ACCA PAPER F7 - INTERNATIONAL

PREPARING FINANCIAL STATEMENTS STATEMENT OF CASH FLOWS

IAS 7 - STATEMENT OF CASH FLOWS
INTRODUCTION

1.

An important additional financial statement that shows how changes in assets, liabilities, equities, income
and expenses account affect cash and cash equivalents.
The preparation of Statement of Cash Flows is prescribed by IAS 7.
It shows the sources and uses of cash flows and acts as a useful indicator of liquidity and solvency.
It complements the importance of financial information which was neglected in accrual accounting.
It shows the ability of the company to generate cash, efficient uses of cash, solvency and the business
survival.
It can drag users attention to critical issues occurred by business entity.
It carry more financial information as compared to profit alone as income statements was prepared using
accrual accounting prescribed by GAAP and conventions.
It is a better means to be used as comparative measurement between companies within same industry as
compared to profit since profit was affected by differences accounting policy adopted by different
companies.
It has broad perspective of usability with straight-forward message than can be easily understood by all
users.
Forecast made using cash flows is easier to understand and more useful than profit forecast.
It is easier to audit than profit.
Relying only on accounting profit can be misleading for example if the companys profit was $1 billion,
users might think that the company will be able to pay them with high dividend. However, this will not
always be true since the ability to pay dividend depend on the sufficient cash position of the company.
DEFINITION OF ELEMENTS IN STATEMENT OF CASH FLOWS

i)
ii)

Cash = Cash on hand and demand deposits.

Cash equivalents = short-term, highly liquid investment, readily convertible to cash and no significant risk
of change in value (normally an investment that has < 3 mths maturity).
iii) Operating activities = principal revenue-producing activities.
iv) Investing activities = acquisition and disposal of NCA and other non-cash equivalent investments.
v) Financing activities = activities that can change the equity capital and borrowings.

2.

PRESENTATION OF STATEMENT OF CASH FLOWS

i)

Statement of cash flows comprises of 3 sections of activities as follow:

i) Operating activities:
Shows the cash movement from operations.
Translate the profit from operations into cash from operations.
Shows ability of the company to generate cash from operations.
Shows the movement and efficiency of working capital.
ii) Investing activities:
Shows new investment in assets that will generate future profit and cash flows.
Show disposal and proceeds from disposal for assets.
iii) Financing activities:
Shows the sources of cash flows components either from equity or borrowings.
Shows the payment made to equity holders and lenders.
Shows the possible outcome for future dividend or interest.
Cash flows can be presented in 2 method:
i) Direct method:
Shows gross cash receipts from sales and services.
Shows payment to trade and other creditors.
Shows payment to employees and other charges e.g. taxes and interest.

ii)

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ACCA PAPER F7 - INTERNATIONAL

PREPARING FINANCIAL STATEMENTS STATEMENT OF CASH FLOWS

ii)

More useful and preferable presentation but not widely applied by company due to
more costly to prepare.
Indirect method:
Shows any adjustment to profit to reflect non-cash items.
Show any adjustment made to profit for any deferrals or accruals of cash receipts and
payments.
Shows any adjustment made to profit for income and expenses related to investing and
financing activities.
Widely applied method by companies because it is easier to prepare.

3.

PREPARING STATEMENT OF CASH FLOWS

Preparing statement of cash flows will involves extracting the movement of cash from statement of
financial position, statement of profit or loss and other comprehensive income and statement of changes
in equity.
It will be affected from the changes in cash movement from all activities (i.e. operating, financing and
investing) such as cash movement in inventory, trade receivables, investment income and etc.
To prepare operating activities, the sources of financial items for changes in cash movement will come
from statement of profit or loss and other comprehensive income and current assets and liabilities (to
reflect the working capital changes) such as items classified in CA, CL and adjustment of PBT to reflect
both non-cash items (e.g. depreciation and amortization) and non-operating items (e.g. gain on disposal of
PPE).
To prepare investing activities, the sources of financial items for changes in cash movement will come
from non-current assets items in consolidated statement of financial position (e.g. PPE, Intangible assets
and etc).
To prepare financing activities, the sources of financial items for changes in cash movement will come
from non-current liabilities and equity items in consolidated statement of financial position and
consolidated statement of changes in equity (e.g. Finance leases, borrowings, share capital and etc).
All non-cash items in the above mention FS should be removed in SCF such as deferred tax liability,
amortised finance cost or income, depreciation and etc.

