313

Chapter 22
CASH FLOW STATEMENTS
CHAPTER CONTENTS
1 2 3 4 Introduction The requirements of IAS 7 Cash Flow Statements Preparation of a cash flow statement Interpretation using the cash flow statement

Financial accounting is primarily concerned with external financial reporting. Companies are required by IAS 7 Cash Flow Statements to include a cash flow statement in their financial statements. The best way to acquire knowledge of IAS 7 is to work through the examples in the chapter.

Objectives
By the time you have finished this chapter you should be able to:

classify cash flows into appropriate headings prepare a cash flow statement from various data sources understand the link between profits and cash comment on the advantages of a cash flow statement to the user of accounts.

Introduction

1.1 Profit versus liquidity

In the preparation of financial statements we have covered so far, we have stressed the importance of accounting concepts of accruals and matching in order to compute a profit figure which shows the additional wealth created for the owners of the business during an accounting period. However, it is important for a business to generate cash as well as make profits. The two do not necessarily go hand in hand. We explained in the chapter dealing with incomplete records that profit represents the increase in net assets in a business during an accounting period. KEY POINT
Profit represents an increase in net assets, which can be in cash or may be tied up in other assets.

This increase can be in cash or it may be tied up in other assets, for example:

non-current assets may have been purchased there may be an increased amount of receivables there may be increased investment in inventory the liabilities of the business may have decreased, i.e. more cash has been spent this year in paying off suppliers more quickly than was the case last year.

We can reconcile profit to cash in an accounting period by taking into account these and other factors. This reconciliation is examined in detail later in the chapter. KEY POINT
Purposes of cash flow statement:

1.2

The need for a cash flow statement

additional information assess current liquidity show major cash flows estimate future cash flows distinguish transaction and
other cash flows.

A cash flow statement is needed as a consequence of the above differences between profits and cash. In particular, there is a need for a further statement to be presented as part of the financial statements which will help to achieve the following:

provide additional information on business activities help to assess the current liquidity of the business allow the user to see the major types of cash flows into and out of the business help the user to estimate future cash flows determine cash flows generated from trading transactions rather than other cash flows.

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PREPARING FINANCIAL STATEMENTS (INTERNATIONAL STREAM)

The requirements of IAS 7 Cash Flow Statements

2.1 Introduction
The IASC (now IASB) issued IAS 7 in 1977 and revised it in 1992. It requires enterprises to present a cash flow statement as part of their financial statements. A cash flow statement can be presented in a number of ways. It is simply a summary of the cash receipts and payments of an enterprise. Thus a summarised cash book would be a cash flow statement. A cash flow statement is often prepared from the balance sheet and income statement of an enterprise, opening with a reconciliation between reported profit and operating cash flow. KEY POINT
Cash flow statement standard headings:

operating activities investing activities financing activities.

IAS 7 requires the cash flow statement to be presented using standard headings. The objective of the standard headings is to ensure that cash flows are reported in a form that highlights the significant components of cash flow and facilitates comparison of the cash flow performance of different businesses. The standard headings shown in the statement are:

operating activities investing activities financing activities.

2.2 Specimen format for cash flow statement

Here is the specimen format for a cash flow statement from IAS 7, eliminating items not relevant for Paper 1.1. Explanatory notes follow it.
Cash flow statement for the period ended

$000 Cash flows from operating activities Net profit before taxation Adjustments for: Depreciation Interest expense Operating profit before working capital changes Increase in trade receivables Decrease in inventories Decrease in trade payables Cash generated from operations Interest paid Dividends paid Income taxes paid Net cash from operating activities Cash flows from investing activities Purchase of property, plant and equipment Proceeds of sale of equipment Interest received Dividends received Net cash used in investing activities (900) 20 200 200 2,850 490 400 3,740 (500) 1,050 (1,740) 2,550 (270) (300) (420)

$000

1,560

(480)

