1. 20-1 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Chapter 20 Statement of cash flows

2. 20-2 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Objectives Understand the accounting requirements relating to the disclosure of information about an organisation’s cash flows Understand how to construct a cash-flow statement in conformity with AASB 107 ‘Cash Flow Statement’ Understand how the statement of cash flows provides information that is a useful complement to the balance sheet and the income statement Understand how we define ‘cash’ and ‘cash equivalents’ for the purposes of a cash-flow statement and understand that these definitions mean that cash-flow statements 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 cash-flow statement

3. 20-3 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Comparison with other financial statements Balance sheet –shows financial position at a certain date Income statement –shows profit or loss that has been generated for a period of time using accrual accounting Cash-flow statement –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 balance sheet –indicates sources of cash in terms of cash flows from operations, investing, and from financing

4. 20-4 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Purpose of cash flow statement Purpose of the cash-flow statement Assists in assessing the ability of the company or economic entity to –generate cash flows –meet financial commitments as they fall due, including servicing of borrowings and payment of dividends –fund changes in the scope and/or nature of its activities –obtain external finance 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

5. 20-5 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Purpose (cont.) Argued (by some people) to be more reliable than profit data as profit data typically based on numerous subjective and sometimes ‘creative’ judgments Cash-flow data tends to be more ‘factual’ or ‘objective’ Considered by many to be more understandable to users, to give rise to fewer problems with key terms, and to provide greater comparability between companies Cash flows from operations is considered (by some people) to be a superior performance measure and useful in assessing liquidity and solvency

6. 20-6 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Objective Objective of AASB 107 ‘Cash Flow Statements’ is to require the provision of information about the historical changes in cash and cash equivalents of an entity by means of a cash-flow statement, which classifies cash flows during the period from operating, investing and financing activities

7. 20-7 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Defining ‘cash’ and ‘cash equivalents’ AASB 107 requires the cash-flow statement 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 at the investor’s option and are subject to an insignificant risk of changes in value –borrowings that are integral to the cash management function and are not subject to a term facility

8. 20-8 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Defining ‘cash’ and ‘cash equivalents’ (cont.) ‘Cash’ in the cash-flow statement May relate to the total of a number of accounts shown in the balance sheet or accompanying notes May include cash at bank, bank overdrafts, short- term money market deposits, bank bills AASB 107 requires that the amount of ‘cash’ and ‘cash equivalents’ as at the end of the financial year as presented in the cash-flow statement be reconciled (by way of a note to the financial statements) to the related items in the balance sheet (refer to Exhibit 20.2 on page 701 of the text)

9. 20-9 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Defining ‘cash’ and ‘cash equivalents’ (cont.) ‘Cash equivalents’ in the cash-flow statement AASB 107 (par. 7) Cash equivalents are held for the purpose of meeting short- term cash commitments rather than for investment or other purposes. For an investment to qualify as a cash equivalent it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value. Therefore, an investment normally qualifies as a cash equivalent only when it has a maturity of, say, three months or less from the date of acquisition

10. 20-10 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Defining ‘cash’ and ‘cash equivalents’ (cont.) ‘Cash equivalents’ in the cash-flow statement (cont.) 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 cash-flow statement

11. 20-11 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Defining ‘cash’ and ‘cash equivalents’ (cont.) ‘Cash equivalents’ in the cash-flow statement (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

12. 20-12 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan 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) –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 following within the definition of cash

13. 20-13 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Format of cash-flow statement Appendix to AASB 107 provides a suggested format –refer to Exhibit 20.3 (page 704 of the text) –cash flows from operating activities disclosed first, followed by investing activities and financing activities Prior-year comparisons required Some items ordinarily considered operating items for income statement purposes might not be treated the same for cash-flow purposes and vice versa (e.g. interest paid)

14. 20-14 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Cash flows from operating activities Cash flows from operating activities include Receipts from customers Payments to suppliers and employees Dividends received Cash generated from operations Interest paid Income taxes paid

15. 20-15 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Cash flows from investing activities Cash flows from investing activities include: Acquisition of subsidiary X, net of cash acquired Purchase of property, plant and equipment Proceeds from sale of equipment Interest received Dividends received

16. 20-16 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Cash flows from financing activities Cash flows from financing activities include Proceeds from issue of shares Proceeds from borrowings Repayment of borrowings Dividends paid Share buybacks

17. 20-17 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Format of cash-flow statement (cont.) Number of items to be separately disclosed (AASB 107, par. 31) Interest and other items of a similar nature received Dividends received Borrowing costs, including interest and other costs of finance paid Dividends paid Income taxes paid

18. 20-18 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Format of cash-flow statement (cont.) Additional issues Cash flows from operating activities to be disclosed using the direct method—relevant cash inflows and outflows reported in gross terms rather than in net terms (AASB 107, par. 18) An entity to report separately major classes of gross receipts and gross payments arising from investing and financing activities rather than as net amounts (AASB 107, par. 21)— exceptions noted in pars 22 and 24 A reconciliation of cash flows from operating activities with net profit or loss as reported in income statement (AASB 107, par. 20.1)

