Statement of cash flows

CHAPTER 10
DEFINITION
A statement of cash flows is a component of financial
statements summarizing the operating, investing and
financing activities of an entity.
It provides information about the cash receipts and
cash payments of an entity during a period.
Purpose of statement of cash flows
The primary purpose of a statement of cash flows is to
provide relevant information about cash receipts and
cash payments of an entity during a period.
Cash flow information is useful in assessing the ability
of the entity to generate cash and cash equivalents.
Cash and cash equivalents
Cash – comprises cash on hand and demand deposits.
Cash equivalents – short-term highly liquid
investments that are readily convertible into known
amount of cash and which are subject to an
insignificant risk of changes in value. (PAS 7, par. 6)
PAS 7,paragraph 7, provides that an investment
normally qualifies as a cash equivalent only when it
has a short maturity of three months or less from date
of acquisition.
Examples of cash equivalents
a. Three-month BSP treasury bill
b. Three-year BSP treasury bill purchased three months
before date of maturity
c. Three-month time deposit
d. Three-month money market instrument

 Note that what is important is the date of purchase which

should be three months or less before maturity.
 Preference shares with specified redemption date and
acquired three months before redemption date can qualify
as cash equivalents.
Components of cash and cash equivalents
An entity shall disclose the components of cash and
cash equivalents and shall present a reconciliation of
the amounts in the statement of cash flows with the
equivalent items reported in the statement of financial
position.
Necessity to disclose the accounting policy.
Classification of cash flows
The statement of cash flows shall report cash flows
during the period classified as operating, investing
and financing activities.
Classification by activity provides information that
allows users to assess the impact of those activities on
the financial position of the entity and the amount of
its cash and cash equivalents.
Operating activities
Operating activities are the cash flows derived primarily from the
principal revenue producing activities of the entity.
Examples:
a. Cash receipts from sale of goods and rendering of services
b. Cash receipts from royalties, rental, fees, commissions and other revenue
c. Cash payments to suppliers for goods and services
d. Cash payments for selling, administrative and other expenses
e. Cash receipts and cash payments of an insurance enterprise for
premiums and claims, annuities and other policy benefits
f. Cash payments or refunds of income taxes unless they can be
specifically identified with financing and investing activities
g. Cash receipts and payments for securities held for dealing or trading
purposes
Trading securities
PAS 7, paragraph 15, provides that cash flows arising
from the purchase and sale of dealing or trading
securities are classified as operating activities.
Investing activities
Investing activities are the cash flows derived from the acquisition and
disposal of long-term assets and other investments not included in cash
equivalent.
Examples:
a. Cash payments to acquire property, plant and equipment , intangibles
and other long-term assets.
b. Cash receipts from sales of property, plant and equipment, intangibles
and other long-term assets.
c. Cash payments to acquire equity or debt instruments of other entities and
interests in joint ventures (current and long-term investments).
d. Cash receipts from sales of equity or debt instruments of other entities
and interests in joint venture.
e. Cash advances and loans to other parties (other than advances and loans
made by financial institution).
Investing activities
Examples:
f. Cash receipts from repayment of advances and loans
made to other parties.
g. Cash payments for future contract, forward contract,
option contract and swap contract.
h. Cash receipts from future contract, forward contract,
option contract and swap contract.
Financing activities
Financing activities are the cash flows derived from
the equity capital and borrowings of the entity. It result
from transactions:
a. Between the entity and the owners – equity
financing
b. Between the entity and the creditors – debt
financing
Financing activities
Examples:
a. Cash receipts from issuing shares or other equity
instruments
b. Cash payments to owners to acquire or redeem the
enterprise’s shares
c. Cash receipts from issuing debentures, loans, notes,
bonds, mortgages, and other short or long term
borrowings.
d. Cash payments for amounts borrowed.
