CASH FLOWS STATEMENT

1. INTRODUCTION
The statement of cash flows is useful in providing users with a basis to assess the
ability of the enterprise to generate cash and cash equivalents, and the need of the
enterprise to utilise those cash flows. It is important to evaluate the ability of an
enterprise to generate cash, and to assess the timing and certainty of their generation.

The statement of comprehensive income does not show flows of cash into and out
of the business. The statement of comprehensive income may show a favourable position
but the business may have insufficient cash to meet immediate needs. Although in the
long run making profits will have the effects of increasing the cash resources of a
business, in any given year this may not be the case. There are several reasons for this:

 Application of the accruals concept means that expenses are matched with sales,
rather than cash disbursements being matched with cash receipts. Revenues which
accrued to a period may not involve the receipt of cash until later due to sales
being made on credit. Similarly, expenses which are matched against those
revenues may not involve cash outflows, e.g depreciation or purchases on credit.
Profits needs to be adjusted for such accruals if it is to be brought nearer to cash
flow.
 Cash resources may have been affected by transactions other than of an operating
nature, such as the acquisition or sale of fixed assets.
 Cash may come from sources other than the operations summarised in the profit
and loss account, e.g. new issues of shares, and may be used for non – operating
purposes, such as the redemption of debt.

2. IAS 7 — STATEMENT OF CASH FLOWS (SUMMARY)

IAS 7 Statement of Cash Flows requires an entity to present a statement of cash
flows as an integral part of its primary financial statements. Cash flows are
classified and presented into operating activities (either using the 'direct' or
'indirect' method), investing activities or financing activities, with the latter two
categories generally presented on a gross basis.

IAS 7 was reissued in December 1992, retitled in September 2007, and is

operative for financial statements covering periods beginning on or after 1 January
1994.

History of IAS 7

June 1976 Exposure Draft E7 Statement of Source and

 Application of Funds

October 1977 IAS 7 Statement of Changes in Financial Position

July 1991 Exposure Draft E36 Cash Flow Statements

December 1992 IAS 7 (1992) Cash Flow Statements

1 January 1994 Effective date of IAS 7 (1992)

6 September 2007 Retitled from Cash Flow Statements to Statement of

Cash Flows as a consequential amendment resulting
from revisions to IAS 1

16 April 2009 IAS 7 amended by Annual Improvements to IFRSs

2009 with respect to expenditures that do not result
in a recognised asset.

1 July 2009 Effective date for amendments from IAS

27(2008) relating to changes in ownership of a
subsidiary

1 January 2010 Effective date of the April 2009 revisions to IAS 7

29 January 2016 Amended by Disclosure Initiative (Amendments to

IAS 7)

1 January 2017 Effective date of the January 2016 revisions to IAS 7

Summary of IAS 7

Objective of IAS 7

The objective of IAS 7 is to require the presentation of information about the

historical changes in cash and cash equivalents of an entity by means of a
statement of cash flows, which classifies cash flows during the period according to
operating, investing, and financing activities.

Fundamental principle in IAS 7

All entities that prepare financial statements in conformity with IFRSs are required
to present a statement of cash flows. [IAS 7.1]

The statement of cash flows analyses changes in cash and cash equivalents during
a period. Cash and cash equivalents comprise cash on hand and demand deposits,
together with short-term, highly liquid investments that are readily convertible to a
known amount of cash, and that are subject to an insignificant risk of changes in
value. Guidance notes indicate that an investment normally meets the definition of
a cash equivalent when it has a maturity of three months or less from the date of
 acquisition. Equity investments are normally excluded, unless they are in
substance a cash equivalent (e.g. preferred shares acquired within three months of
their specified redemption date). Bank overdrafts which are repayable on demand
and which form an integral part of an entity's cash management are also included
as a component of cash and cash equivalents. [IAS 7.7-8]

Presentation of the Statement of Cash Flows

Cash flows must be analysed between operating, investing and financing activities.
[IAS 7.10]

