Part F Preparing
basic financial statements
23: Statements of cash flows
391
1.7.3 Financing activities
This section of the statement of cash flows shows the share of cash which the enterprise's capital
providers have claimed during the period. This is an indicator of
likely future interest and dividend
payments. The standard gives the following examples of cash flows which might arise under these
headings.
(a)
Cash proceeds from issuing shares
(b)
Cash payments to owners to acquire or redeem the enterprise's shares
(c)
Cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short or long-
term borrowings
(d)
Cash repayments
of amounts borrowed
1.8 Reporting cash flows from operating activities
The standard offers a choice of method for this part of the statement of cash flows.
(a)
Direct method: disclose major classes of gross cash receipts and gross cash payments
(b)
Indirect method: net profit or loss is adjusted for the effects of transactions of a non-cash nature,
any deferrals or accruals of past or future operating cash receipts or payments, and items of
income or expense associated with investing or financing cash flows
The
direct method discloses information, not available elsewhere in the financial statements, which could
be of use in estimating future cash flows. However, the
indirect method is simpler, more widely used and
more likely to be examined.
1.8.1 Using the direct method
There are different ways in which the
information about gross cash receipts and payments can be
obtained. The most obvious way is simply to extract the information from the accounting records. The
pro-forma is shown below. This may be a laborious task, however, and the indirect method below may be
easier.
$
Cash receipts from customers
X
Cash paid to suppliers and employees
X
Cash generated from operations
X
1.8.2 Using the indirect method
This method is undoubtedly
easier from the point of view of the preparer of the statement of cash flows.
The net profit or loss for the period is adjusted for the following.
(a)
Changes during the period in inventories, operating receivables and payables
(b)
Non-cash items, eg depreciation, provisions, profits/losses on the sales of assets
(c)
Other items, the cash flows from which should be classified under investing or financing activities.
A
proforma of such a calculation is as follows and this method may be more common in the exam.
$
Profit before interest and tax (income statement)*
X
Add depreciation
X
Loss (profit) on sale of non-current assets
X
(Increase)/decrease in inventories
(X)/X
(Increase)/decrease in receivables
(X)/X
Increase/(decrease) in payables
X/(X)
Cash generated from operations
X
Interest (paid)/received
(X)
Income taxes paid
(X)
Net cash flows from operating activities
X
Formula to
learn
392
23: Statements of cash flows Part F Preparing basic financial statements
* Take profit before tax and add back any interest expense
It is important to understand why
certain items are added and others subtracted. Note the following
points.
(a)
Depreciation is not a cash expense, but is deducted in arriving at the profit figure in the income
statement. It makes sense, therefore, to eliminate it by adding it back.
(b)
By the same logic, a loss on a disposal of a non-current asset (arising through underprovision of
depreciation) needs to be added back and a profit deducted.
(c)
An increase in inventories means less cash – you have spent cash on buying inventory.
(d)
An increase in receivables means the company's receivables have not paid as much, and therefore
there is less cash.
(e)
If we pay off payables, causing the figure to decrease, again we have less cash.
1.8.3 Indirect versus direct
The direct method is encouraged where the necessary information is not too costly to obtain, but IAS 7
does not demand it. In practice, therefore, the direct method is rarely used. It could be argued that
companies ought to monitor their cash flows carefully enough on an ongoing basis to be able to use the
direct method at minimal extra cost.
1.9 Interest and dividends
Cash flows from interest and dividends received and paid should each be
disclosed separately. Each
should be classified in a consistent manner from period to period as either operating, investing or
financing activities.
Dividends paid by the enterprise can be classified in
one of two ways.
(a) As
a
financing cash flow, showing the cost of obtaining financial resources.
(b)
As a component of
cash flows from operating activities so that users can assess the enterprise's
ability to pay dividends out of operating cash flows.
1.10 Taxes on income
Cash flows arising from taxes on income should be
separately disclosed and should be classified as cash
flows from operating activities unless they can be specifically identified with financing and investing
activities.
Taxation cash flows are often
difficult to match to the originating underlying transaction, so most of the
time all tax cash flows are classified as arising from operating activities.
1.11 Components of cash and cash equivalents
The components of cash and cash equivalents should be disclosed and a
reconciliation should be
presented, showing the amounts in the statement of cash flows reconciled with the equivalent items
reported in the statement of financial position.
It is also necessary to disclose the
accounting policy used in deciding the items included in cash and cash
equivalents, in accordance with IAS 1 Presentation of financial statements, but also because of the wide
range of cash management practices worldwide.
1.12 Other disclosures
All enterprises should disclose, together with a
commentary by management, any other information likely
to be of importance, for example:
(a)
restrictions on the use of or access to any part of cash equivalents;
(b)
the amount of undrawn borrowing facilities which are available; and
(c)
Cash flows which increased operating capacity compared to cash flows which merely maintained
operating capacity.