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IAS 7 CASH FLOW STATEMENTS

Cash Flow Statements PREFACE This series of workbooks has been updated by the project team of the European Union project Implementation of the Accounting Reform in the Russian Federation. The workbooks cover the concepts of International Financial Reporting Standards (IFRS). They are intended to be practical self-instruction aids that practicing accountants can use to upgrade their knowledge, understanding and skills. Each workbook is designed for a maximum of three hours of study. Each workbook is a combination of:

CONTENTS
1. INTRODUCTION....................................................................3 2. DEFINITIONS.........................................................................3 3. PRESENTATION OF A CASH FLOW STATEMENT.............4 4. REPORTING CASH FLOWS FROM OPERATING ACTIVITIES.................................................................................7 5. FOREIGN CURRENCY CASH FLOWS..................................8 6. COMPONENTS OF CASH (AND CASH EQUIVALENTS)...11 7. CASH FLOW STATEMENT FOR A FINANCIAL INSTITUTION............................................................................15 8. MULTIPLE CHOICE QUESTIONS.......................................15 9. ANSWERS TO MULTIPLE CHOICE QUESTIONS..............19

Information with examples Self Test Questions Multiple choice and Exercises Answers to Self Test Questions

The members of the project team were contributed by PricewaterhouseCoopers, ACCA, FBK and Agriconsulting. The Workbook Series consists of a range of titles listed on our website. The copyright of the material contained in each workbook belongs to the European Union and, according to its policy, may be used free of charge for any non-commercial purpose. The project team would like to express thanks to those who have contributed their time and thoughts to the content of the workbooks. Contact: e-mail Victoria.stepanova@ru.pwc.com Tel. + 7 495- 967-6000 Moscow, Russia, February 2007 (updated) Web www.accountingreform.ru Fax. + 7 495- 967-6001

Cash Flow Statements

1. Introduction
AIM The aim of this workbook is to assist the individual in understanding Cash Flow Statements according to IFRS. OBJECTIVE Cash Flow Statements are the subject of IAS 7. Information about the cash flows of an undertaking is useful in providing users with a basis to assess the ability to generate cash (and cash equivalents) and the needs to utilise those cash flows. Also required are the timing (and certainty) of their generation. The objective of IAS 7 is to require the provision of information about the changes in cash (and cash equivalents) of an undertaking, by means of a cash flow statement. This classifies cash flows during the period from: -operating, -investing and -financing activities.

Cash flow information is useful in assessing the ability to generate cash (and cash equivalents), and enables users to develop models to compare the present value of cash flows of different undertakings. It also enhances the comparability of the reporting of operating performance by different undertakings, as it eliminates the effects of using different accounting treatments for the same transactions. Historical cash flow information is often used as an indicator of the amount, timing and certainty of future cash flows. It is also useful in checking the accuracy of past assessments of future cash flows, and in examining the relationship between profitability, net cash flow, and the impact of changing prices.

2. Definitions
Cash comprises cash on hand, and deposits that can be repaid on demand. Cash equivalents are 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. EXAMPLE Cash equivalents Holding cash earns no interest on your funds. To earn interest on cash balances, your firm places money on short-term deposits, at its bank. Each day, you add receipts to the deposit, and subtract money needed to pay creditors. Cash flows are inflows and outflows of cash (and cash equivalents). Operating activities are the principal revenue-producing activities of the undertaking, and other activities that are not investing, or financing activities. EXAMPLE- Operating activities Daily sales and purchases, employee costs and general overheads comprise the operating activities. Investing activities are the acquisition, and disposal, of long-term assets (and other investments not included in cash equivalents).

Scope
An undertaking should prepare a cash flow statement in accordance with IAS 7, and should present it as an integral part of its financial statements, for each period for which financial statements are presented. Users are interested in how the undertaking generates, and uses, cash (and cash equivalents). Businesses need cash to conduct their operations, to pay their obligations, and to provide returns to their investors. IAS 7 requires all undertakings to present a cash flow statement.

Benefits of Cash Flow Information

A cash flow statement, when used in conjunction with the rest of the financial statements, provides information that enables users to evaluate the changes in net assets of an undertaking, its financial structure (including its liquidity and solvency) and its ability to affect the amounts (and timing) of cash flows, in order to adapt to changing circumstances, and opportunities.

Cash Flow Statements Financing activities are activities that result in changes in the size (and composition) of the equity capital, and borrowings, of the undertaking. Cash and cash equivalents Cash equivalents are held for the purpose of meeting short-term cash commitments, rather than for investment. For an investment to qualify as a cash equivalent, it must be readily convertible to a known amount of cash, and be subject to an insignificant risk of changes in value. An investment normally qualifies as a cash equivalent only when it has a maturity of three months (or less), from the date of acquisition. Equity investments are excluded from cash equivalents, unless they are, in substance, cash equivalents, for example in the case of preferred shares acquired within a short period of their maturity (and with a specified redemption date). EXAMPLE- Preferred shares acquired within a short period of their maturity You buy some preferred shares of a large, listed company in January. They will redeemed in full in March. (The company will buy back the shares from you.) These may be considered to be cash equivalents. Bank borrowings are generally considered to be financing activities. However, in some countries, bank overdrafts (which are repayable on demand) form an integral part of an undertaking's cash management. In these circumstances, bank overdrafts are included as a component of cash (and cash equivalents). The bank balance often fluctuates from being positive to overdrawn. EXAMPLE-Overdraft You have a seasonal business. For the first half of the year you have positive cash balances, which you place in short-term deposits. In the second half of the year, you have negative cash balances, which are financed by a bank overdraft. The overdraft is treated as a cash equivalent. Cash flows statements do not disclose movements between items that constitute cash (or cash equivalents) because these components are part of cash management, rather than part of its operating, investing and financing activities. Cash management includes the investment of excess cash in cash equivalents.

