TABBA

The following draft financial statemets relate to TAABA, a private limited company.

Tabba - Statement of financial position

31September 20X5 31 September 20X4

$000 $000 $000 $000
Non current assests
Tangible non current assests 10,600 15,800

10,600 15,800
Current assets
Inventory 2,550 1,850
Trade receivables 3,100 2,600
Insurance claim ( note ii ) 1,500 1,200
Cash and bank 850 8,000 nil 5,650

Total assets 18,600 21,450

Equity and Liabilities

Equity shares of $1 each 6,000 6,000
Reserves
Revaluation ( note ii ) nil 1,600
Retained earnings 2,550 2,550 850 2,450

Equity 8,550 8,450

Non current liabilities
Finance lease obligation (note ii ) 2,000 1,700
Deferred tax 200 500
6% Loan notes 800 nil
10% loan notes nil 4,000
Government grants ( note ii ) 1,400 4,400 900 7,100

Current Liabilities
Trade payables 4,050 2,950
Bank overdraft nil 550
Taxation 100 1,200
Finacnce lease obligations 900 800
Government grants ( note ii ) 600 5,650 400 5,900

Total equity and Liabilities 18,600 21,450

The following information is relevant:
(i) Income statement extract for the year ended 30 September 20X5:
$000
Operating profit before interest and tax 270
Interest expense (260)
Interest receivable 40

Profit before tax 50

Net tax credit 50

Profit for the period 100

Note: the interest expense includes finance lease interest

(ii) The details of the tangible non current assets are:

Cost Accumulated Carrying
Depreciation value
$000 $000 $000
At 30 September 20X4 20,200 4,400 15,800
At 30 September 20X5 16,000 5,400 10,600

During the year Tabba sold its factory for its fair value $ 12 m and agreed to rent it
back, under an operating lease, for a period of five years at $ 1 m per annum. At the
date of sale it had a carrying value fo $7.4 m based on a previous revaluation of $8.6 m
less depreciation of $1.2 m since the revaluation. The profit on the sale of factory has
been included in operating profit. The surplus on revaluation reserve related entirely to
the factory. No other disposals of non current assets were made during the period.

Plant acquired under the finacne leases during the year was $1.5 m. Other purchases of
plant during the year qualified for government grants of $950,000.
Amortization of government grants has been credited to the cost of sales.
(iii) The insurance claims relates to flood damage to the company's inventories which
occurred in September 20X4.

The original estimate has been revised during the year after negotiations with the
insurance company. The claim is expected to be settled in the near future.

Required

(a) Prepare a cash flow statement for Tabba for the year to 30 September 20X5 in
accordance with IAS 7 Cash Flow Statements.
(b) Using the information in the question and your cash flow statement, comment on the
change in the financial position of Tabba during the year ended 30 September 20X5.
TABBA Solution

(a) Cash flow statement of Tabba for the year ended 30 September 20X5
$000 $000
Cash flows from Operating activities
Profit before tax 50
Adjustments for:
Depreciation 2,200
Amortization of government grant (250)
Profit on the sale of factory (4,600)
Increase in insurance claim provision (300)
Interest receivable (40)
Interest expense 260 (2,730)
(2,680)
Working capital adjustments:
Increase in inventories (700)
Increase in trade receiveables (500)
Increase in trade payables 1,100 (100)

Cash outflow from operations (2,780)

Interest paid (260)
Income tax paid (1,350)

Net cash outflow used in operating activities (4,390)

Cash flows from investing activities

Sale of factory 12,000
Purcahse of non current assets (2,900)
Receipt of government grant ( from question) 950
Interest received 40
Net cash flows from investing activities 10,090

Cash flows from financing activites

Issue of 6% loan notes 800
Redemption of 10% loan notes (4,000)
Repayment of finance leases (1,100)

Net cash used in financing activities (4,300)

Net increase in cash and cash equivalents 1,400
Cash and cash equivalents at beginning of the period (550)
Cash and cash equivalents at end of the period 850
(b)
Consideration of the cash flow statement reveals some important information in
assessing the change in the financial position of Tabba in the year ended 30 September
20X5. There is a huge net cashout flows from operating activities of $4,390,000 despite
Tabba reporting a modest operating profit of $270,000. More detailed analysis of this
higher operating cash flows than the underlying operating profit mainly due to
depreciation changes being added back to profits to arrive at the cash flows. This is
ceratinly true in taabba's case, where operating profit have been improved by $2.2 m
during the year in terms of the underlying cash flows.

