Chapter 18

Statement of
Cash Flows
 Learning objectives
After studying this presentation you should be able to:
18.1 explain the reasons for preparing a statement
of cash flows
18.2 describe the general format of the statement
of cash flows
18.3 define the concept of cash in accordance with
IAS 7/AASB 107 Statement of Cash Flows
18.4 classify cash inflows and cash outflows into
operating, investing and financing activities
 Learning objectives
18.5 prepare a statement of cash flows for a
sole trader using the direct method and
indirect method
18.6 identify and explain some of the more
advanced issues involved in the
preparation of the statement of cash flows
18.7 identify the limitations of the statement of
cash flows
Purpose of the statement of cash flows
• According to the accounting standard, the statement of cash
flows, when used in conjunction with the other financial
statements, will enable users to:
– evaluate the entity’s financial structure, including its
liquidity and solvency
– assess the entity’s ability to generate cash in the future
and predict future cash flows
– The entity’s ability to pay dividends and meet obligations
– check the accuracy of past assessments of future cash
flows
– examine the relationship between profitability and net
cash flow
Purpose of the statement of cash flows
• The balance sheet reveals the opening and closing
balance of cash
• The cash flow statement provides information about
what caused the movement in the cash balance
• A business cannot operate/survive without sufficient
cash
• Under accrual accounting evaluating cash
performance is difficult
 General format of the statement of cash flows

• The standard specifies that the statement must

contain separate disclosure of cash inflows and
outflows, classified as arising from operating,
investing or financing activities, as appropriate
• The international (IASB) standard allows the use
of either the direct method of reporting cash
flows or the indirect method
• The use of the direct method is encouraged by
the IASB
General format of the statement of cash flows
ABC Corporation
The net cash flows Statement of Cash Flows

for each for the year ended 30 June 2020

classification are Cash flows from operating activities:

then totaled to Cash receipts from customers

Cash paid to suppliers and employees
$17 940
(10 260)
provide the net Net cash from operating activities $7 680

increase Cash flows from investing activities:

Purchase of property, plant and equipment* (10 950)
(decrease) in cash Net cash used in investing activities (10 950)

over the reporting Cash flows from financing activities:

Proceeds from owner contribution 6 000
period Proceeds from long-term borrowings 4 800
Drawings paid (6 690)
Net cash from financing activities 4 110

Net increase (decrease) in cash and cash equivalents 840

Cash and cash equivalents at beginning of year** (300)
Cash and cash equivalents at end of year $540
 General format of the statement of cash flows

• Certain cash flows must be disclosed as separate

items, and classified consistently from period to
period regardless of the classification of cash flows
used
• The items that must be separately disclosed
under the standard are:
– interest received and paid
– dividends received and paid
– income tax paid
 Concept of cash
• Cash comprises cash on hand and demand
deposits
• Cash equivalents are short‐term highly liquid
investments that are readily convertible into
known amounts of cash, and that are subject to
an insignificant risk of changes in value
• An entity preparing a statement of cash flows is
required to disclose, by way of note, the policy
adopted for determining which items are
classified as cash and cash equivalents in the
statement of cash flows
 Concept of cash
• Concept of cash and cash equivalents in IAS 7/AASB
107:
Classification of cash flow activities
• IAS 7/AASB 107 requires the entity’s
statement of cash flows to report the cash
inflows and cash outflows associated with
each of the entity’s major activities for the
reporting period
Classification of cash flow activities
• Cash flows from operating activities:
– Operating activities are defined in the standard as
the ‘principal revenue‐producing activities of the
entity and other activities that are not investing or
financing activities’.
– Cash flows from operating activities are regarded
as very important because they represent cash
flows generated by the entity’s major business
operations.
Classification of cash flow activities
• Cash flows from operating activities:
+ receipts from customers
+ interest and dividends received
– payments to suppliers and employees
– interest paid
– income tax paid
Classification of cash flow activities
• Cash flows from investing activities:
– The standard defines investing activities as those
that relate to the acquisition and disposal of
long‐term assets and other investments (such as
other entities shares and debentures) that are not
included in cash equivalents.
Classification of cash flow activities
• Cash flows from investing activities:
– /+ purchases/sales of property and equipment
– /+ purchases/sales of equity investments
– /+ purchases/sales of businesses
– /+ make/collection loans to other enterprises
– + Interest or Dividends received
Classification of cash flow activities
• Cash flows from financing activities:
– Activities that relate to changes in the size and
composition of the equity and borrowings of an
entity give rise to cash flows from financing
activities.
– Borrowing costs paid from financing activities &
dividends paid: either financing activities or
operating activities
Classification of cash flow activities
• Cash flows from financing activities:
+/- borrowing/repaying debt
+/- issuing shares/buy back of shares
– Dividends paid
– Drawings
 Classification of cash flow activities
• Summary of classification:
Typical cash inflows and cash outflows classified by activity:
 Classification of cash flow activities

