where shares are issued for cash,it becomes a source of funds while preparing a

funds flow statement but it is not an item ofincomefor an income statement.

(iii) Sources of funds are many besides operations such as share capital,
statement
results fixed
of operations
sale of assets, etc. An income which
cannot even accurately tell about the funds from discloses
debentures,
operations alone because of non-fund items(such as depreciation, writing of
etc.) being included therein.
of fictitious assets, have different
funds flow statement
Thus, both income
statement
management needs
and
both. One cannot be a substitute functions
efor the other to
rathe
perform. Modern
to each other.
they are complementary
OF FUNDS FLOW STATEMENT
PREPARATION
statement, it is necessary to find out the 'sources' and
funds flow
In orderto prepare a
"applications' offunds.
Sources of Funds
can be both internal as well as external.
The source of funds only internal source of funde
from operations are the
1. Internal Sources Funds be required in the figure of net profit for finding out
However, following adjustments will
real funds from operations: outflow of funds:
Add the following items as they do not result in
(a)
assets
() Depreciation on fixed
Preliminary expenses or goodwill, etc., written off
(i)
debenture redemption fund, transfer to general reserve. etc.if
(ü) Contribution to arriving at the figure of net profit
they have been deducted beforeproposed dividend are usuallv taken as
and
(iv) Provision for taxation and not current liabilities for the puposes af
appropriation of profits only
statement. This is being discussed in detail later. Tax or dividends
funds flow applications of funds. Similarly interim dividend
actually paid are taken as these items will be added backto
application of funds. All
paid is shown as an from operations.
net profit, if already deducted, to find funds
(v) Loss on sale of fixed assets
increase funds:
(b) Deduct the following items as they do not proceeds are taken asa
full sale
) Profit on sale of fixed assets, since the will result in duplication
separate source of funds and inclusion here
dividend.
(i) Profit on revaluation of fixed assets accrued
(i) Non-operating incomes, such as dividend received or items increase
These under
refund of income tax, rent received or accrued rent. be ashown
funds but they are non-operating incomes. They will
funds flow statement.
separate heads as 'source of funds' in the
itet
as an
should be taken
In case the profit and loss account shows 'net loss', this
which decreases the funds.
 PREPARATION OF FUNDS FLOW STATEMENT
Inorder to prepare a funds flow statement, it is necessary to find out the 'sources ana
'applications' of funds.

Sources of Funds
The source of funds can be both internal as well as external.
1. Internal Sources Funds from operations are the only internal source of funds
However, following adjustmentswill be required in the figure of net profit for finding out
real funds from operations:
(a) Add the following items as they do not result in outflow of funds:
) Depreciation on fixed assets
(i) Preliminary expenses or goodwill, etc., written off
(ü) Contribution todebenture redemption fund, transfer to general reserve, etc., if
they have been deducted before arriving at the figure ofnet profit
(iv) Provision for taxation and proposed dividend are usually taken as
appropriation of profitsonly and not current liabilities for the purposes of
funds flow statement. This is being discussed in detail later. Tax or dívidends
actually paid are taken as applications of funds. Similarly interim dividend
paid is shown as an application of funds. All these items wil be added back to
net profit, if already deducted, to find funds from operations.
(v) Loss on sale of fixed assets
(b) Deduct the following items as they do not increase funds:
() Profit on sale of fixed assets, since the full sale proceeds are taken
separate source of funds and inclusion here will result in duplication
(i) Profit on revaluation of fixed assets
(iü) Non-operating incomes, such as dividend received or accrued dividend,
refund of income tax, rent received or accrued rent. These items increase
funds but they are non-operating incomes. They will be a shown under
separate heads as 'source of funds' in the funds flow statement.
In case the profit and loss account shows 'net loss', this should be taken as an item
which decreases the funds.
 Funds Flow Statement 3.79

