Statements of Cash Flows IAS 7 Statement of cash flows

Purpose
1 Purpose
 The statement of cash flows shows the movement between a
company's cash and cash equivalents at the beginning and the
end of the year.
 Syllabus learning outcomes
• Differentiate between profit and cash flows and understand the need for management
to control cash flow.
• Recognise the benefits and drawbacks to users of the financial statements of a
statement of cash flows.
• Classify the effect of transactions on cash flows and how they should be treated in a
company's statement of cash flows.
• Calculate the figures needed for the statement of cash flows including cash flows from
operating, investing and financing activities.
• Calculate the cash flow from operating activities using the direct and indirect method.
• Prepare extracts from statements of cash flows from given information.
Overview
Cash Cash equivalents

Cash flows

Statements of
cash flows

IAS 7

Cash flows from Cash flows from Cash flows from

operating activities investing activities financing activities

Indirect method Direct method

 IAS 7 Statement of cash flows 1
Purpose
• A statement of cash flows shows the effect of an entity's commercial transactions on
its cash balance.
• It is thought that users of accounts can readily understand cash flows, as opposed to
statements of profit or loss and statements of financial position, which are subject to
manipulation by the use of different accounting policies.
 IAS 7 Statement of cash flows 2
Format
IAS 7 Statement of cash flows splits cash flows into the following headings:
• Cash flows from operating activities
• Cash flows from investing activities
• Cash flows from financing activities
• The IAS requires a reconciliation of cash and cash equivalents.
Chapter summary
Statements of cash flows (IAS 7)
 Cash comprises cash on hand and on demand deposits, less
bank overdrafts.
 Cash equivalents are short term, highly liquid investments
such as current asset investments (shares) which can be
converted in to known amounts of cash relatively quickly
without having a major impact on the entity's activities.
Cash flows from operating activities
 This section of the statement of cash flows shows the cash
and cash equivalents generated by and used in the entity's
main trading activities.
 Cash Equivalent is any asset that can be converted to cash
“readily and at a known amount”
 Cash received from customers
 Operating expenses
 Taxes Paid / Interest Paid / Dividend Paid
Cash flows from investing activities
 This section shows the cash flows related to the acquisition
and disposal of non-current assets and returns on
investments such as interest and dividends received.

 Buying and selling of non current assets

 Buying and selling of shares in other entities

 Investments made and dividends received

Cash flows from financing activities
 Cash flows from financing activities include the monies raised
from issuing shares and loans and the cash used in the
repayment of loans and the payment of dividends.

 Buying and Selling of Own Shares

 Taking or returning Loans (principal amounts only)

 IAS 7 Statement of cash flows
Format
IAS 7 Statement of cash flows splits cash flows into the following headings:
• Cash flows from operating activities
• Cash flows from investing activities
• Cash flows from financing activities
• The IAS requires a reconciliation of cash and cash equivalents.
Operating Activities – Two Methods
Cash flow from operating activities using the direct method
 The statement of cash flows can be produced using one of two
methods: the direct or the indirect method. The direct
method provides exactly the same cash flow information but
calculates the cash flow from operating activities using a
slightly different calculation from the indirect method.
Using the IS and BS Together
Cash received from customers
Current Year Income Statement
Opening Balance 10,000
Current Year and Last Year Balance Sheet
Add Sales 100,000
110,000
Income Statement 2014 Less closing balance (12,000)
Sales 100,000 Cash received from 98,000
Purchases 60,000
Interest Expense 3,000 Cash Paid to Suppliers
Income Tax Expense 7,000 8,000+60,000-6000=62,000

Balance Sheet 2013 2014 Tax Paid

Receivables 10,000 12,000 6000+7000-5000=8,000
Payables 8,000 6,000
Income Tax Payables 6,000 5,000 Interest Paid
Interest Payable 2,000 0 2000+3000-0=5000
 Lecture example 5 - Direct Method
Cash flow statement for the year ended 31 December 20X0
$ $
Operating activities
Cash received from customers 47,300
Cash paid to suppliers (28,500)
Cash paid to & on behalf of employees (15,000)
Interest paid (4,400)
(600)
Net cash inflow from operating activities
Cash flow from investing activities
Payments to acquire tangible fixed assets (40,000)
Cash flow from financing activities
Proceeds from long-term loan 60,000
Issue of ordinary shares 50,000
Repayment of loan (6,000)
104,000
Increase in cash balances 63,400
Basic Concept
Sales 100
COS (50)
Gross Profit 50
Admin Exp (10)
Dist Exp (10) “ Non cash expenses you add back because you previously
Depreciation (5) subtracted from revenue but you never paid them out as cash,
Net Profit 25 so cash is still in the business, therefore add it back “

How much is cash available?