However, the major reconciling difference is the profit on the sales of Tabba's factory of
$4.6 m. This amount has been credited to the income statement and has dramatically
distorted the operating profit. If the sale and lease back of the factory has not taken
place,Tabba's operating profit would be in a sorry state showing losses of $4.33 m
(ignoring any possible tax effects). When Tabba publishes its financial statements this
profits will almost certainly require separate disclosure which should make the effects of
the transaction more transparent to the user of the financial statements. A further
indication of poor operating profits is that they have been boosted by the $300,000 due
to an increase in the insurance claim provision ( again this is not a cash flow) and
$250,000 amortization of government grants.

Many commentators believe that the net cash flows from operating activities is the most
important figure in the cash flow statement. This is because it is a measure of expected
or maintainable future cash flows. In Tabbas's case this highlights a very important
point; although Tabba has increased its cash position during the year by $1.4 m, $ 12 m
has come from the sale of its factory. Clearly this is a one off transaction that cannot be
repeated in future years. If the drain on the operating cash flows continues at the current
rates, the comapny will not survive for very long.

The tax postion is worty of comment. There is a small tax credit in the income
statement, perhaps due to current year trading losses, whereas the cash flow statement
shows that tax of $1.35 m has been paid during the year. This payment of tax is on what
must have been a substantial profit for the previous year. This seems to confirm the
deteriorating position of the comapny.

Another relevant point is that there has been a very small increase in working capital of
$100,000. However, underlying this the fact both inventories and trade receivables
substantial increase ( despite the profit deterioration), which may indicate the presence of
bad debts or obslolete inventories, and trade payables have also increased substantially (
by $1.1 m ) which may be a symptom of liquidity problems prior to the sale of the
factory.

On the positive side there has been substantial investment in non current assets ( after
allowing for the sale of factory ), but even this is partly due to leasing assets of $1.5 m
(companies often lease assets when they do not have the resources to purchase them
outright) and finance from a government grant of $950,000.

The company appears to have taken advantage of the proceeds from the sale of the
factory to redeem the expensive 10% $4 m loan note (this has partly been replaced by a
less expensive 6% $ 800,000 loan note).
 In the conclusion the cash flow statement reveals some interesting and worrying issues
that may indicate a bleak future for Tabba and serves as a illustration of the importance
of a cash flow statement to the users of financial statements.
Solution : TAABA
Tangible assets a/c Acc. Dep. a/c
Dr. Cr. Dr. Cr.
O/B 20,200 Disp: 8,600 Disp 1,200 O/B 4,400
Lease 1,500 Dep 2,200
Cash 2,900 c/d 5,400
c/d 16,000
24,600 24,600 6,600 6,600
Disposal a/c Lease a/c
Dr. Cr. Dr. Cr.
T.assets 8,600 Acc.dep 1,200 Cash 1,100 O/B 1,700
Gain 4,600 Cash 12,000 C/B 2,000 O/B 800
C/B 900 PPE 1,500
13,200 13,200 4,000 4,000

Revaluation a/c Stock a/c

Dr. Cr. Dr. Cr.
R.E 1,600 O/B 1,600 O/B 1,850
C/B 0 700
C/B 2,550
1,600 1,600 2,550 2,550

Disposal securities a/c 6%Loan a/c

Dr. Cr. Dr. Cr.
Gain 150 Cash 177 O/B 0
Cash 800
Gain 27 C/B 800
177 177 800 800

A/R a/c A/P a/c

Dr. Cr. Dr. Cr.
O/B 2,600 O/B 2,950
Cash 700 C/B 4,050 1,100
C/B 3,100
3,100 3,100 4,050 4,050

Taxation a/c Insurance claim a/c

Dr. Cr. Dr. Cr.
P/L 50 O/B© 1,200 O/B 1,200
Cash 1,350 O/B (D) 500 P/L 300
C/B© 100 C/B 1,500
C/B(D) 200 1,500 1,500
1,700 1,700

Insurance claim a/c Interest receivable a/c

Dr. Cr. Dr. Cr.

260 P/L 260 P/L 40 40

260 260 40 40
10%Loan a/c Govt. grant a/c
Dr. Cr. Dr. Cr.
O/B 4,000 Amorti. 250 O/B 900
4,000 C/B 1400 O/B 400
C/B 0 C/B 600 Cash 950
4,000 4,000 2,250 2,250