CHAPTER 22

CASH FLOW STATEMENTS Cash flows from financing activities Proceeds of issue of shares Repayment of loans Net cash used in financing activities Net increase in cash and cash equivalents Cash and cash equivalents at the beginning of the period Cash and cash equivalents at the end of the period Explanatory notes

315

1,210 (2,000) (790) 290 120 410

Cash flows from operating activities

This section of the statement begins with the profit before tax as shown in the income statement. The remaining figures are the adjustments necessary to convert the profit figure to the cash flow for the period.
Depreciation Interest expense Increase in trade receivables Decrease in inventories Decrease in trade payables Interest paid Dividends paid Income taxes paid These are the amounts actually paid in the year Added back to profit because it is a non-cash expense Added back because it is not part of cash generated from operations (the interest actually paid is deducted later) Deducted because this is part of the profit not yet realised into cash but tied up in receivables Added on because the decrease in inventories liberates extra cash Deducted because the reduction in payables must reduce cash

Cash flows from investing activities

The items here are cash spent on non-current assets, proceeds of sale of non-current assets and income from investments.

Cash flows from financing activities

Under this heading go the proceeds of issue of shares and long-term borrowings made or repaid.

Net increase in cash and cash equivalents

This is the overall increase (or decrease) in cash and cash equivalents during the year. After adding the cash and cash equivalents at the beginning of the year, the final balance of cash and cash equivalents at the end of the year emerges.

Meaning of cash and cash equivalents

KEY POINT
Cash: cash on hand and available on demand. Cash equivalents: short-term highly liquid investments.

Cash means cash on hand and deposits available on demand. Cash equivalents means 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. (Investments are thus not cash equivalents unless they have these two attributes of being readily convertible and with little or no risk of change in value).

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PREPARING FINANCIAL STATEMENTS (INTERNATIONAL STREAM) IAS 7 requires a note to the cash flow statement giving details of the make-up of cash and cash equivalents:
Cash and cash equivalents

At end of year Cash on hand and balance at banks Short-term investments $000 40 370 410

At beginning of year $000 25 95 120

Preparation of a cash flow statement

3.1 Direct and indirect methods

Figures for the cash flow statement will be derived either from the accounting records or from the other financial accounting statements the balance sheets for the current year end and the previous period, and the income statement for the period. The item requiring most work will often be the top of the statement to determine the net cash flow from operating activities. The two alternative methods of calculation are shown below (figures invented) in a simplified example: Direct method Cash received from customers Cash payments to suppliers Cash paid to and on behalf of employees Other cash payments Net cash inflow from operating activities $000 15,424 (5,824) (2,200) (511) Indirect method Profit before tax Depreciation charges $000 6,022 899

Increase in inventories Increase in receivables Increase in payables

(194) (72) 234 6,889

6,889

KEY POINT
Direct method: records the gross trading cash flows. Indirect method: starts with profit, not cash, and adjusts profit for the non-cash expense of depreciation and for the movements in working capital.

The direct method is so called because it records the gross trading cash flows; the indirect method starts with profit, not cash, and adjusts profit for the non-cash expense of depreciation (added to profit) and for the movements in working capital items as shown. The information for the direct method could be found in the accounting records or derived from the other financial statements. The information for the indirect method is found in the other financial statements. For example, we shall need to calculate the operating cash flow from the profit, as shown in the example below.

Example of calculations using the indirect method

The summarised balance sheets of Grasmere, a limited company, at 31 December 20X4 and 20X5 were as follows:

CHAPTER 22

CASH FLOW STATEMENTS 20X4 $ Non-current assets Plant and machinery, at cost Less: Depreciation Current assets Inventory Receivables Cash 15,000 8,000 7,000 20,000 10,000 5,000 42,000 20,000 17,000 5,000 42,000 20X5 $ 16,500 10,000 6,500 23,500 15,000 2,000 47,000 20,000 21,000 6,000 47,000

