This document discusses the requirements of IND AS 7 regarding the statement of cash flows. It defines cash flows, cash, and cash equivalents. It explains the three categories of cash flows - operating, investing and financing activities. It provides examples of cash flow activities that fall under each category. It discusses the direct and indirect methods for preparing the statement of cash flows. It addresses the classification and disclosure requirements regarding interest, dividends, taxes, acquisitions and disposals.
2. WHAT ARE CASH FLOWS, CASH, AND CASH
EQUIVALENTS?
Cash flows are inflows and outflows of cash and cash
equivalents;
Cash is cash on hand and held in demand (at call)
deposits;
Cash equivalents are short-term, highly liquid
investments readily convertible to cash and subject to an
insignificant risk of changes in value. An investment will
generally be short-term if it is purchased and sold as part
of the entity’s cash management activities and has a
maturity of three months or less from the date of
acquisition – for example, short-term money market
investments and fixed term deposits with a maturity
period of less than three months.
3. • principal revenue-producing activities
• not investing or financing activities
Operating
activities
• acquisition and disposal of long-term
assets
• other investments that are not cash
equivalents
Investing
activities
• activities that change the size and
composition of the contributed equity
and borrowings of the entity
Financing
activities
HOW IS THE STATEMENT OF CASH FLOWS
PRESENTED?
4. Operating
activities
• sale of goods
• suppliers goods and
services
• employees
• insurance
premium/claims
• income taxes
Investing
activities
• cash payments to
acquire and
proceeds from sale
of PPE
• cash payments to
acquire and
proceeds from sale
of equity or debt
• proceeds from sale
of equity or debt
• cash advances and
loans, including
repayments
(excluding loans
from banks)
Financing
activities
• cash proceeds from
issuing shares and
payments for their
redemption;
• cash proceeds from
issuing debentures
and loans and their
repayment;
• cash payments by a
lessee to reduce a
finance lease
liability;
• interest paid (if
classified on that
basis).
EXAMPLES
6. The following requirements apply to the classification of cash flows
from interest, dividends and tax
Source Classification
Interest paid Must be classified consistently from
period to period as operating or
financing
Dividend paid Must be classified as financing
Interest and
dividends
received
Must be classified consistently from
period to period as operating or
investing
Taxes on
income
Must be separately disclosed and
classified as operating activities unless
they can be specifically identified with
financing and/or investing activities
HOW IS INTEREST, DIVIDENDS AND TAX
CLASSIFIED?
7. A reconciliation of cash flows arising from operating activities to
profit or loss
Non-cash financing and investing activities
The components of cash and cash equivalents
a reconciliation of the cash disclosed in the cash flow
statement to items in the balance sheet
Significant cash and cash equivalent balances held that are not
available for use
7
WHAT DISCLOSURES ARE REQUIRED?
8. Disclosures of the following information (in aggregate) is required
in relation to acquisitions and disposals of subsidiaries and
business units:
Total purchase or disposal consideration
The amount of consideration discharged in cash
The amounts of cash and cash equivalents in the subsidiary or
business unit
The non-cash assets and liabilities in the subsidiary or business
unit
WHAT DISCLOSURES ARE REQUIRED?
Provide a background to IAS 7:
The statement of cash flows (cash flow statement) is one of the primary statements in financial reporting (along with the statement of comprehensive income, the balance sheet and the statement of changes in equity). It provides users with a basis to assess the entity's ability to generate and utilise its cash.
IAS 7 requires a statement of cash flows to be presented and specifies the manner in which a statement is to be prepared, including a requirement that cash flows must be classified as arising from operating, investing or financing activities. All entities must include a cash flow statement as part of their financial statements to be IFRS compliant. There are no exemptions available from this requirement.
This session is one of the topics on preparing financial statements, which also includes IAS 1 and IAS 8.
Cash flows
The resulting cash flow total for the period is the movement in the balance of cash and cash equivalents from the start of the period to the end. If the total for cash and cash equivalents presented cannot be traced directly to the balance sheet, a reconciliation is presented in the notes to the financial statements disclosing the components of cash and cash equivalents used for the cash flow statement and how these reconcile back to the balance sheet. [IAS 7 para 45].
Cash
Demand deposits are not defined in IFRSs, but a view in practice is that demand deposits should have the same level of liquidity as cash, and therefore, should be able to be withdrawn at any time without penalty. There is no requirement for demand deposits to be held with a financial institution.
Cash equivalents
Cash equivalents are defined as "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". Short-term is viewed by IAS 7 as normally meaning investments with an original maturity of three months or less. [IAS 7 paras 6, 7]. Investments with a longer maturity at acquisition do not become cash equivalents once their remaining maturity period falls to three months. [IAS 7 para 7]
Items that are not ‘known amounts of cash’, such as investments in equity securities, are not cash equivalents.
In practice, an overriding test is that cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For example, an entity gives a three-month loan to a customer to assist the customer in managing its short-term liquidity position. A view in practice is that this loan is not a cash equivalent because it was given for a purpose other than for the entity to manage its own short-term cash commitments.
When a bank overdraft is used as part of an entity’s day-to-day cash management tools rather than as a financing arrangement, it is included in the balance of cash and cash equivalents. Typically, such overdraft accounts will regularly fluctuate between a positive and a negative balance. [IAS 7 para 8] In all other circumstances, an overdraft balance is treated as part of the entity’s financing.
Cash flows are classified as cash flows from operating activities if:
they arise from activities that are the principal revenue-producing activities of the entity; or
they are otherwise not investing or financing activities. (Effectively, this makes operating activities the default category.)
Cash flows from investing activities include:
cash payments to acquire property, plant and equipment, and proceeds from their sale;
cash payments to acquire equity or debt instruments, and proceeds from their sale;
cash advances and loans and their repayment (excluding loans made by financial institutions).