Key principles specified by IAS 7 for the preparation of a statement of cash flows
are as follows:

 operating activities are the main revenue-producing activities of the entity that
are not investing or financing activities, so operating cash flows include cash
received from customers and cash paid to suppliers and employees [IAS 7.14]
 investing activities are the acquisition and disposal of long-term assets and other
investments that are not considered to be cash equivalents [IAS 7.6]
 financing activities are activities that alter the equity capital and borrowing
structure of the entity [IAS 7.6]
 interest and dividends received and paid may be classified as operating, investing,
or financing cash flows, provided that they are classified consistently from period
to period [IAS 7.31]
 cash flows arising from taxes on income are normally classified as operating,
unless they can be specifically identified with financing or investing activities
[IAS 7.35]
 for operating cash flows, the direct method of presentation is encouraged, but the
indirect method is acceptable [IAS 7.18]
The direct method shows each major class of gross cash receipts and gross cash
payments. The operating cash flows section of the statement of cash flows under
the direct method would appear something like this:

Cash receipts from customers xx,xxx

Cash paid to suppliers xx,xxx

Cash paid to employees xx,xxx

Cash paid for other operating expenses xx,xxx

Interest paid xx,xxx

Income taxes paid xx,xxx

Net cash from operating activities xx,xxx

 The indirect method adjusts accrual basis net profit or loss for the effects of non-
cash transactions. The operating cash flows section of the statement of cash flows
under the indirect method would appear something like this:

Profit before interest and income taxes xx,xxx

Add back depreciation xx,xxx

Add back impairment of assets xx,xxx

Increase in receivables xx,xxx

Decrease in inventories xx,xxx

Increase in trade payables xx,xxx

Interest expense xx,xxx

Less Interest accrued but not yet paid xx,xxx

Interest paid xx,xxx

Income taxes paid xx,xxx

Net cash from operating activities xx,xxx

 the exchange rate used for translation of transactions denominated in a foreign

currency should be the rate in effect at the date of the cash flows [IAS 7.25]
 cash flows of foreign subsidiaries should be translated at the exchange rates
prevailing when the cash flows took place [IAS 7.26]
 as regards the cash flows of associates, joint ventures, and subsidiaries, where the
equity or cost method is used, the statement of cash flows should report only cash
flows between the investor and the investee; where proportionate consolidation is
used, the cash flow statement should include the venturer's share of the cash flows
of the investee [IAS 7.37]
 aggregate cash flows relating to acquisitions and disposals of subsidiaries and
other business units should be presented separately and classified as investing
activities, with specified additional disclosures. [IAS 7.39] The aggregate cash
paid or received as consideration should be reported net of cash and cash
equivalents acquired or disposed of [IAS 7.42]
 cash flows from investing and financing activities should be reported gross by
major class of cash receipts and major class of cash payments except for the
following cases, which may be reported on a net basis: [IAS 7.22-24]
o cash receipts and payments on behalf of customers (for example, receipt
and repayment of demand deposits by banks, and receipts collected on
behalf of and paid over to the owner of a property)
o cash receipts and payments for items in which the turnover is quick, the
amounts are large, and the maturities are short, generally less than three
 months (for example, charges and collections from credit card customers,
and purchase and sale of investments)
o cash receipts and payments relating to deposits by financial institutions
o cash advances and loans made to customers and repayments thereof
 investing and financing transactions which do not require the use of cash should
be excluded from the statement of cash flows, but they should be separately
disclosed elsewhere in the financial statements [IAS 7.43]
 entities shall provide disclosures that enable users of financial statements to
evaluate changes in liabilities arising from financing activities [IAS 7.44A-44E]*
 the components of cash and cash equivalents should be disclosed, and a
reconciliation presented to amounts reported in the statement of financial position
[IAS 7.45]
 the amount of cash and cash equivalents held by the entity that is not available for
use by the group should be disclosed, together with a commentary by management
[IAS 7.48]

* Added by Disclosure Initiative amendments, effective 1 January 2017.

