B.

INDIRECT
For calculatingMETHOD
Cash Flows from operating activities
through indirect method,
we start from the figure of profit,
which should be before tax and extra ordinary item.
Further, this profit requires certain adjustments related to
non-cash and non-operating items like:
i) An increase or decrease in the value of current assets and
current liabilities, (depreciation, provision, impairment.)
ii) Loss on sale of assets
iii) assets written off (e.g bad debts) are to be added back
because they are non-cash items that do not result in the
outflows of cash.
i) which also affect the cash flows, so these should be adjusted to net profit.
ii) Other items which effects investing or financing cash flows are
dividend or
interest income, etc.
 Cash Flows from Operating Activities (Indirect Method)
PARTICULARS

AMOUNT N

Net Profit before interest, tax and extraordinary items xxx

Adjustment for:
Depreciation
xxx
Loss on sale of fixed assets
xxx
Provision for contingencies
xxx
Provision for retirement benefits
xxx
Profit on sale of investment/fixed assets
Less: Increase in current assets (xxx)
Less: Decrease in current liabilities (xxx)

Cash generated from operations xxx

Tax paid (xxx)

Cash flows before extraordinary items xxx

± Extra ordinary items xxx

NET CASH FROM OPERATING ACTIVITIES xxx

 Treatment of Non-cash and Non-operating items (Expenses or
Reserves
 Non-cash items refer to those items which have appeared
in the Income Statement as an expenditure or revenue but
they do not have any impact on cash balance.
 These items affect the net profit as shown by Income
Statement without causing any inflow or outflow of cash in
the business.
 So, to convert accrual base income statement into cash
base income statement, these items must be adjusted.
a) Depreciation on Fixed Assets:
 Being a non-cash expense, this does not lead to reduction
in the cash balance in any way. So while computing cash
flows from operating activities, this item should be added
back to the net profit.
b) Amortization of Intangible assets, viz., Goodwill, Trade
Marks, Patents, etc.:
 This amortization of intangible assets reduces the net profit
but do not affect the cash flow in any way. So to calculate cash
flows from operating activities, the value of amortization of
assets should be added back to net profit.
c) Fictitious Assets written off, e.g., preliminary expenses:
 These also have nothing to do with the cash flows but reduce
the net profit. So these expenses should be added back for the
computation of cash flow from operating activities.
d) Profit or loss on sale of fixed assets:
 Profit or loss on sale of fixed assets should be added back or
deducted respectively, to the net profit figure, so that cash flow
from operating activities can be computed.
 In case, a fixed assets is sold during the year following
treatment should be accounted for:
(i) Calculate the depreciation charged on the assets during
the year by preparing “Accumulated Depreciation
Account” to be added to the net income for the year
before adjustment.
(ii) Calculate amount of profit or loss on the sale of the part
of that fixed assets which shall either of subtracted or
add respectively to the net income for the year before
adjustment.
(iii) Amount of cash received on sale of asset must be
added under the head “Cash Flow from Investing
Activities”
(iv) Amount of cash paid (if any) on purchase of fixed assets
must be subtracted from investing activities.
((v) Provision for Bad and Doubtful Debts: This item also reduce the
net profit but do not affect the cash. To calculate Cash Flows from
Operating Activities, these items must be added back to the net
profit.
(vii) Tax Provision, Dividend, Sale/Purchase of fixed assets:
 In case of proposed dividends, the provision created during the year
must be added to net income before adjustments and the amount
actually paid during the year must be subtracted under the head
“Cash Flow from Financing Activities”.
 In case of provision for taxation, the provision created during the
year must be added to net income before adjustments and the
amount actually paid during the year is subtracted from “Cash
Flow from Operating Activities’.
 TREATMENT OF SOME SPECIAL
ITEMS of Interest:
1. Treatment
(a) If it is financial enterprise (bank): Cash flows
from interest paid and interest received should
be treated as Cash Flows from Operating
Activities.
(b)If it is other than financial enterprise: Cash
flows from interest paid should be treated as
Cash Flows from Financing Activities while
interest received should be treated as Cash Flows
from Investing Activities.
NOTE: Interest on calls-in-arrears is a cash flow
from financing activities.
2. Treatment of Dividend:
(i) If it is a financial enterprise:(bank or
investment fund) Cash flows from dividend
received should be treated as cash flows from
Operating Activities, while cash flows from
dividend paid should be treated as cash flows
from Financing Activities.
(ii) If it is other than financial enterprise: Cash
flows from dividend received should be treated
as cash flows from Investing Activities, while
cash flows from dividend paid should be treated
as cash flows from Financing Activities.
NOTE: Dividend paid should always be treated
3. Treatment of Taxes on Income:
 Taxes on income should be disclosed separately.
 It has also stated that it can’t be indentified specifically
with Financing Activities or Investing Activities then, it
should be classified as cash flows from Operating
Activities.
 While preparing CFS current year’s tax provision should
be added back to the current year’s profit to arrive at cash
flows from operating activities.
 Tax paid during the year should be deducted from
cash before tax from Operating Activities.
 Students are advised to prepare ‘Provision for Tax
Account’ to know hidden transactions, if any.
 Provision for Tax Account
Dr Cr
. PARTICULARS Amount PARTICULARS .Amount
N N