317

Share capital Reserves Payables

No non-current assets have been sold during the period under review. Depreciation provided for the year amounted to $2,000. There is no interest paid, dividends paid or taxation paid. You are required to prepare a cash flow statement for the year ended 31 December 20X5. Discussion Examination questions often present two balance sheets like this from which you are to prepare a cash flow statement. At first sight there may seem to be no connection between the balance sheets and the companys cash flows, but there is. Take the first item in these balance sheets the plant and machinery. The cost has risen from $15,000 to $16,500. This must mean that $1,500 has been spent on new plant during the year, a cash outflow of $1,500 under investing activities. All the other differences between the opening and closing balances are various types of cash flow, or otherwise required to produce the cash flow statement. KEY POINT
Using the indirect method, we need to calculate the operating cash flow by adjusting the profit figure for non-cash expenses like depreciation and for the movements in the working capital items inventory, receivables and payables.

Using the indirect method we need to calculate the operating cash flow by adjusting the profit figure for non-cash expenses like depreciation and for the movements in the working capital items inventory, receivables and payables. If a question gives you an income statement you obviously have the profit before tax figure. If you only have the balance sheets it is still possible to calculate the profit. How? By using the increase in the retained profit (in the case of Grasmere ($21,000 minus $17,000 or $4,000) and adding back the periods dividends and tax charge to arrive at profit before tax. In the simplified Grasmere situation there are no dividends or tax, so the profit before tax must be $4,000. A possible way of preparing a cash flow statement from examination-style information is to set up a format consisting of the three headings in the specimen layout above, leaving plenty of space between them, then go through the given balance sheets from the top entering the differences in the correct positions in the format. With this explanation you may like to try to produce Grasmeres cash flow statement before looking at the answer below.

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PREPARING FINANCIAL STATEMENTS (INTERNATIONAL STREAM)

Grasmere Cash flow statement for the year ended 31 December 20X5

$ Cash flows from operating activities Profit before tax (21,000 17,000) Depreciation (10,000 8,000) Increase in inventories Increase in receivables Increase in payables Net cash outflow from operating activities Cash flows from investing activities Payments to acquire non-current assets Decrease in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year 4,000 2,000 (3,500) (5,000) 1,000

(1,500) (1,500) (3,000) 5,000 2,000

Tutorial note: as there is no tax or dividends, the movement in reserves per the balance sheets represents the profit before tax for the year. The example shows the important information that can be directly given by a cash flow statement. Despite making a profit of $4,000 in the period, the business has suffered a $3,000 reduction in cash. This is largely due to the amount of profit tied up in increased working capital (inventory, receivables less payables).

A further example
The balance sheets of Fox, a limited company, as at 31 December were as follows: 20X8 $000 Non-current assets Property (as revalued) Plant and machinery Cost Aggregate depreciation Trade investment at cost Current assets Inventory Receivables Cash 16,000 9,950 25,950 _____ 55,700 Capital and reserves Issued share capital Revaluation reserve Accumulated profit Non-current liabilities 10% loan notes Current liabilities Trade payables Bank overdraft 16,000 4,000 10,000 30,000 6,000 8,000 11,700 19,700 55,700 11,000 11,000 37,000 $000 22,000 10,000 2,250 7,750 29,750 29,750 5,000 2,000 $000 20X7 $000 12,000 3,000 15,000 7,000 22,000

11,000 2,700 1,300 15,000 _____ 37,000 14,000 2,000 16,000 10,000

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CASH FLOW STATEMENTS Notes

319

1 At the beginning of the year machinery which had cost $1,000,000 and which had a book value of $250,000, was sold for $350,000. 2 In addition to the interest on the loan notes, interest paid on the overdraft amounted to $800,000. 3 $4,000,000 of loan notes were redeemed on 31 December 20X8. 4 The trade investment was sold for $10,000,000 during the year. No dividends were received from it. You are required to prepare a cash flow statement for the company for the year ended 31 December 20X8 complying with the requirements of IAS 7. Discussion With this question we meet a new problem sales of non-current assets. It is now not possible to calculate all the figures needed from the balance sheets without some further workings. The clue to this is that further information is given below the balance sheet. As soon as you see this you know that you will have to have some extra workings. In the case of non-current asset sales, three working ledger accounts will be needed:

non-current asset cost non-current asset accumulated depreciation non-current asset disposal.
The technique is to enter the opening and closing balances from the balance sheets, then record the additional information given in the notes below the balance sheet. Note that a double entry is required for all additional information either an entry between two working accounts or an entry between one working and the cash flow statement (i.e. cash). In using these three working accounts you are simply reconstructing the non-current asset accounts as they would be in the underlying records.

