INTERMEDIATE ACCOUNTING 3 (AE 17)

LEARNING MATERIAL

UNIT NUMBER/ HEADING: STATEMENT OF CASH FLOWS

Presentation of Content

CONCEPTS OF STATEMENT OF CASH FLOWS

 Statement of cash flows is a component of financial statements summarizing the

operating, investing and financing activities of an entity
 It provides the information about the cash receipts and cash payments of entity during
the period. It explains the nature of change in an entity’s cash and cash equivalents.
 Frequently given as an additional statement; supplementing the statement of financial
position, statement of profit or loss and other comprehensive income and related
notes.
 Should be presented as an integral part of an entity’s financial statements

IAS 7 Statement of Cash Flows which aims:

o to provide information to users of financial statements about the entity’s
ability to generate cash and cash equivalents.
o Requires an entity to present a statement of cash flows as an integral part of its
primary financial statements.
The standard gives the following 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.

THE 3 CLASSIFICATION OF CASH FLOWS

1. Operating activities are the principal revenue-producing activities of the entity and
other activities that are not investng or financing activities.
- most of the components of cash flows from operating activities will be those items
which determine the net profit or loss of the entity.
Examples are:
 Cash receipts from the sale of goods and the rendering of services

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  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 for taxes
 Cash payments for interest expense
 Cash payments for other operating expenses

An entity reports cash flows from operating activities using either:

o Direct method, whereby major classes of gross cash receipts and gross cash payments
are disclosed; or
o Indirect method, whereby 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.
- this 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:
a. Changes during the period in inventories, operating receivables and
payables;
b. Non cash items, e.g. depreciation, provisions,
profits/losses on the sales of the assets
c. Other items, the cash flows from which should be classified under
the investing or financing activities
- proforma of such calculation is as follows:

Cash flows from operating

activities x
Profit before x
taxation
xx
Adjustments for:
xx
Depreciation (xx
Foreign exchange )
loss Investment xx
income xx
Increase in trade and other
Interest expense
receivables (xx
Decrease in inventories )
Decrease in trade xx
payables (xx
Cash generated from )
operations Interest paid xx
Income taxes paid (xx
Net cash from operating activities )
(xx
)
xx
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 It is important to understand why certain items are added and others subtracted. Note the
following:
a. Depreciation is not a cash expense but is deducted in arriving at profit. It makes sense,
therefore, to eliminate it by adding it back.
b. By the same logic, a loss on a disposal of a non-current asset (arising through under
provision of depreciation) needs to be added back and a profit deducted.
c. An increase in inventories means less cash – you have spent cash on buying
inventory.
d. An increase in receivables means the company’s debtors have not paid as much, and
therefore there is less cash
e. If we pay off payables, causing the figure to decrease, again we have less cash.
2. Investing Activities are the acquisition and disposal of long-term assets
and other investments not included in cash equivalents. Examples are:
 Cash payments to acquire property, plant and equipment, intangibles and other non-
current assets, including those relating to capitalized development costs and self-
constructed property, plant and equipment
 Cash receipts from collections of notes receivable
 Cash receipts from sales of property, plant and equipment,
intangibles and other non-current 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
3. Financing activities are activities that result in changes in the size and
composition of the contributed equity and borrowings of the equity. Examples are:
 Cash proceeds from issuing shares
 Cash payments to owners to acquire or redeem the entity’s sharea
 Cash proceeds from issuing debentures, loans, notes, bonds, mortgages and
other short or long-term borrowings
 Principal repayments of amounts borrowed under leases. (amounts as
financing acitivities are repayment of the principal while payment of interest
will be shown under operating activities)

Other matters
 Trading securities

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o Cash flows arising from the purchase and sale of dealing or trading securities are
classified as operating activities. Similarly, with cash advances and borrowings
made by financial institutions since they relate to the main revenue producing
activity.
 Interests
o Interest paid and interest received shall be classified as operating cash flows.
Alternatively, interest paid may be classified as financing cash flow as it is a cost of
borrowing funds, while interest received may be classified as investing as a return on
investment.
 Dividends
o Dividend received shall be classified as operating cash flow, alternatively, may be
classified as investing cash flow because it is a return on investment.
o Dividend paid shall be classified as financing cash flow because it is a cost of
obtaining financial resources, alternatively, may be classified as operating cash flow.
 Income taxes
o Separately disclosed as cash flows from operating activities unless they can be
specifically identified with investing and financing activities.

