Statement of cash flows

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1 6 Statemet of cash flows this chapter covers... I this chapter we study the statemet of cash flows, which liks profit from the statemet of profit or loss ad other comprehesive icome with chages i assets ad liabilities i the statemet of fiacial positio, ad the effect o the cash of the compay. We will cover: a appreciatio of the eed for a statemet of cash flows the cash flows for the sectios of the statemet how the cash flows relate to the areas of busiess activity the iterpretatio of a statemet of cash flows The iteratioal fiacial reportig stadard that sets out the layouts ad gives detailed guidace o the preparatio of statemets of cash flows is IAS 7. There are two ways of settig out statemets of cash flows: the direct method ad the idirect method. The mai part of the chapter focuses o the idirect method ad the, o page 175, we see how the direct method is used ad we ote that it is oly the first sectio of the statemet of cash flows that varies betwee the two methods. (Note that AAT s Assessmet for Fiacial Statemets requires the statemet of cash flows to be drafted usig oly the idirect method. For the direct method, a kowledge of examples of cash flows from operatig activities see page 175 is required.)

2 s t a t e m e t o f c a s h f l o w s I t r o d u c t I o The statemet of profit or loss ad other comprehesive icome shows profitability, ad the statemet of fiacial positio shows asset stregth. While these two fiacial statemets give us a great deal of iformatio o the progress of a compay durig a accoutig period, profit does ot equal cash, ad stregth i assets does ot ecessarily mea a large bak balace. The statemet of cash flows liks profit with chages i assets ad liabilities, ad the effect o the cash of the compay. A statemet of cash flows uses iformatio from the accoutig records (icludig statemets of profit or loss ad other comprehesive icome ad fiacial positio) to show a overall view of moey flowig i ad out of a compay durig a accoutig period. Such a statemet explais to the shareholders why, after a year of good profits for example, there is a reduced balace at the bak or a larger bak overdraft at the year-ed tha there was at the begiig of the year. The statemet of cash flows cocetrates o the liquidity of the busiess: it is ofte a lack of cash (a lack of liquidity) that causes most busiesses to fail. Such is the importace of cash flows that compaies preparig ad presetig accouts i accordace with iteratioal fiacial reportig stadards are required to iclude a statemet of cash flows as a itegral part of their fiacial statemets. F o r m at o F t h e S tat e m e t o F c a S h F L o W S IAS 7, Statemet of Cash Flows, provides the guidelies for a format, divided ito three sectios: Operatig activities the mai reveue-producig activities of the busiess, together with the paymet of iterest ad tax Ivestig activities the acquisitio ad disposal of o-curret assets, ad other ivestmets, together with iterest ad divideds received Fiacig activities receipts from the issue of ew shares, paymets to repay shares, chages i log-term borrowigs, paymet of divideds The cash flows for the year affectig each of these three areas of busiess activity are show i the statemet. At the bottom of the statemet of cash flows is show the et icrease i cash ad cash equivalets for the period, together with the cash ad cash equivalets, both at the begiig ad at the ed of the period.

3 1 6 0 f i a c i a l s t a t e m e t s t u t o r i a l Note the followig terms: cash, which comprises cash o had ad demad deposits cash equivalets, which are short-term, highly liquid ivestmets that ca easily be coverted ito cash (a example of a cash equivalet is moey held i a term accout, provided that the moey ca be withdraw withi three moths from the date of deposit) Bak overdrafts which are payable o demad are icluded as a part of cash ad cash equivalets. The diagram o the ext page shows the mai cash flows (iflows ad outflows of cash ad cash equivalets) uder each headig, ad idicates the cotet of the statemet of cash flows. The first sectio operatig activities eeds a word of further explaatio, particularly as it is the mai source of cash flow for most compaies. o p e r a t i g a c t i v i t i e s ( i d i r e c t m e t h o d ) The cash flow from operatig activities is calculated by usig figures from the statemets of profit or loss ad other comprehesive icome ad fiacial positio as follows: profit from operatios* (profit, before deductio of tax & iterest) add depreciatio charge for the year add loss o sale of o-curret assets, or deduct gai o sale of ocurret assets see page 166 deduct divideds received (show i ivestig activities) add decrease i ivetories, or deduct icrease i ivetories add decrease i trade ad other receivables, or deduct icrease i trade ad other receivables add icrease i trade ad other payables, or deduct decrease i trade ad other payables equals cash used i/from operatios deduct iterest paid i period deduct tax paid o icome i period (eg corporatio tax) equals et cash used i/from operatig activities * Profit from operatios is always the startig poit i AAT Assessmets where a task requires you to recocile profit or loss to the et cash from operatig activities. A example of such a recociliatio is show o page 162. Notes: Depreciatio is added to profit because depreciatio is a o-cash expese, that is, o moey is paid out by the compay i respect of depreciatio charged to the statemet of profit or loss ad other comprehesive icome. Cash flows relatig to the purchase ad sale of o-curret assets are show i the ivestig activities sectio.

