statement of cash flows reading

8/6/2019 Statement of Cash Flows Reading

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Anne Itotia, rsm

MBA Social Entrepreneurship & ManagementFINANCIAL ACCOUNTING

Statements of Cash Flows

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Introduction

The two key financial objectives of every entity are to operate profitably and stay liquid and solvent;therefore, each organization should be keenly aware of their cash inflows and outflows.

The statement of financial position reflects the financial position of an entity at a particular point intime. To some extent, the statement of financial position may be able to reflect the liquidity and

solvency of an accounting entity. Users of accounting information, however, require more

information to enable them assess the ability of an entity to meet her obligations as and when theyfall due. This need is best served through the preparation and presentation of a statement of cash

flows.

Unlike the statement of financial position and the statement of income, which are required by the

Companies Act, the statement of cash flows is a requirement of the International Financial ReportingStandards, International Accounting Standard No.7 in particular. The statement of cash flows orstatement of sources and application of funds or statement of changes in financial position is not a

legal requirement.

The Income StatementThis is designed to measure the results of operations of an entity in meeting its profit objective for agiven period of time. The statement of income is based on accrual accounting. Therefore, the

revenues, expenses, gains, and losses reported in the statement of income do not necessarily represent

cash inflows and outflows. In general, five distinct classes of items cause differences between income

flows and cash flows:

1. Items that appear on the statement of income that do not represent cash inflows and outflow,such as depreciation, amortization expense and depletion. Such items are referred to as non-cash items.

2. Operating cash flows that do not appear on the statement of income but appear instead on thestatement of financial position as prepayments, deferrals, unearned revenue, or reductions ofaccruals.

3. Credit items that have been included in the calculation of operating profit but do not affect thecash inflows and outflows in the same period. Examples include credit sales, credit purchasesand accrued expenses.

4. Activities that result in changes in size and composition of equity capital and borrowings ofthe enterprise. Such activities referred to as financing activities, usually affect cash but maynot be reflected fully in the statement of income. Examples include the issuing of shares,

redemption of shares, borrowings and repayment of the principal amount borrowed.

5. Activities that result in the acquisition and disposal of long term assets and other investmentsnot included in cash equivalents. Such activities, referred to as investing activities, usuallyaffect cash flows but may not be fully reflected on the statement of income. Examples include

the purchase or sale of equity and or debt instruments of other enterprises and the purchase or

sale of items of property, plant and equipment.


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Cash Flow Statement

The basic purpose of a Statement Cash Flows is to provide information about the sources and

application of cash and cash equivalents of an entity. Information about cash receipts and cashpayments of an entity during an accounting period would help creditors and others in assessing the

following:

the entitys ability to generate positive cash flows in future periods.

the entitys ability to meet its obligations and to pay dividends.

the reasons for the difference between the accounting net income and the related net cash flowsfrom operations of an entity for an accounting period.

both the cash and non-cash aspects of an entitys investment and financing transactions for the

period.

Benefits of cash flow information.

a) A statement of cash flows when used in conjunction with the rest of the financial statementsprovides information that enables users to evaluate the changes in net assets of an enterprise,its financial structure (i.e. liquidity and solvency) and its ability to affect the amounts and

timing of cash flows in order to adapt to changing circumstances and opportunities.

b) Cash flow information is useful in assessing the ability of the enterprise to generate cash andcash equivalents and enables users to develop models to assess and compare the present value

of the future cash flows of different enterprises.

c) A statement of cash flows enables the comparability of the reporting of results by differententerprises because it eliminates the effects of using different accounting treatments for thesame transactions and events.

d) Cash flow information is also useful in checking the accuracy of past assessments of futurecash flows and in examining the relationship between profitability and net cash flow and the

impact of changing prices.

e) Historical cash flow information is often used as an indicator of the amount, timing andcertainty of cash flows.

Definitions

a) Cash comprises of cash on hand, and demand deposits (including those in foreign currencies)net of bank overdrafts.

b) Cash equivalents are short-term, highly liquid investments that are readily convertible toknown amounts of cash and which are not subject to any significant risk of changes in value.

They include short-term securities; investments that have a short maturity of three months or

less from the specified redemption date.c) Cash flows are inflows and outflows of cash and cash equivalents.


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Presentation of statements of cash flows.

The statement of cash flows should classify cash flows during the period between:

operating activities,

investing activities, and

financing activities.

Operating Activities

Cash flows from operating activities are primarily derived from the principle revenue producing

activities of an enterprise. They generally arise from transactions that involve the determination of netprofit. Examples of operating activities include:

cash receipts from the sale of goods and rendering of services;cash receipts from royalties, fees, commissions and other revenues;

cash payments to suppliers for goods and services;

cash payments to and on behalf of employees;cash receipts and payments of an insurance enterprise for premiums and claims, annuities and

other policy benefits; and

cash payments or refunds of income taxes unless they can be specifically identified with

financing and investing activities; and

Where an enterprise holds securities for trade purposes, cash flows arising from the sale or purchases

of such securities are classified as operating activities since they are similar to inventory acquiredspecifically for resale.

In the case of financial institutions, cash advances and loans made by them are classified as operatingtransactions since they relate to the main revenue producing activities of that enterprise.

Investing Activities

These are the acquisition and disposal of long term and other investments not included in cashequivalents. Separable disclosure of cash flows arising from investing activities is important because

the cash flows represent the extent to which expenditures have been made for resources intended togenerate future income and cash flows. Examples of cash flows arising from investing activities are:

a) cash payments to acquire property, plant and equipment, intangibles and other long termassets. These payments include those relating to capitalized development costs and selfconstructed property, plant and equipment;

b) cash receipts from sales of property, plant and equipment, intangibles and other long-termassets;


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c) cash payments to acquire equity or debt instruments of other enterprises and interests in jointventures (other than payments of those instruments considered to be cash equivalents and

those held for dealing or trading purposes);

d) cash receipts from sales of equity or debt instruments of other enterprises and interests in jointventures (other than receipts for those instruments considered to be cash equivalents and thoseheld for dealing or trading purposes);

e) cash advances and loans made to other parties (other than advances and loans made by afinancial institution); and

f) cash receipts from the payment of advances and loans made to other parties (other thanadvances and loans for a financial institution).

Financing activities

These are activities that result in changes in size and composition of the equity capital and

borrowings of the enterprise. Examples of cash flows arising from financing activities are:

a) cash proceeds from issuing shares or other equity instruments;b) cash payments to owners to acquire or redeem the enterprises shares;c) cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short or

long-term borrowings;d) cash repayments of amounts borrowed; ande) cash payments by a lessee for the reduction of outstanding liability relating to a finance lease.

Investing and financing transactions that do not require the use of cash or cash equivalents should be

excluded from a statement of cash flows. Such transactions should be disclosed elsewhere in the

financial statements in a way that provides all the relevant information about these investing andfinancing activities. Examples of such transactions include:

a) the conversion of debt into equity;b) the acquisition of an entity by means of an equity issue; andc) the acquisition of assets either by assuming directly related liabilities.

Format of Presentation:

Enterprises are required to report cash flows from operating activities using either the

direct method, or

indirect method.

Required

With examples demonstrate your understanding of both the direct and indirect methods.

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