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MBA PROGRAMME
MBAD 505: FINANCIAL ACCOUNTING
The basic purpose of a statement cash flows is to provide information about the
sources and application of cash and cash equivalents of an entity. Information
about cash receipts and cash payments of an entity during an accounting period
would help creditors and others in assessing:
The two key financial objectives of every entity are to operate profitably and
stay liquid and solvent. The income statement is designed to measure the
results of operations of an entity in meeting its profit objective for a given period
of time. The statement of income is based on accrual accounting. Therefore, the
revenues, expenses, gains, and losses reported in the statement of income do
not necessarily represent cash inflows and outflows. In general, five distinct
classes of items cause differences between income flows and cash flows:
a) Items that appear on the statement of income that do not represent cash
inflows and outflow, such as depreciation, amortization expense and
depletion. Such items are referred to as non-cash items.
b) Operating cash flows that do not appear on the statement of income but
appear instead on the statement of financial position as prepayments,
deferrals, unearned revenue, or reductions of accruals.
c) Credit items that have been included in the calculation of operating profit
but do not affect the cash inflows and outflows in the same period.
Examples include credit sales, credit purchases and accrued expenses.
d) Activities that result in changes in size and composition of equity capital
and borrowings of the enterprise. Such activities referred to as financing
activities, usually affect cash but may not be reflected fully in the
statement of income. Examples include the issuing of shares, redemption
of shares, borrowings and repayment of the principal amount borrowed.
e) Activities that result in the acquisition and disposal of long term assets
and other investments not included in cash equivalents. Such activities,
referred to as investing activities, usually affect cash flows but may not be
fully reflected on the statement of income. Examples include the purchase
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or sale of equity and or debt instruments of other enterprises and the
purchase or sale of items of property, plant and equipment.
Unlike the statement of financial position and the statement of income, which
are required by the Companies Act, the statement of cash flows is a requirement
of the International Financial Reporting Standards, International Accounting
Standard No.7 in particular. The statement of cash flows or statement of
sources and application of funds or statement of changes in financial position is
not a legal requirement.
a) A statement of cash flows when used in conjunction with the rest of the
financial statements provides information that enables users to evaluate
the changes in net assets of an enterprise, its financial structure (i.e.
liquidity and solvency) and its ability to affect the amounts and timing of
cash flows in order to adapt to changing circumstances and opportunities.
b) Cash flow information is useful in assessing the ability of the enterprise to
generate cash and cash equivalents and enables users to develop models
to assess and compare the present value of the future cash flows of
different enterprises.
c) A statement of cash flows enables the comparability of the reporting of
results by different enterprises because it eliminates the effects of using
different accounting treatments for the same transactions and events.
d) Cash flow information is also useful in checking the accuracy of past
assessments of future cash flows and in examining the relationship
between profitability and net cash flow and the impact of changing prices.
e) Historical cash flow information is often used as an indicator of the
amount, timing and certainty of cash flows.
Definitions
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c) Cash flows are inflows and outflows of cash and cash equivalents.
The statement of cash flows should classify cash flows during the period
between:
a) operating activities,
b) investing activities, and
c) financing activities.
Operating activities.
Cash flows from operating activities are primarily derived from the principle
revenue producing activities of an enterprise. They generally arise from
transactions that involve the determination of net profit. Examples of operating
activities include:
Where an enterprise holds securities for trade purposes, cash flows arising from
the sale or purchases of such securities are classified as operating activities
since they are similar to inventory acquired specifically for resale.
In the case of financial institutions, cash advances and loans made by them are
classified as operating transactions since they relate to the main revenue
producing activities of that enterprise.
Investing activities.
These are the acquisition and disposal of long term and other investments not
included in cash equivalents. Separable disclosure of cash flows arising from
investing activities is important because the cash flows represent the extent to
which expenditures have been made for resources intended to generate future
income and cash flows. Examples of cash flows arising from investing activities
are:
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a) cash payments to acquire property, plant and equipment, intangibles and
other long term assets. These payments include those relating to
capitalized development costs and self constructed property, plant and
equipment;
b) cash receipts from sales of property, plant and equipment, intangibles and
other long-term assets;
c) cash payments to acquire equity or debt instruments of other enterprises
and interests in joint ventures (other than payments of those instruments
considered to be cash equivalents and those held for dealing or trading
purposes);
d) cash receipts from sales of equity or debt instruments of other enterprises
and interests in joint ventures (other than receipts for those instruments
considered to be cash equivalents and those held for dealing or trading
purposes);
e) cash advances and loans made to other parties (other than advances and
loans made by a financial institution); and
f) cash receipts from the payment of advances and loans made to other
parties (other than advances and loans for a financial institution).
Financing activities.
These are activities that result in changes in size and composition of the equity
capital and borrowings of the enterprise. Examples of cash flows arising from
financing activities are:
Investing and financing transactions that do not require the use of cash or cash
equivalents should be excluded from a statement of cash flows. Such
transactions should be disclosed else where in the financial statements in a way
that provides all the relevant information about these investing and financing
activities. Examples of such transactions include:
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Format of Presentation:
Enterprises are required to report cash flows from operating activities using
either the
a) direct method, or
b) indirect method.
Under this method information about major classes of gross cash receipts and
gross cash payments are disclosed.
Illustrative format
XYZ CO. LTD.
STATEMENT OF CASH FLOWS
FOR THE PERIOD ENDED 31ST DECEMBER 2008.
Interest received XX
Dividends received XX
Proceeds from sale of marketable securities XX
Purchase of marketable securities (XX)
Purchase of plant and equipment (XX)
Proceeds from sale of equipment XX
Net cash from investing activities XX
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Add: Cash and cash equivalents at beginning of period XX
Cash and cash equivalents at end of period XX
Illustrative format
XYZ CO. LTD.
STATEMENT OF CASH FLOWS
FOR THE PERIOD ENDED 31ST DECEMBER 2008
Interest received XX
Dividends received XX
Proceeds from sale of marketable securities XX
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Purchase of marketable securities (XX)
Purchase of plant and equipment (XX)
Proceeds from sale of equipment XX
Net cash from investing activities
XX
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