3. Presentation of a Cash Flow Statement

The cash flow statement should report cash flows during the period, classified by operating, investing and financing activities. An undertaking presents its cash flows from operating, investing and financing activities in a manner that is most appropriate to its business. Classification by activity provides information that allows users to assess the impact of those activities on the financial position of the undertaking, and the amount of its cash (and cash equivalents). This information may also be used to evaluate the relationships among those activities. A single transaction may include cash flows that are classified differently. EXAMPLE-Single transaction-both operating and financing activity A cash repayment of a loan includes both interest and capital, the interest element may be classified as an operating activity, and the capital element is classified as a financing activity. Operating Activities The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations have generated sufficient cash flows to repay loans, maintain the operating capability of the undertaking, pay dividends (and make new investments) without recourse to external sources of financing.

EXAMPLE Operating activities not generating cash Your manufacturing activities are not generating cash, as inventories are increasing rapidly, and your clients are taking excessive credit. Unless corrective action is taken, you will need to obtain more cash from banks or investors. If this is a planned expansion, the financial needs should have been planned in advance. 4

Cash Flow Statements Information about the specific components of operating cash flows is useful, in conjunction with other information, in forecasting operating cash flows. EXAMPLES Forecasting operating cash flows 1. You run a chain of super markets. Every store that you open requires $50.000 of additional inventory. This fact can be notified to users, and monitored in future periods. 2. You are a manufacturer. Every time that you enter a new foreign market, you have to provide $80.000 of inventory, and accounts receivable increase by $120.000. This fact can be notifies to users, and monitored in future periods. Cash flows from operating activities are primarily derived from the principal revenue-producing activities of the undertaking. Therefore, they generally result from the transactions that enter into the determination of net profit. Examples of cash flows from operating activities are: (i) (ii) receipts from the sale of goods, and the rendering of services; receipts from royalties, fees, commissions and other revenue; EXAMPLE- Loans made by financial institutions You are a financial institution. Making loans, and receiving loan repayments is your primary business. The cash flows from these loans are shown as operating activities. Investing Activities The separate disclosure of cash flows arising from investing activities represents the extent to which expenditures have been made for resources intended to generate future income and cash flows. Examples of cash flows arising from investing activities are: (iv) (v) (vi) (vii) payments to (and on behalf of) employees; (i) receipts and payments of an insurance undertaking for premiums and claims, annuities and other policy benefits; payments (or refunds) of income taxes unless they can be specifically identified with financing and investing activities; and receipts (and payments) from contracts held for dealing (or trading) purposes. payments to acquire property, plant and equipment, intangibles and other long-term assets. These payments include those relating to capitalised development costs and self-constructed property, plant and equipment; Some transactions, such as the sale of an item of plant, may give rise to a gain (or loss) that is included in net profit. However, these cash flows are cash flows from investing activities. EXAMPLE - sale of an item of plant: a gain that is included in net profit You sell a machine, and record a gain of $4.000 in your net profit. For cash flow purposes, this gain is deducted from net profit, and recorded in investing activities. A specialist trading in securities will treat them as inventory acquired specifically for resale. Cash flows arising from the purchase and sale of dealing (or trading) securities are classified as operating activities. For other businesses, they will either be operating activities, or cash equivalents (see above). Cash advances, and loans made by financial institutions, are usually classified as operating activities, as they relate to the main revenue-producing activity of that undertaking.

EXAMPLE- fees You control a franchise of restaurants. You receive an annual franchise fee from each restaurant, and a fee for every meal served. (iii) payments to suppliers for goods (and services);

EXAMPLE- Self-constructed property To expand your business you build a new factory. You capitalise the construction costs. This is an investment activity, for cash flow purposes.

Cash Flow Statements (ii) receipts from sales of property, plant and equipment, intangibles and other long-term assets; You have purchased products from Japan on credit. This is an operating activity. You will need to pay for them in Yen in 3 months time. You have a forward contract to fix the purchase price of the Yen. This will also be treated as an operating activity. Financing Activities The separate disclosure of cash flows arising from financing activities is needed to predict claims on cash flows by providers of capital to the undertaking. Examples of cash flows arising from financing activities are: (i) (ii) (iii) (iv) (v) proceeds from issuing shares, or other equity instruments; payments to owners to acquire, or redeem the undertaking's shares; proceeds from issuing debentures, loans, notes, bonds, mortgages and other short or long-term borrowings; repayments of amounts borrowed; and payments by a lessee for the reduction of the outstanding liability relating to a finance lease.