Net Profit 25
Add Back Non Cash Expenses 5
Subtract non cash income (3)
Cash 27
XYZ Co – Cash Flow statement (Indirect method)
$000 $000
Cash flows from operating activities
Net profit before taxation 3,570
Adjustment for:
Depreciation 450
Investment income (500)
Interest expense 400
Operating profit before working capital changes 3,920
Increase in trade and other receivables (500)
Decrease in inventories 1,050
Decrease in trade payables (1,740)
Cash generated from operations 2,730
Interest paid (270)
Income taxes paid (900)

Net cash from operating activities 1,560

XYZ Co – Cash Flow statement (Indirect method)
Cash flows from investing activities
Purchase of property, plant and equipment (900)
Proceeds from sale of equipment 20
Interest received 200
Dividends received 200
Net cash used in investing activities (480)
Cash flows from financing activities
Proceeds from issuance of share capital 250
Proceeds from long-term borrowings 250
Dividends paid (1,290)
Net cash used in financing activities (790)
Net increase in cash and cash equivalents 290
Cash and cash equivalents at beginning of period 120
Cash and cash equivalents at end of period 410
 IAS 7 Statement of cash flows 9
Advantages
• Business survival needs cash
• Cash flow is more objective than profit
• Trade accounts payable need to know if they will be paid
• More comparability between entities
• Better basis for decision making
• Easy to understand, prepare and audit
 IAS 7 Statement of cash flows 10
Disadvantages
• The disadvantages of cash flow accounting are basically the opposite of advantages of
accruals accounting.
• For example, cash flow does not match income and expenditure in the statement of
profit or loss.
 IAS 7 Statement of cash flows 11
Criticisms of IAS 7
• Inclusion of cash equivalents does not reflect the way businesses are managed.
• The requirement that a cash equivalent has to be within three months of maturity is
unrealistic.
• Management of cash equivalents is not distinguished from other investment decisions.
 IAS 7 Statement of cash flows 6
• Cash and cash equivalents consist of cash on hand and balances with banks, and
investments in money market instruments. Cash and cash equivalents included in the
cash flow statement comprise the following statement of financial position amounts.
20X7 20X8
$m $m
Cash on hand and balances with banks 40 25
Short-term investments 370 95
Cash and cash equivalents 410 120
 IAS 7 Statement of cash flows 7
• The company has undrawn borrowing facilities of $2,000, of which only $700 may be
used for future expansion.
• This proforma is for the indirect method.
 IAS 7 Statement of cash flows 8
Direct method
• The direct method proforma is the same except for the first part which appears as
follows:
 Tackling the exam
• Examination questions will probably require the indirect method.
If the direct method is required, the necessary information will be given to you.
 Lecture example 1
In the statements of financial position of Tacks Co as at 31 December 20X9 and 31
December 20X8 were the following amounts for income tax payable.
31 December
20X9 20X8
$ $
Income tax payable 156,000 168,000

The statement of profit or loss tax charge for 20X9 amounted to $104,000.
 Lecture example 1 (cont'd)

Required
What is the amount of income taxes paid during the year?
Answer to lecture example 1
Income taxes paid
Income tax payable
$'000 $'000
Income tax paid 116 Bal b/d 168
Bal c/d 156 SPL 104
272 272
 Lecture example 2
On 31 December 20X8 the value of plant and equipment in the books of Erosion Co was
as follows:
$
Plant and equipment at cost 200,000
Accumulated depreciation 80,000
Plant and equipment at net book value 120,000

On 1 January 20X9 an item of plant was sold for $8,000 which had originally cost $20,000
when new, but had a net book value of $11,000 at the time of sale. (The statement of
financial position values shown above do not show that this sale has taken place.)
 Lecture example 2 (cont'd)
On 31 December 20X9 the value of plant and equipment in the statement of financial
position was:
$
Plant and equipment at cost 280,000
Accumulated depreciation 111,000
Plant and equipment at net book value 169,000

Required
Show the relevant entries for property, plant and equipment which would appear in a
statement of cash flows for Erosion Co in 20X9.
Answer to lecture example 2
Property, plant and equipment
Plant and equipment – cost
$'000 $'000
Bal b/d 200 Disposal 20
Addition 100 Bal c/d 280
300 300

Accumulated depreciation
$'000 $'000
Disposal 9 Bal b/d 80
Bal c/d 111 SPL Charge 40
120 120
Answer to lecture example 2 (cont'd)
Profit/loss on disposal:
$
Net book value of asset sold 11,000
Sales proceeds (8,000)
Loss on sale (3,000)
The entries in the statement of cash flows for 20X9 would be:
$
(i) Cash flows from operating activities (extract)
Adjustments for
Depreciation 40,000
Loss on sale of plant 3,000
43,000
(ii) Cash flows from investing activities (extract)
Purchase of property, plant and equipment (100,000)
Proceeds from sale of plant 8,000
(92,000)
 Lecture example 3
Distribution Co statement of financial position extract for the year ended 31 December
20X9
20X9 20X8
$'000 $'000
Dividends payable 45 35
Dividends charged to retained earnings were $60,000.

