STATEMENT OF CASH FLOW

Statement of cash flow

 also referred as Cash Flow Statements
 act as a bridge between the income statement and balance sheet by
showing how money or the cash and cash equivalents moved in and out of
the business.
 Is a component of financial statements summarizing the operating, investing
and financing activities of an entity.1
Cash Flow Statement is Utilized;

a) allows investors to understand how a company's operations are running, where

its money is coming from, and how money is being spent
b) Creditors, on the other hand, can use the CFS to determine how much cash is
available (referred to as liquidity) for the company to fund its operating expenses
and pay its debts. 2

Purpose of Statement of cash flows

1. The primary purpose of the statement of cash flows is to provide relevant

information about cash receipts and cash payments of an entity during a
period.3
2. Cash flow information is useful in assessing the ability of the entity to generate
cash and cash equivalents.
3. The statement of cash flows also enhances the comparability of operating
performance by different entities.
4. Users of an entity’s financial statements are interested in how the entity
generates and uses cash and cash equivalents.
5. Entities need cash to conduct their operations, to pay their obligations and to
provide returns to their investors.4

Cash and Cash Equivalents

The statement of cash flows is designed to provide information about the

change in an entity’s cash and cash equivalents.

Cash comprises cash on hand and demand deposits.

Cash equivalents are short term highly liquid investments that are readily convertible to
known amount of cash and which are subject to insignificant risk of change in value.

PAS 7, paragraph 7, provides that an investment normally qualifies as a cash and cash
equivalent only when it has a short maturity of three months or less from the date of

1 CFI.What is the Statement of Cash Flows?. Retrieved from

https://corporatefinanceinstitute.com/resources/knowledge/accounting/statement-of-cash-flows/.
2 Murphy, C(May 2019). Investopedia. What is a Cash Flow Statement?. Retrieved from https://www.investopedia.com/investing/what-is-

a-cash-flow-statement/
3 Statement of Cash Flows. Retrieved from http://web.csulb.edu/~mdchase/CashFlows500.pdf.
4 Valix,C.Financial Accounting(Volume 3).Chapter 16 Statement of Cash Flows.
acquisition. In other words, the investment must be acquired three months of less before
the date of maturity.

Examples of Cash Equivalents

a. Three-month BSP treasury bill

b. Three-year BSP Treasury bill purchases three months before date of maturity
c. Three-month time deposit
d. Three-month money market instrument or commercial paper.

CLASSIFICATION OF CASH FLOWS

Cash flows are inflows and outflows of cash and cash equivalents.

The statement of cash flow shall report cash flows during the period classified as
operating, investing and financing activities.

Classification by activity provides information that allows users to assess the impact of
those activities on financial position of the entity and the amount of its cash and cash
equivalent.5

The cash flow statement is partitioned into three segments, namely:

1. Cash flow resulting from operating activities

2. Cash flow resulting from investing activities
3. Cash flow resulting from financing activities
4. A fourth category, disclosure of noncash activities, is sometimes included when
prepared under the generally accepted accounting principles, or GAAP.

5 Valix,C.Financial Accounting(Volume 3).Chapter 16 Statement of Cash Flows.

Components and Presentation of Statement of Cash Flows

PRESENTATION OF STATEMENT OF CASH FLOWS

CASH FLOWS FROM (Used in) OPERATING ACTIVITIES

Cash receipts from customers XX
Less: Cash paid to suppliers and
employees (XX)
Cash generated from operation XX
Less: Interest paid (XX)
Less: Income taxes paid (XX)
Net cash flows from operating activities XX
CASH FLOWS FROM (Used in) INVESTING ACTIVITIES
Proceeds from the sale of equipment XX
Dividends received XX
Net cash flows from investing activities XX
CASH FLOWS FROM (Used in) FINANCING ACTIVITIES
Dividends paid (XX)
Net cash flows in financing
activities (XX)

Net increase in cash and cash equivalents XX

Cash and cash equivalents, beginning of year XX
Cash and cash equivalents, end of year XX

Direct and Indirect Method of Preparation

Cash flow is calculated by making certain adjustments to net income by adding

or subtracting differences in revenue, expenses and credit transactions (appearing on
the balance sheet and income statement) resulting from transactions that occur from
one period to the next. These adjustments are made because non-cash items are
calculated into net income (income statement) and total assets and liabilities (balance
sheet). So, because not all transactions involve actual cash items, many items have to
be re-evaluated when calculating cash flow from operations.