EXAMPLE- Receipt from sales of property You sell your head office. As a rare event, this will not be considered to be an operating activity. It will be an investment activity. (iii) payments to acquire shares or debt instruments of other undertakings, and interests in joint ventures (other than for instruments that are cash equivalents, or held for dealing (or trading purposes));

EXAMPLE- Payments to acquire shares You buy a competitors business, and acquire all of its shares. This is an investment activity. (iv) receipts from sales of shares (or debt) instruments of other undertakings and interests in joint ventures (other than for instruments that are cash equivalents, or held for trading purposes); advances (and loans) made to other parties (other than by a financial institution); receipts from the repayments of advances and loans made to other parties (other than those of a financial institution); payments for futures contracts, forward contracts, option contracts and swap contracts (except when the contracts are held for dealing or trading purposes, or the payments are classified as financing activities); and receipts from futures contracts, forward contracts, option contracts and swap contracts (except when the contracts are held for dealing or trading purposes, or the receipts are classified as financing activities).

(v) (vi) (vii)

EXAMPLE-Finance lease (see IAS 17 workbook) You lease some machinery on a finance lease. The lease is a form of a loan (see IAS 17). Each payment includes 2 parts: an interest payment and a capital payment. The interest the interest element may be classified as an operating activity, and the capital element is classified as a financing activity.

(viii)

When a contract is accounted for as a hedge of an identifiable position, the cash flows of the contract are classified in the same manner as those of the position being hedged. EXAMPLE Hedging 6

Cash Flow Statements

4. Reporting Cash Flows From Operating Activities

An undertaking should report cash flows from operating activities using either: (i) (ii) the direct method, whereby major classes of gross receipts and gross payments are disclosed; or the indirect method, whereby net profit is adjusted for the effects of transactions of a non-cash nature, any deferrals (or accruals) of past (or future) operating cash receipts (or payments), and items of income (or expense) associated with investing or financing cash flows.

Under the indirect method, the net cash flow from operating activities is determined by adjusting net profit for the effects of: (i) (ii) changes in inventories, operating receivables, and payables; non-cash items such as depreciation, provisions, deferred taxes, unrealised foreign currency gains (and losses), undistributed profits of associates, and minority interests; and all other items, which are investing or financing cash flows.

(iii)

PRACTICAL NOTE The indirect method can be produced from the opening and closing balance sheets, together with some information from the income statement. The direct method normally needs more comprehensive information from the accounting records, to identify major classes of gross receipts, and gross payments. Undertakings are encouraged to report cash flows from operating activities using the direct method. The direct method provides information that is not available under the indirect method. Under the direct method, information about major classes of gross receipts, and gross payments, may be obtained either: (1) (2) from the accounting records; or by adjusting sales, cost of sales (interest and similar income, and interest expense and similar charges, for a financial institution) and other items in the income statement for changes in inventories, operating receivables, and payables; other non-cash items; and other items, for which the cash effects are investing, or financing cash flows.

Alternatively, the net cash flow from operating activities may be presented under the indirect method, by showing the revenues and expenses disclosed in the income statement, and the changes during the period in inventories, operating receivables and payables.

Reporting Cash Flows From Investing and Financing Activities

An undertaking should report separately major classes of gross receipts, and gross payments, arising from investing and financing activities, except to the extent that cash flows are reported on a net basis.

Reporting Cash Flows on a Net Basis

Cash flows arising from the following operating, investing or financing activities may be reported on a net basis: (i) receipts and payments on behalf of clients, when the cash flows reflect the activities of the client, rather than those of the undertaking; and

(i) (ii) (iii)

EXAMPLE Cash flows shown on a net basis. You collect money on behalf of a client, and immediately pay it to the client, less a commission. If you take no risk (if no money is received, you are not liable to the client), the commissions could be shown net, rather than showing the gross receipts and payments. (ii) receipts and payments for items in which the turnover is quick, the amounts are large, and the maturities are short.

Cash Flow Statements Examples of these receipts and payments are: (i) (ii) (iii) the acceptance (and repayment) of demand deposits of a bank; funds held for clients by an investment undertaking; and rents collected on behalf of (and paid over to) the owners of properties. You receive $600.000 on March 12. Your functional currency is Euros. The exchange rate on March 12 is Euro1= $1.20. The transaction is reported as Euros 500.000 (600.000/1.2). The cash flows of a foreign subsidiary should be translated at the exchange rates between the functional currency, and the foreign currency, at the dates of the cash flows. Cash flows denominated in a foreign currency are reported in a manner consistent with IAS 21 Foreign Currency. This permits the use of approximate exchange rates. For example, a weightedaverage exchange rate for a period may be used for recording foreign currency transactions, or the translation of the cash flows of a foreign subsidiary. EXAMPLE-Reporting foreign currency, at weighted-average rate. You receive $600.000 on March 12. Your functional currency is Euros. The exchange rate on March 12 is Euro1= $1.20. The weighted-average rate for the period is Euro1= $1.25. Your policy is to use the weighted-average rate. The transaction is reported as Euros 480.000 (600.000/1.25). Unrealised gains (and losses) arising from changes in foreign currency exchange rates are not cash flows. EXAMPLE- Unrealised gain arising from changes in foreign currency. You have a foreign investment worth $1,2m. Your functional currency is Euros. The exchange rate on January 1 is Euro1= $1.20. The exchange rate on December 31 is Euro1= $1.25. The unrealised gain in Euros is not a cash flow. However, the effect of exchange rate changes on cash held (or due) in a foreign currency is reported in the cash flow statement, in order to reconcile cash at the beginning, and the end, of the period. This amount is presented separately from cash flows from operating, investing and financing activities and includes the differences, if any, had those cash flows been reported at end of period exchange rates.