Only expenditures that result in a recognised asset in the balance sheet are eligible for classification as cash flows from investing activities. This may impact the classification of expenditure such as that on exploration activities or internal research activities where this cannot be capitalised as an intangible asset
Cash flows from financing activities include cash flows relating to obtaining, redeeming (and potentially servicing) sources of finance;
Now can you give me some examples of what are cash flows from: (i) operating activities; (ii) investing activities; (iii) financing activities
Some examples of cash flows relating to operating activities include:
cash receipts from the sale of goods;
cash receipts from providing services;
cash payments to suppliers for goods and services;
cash payments to employees;
cash payments for insurance premium/claims;
cash payments for income taxes.
Some examples of cash flows relating to investing activities include:
cash payments to acquire property, plant and equipment, and proceeds from their sale;
cash payments to acquire equity or debt instruments, and proceeds from their sale;
cash advances and loans and their repayment (excluding loans made by financial institutions).
Some examples of cash flows relating to financing activities include:
cash proceeds from issuing shares and payments for their redemption;
cash proceeds from issuing debentures and loans and their repayment;
cash payments by a lessee to reduce a finance lease liability;
interest paid on borrowings.
Management may present operating cash flows by using either the direct method or the indirect method. The direct method reports major classes of gross cash receipts and gross cash payments. The indirect method reports the adjustment of net profit or loss for non-operating and non-cash transactions, and for changes in working capital.
Entities are encouraged to report cash flows from operating activities using the direct method, because the information provided is more useful. [IAS 7 para 19].
Now we’ll take a look at examples of statement of cash flows in the PricewaterhouseCoopers Illustrative Financial Statements. There are also examples provided in IAS 7 Illustrative Examples.
[Instructors’ note: walk through the cash flow statements pointing out the different types of cash flows from operating, investing and financing activities, and the difference between the direct and indirect method.]
Interest and dividend cash flows
The cash flows arising from dividends and interest receipts and payments should be classified in the cash flow statement, in a consistent manner from period to period, under the activity appropriate to their nature. These items are required to be disclosed separately on the face of the cash flow statement. IAS 7 does not dictate how dividends and interest cash flows should be classified, but rather allows an entity to determine the classification appropriate to its business.
It is generally accepted that dividends received and interest paid or received in respect of the cash flows of a financial institution will be classified as operating activities. For other types of entities, interest and dividends received may be classified in either operating or investing activities. Interest and dividends paid are normally classified as either operating or financing activities. [IAS 7 paras 33, 34].
In May 2012, the IASB issued an improvements exposure draft proposing that payments relating to interest capitalised under IAS 23 are classified in accordance with the classification of the underlying asset on which those payments were capitalised. This would mean, for example, that payments of interest capitalised as part of the cost of property, plant and equipment would be classified as investing activities, and payments of interest capitalised as part of the cost of inventories would be classified as operating activities. This outcome of this proposed improvement is pending at the time of writing this material.
Taxes on income
Tax cash flows are normally classified as operating cash flows. However, where specific cash flows can be identified with either investing activities or financing activities, then it is appropriate to classify that element of the tax cash flows as investing or financing respectively. [IAS 7 para 10]. Where the tax cash flows are included in investing or financing categories, disclosure of the total tax cash flows should also be given. [IAS 7 para 36].
Reconciliation of cash flows arising from operating activities to profit or loss
When an indirect cash flow method is prepared, the entity is required to reconcile cash flows arising from operating activities to profit or loss (IAS 7 para 20). See an example of this reconciliation on page 100 of the PricewaterhouseCoopers Illustrative Financial Statement (note 36)
Non-cash financing and investing activities
Investing and financing transactions that do not require the use of cash and cash equivalents is excluded from the statement of cash flows. Examples are the acquisition of assets either by assuming directly related liabilities or by means of a finance lease; the issue of equity for the acquisition of a subsidiary; and the conversion of debt to equity. Such transactions are required to be disclosed elsewhere in the financial statements in a way that provides all the relevant information about these investing and financing activities. It is important to note that only significant non-cash transactions should be disclosed, not every non-cash transactions. Other non-cash transactions that are not typically significant include impairment losses/reversals; depreciation; amortisation; fair value gains/losses; and income statement charges for provisions. [IAS 7 para 43].
Components of cash and cash equivalents
Components of cash and cash equivalent are required to be disclosed (see page 80 of the PricewaterhouseCoopers Illustrative Financial Statement) [IAS 7 para 45]
If the total for cash and cash equivalents presented in the cash flow statement cannot be traced directly to the balance sheet, a reconciliation is presented in the notes to the financial statements disclosing the components of cash and cash equivalents used for the cash flow statement and how these reconcile back to the balance sheet. [IAS 7 para 45].
In view of the variety of cash management practices and banking arrangements around the world and in order to comply with IAS 1, an entity should disclose the policy which it adopts in determining the composition of cash and cash equivalents
Cash and cash equivalent held that are not available for use
Restricted cash balances should be disclosed in a note to the cash flow statement, including a narrative explanation of any restriction. [IAS 7 para 48]. There are circumstances where cash and cash equivalent balances held by an entity are not available for use by the entity, for example, cash held by an entity that acts as an ‘agent’ to its customers, and cash held by a subsidiary that operates in a country where exchange controls or other legal restrictions apply when the balances are not available for general use by the parent or other subsidiaries.
Some more disclosures are required if you prepare group accounting. These disclosures relate to changes in ownership interests in subsidiaries and other businesses. [Paragraph 39 to 42B of IAS 7]
Look at an example disclosure for total purchase consideration during the period on page 107 (note 42) of the PricewaterhouseCoopers Illustrative Financial Statements