e. Cash payments by lessee for the reduction of the
outstanding principal lease liability.
Noncash transactions
PAS 7, paragraph 43, provide that investing and
financing transactions that do not require use of cash
or cash equivalents shall be excluded from the
statement of cash flows.
Such transactions shall be disclosed elsewhere in the
financial statements either in the notes to financial
statements or in a separate schedule or in a way that
provides all relevant information about these
transactions.
Noncash transactions
The following noncash transactions are disclosed
separately:
a. Acquisition of asset either by assuming directly
related liability or by means of a lease.
b. Acquisition of asset either by means of issuing share
capital or bonds payable.
c. Conversion of debt to equity, for example conversion
of bonds payable to share capital.
d. Conversion of preference share to ordinary share.
Interest
PAS 7, paragraph 33, provides that interest paid and interest
received shall be classified as operating cash flows because
they enter into the determination of net income or loss.
Alternatively, interest paid may be classified as financing cash
flow because it is a cost of obtaining financial resources.
Alternatively, interest received may be classified as investing
cash flow because it is a return on investment.
For a financial institution, interest paid and interest received
are usually classified as operating cash flows.
Cash flows from interest paid and interest received shall be
classified in a consistent manner from period to period as
either operating, investing or financing activities.
Dividends
PAS 7, paragraph 33, provides that dividend received shall be classified
as operating cash flows because it enters into the determination of net
income or loss.
Alternatively, dividend received may be classified as investing cash
flow because it is a return on investment.
PAS 7, paragraph 34, provides that dividend paid shall be classified as
financing cash flow because it is a cost of obtaining financial resources.
Alternatively, dividend paid may be classified as operating cash flow in
order to assist users to determine the ability of the entity to pay
dividends out of operating cash flows.
The classification of dividend received and dividend paid as either
operating, investing or financing activity shall be made on a consistent
manner from period to period.
Income taxes
PAS 7, paragraph 35, provides that cash flows arising
from income taxes shall be separately disclosed as
cash flows from operating activities unless they can be
specifically identified with investing and financing
activities.
Reporting cash flows from operating
activities
PAS 7, paragraph 18, provides that an entity shall
report cash flows from operating activities using either
a. the direct method, whereby major classes of gross
cash receipts and gross cash payments are disclosed;
or
b. the indirect method, whereby the 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.
Direct method
The direct method shows in detail or itemizes the
major classes of gross cash receipts and gross cash
payments.
The cash receipts are listed one by one, the cash
payments are listed one by one, and the difference
represents the net cash flow from operating
activities.
The direct method is the “cash basis” income
statement.
PAS 7, paragraph 19, provides that entities are
encouraged to report cash flows from operating
activities using the direct method because it provides
Direct method
Following is a general format of the operating activities
section of a statement of cash flows.
Cash flows from operating activities
Cash receipts from customers P xx
Cash paid to suppliers and employees (xx)
Cash paid for other expenses (xx)
Cash generated from operations P xx
Interest paid (xx)
Income taxes paid (xx)
Net cash from operations P xx
PAS 7, paragraph 32, provides that interest paid is
disclosed separately whether it has been recognized in
profit or loss or capitalized. Paragraph 35 provides that
income tax paid is also disclosed or presented
separately.
Direct method
A summary of typical computations follows.
Accrual basis Adjustment required Cash basis
Net sales + Accounts receivable, = Cash receipts from
beg customers
- Accounts receivable,
end
- Customer advances,
beg
+ Customer advances,
end
Cost of sales + Inventory, end = Cash paid to suppliers
+ Accounts payable, beg
- Inventory, beg
- Accounts payable,
end
Operating expense + Prepaid expense, end = Cash paid for operating
(e.g. insurance, + Accrued expense, beg expense
wages) - Prepaid expense, beg
- Accrued expense,
Direct method
A summary of typical computations follows.