Examples of these receipts and payments are advances made for (and the repayment of): (i) (ii) (iii) principal amounts relating to credit card clients; the purchase and sale of investments; and other short-term borrowings, for example, those which have a maturity period of three months or less.

Cash flows arising from each of the following activities of a financial institution may be reported on a net basis: (i) (ii) (iii) receipts, and payments, for the acceptance (and repayment) of deposits with a fixed maturity date; the placement of deposits with (and withdrawal of deposits from) other financial institutions; and advances, and loans made to clients (and the repayment of those advances and loans).

5. Foreign Currency Cash Flows

(see IAS 21 workbook) Cash flows, arising from transactions in a foreign currency, should be recorded in an undertaking's functional currency, by applying the exchange rate between the functional currency, and the foreign currency, at the date of the cash flow.

EXAMPLE-Reporting foreign currency, at the date of the cash flow. EXAMPLE- Effect of exchange rate changes on cash held 8

Cash Flow Statements You have a cash balance worth $2,4m. Your functional currency is Euros. The exchange rate on January 1 is Euro1= $1.20. The exchange rate on December 31 is Euro1= $1.25. The 8.000 gain in Euros is an exchange difference shown under operating activities. Taxes paid are usually classified as cash flows from operating activities. When tax cash flows are allocated over more than one class of activity, the total amount of taxes paid is disclosed. EXAMPLE - Total amount of taxes paid is disclosed Your cash flow reports tax payments of $10m for operating activities, $2m for investment activities and $6m for finance activities. The total tax paid of $18m should also be noted in the notes to the cash flow statement. Cash flows arising from taxes on income should be separately disclosed, and should be cash flows from operating activities, unless they can be specifically identified with financing and investing activities. While tax expense may be readily identifiable with investing or financing activities, the related tax cash flows are often impracticable to identify, and may arise in a different period from the cash flows of the underlying transaction. When it is practicable to identify the tax cash flow with an individual transaction, that provides cash flows that are investing or financing activities, the tax cash flow is classified as an investing or financing activity, as appropriate. EXAMPLE- Tax on investing activity You sell a subsidiary. The following year you have to pay capital gains tax of $150m on the gain from that sale. This can be classified as a tax on investing activities.

Interest and Dividends

Cash flows from interest and dividends received, and paid, should each be disclosed separately. Each should be classified consistently as operating, investing or financing activities. The total amount of interest paid during a period is disclosed in the cash flow statement (whether it has been recorded as an expense in the income statement, or capitalised in accordance with IAS 23 Borrowing Costs). EXAMPLE Interest capitalised. You have paid a total of $600.000 in interest of which $100.000 has been capitalised into a building. The cash outflow will be shown as $600.000, noting that $100.000 has been capitalised. The charge for interest paid in the income statement will be $500.000 (600.000-100.000), if no interest is accrued at either the start or the end of the period. Interest paid, and interest and dividends received, are usually classified as operating cash flows for a financial institution. There is no consensus on the classification of these cash flows for other undertakings. Interest paid, and interest and dividends received, may be classified as operating cash flows, as they enter contribute to net profit. Alternatively, interest paid, and interest and dividends received, may be financing and investing cash flows respectively, because they are costs of obtaining financial resources, or returns on investments. Dividends paid may be classified as a financing cash flow, as they are a cost of obtaining financial resources. Alternatively, dividends paid may be cash flows from operating, to assist users to determine the ability to pay dividends out of operating cash flows.

Investments in Associates and Joint Ventures

When accounting for an associate (see IAS 28), an investor is restricted to the cash flows between itself and the investee, for example, to dividends and advances. EXAMPLE-Associate You own 25% of another company. You provide a loan of $44m to the associate, and receive $6m in dividends. These transactions appear in your cash flow statement. The internal cash flows of the associate are not consolidated into your cash flow figures. An undertaking, which reports its interest in a jointly-controlled entity (see IAS 31 Joint Ventures) using proportionate consolidation, includes its proportionate share of the jointly-controlled entity's cash flows. 9

Taxes on Income

Cash Flow Statements EXAMPLE- Joint venture You own 60% of a joint venture. Using proportionate consolidation, you consolidate 60% of all its cash flows into your accounts. For an undertaking, which reports such an interest using the equity method (an alternative allowed under IAS 31), the cash flows in respect of its investments in the jointly-controlled entity, and distributions (and other payments or receipts between it and the jointly controlled entity). The accounting is the same as for an associate (see above). You buy a company and sell another in the same period. The cash flows of the two companies are shown separately under investing activities. (They are not netted.) The aggregate amount of the cash paid (or received) as purchase (or sale) consideration is reported net of cash acquired (or disposed of). EXAMPLE- Buying a company which has cash You pay $90m for a company. It holds cash balances of $60m at the time of purchase. In your cash flow statement, you show the purchase price as $30m.