Solution
Fox Cash flow statement for the year ended 31 December 20X8

$000 Cash flows from operating activities Net profit before taxation (10,000 2,000) Depreciation (W2) Profit on sale of plant (W3) Profit on sale of investment Interest expense Operating profit before working capital changes Increase in inventory Increase in receivables Decrease in payables Cash generated from operations Interest paid Net cash outflow from operating activities 8,000 1,000 (100) (3,000) 1,800 7,700 (5,000) (7,250) (3,000) (7,550) (1,800)

$000

(9,350)

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PREPARING FINANCIAL STATEMENTS (INTERNATIONAL STREAM) Cash flows from investing activities Purchase of: Plant and machinery (W1) Property (10,000 4,000) Proceeds of sale of investments Proceeds of sale of plant Net cash outflow from investing activities Cash flows from financing activities Issue of ordinary shares Redemption of loan notes Net cash used in financing activities Net decrease in cash and cash equivalents Cash and cash equivalents at 1 January 20X8 Cash and cash equivalents at 31 December 20X8 2,000 (4,000) (2,000) (13,000) 1,300 (11,700)

(6,000) (6,000) 10,000 350 (1,650)

IAS 7 requires the inclusion of a note disclosing the components of cash and cash equivalents and reconciling them with the amounts in the balance sheet. In a case like this, where the only items are cash at bank and overdraft, the last lines of the statement itself provide the information. The note takes the form:
Cash and cash equivalents

Cash on hand and balances with banks

31 December 20X7 20X8 $000 $000 (11,700) 1,300

Workings
(W1) Plant and machinery cost

Balance b/d Additions during year (balancing figure)

$000 5,000 6,000 _____ 11,000 _____

Transfer disposal Balance c/d

$000 1,000 10,000 _____ 11,000 _____

(W2)

Plant and machinery accumulated depreciation

$000 Depreciation: disposals during year $(1,000 250) 750 Balance c/d 2,250 ____ 3,000 ____

$000 Balance b/d 2,000 Depreciation for year (bal fig) 1,000 ____ 3,000 ____

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CASH FLOW STATEMENTS

(W3) Plant and machinery disposal

321

Cost of disposals Profit on sale

$000 1,000 100 ____ 1,100 ____

Depreciation on disposals Sale proceeds

$000 750 350 ____ 1,100 ____

That was quite a difficult example. Points to note are: 1 The calculation of the cash from operations. The retained profit has increased by $8,000,000. To calculate operating profit it is necessary to deduct the profit on sale of the plant and the trade investment. 2 The workings necessary to calculate the movement on the non-current assets. The opening and closing balances for cost and accumulated depreciation were first entered, then from Note 1 to the question we may insert the transfers from those accounts for the disposal. The balancing figure on the cost account is then the additions during the year, and the balance on the depreciation account is the depreciation charge for the year. Finally, in the disposal account, the inclusion of the sale proceeds allows us to calculate the profit on the sale which has to be eliminated from the profit as part of the calculation of the operating cash flow. 3 The fact that some loan notes were repaid at the end of the year means that loan interest at 10% must have been paid on the whole $10,000,000.

