B407F Advanced Financial Reporting and Analysis I

Consolidated statement of cash flows

Learning outcomes
- Discuss the purpose of a statement of cash flow
- Discuss how to prepare consolidated statements of cash flows
- Prepare consolidated statement of cash flows
- Describes the disclosure requirements for consolidated statement of cash flows

Students are expected to know how to prepare a simple cash flow statement for a
company using either the direct or the indirect method from their prior course ACT
B332F.

Statement of cash flows is an important component of the financial statements. The

purpose of a statement of cash flows is to provide users with information about an
entitys inflows and outflows of cash and cash equivalents. These are useful indicators
of the liquidity and solvency of an entity, and whether a company has utilized its cash
flows in a best way. In particular, users of financial statements can rely on a statement
of cash flows to assess:

the entitys ability to generate cash from operating activities

the entitys ability to repay debts and dividends

the reasons for the difference between operating profits and cash profits

cash inflows/outflows from investing and financing activities

A recap of statement of cash flows

HKAS 7 Statement of cash flows specifies the principles and format of a cash flow
statement. A statement of cash flows explains the increase (or decrease) in cash and
cash equivalents of a company during a financial period.

HKAS 7 defines cash and cash equivalents as:

Cash comprises cash on hand and demand deposits

Cash equivalents are short-term, highly liquid investments that are readily
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 convertible to known amounts of cash without notice and which are subject to an
insignificant changes in value.

HKAS 7 adopts the view that normally only investments with a short maturity of three
months or less from the date of acquisition qualifies as cash equivalents. In this sense,
a 1-year fixed bank deposit that will mature within 2 months from the reporting date
should not be considered as cash equivalent as it has a maturity of more than 3 months
at acquisition date.

Content of a statement of cash flows

1 Cash flows from operating activities;

2 Cash flows from investing activities; and

3 Cash flows from financing activities.

Cash flows from operating activities

Cash flows from operating activities are cash flows derived from the companys
principal revenue-producing and other activities that are not investing or financing
activities. It provides information on the ability of a company to generate sufficient cash
to finance its investing and financing activities. Cash flow from operating activities can
be prepared using:

the direct method, and

the indirect method

Briefly, the direct method presents cash flows from operating activities by the major
classes of gross cash receipts and payments. Examples include:
cash receipts from customers
interest and dividends received
cash paid to suppliers and employees
interests and dividends paid
other operating cash receipts and payments

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The indirect method starts with profit before tax followed by the adjustments of non-
cash nature transactions to derive cash flow from operating activities.

Cash flows from investing activities

Cash flows from investing activities relate to acquisition and disposal of non-current
assets and other investments not included in cash equivalents. It provides indication
on the extent that the company has spent resources with the intention to generate future
cash flows

Free cash flows is operating cash flow after deducting capital expenditure for
investing activities. Financial analysts usually look at free cash flows more than
operating cash flow. Free cash flows indicate surplus cash/cash equivalent generates
from operating activities after meeting the need for investing activities. How to make
the best use of free cash flows is an important topic in corporate financial management.

Cash flows from financing activities

Cash flows from financing activities result from issue or redemption of shares and
debentures, receipts from or repayment of borrowings. This information is useful in
predicting claims on the future cash flows by the providers of capital.

Example 1

The following are extracted from the accounts of ABC Ltd:

Statement of profit or loss for the year ended 31 December 20x2 (Extract)

$000
Operating profit 3,540
Interest expenses
- debentures (90)
- finance lease (60)
Profit before tax 3,390

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Statement of financial position as at 31 December (Extract)

20x2 20x1
Non-current assets $000 $000
PPE 6,850 4,850
Less: accumulated depreciation (2,135) (2,300)
4,715 2,550
Current liabilities
Obligations under finance lease 320 -
Non-current liabilities
Obligations under finance lease 890

Share capital 6,952 5,962

The following information relating to changes in non-current assets is available for the
year ended 31 December 20x2:

1. A new machine is acquired for $1,500,000 under a finance lease agreement. The
rental paid was $350,000 (includes an interest element of $60,000).

2. A machine with an original cost of $500,000 and accumulated depreciation of

$365,000 was sold for a profit of $30,000.

