UBAF 1163

Financial Accounting Framework II

Topic 10

The Statement of Cash Flows

[Direct Method / Indirect Method]
 Learning Objectives:

Explain the purpose of cash flow information

Discuss the usefulness of the statement of
cash flows.
Determine cash and cash equivalents.
Prepare a statement of cash flows using direct
method.
Prepare a statement of cash flows using the
indirect method.
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 The Statement of Cash Flows
Statutory requirement required by CA 1965, FRS107
and PERS.
The Statement of Cash Flows provides information
as to management decisions on the companys cash
flow and its effect on the liquidity of the company.
The statement provides information as to the
sources from which the company received cash
(cash inflow) and how the cash is used (cash
outflow) during the financial year.
Helps users to assess effectiveness of cash mgmt by
the company mgmt.
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 Cash and Cash Equivalents

Cash
o Cash is defined as cash in hand, at bank and demand
deposits.
Cash Equivalents
o Cash equivalents are short-term, highly liquid investment,
which are readily convertible to cash.
o The short-term investment should be readily convertible
into a known amount of cash and will not be subject to
significant risk of changes in the value.
o The maturity date should NOT be more than 3 months
from the date of acquisition.
o E.g. short-term deposit, bank overdraft (repayable) 4
 The Usefulness of the
Statement of cash flows
The entitys ability to generate future cash
flows.
The statement discloses and identifies the activities
that generated cash and used cash.
It is a useful indicator of the timing and certainty of
the inflow and outflow of cash.
The entitys ability to pay dividends and meet
obligations.
The creditors will be able to assess the ability of the
company to pay them.
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 The Usefulness of the
Statement of cash flows
Differentiate between profit and net cash.
Cash flow is more easily understood than a
statement of comprehensive income as the profit
and loss for the year is derived using the accruals
principle.
The cash investing and financing activities.
It may assist users of financial statement in
examining both investing and financing transaction
and understand better the change of assets and
liabilities during the period.

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 Disadvantages
Provides historical information
Analysis and interpretation based on past
info
Subject to window dressing by mgmt
Includes cash equivalents which is difficult
to understand by non-accountants
Its preparation can be complicating and
presentation not easily understood

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 Components of
the Statement of Cash Flows
Operating Activities:
Operating activities are the principal revenue-
producing activities of a company, such as sales of
goods and services and all incidental costs incurred to
earn that revenue.
Cash inflows:
Cash receipts from cash sales.
Cash receipts from royalties, commission, fees and
other income
Cash outflows:
Cash payments for purchase (suppliers) and
employees.
Cash payments for expenses.
Cash payments for taxes and interest. 8
 Components of
the Statement of Cash Flows
Investing Activities:
Investing activities are transaction which involve
acquisition and disposal of non-current assets.
Cash inflows
Cash receipts on disposal of tangible or intangible non-
current assets (long term assets).
Cash receipts on sale of long-term investments.
Cash outflows:
Cash payments to acquire tangible and intangible non
current assets (long term assets).
Cash payments for investment.
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 Components of
the Statement of Cash Flows
Financing Activities:
Financing activities are transactions that involve the
obtaining and repaying of financial resources from
shareholders.
Cash inflows:
Cash receipts from the issue of share capital.
Cash receipts from the issue of debentures.
Cash outflows:
Cash payment to buy back or redeem the companys shares
(share redemption).
Cash payment on loan repayment and redemption of
debentures.
Cash payment to pay dividends.
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 Other disclosures
Taxes paid must be shown under operating
activities but shown separately
Interest paid must be shown separately
under operating activities
Dividends paid must be shown under
financing activities
Dividends income (received) must be
shown under investing activities

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 Significant Non-Cash Activities

Transactions which do not involve cash.