4 s t a t e m e t o f c a s h f l o w s The divideds received deducted here will be added i the ivestig activities sectio. The operatig activities sectio is calculated differetly for the direct method see page 175. L ay o u t o F a S tat e m e t o F c a S h F L o W S A statemet of cash flows uses a commo layout which ca be ameded to suit the particular eeds of the compay for which it is beig prepared. The example layout show o page 162 (with specime figures icluded) is commoly used. It is suggested that you study a recet statemet of cash flows for a large public limited compay the web directory at the begiig of this book lists some sources. The diagram below shows the cotets of a statemet of cash flows usig the idirect method. Note that the direct method is discussed o page 175 where we will see that it is oly the operatig activities sectio which is set out i a differet way. s t a t e m e t o f c a s h f l o w s ( i d i r e c t m e t h o d ) Operatig activities Profit from operatios (ie profit, before deductio of tax ad iterest) Depreciatio charge for the year (see page 166 for treatmet of a gai or a loss o sale of ocurret assets) Less divideds received (show i ivestig activities) Chages i ivetories, trade ad other receivables ad payables Less iterest paid Less taxes paid o icome (eg corporatio tax) Ivestig activities Iflows: sale proceeds from property, plat ad equipmet, itagibles, ad other o-curret assets Outflows: purchase cost of property, plat ad equipmet, itagibles, ad other o-curret assets Iterest received Divideds received Fiacig activities Iflows: receipts from icrease i share capital (ote: o cash iflow from a bous issue of shares see page 69), raisig/icrease of loas Outflows: repaymet of share capital/loas, ad fiace lease liabilities Divideds paid

5 1 6 2 f i a c i a l s t a t e m e t s t u t o r i a l S t a t e m e t o F c a S h F L o W S : I d I r e c t m e t h o d ABC LIMITED STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20-6 et cash used i/from operatig activities 78,000 cash flows from ivestig activities Purchase of o-curret assets 125,000 Proceeds from sale of o-curret assets 15,000 Iterest received 10,000 Divideds received Net cash used i/from ivestig activities 100,000 cash flows from fiacig activities Proceeds from issue of share capital 275,000 Repaymet of share capital Proceeds from log-term borrowigs Repaymet of log-term borrowigs 140,000 Divideds paid (ote: amout paid durig year) 22,000 Net cash used i/from fiacig activities 113,000 et icrease/decrease i cash ad cash equivalets 91,000 cash ad cash equivalets at begiig of year 105,000 cash ad cash equivalets at ed of year 196,000 recociliatio of profit From operatios to et cash From operatig activities Profit from operatios (ote: before tax ad iterest) 75,000 Adjustmets for: Depreciatio for year 10,000 Decrease i ivetories 2,000 Icrease i trade ad other receivables 5,000 Icrease i trade ad other payables 7,000 Cash used i/from operatios 89,000 Iterest paid (ote: amout paid durig year) 5,000 Icome taxes paid (ote: amout paid durig year) 6,000 et cash used i/from operatig activities 78,000

6 s t a t e m e t o f c a s h f l o w s Case Study o t e s o t h e l a y o u t o f a s t a t e m e t o f c a s h f l o w s The separate amouts show for each sectio ca, if preferred, be detailed i a ote to the statemet of cash flows. The operatig activities sectio is ivariably set out i detail as a ote below the statemet of cash flows, with just the figure for et cash from operatig activities (see example opposite) beig show o the statemet see grey lie. Moey amouts show i brackets (or a mius sig) idicate a deductio or, where the figure is a sub-total, a egative figure. The chages i the mai workig capital items of ivetories, trade ad other receivables, ad trade ad other payables have a effect o cash balaces. For example, a decrease i ivetory icreases cash, while a icrease i trade receivables reduces cash. IAS 7 allows some flexibility i the way i which compaies preset their statemets of cash flows. I particular, the cash flows from iterest ad divideds received ad paid ca be classified as operatig or ivestig or fiacig activities i AAT Assessmets iterest received ad divideds received are always treated as ivestig activities (ote that for AAT, iterest paid is show as a operatig activity, ad divideds paid is show as a fiacig activity). Cash flows arisig from taxes o icome eg corporatio tax are always classified as operatig activities, uless they ca be specifically idetified with fiacig ad ivestig activities. The statemet of cash flows cocludes with a figure for the et icrease or decrease i cash ad cash equivalets for the year. This is calculated from the subtotals of each of the three sectios of the statemet. Added to this is the amout of cash ad cash equivalets at the begiig of the year. Thus the fial figure of the statemet is that of cash ad cash equivalets at the ed of the year. S tat e m e t O F C A S H F L O W S s i t u a t i o the statemets of fiacial positio of ewtow tradig Compay Limited for 20-5 ad 20-6 are show o the ext page. Prepare a statemet of cash flows for the year eded 31 December 20-6 ad commet o the mai poits highlighted by the statemet. ote the followig poits: extract from the statemet of profit or loss ad other comprehesive icome for 20-6: Profit from operatios 9,400 Iterest paid 400 Profit before tax 9,000 tax 1,500 Profit for the year 7,500 Divideds of 1,500 were paid i 20-5, ad 2,000 i Durig 20-6 the property was revalued at 125,000.