3.2 Example of calculations using direct method

KEY POINT
Gross cash flows can be derived:

As previously stated, gross cash flows from operating activities can be used to compute net cash flow from operating activities. The gross cash flows can be derived: 1 from the accounting records of the entity by totalling the cash receipts and payments directly, or 2 from the opening and closing balance sheets and income statement for the year by constructing summary control accounts for:
sales (to derive cash received from customers) purchases (to derive cash payments to suppliers) wages (to derive cash paid to and on behalf of employees).

by totalling the cash receipts and payments directly or from the opening and closing balance sheets and income statement.

3.3 Example using control accounts

The balance sheets of a business are: Last year $ 153,364 265,840 419,204 200,000 200,000 219,204 419,204 This year $ 149,364 346,000 165,166 660,530 200,000 141,640 341,640 318,890 660,530

Non-current assets Inventories Receivables Cash Share capital Reserves Current liabilities

322

PREPARING FINANCIAL STATEMENTS (INTERNATIONAL STREAM) Extracts from the income statement for the year are: $ Sales revenue Cost of sales Purchases (no inventory) Wages and salaries Depreciation Administration Purchases Salaries Operating profit and retained profit for the year Additional information 1 Payables consist of: Last year $ Payables ledger Re non-current assets Other Wages accrued 210,564 8,640 This year $ 46,000 258,240 14,650 1,021,830 145,900 84,000 (1,251,730) 96,077 100,000 (196,077) 141,640 $ 1,589,447

2 Purchase invoices relating to the acquisition of non-current assets totalling $80,000 have been posted to the payables ledger during the year. Prepare the cash flow statement using the direct method.

Solution
Cash flow statement

$ Operating activities Cash received from customers (W1) Cash payments to suppliers (W2) Cash paid to and on behalf of employees (W3) Net cash inflow from operating activities Investing activities Purchase of non-current assets (W4) Increase in cash and cash equivalents Cash and cash equivalents at start of period Cash and cash equivalents at end of period 1,509,287 (1,070,231) (239,890) 199,166 (34,000) 165,166 165,166

Workings
(W1) Receivables ledger control

Balance b/d Sales revenue

$ 265,840 1,589,447 _______ 1,855,287 _______

Cash receipts Balance c/d

$ 1,509,287 346,000 _______ 1,855,287 _______

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CASH FLOW STATEMENTS

323

(W2) Payables ledger control (excluding non-current asset purchases)

Cash paid (bal fig) Balance c/d

$ 1,070,231 258,240 _______ 1,328,471 _______

Balance b/d Purchases Cost of sales Administration

$ 210,564 1,021,830 96,077 _______ 1,328,471 _______

Tutorial note: information relating to non-current assets is not included in the payables ledger control account above in order to compute cash paid to suppliers of operating costs.
(W3) Wages control

Net wages paid (bal fig) Balance c/d

$ 239,890 14,650 ______ 254,540 ______

Balance b/d Cost of sales Administration

$ 8,640 145,900 100,000 ______ 254,540 ______

Non-current asset expenditure Cash paid for non-current assets is 80,000 46,000 = $34,000. The $80,000 invoices agrees with the movement in non-current assets per the balance sheets.
(W4) Non-current assets (NBV)

Balance b/d Addition (bal fig)

$ 153,364 80,000 ______ 233,364 ______

Depreciation charge Balance c/d

$ 84,000 149,364 ______ 233,364 ______

Tutorial note: Net cash inflow from operating activities could have been derived from operating profit as follows:
Reconciliation of operating profit to net cash inflow from operating activities

Operating profit Depreciation charges Increase in inventory Increase in receivables Increase in payables (excluding those for non-current assets)

$ 141,640 84,000 (80,160) 53,686 199,166

3.4 Non-cash transactions

Non-cash transactions, such as a revaluation of non-current assets, cannot appear in the cash flow statement. They may, however, need to be included in workings calculating other figures needed for the statement.