ILUSTRATION22.1. From the following profit and loss account, compute the funds from
operations:
Profit and Loss Account
Particulars
Particulars
ToSalaries 5,000 By Gross Profit b/d 1,000
To Rent
2,000 By Rent 5,000
ToDepreciation 1,000 By Interest on Investments 4,000
To Preliminary Expenses 2,000 By Net Loss 5,000
sale ofland 5.000
To Loss on
15,000 15.000

SoLUTION:
Funds from Operations

Net Loss as per Profit and Loss A/c ()5,000

Add: Items which do not decrease funds: 1,000
Depreciation
Preliminary Expenses 2,000
Loss on Sale of Land 5,000 8,000
3.000
Funds from Operations
It may be noted that the two items 'Rent' and 'Interest on Investments' are strictly, not items of operating
incomes. In case it is desired to calculate funds from operations' in astrict sense,any non-operating income wil have
dIso to be excluded while finding out funds from operations. Such items will be shown as aseparate source under the
cau Non-operating Incomes' in the funds flow statement. In the present Illustration the items wvill then appear in
the funds flow statement as
follows:
Funds Flow Statement

Sources: 9,000
Funds from Non-operating
ions: of Funds on accountIncomes
ApplicatOutflow of operations 3,000 -79,000) 6,000

Increase in Working 3,000

Capital
Tutorial Note:
an The students may not interpret the term 'funds from operations so
strictly. They may solve

examination problemn as per solution given in thefirst alternative.

lNenSdeTRdA3|TION 2.2. The net
The folowinMag rcitems:
h 2007 amounts
profitafter making aprovision
toD3,00,000. This figure of the
of
net
3,30,000
profit
for
has
Income
been
Tax
arrived
of Tata Ltd for the vear
at after taking into account
3.80 Funds Flow Statement

Depreciation on Fixed Assets 65,000

Preliminary Expenses written off 1,000
Bad debts 1,000
Loss on sale of furmiture 1,500
Profit on sale of long-term investments S,.000
Calculate Funds from Operations.
SoLUTION: Funds from Operations

Profit after Tax 3,00,000

65,000
Add: Depreciation on Fixed Assets
7,000
Preliminary expenses written off
Loss on sale of furniture 1,500
73,500
3,73,500
Less: Profit on sale of Long-term Investments 5,000
3,68,500
Funds from Operations
on 31 December 2006 and31
ILLUSTRATION2.3. Following are the extracts from the balance sheet ofa company as
December 2007. You are required to calculate funds from operations:
Balance Sheet
as on 31 December

As on 31 December
2006 2007

30,000 40,000
Profit and Loss Appropriation Account 25,000
20,000
General Reserve s000
10,000
Goodwill 4.000
6.000
Preliminary Expenses 10,000 12,000
Provisions for Depreciation on Machinery
SoLUTION:
Funds from Operations

40,000
Profit and Loss Appropriation A/c balance as on 31December 2007
Add: Items which do not decrease funds: S.000
Transfer to General Reserve 5,000
Goodwill written off 2000
Preliminary Expenses written off 2000
Provision for Depreciation on Machinery s4000
30000
Less: Profit and Loss Appropriation A/c balance as on 31 December 2006 24000
Funds from Operations
account:
andloss
The funds from operations can also be found out by preparing an adjusted profit
 Funds Flow Statement 3.81

Adjusted Profit and Loss Account

Particulars Particulars
GeneralReserve S,000 By Balance b/d 30,000
To Transferto
writtenoff S,000 By Funds from Operations
ToGoodwill
Expenseswrittenoff 2,000 (bal. fig.) 24,000
ToPreliminary
Depreciation 2.000
To Provision for
ToBalancecld 40,000
S4,000 54,000

2. External Sources These sources include:

() Funds from long-term loans Long-term loans, such as debentures,
borrowings from financial institutions, will increase the working capital and
therefore, there will be flow of funds. However, if the debentures have been
issued in consideration of some fixed assets, there will be no flow of funds.
(i) Sale of fixed assets Sale of land, buildings, long-term investments will result
in generation of funds.
(iü) Funds from increase in share capital Issue of shares for cash or for any other
current asset results in increase in working capital and hence there will be
flow of funds.

