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Discuss the purposes of the statement of cash flows

  1. 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.

  1. 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.

  1. 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

  1. Prepare a statement of cash flows from operating activities only for Hutt Electrical for the year ended 30 June 2017 using the direct method.
  2. 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).

  1. 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

  1. Prepare the statement of cash flows for the company for the year ended 30 June 2017. Use the direct method.
  2. 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

  1. Prepare a statement of cash flows for the year ended 30 June 2018 using the direct method.
  2. 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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