LaiACCT1200/Fall 19 (lecture 8)

ADA University, School of Business

ACCT1200 Principles of Financial Accounting, Fall 2019
Lecture 8 – Cash-Flow Statement

 “Money does not grow on trees, but why do banks have branches?”
This lecture is all about money – the cash flow statement.

 Inadequacies of the profit and loss account and balance sheet with respect to the cash flow
and liquidity position of a company:
 The profit shown on the profit and loss account is not a good indicator of the cash or
liquidity position of a company. The reason for this is because the profit and loss
account is prepared on an accrual basis, thus many non-cash items are included in it
such as credit sales; depreciation / amortization; increase or decrease in the
provision for bad and doubtful debts; profit or loss on sales of fixed assets. Thus a
company can show a substantial profit but yet has inadequate cash and vice versa.
In other words, profitability and liquidity are not the same thing.
 Although the balance sheet shows the cash balance at a given date, it does not show
how the cash funds have been generated and used during the accounting year.

 Definition of the term “cash”:

 Under Financial Reporting Standard 1 (FRS1) – cash flow statement, the term “cash”
means cash balances and bank balances. In addition, only current account deposits
can be considered as “cash”; fixed deposits are not included under the term “cash”.

 Purposes of the cash flow statement (a preliminary discussion):

 To show the reasons for the change in the cash and bank balances over the
accounting year.
 To show us where the cash has come from / how it has been generated (sources of
cash funds) and where they have gone to / how it has been used (uses of cash funds).

 Sources and Uses of cash funds of companies.

Sources – cash comes from:
(a) Operating profit for the year before interest, taxation and dividends.
(b) Sales of fixed assets/investments.
(c) Increases in current liabilities.
(d) Decreases in current assets (other than bank and cash).
(e) Introduction of capital.
(f) Loans received.

Uses – cash goes to:

(a) Losses.
(b) Purchase of fixed assets/investments.
(c) Decreases in current liabilities.
(d) Increases in current assets.
(e) Buying-back (redeeming) of shares.
(f) Loans repaid.
(g) Payment of dividends.

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 Format of the cash flow statement – the FRS 1 format:

FRS 1 requires the items that are normally contained in a cash flow statement to be
classified / grouped under seven headings in the following order:
1. Net cash inflow (or outflow) from operating activities.
This refers to the net increase (or decrease) in cash that results from the trading (or
operating) activities of the company.
2 Returns on investments and servicing of finance.
Cash inflows from (returns on) investments consist of interest and dividends
received. Cash outflows from (servicing of) finance consist of interest payable on
loans, bonds and debentures; and dividends paid on preference shares.
3. Taxation.
4. Capital expenditure.
Refers to the cash flows arising from the acquisition and disposal of fixed assets
(should separate receipts from payments and also intangible from tangible fixed
assets).
5. Equity dividends paid.
Refers to the dividends paid on ordinary shares during the year.
6. Management of liquid resources.
Refers to the cash flows arising from the purchase or sale of short term investments
(cash equivalents) such as short-term bank deposits and shares of listed companies.
Only the principal amounts are shown here, the dividends and interest are included in
section 2 above.
7. Financing.
Refers to the cash received and paid in respect of the principal amounts of the
financing activities (issue and redemption of ordinary and preference shares, bonds,
debentures and loans). Cash inflows include the receipts from issuing shares, bonds,
debentures and loans. Cash outflows include the repayment of bonds, debentures,
loans; and payments to redeem (buy-back) the entity’s shares. Only the principal
amounts are shown here, the dividends and interest are included either in sections 2 or
5 above.

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 The layout of the FRS 1 format is as follows:

Poor Lecturer Ltd
Cash flow statement for the year ended 31 December 2015
$ $
Net cash inflow (outflow) from operating activities (see Note 1) X
Returns from investments and servicing of finance:
Dividends received X
Interest received X
Interest paid (X)
Preference dividends paid (X) X
Taxation (X)
Capital expenditure:
Receipts from sale of tangible fixed assets X
Payments to acquire intangible fixed assets (X)
Payments to acquire tangible fixed assets (X) X
Equity dividends paid (X)
Management of liquid resources:
Cash withdrawn from 1 month fixed deposit X
Purchase of government securities (X)
Sale of corporate bonds and shares (other companies’) X X
Financing:
Issue of ordinary share capital X
Issue of preference share capital X
Issue of debenture / bond X
Repurchase of debenture loan (X) X
Increase / (decrease) in cash during the period X

