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ACC203

Financial Accounting 2
Lecture 5
Statement of Cash Flows
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2
Lecture 5 Outline
• Explain the reasons for preparing a statement of cash flows
1. • Describe the general format for a statement of cash flows

• Explain the classification of cash flow activities


• Classify cash inflows and outflows into operating, investing and
2. financing activities

• Prepare reconstruction accounts when converting from accrual based


information to cash based information
3.

• Prepare a comprehensive statement of cash flow


• Discuss the limitations of Cash Flow Statements
4.
Reference
• Company accounting 10th Edition 2015, Leo K.,
Prescribed
Knapp J., McGowan S., and Sweeting J. -
Text Chapter 16

• AASB 107 Statement of Cash Flows


AASB

• Tutorial 6. Refer Detailed Weekly Schedule for


Tutorial question numbers
Cash Flow Statement
Balance Sheet, Income Statement and Statement of Owners Equity

Based on accrual accounting No detail on cash flows

Cash Flow statement – uses cash basis not accrual

Cash inflows Cash outflows

Inflows minus outflows = Net cash used from all activities


Purpose of the statement of
cash flows
Evaluating
Certainty - cash Ability to financial
Timing - cash generate cash structure.
E.g. liquidity

Differences
between profit Comparing Entity’s ability to
and net cash entities adapt to change
from operations
General format – AASB107

All cash flows to be


Refer text Figure 16.1
reported on a gross
basis
AASB107

A net basis is only


allowed if: It reflects
the activities of the See Appendices to
customer or there is AASB107 for
quick turnover, large acceptable formats
amounts and short
maturities
General Format – AASB107
Operating cash flows may be reported using either:

Direct method Indirect method

Direct method discloses:

Classes of gross cash receipts and payments

Indirect method-Accruals basis


Net profit adjusted for: Non cash items, accrual entries
and non-operating items
General format – AASB107
AASB107 requires that all cash flows be classified as:
Operating Investing Financing

An entity shall report separately major classes of:

Gross cash receipts and gross cash payments arising from:

Investing Financing
Concept of cash –
AASB107
• Cash is defined as cash and cash equivalents
• Cash: cash on hand and demand deposits
Cash

• Highly liquid investments with short periods to maturity


• Readily convertible to cash
Cash
equivalents
• Minimal risk of value changes. E.g. Bank bills

• An investment will only qualify as a cash equivalent if:


• It is convertible to a known amount of cash
Cash • Subject to insignificant risk of changes in value
equivalents • Has a maturity date of less than 3 months.
Concept of Cash

Bank • Usually considered to be financing activities.


borrowings

• A bank overdraft is an exception if it forms an


Exception integral part of the entity’s cash management
function and is payable on demand.

• A characteristic of such bank arrangements


Example is where balances fluctuate from being
positive or overdrawn.
Classifying cash flow
activities: Operating activities
The principal revenue-producing activities of an entity.
Examples include:

Cash inflows from: Cash outflows to:


Sale of goods/rendering of Suppliers and employees
services for goods and services
Royalties, fees, Government for income
commissions taxes
Interest received Lenders for interest
(may be investing) (may be financing)
Dividends received
(may be investing)
Classifying cash flow
activities: Investing activities
The acquisition/disposal of long-term assets and other
investments. Examples include:

Cash inflows from: Cash outflows to:


Sale of non-current assets Acquire non-current
(PP&E, intangibles, share assets
investments) (PP&E, intangibles, share
investments)

Repayments of loans Lend money to other


advanced to other parties parties
Classifying cash flow
activities: Financing activities
Activities that result in size and composition changes in
equity capital and borrowings. Examples include:

Cash inflows from: Cash outflows to:

Issuing shares and other equity Buy back shares


instruments

Issuing debentures and other Repay debentures and other


borrowings borrowings

Pay dividends
(may be operating)
Class Activity
Indicate whether the following transactions are: Cash Inflows (CI)/ Cash
Outflows (CO) or Non Cash Flows (NCF) and if there is a cash flow, indicate
whether it is: operating (O), investing (I) or financing (F).

1. Issued ordinary shares (for cash)


2. Exchanged a building for land
3. Purchased inventory on credit
4. Sold inventory on credit
5. Made a cash sale of inventory
6. Redeemed debentures
7. Purchased machinery for cash
8. Purchased land costing $500 000 with a deposit of $100 000
and a mortgage of $400 000
9. Purchased inventory for cash
10. Sold a plant asset (with a carrying amount of $30 000)
for $25 000 cash
11. Paid wages
Classifying transactions
Indicate whether the following transactions are: Cash Inflows (CI)/ Cash
Outflows (CO) or Non Cash Flows (NCF) and if there is a cash flow, indicate
whether it is: operating (O), investing (I) or financing (F).