19. 20-19 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Difference between operating profit and net cash flows from operating activities Reconciliation of operating profit with net cash flows from operating activities is required (par. 20.1) Items that might cause a difference include -depreciation and amortisation -increases/decreases in accounts receivable and payable, interest payable and receivable, accrued expenses, income tax payable, deferred taxes payable, prepaid expenses, inventories -loss/gain on sale of plant and equipment -refer to Table 20.2 on page 704 for an example, and to Exhibit 20.4 on page 706—Reconciliation of cash flows from operations to net profit

20. 20-20 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Non-cash financing and investment activities Required note AASB 107 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 accounts or the consolidated accounts where the transactions and other events -involve parties external to the entity; and -relate to financing and investing activities Refer to AASB 107, par. 43

21. 20-21 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Non-cash financing and investment activities (cont.) Examples of non-cash financing and investing transactions –conversions of liabilities to equity –acquisitions of entities by means of an equity issue –acquisitions of assets by assumption of directly related liabilities such as purchase of a building by incurring a mortgage to the seller –acquisitions of assets by entering into finance leases –exchange of non-cash assets or liabilities for other non-cash assets or liabilities Refer to Exhibit 20.5 on page 707—Note relating to non-cash financing and investing activities

22. 20-22 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan 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. 30) Refer to Exhibit 20.6 on page 708 for an example of a financing facility note

23. 20-23 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Calculating cash inflows and outflows Cash flows from operating activities Cash receipts from customers =sales + beginning receivables – ending receivables – bad debts expense (where bad debts are written off directly against debtors) – transfer from provision for doubtful debts (where debts that have previously been considered doubtful have subsequently proven uncollectable) – any discounts that may have been given to customers for early payment Refer to Worked Example 20.1 on page 709—The calculation of cash received from customers

24. 20-24 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Calculating cash inflows and outflows (cont.) Cash flows from operating activities (cont.) Classification of interest and dividends received –AASB 107 (refer to par. 33) provides choice as to where interest paid and dividends and interest received are to be presented –Appendix A of AASB 107 includes interest paid in operating activities but includes interest and dividends received as part of financing activities –AASB 107 (par. 34) states that dividends paid are to be classified as a financing cash flow as they relate to the cost of obtaining external resources

25. 20-25 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Calculating cash inflows and outflows (cont.) Cash flows from operating activities (cont.) Calculation of cash received from interest revenue =interest revenue + opening interest receivable – closing interest receivable – discount amortisation + premium amortisation Calculation of cash received from dividends =dividend income + opening dividends receivable – closing dividends receivable Cash payment of interest =interest expense + opening interest payable – closing interest payable – discount amortisation + premium amortisation

26. 20-26 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Calculating cash inflows and outflows (cont.) Cash flows from operating activities (cont.) Cash payment of income taxes =income tax expense + opening income tax payable – closing income tax payable + opening deferred tax liability – closing deferred tax liability + closing deferred tax asset – opening deferred tax asset Note (AASB 107, par. 35) –cash flows arising from taxes on income are to be separately disclosed and classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities

27. 20-27 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Calculating cash inflows and outflows (cont.) Cash flows from operating activities (cont.) Cash payments to suppliers =opening accounts payable – closing accounts payable + cost of sales + closing inventory – opening inventory – discounts given by suppliers + stock write-offs Refer to Worked Example 20.2 on page 713—Calculating the cash payments made to suppliers

28. 20-28 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Calculating cash inflows and outflows (cont.) Cash flows from investing activities Cash payments for non-current assets =closing balance of non-current assets – opening balance of non- current assets + original cost of assets sold – assets acquired through non-cash transactions – revaluation increases + accumulated depreciation written back to revalued 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 20.3 on pp. 715—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 cash-flow statement, not gain or loss on sale

29. 20-29 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Calculating cash inflows and outflows (cont.) Cash flows from financing activities Payment of cash dividends =Dividends paid + dividends proposed + opening dividends payable – closing dividends payable 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

30. 20-30 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Calculating cash inflows and outflows (cont.) Refer to Worked Example 20.4 on pp. 716— Comprehensive example of preparation of cash-flow statement, 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

31. 20-31 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan 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

32. 20-32 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Summary Cash-flow statement considered to be very useful complement to an entity’s balance sheet and income statement 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

33. 20-33 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan Summary (cont.) Cash-flow statement 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

34. 20-34 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Australian Financial Accounting 5e by Craig Deegan Slides prepared by Craig Deegan 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 cash-flow statement with related balance sheet items a reconciliation of cash flows from operating activities with profit or loss as reported in income statement material financing and investing transactions and events that do not result in cash flows Calculation of cash flows can be applied using either equation approach or t-account approach