7 1 6 4 f i a c i a l s t a t e m e t s t u t o r i a l tutorial ote: Whe preparig a statemet of cash flows from fiacial statemets, take a momet or two to establish which is the earlier year ad which is the later year. I this Case Study they are set out from left to right, ie 20-5 followed by I some Assessmets, the later year is show first, ie 20-6 followed by ewtow tradig compay LImIted Statemet of FIacIaL positio as at 31 december assets cost dep et cost or dep et reval o-curret assets Property 75,000-75, , ,000 Plat ad equipmet 22,200 6,200 16,000 39,000 8,900 30,100 97,200 6,200 91, ,000 8, ,100 curret assets Ivetories 7,000 11,000 trade ad other receivables 5,000 3,700 Cash ad cash equivalets 1, ,000 15,200 total assets 104, ,300 equity ad LIaBILItIeS equity Share capital 80,000 90,000 Share premium 1,500 2,500 Revaluatio reserve 50,000 Retaied earigs 11,000 16,500 total equity 92, ,000 o-curret liabilities Debetures 5,000 3,000 curret liabilities trade ad other payables 5,500 6,800 tax liabilities 1,000 1,500 6,500 8,300 total liabilities 11,500 11,300 total equity ad liabilities 104, ,300

8 s t a t e m e t o f c a s h f l o w s s o l u t i o ewtow tradig compay LImIted Statemet of cash FLoWS For the year eded 31 december 20-6 et cash used i/from operatig activities (see below) 9,300 cash flows from ivestig activities Purchase of o-curret assets (plat ad equipmet) 16,800 Net cash used i/from ivestig activities 16,800 cash flows from fiacig activities Issue of ordiary shares at a premium ie 10, ,000 = 11,000 Repaymet of debetures 2,000 Divideds paid 2,000 Net cash used i/from fiacig activities 7,000 et icrease/decrease i cash ad cash equivalets 500 cash ad cash equivalets at begiig of year 1,000 cash ad cash equivalets at ed of year 500 recociliatio of profit From operatios to et cash From operatig activities Profit from operatios (before tax ad iterest) 9,400 Adjustmets for: Depreciatio for year* 2,700 Icrease i ivetories 4,000 Decrease i trade ad other receivables 1,300 Icrease i trade ad other payables 1,300 Cash used i/from operatios 10,700 Iterest paid 400 Icome taxes paid 1,000 et cash used i/from operatig activities 9,300 * Depreciatio charged: 8,900 6,200 = 2,700 o t e s o t h e s t a t e m e t o f c a s h f l o w s the liability for tax which is a curret liability at 31 December 20-5 is paid i Likewise, the curret liability for tax at 31 December 20-6 will be paid i 20-7 (ad will appear o that year s statemet of cash flows). the divided is the amout paid durig 20-6, ie 2,000. the revaluatio of the property (icrease i the value of the o-curret asset, ad revaluatio reserve recorded i the equity sectio) does ot feature i the statemet of cash flows because it is a o-cash trasactio. Remember that the amout of the revaluatio will also be show as other comprehesive icome i the statemet of profit or loss ad other comprehesive icome.

9 1 6 6 f i a c i a l s t a t e m e t s t u t o r i a l h o w u s e f u l i s t h e s t a t e m e t o f c a s h f l o w s? the followig poits are highlighted by the statemet o the previous page: cash geerated from operatios is 10,700 (this is before iterest ad tax is paid for the year) et cash from operatig activities is 9,300 a purchase of plat ad equipmet of 16,800 has bee made, fiaced partly by operatig activities, ad partly by a issue of shares at a premium the bak balace durig the year has falle by 500, ie from 1,000 to 500 I coclusio, the picture show by the statemet of cash flows is that of a busiess which is geeratig cash from its operatig activities ad usig the cash to build for the future. g a I o r L o S S o d I S p o S a L o F o - c u r r e t a S S e t S c a r r y i g a m o u t a d s a l e p r o c e e d s Whe a compay disposes of o-curret assets it is most ulikely that the resultat sale proceeds will be equal to the carryig amout (cost/revaluatio less accumulated depreciatio) there will be a gai or loss o disposal. d e a l i g w i t h a g a i o r l o s s o d i s p o s a l The accoutig solutio is to trasfer ay small gai or loss o disposal o-cash items to the statemet of profit or loss ad other comprehesive icome. However, such a gai or loss o disposal must be hadled with care whe preparig a statemet of cash flows because, i such a statemet we have to adjust for o-cash items whe calculatig the et cash from operatig activities; at the same time we must separately idetify the amout of the proceeds of sale of o-curret assets i the ivestig activities sectio. Case Study G A I O R L O S S O D I S P O S A L O F O - C U R R e t A S S e t S s i t u a t i o H & J Wells Limited is a electrical cotractor. For the year eded 30 Jue 20-6 its statemet of profit or loss ad other comprehesive icome is as follows:

