Accounting and Reporting on a Chapter 1 Accounting and Reporting on a Cash Flow Basis

Objectives By the end of this chapter, you should be able to: explain the extent to which cash flow accounting satisfies the information needs of shareholders and managers; prepare a cash budget and operating statement of cash flows; explain the characteristics that makes cash flow data a reliable and fair representation; critically discuss the use of cash flow accounting for predicting future dividends.

Shareholders External users – Restricted information Quality of information Tensions between investor needs and management’s willingness to provide Projections based on “best” estimates General-purpose reports Cannot provide detailed information for all user needs Shareholders’ information needs primary concern. They are the owners and providers of economic resources

External users – accountants’ skills External users expect accountants to have: Technical expertise – IFRS compliance Commercial awareness – substance over form WHEREAS: Internal users – Accountants are Managers and have: Access to detailed financial budget/actual results No statutory restriction on detail Companies operate on ‘need to know’ basis i.e managers only get the information they need to carry out their responsibilities to the best of their abilities

Internal reports – accountants’ skills Ability to provide reports specific to the needs; so, they are a good basis for decisions Skilled communicator Reports are clear and precise User confidence that reports are: Relevant and timely Objective and verifiable Reliable and complete in material respects Fair representations.

Steps when reporting to users. See example pp. 8-15 (pp Steps when reporting to users. See example pp.8-15 (pp.4-11) of text book Figure 1.1 General financial decision model to illustrate the user/accountant interface

Illustration of cash-based statements Need to be familiar with IRR calculation Initial investment appraisal (see p.8 (p.7)) NPV of cash flows – criterion is positive NPV at 10% Investment data (p.9 (p.7)) Capital outlay 80,000 (cost of lease) Forecast income 30,000 annually for 5 years Final receipt 29,000 in year 6.

Illustration – forecast (expected) period financial report for first 6 months Figure 1.6 Forecast of realised operating cash flows

Illustration – first 6 months actual cash flows for monthly sales Figure 1.7 Monthly sales, purchases and expenses for 6 months ended 30 June 20X1

Illustration – realised operating cash flows Figure 1.8 Monthly realised operating cash flows

Illustration – realised operating cash flows for first 6 months Figure 1.9 Realised operating cash flows for the 6 months ended 30 June 20X1

Illustration – budget/actual comparison Figure 1.10 Forecast/actual comparison

What characteristics make this data relevant? Objective Consistent Confirmatory Predictive Accounting standards only required when judgements have to be made – Eg. estimating bad and doubtful debts Cash based; so, No need for FRSs or IFRSs.

Statement of financial position under cash flow concept needed as: Basis to assess stewardship The accounting system records all transactions Includes capital cash flows Preparation of a statement of financial position Basis to evaluate working capital policies.

Illustration – cash flow statement See Figure 1.8 for operating cash flows. Figure 1.11 Cash flow statement to calculate the net cash balance

Illustration – Statement of financial position Figure 1.12 Statement of financial position

Illustration – Statement of financial position Assuming lease has a realisable value of 74,000 with an unrealised operating outflow of 6,000 Figure 1.13 Statement of financial position as at 30 June 20X1 (assuming that there were unrealised operating cash flows)

Characteristics that make data reliable Prudence Reasonable, but NOT excessive Neutrality Present best picture for business, but not a misleading one Completeness Faithful representation Substance over form – commercial reality.

Summary – cash flow accounting How useful is it for internal decision-making? Forecast CFs are relevant for investment appraisal Actual CFs are relevant for confirmation of the investment decision Both forecast and actual CFs are relevant for working capital management

Summary – cash flow accounting (Continued) How useful is it for making management accountable? Realised cash flows are useful for capital investment decision and monitoring Note that unrealised cash flows are also necessary for stewardship purposes.

Summary – cash flow accounting (Continued) How useful is it for external reporting? Relevant for stewardship and accountability Reliable Objective Consistent Prudent Neutral.