LECTURE EXAMPLE 1 STATEMENTS OF CASH FLOWS

Contoh PLC manufactures toys and children education merchandises. The followings are the draft financial
statement of Contoh PLC for the reporting period ended 31 December 2011.
STATEMENT OF PROFIT OR LOSS FOR THE YEAR
$ million
120
(50)
70
10
(20)
(20)
(15)
25
(2)
23

Revenue
Cost of sales
Gross profit
Investment income (interest)
Distribution costs
Administrative expenses
Finance costs
Profit before tax
Income tax expenses
Profit for the year
STATEMENT OF FINANCIAL POSITION

$ million
2011
Non-current Assets
Property, plant and equipment (ii)
Intangible assets

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400
260

$ million
2010
320
180

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PREPARING FINANCIAL STATEMENTS STATEMENT OF CASH FLOWS
Fair value to profit or loss investments (i)

40

180
360
60
20
1,280

120
270
5
935

Equity and liabilities

Ordinary shares of $1 each (iv)
Share premium (iv)
Revaluation surplus
Retained earnings

300
200
80
150

200
150
60
145

Non-current liabilities
Long-term borrowings
Provision (iii)

150
50

80
-

140
80
130
1,280

100
100
100
935

Current assets
Inventories
Trade receivables
Short-term investments (v)
Cash
Total assets

Current liabilities
Trade payables
Overdraft
Income tax payable
Total equity and liabilities

Following are additional information for the preparation of statement of cash flow:
i)

The financial asset was sold at $38 million and the differences between the carrying amount and its fair
value at disposal was accounted into finance cost. There were no changes in fair value of the investment
since the beginning until disposal.
ii) During the year ended, equipment with a carrying amount of $25 million was sold at $30 million. The
equipment was acquired in previous 10 years at $50 million. The depreciation was included into cost of
sales for the year ended at $30 million.
iii) The provision was related to future dismantling and restoration of site from extracting ore minerals. This
amount was taken at its present value at 10% cost of capital at the year ended. The cost was included into
initial cost of the plant above.
iv) Ordinary share capital was issued during the year at 50% premium. No bonus or right issues during the
year ended.
v) The cash and cash equivalent includes all short-term investments that will mature within 6 months from
investment.
vi) Dividends of 6 cents per share (all issued shares) were paid during the year ended.
Required
Prepare a statement of cash flows for the year to 31 December 2011 according to IAS 7.
Step by Step Solution
NB: IAS 7 has given the preparer a choice to prepare SOCF in direct or indirect. This example will prepare the
SOCF in indirect method
Step 1 Compute the gain or loss on disposal of FVTPL investment (to be adjusted for cash from operating
activities computation).
$ million
Sales proceeds
Carrying amount

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40

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PREPARING FINANCIAL STATEMENTS STATEMENT OF CASH FLOWS
Loss

(2)

Step 2 - Compute the gain or loss on disposal of equipment (to be adjusted for cash from operating activities
computation).
$ million
Sales proceeds
Carrying amount
Gain

30
25
5

Step 3 Compute the movement in inventories by comparing the different between the opening and closing
balance (to be used later in arriving to cash from operations)
$ million
120
(180)
(60)

Bal. b/d
Bal. c/d
Increased (cash outflows)

Step 4 Compute the movement in trade receivables by comparing the different between the opening and
closing balance (to be used later in arriving to cash from operations)
$ million
270
(360)
(90)

Bal. b/d
Bal. c/d
Increased (cash outflows)

Step 5 Compute the movement in trade payables by comparing the different between the opening and
closing balance (to be used later in arriving to cash from operations)
$ million
100
(140)
40

Bal. b/d
Bal. c/d
Increased (cash inflows)

Step 6 Compute the movement in income tax liabilities (should include deferred taxes if any) by comparing
the different between the opening and closing balance (to be used later in arriving to cash from operations)
$ million
Bal. b/d
100
Income tax expenses
2
Bal. c/d
(130)
Refund (cash inflows)
28
Step 7 - Compute the movement in finance cost (should include deferred taxes if any) by comparing the
different between the opening and closing balance (to be used later in arriving to cash from operations)
$ million
Bal. b/d
I/S
Loss on disposal of FVTPL
Interest income (per Q)
Bal. c/d
Paid

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15
(2)
(10)
(3)

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PREPARING FINANCIAL STATEMENTS STATEMENT OF CASH FLOWS
Step 8 Pass the necessary adjustment to the profit for the year in order to obtain the cash flows from
operation by 1) eliminating all non-cash gain or losses; 2) all results from non-operating activities e.g gain on
disposal of property; and 3) changes in the working capital i.e. inventories etc.
$ million
Profit before tax (as per Q)
Adjustment for:
(+) Depreciation (as per Q)
(+) Loss on disposal FVTPL (Step 1)
(-) Gain on disposal PPE (Step 2)
(+) Finance cost net (15 -2 - 10)
Adjusted profit
Increase in inventories (Step 3)
Increase in trade receivables (Step 4)
Increse in trade payables (Step 5)
Cash generated from operations
Income tax refund (Step 6)
Finance cost paid (Step 7)
Net cash from operating activities