Acquisitions and Disposals of Subsidiaries and Other Business Units

The aggregate cash flows arising from acquisitions and disposals of subsidiaries (or other business units) should be presented separately as investing activities. EXAMPLE -Disposals You sell a subsidiary. You show the cash flow figures as an investing activity, including the proceeds of sale. An undertaking should disclose, in aggregate, in respect of both acquisitions and disposals of subsidiaries, (or other business units during the period) each of the following: (i) (ii) (iii) (iv) the total purchase (or disposal) consideration the portion of the purchase (or disposal) consideration, discharged by cash and cash equivalents; the amount of cash (and cash equivalents) in the subsidiary (or business unit) acquired (or disposed of); and the amount of the assets and liabilities other than cash (or cash equivalents) in the subsidiary (or business unit) acquired (or disposed of), summarised by each major category.

Non-cash Transactions
Investing and financing transactions that do not require the use of cash, should be excluded from a cash flow statement. EXAMPLE- Non-cash transaction: conversion of debt to equity You redeem $100m of company bonds by issuing shares of the same value. This transaction will not be shown in the cash flow statement, as no cash changed hands, but it will be noted in the notes relating to share capital and bonds. Such transactions should be disclosed elsewhere in the financial statements, in a way that provides all the relevant information about these investing, and financing activities. Many investing and financing activities do not have a direct impact on current cash flows, although they do affect the capital and asset structure. Examples of non-cash transactions are: (i) the acquisition of assets, either by assuming directly related liabilities, or by means of a finance lease; (ii) (iii) the acquisition of an undertaking, by means of an equity issue, and the conversion of debt to equity.

The cash flow effects of disposals are not deducted from those of acquisitions. EXAMPLE-Disposals and acquisitions in the same period 10

Cash Flow Statements

6. Components of Cash (and cash equivalents)

An undertaking should disclose the components of cash (and cash equivalents), and should present a reconciliation of the amounts in its cash flow statement with the equivalent items reported in the balance sheet. Cash and cash equivalents: EXAMPLE - Cash and cash equivalents sample policy and note Cash and cash equivalents includes cash in hand, deposits held at call with banks, other short-term highly liquid investments with original maturities of three months or less, and bank overdrafts. Bank overdrafts are shown within borrowings in current liabilities on the balance sheet. Cash and cash equivalents: 2004 12,698 9,530 22,228 2003 30,798 5,414 36,212

An undertaking should disclose, together with a commentary by management, the amount of significant cash and cash equivalent balances, held by the undertaking, which are not available for use by the group. EXAMPLE- Cash not available for use by the group. Your foreign subsidiary has cash balances, but the local government has frozen them, due to tax transgressions that the subsidiary is alleged to have made. The amount of these balances would be disclosed as cash not available for use. There are various circumstances in which cash (and cash equivalent) balances are not available for use by the group. Examples include cash (and cash equivalent) balances held by a subsidiary, that operates where exchange controls (or other restrictions) apply, when the balances are not available for general use by the parent, or other subsidiaries Additional information may be relevant to users in understanding the financial position, and liquidity of an undertaking. Disclosure of this information, together with a commentary by management, is encouraged and may include: (i) the amount of undrawn borrowing facilities that may be available for future operating activities, and to settle capital commitments, indicating any restrictions on the use of these facilities;

Cash at bank and in hand Short-term bank deposits

The effective interest rate on short-term bank deposits was 5.9% (2003: 5.6%); these deposits have an average maturity of 20 days. Cash and bank overdrafts include the following for the purposes of the cash flow statement: 2004 2003 Cash and cash equivalents 22,228 36,212 Bank overdrafts (2,650) (6,464) 19,578 29,748 An undertaking discloses the policy that it adopts in determining the composition of cash (and cash equivalents). The effect of any change in the policy for determining components of cash (and cash equivalents), for example, a change in the classification of financial instruments previously considered to be part of an undertaking's investment portfolio, is reported in accordance with IAS 8 Changes in Accounting Policies.

EXAMPLE-Facilities You have a line of credit for $250m, of which you are only currently using $35m. The line of credit is available for 5 years, at a cost of 1% above the national bank rate. This information helps users know what finance is available for your expansion plans. (ii) the aggregate amounts of the cash flows from each of operating, investing and financing activities, related to interests in joint ventures, reported using proportionate consolidation; EXAMPLE- Joint venture You own 60% of a joint venture. Using proportionate consolidation, you consolidate 60% of all its cash flows into your accounts. You also show the aggregate amounts included in the operating, investing and financing activities totals. 11

