IAS 7 - Statement of Cash Flows (detailed review)

Thursday, March 6, 2014 Print Email

Objective

The users of financial statements also take into account the entity’s cash generating ability and cash needs to evaluate its liquidity position in order to take economic decisions as the entity needs cash to carry on its operations, for payment of its liabilities and distributions of returns to its investors.
This standard prescribe the guide lines, which require an entity to present information about its historic cash flows and changes in those cash flows during the accounting period, to intimate the users of financial statements about the cash generating ability and cash needs of the entity, in the form of statement of cash flows by classifying such cash flows into operating, investing and financing functions or activities.

Scope

The requirements of this standard are applicable for the preparation and presentation of statement of cash flows which is presented as an essential component of the financial statements in each accounting period.

Definitions

Cash

It encompasses currency notes, coins used as currency and short term deposits accessible on demand.

Cash Equivalents

The short term investments which are highly liquid and are convertible in to identifiable amount of cash within a period of three months or less, these have least chances of variation in value, are termed as cash equivalents

  • These are normally held by entity in order to meet its short term cash needs or commitments rather than held for investment purposes
  • These also include bank overdrafts which are held by the entity for the purpose of cash management.

Cash Flows

The inflows and outflows in the normal conduct of the business, of cash and cash equivalents are termed as cash flows.

Operating Activities

The principal business activities of the entity, which generate revenues for the entity are termed as operating activities

Investing Activities

The activities which are undertaken by the entity, for the purchase of long term assets and investments (which are not the part of cash equivalents), including the disposal of such long term assets and investments are termed as investing activities.

Financing Activities

The activities which are undertaken by the entity to raise capital or long term funds for the business, and which results in change in the equity and borrowed funds of the entity are termed as financing activities

Presentation of Statement of Cash Flows

The entity is required prepare the statement of cash flows by classifying such cash flows into operating, investing and financing activities. Classification of cash flows of the entity by activity will enable the users of financial statements to understand the effect of each category of cash flows upon the financial position of the business.

Operating Activities

The cash flows which are generated by the principal business activities of the entity are termed as cash flows from operating activities. Cash flows from the operating activities reflects the cash generating ability of the operations and the extent to which such cash flows can be used to carry on operations, for the payment of liabilities, distribution to shareholders and for the acquisition of new investments.
The following are the examples of cash flows from operating activities:

  • Cash received related the sale of goods
  • Cash received related to rendering of service
  • Cash received related to royalty or commissions income
  • Cash received related to the sale of investments, which are held for trading
  • Cash paid or received by a financial institute for the grant and receipt of loan amount
  • Cash received or paid by the insurance company in respect of for premiums and claims
  • Cash paid to suppliers for purchase of goods or services
  • Salaries Paid to employees;
  • Any cash paid or received as a refund of income tax

Any cash received from disposal of a non-current asset is not the part of cash flows from operating activities, instead it is included in cash flows from investing activities.

Investing Activities

The activities which are undertaken by the entity, for the purchase of long term assets and investments (which are not the part of cash equivalents), including the disposal of such long term assets and investments are termed as investing activities. Cash flow from investing activities reflects the amount of expenditure made by the entity for the purchase of long term assets to generate economic benefits for a long time period.
The following are the examples of cash flows from investing activities:

  • Cash paid to purchase non-current assets (tangible and intangible both)
  • Cash paid to purchase long term investments other those held for trading
  • Cash paid for the capitalized development expenditure
  • Cash paid for the self constructed asset
  • Cash received from disposal of non-current assets (tangible and intangible both) and long term investments
  • Loans granted to other party (except loans granted by the financial institution)
  • Cash received in respect of loan receivables
  • Cash received as a result of government grant
  • Interest and dividend income received on long term investments

Financing Activities

The activities which are undertaken by the entity to raise capital or long term funds for the business, and which results in change in the equity and borrowed funds of the entity are termed as financing activities. Cash flows from financing activities enable the users to evaluate the finance structure of the entity.
The following are the examples of cash flows from investing activities:

  • Proceeds received on issue of equity instruments such as ordinary shares
  • Proceeds received on issue of loan notes, debentures or bonds
  • Bank loan borrowed
  • Repayments of loan notes, debentures, bonds or a bank loan
  • Repayment of finance lease by lessee
  • Dividend paid to the owners of finance

Reporting Cash Flows from Operating Activities

The entity will report cash flow from operating activities either using:

  • Direct Method or
  • Indirect Method

Direct Method

Under direct method, the entity will present the gross cash inflows and outflows related to the major classes, related to the operations which will be obtained from the accounts of the entity.

Indirect Method

Under indirect method, the cash flow from operating activities are determined by adjusting the profit or loss before tax for the effect of non-cash items (such as depreciation, amortization , impairment loss and provision) and the items which are related to investing and financing activities

However, this method supports the use of direct method, because under direct method users are able to evaluate the information about the cash inflows and outflows related to the major classes of the operations which is not available under indirect method.

Reporting Cash Flows from Operating Activities

The entity will present cash inflows and outflows related to major classes of the investing and financing activities, under the respective functions as per the requirements of this standard.