To Bank A/c xxx By Balance b/d xxx

(Tax
paid)
To Balance c/d xxx By Profit and Loss A/c xxx
(Current year’s
provision)
xxx xxx

By Balance b/d xxx

NOTE:
1. Tax paid should be subtracted after
deducting the refund of tax cash
before
from tax from operating activities as actual
tax paid is the outflows.
2. In the absence of specific information
Provision for Tax shown in the previous
year’s balance sheet should be treated as tax
paid and Provision for Tax shown in the
current year’s balance sheet should be
treated as current year’s tax provision.
NOTE:
1. Tax paid should be subtracted after
deducting the refund of tax cash
before
from tax from operating activities as actual
tax paid is the outflows.
2. In the absence of specific information
Provision for Tax shown in the previous
year’s balance sheet should be treated as tax
paid and Provision for Tax shown in the
current year’s balance sheet should be
treated as current year’s tax provision.
 Example: Following are the extract from the
Liabilities balance sheets Assets
31.3.2022 31.3.2023 of ABC Ltd.31.3.2023
31.3.2022

OWNERSequity 60,000 1,00,000

Tax liability 10,000 15,000

70,000 1,15,000
 Show how the related item will appear in the CFS.
Calculation of Profit before taxation and extraordinary
Profit made during the year
items: 40,000
(1,00,000 – 60,000)
Add: Provision for Tax 11,200
40000x0,28%
NP before taxation 52,200

Cash Flow Statement

For the Year ended 31st March,
2012 Cash Flow from Operating Activities:
Net Profit before taxation & 51,200
extraordinary items Less: Income Tax paid 6200

Net cash from Operating activities 45,000

 Working Note:
Provision for Tax Account
Dr Cr
. .
PARTICULARS Amount PARTICULARS Amount
N N

To Cash A/c 6,200 Opening balance 10,000

(Tax (Current year’s provision) 11,200
paid) 15,000
Closing
Balance c/d

15,000 21,200
 Example: Following are the extract from the Balance Sheets of
ABC Ltd.

LIABILITIES 31.3.22 31.3.23 ASSETS 31.3.11 31.3.12

R R R

Profit and Loss

Account 60,000 1,00,000
Tax liability 10,000 15,000

Additional information
During the year tax
paid N 12,000.
Show how the related
items will appear in
CFS.
Solution:
Calculation of Profit before taxation & extraordinary items:
Profit made during the N40,000
year Add: Provision for N17,000
Tax
Net Profit before taxation & EOI N57,000

Cash Flow Statement

For the year ended 31st March, 2012
Cash from Operating Activities:
Net Profit before taxation & extraordinary items N57,000
Less: Income tax paid N12,ooo

Net Cash from Operating Activities N45,000

 Working Note:
Provision for Tax Account
Dr Cr
. .
PARTICULARS Amount PARTICULARS Amount
N N

To Cash A/c 12,000 By Balance b/d 10,000

(Tax By Profit & Loss A/c 17,000
paid) 15,000 (Current year’s
To Balance provision being balancing
c/d figure)

27,000 27,000
 Example: Following are the extract for the Balance Sheets of ABC Ltd.
31.13.11 31.12.12
N N
Profit and Loss A/c 60,000 1,00,000
Provision for Tax 10,000 15,000
Additional information:
Provision for tax made during the year 2011-12 N14,000.
Solution:
Calculation of Profit before tax & extraordinary items
Profit made during the N40,000
year Add: Provision for tax N
14,000
Net Profit before tax & extraordinary items N 54,000
 Cash Flow Statement
Cash from Operating Activities:
Net Profit before tax and
extraordinary items N54,000
Less: Income tax paid N 9,000