Other Disclosures

Cash Flow Statements (iii) the aggregate amount of cash flows that represent increases in operating capacity, separately from those cash flows that are required to maintain operating capacity; and The following additional information is also relevant for the preparation of the statements of cash flows: All of the shares of a subsidiary were acquired for 590. The fair values of assets acquired and liabilities assumed were as follows: Inventories Accounts receivable Cash Property, plant and equipment Trade payables Long-term debt 250 was raised from the issue of share capital, and a further 250 was raised from long-term borrowings. Interest expense was 400, of which 170 was paid during the period. 100 relating to interest expense of the prior- period was also paid during the period. Dividends paid were 1.200. The liability for tax at the beginning and end of the period was 1.000 and 400 respectively. During the period, a further 200 tax was provided for. Withholding tax on dividends received amounted to 100. During the period, the group acquired property, plant and equipment with an aggregate cost of 1.250 of which 900 was acquired by means of finance leases. Cash payments of 350 were made to purchase property, plant and equipment. Plant, with original cost of 80 and accumulated depreciation of 60, was sold for 20. Accounts receivable as at end of 2XX2 include 100 of interest receivable. 100 100 40 650 100 200

EXAMPLE- Increases in operating capacity Your only factory has reached full capacity. Your investing activities from your business have generated $75m. At the very end of the year, you buy some land for $10m, on which you will build a new factory. Showing this amount separately enhances the information provided to users. (iv) the amount of the cash flows arising from the operating, investing and financing activities of each reported industry and geographical segment (see IFRS 8 Operating Segments).

The separate disclosure of cash flows that represent increases in operating capacity, and cash flows which are required to maintain operating, enables the user to determine whether the undertaking is investing adequately in the maintenance of its operating capacity. An undertaking that does not invest adequately in the maintenance of its operating capacity may be prejudicing future profitability, for the sake of current liquidity, and distributions to owners. The disclosure of segmental cash flows enables users to obtain a better understanding of the relationship between the cash flows of the business as a whole, and those of its component parts, and the availability (and variability) of segmental cash flows.

Cash Flow Statement for an Undertaking other than a Financial Institution

The examples show only current period amounts. Corresponding amounts, for the preceding period, are required to be presented in accordance with IAS 1 Presentation of Financial Statements. Information from the income statement and balance sheet is provided to show how the statements of cash flows under the direct method and indirect method have been derived.

Consolidated Income Statement for the period ended 2XX2

12

Cash Flow Statements Sales Cost of sales Gross Profit Depreciation Administrative and selling expense Interest expense Investment income Foreign exchange loss Net profit before taxation Taxes on income Net profit 30.650 (26.000) 4.650 (450) (910) (400) 500 (40) 3.350 (300) 3.050 2XX2 230 1.900 1.000 2.500 3.730 (1.450) 2.280 7.910 250 230 400 2.300 3.180 1.500 3.410 4.730 7.910 1.910 (1.060) 850 6.600 1.890 100 1.000 1.040 4.030 1.250 1.380 2.630 6.660 2XX1 160 1.200 1.950 2.500

Direct Method Cash Flow Statement

Cash flows from operating activities Cash receipts from clients Cash paid to suppliers and employees Cash generated from operations Interest paid Income taxes paid Net cash from operating activities Cash flows from investing activities Acquisition of subsidiary X net of cash acquired (Note A) Purchase of property, plant and equipment (Note B) Proceeds from sale of equipment Interest received Dividends received Net cash used in investing activities Cash Flows from financing activities Proceeds from issuance of share capital Proceeds from long-term borrowings Payments of finance lease liabilities Dividends paid* Net cash used in financing activities Net increase in cash (and cash equivalents) Cash (and cash equivalents) at beginning of period (Note C) Cash (and cash equivalents) at end of period (Note C) * This could also be shown as an operating cash flow. 30.150 (27.600) 2.550 (270) (900)

2XX2

1.380 (550) (350) 20 200 200 (480) 250 250 (90) (1.200) (790) 110 120 230

Consolidated balance sheet

Assets Cash (and cash equivalents) Accounts receivable Inventory Portfolio investments Property, plant and equipment at cost Accumulated depreciation Property, plant and equipment net Total assets Liabilities Trade payables Interest payable Income taxes payable Long term debt Total liabilities Shareholders' Equity Share Capital Retained earnings Total shareholders equity
Total liabilities and shareholders equity

13

Cash Flow Statements

Indirect Method Cash Flow Statement

2XX2 Cash flows from operating activities Net profit before taxation Adjustments for: Depreciation Foreign exchange loss Investment income Interest expense Increase in trade and other receivables Decrease in inventories Decrease in trade payables Cash generated from operations Interest paid Income taxes paid Net cash from operating activities Cash flow from investing activities Acquisition of subsidiary X net of cash acquired (Note A) Purchase of property. plant and equipment (Note B) Proceeds from sale of equipment Interest received Dividends received Net cash used in investing activities Cash flows from financing activities Proceeds from issuance of share capital Proceeds from long-term borrowings Payment of finance lease liabilities Dividends paid* Net cash used in financing activities Net increase in cash (and cash equivalents) Cash (and cash equivalents) at beginning of period (Note C) Cash (and cash equivalents) at end of period (Note C) * This could also be shown as an operating cash flow. 3.350 450 40 (500) 400 3.740 (500) 1.050 (1.740) 2.550 (270) (900) 1.380 (550) (350) 20 200 200 (480) 250 250 (90) (1.200) (790) 110 120 230

Notes to the Cash Flow Statement (direct method and indirect method)
A. Acquisition of Subsidiary