Cash Flows in Foreign Currency

The entity is required to adjust the cash flows in foreign currency as follows:

  • Cash flows which arise from a foreign currency transaction will be presented in the functional currency of the entity, using the exchange rate on the date of cash flow.
  • Cash flows related to the foreign subsidiary will be translated, using the exchange rate on the date of cash flow.
  • The exchange gain and loss related to foreign currency transactions are unrealized, therefore are treated as non-cash items in the preparation of statement of cash flows.

Interest and Dividend

The entity will account for the cash flows related to interest and dividend as follows:

  • The interest and dividend income can either be presented under operating activities as these are used to determine the profits, or under investing activities as these are related investments.
  • The interest expense can either be presented under operating activities as these are used to determine the profits, or under financing activities as these are related cost for the funds borrowed.
  • The dividend paid can either be presented under operating activities to enable the users to identify the sufficiency of profits to pay dividends, or under financing activities as these are related cost of the equity funds

Investment in Subsidiary, Associate and Joint Venture

The entity is required to account for the cash flows related to, Investment in Subsidiary, Associate and Joint Venture as follows:

  • If the investment in subsidiary, associate or joint venture is accounted for using cost or equity method then the investor will only report cash flows in the form of dividend
  • The cash inflows or outflows related to disposal or acquisition of interest in subsidiary, which results in acquisition or loss of control are reported in investing activities
  • The cash inflows or outflows related to disposal or acquisition of interest in subsidiary which does not results in acquisition or loss of control are reported in financing activities except when such investment is held by the investment entity
  • The cash inflows or outflows related to disposal or acquisition of interest in subsidiary, which results in acquisition or loss of control are reported in investing activities net of the cash or cash equivalent acquired or transferred with that subsidiary.

Non-Cash items

The entity will not take into account the effect of non-cash items which are relating to investing and financing activities such as:

  • Purchase of a non-current asset on credit
  • Purchase of subsidiary by issue of equity instruments
  • Bonus issue

Disclosures

The entity is required to disclose the components of the cash and cash equivalents

Proposed Format

Operating Activities:

a) Direct Method

Proceeds received from cash sales (goods or services)                                    

x

Cash received from customers                                                                           

x

Other cash incomes                                                                                            

x

Payment made for cash purchases                                                                    

(x)

Cash paid to suppliers for purchase of goods or services                                 

(x)

Other expenses paid in cash                                                                             

(x)

Any cash paid or received as a refund of income tax                                       

(x)

Net cash flow from operating activities                                                              

x/(x)

b) Indirect Method

Profit/(Loss) before tax                                                                                      

 

(x)/x

Adjustments:

 

 

Depreciation / Amortization of non-current assets                              

x

 

(Gain)/Loss on disposal of non-current asset                                   

(x)/x

 

Increase/(decrease) in provision                                                       

x/(x)

 

Interest Expense                                                                                  

X

 

Interest income                                                                                    

(x)

 

Impairment loss                                                                                    

X

 

Amortization of Govt. Grant                                                                

(x)

 

Exchange (Gain)/Loss on Foreign Currency transaction                   

(x)/x

 

Operating profit before Working Capital Changes                                              

 

x/(x)

Working Capital Changes:

 

 

(Increase)/decrease in inventory                                                        

(x)/x

 

(Increase)/decrease in trade receivable                                             

(x)/x

 

Increase/(decrease) in trade Payable                                                  

x(/x)

 

Cash Generated from Operations                                                                       

 

(x)/x

Interest Paid                                                                                                         

 

(x)

Tax (Paid)/Refund                                                                                               

 

(x)/x

Net cash flow from operating activities                              (A)                      

 

(x)/x

Investing Activities:

 

 

Cash paid to purchase non-current assets              

(x)

 

Cash paid to purchase long term investments         

(x)

 

Cash paid for the capitalized development expenditure                                        

(x)

 

Cash paid for the self constructed asset                                                               

(x)

 

Cash received from disposal of non-current assets                                               

x

 

Loans granted to other party (except by the financial institution)                          

(x)

 

Cash received in respect of loan receivables                                                          

x

 

Cash received as a result of government grant                                                      

x

 

Interest and dividend income received on long term investments                          

x

 

Net cash flow from investing activities                               (B)                       

 

(x)

Financing Activities:

 

 

Proceeds received on issue of ordinary shares           

x

 

Proceeds received on issue of loan notes, debentures or bonds                            

x

 

Bank loan borrowed                                                                                                 

x

 

Repayments of loan notes, debentures, bonds or a bank loan                              

(x)

 

Repayment of finance lease by lessee                                                                   

(x)

 

Dividend paid to the owners of finance                                                                   

(x)

 

Net cash flow from financing activities                               (C)                      

 

(x)/x

Net increase/(decrease) in cash for the year                  (A+B+C)

 

x/(x)

Opening Cash and Cash equivalent

 

x/(x)

Closing Cash and Cash equivalent

 

x/(x)

Note:

The entity will report cash flow from operating activities either using direct method or indirect method

Quote tribalia, 15 June, 2016
cool explanations!!!

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