10 s t a t e m e t o f c a s h f l o w s Gross profit 37,500 expeses: Geeral expeses 23,000 Provisio for depreciatio: plat 2,000 equipmet 3,000 28,000 Profit from operatios 9,500 g a i o d i s p o s a l Durig the course of the year the compay has sold the followig o-curret asset; the effects of the disposal trasactio have ot yet bee recorded i the statemet of profit or loss ad other comprehesive icome: Plat: cost price 1,000 depreciatio to date 750 carryig amout 250 proceeds of sale 350 As the plat has bee sold for 100 more tha the carryig amout, this gai o disposal is show i the statemet of profit or loss ad other comprehesive icome, as follows: Gross profit 37,500 Gai o disposal of o-curret assets ,600 expeses: Geeral expeses 23,000 Provisio for depreciatio: plat 2,000 equipmet 3,000 28,000 Profit from operatios 9,600 the statemet of cash flows, based o the ameded statemet of profit or loss ad other comprehesive icome, will iclude the followig figures:

11 1 6 8 f i a c i a l s t a t e m e t s t u t o r i a l Statemet of cash FLoWS (extract) of h & J WeLLS LImIted For the year eded 30 Jue 20-6 cash flows from operatig activities Profit from operatios 9,600 Adjustmets for: Depreciatio for year 5,000 Gai o disposal of o-curret assets 100 Icrease/decrease i ivetories... Icrease/decrease i trade ad other receivables... Icrease/decrease i trade ad other payables... Net cash used i/from operatig activities 14,500 cash flows from ivestig activities Purchase of o-curret assets... Proceeds from disposal of o-curret assets 350 Net cash used i/from ivestig activities 350 ote that the gai o disposal of o-curret assets is deducted i the operatig activities sectio because it is o-cash icome. (Oly the sectios of the statemet of cash flows affected by the disposal are show above.) l o s s o d i s p o s a l If the plat i the Case Study had bee sold for 150, this would have give a loss o disposal of 100. This amout would be debited to the statemet of profit or loss ad other comprehesive icome, to give a ameded profit from operatios of 9,400. The effect o the statemet of cash flows would be twofold: 1 I the operatig activities sectio, loss o disposal of o-curret assets of 100 would be added; the et cash from operatig activities remais at 14,500 (which proves that both gai ad loss o disposal of o-curret assets are items which do ot affect cash) 2 I the ivestig activities sectio, proceeds from disposal of o-curret assets would be 150 c o c l u s i o : d i s p o s a l o f o - c u r r e t a s s e t s The rule for dealig with a gai or a loss o disposal of o-curret assets i a statemet of cash flows is: add the amout of the loss o disposal, or deduct the amout of the gai o disposal, to or from the profit from operatios whe calculatig the et cash from operatig activities

12 s t a t e m e t o f c a s h f l o w s show the total disposal proceeds, ie the amout of the paymet received, as proceeds from sale of o-curret assets i the ivestig activities sectio The Case Study below icorporates calculatios for a gai o disposal of o-curret assets. r e va L u at I o o F o - c u r r e t a S S e t S From time-to-time some o-curret assets are revalued upwards ad the amout of the revaluatio is recorded as other comprehesive icome ad is take to the statemet of fiacial positio. The most commo asset to be treated i this way is property. The value of the o-curret asset is icreased ad the amout of the revaluatio is placed to a revaluatio surplus i the equity sectio of the statemet of fiacial positio where it icreases the total equity of the compay. As a revaluatio is purely a book adjustmet, ie o cash has chaged hads, it does ot feature i a statemet of cash flows see the Case Study of Newtow Tradig Compay Limited o pages 163 to 166. p r e pa r I g F o r a S S e S S m e t I AAT Assessmets there are two tasks which require fiacial statemets to be drafted. I Chapter 3 we have already see (page 72) the two tasks for preparig statemets of profit or loss, chages i equity, ad fiacial positio. The alterative two tasks i assessmets focus o the statemet of cash flows. Here you will be provided with a statemet of profit or loss ad other comprehesive icome for a sigle year ad statemets of fiacial positio for two years: i the first task you will be required to prepare a recociliatio of profit from operatios to et cash from operatig activities ad a statemet of cash flows i the secod task you will be required to draft a statemet of chages i equity (see page 174) Both of these tasks use the same statemets of profit or loss ad other comprehesive icome ad fiacial positio. Blak layouts are provided ad, i the AAT Assessmet, you select arrative items from pick lists ad eter moey amouts ito gap fill boxes. Pro-formas for workigs are also provided, as appropriate, i the assessmet ad partial marks ca be obtaied from these i the evet of errors beig made i the mai layouts for the statemets. Note that pro-formas for layouts ad workigs i the format

13 1 7 0 f i a c i a l s t a t e m e t s t u t o r i a l used i AAT Assessmets are provided i the Appedix of this book. I the Case Study which follows we see how the aspects of the statemet of cash flows ad the statemet of chages i equity are prepared from the statemets of profit or loss ad other comprehesive icome ad fiacial positio ie the two tasks for this type of AAT Assessmet. Case Study S tat e m e t O F C A S H F L O W S s i t u a t i o You have bee asked to prepare the statemet of cash flows ad chages i equity for Doddigto Ltd for the year eded 31 December 20X6. the most recet statemet of profit or loss ad statemet of fiacial positio (with comparatives for the previous year) of Doddigto Ltd are set out below. doddigto Ltd Statemet of profit or loss for the year eded 31 december 20X6 cotiuig operatios 000 reveue 755 Cost of sales 546 Gross profit 209 Divideds received 6 Gai o disposal of property, plat ad equipmet 10 Distributio costs 115 Admiistrative expeses 79 profit from operatios 31 Fiace costs 3 profit before tax 28 tax 7 profit for the period from cotiuig operatios 21