These transactions are reported separately in the
bottom of the Statement of Cash Flows.
Example:
Issuance of shares capital to exchange non-current assets
The conversion of debentures into ordinary shares
Issuance of debenture to purchase non-current assets

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13
Method of Preparing the Statement
of Cash Flows
1. Direct Method provides the sources of operating
cash and the uses of operating cash. The major
sources of operating cash are cash received from
customers. Uses of cash include the cash paid to
the suppliers
Direct, easy to comprehend
No adjustments for non-cash items required
Detailed info on cash from operations required
Use incomplete record approach to work out
certain cash items, such as cash sales, cash
purchases, etc. 14
Method of Preparing the Statement of
Cash Flows
Indirect Method - provides the operating
cash flow from beginning with net income
and adjusting it for revenues and
expenses that do NOT involve the receipt
or payment of cash.
Starts with profit before tax (re: Statement
of Comprehensive income)
If Statement of Comprehensive income is
not available, it is still possible to work out
the net profit by comparing retained
earnings of last 2 yrs 15
Method of Preparing the Statement
of Cash Flows
Note: Statement of Comprehensive income is
prepared on accrual basis, but SCF is based on
actual cash flow
Adjustments are required for non-cash expenses
and increase/decrease in working capital

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 Changes in cash & cash
equivalents (CACE)
Net changes in CACE refer to the
difference between opening balance and
closing balance of cash and cash
equivalents, such as cash at bank, cash on
hand, bank overdraft, and short-term
deposits.

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 Indirect Method Example 1
Avengers Bhd
Statement of Financial Position as at 31 Dec 2011
Change
Current Assets: 2011 2010 (Increase/Decrease)
Cash 55,000 33,000 22,000 Increase
Account Receivable 20,000 30,000 (10,000) Decrease
Inventory 15,000 10,000 5,000 Increase
Prepaid expense 5,000 1,000 4,000 Increase
Non-Current Assets:
Land 130,000 20,000 110,000 Increase
Building 160,000 40,000 120,000 Increase
Accumulated Depn -Building (11,000) (5,000) (6,000) Increase
Equipment 27,000 10,000 17,000 Increase
Accumulated Depn -Equipment (3,000) (1,000) (2,000) Increase
Total Assets 398,000 138,000 18
 Indirect Method Example 1
Liabilities and Shareholders 2011 2010 Change (increase/
equity Decrease)
Current Liabilities:
Account Payable 28,000 12,000 16,000 Increase
Income tax payable 6,000 8,000 (2000) Decrease
Non-Current Liabilities:
Bonds Payable 130,000 20,000 110,000 Increase
Shareholders Equity:
Share Capital 70,000 50,000 20,000 Increase
Retained Earnings 164,000 48,000 116,000 Increase
Total Liabilities and equity 398,000 138,000

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 Indirect Method Example 1
Avengers Bhd
Statement of Comprehensive Income for the year ended 31 Dec 2011
RM RM
Sales 507,000
Cost of Sales 150,000
Gross Profit 357,000
Expenses (excluding Depreciation) 111,000
Depreciation 9,000
Interest expense 42,000
Loss on sale of equipment 3,000 165,000
Net Profit Before Taxes (NPBT) 192,000
Income tax expense 47,000
Net Profit After Taxes (NPAT) 145,000
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 Indirect Method Example 1
Additional Information:
a. The company declared and paid RM29,000 cash dividend.
b. Issued RM110,000 of non-current bond in exchange for land
c. A building costing RM120,000 was purchased for cash.
Equipment costing RM25,000 was also purchased for cash.
d. The company sold equipment with a carrying amount of
RM7,000 (cost RM8,000, less accumulated depreciation
RM1,000).
e. Issued ordinary share for RM20,000 cash
f. Depreciation expense comprised RM6,000 for building and
RM3,000 for equipment.