As a result, there are two methods of calculating cash flow: The direct method and the
indirect method.

Direct Method
 Shows in detail or itemizes the major classes of gross cash receipts and gross cash
payments.
 The cash receipts are listed one by one, the cash payments are listed one by
one, and the difference represents the net cash flow from the operating
activities.
 It is “cash basis” income statement.

Formulas may be necessary for determining for determining cash receipts and
cash payments:
 Computation of collections
Trade accounts and notes receivable-beginning XX
Add: Sales(accrual basis) XX
Total XX
Less: Trade accounts and notes receivable-end XX
Collections of accounts and notes receivable XX

Computation of payments to merchandise creditors

Trade accounts and notes payable - beginning XX
Add: Purchases (accrual basis) XX
Total XX
Less: Trade accounts and notes payable - end XX
Payment to merchandise creditors XX

Computation of payments for expenses

Expenses (accrual) XX
Prepaid expense -
XX
Add: end
Accrued expense - beginning XX
Total XX
Less: Prepaid expense - beginning XX
Accrued expense -
XX XX
end
Expenses paid XX

ILLUSTRATION-OPERATING ACTIVITIES

Luhan Company reported the following comparative statement of financial position

and income statement for 20x6.

ASSETS 20x6 20x5

Cash 3,000,000 2,000,000

Accounts Receivable 940,000 350,000

Inventory 175,000 100,000

Prepaid Insurance 15,000 20,000

Property, Plant, and Equipment 2,000,000 2,000,000

Accumulated Depreciation (550000) (500000)

Patent 40,000 50,000

Total Assets 5,620,000 4,020,000

LIABLITIES AND EQUITY

Accounts payable 170,000 150,000

Accrued Salaries Payable 25,000 10,000

Accrued Interest Payable 10,000 15,000

Income Tax Payable 350,000 250,000

Unearned Rent Income 10,000 40,000

Mortgage Payable 5,000,000 500,000

Share Capital 2,000,000 2,000,000

Retained Earnings 2,555,000 1,055,000

Total Liabilities and Equity 5,620,000 4,020,000

 Income Statement
Year Ended December 31,
20x6

Sales 6,500,000
Cost of goods sold

Inventory-January 1 100,000

Purchases 3,200,000

Goods Available for sale 3,300,000

Inventory-December 31 (175000) 3,125,000

Gross Income 3,375,000

Rent Income 80,000

Total Income 3,455,000

Expenses:
Salarie
s 950,000

Insurance 40,000

Other Expenses 500,000

Depreciation 50,000

Amortization of patent 10,000

Interest
Expense 55,000 1,605,000

Income before tax 1,850,000

Income tax 350,000

Net Income 1,500,000

COMPUTATIONS UNDER DIRECT METHOD

Accounts Receivable – 20x5 350,000 Insurance 40,000
Sales 6,500,000 Prepaid Insurance-20x6 15,000
Total 6,850,000 Total 55,000
Accounts Receivable-20x6 (940,000) Prepaid Insurance-20x5 (20,000)
Payment for
Collections from customers 5,910,000 Insurance 35,000

Rent Income 80,000 Other Expenses 500,000

Unearned Rent Income-20x6 10,000
Total 90,000 Interest Expense 55,000
Accrued Interest payable-
Unearned Rent Income-20x5 (40,000) 20x5 15,000
Rent Received 50,000 Total 70,000
Accrued Interest payable-
20x6 (10,000)
Accounts Payable-20x5 150,000 Interest Paid 60,000
Purchases 3,200,00
Total 3,350,000 Income Tax 350,000
Accounts Payable-20x6 (170,000) Income Tax Payable-20x5 250,000
Payments to merchandise creditors 3,180,000 Total 600,000
Income Tax Payable-20x6 (350,000)
Salaries 950,000 Payment for Income Tax 250,000
Accrued Salaries Payable-20x5 10,000
Total 960,000
Accrued Salaries Payable-20x6 (25,000)
Salaries Paid 935,000

