170 PAS7 PAS 7 Statement of Cash Flows Learning Objectives 1 Describe the statement of cash flows. 2. Differentiate between the following: (1) Operating activities, (2) Investing activities, and (3) Financing, activ ities. 3. State the classifications of the following in a statement of cash flows: (a) dividends received, (b) dividends paid, (c) interest paid and (d) interest received. Introduction PAS 7 prescribes the requirements in the presentation of statement oO! f cash flows. The statement of cash flows provides information about the sources and utilization (ie., historical changes) of cash and cash equivalents during the period. Definition of terms Cash comprises cash on hand and cash in bank. 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.” (PAS 7.6) Only debt instruments acquired within 3 months or less before their maturity date can qualify as cash equivalents. Examples of cash equivalents: a. 1-year treasury bill acquired 3 months before maturity date b. 90-day money market instrument or commercial paper ¢. 3-month time deposit Cash flows include inflows (sources) and outflows (uses) of cash and cash equivalents.of Case Flows When used in conjunction with the rest of the financial statements, the statement of cash flows helps users assess: a. the ability of the entity to generate cash and cash equivalents, b. the timing and certainty of the generation of cash flows, and c. the needs of the entity to utilize those cash flows The statement of cash flows may also provide information on the quality of earnings of an entity. An entity may report profit under the accrual basis but suffers negative cash flows from its operating activities. This may provide indicators of, among other things, difficulty in collecting accounts receivable. As the statement of cash flows can only be prepared on a cash basis, it enhances inter-comparability among different entities because it eliminates the effects of using different accounting treatments for the same transactions and events. Classification of cash flows The statement of cash flows presents cash flows according to the following classifications: 1. Operating activities 2. Investing activities 3. Financing activities “Cash flows from operating activities are primarily derived from the principal revenue-producing activities of the entity.” (PAS7.14) Operating activities usually include cash inflows and outflows on items of income and expenses, or those that enter into the determination of profit or loss (i.e., included in the income statement). Examples of cash flows from operating activities: a. cash receipts from the sale of goods, rendering of services, or other forms of income b. cash payments for purchases of goods and services172 7 PAS? c. cash payments for operating expenses, such as employee benefits, insurance, and the like, and payments or refunds of income taxes d. cash receipts and payments from contracts held for dealing or trading purposes Special items included in operating activities > Cash flows from buying and selling held for trading securities (whether financial assets or financial liabilities) are classified as operating activities. Held for trading securities are similar to inventories in the sense that they are acquired specifically for resale. Some entities, in the ordinary course of their activities, routinely manufacture or acquire items of property, plant and equipment to be held for rental to others and subsequently transfer these assets to inventories when they cease to be rented and become held for sale. For these entities from the acquisition, rentals and subsequent sale of such assets are considered operating activities. The proceeds from the sale of such assets are recognized as revenue. Loan transactions of financial institutions (e.g., banks) are operating activities because they relate to the main revenue- producing activity of a financial institution. cash flows Investing activities Investing activities involve the acquisition and disposal of noncurrent assets and other investments. Examples includ a. cash receipts and cash payments in the acquisition and disposal of property, plant and equipment, investment Property, intangible assets and other noncurrent assets cash receipts and cash payments in the acquisition and sale of equity or debt instruments of other entities (other than those that are classified as cash equivalents or held for trading) ae ‘eceipts and cash payments on derivative assets and liabilities (other than those that are held for trading or classified as financing activities)ash Flows 173 d. loans to other parties and collections thereof (other than loans made by a financial institution) Financing activities Financing activities are those that affect the entity's equity capital and borrowing structure. Examples include ther equity instruments a. cash receipts from issuing, shares or and cash payments to redeem them b. cash receipts from issuing notes, loans, bonds and mortgage payable and other short-term or long-term borrowings, and their repayments cash payments by a lessee for the reduction of the outstanding liability relating to