Note to the cash flow statement

1. Reconciliation of operating profit to net cash inflow / outflow from operating activities:
$
Operating profit X
Depreciation charges X
(Profit) / loss on sale of tangible fixed assets X
Increase / (decrease) in provision for bad and doubtful debts X
(Increase) / decrease in stocks X
(Increase) / decrease in debtors X
Increase / (decrease) in creditors X
Net cash inflow (outflow) from operating activities X

 As can be seen from Note 1 (reconciliation of operating profit to net cash inflow /
outflow from operating activities), the “starting point” of all cash flow statements is
operating profit (before interest, taxation and dividends) but we usually have to adjust
the operating profit figure to take account of non-cash items and for changes in the
working capital items (because these changes are not reflected in the profit and loss
account). The non-cash items which need to be adjusted from the operating profit are:
(a) depreciation – this needs to be added back.
(b) provisions for bad and doubtful debts – increase in the provision has to be added
back; decrease in the provision has to be deducted.

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 LaiACCT1200/Fall 19 (lecture 8)

(c) “book” profit / loss on sales of fixed assets, for example:

 book profit – a fixed asset, net book value $5,000 is sold for $6,400 cash, the flow
of cash is $6,400 only. The book profit of $1,400 does not provide any
more cash above the figure of $6,400. Therefore the book profit should be
deducted from the net profit figure.
 book loss – an asset, net book value $3,000 is sold for $2,200 cash, the flow of
cash is $2,200. The book loss of $800 does not mean there is an outflow of $800.
Therefore book loss should be added back to the net profit figure.

 Example:
The following are the balance sheets of Rich Student Ltd as at 31 March 2014 and 31
March 2015:
31 March 2014 31 March 2015
$ $ $ $
Fixed assets at cost 173,000 165,000
Less Accumulated depreciation (46,000) (52,000)
127,000 113,000
Current assets
Stock 48,400 56,700
Debtors 39,100 36,200
Less Provision for bad and
Doubtful debts (1,700) (1,400)
37,400 34,800
Cash and bank 8,600 17,300
94,400 108,800

Current liabilities
Creditors (31,400) (32,800)
Corporation tax (15,700) (18,500)
Proposed dividends (26,200) (29,600)
(73,300) (80,900)
Net current assets 21,100 27,900
148,100 140,900
Long-term liabilities
10% debentures (52,000) (20,000)
Net assets 96,100_ 120,900

Capital and reserves:

Issued and paid up capital
Ordinary shares, $1 par value 50,000 60,000
Reserves
Share premium 18,000 26,000
General reserve 6,400 9,600
Profit and loss account 21,700 25,300
46,100 60,900
Shareholders’ interests 96,100 120,900

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Further information:
(a) Fixed assets which cost $8,000 and had a net book value of $4,200 were disposed
of during the year ended 31 March 2015 at a price of $3,500. There were no other
acquisitions or disposals of fixed assets during the year.
(b) The total depreciation on fixed assets for the year was $9,800.
(c) The corporation tax outstanding at 31 March 2014 of $15,700 was paid on
31 December 2014.
(d) The proposed ordinary dividend at 31 March 2014 of $26,200 was paid on 1 May
2014. In addition, an interim ordinary dividend of $8,600 was paid on 1 October 2014.
(e) During the year, 10,000 ordinary shares were issued at a price of $1.80 each.
(f) The operating profit for the year ended 31 March 2015 is $68,200.
(g) Interest paid during the year was $4,700.

Required: Prepare a cash flow statement for the year ended 31 March 2015

Note to the cash flow statement

1. Reconciliation of operating profit to net cash inflow / outflow from operating activities:
$
Operating profit 68,200
Depreciation charges 9,800
Loss on sale of tangible fixed assets 700
(Decrease) in provision for bad and doubtful debts (300)
(Increase) in stocks (8,300)
Decrease in debtors 2,900
Increase in creditors 1,400
Net cash inflow (outflow) from operating activities 74,400

Hint: Technique of preparing the reconciliation note (note 1):

(a) start with operating profit;
(b) then adjust for non-cash items in the profit and loss account;
(c) then adjust for working capital items (in the balance sheet) which involve inflows or
outflows of cash.

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Rich Student Ltd

Cash flow statement for the year ended 31 March 2015
$ $
Net cash inflow (outflow) from operating activities (see Note 1) 74,400
Returns from investments and servicing of finance:
Interest paid (4,700) (4,700)
Taxation (15,700)
Capital expenditure:
Receipts from sale of tangible fixed assets 3,500 3,500
Equity dividends paid ($26,200 + $8,600) (34,800)
Management of liquid resources: -
Financing:
Issue of ordinary share capital 18,000
Repayment of debenture loan (32,000) (14,000)
Increase in cash during the period 8,700_

 Purposes of the cash flow statement – further discussion:

(a) To show the effects on cash flow of an entity’s operating, investing and
financing activities for a period.
(b) To provide information that assists in the assessment of liquidity, solvency
and financial adaptability.
(c) Useful in assessing the entity’s ability to pay its debts, interest and dividends.
(d) Explain why an entity may have a substantial net profit for the year, but
nevertheless has insufficient cash to pay a large dividend.