1. Issued ordinary shares (for cash) CI – F


2. Exchanged a building for land NCF
3. Purchased inventory on credit NCF
4. Sold inventory on credit NCF
5. Made a cash sale of inventory CI – O
6. Redeemed debentures CO – F
7. Purchased machinery for cash CO – I
CO – I
8. Purchased land costing $500 000 with a deposit of $100 000
NCF
and a mortgage of $400 000
CO – O
9. Purchased inventory for cash
10. Sold a plant asset (with a carrying amount of $30 000)
CI – I
for $25 000 cash CO - O
11. Paid wages
Preparation – direct method

• Cash flow is NOT prepared from the trial balance.


• Comparative statements of financial position are
1. often used

• Supplementary information from the statement of


comprehensive income and specific general
2. ledger transactions are often used.

• Spreadsheet approach
• Reconstruction (T-account) method
Common
methods
• Formula method
Cash flow from operating
activities
Receipts
from
customers

Interest Operating Payments


paid and activities to
received suppliers
Examples

Payments
to
employees
Receipts from customers
Sales revenue represents both:
Cash sales Credit sales

Cash received in current year includes:


Current and prior year sales received
now

Cash inflow is determined using:


Movement in Accounts Receivable
Receipts from customers
Accounts Receivable

Begining balance 600 cash received 14,100


from customers
sales 14,500 Ending balance 1,000
15,100 15,100

 Balances of accounts receivable come from the balance sheet.


 Sales comes from the income statement.

 Cash receipts can then be determined as follows:


 Sales + beginning accounts receivable – ending accounts receivable
= cash receipts from customers
Calculating Receipts from
Customers

Sales

Factors Movement
Discounts to
customers to in Accounts
Receivable
consider

Bad debts
Written off
Discounts Allowed and Bad Debt
Write-offs
Journal entry to record discount allowed to a customer:
DR Cash at Bank
DR Discount Allowed
CR Accounts Receivable

Journal entry to write-off a bad debt:


DR Allowance for Bad Debts
CR Accounts Receivable
From these journals you can see there is no cash impact on
Accounts Receivable. These adjustments must be added back to
avoid overstatement of receipts.
Worked Example – cash
receipts
DATA:

2011 2012

Accounts Receivable $189 000 $246 500

Allowance for Doubtful Debts 9 500 12 500

Sales 6 930 000

Discounts Allowed 4 750

Bad Debts Expense 11 000


Worked Example – cash receipts
STEP ONE: Calculate bad debts written off

Allowance for Doubtful Debts


Bad debts W/O 8 000 Opening balance 9 500

Closing balance 12 500 Bad debts expense 11 000

20 500 20 500
Worked Example – cash receipts
STEP TWO: Reconstruct Accounts Receivable

Accounts Receivable
Opening balance 189 000 Cash Received 6 859 750
Bad debts W/O 8 000
Discount allowed 4 750

Sales 6 930 000 Closing balance 246 500

7 119 000 7 119 000


To calculate cash receipts with a
bad debt write-off
STEP ONE:
Reconstruct the Allowance for Doubtful Debts
account to calculate the bad debts written off.

STEP TWO:
Use the bad debts written off amount calculated in
step one in the reconstruction of Accounts
Receivable (and any discount allowed) before
calculating the cash received from customers.
Calculating Payments to Suppliers

What is • Payment for Inventory purchases


this? • Payment for all other supplies and services

• Payments for current and prior year


purchases
Includes: • Current year (pre)payments that will be
expensed in future years

• Current year purchases where the cash will


be paid in a future year
Excludes: • Expenses recognised in the current year that
were (pre)paid in prior years
Payments to suppliers of
inventory
Purchases of inventory can be calculated by reconstruction of
the inventory account.
The purchases amount is then transferred to the accounts
payable reconstruction account to determine the cash paid for
inventory.

Data: 2011 2012

Inventory 4,830 4,710


Accounts Payable 4,715 4,400
Cost of Sales 36,600
Payments to suppliers of
inventory
Inventory

beg. bal. 4,830 COS 36,600

purchases 36,480 end. bal. 4,710


41,310 41,310

Accounts Payable

cash paid 36,795 beg. bal. 4,715

end. bal. 4,400 purchases 36,480


41,195 41,195
Discounts Received on
Inventory

The journal entry to record the discount received is:

DR Accounts Payable
CR Discount Received
CR Cash at Bank

From this journal you can see there is no cash impact on


Accounts Payable. This adjustment must be added back to
avoid an overstatement of payments.
Worked Example – cash paid to
suppliers of inventory

DATA:

2011 2012

Accounts Payable $471 500 $440 000

Inventory 483 000 471 000

Cost of Sales 3 660 000

Discounts Received 10 500


Worked Example – cash paid to
suppliers of inventory

STEP ONE: Calculate purchases

Inventory
Opening balance 483 000 Cost of sales 3 660 000

Purchases 3 648 000 Closing balance 471 000

4 131 000 4 131 000


Worked Example – cash paid to
suppliers of inventory
STEP TWO: Reconstruct Accounts Payable

Accounts Payable

Discount received 10 500 Opening balance 471 500

Cash Paid 3 669 000 Purchases 3 648 000

Closing balance 440 000

4 119 500 4 119 500


Notes to the Statement of Cash
Flows Disclosure:
AASB107
Para. 45 • Reconciliation of Cash
Note 1

AASB107 • Reconciliation - Profit After Tax


Para. 20 with Cash Flows from Operating
Note 2 Activities (indirect method)

AASB107
• Non-Cash Financing and
Para. 43
Investing Activities
Note 3
Operating activities - the indirect
method
• Under the indirect method; profit/(loss) is adjusted
for:
1. • Non-cash items

• Items relating to investing or financing activities


(non-operating items)
2.

