IAS23:IAS 7-STATEMENT OF CASH FLOWS

IAS 7-STATEMENT OF CASH FLOWS

Group: Statement of Cash Flows

OBJECTIVE

The objective of this Standard is to require the provision of information about the historical changes in cash and cash equivalents of an entity by means of a statement of cash flows which classifies cash flows during the period from operating, investing and financing activities.

Benefits of Cash Flow Information

  • Cash flow information is useful in assessing the ability of the entity to generate cash and cash equivalents and enables users to develop models to assess and compare the present value of the future cash flows of different entities
  • It also enhances the comparability of the reporting of operating performance by different entities
  • It is also useful in checking the accuracy of past assessments of future cash flows and in examining the relationship between profitability and net cash flow and the impact of changing prices.

DEFINITIONS

The following terms are used in this Standard with the meanings specified:

Cash comprises cash on hand and demand deposits.

Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.

Cash flows are inflows and outflows of cash and cash equivalents.

Operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities.

Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.

Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.

Cash and Cash Equivalents

Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For an investment to qualify as a cash equivalent it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value.

PRESENTATION OF A STATEMENT OF CASH FLOWS

The statement of cash flows shall report cash flows during the period classified by

  • Operating,
  • Investing and
  • Financing activities.

Operating Activities

Cash flows from operating activities are primarily derived from the principal revenue-producing activities of the entity. Examples of cash flows from operating activities are:

  • Cash receipts from the sale of goods and the rendering of services;
  • Cash receipts from royalties, fees, commissions and other revenue;
  • Cash payments to suppliers for goods and services;
  • Cash payments to and on behalf of employees;
  • Cash receipts and cash payments of an insurance entity for premiums and claims, annuities and other policy benefits;
  • Cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities; and
  • Cash receipts and payments from contracts held for dealing or trading purposes.

Investing Activities

Examples of cash flows arising from investing activities are:

  • Cash payments to acquire property, plant and equipment, intangibles and other long-term assets.
  • cash receipts from sales of property, plant and equipment, intangibles and other long-term assets; (c) Cash payments to acquire equity or debt instruments of other entities and interests in joint ventures.

(d) Cash receipts from sales of equity or debt instruments of other entities and interests in joint ventures.

Financing Activities

Examples of cash flows arising from financing activities are:

  • cash proceeds from issuing shares or other equity instruments;
  • cash payments to owners to acquire or redeem the entity‘s shares;
  • cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short-term or longterm borrowings;
  • cash repayments of amounts borrowed; and
  • Cash payments by a lessee for the reduction of the outstanding liability relating to a finance lease.

REPORTING CASH FLOWS FROM OPERATING ACTIVITIES

An entity shall report cash flows from operating activities using either:

  • the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or
  • the indirect method, whereby 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.

Under the indirect method, the net cash flow from operating activities is determined by adjusting profit or loss for the effects of:

  • changes during the period in inventories and operating receivables and payables;
  • Non-cash items such as depreciation, provisions, deferred taxes, unrealized foreign currency gains and losses, and undistributed profits of associates; and all other items for which the cash effects are investing or financing cash flows.

A proforma of such a calculation is as follows and this method may be more common in the exam.

                 $
Profit before taxation (statement of profit or loss and other comprehensive income)                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

It is important to understand why certain items are added and others subtracted. Note the following points.

  • Depreciation is not a cash expense, but is deducted in arriving at the profit figure in the statement of comprehensive income. It makes sense, therefore, to eliminate it by adding it back.
  • By the same logic, a loss on a disposal of a non-current asset (arising through under provision of depreciation) needs to be added back and a profit deducted.
  • An increase in inventories means less cash – you have spent cash on buying inventory.
  • An increase in receivables means the company’s credit customers have not paid as much, and therefore there is less cash.
  • If we pay off payables, causing the figure to decrease, again we have less cash.

Indirect versus direct

The direct method is encouraged where the necessary information is not too costly to obtain, but IAS 7 does not require it, and favours the indirect method. In practice, therefore, the direct method is rarely used. It is not obvious that IAS 7 is right in favouring the indirect method. 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.

Reporting cash flows from investing and financing activities

An entity shall report separately major classes of gross cash receipts and gross cash payments arising from investing and financing activities, except to the extent that cash flows described below are reported on a net basis.

Cash flows arising from the following operating, investing or financing activities may be reported on a net basis:

  • cash receipts and payments on behalf of customers when the cash flows reflect the activities of the customer rather than those of the entity; and
  • Cash receipts and payments for items in which the turnover is quick, the amounts are large, and the maturities are short.