During the period the group acquired subsidiary X. The fair value of assets acquired and liabilities assumed were as follows: Cash Inventories Accounts receivable Property, plant and equipment Trade payables Long-term debt Total purchase price Less: Cash of X Cash flow on acquisition net of cash acquired B. Property, Plant and Equipment 40 100 100 650 (100) (200) 590 (40) 550

During the period the Group acquired property, plant and equipment with an aggregate cost of 1.250, of which 900 was acquired by means of finance leases. Cash payments of 350 were made to purchase property, plant and equipment. C. Cash (and cash equivalents)

Cash (and cash equivalents) consist of cash on hand and balances with banks, and investments in money market instruments. Cash (and cash equivalents) included in the cash flow statement comprise the following balance sheet amounts: 2XX2 40 190 230 230 2XX1 25 135 160 (40) 120

Cash on hand and balances with banks Short-term investments Cash (and cash equivalents) as previously reported Effect of exchange rate changes Cash (and cash equivalents) as restated

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Cash Flow Statements Cash (and cash equivalents) at the end of the period include deposits with banks of 100 held by a subsidiary which are not freely remissible to the holding company because of currency exchange restrictions. The Group has undrawn borrowing facilities of 2.000 of which 700 may be used only for future expansion. D. Segment Information Segment A Cash flows from: Operating activities Investing activities Financing activities 1,520 (640) (570) 310 Segment B (140) 160 (220) (200) Total 1,380 (480) (790) 110 2XX2 Cash flows from operating activities Interest and commission receipts Interest payments Recoveries on loans previously written off Cash payments to employees and suppliers (Increase) decrease in operating assets: Short-term funds Deposits held for regulatory or monetary control purposes Funds advanced to clients Net increase in credit card receivables Other short-term negotiable securities Increase (decrease) in operating liabilities: Deposits from clients Negotiable certificates of deposit Net cash from operating activities before income tax Income taxes paid Net cash from operating activities Cash flows from investing activities Disposal of subsidiary M Dividends received Interest received Proceeds from sales of non-dealing securities Purchase of non-dealing securities Purchase of property, plant and equipment Net cash from investing activities Cash flows from financing activities Issue of loan capital Issue of preference shares by subsidiary undertaking Repayment of long-term borrowings Net decrease in other borrowings Dividends paid Net cash from financing activities Effects of exchange rate changes on cash (and cash equivalents) Net increase in cash (and cash equivalents) Cash (and cash equivalents) at beginning of period Cash (and cash equivalents) at end of period 28.447 (23.463) 237 (997) 4.224 (650) 234 (288) (360) (120) 600 (200) 3.440 (100) 3.340 50 200 300 1.200 (600) (500) 650 1.000 800 (200) (1.000) (400) 200 600 4.790 4.050 8.840

Alternative Presentation (indirect method) As an alternative, in an indirect method cash flow statement, operating profit before working capital changes is sometimes presented as follows: Revenues excluding investment income Operating expense excluding depreciation Operating profit before working capital changes 30,650 (26,910) 3,740

7. Cash Flow Statement for a Financial Institution

1. The example shows only current period amounts. Comparative amounts for the preceding period are required to be presented. 2. The example is presented using the direct method.

8. Multiple Choice Questions

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Cash Flow Statements 1. A company provides consolidated accounts, with comparative accounts for 5 previous periods. For how many periods are cash flow statements are required? 1. 1 2. 5 3. 6 2. Cash flow statements are required from: 1. All companies. 2. Listed companies. 3. Financial institutions. 3. A cash flow statement provides information that enables users to evaluate the changes in: 1. Net assets of an undertaking. 2. Its financial structure. 3. Its liquidity. 4. Solvency. 5. Profitability. 4. A cash flow statement helps in examining the relationship between: 1. Profitability. Net cash flow. The use of assets and liabilities. Staffing levels. 1. 2. 3. 4. i i-ii i-iii i-iv 3. Financial activities. 7. Activities that result in changes in the size (and composition) of the equity capital, and borrowings are: 1. Operating activities. 2. Investing activities. 3. Financial activities. 8. For an investment to qualify as a cash equivalent, it must be: 1. Illiquid and low risk. 2. Liquid and low risk. 3. Liquid and medium risk. 9. The maximum maturity of a cash equivalent is: 1. 3 months. 2. 6 months. 3. 1 year. 10. Bank borrowings are generally considered to be: 1. Operating activities. 2. Investing activities. 3. Financial activities. 4. Cash equivalents. 11. If bank overdrafts form an integral part of an undertaking's cash management, they are considered to be: 1. Operating activities. 2. Investing activities. 3. Financial activities. 4. Cash equivalents. 12. A single transaction: 1. May include cash flows that are classified differently. 2. Must be included in full in one of the three headings. 3. May be spread over more than one period. 13. The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations have generated sufficient cash flows to: 1. Repay loans. 2. Maintain the operating capability of the undertaking. 3. Pay dividends. 16

5. Daily sales and purchases, employee costs and general overheads comprise: 1. Operating activities. 2. Investing activities. 3. Financial activities.