• The effects of accruals


3.
Operating activities - the indirect
method

• The first two types of adjustments are identified


by reviewing the statements of comprehensive
1. income.

• Per statement of comprehensive income:


2.

• CR items are deducted; such as


• Dr items are added back
3.
Operating activities - the indirect
method
• The third type of adjustments involve identifying
movements in statement of financial position
1. that relate to operating activities.

• Movement per statement of financial position:


2.

• DR movements are deducted


• CR movements are added back
3.
Classifying cash flows
• AASB 107 does not prescribe how interest and dividends
Interest &
Dividends
should be classified (i.e. O/I/F)

• Does require them to be separately disclosed and


Disclosure classified consistently across periods

• Interest received > investing BUT Interest paid > operating


Text book • Dividends received > investing BUT Dividends paid > financing
approach

• AASB 107 also requires separate disclosure of income tax as an


Income Tax
operating activity
Dividends paid
Financing cash outflow
The journal entries are:
Record the dividend at the time of declaration:
DR Dividend Declared
CR Dividend Payable

Closing entry at the end of the financial year:


DR Retained Earnings
CR Dividend Declared

Payment of dividend (usually the following year)


DR Dividend Payable
CR Cash
Dividends paid
Financing cash outflow

• To calculate the amount paid in dividends:


1.

• Reconstruct the Dividend Payable account to find


the amount of cash paid for dividends.
2.

• If not told how much has been declared in dividends,


then reconstruct the Retained Earnings Account.
3.
Worked Example – cash
paid for dividends
DATA:
2011 2012
Dividend Payable $160 000 $174 000
Dividends Declared 174 000

Dividend Payable
Cash paid 160 000 Opening balance 160 000

Closing balance 174 000


Dividend Declared 174 000
334 000 334 000
Reconstruction of Retained
Earnings
Retained Earnings
Appropriations: Opening balance

Dividends Operating profit after tax

Transfers to reserves

Closing balance Transfers from reserves


Income tax paid
Operating cash outflow
The journal entry to record the payment of tax is:

DR Current Tax Liability


CR Cash at Bank

Current Tax Liability

Opening balance
Tax Paid – cash outflow
Closing balance Income tax expense
Worked Example – cash paid for
income tax with no temporary
differences

DATA:
2011 2012

Current tax liability $4 200 $6 600

Income tax expense 23 361

Assuming there are no temporary differences, then


the income tax expense relates entirely to the
current tax liability (ie: assumes no DTA or DTL)
Worked Example – cash paid for
income tax with no temporary
differences

Current Tax Liability

Tax Paid 20 961 Opening balance 4 200

Closing balance 6 600 Income tax expense 23 561

27 561 27 561
Income tax paid with temporary
differences

• Where temporary differences exist, the balance in the income tax


expense account contains entries relating to:
*

• Current Tax Liability


• Movements in Deferred Tax Assets and/or Deferred Tax Liabilities
*
• To calculate the amount of income tax expense that was credited to
the Current Tax Liability account, it is necessary to reconstruct all the
* tax journal postings that were raised at the end of the year.
Income tax paid
Operating cash outflow
Recall the journal entries to record year end tax:

Entry relating to current tax:


DR Income Tax Exense
CR Current Tax Liability

Entry relating to deferred tax:


DR DTA
CR DTL
DR/ CR Income Tax Expense
Worked Example – income tax paid
with temporary differences
DATA:

2012 2011
Balance Sheet Extracts:
Deferred Tax Asset 2 200 2 000
Current Tax Liability 290 000 250 000
Deferred Tax Liability 7 500 6 500
Income Statement Extract:
Income Tax Expense 295 000

The amount of cash paid can be determined by a TWO STEP process:


STEP ONE: reconstruct the income tax expense account
STEP TWO: use the current income tax expense amount to
reconstruct the current tax liability account
Worked Example –income tax
paid with temporary differences
Income Tax Expense
Opening balance 0 Movement in DTA 200
Movement in DTL 1 000
Current income tax expense 294 200 Closing balance 295 000

295 200 295 200

Current Tax Liability


Cash Paid 254 200 Opening balance 250 000

Closing balance 290 000 Income tax expense 294 200

544 200 544 200


Limitations of the
Statement of Cash Flows

• Only past cash flows are reported


• Non-cash transactions and events are not included
1.

• Much detail is included in the notes


• Liquidity/solvency evaluation are not adequately addressed
2.

• May be subject to management manipulation


3.