Discuss the purposes of the statement of cash flows
- Discuss the purposes of the statement of cash flows.
The purpose of a cash flow statement is to provide information about the historical changes to an entity’s cash and cash equivalents. It is designed to help users of GPFSs to assess the ability of the entity to generate cash and the needs of the entity to use cash. According to the standard, the cash flow statement, when used in conjunction with the other financial statements will benefit users in that it will enable them to:
- Evaluate the changes in net assets of the entity
- Evaluate the entity’s financial structure, including its liquidity and solvency
- Evaluate the entity’s ability to adapt to changing circumstances and opportunities
- Assess the entity’s ability to generate cash in the future and enable predictions of future cash flows to be made
- Compare the performance of this entity with other entities because it eliminates the effects of using different accounting treatments (for example depreciation methods) for the same transactions and events
- Check the accuracy of past assessments of future cash flows, and
- Examine the relationship between profitability and net cash flow
The cash flow statement can also provide useful information to internal users such as managers in their planning and controlling operations.
- Describe the concept of cash used in the preparation of the statement of cash flows.
The concept of cash adopted by IAS 7/AASB 107 covers both cash and cash equivalents. Note the definitions of ‘cash’ and ‘cash equivalents’ in the standard. Note also (from paragraph 8 of the standard) that certain borrowings (e.g. bank overdrafts) may be included in the definition of cash equivalents if they are repayable on demand and form an integral part of the entity’s cash management function.
The definition of ‘cash and cash equivalents’ is important as an item included in this concept cannot generate a cash flow and is therefore is not reported in the cash flow statement. That is, increasing a bank balance with funds from a short-term bank bill doesn’t generate a cash flow, whereas decreasing a bank account to purchase machinery is a cash flow.
- Describe the direct method of preparing the cash flows from operating activities in a statement of cash flows. Contrast this with the indirect method.
When preparing the cash flows from operating activities using the direct method, entities are required to show major classes of revenue as gross cash inflows from operations and major classes of expenses as cash outflows from operations. Subsequently, the net cash flows from operating activities is calculated as the difference between the cash inflows and cash outflows from operations. In order to determine the net cash flows from operating activities under the direct method, items used in determining profit (i.e. revenues and expenses) under accrual basis must be converted into cash basis. For example, accrual-basis sales and other revenues are adjusted to provide cash receipts from customers. Accrual-basis expenses (e.g. cost of sales, wages, and other expenses) are adjusted to reflect cash outflows from various classes of operating activities.
The indirect method, on the contrary, does not show major classes of operating cash inflows and outflows. When using the indirect method to determine net cash flows from operating activities, non-cash items (such as gains or losses from disposal of non-current assets and depreciation) and any changes in current assets and current liabilities are added or subtracted from accrual-basis profit to make adjustment to cash-basis profit.
Although entities are allowed to use either direct method or indirect method in preparing cash flows from operating activities, the AASB 107 recommends the use of direct method because it provides information not otherwise available in the other financial statements and a more reliable basis for estimating future cash flows from operations, whereas the indirect method does not provide information about cash inflows or outflows from individual items of operating activities.
Exercise 18.8
Direct and indirect methods
The comparative statements of financial position of Hutt Electrical as at 30 June 2016 and 2017 and the income statement for the year ended 30 June 2017 are shown overleaf.
Additional information
- Other expenses include $55 500 depreciation expense.
- All sales and purchases of inventory are on credit.
Required
- Prepare a statement of cash flows from operating activities only for Hutt Electrical for the year ended 30 June 2017 using the direct method.
- Repeat requirement A using the indirect method.
