ACCOUNTING Financial and Organisational Decision Making

1. ACCOUNTINGFinancial and Organisational Decision Making Chapter 10 Statement of cash flows Slides written and designed by Tony Van Eekelen

2. Learning Objectives • In this chapter you will be introduced to : • the purpose of a statement of cash flows • the relationship between the statement of cash flows and other general purpose reports • a definition of cash and cash equivalents and how they are treated in a statement of cash flows • The classification of cash flows as operating, investing and financing and the significance of these distinctions

3. Learning Objectives • the preparation of statements of cash flows using the transactions-based method and the financial statement based method • how to determine cash flow from operations using two methods described as the direct and indirect methods. • the schedules required by the accounting standards to accompany the statement.

4. Introduction • Two financial statements have been covered so far, the profit and loss statement and the balance sheet. • Another statement required by the IASC is the statement of cash flows. • The main emphasis is on cash movements during the period

5. Introduction • The statement is to assist in assessing the ability of the entity to: • generate positive net cash flows in the future • meet its financial commitments as they fall due, including the servicing of borrowing and the payments of dividends • fund changes in the scope and/or nature of its activities • obtain external finance where necessary

6. Definitions - cash • What are cash flows: • cash on hand • notes, coins and deposits held at call with a financial institution • cash equivalents • short term highly liquid investments and any short term borrowings

7. Definitions - classification • Cash flows are classified under three headings: OPERATING INVESTING FINANCING

8. Investing • Relates to the acquisition and disposal of non-current assets. • Eg. Property, • plant and equipment • purchase of shares • sale of motor vehicles • disposal of segments of an entity’s own operations

9. Operating • Involves the receipts and payments for the normal operations of the entity. • Eg. Movements in working capital accounts • payment of interest and taxes • receipts of cash from customers • payments for inventory, wages and rent

10. Financing • Relates to composition of the financial structure of the entity • eg. • Capital contributions • withdrawals via dividends • acquiring funds through debt • repayment of debt

11. The purpose and use of the statement of cash flows • Indicates how the firm’s control over a major resource, cash has changed and can be used as an indicator of the future.

12. Answers from the cash flows statement • External users may receive answer for the following: • Were operations the major source of receipts? • Were any debts repaid? • Why is the entity short of cash despite making a profit? • How was it possible to pay a dividend when the firm made a loss? • What use was made of the proceeds of borrowings?

13. Statement of cash flows in Australia • Due to large number of failures in Australia during the early 1990’s, the cash flows statement replaced the funds statement in 1991 as per AAS 28 and AASB 1026.

14. Features: • Classified into operating, investing and financing • Inflows and outflows shown separately. • Use direct method for operating cash flows • Indirect method and non-cash investing and financing items in notes • Comparative data from prior period • Must identify: interest received and paid, dividends received and paid & income taxes paid

15. Preparation of cash flow statement • Two ways of preparing a statement of cash flows: • Transactions based method is to analysis each transaction and then classified the appropriate cash transactions into operating, investing and financing

16. Preparation of cash flows statement • Financial statement-based methodis where one uses existing financial statements and summarises the cash effects. • This approach involves taking two balance sheets and the current profit and loss statement and eliminate all the non cash transactions

17. Steps in preparation • Calculate the differences columns • Using the balance sheet calculate the differences between the balances for each item. • These differences are a result of cash and non cash transactions.

18. Steps • Identity the non-cash items and remove their effects from both sides of the ledger • Non cash items can be either • book entries • Non-cash transactions with external parties

19. Book entries • Items like depreciation and other provision need to be removed from the calculations. • To remove depreciation one needs to reverse the original transaction. • ie • Dr Accumulated depreciation • Cr Depreciation

20. Non-cash transactions • Removing the non-cash items from revenue and costs of operation, effect the balance sheet and the profit and loss statement. • Cash from customers • Credit sales (accounts receivable) have been included and must be removed - increase in accounts receivable cash from customers = sales or + decrease in accounts receivable

21. Non cash transactions • Payments for expenses • Payments to suppliers • This involves calculating the purchases and then the cash paid to suppliers - increase in inventory cost of goods sold = purchases or + decrease in inventory

22. Non cash transactions • Payments to suppliers • Now we need to adjust the accounts payable account - increase in accounts payable cash paid to suppliers = purchases or + decrease in accounts payable

23. Non cash transactions • Accruals • Accruals effect the current liabilities - increase in accruals wages paid = wages expense or + decrease in accruals

24. Non cash transactions • Prepayments • Prepayments effect the current assets and have not been included in the profit and loss. + increase in prepayments rent paid =rent expenses or - decrease in prepayments

25. Steps • Classify the remaining movements in cash as operating, financing, investing or cash, and prepare a statement of cash flows • The statement can be shown using the direct method • ie cash inflows less outflows • or the indirect method • adding back non cash items to the net profit/loss

26. Example of reconciliation statement Reconciliation of cash flows from operations to operating profit after tax $ $ Net Loss (1009) Depreciation 37 Adjustments for changes in operating working capital Increases in current assets Prepayments (320) Decrease in current assets Debtors 155 Increases in current liabilities Accrued wages 270 105 Cash flows from operations$(867)

27. Other factors to consider • Depreciation • Gains and losses on sale of assets • book entry which may require the reconstruction of accounts • Transfer to reserves • transfers between accounts are book entries and need to be adjusted. • Eg asset revaluation • Provisions • Dividends, taxation are all book entries

28. Other factors to consider • Bonus issues of shares • No cash involve and is only a book entry • Take-overs involving shares and debt instruments • Again no cash involved and need to be eliminated from the ledger.