Applications of Funds
The uses to which funds are put are called 'applications of funds'. Following are some of
the purposes for which funds may be used:
1. Purchase of fixed assets Purchase of fixed assets such as land, building, plant,
machinery and long-term investments, results in decrease of current assets without any
decrease in current liabilities. Hence, there will be a flow of funds. But in case shares or
debentures are issued for acquisition of fixed assets, there will be no flow of funds.
2. Payment of dividend Payment of dividend results in decrease of a fixed liability
and, therefore, it affects funds. Generally, recommendation of directors regarding
declaration of dividends (i.e.,proposed dividends) is simplytaken as an appropriation of
profits and not as an item affecting the working capital. This has been explained in detail
later.
3. Payment of fixed liabilities Payment ofa long-term liability, such as redemption of
debentures or redemption of redeemable preference shares, results in reduction of working
Capital and hence it is taken as an application of funds.
4. Payment of tax liability Provision for taxation is generally taken as an appropriation
Uproñts and not as an application of funds. But if the tax has been paid, it will be taken 2s
application of funds. This has been explained in detail later.

Techni
A q ue for Preparing a Funds FlowStatement
funds flow statement depicts change in working capital. It will, therefore,
ior the be better
students
to prepare first a schedule of changes in working capital before
Preparing a funds flow statement.
 Statenent
Funds Flow
Schedule of Changes in
3.82 Working Capital The schedule of changes in working capital
the current assets and the current
comparing
prepared by following form:
can be may be in the
periods. It
liabilities of two
Ttems
as on
Change
Increase
Decrease
Current Assets:
Cash balance
Bank balance
Marketable Securities
Accounts Receivable

Stock-in-trade
Prepaid Expenses
CurrentLiabilities:
Bank Overdraft
Outstanding Expenses
Accounts Payable
Working Capital:
Net Increase Decreasein
the schedule: capital:
increase (+) in 'workingcapital'.
Rules of preparing current asset, results in 'working
(i) Increase in a current asset,results in decrease ( in 'working capital'
(i) Decrease in acurrent liability, results in decrease ( in
(iüi) Increase in a current liability, results increase (+) in
'working capital':.
(iv) Decrease in a flow statement, current assets and
cumat
funds
Funds Flow Statement
While preparing a
to be given to changes in fixed assets and fixt
Attention is
liabilities are to be ignored. prepared in the following form:
may be
liabilities. The statement
Funds Flow Statement

Sources of Funds:
Issue of Shares
Issue of Debentures
Long-termn Borrowings
Sale ofFixed Assets
Operating Profit*
Total Sources
Applications of Funds:
Redemptionof Redeemable Preference Shares
Redemption of Debentures
Payment of other Long-term Loans
Purchase of Fixed Assets
Operating Loss*
Payment of Dividends, Tax, etc. TotalUses
-Total Uses)
Net Increase/Decrease in Working Capital (Total Sources-

* Only one of the figures will be there.

 Funds Flow Statement 3.83

funds flow
statement can also be prepared in T' shape form as shown below:
The Funds Flow Statement

Particulars Particulars

Surces ofFunds: Applications of Funds:

Issue ofShares Redemption of Redeemable
IssueofDebentures Preference Shares
Long-termBorrowings Redemption of Debentures
SaleofFixedAssets Payment of Other Long-term Loans
OperatingProfit* Purchase of Fixed Assets
Capital* Operating Loss*
Decreasein Working Payment of Dividends, Tax, etc.
Increase in Working Capital*
figures will be there.
Only one of the
The change in working capital, as disclosed by the 'schedule of changes in working
capital', willtally with the change disclosed by 'funds flow statement'.
TREATMENT OF PROVISION FOR
TAXATION AND PROPOSED DIVIDENDS
Provision of Taxation
Ih the chapter on 'Financial Statement: Analysis and Interpretation' we have studied that
the provision for taxation is a current liability. While preparing a funds flow statement, there
are two options available:
) Provision for taxation may be taken as a current liability. In such a case, when
provision for taxationismade, the transaction involves profit and loss appropriation
account, which is a fixed liability and provision for taxation account, which is a
current liability. It will thus decrease the working capital. On payment of tax there
willbenochange in working capital because it will involve one current liability (i.e.,
provision for tax) and the other current asset (i.e., bank or cash balance).
FTovision for taxation may be taken only as an appropriation of profit. It
heans there will be no change in working capital position when provision
Or tax is made since it will involve two fixed liabilities, i.e., profit and loss
PPropriation account and provision for taxation account. However, when
tax is paid, it will be taken as application of funds, because it will then
involve 'provision for taxation account' which has been taken as afixed li-
6.t may be ability and bank account' which is acurrent asset.
noted that AS: 3 'S"Statement of Changes in Financial Position,' [now replaced by AS 3
IRevised):both
aowed
one
Cash Flow Statements] issued bythe Institute of Chartered Accountants of ndia,
ormat it the options given above. Itgave two formats in the Appendix attached to AS: 3. In
prhatovitshieon for showed
Tax Payment of dividends' in the funds flow statement as an application, while
as a current
liability in the schedule for changes in working capital. It meant
taken as proposed
a
dividends was taken as a non-current liability while provision for tax was
applications current
of f funds'liability. In the second format it showed both dividends and tax paid as

lCearIousntr-acltyuiNrtehnetaccount
. In other Words proposed dividends and provision forpresentation
taxation were taken
onlmannery anding in no way prescriptive. Other methods of presentation may equally comply
with he liabilities. Moreover, it was also stated that methods of used are

standard.
in which theThe
format used should be selected with a view to demonstrate
financiacial resources have been obtained and
utilized.
 Funds Flow Statement
3.84

Dividends
Proposed
Whatever has been, said about the
'provision
for
'proposed dividends.' Proposed dividends can also be taxation' is
() Proposed dividends may be taken as a
dealt
with in two also applicable to
dividends by the shareholder in a
declared in the general meeting, they will have simplycurrentsince ways:
liability
formality.
Once the
their declaration. In case proposed dividend is to be paid
will appear as one of the items
decreasing
working capital
within
taken as a current 30 are
of
of
ddeicvliadreantidosdnays
applicationschhaebdilultyfeunds
changes in working capital'. It will not be in the
when dividend is paid later on. as an shown t
of
(i) Proposed dividends may simply be taken as an of
a case proposed dividend for the current year will be
year's profits in order to find out funds from
appropriation
of
added bprofits. In such
operations if such back to
has already been charged to
'application of funds.'
profits. Payment of dividend will
be of diCurvidasendentan
amountshown
ILLUSTRATION 2.4. Fromn the following balance sheets as on31
December 2006 and 31
required to prepare a schedule of changes in the working capital and afunds flow December
(i) the provision for tax and proposed dividends as non-current liabilities
(ii) the provision for tax and proposed dividends as current liabilities
statement taking: 2007,yout
Balance Sheet
as on 31December
2006 2007
Liabilities Assets 2007

Share Capital 10,000 15,000 FixedAssets 10.000 20,00

Profit and Loss Account 4,000 6,000 Current Assets 13.000 450
Provision for Tax 2,000 3,000
Proposed Dividends 1,000 1,500
Sundry Creditors 4,000 6,000
Outstanding Expenses 2,000 3,000
23,000 34,500 23.000

Additional Information:
00
Tax paid during 2007 TI.00
Dividends paid during 2007
SOLUTION:
(i) When provision for tax and proposed dividends are taken as non-current liabilittes?
Schedule of Changes in Working Capital Decrease(
Increase(t)
Particulars 200