Foreign currency cash flows

Cash flows arising from transactions in a foreign currency shall be recorded in an entity‘s functional currency by applying to the foreign currency amount the exchange rate between the functional currency and the foreign currency at the date of the cash flow.  The cash flows of a foreign subsidiary shall be translated at the exchange rates between the functional currency and the foreign currency at the dates of the cash flows.

Interest and dividends

Cash flows from interest and dividends received and paid shall each be disclosed separately. Each shall be classified in a consistent manner from period to period as either operating, investing or financing activities.

Interest paid and interest and dividends received may be classified as operating cash flows because they enter into the determination of profit or loss. Alternatively, interest paid and interest and dividends received may be classified as financing cash flows and investing cash flows respectively, because they are costs of obtaining financial resources or returns on investments.

Dividends paid may be classified as a financing cash flow because they are a cost of obtaining financial resources. Alternatively, dividends paid may be classified as a component of cash flows from operating activities in order to assist users to determine the ability of an entity to pay dividends out of operating cash flows.

Taxes on income

Cash flows arising from taxes on income shall be separately disclosed and shall be classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities.

Other disclosures

All entities should disclose, together with a commentary by management, any other information likely to be of importance.

  • Restrictions on the use of or access to any part of cash equivalents.
  • The amount of undrawn borrowing facilities which are available.
  • Cash flows which increased operating capacity compared to cash flows which merely maintained operating capacity.

CONSOLIDATED STATEMENT OF CASH FLOWS

The special features of a consolidated statement of cash flows

A consolidated statement of cash flows is prepared largely from the consolidated statement of financial position, statement of comprehensive income (or income statement) and statement of changes in equity.

The rules for preparing a group statement of cash flows are similar to the rules for a statement of cash flows for an individual entity.

However, there are additional items in a consolidated statement of cash flows that are not found in the statement of cash flows of an individual company. The most significant of these are cash flows (or adjustments to profit before tax) relating to:

  • Non-controlling interests
  • Associates
  • And acquiring or disposing of subsidiaries during the year.

Illustrative format

It might be useful to look at the format of a consolidated statement of cash flows, to see where these items appear. The indirect method is used here to present the cash flows from operating activities.

Entity XYZ

Statement of cash flows for the year ended 31 December 20X7      
  $000   $000
Cash flows from operating activities      
Profit before tax 440    
Adjustments for:      
Depreciation and amortisation charges 450    
Loss on disposal of plant and machinery 50    
Share of profit of associates and joint ventures (100)    
Foreign exchange loss 40    
Investment income (25)    
Interest expense 25    
  880    
Increase in trade and other receivables (80)    
Increase in inventories (60)    

Increase in trade payables

Cash generated from operations

Interest paid (30)    
Income taxes paid (200)    
Net cash from operating activities     550
Cash flows from investing activities      
Acquisition of subsidiary, net of cash acquired (note 1) (450)    
Purchase of property, plant and equipment (note 2) (220)    
Proceeds from the sale of equipment 30    
Interest received 25    
Dividends received from associates 45    
Net cash used in investing activities     (570)
Cash flows from financing activities      
Proceeds from the issue of share capital 500    
Proceeds from long-term loan 100    
Redemption of debt securities (150)    
Payment of finance lease liabilities (80)    
Dividends paid to non-controlling interests (NCI) (70)    
Dividends paid to parent company shareholders (200)    
Net cash inflow from financing activities     100

Net increase in cash and cash equivalents

Cash and cash equivalents at the beginning of the period (note 3)

Cash and cash equivalents at the end of the period (note 3)   230
     

Exchange rate differences

A gain or loss arising from exchange rate differences is not a cash flow item. When the indirect method is used to present cash flows from operating activities, it is therefore necessary to make an adjustment to get from ‘profit’ to ‘cash flow’.

  • A loss arising from exchange rate differences (shown in the example above as a ‘foreign exchange loss’) must be added back.
  • A gain arising from exchange rate differences must be subtracted.

Cash flows to the non-controlling interest

The non-controlling interest represents a third party so dividends paid to the non-controlling interest are reflected as a cash outflow. This payment should be presented separately and classified as ‗Cash flows from financing activities‘

  $
Non-controlling interest in group net assets at the beginning of the year X
Non-controlling interest in profits after tax for the year X
  X
Non-controlling interest in group net assets at the end of the year (X)
Dividends paid to non-controlling interests (balancing figure) X

 

The dividend paid of $120,000 will be disclosed as a cash flow from financing activities.

Associates and the group statement of cash flows

When a group has an interest in an associate entity, the consolidated statement of cash flows must show the cash flows that occur between the associate and the group. The consolidated statement of cash flows shows the effect on the group’s cash position of transactions between the group and its associate.