 3. FORMAT (pro – forma statement) – IAS 7
Indirect method Direct method

Profit before income taxes X Cash flows from operating activities

Adjustment for: Cash receipts from customers X
Interest expense X Cash payments to suppliers (X)
Investment income (X) Cash payments to employees (X)
Depreciation of PPE (amortization/depletion) X
Impairment loss X
Gain on disposal of PPE (X)
Operating cash flow before changes in working X
capital
Increase in trade receivable (X)
Decrease in inventories X
Increase in trade payables X
Cash generated from operations 1 Cash generated from operations 1
Interest paid (2)

--------------------Same information---------------
Taxes paid (3)
Dividends paid (X)
Net cash flow from operating activities X
Cash flows from investing activities
Purchase of plant and equipment (X)
Proceeds from sale of equipment X
Dividends/ interest received (4)
Net cash flows from investing activities X
Cash flows from financing activities
Proceeds from issue of share capital X
Proceeds from long term borrowings X
Payment of finance lease liabilities (X)
Net cash flow from financing activities X
Net increase in cash and cash equiv. X
Cash and cash equiv. at start of the period X
Cash and cash equiv. at end of the period X

2: interest and dividends paid may be classified as Operating or Financing cash

flows, provided that they are classified consistently from period to period.

3: cash flows arising from taxes on income are normally classified as

Operating, unless they can be specifically identified with financing or investing
activities.

4: interest and dividends received may be classified as Operating or Investing

cash flows, provided that they are classified consistently from period to period.
4. PREPARINGSTATEMENT OF CASH FLOWS -
TECHNIQUES
If you are preparing statement of cash flows in an examination setting then it is
virtually certain that you will be presented with some, of not all, of the following:

 A statement of comprehensive income (SCI) for the period;

 A statement of financial position at the beginning and end of the period;
and
 Various notes to the financial statements.

Basically, what the preparation of a statement of cash flows is, like the statement
of comprehensive income, a period statement. Therefore, a figure will be taken from the
SCI for the period and converted into a cash flow. For example, the operating profit from
the SCI is converted into the cash flow from operating activities by making adjustments
such as adding back depreciation and other items which do not involve a cash flow.

Conversely the statement of financial position is a point of time statement.

Therefore, when deriving cash flows from figures in statement of financial position it is
basically movements between two statements of financial position that are reconciled.
For example, the movement in tangible fixed assets between the end of two reporting
periods is analysed to give us cash inflows in respect of the sale of fixed assets and cash
outflows in respect of the purchase of fixed assets.

It is probably best to adopt the following approach:

1. Read the question thorough before doing any computational work at all.
Make notes of key factors while reading the questions.
2. Draft out a pro – forma statement, which obviously at this stage will just be
a series of headings;
3. Insert the opening and closing balance of cash and cash equiv. as these can
be extracted easily from the statement of financial position provided;
4. Extract the “profit before tax” figure from SCI and make adjustments for
items that are easily identified from the SCI such as:
 Investment (including interest) income
 Finance expense
 Depreciation of PPE and/or amortisation of IA
 Impairment of assets
 Remeasurement G/L on assets/liabilities that credited/charges to P/L
 G/L on disposal of PPE and/or IA
5. Cast the sub-total to determine the “operating cash flow before changes in
working capital” and account for the cash flows due to the changes in
working capital.
6. Account for the following residual items to determine “net cash flow from
operating activities”

 Tax paid
 Interest paid
 Dividend paid
7. Account for “net cash flow from investing activities” by considering the
following common items:
 Cash used to purchase and/or from sale of PPE
 Interest received
 Dividend received
8. Account for “net cash flow from financing activities” by considering the
following common items:
 Proceeds from issuance of share capital
 Proceeds from long – term liabilities
 Payment of finance lease liabilities
 5. FORMAT (pro – forma statement) –US GAAP
Indirect method Direct method
Cash flows from operating activities Cash flows from operating activities
Net income Cash receipts
Adjustmentsto reconcile net income to net Cash receipts from sales (A.R analysed)
cash provided by operating activities:
1. Adjustments for operating items not Cash receipts from Rent revenue (Rent Receivable
providing or using cash analysed)

+Depreciation, depletion, and amortization Cash receipts from Interests Revenue (Interest
Receivable analysed)
+Accrued expenses reported in income Cash receipts from Dividends revenue (Dividend
receivable analysed)
– Accrued revenues reported in income Cash payments
2. Adjustmentsfor nonoperating items Cash payments to suppliers (COGS, AP, MI
analysed)
+Loss on disposal of long – term assets Cash payments to employees (Wages payable,
Wages expenses)
+Loss on retirement of debt Cash payments to operations (Prepaid expenses,
Accrued liabilities, Operating expenses)
– Gain on disposal of long – term assets Cash payments for interest (Interest Payable,
Interest expense)
– Gain on disposal of long – term assets Cash payments for taxes (Income tax expense,
3. Adjustments for changes in current assets Income tax payable)
and current liabilities