Transaction Section Amount

1 Accounts receivable decreased by $30 000 during the year Operating 30 000 +
2 Sold for $50 000 cash equipment with a carrying amount of $25 000 Investing 50 000 +
3 The owner contributed cash of $40 000 Financing 40 000 +
4 Purchased a motor vehicle for $27 000, giving $7 000 cash and by borrowing
Investing$20 0007 000 –
5 Paid interest on borrowings of $2000 Operating 2 000 –
6 Purchased equity investments for $50 000 cash Investing 50 000 –
7 Repaid fixed-term loan principal of $40 000 Financing 40 000 –
8 Accounts payable decreased by $15 000 during the year Operating 15 000 –
9 Owner withdrew $18 000 in cash for personal use Financing 18 000 –
 Exclusions
The statement of cash flows excludes non-cash investing and
financing activities, such as:
– Purchase of investments or property by incurring long-term
debt.
– Acquiring another business entity by issuing shares.
– Conversions of liabilities to equity.
– Acquiring equipment by entering into a lease.
– Acquiring investments or property in exchange for other
investments or property
These items are reported in a separate schedule at the bottom of
the statement of cash flows, or in a separate note or supplementary
schedule to the financial statements
 Preparing the statement of cash flows

• The direct method only takes the cash

transactions into account and produces the cash
flow from operations
• The indirect method uses net income as the base
and converts the accrued income into cash flow
through the use of adjustments
• The main difference between the direct method
and the indirect method of presenting the
statement of cash flows involves only the cash
flows from operating activities
 Direct method
1. Analysis of cash and other records:
A statement of cash flows can be prepared using Cash
Receipts and Cash Payments Journals:
– Step 1: Work out net cash from operating activities
using the cash inflows and cash outflows identified as
coming from operating activities, grouped according
to the requirements of the standard
– Step 2: Work out net cash used in investing activities
– Step 3: Work out net cash used in financing activities
– Step 4: Work out net cash and cash equivalents
increase (decrease) for the period
– Step 5: Reconcile cash and cash equivalents at the end
of the period to that at the beginning of the period
 Cash Receipts from customers = 942,000
Direct method
1. Analysis of cash and other records:
Cash received from accounts receivable $ 942,000
Cash paid to accounts payable 656,000
Interest received on investment 2,100
Wages and salaries paid 126,000
Insurance paid 12,000
Other expenses paid 24,000
U.Drink, cash drawings 40,000
New equipment purchased 80,000
Proceeds from sales of equipment 6,000
Investments purchased 20,000
Cash at 1 July 2016 50,000
Cash at 30 June 2017 42,100
 Cash paid to suppliers and employees
= 656,000 +126,000 +12,000 +24,000 =(818,000)
Direct method
1. Analysis of cash and other records:

Cash received from accounts receivable $ 942,000

Cash paid to accounts payable 656,000
Interest received on investment 2,100
Wages and salaries paid 126,000
Insurance paid 12,000
Other expenses paid 24,000
U.Drink, cash drawings 40,000
New equipment purchased 80,000
Proceeds from sales of equipment 6,000
Investments purchased 20,000
Cash at 1 July 2016 50,000
Cash at 30 June 2017 42,100
 Cash Receipts from customers = 942,000
Cash paid to suppliers and employees, other expenses
Direct method = 656,000 +126,000 +12,000 +24,000 =(818,000)
Net cash from operating activities = 124,000

1. Analysis of cash and other records:

Cash received from accounts receivable $ 942,000

Cash paid to accounts payable 656,000
Interest received on investment 2,100
Wages and salaries paid 126,000
Insurance paid 12,000
Other expenses paid 24,000
U.Drink, cash drawings 40,000
New equipment purchased 80,000
Proceeds from sales of equipment 6,000
Investments purchased 20,000
Cash at 1 July 2016 50,000
Cash at 30 June 2017 42,100
 Purchase of equipment = (80,000)
Direct method Purchase of investment
Proceeds from sales of equipment
= (20,000)
= 6,000
Interest received = 2,100
Net cash used in investing activities = (91,900)

1. Analysis of cash and other records:

Cash received from accounts receivable $ 942,000
Cash paid to accounts payable 656,000
Interest received on investment 2,100
Wages and salaries paid 126,000
Insurance paid 12,000
Other expenses paid 24,000
U.Drink, cash drawings 40,000
New equipment purchased 80,000
Proceeds from sales of equipment 6,000
Investments purchased 20,000
Cash at 1 July 2016 50,000
Cash at 30 June 2017 42,100
 U.Drink, cash drawings = (40,000)
Net cash used in financing activities = (40,000)
Direct method
1. Analysis of cash and other records:

Cash received from accounts receivable $ 942,000

Cash paid to accounts payable 656,000
Interest received on investment 2,100
Wages and salaries paid 126,000
Insurance paid 12,000
Other expenses paid 24,000
U.Drink, cash drawings 40,000
New equipment purchased 80,000
Proceeds from sales of equipment 6,000
Investments purchased 20,000
Cash at 1 July 2016 50,000
Cash at 30 June 2017 42,100
 Direct method
COFFEE HOUSE
Statement of Cash Flows
For the year ended 30 June 2017

Cash flows from operating activities

Cash Receipts from customers 942,000
Cash paid to suppliers and employees (818,000)
Net cash from operating activities 124,000
Cash flows from investing activities
Purchase for Investment (20,000)
Payment on equipment (80,000)
Proceed from sale of equipment 6,000
Interest received 2,100
Net cash used in investing activities (91,900)
Cash flows from financing activities
U.Drink, drawings (40,000)
Net cash generated in financing activities (40,000)
Net increase in cash and cash equivalents (7,900)
Cash and cash equivalents at beginning of the year 50,000
Cash and cash equivalents at end of the year 42,100
 Direct method
2. Analysis of financial statements:
– A statement of cash flows can be prepared also by
using:
• comparative statements of financial position/balance
sheets for successive periods
• the statement of profit and loss and other
comprehensive income/income statement
• the statement of changes in equity of the entity
• together with additional information extracted from
the accounting records of the entity
 Direct method
2. Analysis of financial statements:
– Step 1: Work out net cash from operating
activities by converting items used in determining
profit under the accrual basis to a cash basis
• cash receipts from customers
• cash paid to suppliers and employees
• other expense items affecting cash flows
– Step 2,3,4,5: same as with SCF prepared using
Cash Receipts and Cash Payments Journals
 Direct method
2. Analysis of financial statements: (figure 18.6, page 760)
– Cash receipts from customers:
Accrual-basis sales + Beginning AR – Ending AR
960,000 + 86,000 – 104,000 = $942,000
OR
Accrual-basis sales + decrease in AR (or – increase in AR)
960,000 – 18,000 = $942,000
 Direct method
2. Analysis of financial statements:
– Cash paid to suppliers for purchases:
Accrual-basis purchases =
Accrual-basis COS – Beginning Inventory + Ending Inventory
672,000 - 104,000 +100,000 = $668,000
[Accrual-basis COS – decrease in inventory (or +increase in
inventory]
Cash paid to suppliers for purchases
= Accrual-basis purchases + Beginning AP – Ending AP
668,000 + 64,000 - 76,000 = $656,000
[Accrual-basis purchases + decrease in AP (or – increase in AP)]
 Direct method
2. Analysis of financial statements:
– Cash paid to suppliers of services and labor:
= Accrual-basis expenses
+ increase in prepaid expense - decrease in prepaid expense
+decrease in accrued expense - increase in accrued expense
130,000 – 4,000 +16,000 –4,000 +22,000 +2,000 = $162,000

Net cash from operating activities =

942,000 - 656,000 - 162,000 = $124,000
 Indirect method

Accrual method Cash method

Revenue earned Non-cash expenses
+ (e.g. depreciation)
– Expenses incurred
+ Decreases in current assets
Increases in current liabilities
Net profit
Increases in current assets
– Decreases in current liabilities
Cash flow from
operations
 Cash flows CURRENT ASSETS
2016 2017 CHANGE

from operating Cash at bank

Accounts Receivable
22,500
82,500
69,000
70,500
46,500
(12,000)

activities- Inventory
Prepaid Insurance
165,000
7,500
216,000
1,500
51,000
(6,000)
both methods ST Investment
277,500
-
357,000
-

Sales 1,047,000 NON-CURRENT ASSETS

Less: Cost of sales 780,000 Property 190,500 172,500 (18,000)
Gross Profit 267,000
Plant and Equipment 757,500 1,072,500 315,000
Add: Other income
A/D- Plant and Equipment (102,000) (154,500) (52,500)
Rent income 9,000
LT Investment - - -
Gain on sale of
property 20,000 29,000 846,000 1,090,500
TOTAL ASSETS 1,123,500 1,447,500
296,000
CURRENT LIABILITIES
Less: Expenses Banl overdraft - - -
Interest expense 34,500
Accounts Payable 64,500 75,000 10,500
Loss on sale of
plant 6,500 Other accrued expenses 13,500 18,000 4,500
Other expenses 231,000 272,000 Interest Payable 7,500 4,500 (3,000)
Profit 24,000 Tax Payable -
NON-CURRENT LIABILITIES
- Other expenses include $55,500 Mortgage payble 367,500 442,500 75,000
depreciation expenses EQUITY

