Lecture 4 :The statement of cash flows

Lecture 4 :The statement of cash flows
HI5020 Corporate Accounting
Holmes Institute
Applied Business Statistics for Managers
Topics covered in this session
Understand what a statement of cash flows is, and why it is useful
Understand the accounting requirements relating to the disclosure of
information about an organisation’s cash flows
Understand the differences between cash flows from operating, cash
flows from investing, and cash flows from financing activities
Understand how to construct a statement of cash flows in conformity
with AASB 107 Statement of Cash Flows
Understand how the statement of cash flows provides information that is
a useful complement to the statement of financial position and the
statement of profit or loss and other comprehensive income
Holmes Institute
Applied Business Statistics for Managers
Comparison with other financial statements
Statement of financial position shows the financial position as at a point in time
Statement of profit or loss and other comprehensive income shows the profit or loss and
other items of comprehensive income that have been generated for a period of time using
accrual accounting
Statement of changes in equity provides a reconciliation of opening and closing equity as well
as the various equity accounts that are impacted by the period’s total comprehensive income
Statement of cash flows
➢ explains the movements in cash and ‘cash equivalents’ for a given period
➢ provides a reconciliation of opening and closing total of cash and cash equivalent balances
appearing in the statement of financial position
➢ indicates sources of cash in terms of cash flows from operating and investing, and from
financing activities
Holmes Institute
Applied Business Statistics for Managers
Purpose of the statement of cash flows
Assists in assessing the ability of the reporting entity to:
➢ generate cash flows
➢ meet financial commitments as they fall due, including servicing of
borrowings and payment of dividends
➢ fund changes in the scope and/or nature of its activities
➢ obtain external finance
• By having knowledge of both cash flows and accrual profits/losses,
investors are likely to be better able to assess the performance and
viability of the reporting entity
Holmes Institute
Applied Business Statistics for Managers
Purpose of the statement of cash flows
Argued (by some) to report information that is more reliable than profit data as profit data is
typically based upon numerous subjective and sometimes ‘creative’ professional judgements
Cash-flow data tends to be more ‘factual’ or ‘objective’
Considered by many people to be more understandable to users, to give rise to fewer problems
with key terms, and to enable greater comparability between organisations.
Cash flows from operating activities are considered (by some people) to be a superior
performance measure and more useful in assessing liquidity and solvency
Holmes Institute
Applied Business Statistics for Managers
Quandary? Cash Flow v.s. Profit
• It should be noted that a business can achieve good profits but have
cash-flow problems, in fact this could potentially create significant
concerns. Why?
• A good profit is determined by activities during the year. Please take
note that most businesses apply the accrual method and not cash.
• They may also have significant expenditure in capital investments.
• Impact can be for public companies a backlash from the “market”, share
prices fall.
Holmes Institute
Applied Business Statistics for Managers
Defining ‘cash’ and ‘cash equivalents
AASB 107 requires the statement of cash flows to provide information
about ‘cash’ and ‘cash equivalents’:
Cash flows: inflows and outflows of cash and cash equivalents
Cash: cash on hand (notes and coins held) and demand deposits
(deposits on call with a financial institution)
Cash equivalents: short-term highly liquid investments that are readily
convertible to known amounts of cash and are subject to an insignificant
risk of changes in value. May include cash at bank, bank overdrafts, short-term money
market deposits, bank bills
Holmes Institute
Applied Business Statistics for Managers
Cash Equivalent
Holmes Institute
Applied Business Statistics for Managers
Composition of Cash Flow Statement
The statement must:
A. Identify cash at beginning and end of period.
B. Separately disclose cash inflows and outflows.
C. Classify cash flows as arising from operating,
investing or financing activities.
D. Australian standard specifies the direct method of
reporting cash flows.
Holmes Institute
Applied Business Statistics for Managers
Classification of cash flows
AASB 107 requires that cash flows be classified into those relating to:
operating activities
❑ the principal revenue-producing activities of the entity and other activities that are not investing
and financing activities, that is, relate to the provision of goods and services, and other activities
that are neither financing nor investing activities (refer to definitions of financing and investing)
investing activities
❑ the acquisition and/or disposal of long-term assets (including property, plant and equipment) and
other investments (such as securities) not included in cash equivalents
financing activities