6. The acquisition, and disposal, of long-term assets are: 1. Operating activities. 2. Investing activities.

Cash Flow Statements 4. Make new investments. 5. All 14. Examples of cash flows from operating activities are: (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) 1. 2. 3. 4. 5. 6. 7. 8. Receipts from the sale of goods, and the rendering of services. Receipts from royalties, fees, commissions and other revenue. Payments to suppliers for goods (and services). Payments to (and on behalf of) employees. Receipts and payments of an insurance undertaking for premiums and claims, annuities and other policy benefits. Payments (or refunds) of income taxes unless they can be specifically identified with financing and investing activities. Receipts (and payments) from contracts held for dealing (or trading) purposes. (viii) Sale of an item of plant, giving rise to a gain (or loss) that is included in net profit. i i-ii i-iii i-iv i-v i-vi i-vii i-viii 1. 2. 3. 4. 5. 6. 7. 8. (v) (vi) (vii) (iv) (ii) (iii) Receipts from sales of property, plant and equipment, intangibles and other long-term assets. Payments to acquire shares or debt instruments of other undertakings, and interests in joint ventures (other than for instruments that are cash equivalents, or held for dealing (or trading purposes)). Receipts from sales of shares (or debt) instruments of other undertakings and interests in joint ventures (other than for instruments that are cash equivalents, or held for trading purposes). Advances (and loans) made to other parties (other than by a financial institution). Receipts from the repayments of advances and loans made to other parties (other than those of a financial institution). Payments for futures contracts, forward contracts, option contracts and swap contracts (except when the contracts are held for dealing or trading purposes, or the payments are classified as financing activities). Receipts from futures contracts, forward contracts, option contracts and swap contracts not held for dealing or trading purposes. i i-ii i-iii i-iv i-v i-vi i-vii i-viii

16. Examples of cash flows arising from financing activities are: 15. Examples of cash flows arising from investing activities are: (i) (i) Payments to acquire property, plant and equipment, intangibles and other long-term assets. These payments include those relating to capitalised development costs and self-constructed property, plant and equipment. (ii) (iii) Proceeds from issuing shares, or other equity instruments. Payments to owners to acquire, or redeem the undertaking's shares. Proceeds from issuing debentures, loans, notes, bonds, mortgages and other short or long-term borrowings. 17

Cash Flow Statements (iv) (v) (vi) 1. 2. 3. 4. 5. 6. 17. Repayments of amounts borrowed. Payments by a lessee for the reduction of the outstanding liability relating to a finance lease. Receipts by a lessor for the reduction of the outstanding liability relating to a finance lease. i i-ii i-iii i-iv i-v i-vi Which method of cash flow reporting starts with net profit? 1. Direct method. 2. Indirect method. 3. Both. 4. Neither. 18. Which method of cash flow reporting starts with changes in inventories? 1. Direct method. 2. Indirect method. 3. Both. 4. Neither. 19. If you start with net profit, to calculate the cash generated from operating activities, you: adjust net profit for the effects of: (i) (ii) Changes in inventories, operating receivables, and payables. Non-cash items such as depreciation, provisions, deferred taxes, unrealised foreign currency gains (and losses), undistributed profits of associates, and minority interests. Investing cash flows. Financing cash flows. Social security costs. 1. 2. 3. 4. 5. i i-ii i-iii i-iv i-v

20. Examples of these receipts and payments that can be netted are advances made for (and the repayment of): (i) (ii) (iii) Principal amounts relating to credit card clients. The purchase and sale of investments. Short-term borrowings (3 months, or less). 1. i 2. i-ii 3. i-iii 21. Cash flows, arising from transactions in a foreign currency, should be recorded in: 1. Local currency. 2. An undertaking's functional currency, at the rate of the date of the transaction. 3. An undertaking's functional currency, at the rate at the end of the period.

22. When translating the cash flows of a foreign subsidiary, use the group's functional currency: (i) At the rate of the start of the period. (ii) At the rate at the end of the period. (iii) At the dates of the transactions. 1. 2. 3. 4. 5. (i) only. (ii) only. (iii) only. (i) or (ii) (i) or (iii) 18

(iii) (iv) (v)

Cash Flow Statements 6. (ii) or (iii) 7. (i), (ii) or (iii) 23. Unrealised gains (and losses) arising from changes in foreign currency exchange rates are: 1. Translated at closing rate. 2. Translated at opening rate. 3. Not cash flows. 24. Cash flows from interest and dividends received, and paid, should: 1. Each be disclosed separately. 2. Be shown as a net figure. 3. Be excluded from the cash flow statement. 25. Taxes paid are usually classified as cash flows from: 1. Operating activities. 2. Investing activities. 3. Financial activities. 26. When accounting for an associate, an investor reports the cash flows: 1. Using proportional consolidation. 2. Only the cash flows between itself and the investee. 3. In a separate cash flow statement. 27. When accounting for a joint venture, an investor reports the cash flows: 1. Using proportional consolidation. 2. Only the cash flows between itself and the investee. 3. In a separate cash flow statement. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 3 1 2 3 2 1 3 4 1 5 7 8 5 2 4 4 3 2 3 3 1 1 2 1

9. Answers to Multiple Choice Questions

Question
1. 2. 3.

Answer
3 1 4 19

Cash Flow Statements This publication has been produced with the assistance of the European Union. The contents of this publication are the sole responsibility of ZAO PricewaterhouseCoopers ACCA, FBK and Agriconsulting and can in no way be taken to reflect the views of the European Union.

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