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 SOLUTION: Step 1 Operating
Activities
Adjustment for non-cash items:
Non Cash Changes Adjustment

Expenses items +
Income/ revenue items _

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 SOLUTION: Step 1 Operating
Activities
RM RM
Cash flows from operating activities:
Net Profit before taxation 192,000
Adjustments for:
(+) Depreciation 9,000
(+) Loss on disposal of PPE 3,000
(+) Interest expense 42,000 54,000
Operating profit before working capital changes 246,000

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 SOLUTION: Step 1 Operating
Activities
Working Capital: Increase Decrease
Current Assets - +

Current Liabilities + -

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 SOLUTION: Step 1 Operating
Activities
Change in Current Assets: (check the
increase/decrease in the current asset
except for the cash and cash equivalent
items)
Accounts receivable decrease by RM10,000
Inventory increase by RM5,000
Prepaid expenses increase by RM4,000

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 SOLUTION: Step 1 Operating
Activities
Change in Current Liabilities: (check the
increase/decrease in the current liabilities
except for the cash and cash equivalent
items)
Accounts payables increase by RM16,000
Income tax payable decrease by RM2,000

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 SOLUTION: Step 1 Operating
Activities
RM RM
Cash flows from operating activities:
Net Profit before taxation 192,000
Adjustments for:
(+) Depreciation 9,000
(+) Loss on disposal of PPE 3,000
(+) Interest expense 42,000 54,000
Operating profit before working capital changes 246,000
(-) Increase in inventories (5,000)
(+) Decrease in account receivable 10,000
(-) Increase in Prepaid expense (4,000)
(+) Increase in account payable 16,000 17,000
Cash generated from operations 263,000
Interest paid (42,000)
Income taxes paid (-47,000 - 2000) (49,000) (91,000)
Net cash flows from operating activities 172,00027
 SOLUTION: Step 1 Operating
Activities
To get the net cash flow from operating
activities:
1. Deduct the interest paid:
Interest expense in the statement of comprehensive
income need to be adjusted with any interest payable
in the balance sheet.

2. Deduct the tax paid:

Taxation expense in the statement of comprehensive
income need to be adjusted with any tax recoverable
or tax payable in the balance sheet.
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 SOLUTION: Step 1 Operating
Activities
Example: tax payable
Tax payable
*Bank 49,000 Balance b/d 8,000
Balance c/d 6,000 SOCI 47,000

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 SOLUTION: Step 2 Investing
activities
Increase in Land
Land cost RM110,000 was purchased through the
issue of non-current bonds.
Considered non-cash activity merits disclosed in
the financial statement
Increase in Building
An office building was acquired for RM120,000
cash.

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 SOLUTION: Step 2 Investing
activities
Increase in Equipment
Equipment a/c increased RM17,000
Two transaction involved:
A purchase of equipment of RM25,000
The sale for RM4,000 of equipment costing
RM8,000

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 Equipment Account
Bal b/d 10,000 Disposal 8,000
New Purchase 25,000 Bal c/d 27,000
35,000 35,000

Disposal of Equipment
Equipment 8,000 Accumulated Depreciation 1,000
Loss on Sales 3,000
Cash 4,000
8,000 8,000

` Accumulated Depreciation - Equip

Disposal 1,000 Bal b/d 1,000
Bal c/d 3,000 Depreciation expense 3,000
4,000 4,000

Profit and Loss Account

Equip disposal (Loss) 3,000

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 SOLUTION: Step 2 Investing
activities

Cash flows from investing activities:

(-) Purchases of building (c ) (120,000)
(-) Purchases of Equipment (c ) (25,000)
(+) Proceeds from the disposal of PPE (d) 4,000
Net cash flows used in investing activities (141,000)

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 SOLUTION: Step 3 Financing
activities
Increase in Bonds Payable
Bond payable a/c increased RM110,000
Reported separately in the financial statement
Increase in Ordinary Shares
Share capital increased RM20,000
Increase in Retained Earnings
Retained earnings increased RM116,000
Two transactions involved:
Profit of RM145,000 increased in retained earnings
Dividends of RM29, 000 decreases retained earnings

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 SOLUTION: Step 3 Financing
activities

Cash flows from Financing activities:

(+) Proceeds from the issue of ordinary shares (e) 20,000
(-) Dividend paid (a) (29,000)
Net cash flows used in financing activities (9,000)

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SOLUTION: Step 4 Net Change in
Cash
The net change in cash during the period was an
increase of RM22,000.
Refer to the Statement of Cash Flows Format

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 Direct Method : Operating
Activities
Cash receipts Cash Payments = Net cash provided by
operating activities.