Accrual basis Adjustment required Cash basis

Other income (e.g. + Unearned income, end = Cash received from other
Rent, Commission) + Accrued income, beg income
- Unearned income, beg
- Accrued income, end
Interest expense + Interest payable, beg = Cash paid for interest
+ Amortization of
premium on
bonds payable
- Interest payable, end
- Amortization of
discount on bonds
payable
Income tax expense + Income tax payable, = Cash paid for income tax
beg
- Income tax payable,
end
- Deferred tax asset, beg
+ Deferred tax asset, end
+ Deferred tax liability,
Indirect method
Under the indirect method, the net cash flow from operating
activities is determined by adjusting the profit or loss for the
effects of:
a. Changes in current assets (other than cash and cash
equivalents) and current liabilities involved in the
company’s operating cycle that affected cash flows
differently than profit;
b. Non-cash items such as depreciation, deferred taxes,
unrealized foreign currency gains and losses, undistributed
earnings of associates; and
c. All other items for which the cash effects are investing or
financing cash flows
Indirect method
This method provides a useful link between the
statement of cash flows and the profit or loss in the
statement of comprehensive income and the account
balances listed in the statement of financial position.
Most accountants prefer this method for the ease and
convenience in its preparation.
Indirect method
An operating activities section of a statement of cash flows using the
indirect method is presented below.
Cash flows from operating activities:
Profit before income tax P xx
Adjustments for
Depreciation xx
Foreign exchange loss xx
Income from associates (xx)
Interest expense xx
Increase in trade and other receivables (xx)
Decrease in inventories xx
Decrease in trade payables (xx)
Cash generated from operations P xx
Interest paid (xx)
Income taxes paid (xx)
Net cash from operations P xx
Indirect method
Common Adjustments to Profit Before Tax
Items that appear as Explanation of cash vs. Adjustment
adjustments to profit income tax effect
before tax
Depreciation, Expense items that Add to profit
depletion, amortization decrease profit but have
of intangibles no cash effect
Interest income Item that increases profit Deduct from profit
but is required to be
reported separately
Income from associates Item that increases profit Deduct from profit
but has no cash effect
Gain (or loss) on sale The gain increases (loss Deduct gain from (add
of assets decreases) profit but the loss to) profit
cash effect is shown in
investing activities
section
Indirect method
Common Adjustments to Profit Before Tax
Items that appear as Explanation of cash vs. Adjustment
adjustments to profit income tax effect
before tax
Interest expense Item that decreases profit Add to profit
but is required to be
reported separately
Increase in trade Represents revenue Deduct from profit
receivables recognized for the period
with no corresponding
cash receipts
Decrease in trade Represents cash receipts Add to profit
receivables from revenue of previous
periods
Increase in inventory Portion of purchases for Deduct from profit
the period does not form
part of cost of sales;
hence, profit is increased
Indirect method
Common Adjustments to Profit Before Tax
Items that appear as Explanation of cash vs. Adjustment
adjustments to profit income tax effect
before tax
Decrease in inventory Cost of sales includes goods Add to profit
purchased and paid in prior
years
Increase in prepaid Payments during this period Deduct from profit
expenses exceed related expenses shown
in profit or loss
Decrease in prepaid Expenses recognized during Add to profit
expenses this period exceed related
payments for goods and
services
Increase in trade Expenses exceed related Add to profit
payables and accrued payments to suppliers and
expenses others
Decrease in trade Cash payments to suppliers and Deduct from profit
payables and accrued others exceed related expenses
expenses
Presentation of operating, investing and
financing activities
The direct method and indirect method are applicable
only to operating activities.
PAS 7, paragraph 21, provides that an entity shall
report separately major classes of gross cash receipts
and gross cash payments arising from investing and
financing activities using the direct method.
Illustration – Operating activities
Simple Company reported the following comparative statement
of financial position and income statement for 2017.
Assets 2017 2016
Cash 3,000,000 2,000,000
Accounts receivable 940,000 350,000
Inventory 175,000 100,000
Prepaid insurance 15,000 20,000
Property, plant and equipment 2,000,000 2,000,000
Accumulated depreciation (550,000) (500,000)
Patent 40,000 50,000
Total assets 5,620,000 4,020,000
Illustration – Operating activities
Liabilities and Equity 2017 2016
Accounts payable 170,000 150,000