- All sales and purchases of Share Capital 500,000 750,000 250,000

inventory are on credit Retained Earnings 170,500 157,500 (13,000)

TOTAL LIABILITIES & EQUITY 1,123,500 1,447,500
Cash flows from operating activities- both methods
Cash flows from operating activities
Direct
+ Cash Receipts from customers 1,059,000
method
- Cash paid to suppliers (820,500)

- Cash paid for other expenses

(165,000)
- Cash paid for interest (37,500)
(1,023,000)
Net cash from operating activities 36,000

Cash flows from operating activities

Net income 24,000
Adjustments: Indirect
+ Depreciation/Amortization expense 55,500 method
- Gain on sale of PPE or Investment (20,000)
+ Loss on sale of PPE or Investment 6,500
-Rent income (9,000) 33,000
Change in working capital:
+ Decrease in current assets 18,000
+ Increase in current liabilities 15,000
- Increase in current assets (51,000)
- Decrease in current liabilities (3,000) (21,000)
Net cash from operating activities 36,000
 Advanced issues
• Trade accounts receivable:
– Under the direct approach to determining cash
flows from operating activities, the Accounts
Receivable account is used in determining cash
receipts from customers
– Must consider:
• bad debts (direct write‐off)
• allowance for doubtful debts
• discount allowed
 Advanced issues
• Trade accounts payable and discount received:
– If discounts received have arisen on payments to
accounts payable, this amount, which represents a
non‐cash entry (debit) to accounts payable, must be
adjusted to convert accrual‐basis cost of sales to
cash payments to suppliers.
– This process is:
 Advanced issues
• Non‐trade receivables and payables:
– In preparing a statement of cash flows, an analysis
must also be made for any non‐trade receivables and
payables that need to be included when determining
cash flows.
– Non‐trade receivables and payables may not be
included in the calculation of cash flows from
operating activities (treated as cash flows from
investing activities if such items involve investments,
or cash flows from financing activities if they are akin
to borrowings)
 Advanced issues
• Bills receivable and bills payable:
– Bills of exchange and promissory notes are
classified into trade bills and commercial bills.
– Trade bills receivable and trade bills payable are
essentially another form of accounts receivable or
accounts payable respectively, and therefore must
enter into the calculation of cash flows from
operating activities.
 Advanced issues
• Short‐term investments:
– Short‐term investments can appear in the current
assets and current liabilities section of a statement of
financial position.
– Some short‐term investments could qualify as cash
equivalents, and others generally are classified as an
investing activity of an entity.
– These short‐term investments are not included in the
process of converting accrual‐basis expenses to
cash‐basis expenses to arrive at cash flows from
operating activities.
 Advanced issues
• Dividends:
– Companies commonly pay cash dividends.
– For the purpose of a statement of cash flows, only
cash payments for dividends are considered —
dividends declared are not considered.
– The payment of cash dividends is usually reported
in the statement of cash flows as a financing
activity but may be shown as an operating activity.
 Advanced issues
• Income tax:
– Companies are regarded as separate legal entities
and are therefore required to pay income tax.
– Income tax is reported in the financial statements
by showing income tax expense in the income
statement/statement of profit or loss and other
comprehensive income, and recording the liability
for tax as a current tax liability in the statement of
financial position.
 Interpretation
The statement of cash flows is useful in identifying liquidity
problems. In this regard, look for the following warning
signals:
• A significant decline in operating cash flows, or in the quality of earnings
ratio (operating cash flow/net profit) relative to the prior period.
Interpretation:
– If caused by a large increase in receivables, is it possible that the
company is having difficulties collecting its receivables?
– If caused by a large increase in inventories, is it possible that the
company is having difficulties selling its inventories?
 Interpretation
• A significant increase in payables. Interpretation: Is it possible
that the company is delaying a liquidity problem by not paying
its short-term obligations on a timely basis?
• A significant increase in cash provided from sales of
investments or property. Interpretation: Is it possible that the
company is selling off its noncurrent assets in order to avoid a
liquidity problem?
• Net cash flow from investing activities that is a positive
number. Interpretation: Is it possible that the company is
unable to find worthwhile growth opportunities?
 Interpretation
Balance sheet Income Statement Statement of CFs

increasing accounts what is happening to cash

steady sales revenue
receivable from customers
decreasing inventory
and are they straining to keep up inventory levels,
increasing accounts or are they struggling to pay suppliers?
payable
are they receiving the cash
increasing sales and from customers
steady bad debts or should they provide for
more bad debts?
Limitations of the statement of cash flows

• The main limitations are:

– past cash flows reported
– large number of non-cash transactions and events
– disclosures in notes to the statement
– insufficient information on liquidity/solvency
– management manipulation
– costs (direct method is encouraged but more costly)