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PREPARING FINANCIAL STATEMENTS (INTERNATIONAL STREAM)

3.5 Approach to examination question

The summarised financial statements of Charlton, a limited company, are as follows:
(a) Balance sheets at 31 December

Non-current assets (net book value) Inventory Receivables Bank

20X5 $ 40,406 27,200 15,132 4,016 86,754 40,000 8,000 19,933 10,000 3,621 5,200 86,754

20X6 $ 47,759 30,918 18,363 2,124 99,164 50,000 10,000 22,748 10,416 6,000 99,164

Share capital Share premium Accumulated profit Loan notes Payables Taxation

(b)

Income statement for the year ended 31 December 20X6

Profit (after charging depreciation of $2,363 and interest of $900) Taxation Profit after tax

$ 17,215 6,000 11,215

An interim dividend of $2,000 was paid during the year, as well as a final dividend for the year ended 31 December 20X5 of $6,400. An item of machinery with a net book value of $1,195 was sold for $1,614. The depreciation charge of $2,363 does not include the profit/loss on the sale of the noncurrent asset. You are required to prepare a cash flow statement for the year ended 31 December 20X6.

Solution
Step 1

Allocate a page to the cash flow statement so that easily identifiable cash flows can be inserted. Use a separate page if the main statement is likely to be long. Allocate a further page to workings. Step 2 Go through the balance sheets and take the balance sheet movements to the cash flow statement or to workings as appropriate. Tick off the information in the balance sheets once it has been used. Step 3 Go through the additional information provided and deal with as per Step 2. Step 4 The amounts transferred to workings can now be reconciled so that the remaining cash flows can be inserted on the statement.

CHAPTER 22

CASH FLOW STATEMENTS Step 5 Complete the cash flow statement.

Charlton Cash flow statement for the year ended 31 December 20X6

325

$ Cash flows from operating activities Net profit before taxation Adjustment for: Depreciation Profit on sale of non-current asset (W1) Interest expense Operating profit before working capital changes Increase in inventory Increase in receivables Increase in payables (10,416 3,621) Cash generated from operations Interest paid Dividends paid Tax paid (W2) Net cash from operating activities Cash flows from investing activities Purchase of non-current assets (W1) Proceeds of sale of non-current assets Net cash used in investing activities Cash flows from financing activities Proceeds of issue of shares (10,000 + 2,000) Repayment of loan Net cash from financing activities Net decrease in cash and cash equivalents Cash and cash equivalents at 1 January 20X6 Cash and cash equivalents at 31 December 20X6 12,000 (10,000) (10,911) 1,614 17,215 2,363 (419) 900 20,059 (3,718) (3,231) 6,795 19,905 (900) (8,400) (5,200)

5,405

(9,297)

2,000 (1,892) 4,016 2,124

Cash and cash equivalents

Cash at bank

31 December 20X5 20X6 $ $ 2,124 4,016

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PREPARING FINANCIAL STATEMENTS (INTERNATIONAL STREAM)

Workings
(W1) Non-current assets NBV

Balance b/d Bank (bal fig)

$ 40,406 10,911 _____ 51,317 _____

$ Non-current assets disposal 1,195 Depreciation (income statement)2,363 Balance c/d 47,759 _____ 51,317 _____

Tutorial note: the above account summarises the balances and transactions relating to non-current assets during the year. It was necessary to combine non-current asset cost and non-current asset depreciation in one account because only the net book values were given. The account is required in order to derive the expenditure on non-current assets for the year.
Non-current assets disposal

$ Non-current assets NBV 1,195 Profit on sale (income statement) 419 ____ 1,614 ____

Bank

$ 1,614 ____ 1,614 ____

(W2)

Taxation

Bank (bal fig) Balance c/d

$ 5,200 6,000 _____ 11,200 _____

Balance b/d Income statement

$ 5,200 6,000 _____ 11,200 _____

Tutorial note: the taxation paid in the year has been last years charge. Often there will be a change from last years estimate and thus a ledger account will derive the correct figure paid. This question is probably as hard as any you will get in the examination. All of the problems in it could arise, but it is unlikely that they will all arise in one question.

Interpretation using the cash flow statement

4.1 Introduction
The next chapter deals with the interpretation of financial statements, using ratios largely based on the income statement and balance sheet. To conclude this chapter on cash flow statements we shall review the information users may derive from the cash flow statement.

