PAS 7- STATEMENT OF CASH FLOWS

The statement of cash flows shows the ability of any company to generate cash. It is
a component of financial statements summarizing the operating, investing and financing
activities of an entity. It provides information about the cash receipts and cash payments
of an entity during the period.

However, cash is cash and the statement of cash flows not only shows you HOW MUCH
CASH the company generated over the year, but also WHERE the cash was generated:
• Did the company increase their sales and generated cash by operating activities?
• Did the company sell some of its property and generated cash by investing
activities?
• Or did the company take new loans and generated cash by financing activities?
So, looking to where the cash was generated and spent is as important as assessing the
liquidity ratio, profitability ratio, and other financial indicators.

What is the objective of IAS 7?

The objective of IAS 7 Statement of cash flows is to require the information about the
historical changes in cash and cash equivalents of an entity.
This information shall be provided in the statement of cash flows which classifies cash
flows during the period from operating, investing and financing activities.
What comprises cash and cash equivalents?
The statement of cash flows shows you the movements in cash and cash equivalents.

Cash comprises cash on hand (e.g. petty cash) and demand deposits.

Cash equivalents are short-term, highly liquid investments that are readily convertible to
known amounts of cash and which are subject to an insignificant risk of changes in value.
It is an investment that has a maturity of three months or less from the date of acquisition.
Here, the investment with short maturity (up to 3 months) would qualify for cash equivalent
– for example, state treasury note.
Equity investments are normally excluded, unless they are in substance a cash equivalent
(e.g. preferred shares acquired within three months of their specified redemption date).
Bank overdrafts which are repayable on demand and which form an integral part of an
entity's cash management are also included as a component of cash and cash
equivalents.

Please note that the movements between cash and cash equivalents is a part of cash
management and are not shown in the operating, financing or investing part of the
statement of cash flows. So if your company buys the state treasury bill with short maturity
date, then this movement is not shown (it appears as the cash and cash equivalents have
not moved at all).

How the statement of cash flows shall be presented?

IAS 7 says that the statement of cash flows shall report cash flows during the
period classified by operating, investing and financing activities.

Before we’ll take a look at each part, let me also add that the statement of cash flows
should also contain the final reconciliation in which you summarize the overall
movement in cash and cash equivalents (corresponding with your balance sheet) as
shown in this picture:
In the notes to the financial statements, an entity shall disclose the components of cash
and cash equivalents

Operating activities
Operating activities are the the principal revenue-producing activities of the entity and
other activities that are not investing or financing activities. These are activities that
generally result from transactions and other events that enter into the determination of
net income or loss.
This part is probably the most important, because it shows the ability of the company to
generate cash by its own activities, rather than by external financing or making
investments.
Cash flows from operating activities result from the primary revenue-generating activities
of each company and therefore, there might be differences between different entities.
For example, manufacturing company would report advance given for the acquisition of
PPE as investing activity, but the bank would report similar advance as an operating
activity based on its specific purpose.
However, operating activities generally result from profit making activities and
the examples are:
• Cash receipts from the sale of goods and the rendering of services;
• Cash receipts from royalties, fees, commissions and other revenue;
• Cash payments to suppliers for goods and services;
• Cash payments for selling, administrative and other expenses
• Cash payments to and on behalf of employees;
• Cash receipts and cash payments of an insurance entity for premiums and claims,
annuities and other policy benefits;
• Cash payments or refunds of income taxes unless they can be specifically
identified with financing and investing activities; and
• cash receipts and payments from contracts held for dealing or trading purposes.

Trading securities
• Cash flows arising from the purchase and sale of trading securities are classified
as operating activities.
• Cash advances and loans made by a financial institution are classified as operating
activities since they relate to the main revenue producing activity of the entity.

Direct and indirect method

A company may select from 2 methods of reporting cash flows from operating activities:
1. Direct method: here, you need to disclose major classes of gross cash receipts
and gross cash payments; or
 2. Indirect method: here, you start with the profit or loss before tax and then you
adjust it for the effect of:
o Working capital changes over the period (inventories, operating
receivables, payables);
o Non-cash items (depreciation, unrealized foreign exchange gains or losses,
etc.);
o Items associated with investing or financing activities.

The indirect method adjusts accrual basis net profit or loss for the effects of non-cash
transactions. The operating cash flows section of the statement of cash flows under the
indirect method would appear something like this:

Profit before interest and income taxes xx,xxx

Add back depreciation xx,xxx

Add back impairment of assets xx,xxx

Increase in receivables xx,xxx

Decrease in inventories xx,xxx

 Increase in trade payables xx,xxx

Interest expense xx,xxx

Less Interest accrued but not yet paid xx,xxx

Interest paid xx,xxx

Income taxes paid xx,xxx

Net cash from operating activities xx,xxx

Increase in asset- DEDUCT

Decrease in asset- ADD
Increase in liability- ADD
Decrease in liability- DEDUCT

Direct method provides more understandable information not disclosed under indirect
method. However, in reality, indirect method is far more preferred because it’s easier to
get the information based on your accounting records. (in most cases).