DIRECT METHOD-OPERATING ACTIVITIES

Cash Received from the customers 5,910,000

Rent Received 50,000
Cash payments to merchandise creditors (3,180,000)
Salaries paid (935,000)
Insurance Paid (35,000)
Other Expenses (500,000)
Cash generated from the operations 1,310,000
Interest paid (60,000)
Income tax paid (250,000)
Net cash provided
operating activities 1,000,000

Indirect Method
  cash flows from operating activities are reported by adjusting net income for
revenues, expenses, gains, and losses that appear on the income statement but
do not have an effect on cash.
 It means that the net income/loss is adjusted for the effects of transactions of
anon-cash nature, any deferrals or accruals of past or future operating cash
receipts and payments, and items of income or expense associated with
investing and financing activities.

The following general guidelines are offered for the adjustments of net income to
cash basis:
1. All increases in trade noncash current assets are deducted from net income.
2. All decreases in trade noncash current assets are added to net income.
3. All increases in trade current liabilities are added to net income.
4. All decreases in trade current liabilities are deducted from net income.
5. Depreciation, amortization and other noncash expenses are added back to
net income to eliminate the effect they had on net income.
6. Any gain on disposal of property or gain on early retirement of nontrade
liabilities is included in net income but it is a nonoperating item.Thus, this is
deducted from net income.
7. Any loss on disposal of property of property or loss on early retirement of
nontrade liabilities is deducted from net income but this is a nonoperating
item.
Thus, this is added back no net income.

ILLUSTRATION OF INDIRECT METHOD. Changes in the current assets and current liabilities
are summarized as follows:6

Increase
20x6 20x5
(Decrease)

Accounts Receivable 940,000 350,000 590,000

Inventory 175,000 100,000 75,000

Prepaid Insurance 15,000 20,000 (5000)

Accounts Payable 170,000 150,000 20,000

Accrued Salaries
Payable 25,000 10,000 15,000
Accrued Interest
Payable 10,000 15,000 (5000)

Income Tax Payable 350,000 250,000 10,000

Unearned Rent Income 10,000 40,000 (30000)

Operating Activities

6 Valix,C.Financial Accounting(Volume 3).Chapter 16 Statement of Cash Flows.

  Include any sources and uses of cash from business activities.
 also includes the production, sales, and delivery of the company’s product as
well as collecting payments from its customers.
 This could include purchasing raw materials, building inventory, advertising, and
shipping the product.

These operating activities might include:

 Cash receipts from sales of goods and rendering services

 Cash receipts from royalties, rental, fees, commissions and other revenue
 Cash payments to suppliers for goods and services
 Cash payments for selling, administrative and other expenses
 Cash receipts and payments of an insurance enterprise for premiums and claims,
annuities and other policy benefits
 Cash receipts and payments for securities held for dealing or trading purposes

FINANCING ACTIVITIES

 are the cash flows derived from the equity capital and borrowings of the entity.
In other words, financing activities are the cash flows that result from
transactions;
a) Between the entity and owner – equity financing
b) Between the entity and creditors – Debt financing7
 Financing cash flows typically include cash flows associated with borrowing and
repaying bank loans, and issuing and buying back shares. The payment of
a dividend is also treated as a financing cash flow.
 Changes in cash from financing are "cash in" when capital is raised, and they're
"cash out" when dividends are paid. Thus, if a company issues a bond to the
public, the company receives cash financing; however, when interest is paid
to bondholders, the company is reducing its cash.8

INVESTING ACTIVITIES

 include any sources and uses of cash from a company's investments. A

purchase or sale of an asset, loans made to vendors or received from customers
or any payments related to a merger or acquisition are included in this
category. In short, changes in equipment, assets, or investments relate to cash
from investing.
 Usually, cash changes from investing are a "cash out" item, because cash is used
to buy new equipment, buildings, or short-term assets such as marketable
securities. However, when a company divests an asset, the transaction is
considered "cash in" for calculating cash from investing.
 Cash Flow from Investing Activities includes the acquisition and disposal of non-
current assets and other investments not included in cash equivalents. Investing
cash flows typically include the cash flows associated with buying or

7Valix,C.Financial Accounting(Volume 3).Chapter 16 Statement of Cash Flows.