4.2 Objective of IAS 7

The objective of IAS 7 is to require the provision of information about the historical changes in cash and cash equivalents in a cash flow statement in which cash flows are classified under the three headings operating, investing and financing activities.

CHAPTER 22 KEY POINT

Cash flow statement shows:

CASH FLOW STATEMENTS

327

4.3 Information revealed by the cash flow statement Whether the overall activities reveal a positive cash flow.

whether overall activities

yield positive cash flow been financed.

reveal a positive cash flow

Whether the operating activities yield a positive cash flow. The manner in which the capital expenditure has been financed (for example, whether it has come from internally-generated resources, borrowings, issues of shares or from cash balances).

whether operating activities how capital expenditure has

4.4 An appraisal of the requirements of IAS 7 Formats

The formats in IAS 7 are illustrative only and not obligatory. However, it makes sense to follow them in examination work and they have been followed throughout this chapter.

Benefits of cash flow statements to users

Cash flow statements provide:
information as to how the enterprise generates and uses cash and cash equivalents information to allow an evaluation of changes in net assets, financial structure (including liquidity and solvency) and the ability of the enterprise to adapt to changing circumstances information to assess the ability of the enterprise to generate cash information which is comparable between different enterprises because the effects of using different accounting treatments are eliminated the means by which forecasts of future cash flows may be made the means by which the accuracy of past assessments of future cash flows may be checked.

Conclusion
This chapter has concentrated on the computational techniques involved in the preparation of a cash flow statement. If such a question comes up in the examination you should find that most of the marks are fairly easy to obtain. Practice on the examples in the chapter will result in the IAS 7 format becoming second nature. Do not ignore, however, the possibility of a written question. The information in the chapter will be useful in this regard.

328 SELF-TEST QUESTIONS

PREPARING FINANCIAL STATEMENTS (INTERNATIONAL STREAM)

Cash flow statements 1 2 3 4 5 6 What are the standard headings in a cash flow statement? (2.1, 2.2) What are the main categories of items to adjust profit for in order to arrive at net cash flow from operating activities? (2.2) Is an increase in inventory a deduction or addition to operating profit in the cash flow statement? (2.2) Is a decrease in payables a deduction or addition to operating profit in the cash flow statement? (2.2) Is a decrease in receivables a deduction or addition to operating profit in the cash flow statement? (2.2) Are receipts from the sale of non-current assets an investing activity or a financing activity? (2.2) Is a surplus on the revaluation of property included in the cash flow statement? (3.4) The requirements of IAS 7 Cash Flow Statements

Preparation of cash flow statement 7

MULTIPLECHOICE QUESTION

IAS 7 Cash Flow Statements requires the cash flow statement prepared using the indirect method to include the calculation of net cash from operating activities. Which of the following lists consists only of items which could appear in such a calculation? A B C D Depreciation, increase in receivables, decrease in payables, proceeds of sale of plant. Increase in payables, decrease in inventories, profit on sale of plant, depreciation. Increase in payables, depreciation, decrease in receivables, proceeds of sale of plant. Depreciation, interest paid, equity dividends paid, purchase of plant.

For the answer to this question, see the Answers section at the end of the book. PRACTICE QUESTIONS
Question 1: Bogdanovitch The summarised financial statements of Bogdanovitch, a limited company, are as follows. (a) Balance sheet as at 31 December
20X8 $ Non-current assets: Plant and machinery Fixtures and fittings Current assets: Inventory Receivables Cash $ 2,086 1,381 3,467 1,292 1,763 197 3,252 1,952 2,086 512 4,550 $ 20X9 $ 2,103 1,296 3,399

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CASH FLOW STATEMENTS

6,719 Capital and reserves: Equity capital Share premium Accumulated profit

329
7,949

4,200 800 563 5,563

4,500 900 1,334 6,734

Current liabilities: Trade payables Taxation

899 257 1,156 6,719

903 312 1,215 7,949

(b)