3. A new plant was purchased for $1,000,000. This was settled by issuing 500,000
ordinary shares.

Statement of cash flows for the year ended 31 December 20x2 (Extracts)

$000
Cash flows from operating activities $000
Profit before tax 3,390
Adjustments for non-cash items
Interest expense ($90,000+$60,000) 150
Profit on disposal of machine (30)
Depreciation ($2,135,000 ($2,300,000 $365,000)) 200
XXX

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 Interest paid (150)

Cash flows from investing activities

Sale of machinery 165

Cash flows from financing activities

Capital payment of finance lease (290)

Note:
Material non-cash transactions*
During the year, a new plant was acquired for $1,500,000 under a finance lease, and a
plant was acquired for $10,000,000 which was settled by issuing 500,000 ordinary
shares.

*Acquisition of a new plant was paid for by the issuance of shares. As no cash flows
was involved, there are excluded from the statement of cash flows. HKAS 7 requires
that such transactions should be disclosed in the financial statements as they provide
relevant information about investing and financing activities

In this lecture, we will extend this skill to deal with:

exchange difference
non-controlling interest;
share of profit or loss of associates;
acquisition and disposal of subsidiaries during the year; and
foreign subsidiaries.

Exchange difference

Exchange difference arises when an entity enters into a foreign currency denominated
transaction. Cash flows from these transactions should be the amounts actually received
or paid in the functional currency of the company. Therefore,

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1. Exchange difference recognized in the statement of profit or loss: Foreign exchange
gains (or losses) that do not involve cash flows should be deducted from (or added
back to) profits before tax.

2. Exchange difference arising in restating monetary items: In calculating the

movement (i.e. increase or decrease) in monetary assets and liabilities (e.g., trade
receivable, trade payable, loans etc), the effect of exchange differences should be
eliminated. Similarly, translation gains (losses) on a long-term foreign currency
loan does not involve cash flows should be deducted from (added back to) the loans
in order to ascertain changes in loan payable; and

3. Exchange difference arising in restating cash and cash equivalent: The effect of
changes in exchange rate on cash and cash equivalents held in foreign currency is
reported in the statement of cash flows in order to reconcile cash and cash
equivalents at the beginning and the end of the period.

Example 2

Circle Ltd had the following balances on 31 December:

20x2 20x1
Accounts receivable 30,000 24,000
Cash 45,000 41,000
Loan payable 47,000 35,000

The following information is available:

(a) At 31 December 20x2, accounts receivable (AR) included an amount of FC10,000

which was accounted for initially at the exchange rate of FC1 = HK$0.7. This was
re-stated using the closing rate of FC1 = HK$0.68.

31/12/x2: Exchange difference on AR = FC10,000 x (0.68 -0.70) = $200 loss

(b) A bank loan of FC20,000 was accounted for at 31 December 20x1 at the exchange
rate of FC1 = HK$0.71. This was repaid during 20x2 when the exchange rate was
FC1 = HK$0.69.

Carrying amount = FC20,000 x 0.71 = $14,200

Amount settled = FC20,000 x 0.69 = $13,800
Exchange difference on FC loan = FC20,000 x (0.69 -0.71) = $400 gain
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(c) Cash balance at 31 December 20x2 includes an amount of FC1,500. This was
initially recorded at the exchange rate of FC1 = HK$0.72, and restated at the
closing rate of FC1 = HK$0.68.

Exchange difference on cash = FC1,500 x (0.68 -0.72) = $60 loss

(d) Profit before tax for the year was $6,000.

(e) The exchange differences for 20x2 are calculated as below:

$
Unrealized exchange loss:
Accounts receivable (FC10,000,000 (0.70 0.68)) (200)
Cash (FC1,500,000 (0.72 0.68)) (60)
Realized exchange gain:
Loan payable (FC20,000,000 (0.71 0.69)) 400
Total exchange gains recognized in profit or loss 140

Statement of cash flows for the year ended 31 December 20x2

$ $
Profit before tax 6,000
Adjustment for non-cash items
Net foreign exchange gain (i) (140)
XXX
Adjustment for change in working capital
Increase in AR (ii) ($30,000 -$24,000+$200) (6,200)

Cash flows from financing activities

Repayment of bank loan (iii) (13,800)
New loan raised ($35,000-$14,200-$47,000) 26,200
Net cash flows from financing activities XXX
Net change in cash and cash equivalents 4,060
Opening balance of cash and cash equivalents 41,000
Foreign exchange loss (iv) 60
Closing balance of cash & cash equivalents 45,000

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(i) Net foreign exchange gain recognized in the income statement = $400 $200 - $60
= $140 gain. The exchange gain represents book value adjustment only and
should be adjusted against profit before tax to derive operating cash flows.

