9. statement of cash flows

ACCA PAPER F7 - INTERNATIONAL PREPARING FINANCIAL STATEMENTS – STATEMENT OF CASH FLOWS

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IAS 7 - STATEMENT OF CASH FLOWS

INTRODUCTION

An important additional financial statement that shows how changes in assets, liabilities, equities, income and expenses account affect cash and cash equivalents.

The preparation of Statement of Cash Flows is prescribed by IAS 7.

It shows the sources and uses of cash flows and acts as a useful indicator of liquidity and solvency.

It complements the importance of financial information which was neglected in accrual accounting.

It shows the ability of the company to generate cash, efficient uses of cash, solvency and the business survival.

It can drag users’ attention to critical issues occurred by business entity.

It carry more financial information as compared to ‘profit’ alone as income statements was prepared using accrual accounting prescribed by GAAP and conventions.

It is a better means to be used as comparative measurement between companies within same industry as compared to ‘profit’ since ‘profit’ was affected by differences accounting policy adopted by different companies.

It has broad perspective of usability with straight-forward message than can be easily understood by all users.

Forecast made using cash flows is easier to understand and more useful than ‘profit’ forecast.

It is easier to audit than ‘profit’.

Relying only on accounting ‘profit’ can be misleading for example if the company’s profit was $1 billion, users might think that the company will be able to pay them with high dividend. However, this will not always be true since the ability to pay dividend depend on the sufficient cash position of the company.

1. DEFINITION OF ELEMENTS IN STATEMENT OF CASH FLOWS i) Cash = Cash on hand and demand deposits. ii) Cash equivalents = short-term, highly liquid investment, readily convertible to cash and no significant risk

of change in value (normally an investment that has < 3 mths maturity). iii) Operating activities = principal revenue-producing activities. iv) Investing activities = acquisition and disposal of NCA and other non-cash equivalent investments. v) Financing activities = activities that can change the equity capital and borrowings. 2. PRESENTATION OF STATEMENT OF CASH FLOWS i) Statement of cash flows comprises of 3 sections of activities as follow:

i) Operating activities: Shows the cash movement from operations. Translate the ‘profit’ from operations into cash from operations. Shows ability of the company to generate cash from operations. Shows the movement and efficiency of working capital.

ii) Investing activities: Shows new investment in assets that will generate future profit and cash flows. Show disposal and proceeds from disposal for assets.

iii) Financing activities: Shows the sources of cash flows components either from equity or borrowings. Shows the payment made to equity holders and lenders. Shows the possible outcome for future dividend or interest.

ii) Cash flows can be presented in 2 method: i) Direct method:

Shows gross cash receipts from sales and services. Shows payment to trade and other creditors. Shows payment to employees and other charges e.g. taxes and interest.


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More useful and preferable presentation but not widely applied by company due to more costly to prepare.

ii) Indirect method: Shows any adjustment to profit to reflect non-cash items. Show any adjustment made to profit for any deferrals or accruals of cash receipts and

payments. Shows any adjustment made to profit for income and expenses related to investing and

financing activities. Widely applied method by companies because it is easier to prepare.

3. PREPARING STATEMENT OF CASH FLOWS

Preparing statement of cash flows will involves extracting the movement of cash from statement of financial position, statement of profit or loss and other comprehensive income and statement of changes in equity.

It will be affected from the changes in cash movement from all activities (i.e. operating, financing and investing) such as cash movement in inventory, trade receivables, investment income and etc.

To prepare operating activities, the sources of financial items for changes in cash movement will come from statement of profit or loss and other comprehensive income and current assets and liabilities (to reflect the working capital changes) such as items classified in CA, CL and adjustment of PBT to reflect both non-cash items (e.g. depreciation and amortization) and non-operating items (e.g. gain on disposal of PPE).

To prepare investing activities, the sources of financial items for changes in cash movement will come from non-current assets items in consolidated statement of financial position (e.g. PPE, Intangible assets and etc).

To prepare financing activities, the sources of financial items for changes in cash movement will come from non-current liabilities and equity items in consolidated statement of financial position and consolidated statement of changes in equity (e.g. Finance leases, borrowings, share capital and etc).

All non-cash items in the above mention FS should be removed in SCF such as deferred tax liability, amortised finance cost or income, depreciation and etc.