+Decrease on noncash current asset

– Increase in noncash current asset
+Increase in current liabilities (*)
– Decrease in current liabilities (*)
Net cash flow from operating activities Net cash flow from operating activities
Cash flows from investing activities
-------Same information-------

Purchase of plant and equipment

Proceeds from sale of equipment

Net cash flows from investing activities

Cash flows from financing activities
Proceeds from issue of share capital
Proceeds from long term borrowings
Payment of finance lease liabilities
Net cash flow from financing activities
Net increase in cash and cash equiv.
Cash and cash equiv. at start of the period
Cash and cash equiv. at end of the period
 (*) excluding current portion of long – term debt and any nonsales – related short
– term notes payable – both are financing activities.

6. IAS 7 vs US GAAP DIFFERENCES (Reardon, 2009)

In general, the requirements under IFRS and US GAAP are quite similar.

There are some differences with regard to classification among operating, investing
and financing activities. The most notable of these are the differences in interest and
dividends paid and received:

► Under IFRS, interest and dividends paid can be classified either as

operating or financing cash flows. Interest and dividends received can be
classified either as operating or investing cash flows.
► Under US GAAP, interest paid, interest received and dividends received are
all classified as operating cash flows. Dividends paid are classified as
financing cash flows.

In summary:

US GAAP IFRS
Content, format and classification differences
► Cash flows are presented in three ► Similar
classifications: operating, investing
and financing activities.
► The totals from the three activities ► Similar
(operating, investing, financing) are
summed and this balance is
reconciled with the beginning and
ending cash (and cash equivalents)
balances.
► Operating, investing and financing ► Similar, except for some differences
activities are specifically defined. explained on LATER ON.

► Both the direct and indirect method ► Similar

of presenting cash flows from
operations are allowed.
► Entities must disclose their policy ► Similar
for determining which items are
cash equivalents.
Interest and dividends
► Requires that interest paid and ► Permits an entity: (a) to classify interest
interest and dividends received be and dividends paid or received as
classified as operating cash flows. operating cash flows; or (b) to classify
Dividends paid are a financing cash interest and dividends paid as financing
flow because they are considered a cash flows and interest and dividends
cost of obtaining resources. received as investing cash flows.
 However, interest and dividends must be
classified in a consistent manner from
period to period.

► In practice, there may be little practical significance to this difference because IAS 7
requires separate disclosure of interest paid and received and of dividends paid and
received. Summary of treatment of interest and dividends:

Cash flow classification

Transaction IFRS US GAAP
Operating or
Interest paid Operating
financing
Interest received Operating or investing Operating

Dividends paid Operating or financing Financing

Dividends received Operating or investing Operating
Income taxes
► Requires that income taxes paid be ► Requires that cash payments or refunds of
classified as an operating cash flow. income taxes be classified as operating
activities unless they can be specifically
identified with financing or investing
activities. In that case, the tax cash flows
may be classified as financing or investing
activities, as appropriate.
► Statements would not necessarily result in
a loss of comparability with US GAAP
since IFRS requires disclosure of the total
amount of income taxes paid.

Indirect method
► When using the indirect method of ► The particular income line item that must
presenting operating cash flows, the begin the reconciliation is not specified.
reconciliation from income to cash Thus, an entity could begin the
flows must begin with net income. reconciliation under IFRS with operating
income.

Direct method
► ASC 230-10-45-30 requires that an ► This reconciliation is not required.
entity using the direct method of
reporting net cash flows from
operating activities must provide (in
a separate schedule) a reconciliation
of net income to net cash flows from
 operating activities.
► This has little practical significance,
however, because few enterprises in
the United States use the direct
method. The AICPA Accounting
Trends and Techniques – 2010
reports that 495 companies of the
500 surveyed in 2009 used the
indirect method of presenting
operating cash flows.
Components of cash and cash equivalents
► No required disclosure of the ► Required disclosure of the components of
components of cash and cash cash and cash equivalents.
equivalents. ► The total cash and cash equivalents
► Requires that the cash and cash presented in the statement of cash flows
equivalents line item in the does not need to agree to a single line item
statement of cash flows equals the in the statement of financial position.
cash and cash equivalents in the ► Entities must disclose a reconciliation of
statement of financial position. the components of cash and cash
equivalents to the amounts presented on
the statement of financial position.
► Thus, while users of a statement of cash
flows prepared might not be able to trace
changes in cash and cash equivalents
directly between the statement of financial
position and the statement of cash flows,
this difference from US GAAP has little
practical significance.