Investing activities
Investing activities are the acquisition and disposal of long-term assets and other
investments not included in cash equivalents.

Examples of cash flows classified in investing activities are:

• Cash payments to acquire property, plant and equipment, intangibles and other
long-term assets (including capitalized development costs and self-constructed
PPE);
• Cash receipts from sales of PPE, intangibles and other long-term assets;
• Cash payments to acquire and cash receipts from sales of equity or debt
instruments of other entities and interests in joint ventures (but not for trading or
dealing purposes);
• Cash receipts from sale of equity and debt instruments
• Cash advances and loans made to other parties
• cash receipts from their repayment (other than advances and loans made by a
financial institution – these would go to operating part);
• Cash payments for and cash receipts from various derivative contracts except
when the contracts are held for dealing or trading purposes, or the payments are
classified as financing activities. And cash receipts from these contracts.
Financing activities
Financing activities are activities that result in changes in the size and composition of
the contributed equity and borrowings of the entity.
a. Between the entity and the owners- equity financing
b. Between the entity and the creditors- debt financing

Examples of cash flows arising from financing activities are:

• Cash proceeds from issuing shares or other equity instruments;
• Cash payments to owners to acquire or redeem the entity’s shares;
• Cash payments to acquire treasury shares
• Cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other
short-term or long-term borrowings;
• Cash repayments of amounts borrowed; and
• Cash payments by a lessee for the reduction of the outstanding liability relating to
a finance lease.

 Cash payments to settle such obligations as trade accounts payable and notes
payable, income tax payable, accrued expenses are operating activities, not
financing activities.

Reporting cash flows from investing and financing activities

Cash flows from investing and financing activities shall always be reported GROSS, so
no netting off.
It means that you cannot present the cash paid to acquire some vehicle and cash received
from sale of some other vehicle in 1 line – instead, you must present these cash flows
separately in 2 lines.

However, IAS 7 gives you 2 exceptions where you actually can present net:
• Cash receipts and payments on behalf of customers when the cash flows reflect
the activities of the customer rather than those of the entity. For example, some
real estate company can collect rents from tenants and pay them over to the
property owners.
• Cash receipts and payments for items in which the turnover is quick, the
amounts are large, and the maturities are short.For example, changes in
principal amounts relating to credit card customers.

Also, financial institutions can report certain transactions on the net basis.
Non-cash transactions
 Investing and financing transactions that do not require use of cash or cash
equivalents shall be excluded from the statement of cash flows.
 Noncash transactions shall be disclosed elsewhere in the financial statements
either in the notes, or in a separate schedule.

Some non-cash transactions

a. Acquisition of asset by assuming directly related liability
b. Acquisition of asset by issuing share capital
c. Acquisition of asset by issuing bonds payable
d. Conversion of bonds payable into share capital
e. Conversion of preference shares into ordinary shares.

Interest
• Interest paid and interest received shall be classified as operating cash flows
because such items enter into the determination of net income or loss
 Alternatively, interest paid may be classified as financing cash
flows because it is a cost of obtaining financial resources.
 Alternatively, interest received may be classified as investing cash
flows because it is a return on investment.

Dividends
• Dividend received shall be classified as operating cash flow because it enters
into the determination of net income.
 Alternatively, it may be classified as investing cash flow because it
is a return on investment.
• Dividend paid shall be classified as financing cash flow because it is a cost of
obtaining financial resources.
 Alternatively, dividend paid may be classified as operating cash
flows in order to assist users to determine the ability of the entity to
pay dividends out of operating cash flows.

Income taxes
• Cash flows arising from the income taxes shall be separately disclosed as cash
flows from operating activities unless they can be specifically identitifed with
investing and financing activities.
Other issues

Foreign currency
When there are foreign currency cash flows, then you need to translate them to your
functional currency by applying the exchange rate at the date of the cash flow.
However, be careful at the closing, because unrealized year-end foreign exchange
gains or losses are NOT cash flows. If they relate to your cash or cash equivalents,
then you should present these amounts in the separate line in the final reconciliation.

Interest and dividends

Cash flows from interest and dividends received and paid shall be
presented separately and consistently from period to period.
In fact, you have a choice here for each of these items:
• Interest and dividends paid can be classified either as operating cash flow, or
financing cash flow.
• Interest and dividends received can be classified either as operating cash flow, or
investing cash flow.
Either way you choose, it’s OK, but do it consistently in each reporting period.

Taxes on income
Basically, cash flows arising from income taxes are classified as cash flows from
operating activities.
But if you can specifically identify these taxes with financing or investing activities, then
you should report your cash flows from taxes in these parts.

Investments
When you hold some investments in subsidiaries, associates and joint venture, then
reporting cash flows to and from these investments really depends on the accounting
method you use.
When you apply equity or cost method, then you should include only the cash flows
between yourself and the investee into the cash flow statement (dividends or advances).