Acca f3 Financial Accounting (int) Study Text

Part F  Preparing basic financial statements 

  23:  Statements of cash flows

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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

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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. 

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