14 s t a t e m e t o f c a s h f l o w s doddigto Ltd Statemet of fiacial positio as at 31 december 20X6 assets 20X6 20X o-curret assets Property, plat ad equipmet curret assets Ivetories trade receivables Cash ad cash equivalets total assets equity ad LIaBILItIeS equity Share capital Share premium 10 0 Retaied earigs total equity o-curret liabilities Bak loas curret liabilities trade payables tax liabilities 7 4 Bak overdraft total liabilities total equity ad liabilities

15 1 7 2 f i a c i a l s t a t e m e t s t u t o r i a l Further iformatio: the total depreciatio charge for the year was 36,000. Property, plat ad equipmet costig 40,000 with accumulated depreciatio of 20,000 was sold i the year. All sales ad purchases were o credit. Other expeses were paid for i cash. A divided of 15,000 was paid durig the year. r e q u i r e d (a) Prepare a recociliatio of profit from operatios to et cash from operatig activities for Doddigto Ltd for the year eded 31 December 20X6. (b) Prepare the statemet of cash flows for Doddigto Ltd for the year eded 31 December 20X6. (c) Draft the statemet of chages i equity for Doddigto Ltd for the year eded 31 December 20X6. s o l u t i o (a) doddigto Ltd recociliatio of profit from operatios to et cash from operatig activities 000 Profit from operatios 31 adjustmets for: Depreciatio 36 Divideds received 6 Gai o disposal of property, plat ad equipmet 10 Adjustmet i respect of ivetories 24 Adjustmet i respect of trade receivables 40 Adjustmet i respect of trade payables 15 cash geerated by operatios 2 tax paid 4 Iterest paid 3 et cash from operatig activities 5 tutorial ote for aat assessmets: profit from operatios is always the startig poit for tasks which require the preparatio of this recociliatio divideds received are always treated as ivestig activities therefore they are deducted i the calculatio of cash geerated by operatios

16 s t a t e m e t o f c a s h f l o w s (b) doddigto Ltd Statemet of cash flows for the year eded 31 december 20X6 000 et cash from operatig activities 5 Ivestig activities Divideds received 6 Proceeds o disposal of property, plat ad equipmet 30 Purchases of property, plat ad equipmet 131 et cash used i ivestig activities 95 Fiacig activities Bak loas raised 60 Proceeds of share issue 30 Divideds paid 15 et cash from fiacig activities 75 et icrease/decrease i cash ad cash equivalets 25 cash ad cash equivalets at begiig of year 10 cash ad cash equivalets at ed of year 15 Workigs proceeds o disposal of property, plat ad equipmet 000 Carryig amout of property, plat ad equipmet sold 20 Gai o disposal 10 Proceeds = 30 purchases of property, plat ad equipmet 000 Property, plat ad equipmet at start of year 200 Depreciatio charge 36 Carryig amout of property, plat ad equipmet sold 20 Property, plat ad equipmet at ed of year 275 total property, plat ad equipmet additios = 131

17 1 7 4 f i a c i a l s t a t e m e t s t u t o r i a l (c) doddigto Ltd Statemet of chages i equity for the year eded 31 december 20X6 Share Share retaied total capital premium earigs equity Balace at 1 Jauary 20X chages i equity for 20X6 Profit for the period Divideds Issue of share capital Balace at 31 december 20X h o w u s e f u l i s t h e s t a t e m e t o f c a s h f l o w s? While the type of AAt Assessmet task cosidered here will ot ask you to commet o the statemet of cash flows, aspects of cash flows ca feature i tasks which require the iterpretatio of fiacial statemets (see Chapter 7). the followig poits are highlighted by the statemet of cash flows of Doddigto Ltd for the year eded 31 December 20X6: although there is a reasoable profit from operatios of 31,000, the cash geerated from operatios is just 2,000 isufficiet to cover the tax ad iterest paid ivetories, trade receivables ad trade payables have icreased i particular trade receivables so that a et 49,000 of cash has bee used o-curret assets of 131,000 have bee purchased which have bee almost fiaced by the 120,000 from the sale of o-curret assets, the bak loa raised, ad the proceeds of the share issue with a et decrease of 25,000 i cash ad cash equivalets durig the year, it might have bee prudet to pay a smaller divided the compay appears to be expadig, with icreases i o-curret assets, curret assets ad curret liabilities. Despite the share issue ad the loa raised, quite a lot of the expasio has bee fiaced through the bak. It might have bee better to have obtaied more log-term fiace rather tha usig a bak overdraft.