LECTURE EXAMPLE 1 –STATEMENTS OF CASH FLOWS Contoh PLC manufactures toys and children education merchandises. The followings are the draft financial statement of Contoh PLC for the reporting period ended 31 December 2011. STATEMENT OF PROFIT OR LOSS FOR THE YEAR

$ million

Revenue 120

Cost of sales (50)

Gross profit 70

Investment income (interest) 10

Distribution costs (20)

Administrative expenses (20)

Finance costs (15)

Profit before tax 25

Income tax expenses (2)

Profit for the year 23

STATEMENT OF FINANCIAL POSITION

$ million $ million

2011 2010

Non-current Assets

Property, plant and equipment (ii) 400 320

Intangible assets 260 180


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Fair value to profit or loss investments (i) - 40

Current assets

Inventories 180 120

Trade receivables 360 270

Short-term investments (v) 60 -

Cash 20 5

Total assets 1,280 935

Equity and liabilities

Ordinary shares of $1 each (iv) 300 200

Share premium (iv) 200 150

Revaluation surplus 80 60

Retained earnings 150 145

Non-current liabilities

Long-term borrowings 150 80

Provision (iii) 50 -

Current liabilities

Trade payables 140 100

Overdraft 80 100

Income tax payable 130 100

Total equity and liabilities 1,280 935

Following are additional information for the preparation of statement of cash flow: i) The financial asset was sold at $38 million and the differences between the carrying amount and its fair

value at disposal was accounted into finance cost. There were no changes in fair value of the investment since the beginning until disposal.

ii) During the year ended, equipment with a carrying amount of $25 million was sold at $30 million. The equipment was acquired in previous 10 years at $50 million. The depreciation was included into cost of sales for the year ended at $30 million.

iii) The provision was related to future dismantling and restoration of site from extracting ore minerals. This amount was taken at its present value at 10% cost of capital at the year ended. The cost was included into initial cost of the plant above.

iv) Ordinary share capital was issued during the year at 50% premium. No bonus or right issues during the year ended.

v) The cash and cash equivalent includes all short-term investments that will mature within 6 months from investment.

vi) Dividends of 6 cents per share (all issued shares) were paid during the year ended. Required Prepare a statement of cash flows for the year to 31 December 2011 according to IAS 7. Step by Step Solution NB: IAS 7 has given the preparer a choice to prepare SOCF in direct or indirect. This example will prepare the SOCF in indirect method Step 1 – Compute the gain or loss on disposal of FVTPL investment (to be adjusted for cash from operating activities computation). $ million

Sales proceeds 38

Carrying amount 40


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Loss (2)

Step 2 - Compute the gain or loss on disposal of equipment (to be adjusted for cash from operating activities computation). $ million

Sales proceeds 30

Carrying amount 25

Gain 5

Step 3 – Compute the movement in inventories by comparing the different between the opening and closing balance (to be used later in arriving to cash from operations) $ million

Bal. b/d 120

Bal. c/d (180)

Increased (cash outflows) (60)

Step 4 – Compute the movement in trade receivables by comparing the different between the opening and closing balance (to be used later in arriving to cash from operations) $ million

Bal. b/d 270

Bal. c/d (360)

Increased (cash outflows) (90)

Step 5 – Compute the movement in trade payables by comparing the different between the opening and closing balance (to be used later in arriving to cash from operations) $ million

Bal. b/d 100

Bal. c/d (140)

Increased (cash inflows) 40

Step 6 – Compute the movement in income tax liabilities (should include deferred taxes if any) by comparing the different between the opening and closing balance (to be used later in arriving to cash from operations) $ million

Bal. b/d 100

Income tax expenses 2

Bal. c/d (130)

Refund (cash inflows) 28

Step 7 - Compute the movement in finance cost (should include deferred taxes if any) by comparing the different between the opening and closing balance (to be used later in arriving to cash from operations) $ million

Bal. b/d -

I/S 15

Loss on disposal of FVTPL (2)

Interest income (per Q) (10)

Bal. c/d -

Paid (3)


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Step 8 – Pass the necessary adjustment to the profit for the year in order to obtain the cash flows from operation by 1) eliminating all non-cash gain or losses; 2) all results from non-operating activities e.g gain on disposal of property; and 3) changes in the working capital i.e. inventories etc. $ million

Profit before tax (as per Q) 25

Adjustment for:

(+) Depreciation (as per Q) 30

(+) Loss on disposal – FVTPL (Step 1) 2

(-) Gain on disposal – PPE (Step 2) (5)