❑ relating to changing the size and/or composition of the financial structure of the entity, including
equity and borrowings not falling within the definition of cash
Holmes Institute
Applied Business Statistics for Managers
Holmes Institute
Applied Business Statistics for Managers
Cash flows from operating activities
Cash flows from operating activities include:
➢ receipts from customers
➢ payments to suppliers and employees
➢ dividends received
➢ interest paid
➢ income taxes paid
Holmes Institute
Applied Business Statistics for Managers
Cash flows from investing activities
Cash flows from investing activities include:
➢ acquisition of equity investment in other organisations
➢ purchase of property, plant and equipment
➢ proceeds from sale of equipment
➢ Buying or selling of equity instrument
➢ interest received
➢ dividends received
Holmes Institute
Applied Business Statistics for Managers
Cash flows from financing activities
Cash flows from financing activities include:
➢ proceeds from issue of shares
➢ proceeds from borrowings
➢ repayment of borrowings
➢ dividends paid
➢ share buybacks
Holmes Institute
Applied Business Statistics for Managers
Treatment of Interest and dividend received and
paid
Classification of interest and dividends received
➢ AASB 107 (refer to par. 33) provides choice as to where interest paid and
dividends and interest received are to be presented
➢ Appendix A of AASB 107 includes interest paid in operating activities but
includes interest and dividends received as part of financing activities
➢ AASB 107 (par. 34) states that dividends paid are to be classified as a
financing cash flow as they relate to the cost of obtaining external resources
Holmes Institute
Applied Business Statistics for Managers
Examples of cash flows that would typically be included in the three classifications
of cash flows
Holmes Institute
Applied Business Statistics for Managers
Format of statement of cash flows (cont.)
Number of items to be separately disclosed (AASB 107):
Interest and other items of a similar nature received
Dividends received
Borrowing costs, including interest and other costs of finance
paid
Dividends paid
Income taxes paid
Holmes Institute
Applied Business Statistics for Managers
Difference between profit and net cash flows
from operating activities
Before recent amendments to AASB 107, there was a requirement to provide a
reconciliation of profit or loss with net cash flows from operating activities
Items that might cause a difference between profits and cash flows from
operations include:
– depreciation and amortization (these impact profits but not cash)
– increases/decreases in accounts receivable and payable, interest
payable and receivable, accrued expenses, income tax payable,
deferred taxes payable, prepaid expenses, inventories
– loss/gain on sale of plant and equipment
Holmes Institute
Applied Business Statistics for Managers
Example of indirect method of operating cash flows
Reconciliation of net profit to cash flows from operation
Profit/loss after tax XX
Add:
Depreciation expense XX
Amortisation expense XX
Loss on sale of plant and equipment XX
Increase in interest payable XX
Increase in accrued expenses XX
Increase in accounts payable XX
Increase in income taxes payable XX
Increase in deferred taxes payable XX
Subtract:
Gain on sale of plant and equipment (XX)
Increase in deferred tax asset (XX)
Increase in accounts receivable (XX)
Increase in prepaid expenses (XX)
Increase in interest receivable (XX)
Increase in inventories (XX)
Net cash flows from operating activities XXX
Holmes Institute
Applied Business Statistics for Managers
Non-cash financing and investment activities
AASB 107 requires that information about transactions and events that do not result in
cash flows during the financial year but affect assets and liabilities that have been
recognised are to be disclosed in the financial statements or the consolidated financial
statements where the transactions and other events:
– involve parties external to the entity, and
– relate to financing and investing activities
Examples of non-cash financing and investing transactions
➢ Conversions of liabilities to equity
➢ Acquisitions of entities by means of an equity issue
➢ Acquisitions of assets by assumption of directly related liabilities such as purchase of
a building by incurring a mortgage to the seller
➢ Acquisitions of assets by entering into finance leases
➢ Exchange of non-cash assets or liabilities for other non-cash assets or liabilities
Holmes Institute
Applied Business Statistics for Managers
Calculating cash inflows and outflows
Cash flows from operating activities
Cash receipts from customers
sales + beginning receivables – ending receivables – bad debts expense (where bad debts are
written off directly against debtors) – transfer from allowance for doubtful debts (where debts that
have previously been considered doubtful have subsequently proven uncollectable) – any discounts
that may have been given to customers for early payment = Cash receipts from customers
Holmes Institute
Applied Business Statistics for Managers
Example –cash collected from customer
A company provides the following information and want to know
how much cash was received:

AssignmentTutorOnline

Opening balance, Provision for doubtful debts $ 24,000
Closing balance, Provision for doubtful debts $ 25,000
Holmes Institute
Applied Business Statistics for Managers
Example –cash collected from customers
Holmes Institute
Applied Business Statistics for Managers
Example –cash collected from customers
The total cash received is:

Holmes Institute
Applied Business Statistics for Managers
Calculating cash paid to suppliers
Cash payments to suppliers:
opening accounts payable – closing accounts payable + cost
of sales + closing inventory – opening inventory – discounts
given by suppliers + stock write-offs = cash payments to
suppliers
Holmes Institute
Applied Business Statistics for Managers
Example : cash payment to suppliers
Holmes Institute
Applied Business Statistics for Managers
Example –cash paid to suppliers
Holmes Institute
Applied Business Statistics for Managers
Cash flows from operating activities
❑ Calculation of cash received from interest revenue
=interest revenue + opening interest receivable – closing interest
receivable
❑ Calculation of cash received from dividends

payable
Holmes Institute
Applied Business Statistics for Managers
Cash flows from operating activities
Cash payment of income taxes
income tax expense + opening income tax payable – closing
income tax payable + opening deferred tax liability – closing
deferred tax liability + closing deferred tax asset – opening
deferred tax asset + any increase in DTL due to a revaluation –
any decrease in DTL due to a reversal of a devaluation = cash
payment of income taxes
Holmes Institute
Applied Business Statistics for Managers
Cash flows from investing activities
Cash payments for non-current assets
closing balance of non-current assets – opening balance of
non-current assets + original cost of assets sold – assets
acquired through non-cash transactions – revaluation
increases + accumulated depreciation written back to
revalued assets = cash payments for non-current assets
Need to exclude any increase in assets generated by noncash transactions, for example, acquisition of plant by
mortgage over other assets
Holmes Institute
Applied Business Statistics for Managers
Cash flows from investing activities
Proceeds from sale of non-current assets
Specific information about the sale transaction required—
actual receipt of cash recorded in statement of cash flows,
not the gain or loss on sale
Holmes Institute
Applied Business Statistics for Managers
Example: Cash flows from investing activities
Given the facts below, determine what equipment they acquired for
cash:

Equipment with a carrying value of $140,000 (cost $190,000) has been
revalued to $170,000
Equipment sold for $30,000 (carrying value of $50,000, cost $130,000)
Shares in company exchanged for equipment with a fair value of $80,000
Holmes Institute
Applied Business Statistics for Managers
Example –cash spent on equipment
Step 1 Record the journal entries
Accumulated depreciation 50,000

Holmes Institute
Applied Business Statistics for Managers
Equipment Ledger-cash spent for equipment
Holmes Institute
Applied Business Statistics for Managers
Cash flows from financing activities
Payment of cash dividends
Dividends paid + dividends proposed + opening dividends
payable – closing dividends payable = payment of cash
dividends
Cash flows from financial activities also includes the issue of
shares, issue of debt, repayment of debt
Any increase share where there were no cash involved, need
not be included.
Holmes Institute
Applied Business Statistics for Managers
Example of a cash flow statement
Sunflower Ltd
Cash flow statement
For the period ended 30 June, 2017
$ $
Cash flows from operating activities
Cash collected form customer
Interest Received
Cash paid to employees and suppliers
Insurance expense
Other expenses
Net cash provided from operating activities
Cash flows from investing activities
Proceeds from sale of equipment
Cash used to purchase equipment
Cash used for investment
Net cash used in investing activities
Cash flows from financing activities
Dividend paid
Net cash flows from operating, investing and financing
activities
Cash and cash equivalent at the beginning of the period
Cash and cash equivalent at the end of the period
471000
1050
($328000)
(63000)
($6000)
($12000)
3000
(40000)
(10000)
63050
(47000)
(20000)
………………
(3950)
25000
…………………..
21050
………………………
Holmes Institute
Applied Business Statistics for Managers
Contractual implications
Cash flows from operations would appear to provide an indication of ability to
service debt
➢ Perhaps more so than interest coverage
Traditional financial ratios (such as the current ratio, acid test ratios) are
deficient in monitoring the liquidity of the organization
The use of cash-flow data would provide an earlier indication of solvency
problems than that provided by using conventional financial ratios
Holmes Institute
Applied Business Statistics for Managers
Summary of the Lecture
The statement of cash flows is considered to be a very useful complement to
an entity’s statement of financial position and statement of comprehensive
income
It provides information useful for making assessments about such things as an
entity’s ability to:
➢ generate cash flows
➢ meet financial commitments as they fall due
➢ finance changes in operating activities
➢ obtain and service external debt
Holmes Institute
Applied Business Statistics for Managers
Summary of the Lecture
Cash flows to be classified into
➢ operating activities
➢ investing activities
➢ financing activities
Holmes Institute
Applied Business Statistics for Managers
Summary of the Lecture
Direct method to be applied
Relevant cash inflows are reported in gross terms rather than being netted off against
each other
AASB 107 requires a number of notes to be provided, including:
➢ reconciliation of cash balance per statement of cash flows with related statement of financial
position items
➢ material financing and investing transactions and events that do not result in cash flows
Calculate cash flows using either:
– the equation approach, or
– the t-account approach