18 s t a t e m e t o f c a s h f l o w s S tat e m e t o F c a S h F L o W S : t h e d I r e c t m e t h o d So far i this chapter we have focussed o preparig the statemet of cash flows usig the idirect method. Thus the operatig activities sectio starts with the profit from operatios. As a alterative, IAS 7 allows the direct method. For the operatig activities sectio this method, istead of startig with profit, shows cash flows as follows: cash received from the sale of goods cash paid to suppliers ad employees iterest paid tax paid As a example of the direct method we will use the statemet of cash flows of ABC Limited show o page 162. The cash (used i)/from operatios is calculated i the followig way (with specime figures icluded): cash flows from operatig activities Cash received from the sale of goods 759,000 Cash paid to suppliers ad employees 670,000 Cash used i/from operatios 89,000 Iterest paid 5,000 tax paid 6,000 et cash (used i)/from operatig activities 78,000 Note that the figure of 89,000 for cash from operatios ad the 78,000 et cash from operatig activities are the same as the idirect method o page 162. The statemet of cash flows preseted usig the direct method is show o the ext page. To summarise the direct method: oly the operatig activities sectio is set out differetly from the idirect method cash receipts ad cash paymets are show i the calculatio of cash (used i)/from operatios Note that AAT s Assessmet requires you to have kowledge of the examples of cash flows to be classified as operatig activities whe usig the direct method.

19 1 7 6 f i a c i a l s t a t e m e t s t u t o r i a l S t a t e m e t o F c a S h F L o W S : d I r e c t m e t h o d ABC LIMITED STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20-6 et cash used i/from operatig activities 78,000 cash flows from ivestig activities Purchase of o-curret assets 125,000 Proceeds from sale of o-curret assets 15,000 Iterest received 10,000 Divideds received Net cash used i/from ivestig activities 100,000 cash flows from fiacig activities Proceeds from issue of share capital 275,000 Repaymet of share capital Proceeds from log-term borrowigs Repaymet of log-term borrowigs 140,000 Divideds paid (ote: amout paid durig year) 22,000 Net cash used i/from fiacig activities 113,000 et icrease/decrease i cash ad cash equivalets 91,000 cash ad cash equivalets at begiig of year 105,000 cash ad cash equivalets at ed of year 196,000 calculatio of cash from operatig activities cash flows from operatig activities Cash received from the sale of goods 759,000 Cash paid to suppliers ad employees 670,000 Cash used i/from operatios 89,000 Iterest paid 5,000 tax paid 6,000 et cash used i/from operatig activities 78,000

20 s t a t e m e t o f c a s h f l o w s L I k S t o t h e S tat e m e t o F F I a c I a L p o S I t I o As the statemet of cash flows is oe of the mai fiacial statemets prepared at the ed of a accoutig period, it eeds to be read i cojuctio with the statemet of fiacial positio. I order to help the user of the statemet of cash flows, IAS 7 requires that there should be explaatory otes o cash ad cash equivalets. c a s h a d c a s h e q u i v a l e t s Compaies must disclose the compoets of cash ad cash equivalets ad recocile the amouts show i the statemet of cash flows with the figures from the statemet of fiacial positio. Thus, for ABC Limited (see previous page) the recociliatio could be show as follows, with specime figures used: recociliatio of cash ad cash equivalets 31 december december 20-6 Cash 20,000 26,000 Overdraft 45,000 20,000 Short-term deposits 130, ,000 Cash ad cash equivalets 105, ,000 I t e r p r e t I g t h e S tat e m e t o F c a S h F L o W S The statemet of cash flows is importat because it idetifies the sources of cash flowig ito the compay ad shows how they have bee used. To get a overall view of the compay, we eed to read the statemet i cojuctio with the other mai fiacial statemets profit or loss ad other comprehesive icome ad fiacial positio ad also i the cotext of the previous year s statemets. The followig poits should be bore i mid: Like the other fiacial statemets, the statemet of cash flows uses the moey measuremet cocept. This meas that oly items which ca be recorded i moey terms ca be icluded; also we must be aware of the effect of iflatio if comparig oe year with the ext.

21 1 7 8 f i a c i a l s t a t e m e t s t u t o r i a l Look for positive cash flows from the operatig activities sectio. I particular, look at the subtotal cash (used i)/from operatios this shows the cash from reveue-producig activities before the paymet of iterest ad tax. Make a compariso betwee the amout of profit ad the amout of cash geerated from operatios. Idetify the reasos for major differeces betwee these figures look at the chages i ivetories, trade ad other receivables, ad trade ad other payables, ad put them ito cotext. For example, it would be a warig sig if there were large icreases i these items i a compay with fallig profits, ad such a tred would put a strai o the liquidity of the busiess. Also cosider the compay s policies o collectig trade receivables ad potetial for bad (irrecoverable) debts, paymet to trade payables (is the compay payig too quickly?) ad cotrol of ivetories (are surpluses buildig up?). Look at the figure for et cash (used i)/from operatig activities, ie the cash from operatios after iterest ad tax have bee paid. If it is a positive figure, it shows that the compay has bee able to meet its iterest ad tax obligatios to loa providers ad the tax authorities. The ivestig activities sectio of the statemet shows the amout of ivestmet made durig the year (eg the purchase of o-curret assets). I geeral there should be a lik betwee the cost of the ivestmet ad a icrease i loas ad/or share capital it is t usual to fiace ocurret assets from short-term sources, such as a bak overdraft. I the fiacig activities sectio of the statemet, where there has bee a icrease i loas ad/or share capital, look to see how the moey has bee used. Was it to buy o-curret assets or other ivestmets, or to fiace ivetory ad trade receivables, or other purposes? Look at the amout of divideds paid this is a outflow of cash that will directly affect the chage i the bak balace. As a quick test, the amout of et cash from operatig activities should, i theory, be sufficiet to cover divideds paid; if it does t, the it is likely that the level of divideds will have to be reduced i future years. The statemet of cash flows, as a whole, liks profit with chages i cash. Both of these are importat: without profits the compay caot geerate cash (uless it sells o-curret assets), ad without cash it caot pay bills as they fall due.