a lease. (PAS 7.17e) 7 Cash flows on trade payables, accrued expenses and other operating liabilities are classified as operating activities and not financing activities. Only cash flows on non-operating or non-trade liabilities are included as financing activities. © Remember the following: 1. Operating activities » affect profit or loss — 2. Investing activities > affect non-current assets and other investments | 3._Financing activities __ > _ affect borrowings and equity | Cash flows excluded from the activities sections » Cash flows on movements between “cash” and “cash equivalents” are not presented separately because these are part of the entity’s cash management rather than its operating, investing and financing activities. Bank overdrafts that cannot be offset to cash are presented as financing activities. Those that can be offset to cash (or are a of the entity’s cash management) forms part of the ance of cash and cash equivalents and therefore not Presented separately in the activities sections.PAS7 wa > Cash flows denominated in a foreign currency are translated using the spot © Exchange differences are not cash flows of exchange rate changes on cash and cash equivalents held or gn currency 1S reported in the statement of cash xchange rate at the date of the cash flow “However, the effect due in a forei flows in order to reconcile cash and cash equivalents at the beginning and the end of the period.” (PAS 7.28) The amount of reconciliation is reported separately from the operating, investing and financing activities. General concept in the preparation of statement of cash flows The statement of cash flows is prepared using cash basis. Under the cash basis of accounting, income is recognized only when collected and expenses are recognized only when paid, rather than when these items are earned or incurred. Accordingly, only transactions that affected cash and cash equivaients are reported in the statement of cash flows. Non- cash transactions are excluded and disclosed only. {When preparing statement of cash flows: * Include only transactions that have affected cash and cash equivalents (e.g., purchase of assets by paying cash). = Exclude transactions that have not affected cash and cash equivalents (e.g., purchase of assets by issuing note payable or shares of stocks and conversion of debt to equity). Interests and Dividends Entities (except financial institutions) may classify cash flows on interests and dividends as follows: Cash flows Option 1 | Option 2 | Operating activity | Investing activity Pperating activity | Financing activity |‘Statement interes! dividend Interest > Interest income, expense and income are class operating activities because | activities because they dividend income are ied as| classified as _ investing they enter into the result from investments. | determination of profit or | » Interest expense is classified | loss (ie, income and as financing activity expenses) because it results from > Dividend paid is classified borrowing. as financing _activity | >» Dividend paid is classified because it is a transaction as operating activity with the owners and alters order to assist users in the equity structure. assessing the entity’s ability to pay dividends out of operating cash flows. % Only interests and dividends received or paid in cash are included in the statement of cash flows. For example, dividends declared in Year 1 but paid in Year 2 are excluded from the statement of cash flows in Year 1 and reported only in Year 2. % ’ Only option 7 is available to financial institutions. %* When answering CPA board questions wherein the problem is silent, it is presumed that the entity uses option 1. Presentation Cash flows from operating activities may be presented using either: a. Direct method - shows each major class of gross cash receipts and gross cash payments; or b. Indirect method - profit or loss is adjusted for the effects of non-cash items and changes in operating assets and liabilities.PAS7 176 C —_—_— Indirect Method Direct Method | [Cash tows from operating activities Gash flows from operating 500 | | Profit before tax 280 Cash receipts from customers 00) | | Adusiment fo Cash paid to suppliers {f00) | | ee 2 aoe (100) || Gain on sale of equipment (10) Cast Os fe operetng expenses (120) || impairment toss zl Cesk from operations. 80 | | interest expense -4 coca (10) | 287 pisses ase (20) | | increase in trade and other receivables (150) Net cash from operating actwities _59 || Decrease in inventories 2 Decrease in trade payables OL Cash generated from operations 80 oad (19) income taxes paid 22) Net cash from operating activites = BO PAS 7 does not require any particular method; both methods are acceptable. However, PAS 7 encourages the direct method because it provides information that may be useful in estimating future cash flows which is not available under the indirect method. In practice, however, the indirect method is more commonly used because it is easier to apply. Moreover, the choice between direct and indirect method of Presentation is applicable only for operating activities. For