Income statement for year ended 31 December 20X9

Profit before tax Tax Profit for year $ 1,381 310 1,071

Dividends paid in the year

Final for year ended 31 December 20X8 Interim for year ended 31 December 20X9
You are informed that:

$ 132 168

(a) plant and machinery with a net book value of $184 was disposed of for $203, whilst a new item of plant was purchased for $312 (b) fixtures and fittings with a net book value of $100 were disposed of for $95. Depreciation provided on fixtures and fittings amounted to $351. You are required to prepare a cash flow statement for the year ended 31 December 20X9. (20 marks)

Question 2: Algernon You are given below, in summarised form, the accounts of Algernon, a limited company, for 20X6 and 20X7.

Plant Buildings

Cost $ 10,000 50,000

20X6 Balance sheet Depn Net $ $ 4,000 6,000 10,000 40,000 46,000 50,000 43,000 55,000 40,000 3,000 237,000

Cost $ 11,000 90,000

20X7 Balance sheet Depn Net $ $ 5,000 6,000 11,000 79,000 85,000 80,000 63,000 65,000 50,000 343,000

Investments at cost Land Inventory Receivables Bank

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PREPARING FINANCIAL STATEMENTS (INTERNATIONAL STREAM)

Ordinary shares of $1 each Share premium Revaluation reserve (land) Accumulated profit 10% Loan notes Payables Bank

40,000 12,000 45,000 100,000 40,000 237,000

50,000 14,000 20,000 45,000 150,000 60,000 4,000 343,000

Income statements
20X6 $ 200,000 (100,000) 100,000 (50,000) 50,000 (10,000) 40,000 20,000 20X7 $ 200,000 (120,000) 80,000 (47,000) 33,000 (13,000) 20,000 20,000

Sales revenue Cost of sales Expenses Interest Net profit for year Dividends for year (paid after the balance sheet dates)

You are required: (a) To prepare a cash flow statement for Algernon for 20X7, to explain as far as possible the movement in the bank balance. The cash flow statement should be prepared using the direct method. (10 marks) (b) Using the summarised accounts given, and the statement you have just prepared, comment on the position, progress and direction of Algernon. (8 marks) (Total: 18 marks)

EXAM-TYPE QUESTION

Crash The balance sheets of Crash, a limited liability company, at 31 March 2000 and 31 March 2001 were as follows:
31 March 2000 $000 $000 Non-current assets Cost or valuation Accumulated depreciation Current assets Inventory Receivables Cash 9,000 (3,300) 1,215 1,350 60 31 March 2001 $000 $000 10,950 (3,600) 1,350 1,290 105

5,700

7,350

2,625 8,325 2,250 750 2,640 5,640 1,500

2,745 10,095 3,000 1,200 750 3,045 7,995 750

Issued share capital Share premium account Revaluation reserve Accumulated profits Non-current liabilities: 10% loan notes Current liabilities

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CASH FLOW STATEMENTS

Trade payables Bank overdraft 990 195 1,080 270

331

1,185 8,325

1,350 10,095

Notes Non-current assets During the year non-current assets, which had cost $1,500,000 and which had a book value of $300,000 at 31 March 2000, were sold for $375,000. Land acquired in 1997 was revalued upwards by $750,000 in preparing the balance sheet at 31 March 2001.

Loan notes Interest is due half-yearly on 30 September and 31 March and was paid on the due dates. The company repaid $750,000 loan notes on 31 March 2001. Profit before interest for the year to 31 March 2001 was $555,000. No dividends were paid during the year.

Ignore taxation. Required: Prepare a cash flow statement for Crash for the year ended 31 March 2001 using the indirect method, complying as far as possible with the requirements of IAS 7 Cash Flow Statements. (10 marks)

For the answers to these questions, see the Answers section at the end of the book.

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PREPARING FINANCIAL STATEMENTS (INTERNATIONAL STREAM)