(ii) Foreign exchange loss arising in retranslating FC AR does not involve cash flows
and should be excluded from the changes in these items.

(iii) Exchange gain on translating of FC long-term loan does not involve cash flows,
and should be adjusted in determining the movement of loan. Repayment of loan
involves a cash outflows.

(iv) The exchange difference arising in restating FC cash represents a change in cash &
cash equivalents. It should be included in the statement of cash flows to reconcile
the opening and closing cash & cash equivalents figures.

Consolidated statement of cash flows

Companies that have subsidiaries are required to prepare a statement of cash flows
based on the group accounts. A consolidated statement of cash flow is prepared from the
consolidated statement of profit or loss and other comprehensive income and the
consolidated statements of financial position. The procedures required to prepare cash
flow statement for a single company applies equally to a consolidated statement of cash
flows. However, there are items which are pertinent to group accounts. These
include

non-controlling interest
share of profit of associates /joint ventures
acquisition (or disposal) of subsidiaries; and
foreign subsidiaries

Non-controlling interest (NCI)

In the consolidated statement of financial position, the NCI may:

Increase due to its share of the subsidiarys profit for the year;
Decrease due to its share of the subsidiarys loss for the year; and
Decrease due to dividend payment.

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The actual cash flow to NCI is the amount of dividends paid to NCI which should be
reported under financing activities.

Example 3

Extracts from the financial statements of S Ltd for the year ended 31 December 20x2
are as follows:

Consolidated statement of profit or loss (extracts)

$
Operating profits 2,350
Share of profits in associates 150
Profit before tax 2,500
Taxation (500)
Profit after tax 2,000
Attributable to:
NCI 200
Owners of the parents equity 1,800

Consolidated statement of financial position (extracts)

20x2 20x1
Investment in associates 930 890
Loan to associates 1,000 800
NCI 580 480

The NCI share of profit after tax in 20x2 represents retained profits plus dividends paid.
The amount of dividends paid to NCI during the year is:

NCI balance at 31 Dec 20x1 $ 480

Share of profit in 20x1 200
NCI balance at 31 Dec 20x2 (580)
Dividends paid to NCI 100

Dividends paid to NCI represents part of the distribution to owners and should be
shown as a financing cash flows item.

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Share of profits or loss in associates

Under the equity method of accounting, the consolidated statement of profit or loss
incorporates the groups share of the associates profit. The balance of the investment
in associates account changes due to:

Increase by the groups share of the associates profits for the year;

Decrease by the groups share of the associates losses for the year; and

The amount of dividends received / receivable from the associates.

Similar to NCI, only dividends received from associates represent cash inflows. This is
presented in the groups statement of cash flows as cash inflows under investing
activities or operating activities. We will present it under investing activities in
this course.

Example 3 (continued)

The investment in the associates account represents investment cost in associates plus
the share of post-acquisition reserves in the associates. The amount of dividends
received from the associates company during the year is:

$000
Balance at 31 December 20x0 316
Share of profit in associates for 20x1 36
Balance at 31 December 20x1 (312)
Dividends received in 20x2 (balancing figure) 40

Any outstanding balance resulting from trading activities with associates should be
treated similarly to trade receivables or trade payables. Cash received from associates in
respect of trading transactions should be included as cash received from customers
under the direct methods. Similarly, cash paid to associates for trading transactions
should be shown as cash payments to suppliers.

Loans made to associates and repayments of loans by associates represent cash flows
from investing activities whilst loans from associates and repayment of loans to
associates represent cash flows from financing activities. This is because associates are
not considered part of the group. Hence loan from associates is similar to borrowings
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from outsiders, Loans to associates represents additional investment in associates.

Acquisition or disposal of subsidiaries

Where a group acquires a subsidiary, the amounts of cash and cash equivalents paid in
respect of the consideration should be reported separately in the statement of cash flows
under investing activities. The amount shown should be net of any cash and cash
equivalents acquired.