investing and financing activities, gross cash receipts and gross cash payments for the related transactions are presented separately, unless they qualify for net presentation. Mustration 1: Statement of cash flows (Direct Method) Entity A Statement of cash flows For the year ended December 31, 20x2 Cash flows from operatin, activiti ; Cash receipts from customers a Cash receipts for Tent in “e000 Cash receipts for interest income “5000 Cash Paid to suppliers 3.00) Cash paid for insurance eam) Poet Paid for other expenses 00) ish generate ic an Interest paid oon peas sae Income taxes paiq 315000 (315,000)Statement of Cash Flows = Statement of Cash FOES —__—— quisition of held for | Cash paid for the a Net cash from ‘operating activities __— Cash flows from investing activities Cash receipt from sale of old building | Cash payment for acquisition of building _ ‘Net cash used in investing activities } Cash flows from financing activities Cash proceeds from issuance of share capital Cash payment for short-term loan Cash payment for dividends Net cash from financing activities Net increase in cash and cash equivalents Cash and cash equivalents, beginning Cash and cash equivalents, end Illustration 2: Statement of cash flows (Indirect Method) Entity A Statement of cash flows For the year ended December 31, 20x2 Cash flows from operating activities Profit before tax Adjustments for: Depreciation expense impairment loss on goodwill tine abe ‘sale of building meen on held for trading securities Interest expense Increase in accounts ioonhniedue Decrease in inventory increase in prepaid insurance Increase in accounts payable Decrease in unearned rent | Increase in insurance pa’ trading securities (100,000) 1,500,000 260,000 (2,300,000) | (2,040,000) 4,000,000 (50,000) (310,000: 640,000 100,000 150,000 | 250,000 1,035,000 500,000 10,000 40,000 (20,000) (20,000) 100,000 1,646,000 | (70,000) (15,000) 400,000 | (10,000) | 40,000 (10,000) 15,000 |we __PAS?, 15,000 | Interest received _____15,000_ Cash generated from operations 2,010,000 Interest paid ieooy me taxes paid . . , oun paid for the acquisition of held for trading securities (100,000) ‘Net cash from operating activities _ _ 1,500,000 Cash flows from investing activities Cash receipt from sale of old building 260,000 Cash payment for acquisition of building (2,300,000) Net cash used in investing activities (2,040,000) Cash flows from financing activities ; Cash proceeds from issuance of share capital 4,000,000 Cash payment for short-term loan (50,000) Cash payment for dividends (310,000) Net cash from financing activities 640,000 Net increase in cash and cash equivalents 100,000 Cash and cash equivalents, beginning 450,000 Cash and cash equivalents, end 250,000 Changes in ownership interests in subsidiaries Cash flows arising from acquisitions and disposals of subsidiaries or other business units resulting to loss or obtaining of control are classified as investing activities. Those that do not result to loss or obtaining of control are classified as financing activities. Disclosure PAS 7 requires the following disclosures: a. Components of cash and cash equivalents and a reconciliation f ‘ of amounts in the statement of cash flows with the equivalent items in the statement of financial position. are not available for use b management commentary. Signifi ignificant cash and cash equivalents held by the entity that y the group, together with aStatement of Cash Flows 179 Summary: The statement of cash flows shows the historical changes (ie., . sources and utilization) in cash and cash equivalents during the period It is an integral part of a complete set of financial statements and is used in conjunction with the other financial statements in assessing, the ability of an entity to generate cash and cash equivalents the timing and certainty of their generation, and the needs of the entity to utilize those cash flows. e Cash flows are classified into (a) operating activities, (b) investing activities, and (c) financing activities. © Operating activities include transactions that enter into the determination of profit or loss, i.e., income and expenses. «Investing activities include transactions that affect mon- current assets and other non-operating assets « Financing activities include transactions that affect equity and non-operating liabilities. « Only transactions that have affected cash and cash equivalents are included in the statement of cash flows. Non- cash transactions are excluded and disclosed only. «Entities other than financial institutions have options in presenting cash flows relating to interests and dividends. © Cash flows from operating activities may be reported using either (a) direct method or (b) indirect method. © The direct method shows each major class of gross cash receipts and gross cash payments. Under the indirect method, profit or loss is adjusted for the effects of non-cash items and changes in operating, assets and liabilities. « Cash flows relating to investing and financing activities are presented separately at gross amounts, unless they qualify for Net presentation.