|
hutt electrical Comparative Statements of Financial Position as at 30 June | |||||||||||||
|
2016 |
2017 | ||||||||||||
|
ASSETS Cash at bank Accounts receivable Inventory Prepaid insurance Property Plant and equipment Accum. depreciation – plant and equipment |
$ 22 500 82 500 165 000 7 500 190 500 757 500 (102 000) |
$ 69 000 70 500 216 000 1 500 172 500 1 072 500 (154 500) | |||||||||||
|
TOTAL ASSETS |
$1 123 500 |
$1 447 500 | |||||||||||
|
LIABILITIES AND EQUITY Accounts payable Interest payable Other accrued expenses Mortgage payable Share capital Retained earnings |
$ 64 500 7 500 13 500 367 500 500 000 170 500 |
$ 75 000 4 500 18 000 442 500 750 000 157 500 | |||||||||||
|
TOTAL LIABILITIES AND EQUITY |
$1 123 500 |
$1 447 500 | |||||||||||
|
hutt electrical Income Statement for the year ended 30 June 2017 | |||||||||
|
Sales Less: Cost of sales |
$1 047 000 780 000 | ||||||||
|
Gross profit Add:Other income: Rent income Gain on sale of property |
$ 9 000 20 000 |
267 000 29 000 | |||||||
|
296 000 | |||||||||
|
Less: Expenses: Interest expense Loss on sale of plant Other expenses |
34 500 6 500 231 000 |
272 000 | |||||||
|
Profit |
$24 000 | ||||||||
|
HUTT ELECTRICAL Statement of Cash Flows (Extract) for the year ended 30 June 2017 | ||
|
Cash flows from operating activities: | ||
|
Cash receipts from customers |
$1 059 000 | |
|
Cash paid to suppliers and employees |
(985 500) | |
|
Cash generated from operations |
73 500 | |
|
Interest paid |
(37 500) | |
|
Net cash from operating activities |
$36 000 | |
Workings: Cash receipts from sales
Accounts Receivable
|
Balance b/d |
82 500 |
Cash from customers |
1 059 000 |
|
Sales |
1 047 000 |
Balance c/d |
70 500 |
|
1 129 500 |
1 129 500 |
Cash payments for purchases
Inventory
|
Balance b/d |
165 000 |
Cost of Goods sold |
780 000 |
|
Purchases |
831 000 |
Balance c/d |
216 000 |
|
996 000 |
996 000 |
Accounts Payable
|
Cash |
820 500 |
Balance b/d |
64 500 |
|
Balance c/d |
75 000 |
Purchases |
831 000 |
|
895 500 |
895 500 |
Other Accrued Expenses
|
Cash |
165 000 |
Balance b/d |
13 500 |
|
Balance c/d |
18 000 |
Other expenses* |
169 500 |
|
183 000 |
183 000 |
*Other expenses = $231 000 – $55 500 (depreciation) – $6000 (prepaid insurance) = $169 500
Cash paid to suppliers and employees = $820 500 (creditors) + $165 000 (expenses)
= $985 500
Interest paid
Interest Payable
|
Cash paid |
37 500 |
Balance b/d |
7 500 |
|
Balance c/d |
4 500 |
Expense |
34 500 |
|
42 000 |
42 000 |
Note: Rental income is excluded from operating activities in the statement of cash flows as it is argued that it is earned as a result of an investing activity. Nevertheless there is an argument for including it as an operating activity. See AASB 107 paras. 14 and 33. It is argued here that rent received (on investments) is similar to interest received (on investments).
- Repeat requirement A using the indirect method.
|
HUTT ELECTRICAL Statement of Cash Flows (Extract) | |||
|
for the year ended 30 June 2017 | |||
|
Inflows (Outflows) | |||
|
Cash flows from operating activities: | |||
|
Profit for the period |
$24 000 | ||
|
Depreciation expense |
55 500 | ||
|
Gain on sale of property |
(20 000) | ||
|
Loss on sale of plant |
6 500 | ||
|
Rent income* |
(9 000) | ||
|
Changes in assets and liabilities | |||
|
Decrease in accounts receivable |
$12 000 | ||
|
Increase in inventory |
(51 000) | ||
|
Decrease in prepaid expenses |
6 000 | ||
|
Increase in accounts payable |
10 500 | ||
|
Decrease in interest payable |
(3 000) | ||
|
Increase in accrued expenses |
4 500 |
(21 000) | |
|
Net cash flows from operating activities |
$36 000 | ||
* As noted in part A above, rental income is included under investing activities, not operating activities.