22 s t a t e m e t o f c a s h f l o w s Chapter Summary the objective of a statemet of cash flows is to show a overall view of moey flowig i ad out of a compay durig a accoutig period. IAS 7 is the iteratioal fiacial reportig stadard that sets out the requiremets of statemets of cash flows. A statemet of cash flows is divided ito three sectios: 1 operatig activities the mai reveue-producig activities of the busiess, together with the paymet of iterest ad tax 2 ivestig activities the acquisitio ad disposal of o-curret assets, ad some other ivestmets 3 fiacig activities receipts from the issue of ew shares, paymets to cover the repaymet of shares, chages i log-term borrowigs there are two methods of settig out the operatig activities sectio: the direct method ad the idirect method. Limited compaies are required to iclude a statemet of cash flows as a part of their fiacial statemets.

23 1 8 0 f i a c i a l s t a t e m e t s t u t o r i a l Key Terms statemet of cash flows cash from operatios et cash from operatig activities ivestig activities fiacial activities cash cash equivalets shows a overall view of moey flowig i ad out of a compay durig a accoutig period usig either the direct method or the idirect method profit from operatios (ie before deductio of tax ad iterest), add depreciatio for the year, add loss (or deduct gai) o disposal of o-curret assets, deduct ivestmet icome, together with chages i ivetories, trade ad other receivables, ad trade ad other payables cash geerated from operatios (see above), deduct iterest paid i period, deduct taxes paid o icome i period cost of purchase ad/or proceeds of disposal of o-curret assets; divideds received; iterest received issue or repaymet of share capital ad/or logterm borrowigs; divideds paid cash o had ad demad deposits short-term, highly liquid ivestmets that ca easily be coverted ito cash

24 s t a t e m e t o f c a s h f l o w s Activities A blak photocopiable pro-forma i the format used i AAt Assessmets of the statemet of cash flows is icluded i the Appedix it is advisable to elarge it to full A4 size. Blak workigs sheets are also icluded i the Appedix. Pro-formas ad workigs sheets are also available to dowload from 6.1 A icrease i ivetories will have a egative impact o cash flow i the calculatio of et cash flow from operatig activities. true / False 6.2 A gai o disposal of property, plat ad equipmet will have a egative impact o cash flow i the calculatio of et cash flow from operatig activities. true / False 6.3 A decrease i trade payables will have a positive impact o cash flow i the calculatio of et cash flow from operatig activities. true / False 6.4 A icrease i trade receivables will have a positive impact o cash flow i the calculatio of et cash flow from operatig activities. true / False 6.5 A loss o disposal of property, plat ad equipmet will have a positive impact o cash flow i the calculatio of et cash flow from operatig activities. true / False 6.6 A cash receipt from the sale of property, plat ad equipmet will be classified as a ivestig activity i the statemet of cash flows. true / False

25 1 8 2 f i a c i a l s t a t e m e t s t u t o r i a l 6.7 Whe preparig a statemet of cash flows usig the direct method, which of the followig cash flows are used? 1. cash paid to suppliers ad employees 2. cash received from the sale of goods 3. tax paid 4. iterest paid 3 (a) 1 ad 2 (b) 1, 2 ad 3 (c) 3 ad 4 (d) all of them 6.8 the followig iformatio relates to a compay for the year eded 30 Jue 20X1. Profit from operatios (after deductig depreciatio of 5,000) is 12,400 at X1 at X0 Ivetories 3,600 3,900 trade receivables 4,800 4,200 trade payables 4,100 3,700 What is the et cash geerated from operatig activities (prior to ay tax ad iterest paid)? 3 (a) 17,500 (b) 17,400 (c) 18,700 (d) 12,500