Sundry Creditors
Outstanding Expenses 1,500
Current Assets 1500 3000
Decrease in Working Capital 3.000
 Funds Flow Statement 3.85
Funds Flow Statement

Sources Capital
IncreaseinShare
Funds from Operations: 5,000
Net Profit
2,000
Provision for Tax made during
(<3,000 +2,500-2,000)
theyear Dividends
Add:Proposed 3,500
1,500 7,000
Total Sources
Applications: 12,000
Fixed assets purchased
Tax paid 10,000
Dividends paid 2,500
1,000
Total Applications
13,500
Net Decrease in Working Capital
1,500
i When provision for tax and proposed dividends are taken as current liabilities:

Schedule of Changes in Working Capital

Particulars Increase (+) () Decrease
Sundry Creditors 2,000
Outstanding Expenses 1,000
Current Assets 1,500
Provision for Tax
1,000
Proposed Dividends 500
Decrease in Working Capital 3,000
4.500 4.500

Funds Flow Statement 000)

Particulars

Sources:
Increase in Share Capital $,000
Funds from Operations 2,000
Total Sources 7,000
ApplPurchase
ications: of
Fixed Assets 10,000
Decrease in Working Capital 3,000

Alternative Solutionfor tor dividends,

any appropriations
to
(i): Sometimes
etc. In such
and making
it is desired to showthe real funds from operations before tax
acase proposed dividends and provision for tax are first added back
an profit if
application.already
subtracted l and then any tax or dividend paid for the year or outstanding for the year is shown as
The funds flow statement, intheabove illustration, will appear as follows if this altermate approach is followed.
3.86 Funds Flow Statement

Funds Flow Statement

Particulars

Sources:
Increase in Share Capital
Funds from Operations:
Net Profit
Add: Provision for Tax made during the year 2,000
Proposed Dividends for the year 3,500
1500
Applications:
Fixed assets purchased
Tax paid and outstanding for the year (500 + 3,000)*
(Aj12,000
Dividends paid and outstanding for the year (0+ 1,500)*
3509
150
Decrease in Working Capital (4)- (B) (B1S09
* Provision for tax 300
was2,000 last yea. Tax paid amounts to2,500 this year. It
year. Aprovision of3,5,500 has been made during the year. means excess
for the year therefore amounts to 3,500. In Thus,3,000 is still outstanding. Tax of500 relates to this
other words, whatever was added to the paid and outstanding
ascertaining 'real funds from operations' has been shown amount
as an application. The net effect is zero. of net Profits for
to proposed dividends. The same ammi
It has become customary to take
funds from operations should be foundprovisions for tax as a charge against profits for
out after tax. However, where accounting purposes. Hencg
liability, above approach in respect ofit may be adopted.
the proposed dividend is taken as a curet

Tutorial Note: Students are advised to state their

presumptionsclearly. However, where trom the questiont
is implied that these liabilities are to betaken ascurrent
liabilities(e.g., the
current iabilities in the balance sheet, the students are advised to treatitems have been put under the heating
them as current liabilities. We bave
generally taken these two itens as non-current liabilities.
In case the balance sheet contains the anount ofproposed dividends as well as the amount of
provisat
for taxation', it can be presumed that the proposed dividends and 'provisions for taxation'
appearg in e
year's balance sheet must have been paid during the year in the absence of any other intomatot. t
presumption should generally be made at least for proposed dividends.

Example: The following are extracts from the balance sheets of acompany on two dieru
dates:
December
As on 31 December Ason31
Liabilities 2008
2007
80.000
Profit and Loss A/c 50,000 15,000
Provision for Taxation 10,000 10,000
Proposed Dividends 5,000 follows
Computedas non
On the basis of above information funds from operations will be aretakenas
in those cases, where 'provision for taxation' and 'proposed dividends'
current liabilities.