Chapter 16
Statement of cash flows

Outcome

By the end of this session you should be able to:

 prepare a statement of cash flows for a single entity in accordance with relevant
accounting standards using the indirect method

 compare the usefulness of cash flow information with that of a statement of

profit or loss or a statement of profit or loss and other comprehensive income

 interpret a statement of cash flows together with other financial information to

assess the performance and financial position of an entity

and answer questions relating to these areas.

One of the PER performance objectives (PO7) is to prepare

external financial reports. You take part in preparing and reviewing
financial statements – and all accompanying information – and you
    do it in accordance with legal and regulatory requirements. Working
through this chapter should help you understand how to
PER
demonstrate that objective.

The underpinning detail for this Chapter in your Integrated Workbook can
be found in Chapter 16 of your Study Text

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Overview

Statement Statement Notes to

of profit or of financial the
loss position accounts

Comparison IAS 7
with statement Statement of Interpretation
of profit or loss cash flows

Cash
generated
from
operations

Operating Investing Financing

 
activities activities activities

Change in cash
and cash
equivalents

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 Statement of cash flows

Statement of cash flows

1.1 Objective of a statement of cash flows

 to ensure that all entities provide information about historical cash flows

 to classify those cash flows according to the activities which created them,
either operating, investing or financing activities

1.2 Reconciliation from profit before tax to cash generated from operations
$
Profit before tax X
+/– Non-cash items included X/(X)
(e.g. depreciation)
+/– Non-operating items included X/(X)
(e.g. investment income)
+ Finance costs X
+/– movements in working capital X/(X)
——
Cash generated from operations X
——

Illustrations and further practice

For further detail of adjustments see section 1 in Chapter 16 of the Study Text.
 

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1.3 Statement of cash flows layout summary

$
Cash generated from operations X
Interest paid (X)
Tax paid (X)
——
Net cash from operating activities X/(X)
Net cash from investing activities X/(X)
Net cash from financing activities X/(X)
——
Increase/decrease in cash and cash equivalents X/(X)
Opening cash and cash equivalents X/(X)
——
Closing cash and cash equivalents X/(X)
——

1.4 Definitions

Cash: cash on hand (including overdrafts) and on-demand deposits.

Cash equivalents: short-term highly liquid investments, subject to

insignificant risk of changes in value.
 

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 Statement of cash flows

1.5 Activities

Operating Investing Financing

Cash generated Purchase of Share issue

from operations assets Loan repaid or
Interest paid Sale proceeds received
Tax paid Investment Lease repaid
income Dividends paid

Illustrations and further practice

For further detail of cash flows within each activity see section 1 in Chapter 16
of the Study Text.
 

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Example 1
Cash generated from operations

Extracts from the financial statements of Danny show the following:

20X4
Statement of profit or loss $
Profit from operations 7,800
Finance costs (1,300)
Investment income 400
———
Profit before tax 6,900
Income tax expense (1,680)
———
Profit for the year 5,220
———

Statement of financial position 20X4 20X3

$ $
Current assets
Inventory 1,200 1,150
Receivables 1,760 1,820
Current liabilities
Payables 1,380 1,200
Additional information

During 20X4 depreciation of $1,100 was charged, and Danny sold an item of
plant at a profit of $600.

Calculate Danny’s cash generated from operations for 20X4 using the
indirect method.

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 Statement of cash flows

Example 1 continued
Solution

Cash generated from operations is calculated as follows:

20X4
$
Profit before tax 6,900
Finance costs 1,300
Investment income (400)
Depreciation 1,100
Profit on disposal (600)

Increase in inventory (1,200 – 1,150) (50)

Decrease in receivables (1,820 – 1,760) 60
Increase in payables (1,380 – 1,200) 180
———
Cash generated from operations 8,490
———

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Calculating the cash flow

2.1 Principle

The cash flow for an activity is calculated using the balancing figure when comparing
the opening and closing balances on the statement of financial position, adjusting for
known movements through profit or loss. Various techniques may be used for this,
and these are shown in the following illustration.