Disclosures
► Prohibits disclosure of cash flows ► Does not have restrictions on the
per share. disclosure of cash flows per share.

7. ILLUSTRATIVE CASES
 Case 1: ABC’s comparative BS, income statement, and additional info as follows:

ABC company - Balance sheet

December 31, 2018 and 2017

Assets 2018 2017
Current assets
Cash $17.000 $12.000
AR 60.000 40.000
Merchandise Inventory 84.000 70.000
Prepaid expenses 6.000 4.000
Total current assets 167.000 126.000
Long – term assets
Plant assets 250.000 210.000
Accum depre (60.000) (48.000)
Total assets .$357.000 $288.000

Liabilities
Current liabilities
AP $ 35.000 $40.000
Interest payable 3.000 4.000
Income taxes payable 22.000 12.000
Total current liabilities 60.000 56.000
Long – term bonds payable 90.000 64.000
Total liabilities 150.000 120.000
Equity
Common stock, $5 par 95.000 80.000
Retained earnings 112.000 88.000
Total equity 207.000 168.000
Total liabilities and equity $357.000 $288.000
ABC company Income statement For year ended December 31, 2018
Sales $ 590.000
COGS $300.000
Wages and other operating expenses 216.000
Interest expense 7.000
Depreciation expenses 24.000 (547.000)
43.000
Other gain (losses)
Gain on retirement of bonds 16.000
Loss on sale of plant assets (6.000) 10.000
Income before taxes 53.000
Income taxes expenses (15.000)
Net income $38.000
 Additional ìnformation:

1. The accounts payable balances result from merchandise inventory

purchases.
2. Purchased plant assets costing $70.000 by paying $10.000 cash and issuing
$60.000 of bonds payable.
3. Sold plant assets with an original cost of $30.000 and accumulated
depreciation of $12.000 for $12.000 cash, yielding a $6.000 loss.
4. Received cash of $15.000 from issuing 3.000 shares of common stock.
5. Paid $18.000 cash to retire bonds with a $34.000 bond value, yielding a
$16.000 gain.
6. Declared and paid cash dividends of $14.000.

Require:

a. Prepare CF using indirect method.

b. Prepare CF using direct method.

Case 2:X’s comparative BS, income statement, and additional info as follows:

X company

Balance sheet

December 31, 2018 and 2017

Assets 2018 2017
Cash $43.050 $23.925
AR 34.125 39.825
Merchandise Inventory 156.000 146.475
Prepaid expenses 3.600 1.650
Equipment 135.825 146.700
Accumdepre – Eq (61.950) (47.550)
Total assets $310.650 $311.025

Liabilities and Equity

AP $ 28.800 $33.750
Income taxes payable 5.100 4.425
Dividends payable 0 4.500
Bonds payable 0 37.500
Common stock, $10 par 168.750 168.750
Retained earnings 108.000 62.100
Total liabilities and equity $310.650 $311.025
X company

Income statement

For year ended December 31, 2018

Sales $ 446.100
COGS 222.300
Other operating expenses s 120.300
Depreciation expenses 25.500 (368.100)
78.000
Other gain (losses)
Loss on sale of equipment 3.300
Loss on retirement of bonds 825 (4.125)
Income before taxes 73.875
Income taxes expenses (13.725)
Net income $60.150

Additional ìnformation:

1. Equipment costing $21.375 with accumulated depreciation of $11.100 is

sold for cash.
2. Equipment purchases are for cash.
3. Accumulated Depreciation is affected by depreciation expense and the sale
of equipment.
4. The balance of Retained Earnings is affected by dividend declarations and
net income.
5. All sales are made on credit.
6. All merchandise inventory purchases are on credit.
7. Accounts Payable balances result from merchandise inventory purchases.
8. Prepaid expenses relate to “other operating expenses”

Require:

a. Prepare CF using indirect method.

b. Prepare CF using direct method.