26 s t a t e m e t o f c a s h f l o w s Dewa Ltd has a profit from operatios of 25,000 for 20X1. the compay s statemet of profit or loss ad other comprehesive icome ad statemet of fiacial positio show the followig: depreciatio charge 8,000 decrease i ivetories 3,000 icrease i trade ad other receivables 5,000 icrease i trade ad other payables 2,000 What is the cash from operatios for 20X1? 3 (a) (b) (c) (d) 33,000 iflow 37,000 iflow 13,000 iflow 43,000 iflow 6.10 Sumer Ltd has a loss from operatios of 8,000 for 20X2. the compay s statemet of profit or loss ad other comprehesive icome ad statemet of fiacial positio show the followig: depreciatio charge 7,500 icrease i ivetories 2,500 icrease i trade ad other receivables 1,500 decrease i trade ad other payables 1,000 What is the cash from operatios for 20X2? (a) 4,500 iflow (b) 2,500 outflow (c) 5,500 outflow (d) 4,500 outflow 3

27 1 8 4 f i a c i a l s t a t e m e t s t u t o r i a l 6.11 Zhag Ltd has a profit from operatios of 12,500 for 20X3. the compay s statemet of profit or loss ad other comprehesive icome ad statemet of fiacial positio show the followig: depreciatio charge 8,500 gai o disposal of property, plat ad equipmet 3,500 decrease i ivetories 2,500 icrease i trade ad other receivables 3,000 decrease i trade ad other payables 2,000 What is the cash from operatios for 20X3? (a) 26,000 iflow (b) 15,000 iflow (c) 16,000 iflow (d) 32,000 iflow You have bee asked to prepare the statemet of cash flows for mister Ltd for the year eded 31 march 20X1. the most recet statemet of comprehesive icome ad statemet of fiacial positio (with comparatives for the previous year) of mister Ltd are set out below. mister Ltd Statemet of comprehesive icome for the year eded 31 march 20X1 cotiuig operatios 000 reveue 2,749 Cost of sales 1,312 Gross profit 1,437 Divideds received 25 Gai o disposal of property, plat ad equipmet 53 Distributio costs 624 Admiistrative expeses 347 profit from operatios 544 Fiace costs 54 profit before tax 490 tax 115 profit for the period from cotiuig operatios 375

28 s t a t e m e t o f c a s h f l o w s mister Ltd Statemet of fiacial positio as at 31 march 20X1 20X1 20X assets o-curret assets Property, plat ad equipmet 3,640 2,490 curret assets Ivetories trade receivables Cash ad cash equivalets total assets 4,103 2,824 equity ad LIaBILItIeS equity Share capital 1,500 1,000 Share premium Retaied earigs total equity 2,832 1,932 o-curret liabilities Bak loas 1, , curret liabilities trade payables tax liabilities Bak overdraft total liabilities 1, total equity ad liabilities 4,103 2,824 Further iformatio: the total depreciatio charge for the year was 365,000. Property, plat ad equipmet costig 260,000 with accumulated depreciatio of 95,000 was sold i the year. All sales ad purchases were o credit. Other expeses were paid for i cash. A divided of 225,000 was paid durig the year. required: (a) Prepare a recociliatio of profit from operatios to et cash from operatig activities for mister Ltd for the year eded 31 march 20X1. (b) Prepare the statemet of cash flows for mister Ltd for the year eded 31 march 20X1.

29 1 8 6 f i a c i a l s t a t e m e t s t u t o r i a l 6.13 You have bee asked to prepare the statemet of cash flows ad chages i equity for Velai Ltd for the year eded 31 march 20X2. the most recet statemet of comprehesive icome ad statemet of fiacial positio (with comparatives for the previous year) of Velai Ltd are set out below. velai Ltd Statemet of comprehesive icome for the year eded 31 march 20X2 cotiuig operatios 000 reveue 53,600 Cost of sales 36,420 Gross profit 17,180 Divideds received 45 Loss o disposal of property, plat ad equipmet 110 Distributio costs 11,163 Admiistrative expeses 4,032 profit from operatios 1,920 Fiace costs 109 profit before tax 1,811 tax 347 profit for the period from cotiuig operatios 1,464

30 s t a t e m e t o f c a s h f l o w s velai Ltd Statemet of fiacial positio as at 31 march 20X2 20X2 20X assets o-curret assets Property, plat ad equipmet 12,832 9,911 curret assets Ivetories 5,057 5,168 trade receivables 5,341 4,730 Cash ad cash equivalets 0 1,360 10,398 11,258 total assets 23,230 21,169 equity ad LIaBILItIeS equity Share capital 8,000 6,000 Share premium 2,000 1,000 Retaied earigs 6,052 5,183 total equity 16,052 12,183 o-curret liabilities Bak loas 0 2, ,280 curret liabilities trade payables 6,721 6,410 tax liabilities Bak overdraft ,178 6,706 total liabilities 7,178 8,986 total equity ad liabilities 23,230 21,169 Further iformatio: the total depreciatio charge for the year was 1,520,000. Property, plat ad equipmet costig 450,000 with accumulated depreciatio of 210,000 was sold i the year. All sales ad purchases were o credit. Other expeses were paid for i cash. A divided of 595,000 was paid durig the year. required: (a) Prepare a recociliatio of profit from operatios to et cash from operatig activities for Velai Ltd for the year eded 31 march 20X2. (b) Prepare the statemet of cash flows for Velai Ltd for the year eded 31 march 20X2. (c) Draft the statemet of chages i equity for Velai Ltd for the year eded 31 march 20X2.

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