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 Statement of cash flows

Illustration 1  
Calculation methods

Extracts from the financial statements of West show the following:

20X6 20X5
Statement of profit or loss $ $
Income tax expense (980) (800)

Statement of financial position

Non-current liabilities
Deferred taxation 440 400
Current liabilities
Taxation 900 820

Calculate the tax paid in 20X6.

When calculating cash flows for items with a current and

non-current element, combine the two to calculate a single
cash flow.

Method 1 – T account
Taxation
Balance b/f: taxation 820
Balance: tax paid 860 deferred taxation 400
SPL: income tax expense 980
Balance c/f: taxation 900
deferred taxation 440
——— ———
2,200 2,200
——— ———

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Illustration 1 continued  
Method 2 – Column
$
Balances b/f (820 + 400) 1,220
SPL: income tax expense 980
Balances c/f (900 + 440) (1,340)
———
Tax paid 860
———
Method 3 – Column with balancing figure
$
Balances b/f (820 + 400) 1,220
SPL: income tax expense 980
Tax paid (balance) (860)
———
Balances c/f (900 + 440) 1,340
———
It can be seen that all three methods are in essence the same calculation, so
it is a matter of personal preference as to which you choose to use.
 

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Example 2
Cash flow calculation

Extracts from the statements of financial position of Harrad show the following:
Statement of financial position 20X9 20X8
$ $
Non-current assets
Property, plant and equipment 43,200 33,800

Equity
Share capital 10,500 9,000
Share premium 2,300 1,700
Revaluation surplus 1,850 500

Non-current liabilities
Lease payable 9,300 3,500

Current liabilities
Lease payable 3,500 1,100
Additional information

During 20X9 depreciation of $7,200 was charged, and Harrad sold an item of
plant with a carrying amount of $900 for a profit of $400.

Harrad acquired machinery under a lease agreement. At acquisition the

present value of the lease payments for this machinery totalled $10,000.

The increase in revaluation surplus relates to Harrad’s property which was

revalued during the year. Ignore deferred taxation.

Calculate Harrad’s cash flows from investing and financing activities for
20X9.

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 Statement of cash flows

Example 2 continued
Solution
$
Cash flows from investing activities
Purchase of property, plant and equipment (6,150)
Sale proceeds from sale of plant 1,300

Cash flows from financing activities

Proceeds of share issue 2,100
Lease liability repaid (1,800)
(W1) Property, plant and equipment
Property, plant & equipment
Balance b/f 33,800 Depreciation 7,200
Revaluation (1,850 – 500) 1,350 Disposal 900
Right-of-use asset 10,000
Purchase of assets 6,150 Balance c/f 43,200
——— ———
51,300 51,300
——— ———
(W2) Share capital and premium
Share capital and premium
Share capital b/f 9,000
Share capital c/f 10,500 Share premium b/f 1,700
Share premium c/f 2,300 Share proceeds (bal) 2,100
——— ———
12,800 12,800
——— ———

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Example 2 continued
(W3) Lease liability
Lease liability
Lease repayments (bal) 1,800 Balance b/f: NCL 3,500
Balance b/f: CL 1,100
Balance c/f: NCL 9,300 New lease assets 10,000
Balance c/f: CL 3,500
——— ———
14,600 14,600
——— ———

Illustrations and further practice

Now try TYU questions 1 and 2 from Chapter 16 of the Study Text.
 

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 Statement of cash flows

Cash flow information

 

3.1 Advantages of statements of cash flow

 Helps users make judgements on future cash flows

 Indicates the relationship between profit and cash generated

 Helps users check accuracy of previous assessments

 Difficult to manipulate

3.2 Limitations of statements of cash flow

 Based on historical information, so no predictive quality

 Small scope for manipulation, e.g. delay payments at year-end

 No indication of profitability, necessary for long-term survival

3.3 Interpretation of statements of cash flow

When reviewing a statement of cash flows focus on the following areas:

 Cash generated from operations – indicates sustainability

 Capital expenditure

 Sources of finance

 Net cash flow

 

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For further reading, read Chapter 16 of the Study Text.