PROBLEM ILLUSTRATION
Illustration 1
Riverdale Company provided the following data for the current year:
a. Purchased a building for 1,200,000
Paid 400,000 and signed a mortgage with the seller for the remaining balance.
b. Executed a debt-equity swap and replaced a 600,000 loan by giving the lender
ordinary shares worth 600,000 on the date swap was executed.
c. Purchased land for 1,000,000. Paid 350,000 and issued ordinary shares worth
650,000.
d. Borrowed 550,000 under a long-term loan agreement
Used the cash from the loan proceeds to purchase additional inventory of 150,000, to
pay cash dividend 300,000 and increase cash balance of 100,000

Compute for the cash inflow and outflow from Operating, Investing and Financing
activities.
Step 1: Identify if transactions are cash or noncash transactions a. Cash
400,000 Noncash 800,000
b. Noncash
c. Cash 350,000 Noncash 650,000
d. Cash 550,000
Step 2: Identify the cash transactions as inflow or outflow
a. Outflow 400,000
b. NA
c. Outflow 350,000

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 d. Inflow 550,000 Outflow 450,000

Step 3: Identify what kind of activity is the cash transaction

a. Investing
b. NA
c. Investing
d. Financing and Operating
Step 4: Combine the same group of activities and compute for the net cash
provided or (used).
Operating:
Purchase of inventory (150,000)

Net cash used in Operating activity (150,000)

Investing:
Purchase of building (a) (400,000)
Purchase of land (c) (350,000)
Net cash used in Investing activities (750,000)
Financing:
Proceeds of long-term loan (d) 550,000
Payment of dividends (d) (300,000)
Net cash provided by financing activities 250,000

Observe the following:

1. A transaction may result to one or more kind of activity, refer to transaction
(d), affecting both financing and operating.
2. A transaction may be classified as both cash and noncash transaction, refer to
transaction (a) and (c), and again only cash transactions are taken into consideration.
3. Purchase and payments are negative or deductions while proceeds or receipts are
positive or additions.

Example of a Statement of Cash Flows

Direct Method
ABC Company Statement of
Cash Flows
For the month ended July 31, 2020

Cash flows from Operating Activities:

Cash received from clients P30,330
Cash paid to suppliers and employees (27,600)
Cash generated from operations 2,730
Interest paid ( 270)
Income taxes paid ( 900)
Net cash from operating activities 1,560

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Cash flows from Investing Activities:
Purchase of property, plant and equipment (P 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
Dividends paid* (1,290)
Net cash used in financing activities ( 790)
Net increase in cash and cash equivalents 290
Cash and cash equivalents at the beginning of period 120
Cash and cash equivalents at end of period 410

*This could also be shown as an operating cash flow

Indirect Method

ABC Company Statement of

Cash Flows
For the month ended July 31, 2020
(amounts in millions)

Cash flows from operating activities

Profit before taxation P 3,570
Adjustments for:
Depreciation 450
Investment income ( 500)
Interest expense 400
3,920
Increase in trade and other receivables ( 500)
Decrease in inventories 1,050
Decrease in trade payables ( 1,740)
Cash generated from operations 2,730
Interest paid ( 270)
Income taxes paid ( 900)
Net cash from operating activities 1,560

Cash flows from investing activities

Purchase of PPE ( 900)
Proceeds from sale of equipment 20

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 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
Procees from long-term borrowings 250
Dividends paid* ( 1,290)
Net cash used in financing activities ( 790)
Net increase in cash and cash equivalents 290
Cash and cash equivalents at beginning period 120
Cash and cash equivalents at end of period 410

*This could also be shown as an operating cash flow

Advantages of Cash Flow Accounting

The advantages of cash flow accounting are:

a. Survival in business depends on the ability to generate cash. Cash flow accounting
directs attention towards this critical issue.
b. Cash flow is more comprehensive than profit which is dependent on accounting
conventions and concepts
c. Creditors (lon adn 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.
d. Cash flows reporting provides better means of comparing the results of different
companies than traditional profit reporting.
e. Cash flow reporting satisifies the needs of all user
f. Cash flow forecasts are easier to prepare, as well as more useful, tha profit forecasts
g. They can in some respects be audited more easily than accounts based on the accruals
concept