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Financial Accounting 2
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Theory:
Theory:
What are the FRS 102 Requirements for Cash Flow statements?
Objective of cash flow statements is to provide information about an entity's ability
to generate cash and cash equivalents; as well as indicating the cash needs of an
entity. The cash flow statement provides historical information about cash and cash
equivalents, classifying cash flows between operating, investing and financing
activities.
Definitions:
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 enterprise and
other activities that are not financing or investing activities
Investing Activities are the acquisition and disposal of non-current 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.
All headings (as above, & per the Cash Flow statement) refer to the CASH flows involved. 6
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· Adding back expenses that were deducted from net income but did not cost anything
(e.g., depreciation expense, amortization expense, and depletion expense);
· Taking out capital gains and losses that do not relate to operations (e.g., profit/loss
relating to the sale of plant assets);
· Taking out expenses that were accrued but not yet paid (e.g. income taxes accrued but
not paid in the current year)
· Taking out expenditures that cost cash but were not expensed this year (e.g., the
purchase of inventory that was not sold or supplies that were not used up, and the
payment of prepaid expenses still outstanding at the end of the year);
· Taking out income that was accrued but not yet received (e.g., credit sales where the
account receivable is still outstanding, accrued interest not yet received); and
· Adding back cash receipts that were not treated as income (e.g. customers payments of
accounts receivable that were generated in a prior year)
With the Direct Method, the cash flow from operations is calculated directly
(from scratch).
With the Indirect Method, however, the cash flow from operations is
calculated by taking the net income of the company and then making
adjustments.
These adjustments are required because net income is calculated using the
accrual method, and we are interested only in cash receipts reduced by cash
disbursements (the cash method).
With the Direct Method, the cash flow from operations is calculated directly
(from scratch).
With the Indirect Method, however, the cash flow from operations is
calculated by taking the net income of the company and then making
adjustments.
These adjustments are required because net income is calculated using the
accrual method, and we are interested only in cash receipts reduced by cash
disbursements (the cash method).
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There are two methods for calculating the first section (Cash Flows from
Operating Activities); the direct method and the indirect method.
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Step 1:
and
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Step1 (a):
The starting point (using the indirect method) is Profit/Loss before Interest & Income Tax.
Depreciation:
In the SOCI depreciation will reduce profit depreciation must be added back to
the
profit/loss figure.
Profit/Loss from sale of tangible non-current assets:
In Step 1 the profit/loss from is adjusted to remove the affect of the non-cash item.
(The actual sale proceeds are then accounted for later in the Statement.)
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Step 1 (b):
Inventory
If Inventory has increased money will have flowed out of the Company an
increase in inventory will be subtracted from starting profit figure.
Receivables
If Receivables have increased money is tied up i.e. Being monies owed by customers
an increase will be subtracted from the starting profit figure.
Payables
If payables have increased, there is a positive cash flow perspective as the suppliers
have not yet been paid.
In all cases account for the effect on the Cash Flow of the Company. 12
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Step 1 (c):
Account for the actual payment in the period, not the charge for same. (You may
have to identify the amount paid through the bank based on information provided)
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Step 2:
2. Proceeds from the sale of tangible non-current assets i.e. The total cash value
actually received (the sale proceeds). (This may need to be calculated/identified)
4. Refer to information provided to identify if there are other relevant cash flows.
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Step 3:
3. Payments of Dividends
4. Refer to information provided to identify if there are other relevant cash flows.
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Always start with the figure for Profit/Loss before Interest and Tax.
(This may need to be identified using the figures from the Statement of changes in
Equity and the additional information – see the question ‘Bubbles Ltd’)
You may need to assess the treatment of non-current assets based on NBV only
depending on the information available.
Workings may be required to identify the values paid, i.e. The cash impact of
transactions e.g. Disposal of assets, acquisition of assets, interest and/or tax paid etc.
The Movement in Cash and Cash equivalents from the start to the end of the period
(shown in your Cash Flow statement) should reflect the difference between the
Opening and Closing balances for Cash and Cash Equivalents in the SOFP.
(Remember to check if there are Cash and Cash Equivalents listed in both Current
Assets and Current Liabilities).
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Remember to identify the movement in the comparative balances in the SOFP i.e.
The differences between opening and closing balances.
Show your workings clearly and note them appropriately so they relate back to the
layout e.g. W1.
Do not go over time allotted time if the statement does not reconcile; return to it and
review the discrepancy, if you have time, at the end of the exam.
Practice the questions (at least three of them) immediately in advance of the exam.
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