Net Cash from Operating Activities

N45,000
 Working Note:
Provision for Tax Account
Dr Cr
. .
PARTICULARS Amount PARTICULARS Amount
N N

To Cash A/c 9,000 By Balance b/d 10,000

(Tax paid being balancing By Profit and Loss A/c 14,000
Figure) (Current year’s provision)
To Balance c/d
15,000

24,000 24,000
 II. Cash Flow from Investing
Activities
 Cash flows from acquisition or disposal of long-term assets
or investments are termed as Cash Flows from Investing
Activities.
 The important point is to be noted here that these assets
have not been held by the business concern for resale.
 In this type of classification cash flows represents the
expenditure which have been made with the intention to
generate future income or cash flows.
 As per AS-3 (Revised) following types of activities can be
regarded as cash flow from Investing Activities:
 Cash paid for acquiring tangible or intangible fixed assets
(including those relating to capitalized R & D costs).
 Cash received from sale of fixed assets (tangibles or
intangibles).
 Cash paid for acquiring shares, warrants, or debt
instruments of other enterprises and/or interests in
some joint ventures.
 Cash received from disposal or issue of shares ,
warrants, or debt instruments of other enterprises
and/or interests in some joint ventures.
 Cash given as an advance and loans given to third
parties.
 Cash received from the repayment of advances and
losses given to third parties.
 Cash Flows from Investing
Activities
N
Sale of fixed assets xxx
Purchase of fixed (xxx)
assets (xxx
Purchase of long-term investments )
Sale of long-term investments (xxx
Interest received (non-financial ) xxx
enterprise)
Dividend received (n0n-financial xxx
enterprise)
Net Cash from Investing Activities xxx
Example:
From the following
particulars, calculate cash
flow from investing
Machinery as on 1.4.2011
activities:
R
80,000
Machinery as on 31.3.2012 90,000
Accumulated depreciation as on 1.4.2011 22,500
Accumulated depreciation as on 31.3.2012 37,500
Additional information:
During the year a machine costing 37,500 with
accumulated depreciation of 21,000 sold for 18,200.
Calculate cash flow from investing activities.
 Computation of Cash Flow from Investing Activities

Sale of machinery 18,200

Less: Purchase of machinery (47,500)
Net cash used in investing activities (29,300)
Working Notes:
Accumulated Depreciation Account
To Machinery sold A/c 21,000 By Balance b/d 22,500
To Balance c/d 37,500 By P & L A/c 36,000
(Dep. Provided
during the year
-Bal. fig.)
58,500 58,500
 Machinery Account
To Balance 80,000 By Machinery sold A/c
b/d To Cash 37,500
A/c 47,500 By Balance c/d
(Purchases- 90,000
1,27,500 1,27,500
Bal fig.) Machinery Sold Account
To Machinery 37,500 By Depreciation A/c 21,000
A/c
To P & L A/c 1,700 By Bank A/c 18,200
(Profit on (Sale )
sale) 39,200 39,200
 III. Cash Flows from Financing
Activities
 Cash flows from the activities, which result in change in
the shape and composition of owners’ funds (including
preference share capital) and borrowed funds of the
business are called Cash Flows from Financing Activities.
 Some of the examples of Cash Flows from Financing
Activities are as follows:
 Cash receipts from issuance of share capital.
 Cash receipts from issuance of Debentures and Long-term,
or short-term borrowings, etc.
 Repayment of amount borrowed.
 Payment of dividend.
 Example:

• From the following information related to ABC Ltd., calculate cash

flows from financing activities:
(i) 2,000 equity shares of N 10 per share were issued at par.
(ii)8% Preference shares of N 10,000 were redeemed at premium of
10%.
(iii) dividend paid N 2,000.
Issue of equity shares 20,000
•Solution:Redemption of 8% Preference Shares (11,000)
(at premium)
• Computation of Cash Flows from
Dividend paid Financing(2,000)
Activities
Net Cash from Financing Activities 7,000 •
N
 IV. Calculation of Net Increase or Decrease in Cash and C
Equivalents
Opening Balance Closing Balance
Cash in Hand xxx xxx
Cash at bank xxx xxx
Short-term Investments xxx xxx
Total xxx