Lecture 4 :The statement of cash flows | My Assignment Tutor

Lecture 4 :The statement of cash flowsHI5020 Corporate AccountingHolmes InstituteApplied Business Statistics for ManagersTopics 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 ofinformation about an organisation’s cash flows▪ Understand the differences between cash flows from operating, cashflows from investing, and cash flows from financing activities▪ Understand how to construct a statement of cash flows in conformitywith AASB 107 Statement of Cash Flows▪ Understand how the statement of cash flows provides information that isa useful complement to the statement of financial position and thestatement of profit or loss and other comprehensive incomeHolmes InstituteApplied Business Statistics for ManagersComparison 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 andother items of comprehensive income that have been generated for a period of time usingaccrual accounting▪ Statement of changes in equity provides a reconciliation of opening and closing equity as wellas 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 balancesappearing in the statement of financial position➢ indicates sources of cash in terms of cash flows from operating and investing, and fromfinancing activitiesHolmes InstituteApplied Business Statistics for ManagersPurpose 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 ofborrowings 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 andviability of the reporting entityHolmes InstituteApplied Business Statistics for ManagersPurpose of the statement of cash flows▪ Argued (by some) to report information that is more reliable than profit data as profit data istypically 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 problemswith key terms, and to enable greater comparability between organisations.▪ Cash flows from operating activities are considered (by some people) to be a superiorperformance measure and more useful in assessing liquidity and solvencyHolmes InstituteApplied Business Statistics for ManagersQuandary? Cash Flow v.s. Profit• It should be noted that a business can achieve good profits but havecash-flow problems, in fact this could potentially create significantconcerns. Why?• A good profit is determined by activities during the year. Please takenote 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”, shareprices fall.Holmes InstituteApplied Business Statistics for ManagersDefining ‘cash’ and ‘cash equivalentsAASB 107 requires the statement of cash flows to provide informationabout ‘cash’ and ‘cash equivalents’:Cash flows: inflows and outflows of cash and cash equivalentsCash: 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 readilyconvertible to known amounts of cash and are subject to an insignificantrisk of changes in value. May include cash at bank, bank overdrafts, short-term moneymarket deposits, bank billsHolmes InstituteApplied Business Statistics for ManagersCash EquivalentHolmes InstituteApplied Business Statistics for ManagersComposition of Cash Flow StatementThe 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 ofreporting cash flows.Holmes InstituteApplied Business Statistics for ManagersClassification of cash flowsAASB 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 investingand financing activities, that is, relate to the provision of goods and services, and other activitiesthat 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) andother investments (such as securities) not included in cash equivalentsfinancing activities❑ relating to changing the size and/or composition of the financial structure of the entity, includingequity and borrowings not falling within the definition of cashHolmes InstituteApplied Business Statistics for ManagersHolmes InstituteApplied Business Statistics for ManagersCash flows from operating activitiesCash flows from operating activities include:➢ receipts from customers➢ payments to suppliers and employees➢ dividends received➢ interest paid➢ income taxes paidHolmes InstituteApplied Business Statistics for ManagersCash flows from investing activitiesCash 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 receivedHolmes InstituteApplied Business Statistics for ManagersCash flows from financing activitiesCash flows from financing activities include:➢ proceeds from issue of shares➢ proceeds from borrowings➢ repayment of borrowings➢ dividends paid➢ share buybacksHolmes InstituteApplied Business Statistics for ManagersTreatment of Interest and dividend received andpaidClassification of interest and dividends received➢ AASB 107 (refer to par. 33) provides choice as to where interest paid anddividends and interest received are to be presented➢ Appendix A of AASB 107 includes interest paid in operating activities butincludes interest and dividends received as part of financing activities➢ AASB 107 (par. 34) states that dividends paid are to be classified as afinancing cash flow as they relate to the cost of obtaining external resourcesHolmes InstituteApplied Business Statistics for ManagersExamples of cash flows that would typically be included in the three classificationsof cash flowsHolmes InstituteApplied Business Statistics for ManagersFormat 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 financepaid▪ Dividends paid▪ Income taxes paidHolmes InstituteApplied Business Statistics for ManagersDifference between profit and net cash flowsfrom operating activitiesBefore recent amendments to AASB 107, there was a requirement to provide areconciliation of profit or loss with net cash flows from operating activities▪ Items that might cause a difference between profits and cash flows fromoperations include:– depreciation and amortization (these impact profits but not cash)– increases/decreases in accounts receivable and payable, interestpayable and receivable, accrued expenses, income tax payable,deferred taxes payable, prepaid expenses, inventories– loss/gain on sale of plant and equipmentHolmes InstituteApplied Business Statistics for ManagersExample 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 XXXHolmes InstituteApplied Business Statistics for ManagersNon-cash financing and investment activities▪ AASB 107 requires that information about transactions and events that do not result incash flows during the financial year but affect assets and liabilities that have beenrecognised are to be disclosed in the financial statements or the consolidated financialstatements where the transactions and other events:– involve parties external to the entity, and– relate to financing and investing activitiesExamples 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 ofa 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 liabilitiesHolmes InstituteApplied Business Statistics for ManagersCalculating cash inflows and outflows▪ Cash flows from operating activitiesCash receipts from customerssales + beginning receivables – ending receivables – bad debts expense (where bad debts arewritten off directly against debtors) – transfer from allowance for doubtful debts (where debts thathave previously been considered doubtful have subsequently proven uncollectable) – any discountsthat may have been given to customers for early payment = Cash receipts from customersHolmes InstituteApplied Business Statistics for ManagersExample –cash collected from customerA company provides the following information and want to knowhow much cash was received: Sales – cashSales – creditDiscounts providedDoubtful debts – yearOpening balance, Accounts receivableClosing balance, Accounts receivable$120,000$780,000$ 10,000$ 22,000$154,000$159,000 Opening balance, Provision for doubtful debts $ 24,000Closing balance, Provision for doubtful debts $ 25,000Holmes InstituteApplied Business Statistics for ManagersExample –cash collected from customersHolmes InstituteApplied Business Statistics for ManagersExample –cash collected from customersThe total cash received is: Cash salesAccounts receivableTOTAL$120,000744,000$864,000 Holmes InstituteApplied Business Statistics for ManagersCalculating cash paid to suppliers▪ Cash payments to suppliers:▪ opening accounts payable – closing accounts payable + costof sales + closing inventory – opening inventory – discountsgiven by suppliers + stock write-offs = cash payments tosuppliersHolmes InstituteApplied Business Statistics for ManagersExample : cash payment to suppliersHolmes InstituteApplied Business Statistics for ManagersExample –cash paid to suppliersHolmes InstituteApplied Business Statistics for ManagersCash flows from operating activities❑ Calculation of cash received from interest revenue=interest revenue + opening interest receivable – closing interestreceivable❑ Calculation of cash received from dividends =dividend income + opening dividends receivable – closing dividendsreceivable❑ Calculation of cash payment of interest=interest expense + opening interest payable – closing interest payableHolmes InstituteApplied Business Statistics for ManagersCash flows from operating activities▪ Cash payment of income taxes▪ income tax expense + opening income tax payable – closingincome tax payable + opening deferred tax liability – closingdeferred tax liability + closing deferred tax asset – openingdeferred tax asset + any increase in DTL due to a revaluation –any decrease in DTL due to a reversal of a devaluation = cashpayment of income taxesHolmes InstituteApplied Business Statistics for ManagersCash flows from investing activities▪ Cash payments for non-current assets▪ closing balance of non-current assets – opening balance ofnon-current assets + original cost of assets sold – assetsacquired through non-cash transactions – revaluationincreases + accumulated depreciation written back torevalued assets = cash payments for non-current assets▪ Need to exclude any increase in assets generated by noncash transactions, for example, acquisition of plant bymortgage over other assetsHolmes InstituteApplied Business Statistics for ManagersCash 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 saleHolmes InstituteApplied Business Statistics for ManagersExample: Cash flows from investing activitiesGiven the facts below, determine what equipment they acquired forcash: Opening balanceClosing balance$1,000,000$ 956,000 Equipment with a carrying value of $140,000 (cost $190,000) has beenrevalued to $170,000Equipment sold for $30,000 (carrying value of $50,000, cost $130,000)Shares in company exchanged for equipment with a fair value of $80,000Holmes InstituteApplied Business Statistics for ManagersExample –cash spent on equipmentStep 1 Record the journal entriesAccumulated depreciation 50,000 EquipmentTo eliminate accumulated depreciation to revalue50,000 EquipmentAsset revaluation reserveTo revalue equipment to $170,00030,00030,000 Asset revaluation reserveDeferred tax liability9,0009,000 To recognise the DTL on the equipment revaluation being $30,000 xtax rate)30% (corporate Holmes InstituteApplied Business Statistics for ManagersEquipment Ledger-cash spent for equipmentHolmes InstituteApplied Business Statistics for ManagersCash flows from financing activities▪ Payment of cash dividends▪ Dividends paid + dividends proposed + opening dividendspayable – closing dividends payable = payment of cashdividends▪ Cash flows from financial activities also includes the issue ofshares, issue of debt, repayment of debt▪ Any increase share where there were no cash involved, neednot be included.Holmes InstituteApplied Business Statistics for ManagersExample of a cash flow statementSunflower LtdCash flow statementFor the period ended 30 June, 2017$ $Cash flows from operating activitiesCash collected form customerInterest ReceivedCash paid to employees and suppliersInsurance expenseOther expensesNet cash provided from operating activitiesCash flows from investing activitiesProceeds from sale of equipmentCash used to purchase equipmentCash used for investmentNet cash used in investing activitiesCash flows from financing activitiesDividend paidNet cash flows from operating, investing and financingactivitiesCash and cash equivalent at the beginning of the periodCash and cash equivalent at the end of the period4710001050($328000)(63000)($6000)($12000)3000(40000)(10000)63050(47000)(20000)………………(3950)25000…………………..21050………………………Holmes InstituteApplied Business Statistics for ManagersContractual implications▪ Cash flows from operations would appear to provide an indication of ability toservice debt➢ Perhaps more so than interest coverage▪ Traditional financial ratios (such as the current ratio, acid test ratios) aredeficient in monitoring the liquidity of the organization▪ The use of cash-flow data would provide an earlier indication of solvencyproblems than that provided by using conventional financial ratiosHolmes InstituteApplied Business Statistics for ManagersSummary of the Lecture▪ The statement of cash flows is considered to be a very useful complement toan entity’s statement of financial position and statement of comprehensiveincome▪ It provides information useful for making assessments about such things as anentity’s ability to:➢ generate cash flows➢ meet financial commitments as they fall due➢ finance changes in operating activities➢ obtain and service external debtHolmes InstituteApplied Business Statistics for ManagersSummary of the LectureCash flows to be classified into➢ operating activities➢ investing activities➢ financing activitiesHolmes InstituteApplied Business Statistics for ManagersSummary of the LectureDirect method to be applied▪ Relevant cash inflows are reported in gross terms rather than being netted off againsteach 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 financialposition 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

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