8CFI.What is the Statement of Cash Flows?. Retrieved from
https://corporatefinanceinstitute.com/resources/knowledge/accounting/statement-of-cash-flows/.
 selling property, plant, and equipment (PP&E), other non-current assets, and
other financial assets.

Cash spent on purchasing PP&E is called capital expenditures (or CapEx for short).9

ABC Company had the following cash flows during the current year:
Cash receipts from issuance of ordinary shares P 4,000,000
Cash receipts from customers 2,000,000
Cash receipts from repayment of loan made to another entity 2,200,000
Cash payments for wages and other operating expenses 1,200,000
Cash payments for insurance 100,000
Cash payments for dividends 200,000
Cash payments for taxes 400,000
Cash payment to purchase land 800,000
Cash balance – beginning 3,500,000

Operating Activities:
Cash receipts from customers P 2,000,000
Cash payments for insurance (100,000)
Cash payments for wages and other operating expenses (1,200,000)
Cash payments for taxes (400,000)
Net cash provided by operating activities P 300,000
Investing Activities:
Cash receipts from repayment of loan made to another entity P 2,200,000
Cash payment to purchase land (800,000)
Net cash provided by investing activities P 1,400,000
Financing Activities:
Cash receipts from issuance of ordinary shares P 4,000,000
Cash payments for dividends (200,000)
Net cash provided by financing activities P 3,800,000

Cash balance at year-end:

Cash balance beginning P 3,500,000
Net cash provided by operating activities 300,000
Net cash provided by investing activities 1,400,000
Net cash provided by financing activities 3,800,000
Cash balance – end P 9,000,000

NON-CASH TRANSACTIONS

Pas 7, paragraph 43, provide that investing and financing transactions that do not
require use of cash and cash equivalents shall be excluded from the statement of cash
flows.10

NOTES TO FINANCIAL STATEMENT

NOTES TO FINANCIAL STATEMENT

9 CFI.What is the Statement of Cash Flows?. Retrieved from

https://corporatefinanceinstitute.com/resources/knowledge/accounting/statement-of-cash-flows/.
10 Valix,C.Financial Accounting(Volume 3).Chapter 16 Statement of Cash Flows.
  also referred as footnote disclosures. These provide additional information
pertaining to a company's operations and financial position and are considered
to be an integral part of the financial statements. The notes are required by the
full disclosure principle.
 The notes to the financial statements are a required, integral part of a
company's external financial statements. They are required since not all relevant
financial information can be communicated through the amounts shown (or not
shown) on the face of the financial statements.
 The footnotes list important information that could not be included in the actual
ledgers.
 The notes will list relevant things like outstanding debt and even details on where
the revenue came from.

PURPOSE OF NOTES TO FINANCIAL STATEMENTS

The purpose of notes to financial statements is “to provide the necessary disclosures
required by Philippine Financial Reporting Standards.”

Specifically, PAS 1, paragraph 112, provides that the notes to financial statements shall:

a) Present information about the basic of preparation of the financial statements

and the specific accounting policies used.
b) Disclose the information required by PFRS that is not presented in the financial
statements.
c) Provide additional information which is not presented in the financial statements
but is relevant to an understanding of the financial statements

Order of Disclosure

PAS 1, paragraph 14, provides that an entity normally presents notes in the following
order to assist users understand the financial statements and to compare them with
financial statements of other entities:

a) Statement of compliance with PFRS

b) Statement of significant accounting policies used
c) Supporting information or computation for line items presented in the
financial statements
d) Other disclosures, such as contingent liabilities, unrecognized contractual
commitments and nonfinancial disclosures.

ADJUSTING AND NON-ADJUSTING EVENTS

PAS 10, paragraph 3, defines events after the reporting period as those events, whether
favorable or unfavorable, that occur between the end of reporting period and the
date on which the financial statements are authorized for issue.

