,000 unsecured loan stock at par, 120,000 ordinary shares of $1 each at a value of 280c and $55,000 in cash. No write down of goodwill was required during the period. (e) Total dividends paid by Tastydesserts (parent) during the period amounted to $63,000. Required Prepare a statement of cash flows for Tastydesserts and subsidiaries for the year ended 31 December 20X2 using the indirect method. Notes to the statement of cash flows are not required. Answer TASTYDESSERTS STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20X2 Cash flows from operating activities Profit before taxation 666 Adjustments for: Depreciation 78 Share of profit of associates (120) Interest expense 624 Increase in receivables (W4) (37) Increase in inventories (W4) (41) Increase in payables (W4) 221 Cash generated from operations 767 Interest paid Income taxes paid (W3) (160) Net cash from operating activities 607 Cash flows from investing activities Acquisition of subsidiary Custardpowders net of cash acquired (W5) (48) Purchase of property, plant and equipment (W1) (463) Dividends received from associates (W1) 100 Net cash used in investing activities (411) Part C Group financial statements 17: Group statements of cash flows 497

Cash flows from financing activities Dividends paid (63) Net cash used in financing activities (63) Net increase in cash and cash equivalents 133 Cash and cash equivalents at beginning of year (266) Cash and cash equivalents at end of year (133) Workings 1 Assets Property, plant and equipment Goodwill Associate b/d 3,685-2,175 P/L 120 Depreciation/ Impairment (78) - β Acquisition of sub/assoc 694 42 (W5) Cash paid/(rec'd) β 463 - (100) c/d 4,764 42 2,195 Note. The share of the associate s profit, recognised in the consolidated statement of profit or loss and other comprehensive income, is not a cash item so is added back on the face of the statement of cash flows in the section that calculates the cash generated from operations. The dividend received from the associate is the cash item and appears in the investing activities section. 2 Equity Share Retained Share capital premium earnings b/d 4,776-2,063 P/L 540 Acquisition of subsidiary 120 216 Cash (paid)/rec'd β - - (63)* c/d 4,896 216 2,540 *Dividend paid is given in question but working shown for clarity. 3 Liabilities Loans Tax payable (200 + 180) 380 b/d 653 P/L 126 Acquisition of subsidiary 695 - Cash (paid)/rec'd - (160) β c/d 1,348 346 (235 + 111) 4 Working capital changes Inventories Receivables Payables Balance b/d 1,388 2,436 1,546 Acquisition of subsidiary 306 185 148 1,694 2,621 1,694 Increase/(decrease) (balancing figure) 41 37 221 Balance c/d 1,735 2,658 1,915 498 17: Group statements of cash flows Part C Group financial statements

5 Purchase of subsidiary Cash received on acquisition of subsidiary 7 Less cash consideration (55) Cash outflow (48) Note. Only the cash consideration is included in the figure reported in the statement of cash flows. The shares issued as part of the consideration are reflected in the share capital working (W2) above. Goodwill on acquisition (to show no impairment): Consideration: 55 + 695 (W3) + 120 (W2) + 216 1,086 Non-controlling interest - Net assets acquired (1,044) Goodwill 42 Part C Group financial statements 17: Group statements of cash flows 499

Chapter Roundup Statements of cash flows are a useful addition to the financial statements of companies because it is recognised that accounting profit is not the only indicator of a company's performance. Statements of cash flows concentrate on the sources and uses of cash and are a useful indicator of a company's liquidity and solvency. You need to be aware of the format of the statement as laid out in IAS 7. Setting out the format is an essential first stage in preparing the statement, so this format must be learnt. Remember the step-by-step preparation procedure and use it for all the questions you practise. Consolidated cash flows should not present a great problem if you understand how to deal with acquisitions and disposals of subsidiaries, non-controlling interest and dividends. Quick Quiz 1 What is the objective of IAS 7? 2 What are the benefits of cash flow information according to IAS 7? 3 What are the standard headings required by IAS 7 to be included in a statement of cash flows? 4 What is the 'indirect method' of preparing a statement of cash flows? 5 How should an acquisition or disposal of a subsidiary be shown in the statement of cash flows? 500 17: Group statements of cash flows Part C Group financial statements

Answers to Quick Quiz 1 To provide users of financial statements with information about the entity's ability to generate cash and cash equivalents, and the entity's cash needs 2 See Paragraph 2.2 3 Operating, investing and financing activities. 4 The net profit or loss for the period is adjusted for non-cash items; changes in inventories, receivables and payables from operations; and other items resulting from investing or financing activities. 5 Cash flows from acquisitions and disposal are disclosed separately under investing activities. Now try the question below from the Practice Question Bank Number Level Marks Time Q24 Examination 25 49 mins Part C Group financial statements 17: Group statements of cash flows 501

IAS 7 IE Illustrative examples These illustrative examples accompany, but are not part of, IAS 7. A Statement of cash flows for an entity other than a financial institution 1 The examples show only current period amounts. Corresponding amounts for the preceding period are required to be presented in accordance with IAS 1 Presentation of Financial Statements. 2 Information from the statement of comprehensive income and statement of financial position is provided to show how the statements of cash flows under the direct method and indirect method have been derived. Neither the statement of comprehensive income nor the statement of financial position is presented in conformity with the disclosure and presentation requirements of other Standards. 3 The following additional information is also relevant for the preparation of the statements of cash flows: all of the shares of a subsidiary were acquired for 590. The fair values of assets acquired and liabilities assumed were as follows: Inventories 100 Accounts receivable 100 Cash 40 Property, plant and equipment 650 Trade payables 100 Long-term debt 200 250 was raised from the issue of share capital and a further 250 was raised from long-term borrowings. interest expense was 400, of which 170 was paid during the period. Also, 100 relating to interest expense of the prior period was paid during the period. dividends paid were 1,200. the liability for tax at the beginning and end of the period was 1,000 and 400 respectively. During the period, a further 200 tax was provided for. Withholding tax on dividends received amounted to 100. during the period, the group acquired property, plant and equipment and right-of-use assets relating to property, plant and equipment with an aggregate cost of 1,250, of which 900 related to right-of-use assets. Cash payments of 350 were made to purchase property, plant and equipment. plant with original cost of 80 and accumulated depreciation of 60 was sold for 20. accounts receivable as at the end of 20X2 include 100 of interest receivable. B2108 IFRS Foundation