Required
What are the dividends paid during the year ended 31 December 20X9?
Answer to lecture example 3
Dividends paid
Dividends payable
$'000 $'000
Dividends paid 50 Bal b/d 35
Bal c/d 45 Retained earnings 60
95 95
Lecture example 4
The summarised accounts of the Emma Co for the year ended 31
December 20X8 are as follows:
Statement of financial position as at 31 December
20X8 20X7
$'000 $'000
Non-current assets
Property, plant and equipment 628 514
Current assets:
Inventories 214 210
Trade receivables 168 147
Cash 7 –
389 357
1017 871
Lecture example 4 (cont'd)
20X8 20X7
$'000 $'000
Equity
Share capital ($1 ordinary shares) 250 200
Share premium account 70 60
revaluation surplus 110 100
Retained earnings 314 282
744 642
Non-current liabilities
10% debentures 80 50
Current liabilities
Trade payables 136 121
Income tax payable 39 28
Dividends payable 18 16
Overdraft – 14
193 179
1017 871
Lecture example 4 (cont'd)
Statement of profit or loss for the year ended 31 December
20X8
$'000
Revenue 600
Cost of sales 319
Gross profit 281
Other expenses (including depreciation of
$42,000) 186
Finance costs (interest paid) 8
Profit before tax 87
Income tax expense 31
Profit for the period 56
Lecture example 4 (cont'd)
Movement of retained earnings
$'000
Balance at 31 December 20X7 282 282
Profit for the period 56 56
Dividends (24) (24)
Balance at 31 December 20X8 314
You are additionally informed that there have been no disposals of
property, plant and equipment during the year. The new debentures
were issued on 1 January 20X8.

Required
Produce a statement of cash flows for Emma Co for the year
ended 31 December 20X8.
Approach to lecture example 4
(1) Read requirement and scan additional information
(2) Download SOFP
(3) Download SPL
(4) Deal with additional information
(5) Finish workings
(6) Finish statement of cash flows
Answer to lecture example 4
$'000 $'000
Cash flows from operating activities
87
Profit before taxation
Adjustments for: 42
Depreciation 8
Interest expense
137
Increase in trade receivables (168 – 147) (21)
Increase in inventories (214 – 210) (4)
Increase in trade payables (136 – 121) 15
Cash generated from operations
127
(8)
Interest paid (20)
Income taxes paid (W2)
99
Net cash from operating activities
Answer to lecture example 4 (cont'd)
$'000 $'000
Cash flows from investing activities
Purchase of property, plant and equipment (W1) (146)
Net cash used in investing activities (146)
Cash flows from financing activities
Proceeds from issue of shares (250 + 70 – 200 – 60) 60
Proceeds from issue of debentures (80 – 50) 30
Dividends paid (W3) (22)
Net cash from financing activities 68

Net increase in cash and cash equivalents 21

Cash and cash equivalents at beginning of year (14)
Cash and cash equivalents at end of year 7
Answer to lecture example 4 (cont'd)

Property, plant and equipment (NBV)

b/d 514
Reval'n 10 Dep'n 42
Additions 146
c/d 628
670 670
Answer to lecture example 4 (cont'd)

Income tax payable

b/d 28
Tax paid 20 SPL 31

c/d 39
59 59
Answer to lecture example 4 (cont'd)

Dividends payable
b/d 16
Divs paid 22 Divs (RE) 24

c/d 18
40 40
 Lecture example 5
Required
Using the information in Lecture example 4 produce the 'cash flows from operating
activities' section of the statement of cash flows using the direct method.
 Answer to lecture example 5
$'000 $'000
Cash flows from operating activities
Cash receipts from customers (W1)
Cash payments to suppliers and employees (W2)
Cash generated from operations
Interest paid
Income taxes paid
Net cash from operating activities
Answer to lecture example 5 (cont'd)
$'000 $'000
Cash flows from operating activities
Cash receipts from customers (W1) 579
Cash payments to suppliers and employees (W2) (452)
Cash generated from operations 127
Interest paid (8)
Income taxes paid (20)
Net cash from operating activities 99
Answer to lecture example 5 (cont'd)

Trade receivables
b/d 147
Cash rec'd 579
Revenue 600

c/d 168
747 747
Answer to lecture example 5 (cont'd)

Trade payables
b/d 121
Cash paid 452
Expenses W3 467
c/d 136
588 588
Answer to lecture example 5 (cont'd)
$'000 $'000
Cost of sales 319
Add: closing inventories 214
Less: opening inventories (210)
Purchases 323
Other expenses 186
Less: depreciation (42)
144
467
Specimen paper question

Source: ACCA Paper FFA/F3 Financial Accounting Specimen Exam

Specimen paper answer

Source: ACCA Paper FFA/F3 Financial Accounting Specimen Exam

 Tackling the exam
Exam focus point:

The examiner has repeatedly highlighted statements of cash flows as an area that
students struggle with. The examiner recommended practising full questions on this
topic as they will help you gain a better understanding of the individual parts of the
statement of cash flows and how it links with the statement of financial position and the
statement of profit or loss and other comprehensive income.