Types of events after reporting period:

a. Adjusting events – after the reporting period are those that provide evidence of
conditions that exist at the end of reporting period
 b. Non adjusting events – after reporting period are those that indicative of
conditions that arise after the end of reporting period.

Examples of adjusting events:

1. Settlement after the reporting period of a court case because it confirms that
entity already had a present obligation at the end of reporting period.
2. Bankruptcy of a customer which occurs after the reporting period.
3. The discovery of fraud or errors that show the financial statements were
incorrect.

Examples of non-adjusting events:

1. Plan to discontinue an operation

2. Destruction of a major production plant by a fire after the reporting period
3. Major purchase and disposal of asset or expropriation of major asset by
government.

EXAMPLE OF ADJUSTING AND NON-ADJUSTING EVENTS

The audit of Anne Company for the year ended December 31, 20x7 was completed on
March 1, 20x8.

The financial statements were signed by the managing director on March 15, 20x8 and
approved by the shareholders on March 31, 20x8.

The following events have occurred:

1. The entity’s issued share capital comprised 100,000 ordinary shares with P100 par
value.
The entity issued additional 25,000 shares on March 1, 20x8 at par value. (Non-
adjusting entry)
2. Specialized equipment with carrying amount of P525, 000 was destroyed by fire
on December 15, 20x7.
The entity has booked a receivable of P400, 000 from the insurance entity.
After the insurance entity completed the investigation on February 1, 20x8, it was
discovered that the fire took place due to negligence of the machine operator.
As a result, the insurer’s liability was zero to claim. (Adjusting entry)11

RELATED PARTY TRANSACTIONS

A related party transaction is a transfer of resources or obligations between related

parties, regardless of whether a price is charged.

Related Party – Parties are considered related if one party has:

11 Valix(2017).Financial Accounting(III). Chapter 5. Events After Reporting Period.

 a. The ability to control the other party
- Control is the power over the investee or the power to govern the
financial and operating policies of an entity so as to obtain
benefits.
b. The ability to exercise significant influence over the party
- Significant influence is the power to participate in the financial and
operating policy decision of an entity, but not control of those
policies.
c. Joint control over the entity.
- Joint control is the contractually agreed sharing of control over an
economic activity

Examples of related parties:

1. Associates – an entity over which the investor has significant influence.

2. Entities that directly or indirectly through one or more intermediaries,
control or are controlled by or under one common control with the
reporting entity.
3. Key management personnel are those persons having authority and
responsibility for planning, directing and controlling the activities of the
entity, directly or indirectly.

Related Party Disclosures

Pas 24, paragraph 12, requires disclosure of related party relationships where
control exists irrespective of whether there have been transactions between the related
parties.

Disclosure of related party transaction

As a minimum, the disclosures of related party transactions shall include:

a. The amount of transaction

b. The amount of outstanding balance, terms and conditions, whether secured or
unsecured, and nature of consideration to be provided in settlement.
c. The allowance for doubtful accounts related to the outstanding balance.

The expense recognized during the period in respect of doubtful accounts due from
related parties.12

EXAMPLE OF RELATED PARTY DISCLOSURES

Jambalaya Company reported the following renumeration and other payments made
to the entity’s chief executive officer during the current year:

Annual salary P 2,000,000

Share options and other share-based payments 1,000,000
Contributions to retirement benefit plan 500,000
Reimbursement of travel expense for business trips 1,200,000

12 Valix,C.Financial Accounting(Volume 3).Chapter 4 Related Parties.

What total amount should be disclosed as compensation to key management
personnel?

Annual salary P 2,000,000

Share options and other share-based payments 1,000,000
Contributions to retirement benefit plan 500,000
Compensation P 3,500,000

Dean Company acquired 100% of Morey Company in the prior year. During the year,
the individual entities included in their financial statements the following: 13

Dean Morey

Key officer’s salaries P 750,000 P 500,000

Officer’s personal expenses 200,000 100,000

Loan’s to officers 1,500,000 500,000

13
Valix,C.Financial Accounting(Volume 3).Chapter 4 Related Parties