1. The statement of cash flows
Chapter 19
The statement of cash flows

2. Objectives of this lecture
Understand what a statement of cash flows is, and why it is useful
Understand the accounting requirements relating to the disclosure of information about an organisation’s cash flows
Understand how to construct a statement of cash flows in conformity with AASB 107 Statement of Cash Flows
Understand how the statement of cash flows provides information that is a useful complement to the statement of financial position and the statement of comprehensive income

3. Objectives (cont.)
Understand how we define ‘cash’ and ‘cash equivalents’ for the purposes of a statement of cash flows and understand that these definitions mean that statements of cash flows address transactions beyond those involving merely ‘cash’
Understand the differences between cash flows from operations, cash flows from investing, and cash flows from financing activities
Be aware of the various supporting notes that must accompany a statement of cash flows

4. Comparison with other financial statements
Statement of financial position
shows financial position at a certain date
Statement of comprehensive income
shows profit or loss and other items of comprehensive income that have been generated for a period of time using accrual accounting
Statement of changes in equity
Provides a reconciliation of opening and closing equity as well as the various equity accounts that are impacted by the period’s total comprehensive income

5. Comparison with other financial statements (cont.)
Statement of cash flows
explains the movements in cash and cash equivalents for a given period
provides a reconciliation of opening and closing total of cash and cash equivalent balances appearing in the statement of financial position
indicates sources of cash in terms of cash flows from operations, investing, and from financing activities

6. Purpose of statement of cash flows
Assists in assessing the liquidity of the company or economic entity
By having knowledge of both cash flows and accrual of profits/losses, investors are likely to be better able to assess the performance and viability of the reporting entity
Argued to be more reliable than profit data
Cash-flow data tends to be more ‘factual’ or ‘objective’
Considered to be more understandable to users
Cash flows from operations are considered (by some people) to be a superior performance measure and useful in assessing liquidity and solvency

7. Objective of the standard
Objective of AASB 107 Statement of Cash Flows is: to require the provision of information about the historical changes in cash and cash equivalents of an entity by means of a statement of cash flows, which classifies cash flows during the period from operating, investing and financing activities

8. Defining ‘cash’ and ‘cash equivalents’
AASB 107 requires the statement of cash flows to provide information about ‘cash’ and ‘cash equivalents’ Cash flows—inflows and outflows of cash and cash equivalents Cash—cash on hand (notes and coins held) and demand deposits (deposits on call with a financial institution) Cash equivalents—Highly liquid investments with short periods to maturity that are readily convertible to cash on hand plus borrowings that are integral to the cash management function and are not subject to a term facility

9. Defining ‘cash’ and ‘cash equivalents’ (cont.)
AASB 107 requires that the amount of ‘cash’ and ‘cash equivalents’ as at the end of the financial year as presented in the statement of cash flows be reconciled (by way of a note to the financial statements) to the related items in the statement of financial position (refer to Exhibit 19.2 on page 668 of the text)
Also required to disclose policy adopted by organisation for determining which items are classified as ‘cash’ in the statement of cash flows
Explicit disclosure of this policy to assist users in understanding the statement of cash flows

10. Defining ‘cash’ and ‘cash equivalents’ (cont.)
For an item to be considered to be a ‘cash equivalent’ it must be highly liquid and be used as part of the cash management of the company
Result—cash equivalent in one entity might not be a cash equivalent in another
Depends on the respective cash-management programs adopted—bank and non-bank bills (highly liquid investments) typically meet the definition of cash
Account items such as accounts receivable, accounts payable, any borrowings subject to a term facility or equity securities would be excluded from cash equivalents

11. Classification of cash flows
AASB 107 requires that cash flows be classified into those relating to:
operating activities
the principal revenue-producing activities of the entity and other activities that are not investing and financing activities, i.e. relate to the provision of goods and services, and other activities that are neither financing nor investing activities (refer to definitions of financing and investing)

12. Classification of cash flows (cont.)
investing activities
the acquisition and/or disposal of long-term assets (including property, plant and equipment) and other investments (such as securities) not included in cash equivalents
financing activities
relating to changing the size and/or composition of the financial structure of the entity, including equity and borrowings not falling within the definition of cash

13. Format of statement of cash flows
Appendix to AASB 107 provides a suggested format
Prior-year comparisons required
Some items ordinarily considered operating items for statement of comprehensive income purposes might not be treated the same for cash-flow purposes and vice versa (e.g. interest paid)
Number of items to be separately disclosed (AASB 107)
Additional issues