Share of profit (or loss) of an associate

In the consolidated statement of comprehensive income or the income statement, the group profit includes the group’s share of the profits of associates.

These profits are not a cash flow item. When the indirect method is used to present the cash flows from operating activities, an adjustment is therefore needed to get from ‘profit’ to ‘cash flow’.

  • The group’s share of the profit of an associate must be deducted from profit.  The group’s share of the loss of an associate must be added to profit.

Cash flows involving associates

The cash flows that might occur between a group and an associate, for inclusion in the consolidated statement of cash flows are as follows:

  • Investing activities
    • Cash paid to acquire shares in an associate during the year
    • Cash received from the disposal of shares in an associate during the year –               Dividends received from an associate during the year.
  • Financing activities
    • Cash paid as a new loan to or from an associate during the year
    • Cash received as a repayment of a loan to or from an associate during the year.

Note that dividends received from an associate are shown as cash flows from investing activities; whereas dividends paid to non-controlling interests in subsidiaries are (usually) shown as cash flows from financing activities.

Dividends received from the associate must be disclosed as a separate cash flow classified as ‗Cash flows from investing activities‘.

The cash receipt can be calculated as follows:

 

  $
Group investment in net assets of associate at the beginning of the X
Year  
Group share of associate’s profits before tax X
Group’s share of associate’s tax on profits (X)
  X
Group investment in net assets of associate at the end of the year (X)
Dividends received from associate in the year X

 

 

Acquisitions and disposals of subsidiaries in the statement of cash flows

Acquisition of a subsidiary in the statement of cash flows

When a subsidiary is acquired:

  • The group gains control of the assets and liabilities of the subsidiary, which might include some cash and cash equivalents, and
  • The group pays for its share of the subsidiary, and the purchase consideration might consist partly or entirely of cash.

If the subsidiary is acquired or disposed of during the accounting period the net cash effect of the purchase or sale transaction should be shown separately under ‗Cash flows from investing activities‘. The net cash effect will be the cash purchase price/cash disposal proceeds net of any cash or cash equivalents acquired or disposed of.

Inventory, trade receivables, trade payables

When a subsidiary has been acquired, the working capital brought into the group (receivables plus inventory minus trade payables of the acquired subsidiary) is paid for in the purchase price to acquire the subsidiary. As we have seen, this is treated as a separate item in the investing activities section of the statement of cash flows.

To avoid double counting of the effects of the working capital in the subsidiary at the acquisition date, we need to deduct from the value in the closing statement of financial position, or add to the value in the opening statement of financial position:

  • The receivables in the net assets of the subsidiary acquired, as at the acquisition date
  • The inventory in the net assets of the subsidiary acquired, as at the acquisition date, and
  • The trade payables in the net assets of the subsidiary acquired, as at the acquisition date

Purchases of Non-Current Assets

When non-current assets are at carrying amount (net book value)

When non-current assets are shown at their carrying amount (net book value) and a subsidiary has been acquired during the year, purchases of non-current assets (assumed to be cash payments) are calculated as follows. (Figures have been included in the table for illustrative purposes.)

  $
Non-current assets at carrying amount, at the end of the year 290,000
Minus: Non-current assets acquired on acquisition of the subsidiary (65,000)
  225,000
Net book value of disposals of non-current assets during the year 30,000
Depreciation charge for the year 40,000
  295,000
Non-current assets at carrying amount, at the beginning of the year 240,000
Cash paid to acquire non-current assets during the year 55,000
   
   

 

When non-current assets are at cost

When non-current assets are shown at cost and a subsidiary has been acquired during the year, purchases of non-current assets (assumed to be cash payments) are calculated as follows. (Again, figures have been included in the table for illustrative purposes.)

                                                                                                                                                               $

Non-current assets at cost, at the end of the year                                                                     485,000

Non-current assets acquired on acquisition of the subsidiary                                              (90,000)

395,000

Cost of disposals of non-current assets during the year                                                            60,000

455,000

Non-current assets at cost, at the beginning of the year    (400,000) Cash paid to acquire non-current assets during the year           55,000

Disposal of a Subsidiary in the Statement of Cash Flows

The procedures for reporting the cash effect of disposals of subsidiaries in a group statement of cash flows are similar to those used for acquisitions, except that the process applies in reverse.

In the group statement of cash flows, the cash received from the disposal is the cash actually received from the disposal, minus any cash in the subsidiary at the disposal date.

A note to the statement of cash flows should show the details of the disposal, including the cash received from the sale minus the cash in the subsidiary at the disposal date.

Note:

You should remember the assets and liabilities disposed of, and the non-controlling interest that leaves the group on the disposal, to avoid double counting the other cash flow items in the statement of cash flows.

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