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Users of an enterprise's financial statements are interested in how the enterprise generates and uses cash and cash equivalents. Therefore, the enterprise must identify the activites operating activities, investing activities and financing activities - which cause both inflows and outflows of cash during an accounting period. The objective of International Accounting Standard 7 (IAS 7) is to provide information to users of accounts about the entitys ability to generate cash and cash equivalents as well as indicating the cash requirements of the entity. IAS 7 requires companies to classify cash flows during the period from operating, investing and financing activities. Definitions relevant to this section: Cash comprises cash on hand and demand deposits. 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. A classic example of a highly liquid investment is treasury bills. Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. An investment normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition. Bank overdrafts which are repayable on demand form an integral part of an enterprise's cash management. In these circumstances, bank overdrafts are included as a component of cash and cash equivalents. Operating activities are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities.

Investing activities are the acquisition and disposal of non-current assets and other investments not included in cash equivalents.



1. 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 enterprise, 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. 2. Cash flow information is useful in assessing the ability of the enterprise to generate cash and cash equivalents and enables users to develop models to assess and compare the present value of the future cash flows of different enterprises. 3. It is also useful in checking the accuracy of past assessments of future cash flows. 4. It gives an indication of the relationship between profitability and net cash flow and highlights the quality of the profit earned. Earnings are of good quality if they are represented by cash flows now or in the near future.


Cash flow statement for the period ended Cash flows from operating activities Net profit before tax Adjustments for: Depreciation (note 1) Interest expense (note 2, 3) Investment income Profit on disposal of Property, plant and equipment Loss on disposal PPE X X X (X) (X) X X (X)/X (X)/X X/(X) X (X) (X) X (X) (X) X X X X X (X) X (X) (X) (X) X X X X

(note 4)

(Increase)/ decrease in inventories (note 5) (Increase)/ decrease in trade and other receivables Increase/ (decrease) in trade and other payables Cash generated from operations Interest paid (note 1) Income tax paid Net cash from operating activities Cash flows from investing activities (note 6) Acquisition of subsidiary net of cash acquired Purchase of property, plant and equipment Proceeds from sale of equipment Interest received Dividend received Cash flows from investing activities Cash flows from financing activities (note 7) Cash proceeds from issuing shares or other equity instruments Cash payments to owners to redeem the shares. Cash proceeds from issuing debentures, loan stock or bonds Cash repayments of amounts borrowed Cash payments by a lessee for the reduction of the outstanding liability relating to a finance lease (i.e. the capital element of the rental) Dividends paid Cash flows from financing activities Increase/ (decrease) in cash and cash equivalent (note 8) Cash and cash equivalent at the start of the period Cash and cash equivalent at the end of the period

Hartington Ltd prepares accounts to 31 March each year. The company's balance sheets at 31 March 2003 and 2004 were as follows:

Balance sheet as at 31 March 2003 000 000 Tangible fixed assets: Cost Depreciation to date Current assets: Stocks Trade debtors Bank balance Current liabilities: Trade creditors Corporation tax Proposed dividends Bank balance Net current assets 10% debentures 6% debentures Capital and reserves: Ordinary shares Share premium account General reserve Profit and loss account The following information is also available: 60 430 160 175 250 425 80 75 50 130 335 90 360 60 300 100 20 140 40 300 270

Balance sheet as at 31 March 2004 000 000 400 175 140 210 70 420 70 70 350 575 60 100 160 415 240 45 100 30 415 225

1 Tangible fixed assets which had cost 100,000 in 1997 were sold for 30,000 during the year to 31 March 2004. The written down value of these assets at the time of disposal was 25,000. 2 The 10% debentures were issued in 1998. The 6% debentures were issued on 1 October 2003. In both cases, interest is due every six months on 31 March and 30 September and has been paid on the due dates. 3 Bank overdraft interest paid in the year to 31 March 2004 was 4,000.

4 No dividends were paid or proposed in relation to the year to 31 March 2004. 5 The corporation tax liability for the year to 31 March 2003 was underestimated by 2,000.

(a) (b)

Requirement for question 4 Deduce the companys operating profit or loss for the year to 31 March 2004. 4

Prepare a cash flow statement for the company for the year to 31 March 2004 in accordance with the requirements of accounting standard FRS1 (Revised) using the indirect method. The reconciliation to movement in net debt is not required. 10 Explain how and why the company's cash position has changed during the year to 31 March 2004. 4 Briefly explain why the preparation of a cash flow statement is in accordance with the Statement of Principles for Financial Reporting published by the UK Accounting Standards Board. 2 (20)

(c) (d)

(a) The following extract has been taken from the statement of cash flows of Grutyer plc: Net profit before taxation Adjustments for: Depreciation Surplus on sale of non-current assets Interest expense Operating profit before working capital changes Increase in inventories Decrease in trade receivables Increase in trade payables Cash generated from operations Interest paid Corporation tax paid Net cash from operating activities The following additional information is available: Sales Purchases Corporation tax payable at end of year Corporation tax payable at the start of the year Wages and salaries Other expenses excluding interest and depreciation Discounts allowed Discounts received 12,133,014 9,564,500 158,600 98,420 1,010,500 893,800 33,560 16,540 214,530 (14,400) 32,120 665,694 (18,500) 22,600 27,400 697,194 (32,120) (39,820) 625,254 433,444

Requirement for question 2 (a) Prepare a clear calculation of the cash from operating activities using the direct method. 10

(b) You have received an email from a friend asking for your advice. Your friend is a shareholder in Sodian plc. He is concerned about the safety of his investment and wants to know how well Sodian plc is surviving the credit crunch.