|
Exercise 18.10 |
Proprietary company, with direct and indirect methods |
The following comparative statements of financial position and income statement are for the business of Bargains Galore Pty Ltd:
|
bargains galore PTY LTD Comparative Statements of Financial Position as at 30 June | |||||||||||
|
2016 |
2017 | ||||||||||
|
ASSETS Cash at bank Accounts receivable Inventory Prepaid expenses Plant and equipment Accumulated depreciation – plant and equipment |
$ 20 000 74 000 60 000 44 000 600 000 (180 000) |
$ 30 000 52 000 88 000 36 000 648 000 (230 000) | |||||||||
|
$618 000 |
$624 000 | ||||||||||
|
LIABILITIES AND EQUITY Accounts payable Expenses payable Current tax liability Share capital Retained earnings |
$ 96 000 22 000 50 000 300 000 150 000 |
$ 60 000 40 000 44 000 300 000 180 000 | |||||||||
|
$618 000 |
$624 000 | ||||||||||
|
bargains galore PTY LTD Income Statement for year ended 30 June 2017 | |||||||||
|
INCOME Sales revenue |
$800 000 | ||||||||
|
EXPENSES Cost of sales Wages and salaries Depreciation – plant and equipment Other expenses Income tax expense |
$408 000 160 000 50 000 78 000 44 000 |
740 000 | |||||||
|
PROFIT |
$ 60 000 | ||||||||
Additional information
(a) All sales and purchases of inventory are on credit.
(b) Income tax is paid in one instalment during the year.
(c) A dividend had been paid to shareholders.
(d) Additional plant had been acquired for a cash outlay.
Required
- Prepare the statement of cash flows for the company for the year ended 30 June 2017. Use the direct method.
- Repeat requirement A using the indirect method.
|
BARGAINS GALORE PTY LTD Statement of Cash Flows for the year ended 30 June 2017 | ||
|
Cash flows from operating activities: | ||
|
Cash receipts from customers |
$822 000 | |
|
Cash paid to suppliers and employees |
(684 000) | |
|
Cash generated from operations |
138 000 | |
|
Income taxes paid |
(50 000) | |
|
Net cash from operating activities |
$88 000 | |
|
Cash flows from investing activities: | ||
|
Purchase of plant and equipment |
(48 000) | |
|
Net cash used in investing activities |
(48 000) | |
|
Cash flows from financing activities: | ||
|
Dividends paid |
(30 000) | |
|
Net cash used in financing activities |
(30 000) | |
|
Net increase (decrease) in cash and cash equivalents |
10 000 | |
|
Cash and cash equivalents at beginning of year |
20 000 | |
|
Cash and cash equivalents at end of year |
$30 000 | |
Workings:
Cash receipts from customers
Accounts Receivable
|
Balance b/d |
74 000 |
Cash from customers |
822 000 |
|
Sales |
800 000 |
Balance c/d |
52 000 |
|
874 000 |
874 000 |
Cash paid to suppliers
Cash payments for purchases
Inventory
|
Balance b/d |
60 000 |
Cost of Goods sold |
408 000 |
|
Purchases |
436 000 |
Balance c/d |
88 000 |
|
496 000 |
496 000 |
Accounts Payable
|
Cash paid |
472 000 |
Balance b/d |
96 000 |
|
Balance c/d |
60 000 |
Purchases |
436 000 |
|
532 000 |
532 000 |
Expenses Payable
|
Cash |
212 000 |
Balance b/d |
22 000 |
|
Balance c/d |
40 000 |
Other expenses* |
230 000 |
|
252 000 |
252 000 |
*Other expenses = $160 000 (wages) + $78 000 (other expenses) – $8000 (prepaid expenses
expired)
* = $230 000
Cash paid to suppliers and employees = $472 000 (inventory) + $212 000 (expenses)
= $684 000
Income tax paid
Current Tax Liability
|
Cash paid |
50 000 |
Balance b/d |
50 000 |
|
Balance c/d |
44 000 |
Income tax expense |
44 000 |
|
94 000 |
94 000 |
Dividends paid
Retained Earnings
|
Dividends paid |
30 000 |
Balance b/d |
150 000 |
|
Balance c/d |
180 000 |
Profit for the period |
60 000 |
|
210 000 |
210 000 |
|
Problem 18.2 |
Statement of cash flows for a sole trader | ||
Financial figures of the business of C. Wilson for the last 2 years are shown below.