Readings:
 Sangster, A; Frank Wood’s Business Accounting 1, 13th edition, 2015, Pearson,
chapter 39.
 Leiwy, D and Perks, R; “Accounting: Understanding and Practice”, 4th edition, 2013,
McGraw-Hill Education, chapter 6.

LaiACCT1200/Fall 19 (Tutorial 8)

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 ADA University, School of Business
ACCT1200 Principles of Financial Accounting, Fall 2019
Tutorial 8 – Cash-Flow Statement

 Issue 1:
1.(a) The following information relates to M Bateer Ltd.:
M Bateer Ltd
Balance Sheets as at
30 June 2014 30 June 2015
$ $ $ $
Fixed assets at cost 27,100 24,200
less Accumulated depreciation 9,350 9,900
17,750 14,300
Current assets
Stock 16,320 17,450
Debtors 9,140 8,360
Less Provision for bad and
doubtful debts (380) (290)
8,760 8,070
Bank 5,210 4,230
Cash 160 190
30,450 29,940
Current liabilities
Trade creditors (4,170) (6,470)
Taxation (6,450) (3,100)
Proposed dividend (4,800) (4,000)
(15,420) (13,570)
Net current assets 15.030 16,370
32,780 30,670
Long-term liabilities
Debentures (4,000) -
28,780 30,670
Capital and reserves:
Issued and paid up capital
Ordinary shares, $1 par value 16,000 17,000
Reserves
General reserve 4,000 5,000
Profit and loss account 8,780 8,670
Shareholders’ interests 28,780 30,670

Notes:
(i) The operating profit for the year ended 30 June 2015 was $8,470.
(ii) Debenture interest paid in the year was $480.
(iii) The depreciation on fixed assets for the year ended 30 June 2015 was $2,100.
(iv) Fixed assets which had cost $2,900 and had a book value of $1,350 were sold for
$1,700 during the year ended 30 June 2015.

LaiACCT1200/Fall 19 (Tutorial 8)

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Required:
Prepare a cash flow statement for the year ended 30 June 2015 for M Bateer Ltd in
accordance with FRS 1. You only need to include Note 1 (Reconciliation of operating profit
to net cash inflow from operating activities) with the cash flow statement in your answer.

1.(b) “A company can show substantial profits in its profit and loss account for a
particular period, but yet has insufficient cash.” What are the possible reasons for this?

 Issue 2:
2.(a) The following information is taken from the records of Central Asia Ltd.:
Central Asia Ltd
Balance Sheets as at 31 December
2014 2015
$ $ $ $ $ $
Fixed assets at cost 16,250 14,090
less depreciation 6,070 10,180 5,310 8,780
Current assets
Stock 9,170 12,040
Debtors 4,040 6,310
Less Provision for bad debts 160 3,880 290 6,020
Bank 8,020 1,880
21,070 19,940
Less Current liabilities
Proposed dividend 4,000 3,000
Taxation 3,980 2,070
Trade creditors 2,270 10,250 10,820 1,440 6,510 13,430
21,000 22,210
Debentures 3,000 -
18,000 22,210

Issued share capital 10,000 13,500

General reserve 3,750 5,750
Profit and loss account 4,250 2,960
18,000 22,210

Profit and Loss Account for the year ended 31 December 2015
$ $
Profit on ordinary activities before tax* 5,780
Tax on profit on ordinary activities 2,070
3,710
Undistributed profits from last year 4,250
7,960
Transfer to general reserve 2,000
Proposed dividend 3,000 5,000
Undistributed profits carried to next year 2,960

LaiACCT1200/Fall 19 (Tutorial 8)

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Additional information:
(a) Profit takes into account depreciation $1,040; also loss on asset sold for $200 which had
cost $2,160 and been depreciated $1,800.
(b) The company redeems all its outstanding debentures at the beginning of the year, thus
no interest was required to be paid on them.

Required:
Prepare a cash flow statement for the year ended 31 December 2015 for Central Asia Ltd
in accordance with FRS 1. You only need to include Note 1 (Reconciliation of operating
profit to net cash inflow from operating activities) with the cash flow statement in your
answer.

2.(b) Outline the purposes of the cash flow statement.