For example, if P Ltd acquired 100% of S Ltds equity interest for $10m cash and S
Ltds statement of financial position shows that S Ltd has a $1m in the bank account, the
amount of cash outflow relating to the acquisition shall be reported as $9m. This should
be shown as a single item under the heading of investing activities as follows:

Cash flow from investing activities

Purchase of a subsidiary ($9 m)

Similarly, when a group disposed of a subsidiary, the amounts of cash and cash
equivalents received in respect of consideration should be separately shown as an
investing cash outflow. The amount shown should be net of any cash and cash
equivalents disposed of.

If the cash flow arising from changes in ownership interest in a subsidiary does not
result in loss of control, it should be classified as cash flow from financing activities.

In analysing the changes in the assets and liabilities in order to ascertain the cash flows,
the changes in assets and liabilities arising from acquisition or disposal of a subsidiary
should be eliminated because they do not involve cash flows.

Example 4

On 1 September 20x1, Plant Ltd acquired 80% interest in Tree Ltd. The purchase
consideration consists of 20m ordinary share issue and $5m cash. The fair value of
Plant Ltds shares is $1.2 per share.

Relevant financial information is as follows:

The net assets of Tree Ltd on 1 September 20x2 were as follows:

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 Movement in Sundry Assets

Opening balance 226

$m
Sundry assets from Tree 36
Sundry assets 36
Disposal during year --
Bank 1
Bal c/d (252)
Trade payables (7)
(10)
Net assets acquired 30

Consolidated statement of financial position as at 31 December

20x2 20x1
$m $m
Sundry assets 252 226
Bank 26 35
Trade payables (60) (53)
218 208
Share capital 124 100
Retained profits 94 108
Total equity 218 208

Cash flows from investing activities

Purchase of subsidiary (note 2) $4 m

Notes to the statement of cash flows:

1 Major non-cash transactions

Part of the consideration for the purchase of a subsidiary during the year was in the
form of shares.

2 Purchase of subsidiary

During the year, P Ltd acquired a 80% interest in S Ltd. The fair value of the assets
acquired and liabilities assumed was as follows:

$m
Goodwill 5
Sundry assets 36
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 Bank 1
Trade payables (7)
NCI ($30m x 20%) (6)
Net assets acquired 29

Satisfied by:
Ordinary shares issued 24
Cash 5
29

Cash outflows on business combinations net of

cash acquired ($5m $1m) 4

Acquisition of subsidiary by issuance of shares results in an increase of groups net

assets and equity of the parent entity. These are non-cash transactions in investing and
financing activities. According to HKAS 7, information about such transactions
should be disclosed to provide useful information about investing and financing
activities.

Foreign subsidiaries
Multinational companies operating in different countries/regions need to deal with the
translation of the subsidiaries financial statements in preparing the consolidated
financial statements. When the local currency of a foreign subsidiary is the functional
currency, the financial statements of the subsidiary are translated from the functional
currency to the presentation currency of the parent for consolidation purposes. The
translation process gives rise to translation differences. The exchange difference is
recorded in other comprehensive income and should be excluded when calculating the
movement in equity.

Unrealized gains and losses arising from translating individual items are not cash flows.
Translation differences should be excluded from individual items when calculating the
movements of these items.

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Example 5

H Ltd acquired 80% share capital of S Ltd which is located in a foreign country. S Ltd
used the local currency as its functional currency. Extracts from the consolidated
financial statements of H Ltd are:

20X2 20X1
$000 $000
Non-controlling interest at 31 December 495 450
Profit for the year attributable to non-controlling interest 130

Translation gain recognized as other comprehensive 300

income (excluding the exchange gain arising on goodwill)

Assume H Ltd measured non-controlling interest based on the net assets approach. The
movement of NCI account is as shown below:

$000
NCI as at 31 December 20X1 450
Share of profit attributable to NCI in 20X2 130
Share of exchange difference recognized in OCI (300 x 20%) 60
640
NCI as at 31 December 20X2 (495)
Dividends paid to NCI during the year 145

Example 6

Gold Ltd has the following consolidated accounts:

Consolidated statement of income for the year ended 31 December 20x2

$000
Operating profits 2,670
Share of profits after tax of associates 990
Finance cost (270)
Profit before taxation 3,390
Tax expense (970)
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Profit after tax 2,420
Attributable to: Owners of the parent 2,240
Non-controlling interest 180