14. Difference between operating profit and net cash flows from operating activities
Before recent amendments to AASB 107, there was a requirement to provide a reconciliation of profit or loss with net cash flows from operating activities
AASB 107, par. 43 requires that information about transactions and events that do not result in cash flows during the financial year but affect assets and liabilities that have been recognised are to be disclosed in the financial statements or the consolidated financial statements
Refer to Exhibit 19.5 on page 674—Note relating to non-cash financing and investing activities

15. Disclosure of financing facilities
AASB 107 suggests that information should be disclosed about the external financing arrangements of the entity
Additional information may be relevant to users in understanding the financial position and liquidity of an entity. Disclosure of this information, together with a commentary by management, is encouraged and may include the amount of undrawn borrowing facilities that may be available for future operating activities and to settle capital commitments, indicating any restrictions on the use of these facilities (AASB 107, par. 50a)
Refer to Exhibit 19.6 on page 675 for an example of a financing facility note

16. Calculating cash inflows and outflows
Cash flows from operating activities
Cash receipts from customers
Refer to Worked Example 19.1 on p. 675—The calculation of cash received from customers
Classification of interest and dividends received
Calculation of cash received from interest revenue (see example on p. 676)
Calculation of cash received from dividends

17. Calculating cash inflows and outflows (cont.)
Cash flows from operating activities (cont.)
Cash payment of interest
(see example on p. 677)
Cash payment of income taxes
Cash payments to suppliers
Refer to Worked Example 19.2 on p. 679—Calculating the cash payments made to suppliers

18. Calculating cash inflows and outflows (cont.)
Cash flows from investing activities
Cash payments for non-current assets
Need to exclude any increase in assets generated by non-cash transactions, e.g. acquisition of plant by mortgage over other assets
Refer to Worked Example 19.3 on p. 680—Calculating cash flows from investing activities
Proceeds from sale of non-current assets
Specific information about the sale transaction required—actual receipt of cash recorded in statement of cash flows, not gain or loss on sale

19. Calculating cash inflows and outflows (cont.)
Cash flows from financing activities
Payment of cash dividends
Includes issue of shares, issue of debt, repayment of debt
Note: To determine cash flows from the issue of equity securities, need to consider whether any share issue has been financed out of reserves (e.g. retained earnings or revaluation reserve)—if so, no related cash flow

20. Calculating cash inflows and outflows (cont.)
Refer to Worked Example 19.4 on p. 681—Comprehensive example of preparation of statement of cash flows, including:
calculation and disclosure of cash flows from operating activities
calculation and disclosure of cash flows from investment activities
calculation and disclosure of cash flows from financing activities
reconciliation of net cash provided by operating activities with operating profit after tax
note concerning non-cash financing and investing activities

21. Contractual implications
To date limited information is available on the use of cash-flow data in contractual agreements
Cash flows from operations would appear to provide an indication of ability to service debt
Perhaps more so than interest coverage
Could argue that traditional financial ratios (current ratio, acid test ratios) are deficient in monitoring the liquidity of the organisation
Has been argued that use of cash-flow data would provide an earlier indication of solvency problems than that provided by using conventional financial ratios

22. Summary
The statement of cash flows is considered to be a very useful complement to an entity’s statement of financial position and statement of comprehensive income
It provides information useful for making assessments about such things as an entity’s ability to:
generate cash flows
meet financial commitments as they fall due
finance changes in operating activities
obtain and service external debt
As not based on accrual accounting, its compilation is not greatly influenced by professional judgment

23. Summary (cont.)
The statement of cash flows provides a reconciliation of opening and closing cash, with cash being described as ‘cash on hand’ and ‘cash equivalents’
Cash equivalents
Highly liquid investments with short periods to maturity readily convertible to cash on hand at investor’s option
Borrowings integral to the cash management function of the entity and not subject to a term facility
Cash flows to be divided into:
operating activities
investing activities
financing activities

24. Summary (cont.) Direct method to be applied
Relevant cash inflows are reported in gross terms rather than being netted off against each other
AASB 107 requires a number of notes to be provided, including:
reconciliation of cash balance per statement of cash flows with related statement of financial position items
material financing and investing transactions and events that do not result in cash flows
Calculation of cash flows can be applied using either:
the equation approach or the t-account approach