*Cash receipts = from sales of goods and services to the

customers.
*Cash payments =
1. Cash payments to suppliers
2. cash payments to employees
3. cash payment for operating expenses
4. cash payment for interest.
5. cash payment for taxes.
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 Direct Method Example 2
Income Statement RM RM
Sale 205,000
(-) Cost of Sales (75,000)
Gross Profit 130,000
(-) Expenses:
Wages and Salaries (40,000)
Utility (10,000)
Rent (28,000)
Depreciation (12,000) (90,000)
Net Profit before tax 40,000
(-) Income tax (10,000)
Net Profit after tax 30,000

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 Direct Method Example 1

2012 2011
RM RM
Inventories 25,000 20,000
Account Receivables 40,000 30,000
Account Payables 19,000 15,000
Income tax payable 2,000 1,000
Accrued expenses (utility) 1,000 2,000
Prepayment (rent) 10,000 12,000

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SOLUTION: Cash Receipts from
customers
Account Receivable Control a/c

Bal b/d 30,000 Cash 195,000

Sales 205,000 Bal c/d 40,000

235,000 235,000

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 SOLUTION: Cash Payment for
Suppliers
Inventory a/c
bal b/d 20,000Cost of Sales 75,000
Purchase 80,000Bal c/d 25,000
100,000 100,000

Account Payable control a/c

Cash 76,000Bal b/d 15,000

Bal c/d 19,000Purchase 80,000

95,000 95,000
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 SOLUTION: Cash Payment For
Expenses
Accrued Expenses
Cash 11,000Bal b/d 2,000
Bal c/d 1,000P& L 10,000
12,000 12,000

Prepaid Expenses
Bal b/d 12,000P&L 28,000
Cash 26,000Bal c/d 10,000
38,000 38,000

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SOLUTION: Cash paid for income
taxes
Income Taxes Payable

Cash 9,000Bal b/d 1,000

Bal c/d 2,000P & L 10,000

11,000 11,000

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 SOLUTION: Direct method
Operating activities:
Statement of Cash Flows
For the year ennded 31 December Year 2012
Cash flows from operating activities:
Cash receipt from customers 195,000
Cash payment to Suppliers (76,000)
Cash payment to employees (40,000)
Cash payment for expenses (37,000)
Cash generated from operating activities 42,000
Cash payment for income taxes (9,000)
Net cash flows from operating activities 33,000
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 SOLUTION: Direct method
Operating activities:
Statement of Cash Flows
For the year ennded 31 December Year 2012
Cash flows from operating activities:
Cash receipt from customers 195,000
Cash payment to Suppliers & employees (76 + 40 +37) (153,000)
Cash generated from operating activities 42,000
Cash payment for income taxes (9,000)

Net cash flows from operating activities 33,000

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 How to compute profit
before tax
When Statement of Comprehensive
income is not given in the question, one
has to reconstruct the profit before tax
based on the formula:
Profit after tax = profit before tax
dividends, tax and any other transfers
to reserves
Profit after tax figure is derived by
deducting retained profits b/d current year
from retained profits b/d from prior year.
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EXAMPLE 3

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Statement of Comprehensive Income for the year ended 31 Dec 2X07

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Extract of changes in equity

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Statement of Financial Position as At 31 Dec

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Statement of Financial Position as At 31 Dec

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Additional information
RM10,000 of debentures were converted to
ordinary shares on 1 Jan 2X07
The increase in issued share capital is due to the
issue of shares for cash and the conversion of
debentures
Sale of plant was for cash. There was no purchase
of plant and machinery during the year
Land was purchased for cash
Depreciation charge of RM2,000 in the Statement
of Comprehensive Income comprised depreciation
of RM1,000 each for plant and motor vehicles
Required: Prepare SCF under direct and indirect
methods.
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~ END OF LECTURE ~

~ THANKS ~

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