Consolidated statement of financial position as at 31 December

20x2 20x1
$000 $000 $000 $000
Non-current assets
Buildings 3,735 3,960
Plant and machinery 3,240 540
Goodwill 180 --
Investment in associates 2,718 2,538
Current assets
Inventories 3,555 1,800
Accounts receivables 3,330 2,295
Investment in marketable securities 4,000 --
Cash 4,127 15,012 3,276 7,371
24,885 14,409
Share capital 12,212 7,300
Retained profits 6,272 4,571
Parents equity 18,484 11,871
Non-controlling interest 207 --
18,691 11,871
Long-term liabilities
Loans 3,690 1,113
Deferred tax 270 3,960 117 1,230
Current liabilities
Accounts payables 1,332 864
Income tax 832 390
Accrued finance charges 70 2,234 54 1,308
24,885 14,409

Notes:
1. There had been no acquisitions or disposals of buildings during the year.
Depreciation for the year was $225,000 for buildings and $360,000 for plant and
machinery. Plant and machinery costing $600,000 and a carrying amount of
$420,000 was sold for $600,000.

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2. On 1 January 20x2 Gold Ltd acquired a 75% interest in Silver Ltd. The net assets at
acquisition were as follows:

$000
Machinery 298
Inventories 58
Accounts receivables 50
Cash 202
Trade payables (122)
Income tax (30)
456
Non-controlling interest (114)
342
Goodwill 180
522
1,584,000 shares issued as part consideration 497
Balance of consideration paid in cash 25
522

3. A dividend of $539,000 was paid in November 20x2.

Workings
1 Taxation
Opening balance
Income tax 390
Deferred tax 117 507
Tax expense for current year 970
Tax expense in acquired subsidiary 30
Closing balance
Income tax 832
Deferred tax 270 1,102
Tax paid (cash outflow) 405

2 Purchase of plant and machinery

Opening balance 540
On acquisition of subsidiary 298
Disposal (420)
Depreciation (360)
Closing balance (3,240)
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 Purchase of plant and machinery 3,182

3 Purchase of subsidiary
Cash consideration 25
Less cash balance acquired on acquisition (202)
Cash inflow 177

4 Dividends received from associates

Opening balance 2,538
Share of profit after tax 990
Closing balance (2,718)
Cash inflow 810

5 Proceeds from issue of shares

Opening balance
Share capital 7,300
Shares issued as consideration 497
closing balance
Share capital 12,212
4,415

6 Dividends paid to NCI

Opening balance -
Share of profit for the year 180
On acquisition of subsidiary 114
Closing balance (207)
Cash outflows 87

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Consolidated statement of cash flows for the year ended 31 December 20x2:
$000 $000
Profits before tax 3,390
Adjustments for non-cash flow items:
Finance cost 270
Share of profits in associates (990)
Gain on sale of plant and machinery (180)
Depreciation 585
Change in working capital
Increase in inventories (3,555 1,800 -58) (1,697)
Increase in receivables (3,330 -2,295 -50) (985)
Increase in payables (1,332 864 122) 346
Interest paid (270 (70 54)) (254)
Tax paid (W1) (405) (3,310)
Net cash flow from operating activities 80

Cash flows from investing activities

Purchase of plant and machinery (W2) (3,182)
Proceeds from sale of plant and machinery (Note 1) 600
Purchase of subsidiary, net of cash acquired (W3) 177
Dividends received from associates (W4) 810
Net cash flows from investing activities (1,595)

Cash flows from financing activities

Proceeds from issue of shares (W5) 4,415
Proceeds from issue of LT loans (3,690 1,113) 2,577
Dividends paid to NCI (W6) (87)
Dividends paid (539)
Net cash flows from financing activities 6,366
Net increase in cash and cash equivalents 4,851
Cash and cash equivalent at 1 Jan 20X2 3,276
Cash and cash equivalent at 31 Dec 20X2 8,127
20X2 20X1
Analysis of cash and cash equivalents
Marketable securities 4,000
Cash 4,127 3,276
8,127 3,276

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Analysis
Gold Ltd has a $4,851,000 net increase in cash and cash equivalents. The ending
balance of cash and cash equivalents is $8,127,000.
The cash generated from operations is $80,000.
There is a net cash outflow of $1,595,000 from investing activities. Gold Ltd
does not generate sufficient cash flows from operating activities to finance the
purchase of plant and machinery ($3,182,000). Purchase of plant and machinery
is mainly finance by new issue of shares and bank loans.

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