25
30
2
(5)
3
55
(60)
(90)
40
(55)
28
(3)
(30)

Step 9 - Compute the movement in property, plant and equipment by comparing the different between the
opening and closing balance (to be used later in arriving to cash flows from investing)
$ million
320
(30)
(25)
20
50
(400)
(65)

Bal. b/d
(-) depreciation
(-) Disposal
(+) Revaluation (80 60)
(+) Provision
Bal. c/d
Purchases / acquistion

Step 10 - Compute the movement intangible assets by comparing the different between the opening and
closing balance (to be used later in arriving to cash flows from investing).
$ million
180
(260)
(80)

Bal. b/d
Bal. c/d
Purchases

Step 11 Compute the cash flows from investing activities by comparing the opening and the closing
balances for all NCA items in the CSOFP. Limited to all cash and CE transaction only.
$ million
(65)
(80)
38
30
(77)

Purchases of PPE (Step 9)

Purchases of Intangible assets (Step 10)
Sales proceeds - FVTPL
Sales proceeds - PPE
Net cash used in investing activities

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PREPARING FINANCIAL STATEMENTS STATEMENT OF CASH FLOWS
Step 12 - Compute the movement in ordinary shares capital + share premium by comparing the different
between the opening and closing balance (to be used later in arriving to cash flows from financing).
$ million
350
(500)
150

Bal. b/d (200 + 150)

Bal. c/d (300 + 200)
Issued

Step 13 - Compute the cash flows from financing activities by comparing the opening and the closing for all
NCL and Equity items in the CSOFP. Limited to all cash and CE transaction only.
$ million
150
70
(18)
202

Cash from issuance of shares (Step 12)

Cash from long-term borrowings (80 150)
Dividends payment ($0.06 @ 300 m)
Net cash from financing activities

Step 14 Prepare the CSOCF for the year ended 31 December 2011
$ million
Profit before tax (as per Q)
Adjustment for:
(+) Depreciation (as per Q)
(+) Loss on disposal FVTPL (Step 1)
(-) Gain on disposal PPE (Step 2)
(+) Finance cost net (15 -2 - 10)
Adjusted profit
Increase in inventories (Step 3)
Increase in trade receivables (Step 4)
Increse in trade payables (Step 5)
Cash generated from operations
Income tax refund (Step 6)
Finance cost paid (Step 7)
Net cash from operating activities

25
30
2
(5)
3
55
(60)
(90)
40
(55)
28
(3)

Adjust. of non-cash
items included in P/L

Changes in CA & CL
items other than
interest and taxes

(30)

Investing Activities
Purchases of PPE (Step 9)
Purchases of Intangible assets (Step 10)
Sales proceeds - FVTPL
Sales proceeds - PPE
Net cash used in investing activities
Financing Activities
Cash from issuance of shares (Step 12)
Cash from long-term borrowings (80 150)
Dividends payment ($0.06 @ 300 m)
Net cash from financing activities
Increased in cash and cash equivalents
Cash and cash equivalent at beginning (100 5)
Cash and cash equivalent at year ended (80-60-20)

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$ million

(65)
(80)
38
30

Most figures derived

from P/L, CA & CL
items

Most figures derived

from NCA items

(77)
150
70
(18)

Most figures derived

from EQUITY & NCL
items

202
95
(95)
0

Balancing figure

ACCA PAPER F7 - INTERNATIONAL

PREPARING FINANCIAL STATEMENTS STATEMENT OF CASH FLOWS
4.

INTERPRETATION OF STATEMENTS OF CASH FLOWS

Showing information of relations between the profit for the year (accrual method) and cash generated
from operation.
Sources of Cash and cash equivalent can be clearly shown from all the three activities e.g. the ability to
generate cash from operations.
The used of cash and cash equivalent can be clearly shown from investing and financing activities e.g.
purchased of PPE.
Solely dependent on the profit figure is fatal error in interpreting companys health, since profit is not
made from cash i.e. accrual items comprises of prepayments, receivables, depreciation, non-cash gains
and etc.
Cash flows information provides better picture of companys well-being.
A healthy company can generate high profit and at the same time generate cash inflows.
A healthy company can generate cash from operations through resources available from investing and
financing activities.
High cash from operation usually indicate that the company will be able to settle its short-term and longterm commitments e.g. payables and interest of bonds.
Cash form all the 3 activities should be read together as one set of information (i.e. triangulation) rather
than single independent financial information.

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