You should now be able to answer all TYU questions from Chapter 16 of the
Study Text.

You are now able to attempt the following past exam questions from the Exam
Kit:

Section B: 341 – 350

Section C: 367 Coaltown, 368 Monty, 369 Kingdom, 389 Pinto, 393 Bengal.

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 Statement of cash flows

Answers

Example 1
Cash generated from operations

Extracts from the financial statements of Danny show the following:

20X4
Statement of profit or loss $
Profit from operations 7,800
Finance costs (1,300)
Investment income 400
———
Profit before tax 6,900
Income tax expense (1,680)
———
Profit for the year 5,220
———

Statement of financial position 20X4 20X3

$ $
Current assets
Inventory 1,200 1,150
Receivables 1,760 1,820
Current liabilities
Payables 1,380 1,200
Additional information

During 20X4 depreciation of $1,100 was charged, and Danny sold an item of
plant at a profit of $600.

Calculate Danny’s cash generated from operations for 20X4 using the
indirect method.

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Example 1 continued
Solution

Cash generated from operations is calculated as follows:

20X4
$
Profit before tax 6,900
Finance costs 1,300
Investment income (400)
Depreciation 1,100
Profit on disposal (600)

Increase in inventory (1,200 – 1,150) (50)

Decrease in receivables (1,820 – 1,760) 60
Increase in payables (1,380 – 1,200) 180
———
Cash generated from operations 8,490
———

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 Statement of cash flows

Example 2
Cash flow calculation

Extracts from the statements of financial position of Harrad show the following:
Statement of financial position 20X9 20X8
$ $
Non-current assets
Property, plant and equipment 43,200 33,800

Equity
Share capital 10,500 9,000
Share premium 2,300 1,700
Revaluation surplus 1,850 500

Non-current liabilities
Lease payable 9,300 3,500

Current liabilities
Lease payable 3,500 1,100
Additional information

During 20X9 depreciation of $7,200 was charged, and Harrad sold an item of
plant with a carrying amount of $900 for a profit of $400.

Harrad acquired machinery under a lease agreement. At acquisition the

present value of the lease payments for this machinery totalled $10,000.

The increase in revaluation surplus relates to Harrad’s property which was

revalued during the year. Ignore deferred taxation.

Calculate Harrad’s cash flows from investing and financing activities for
20X9.

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Example 2 continued
Solution
$
Cash flows from investing activities
Purchase of property, plant and equipment (W1) (6,150)
Sale proceeds from sale of plant ($900 + $400) 1,300

Cash flows from financing activities

Proceeds of share issue (W2) 2,100
Lease liability repaid (W3) (1,800)
(W1) Property, plant and equipment
Property, plant & equipment
Balance b/f 33,800 Depreciation 7,200
Revaluation (1,850 – 500) 1,350 Disposal 900
Right-of-use asset 10,000
Purchase of assets 6,150 Balance c/f 43,200
——— ———
51,300 51,300
——— ———
(W2) Share capital and premium
Share capital and premium
Share capital b/f 9,000
Share capital c/f 10,500 Share premium b/f 1,700
Share premium c/f 2,300 Share proceeds (bal) 2,100
——— ———
12,800 12,800
——— ———

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 Statement of cash flows

Example 2 continued
(W3) Lease liability
Lease liability
Lease repayments (bal) 1,800 Balance b/f: NCL 3,500
Balance b/f: CL 1,100
Balance c/f: NCL 9,300 New lease assets 10,000
Balance c/f: CL 3,500
——— ———
14,600 14,600
——— ———

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