|
c. wilson Comparative Statements of Financial Position as at 30 June | |||||||||||||||
|
2017 |
2018 | ||||||||||||||
|
ASSETS Cash at bank Accounts receivable Inventory Plant and equipment Accumulated depreciation – plant and equipment |
$9 000 4 200 |
$4 200 14 400 4 800 |
$10 800 4 500 |
$ 2 820 5 100 16 800 6 300 | |||||||||||
|
Land Buildings Accumulated depreciation – buildings |
12 000 600 |
12 000 11 400 |
12 000 840 |
6 000 11 160 | |||||||||||
|
$46 800 |
$48 180 | ||||||||||||||
|
LIABILITIES AND EQUITY Accounts payable Bank overdraft C. Wilson, Capital |
$ 7 200 3 000 36 600 |
$ 7 800 40 380 | |||||||||||||
|
$46 800 |
$48 180 | ||||||||||||||
The income statement for the business for the year ended 30 June 2018 reveals the following details:
|
C. Wilson Income Statement for the year ended 30 June 2018 | |||||||
|
INCOME Sales revenue OTHER INCOME Gain from sale of land |
$ 18 000 2 400 | ||||||
|
EXPENSES Cost of sales Depreciation of plant and equipment Depreciation of buildings Loss of sale of plant Other expenses |
$9 600 1 200 240 180 2 640 |
20 400 13 860 | |||||
|
PROFIT |
$6 540 | ||||||
Additional information
(a) During the year ended 30 June 2018, Wilson withdrew $30 per week in cash for 52 weeks for private purposes.
(b) Wilson also withdrew $1200 on her business bank account to pay her personal income tax.
(c) Land, shown in the accounts at $6000, was sold during the year for $8400.
(d) Plant costing $1800 and written down to $900 was sold for $720.
(e) Ignore GST.
Required
- Prepare a statement of cash flows for the year ended 30 June 2018 using the direct method.
- Prepare the note to the above statement reconciling cash flows from operating activities with profit.
|
C. WILSON Statement of Cash Flows for the year ended 30 June 2018 | ||
|
Cash flows from operating activities: | ||
|
Cash receipts from customers |
$17 100 | |
|
Cash paid to suppliers and employees |
(14 040) | |
|
Cash generated from operations |
3 060 | |
|
Net cash from operating activities |
$3 060 | |
|
Cash flows from investing activities: | ||
|
Purchase of property, plant and equipment |
(3 600) | |
|
Sale of property, plant and equipment* |
9 120 | |
|
Net cash from investing activities |
5 520 | |
|
Cash flows from financing activities: | ||
|
Drawings** |
(2 760) | |
|
Net cash used in financing activities |
(2 760) | |
|
Net increase (decrease) in cash and cash equivalents |
5 820 | |
|
Cash and cash equivalents at beginning of year*** |
(3 000) | |
|
Cash and cash equivalents at end of year |
$2 820 | |
*Sale of property, plant and equipment = $8 400 (land) + $720 (plant)
= $9 120
**Drawings = ($30 ´ 52 weeks) + $1 200 = $2 760
***Bank overdraft is a part of the entity’s cash management function.
Workings:
Cash receipts from customers
Accounts Receivable
|
Balance b/d |
4 200 |
Cash from customers |
17 100 |
|
Sales |
18 000 |
Balance c/d |
5 100 |
|
22 200 |
22 200 |
Cash paid to suppliers
Cash payments for purchases
Inventory
|
Balance b/d |
14 400 |
Cost of Goods sold |
9 600 |
|
Purchases |
12 000 |
Balance c/d |
16 800 |
|
26 400 |
26 400 |
Accounts Payable
|
Cash paid |
11 400 |
Balance b/d |
72 00 |
|
Balance c/d |
7 800 |
Purchases |
12 000 |
|
19 200 |
19 200 |
Cash paid to suppliers and employees = $11 400 (inventory) + $2640 (other expenses)
= $14 040
Purchase of property and equipment
Plant and Equipment
|
Balance b/d |
9 000 |
Cost of plant sold |
1 800 |
|
Purchase |
3 600 |
Balance c/d |
10 800 |
|
12 600 |
12 600 |
Purchase of property, plant and equipment = $3600 (plant)
Reconciliation of net cash from operating activities to profit
|
Profit for the period |
$6 540 | |
|
Depreciation – plant and equipment |
1 200 | |
|
Depreciation – buildings |
240 | |
|
Gain on sale of land |
(2 400) | |
|
Loss on the sale of plant |
180 | |
|
Changes in current assets and current liabilities: | ||
|
Increase in accounts receivable |
(900) | |
|
Increase in inventory |
(2 400) | |
|
Increase in accounts payable |
600 |
(2 700) |
|
Net cash from operating activities |
$3 060 | |
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