(+) Finance cost –net (15 -2 - 10) 3

Adjusted profit 55

Increase in inventories (Step 3) (60)

Increase in trade receivables (Step 4) (90)

Increse in trade payables (Step 5) 40

Cash generated from operations (55)

Income tax refund (Step 6) 28

Finance cost paid (Step 7) (3)

Net cash from operating activities (30)

Step 9 - Compute the movement in property, plant and equipment by comparing the different between the opening and closing balance (to be used later in arriving to cash flows from investing) $ million

Bal. b/d 320

(-) depreciation (30)

(-) Disposal (25)

(+) Revaluation (80 – 60) 20

(+) Provision 50

Bal. c/d (400)

Purchases / acquistion (65)

Step 10 - Compute the movement intangible assets by comparing the different between the opening and closing balance (to be used later in arriving to cash flows from investing). $ million

Bal. b/d 180

Bal. c/d (260)

Purchases (80)

Step 11 – Compute the cash flows from investing activities by comparing the opening and the closing balances for all NCA items in the CSOFP. Limited to all cash and CE transaction only. $ million

Purchases of PPE (Step 9) (65)

Purchases of Intangible assets (Step 10) (80)

Sales proceeds - FVTPL 38

Sales proceeds - PPE 30

Net cash used in investing activities (77)


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Step 12 - Compute the movement in ordinary shares capital + share premium by comparing the different between the opening and closing balance (to be used later in arriving to cash flows from financing). $ million

Bal. b/d (200 + 150) 350

Bal. c/d (300 + 200) (500)

Issued 150

Step 13 - Compute the cash flows from financing activities by comparing the opening and the closing for all NCL and Equity items in the CSOFP. Limited to all cash and CE transaction only. $ million

Cash from issuance of shares (Step 12) 150

Cash from long-term borrowings (80 – 150) 70

Dividends payment ($0.06 @ 300 m) (18)

Net cash from financing activities 202

Step 14 – Prepare the CSOCF for the year ended 31 December 2011 $ million $ million

Profit before tax (as per Q) 25

Adjustment for:

(+) Depreciation (as per Q) 30

(+) Loss on disposal – FVTPL (Step 1) 2

(-) Gain on disposal – PPE (Step 2) (5)

(+) Finance cost –net (15 -2 - 10) 3

Adjusted profit 55

Increase in inventories (Step 3) (60)

Increase in trade receivables (Step 4) (90)

Increse in trade payables (Step 5) 40

Cash generated from operations (55)

Income tax refund (Step 6) 28

Finance cost paid (Step 7) (3)

Net cash from operating activities (30)

Investing Activities

Purchases of PPE (Step 9) (65)

Purchases of Intangible assets (Step 10) (80)

Sales proceeds - FVTPL 38

Sales proceeds - PPE 30

Net cash used in investing activities (77)

Financing Activities

Cash from issuance of shares (Step 12) 150

Cash from long-term borrowings (80 – 150) 70

Dividends payment ($0.06 @ 300 m) (18)

Net cash from financing activities 202

Increased in cash and cash equivalents 95

Cash and cash equivalent at beginning (100 – 5) (95)

Cash and cash equivalent at year ended (80-60-20) 0

Adjust. of non-cash items included in P/L

Changes in CA & CL items other than interest and taxes

Balancing figure

Most figures derived from P/L, CA & CL

items

Most figures derived from NCA items

Most figures derived from EQUITY & NCL

items


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4. INTERPRETATION OF STATEMENTS OF CASH FLOWS

Showing information of relations between the profit for the year (accrual method) and cash generated from operation.

Sources of Cash and cash equivalent can be clearly shown from all the three activities e.g. the ability to generate cash from operations.

The used of cash and cash equivalent can be clearly shown from investing and financing activities e.g. purchased of PPE.

Solely dependent on the profit figure is fatal error in interpreting company’s health, since profit is not made from cash i.e. accrual items comprises of prepayments, receivables, depreciation, non-cash gains and etc.

Cash flows information provides better picture of company’s well-being.

A healthy company can generate high profit and at the same time generate cash inflows.

A healthy company can generate cash from operations through resources available from investing and financing activities.

High cash from operation usually indicate that the company will be able to settle its short-term and long-term commitments e.g. payables and interest of bonds.

Cash form all the 3 activities should be ‘read’ together as one set of information (i.e. triangulation) rather than single independent financial information.

9. statement of cash flows

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