Accrued salaries payable 25,000 10,000
Accrued interest payable 10,000 15,000
Income tax payable 350,000 250,000
Unearned rent income 10,000
40,000
Mortgage payable 500,000 500,000
Share capital 2,000,000 2,000,000
Retained earnings 2,555,000 1,055,000
Total liabilities and equity 5,620,000 4,020,000
 Income Statement
Year ended December 31, 2017
Sales 6,500,000
Cost of goods sold:
Inventory – January 1 100,000
Purchases 3,200,000
Goods available for sale 3,300,000
Inventory – December 31 (175,000) 3,125,000
Gross income 3,375,000
Rent income 80,000
Total income 3,455,000
Expenses:
Salaries 950,000
Insurance 40,000
Other expenses 500,000
Depreciation 50,000
Amortization of patent 10,000
Interest expense 55,000 1,605,000
Income before tax 1,850,000
Income tax 350,000
Net income 1,500,000
Direct method – operating activities
Cash received from customers 5,910,000
Rent received 50,000
Cash payments to merchandise creditors (3,180,000)
Salaries paid (935,000)
Insurance paid (35,000)
Other expenses paid (500,000)
Cash generated from operations 1,310,000
Interest paid (60,000)
Income tax paid (250,000)
Net cash provided by operating activities 1,000,000
Indirect method – operating activities
Net income 1,500,000
Increase in accounts receivable (590,000)
Increase in inventory (75,000)
Decrease in prepaid insurance 5,000
Increase in accounts payable 20,000
Increase in accrued salaries payable 15,000
Decrease in accrued interest payable (5,000)
Increase in income tax payable 100,000
Decrease in unearned rent income (30,000)
Depreciation 50,000
Amortization of patent 10,000
Net cash provided by operating activities 1,000,000
Comprehensive illustration
Illustrar Company provided the following statement of financial
position at year-end and other financial data relating to activities
during the current year.
Assets 2017 2016
Cash and cash equivalents 600,000 200,000
Accounts receivable, net of allowance 1,100,000 1,040,000
Notes receivable – trade 150,000 200,000
Inventory 1,200,000 1,360,000
Prepaid expenses 110,000 120,000
Investment in equity securities, at cost 300,000 500,000
Property, plant and equipment 3,400,000 2,000,000
Accumulated depreciation (900,000) (600,000)
Patent – 80,000
Total assets 5,960,000 4,900,000
Comprehensive Illustration
Liabilities and Equity 2017 2016
Accounts payable 880,000 840,000
Notes payable - trade 60,000 240,000
Accrued expenses 100,000 330,000
Note payable – bank (short term debt) 400,000 –
Share capital, P100 par 3,000,000
2,400,000
Share premium 530,000 400,000
Retained earnings 990,000 790,000
Treasury shares, at cost – (100,000)
Total liabilities and equity 5,960,000
4,900,000
Comprehensive Illustration
The statement of retained earnings for the year ended
December 31, 2017 showed the following:
Retained earnings – January 1 790,000
Net income for 2017 1,000,000
Total 1,790,000
Cash dividend paid (800,000)
Retained earnings – December 31 990,000
Additional information
The entity sold an investment in equity securities for P240,000
cash. There were no other transactions affecting the investment in
equity securities.
Land was purchased in the current year for P1,200,000, paying
P1,000,000 cash and issuing P200,000 share capital at par value.
Equipment costing P200,000 and having a carrying amount of
P80,000 was sold for P60,000 cash.
Equipment of P400,000 was purchased for cash.
The entity borrowed P400,000 from a bank to be paid June 30,
2018.
Share capital with par value of P400,000 was issued for cash at a
premium of P100,000.
The treasury shares were reissued for P130,000 cash.
The patent was fully amortized.
 Illustrar Company
Statement of Cash Flows
Year ended December 31, 2017

Cash flows from operating activities:

Net income 1,000,000
Increase in accounts receivable (60,000)
Decrease in notes receivable 50,000
Decrease in inventory 160,000
Decrease in prepaid expenses 10,000
Gain on sale of investment (40,000)
Loss on sale of equipment 20,000
Depreciation 420,000
Amortization of patent 80,000
Increase in accounts payable 40,000
Decrease in notes payable (180,000)
Decrease in accrued expenses (230,000)
Net cash provided by operating activities 1,270,000
 Illustrar Company
Statement of Cash Flows
Year ended December 31, 2017

Cash flows from investing activities:

Sale of investment 240,000
Sale of equipment 60,000
Purchase of land (1,000,000)
Purchase of equipment (400,000)
Net cash used in investing activities (1,100,000)
Cash flows from financing activities:
Cash received from bank loan 400,000
Issuance of share capital 500,000
Reissuance of treasury shares 130,000
Payment of cash dividend (800,000)
Net cash provided by financing activities 230,000
Increase in cash and cash equivalents 400,000
Add: Cash and cash equivalents – January 1 200,000
Cash and cash equivalents – December 31 600,000
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