UNITY UNIVERSITY

ACCOUNTING AND FINANCE DEPARTMENT

ADVANCED FINANCIAL ACCOUNTING

I(ACFN 4011)

23-1
 Chapter-5
Revisiting the Statement of Cash Flows
 References
 IAS 7
 Kieso, Weygandt and Warfield, Intermediate Accounting,
IFRS Edition (4rd Ed. John Wiley & Sons, Inc. 2016).
Chapter 23
 Wiley Interpretation and Application of IFRS Standards
2020-Chapter 6
 Ernst & Young LLP, International GAAP, John Wiley & Sons
Ltd. Chapter 37
23-2

 Chapter content

Importance of statement of cash flows

Classifications of cash flows

Preparing the statement of cash flows

23-3
 CHAPTER 5
Statement of Cash Flows
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe the usefulness and
2. Understand categories of cash
format of the statement of cash flows
flows.
3. Prepare a statement of cash flows. 5. Explain the use of a worksheet
4. Contrast the direct and indirect in preparing a statement of cash
methods of calculating net cash flow flows.
from operating activities.

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“SHOW ME THE MONEY!”

"Cash Is King"
 LEARNING OBJECTIVE 1
Statement of Cash Flows Describe the usefulness and
format of the statement of
cash flows.

Primary purpose:
To provide information about a company’s cash
receipts and cash payments during a period.

Secondary objective:
To provide cash-basis information about the company’s
operating, investing, and financing activities.

23-6 LO 1
 Statement of Cash Flows

Usefulness of the Statement of Cash Flows

Provides information to help assess:
1. Entity’s ability to generate future cash flows.

2. Entity’s ability to pay dividends and meet obligations.

3. Reasons for the difference between net income and net

cash flow from operating activities.

4. Cash and non-cash investing and financing transactions

during the period.

23-7 LO 1
 Statement of Cash Flows

Classification of Cash Flows

Operating Investing Financing

Activities Activities Activities

Income Changes in Changes in

Statement Items Investments Equity and
and Other Non- Non-Current
Current Asset Liability Items
Items

23-8 LO 1
 Operating activities -the principal revenue-producing
activities of the entity and other activities that are not
investing or financing activities’.

 It provides a key indicator of the extent to which the

entity has generated sufficient cash flows from its
operations to repay debt, pay dividends and make
investments to maintain and increase its operating
capability, without recourse to external sources of
financing.

 May assist in the process of forecasting future

operating cash flows, when used in conjunction with
other financial statement information.
23-9
 EXAMPLES

a) cash receipts from the sale of goods and the rendering of

services;
(b) cash receipts from royalties, fees, commissions and other
revenue;
(c) cash payments to suppliers for goods and services;
(d) cash payments to and on behalf of employees;
(e) cash receipts and cash payments of an insurance entity for
premiums and claims, annuities and other policy benefits;
(f) cash payments or refunds of income taxes unless they can be
specifically identified with financing and investing activities;
and
(g) cash receipts and payments from contracts held for dealing
or trading purposes

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 Investing activities

Include the acquisition and disposal of property, plant and

equipment and other long-term assets and debt and equity
instruments of other entities that are not considered cash
equivalents or held for dealing or trading purposes. Investing
activities include cash advances and collections on loans made
to other parties (other than advances and loans of a financial
institution).

23-11
 Financing activities

Include obtaining resources from and returning resources to the

owners. Also included are obtaining resources through
borrowings (short term or long term) and repayments of the
amounts borrowed.

Examples
• Proceeds from issuing share capital
• Proceeds from issuing debt (short term or long term)
• Not-for-profits’ donor restricted cash, which is limited to long
term purposes
• Payment of dividends
• Repurchase of entity’s own shares
• Repayment of debt principal, including
• capital lease obligations
23-12
 Classification of Cash Flows

23-13 LO 1
 Classification of Cash Flows

23-14 LO 1
 Cash and Cash Equivalents
The basis recommended by the IASB for the statement of
cash flows is actually “cash and cash equivalents.” Cash
equivalents are short-term, highly liquid investments that are
both:
 Readily convertible to known amounts of cash, and
 So near their maturity that they present insignificant risk of
changes value in (e.g., due to changes in interest rates).

Generally, only investments with original maturities of three

months or less qualify under this definition.
 Can include bank overdrafts if part of cash management activities,
repayable on demand and balance fluctuates between positive and
negative amounts.
23-15 LO 1
Product
Life
Cycle

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 Format of the Statement of Cash Flows

Presentation:
1. Operating activities. Direct Method

2. Investing activities. Indirect Method

3. Financing activities.

Report inflows and outflows from investing and financing

activities separately.

23-17 LO 1
 Reporting Operating Cash Flows
18

Two methods:

 Direct method

 Indirect method
 Either allowed although preference for direct method
Reporting Operating Cash Flows
19

 Direct method
 Reporting Operating Cash Flows20

 Indirect method

23-20
NI vs NCF from Operating Activities
Indirect Method
23-24 LO 1
 Preparing the Statement LEARNING OBJECTIVE 2
Prepare a statement of cash
of Cash Flows flows.

Three Sources of Information:

1. Comparative statements of financial position.
2. Current income statement data.
3. Selected transaction data.

Three Major Steps:

Step 1. Determine change in cash.
Step 2. Determine net cash flow from
operating activities.
Step 3. Determine net cash flows from
23-25 investing and financing activities. LO 2
 Sources of Information for the
Statement of Cash Flows

1. Comparative statements of financial position.

2. An analysis of the Retained Earnings account.
3. All changes that have passed through cash or have resulted
in an increase or decrease in cash.
4. Write-downs, amortization charges, and similar “book”
entries, such as depreciation, because they have no effect
on cash.

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 Net Cash Flow Operating
Activities—Direct Method

23-27 LO 3
 Direct Method Example

Drogba SA, which began business on January 1, 2019, has the

following selected statement of financial position information.

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 Direct Method Example

Drogba’s December 31, 2019, income statement and additional

information are as follows.

Additional Information
(a) Dividends of €70,000 were declared and paid in cash.
(b) The accounts payable increase resulted from the purchase of merchandise.
23-29 (c) Prepaid expenses and accrued expenses payable relate to operating expenses. LO 3
 Operating Activities — Direct Method

Accounts receivable increased €15,000. Thus, cash receipts from

customers are computed as follows.

Accounts Receivable
1/1/20 Balance 0 Receipts from customers 765,000
Sales revenue 780,000

12/31/20 Balance 15,000

23-30 LO 3
 Operating Activities — Direct Method

Drogba SA reported cost of goods sold on its income statement of

€450,000. In 2019, Drogba’s inventory increased €160,000. The
company computes purchases as follows.

Cost of goods sold €450,000

Add: Increase in inventory 160,000
Purchases €610,000

Accounts Payable
1/1/20 Balance 0
Purchases 610,000

12/31/20 Balance 60,000

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 Operating Activities — Direct Method

Drogba determines cash payments to suppliers by adjusting

purchases for the change in accounts payable.

Accounts Payable
1/1/20 Balance 0
Payments to suppliers 550,000 Purchases 610,000

12/31/20 Balance 60,000

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 Operating Activities — Direct Method

Drogba reported operating expenses of €160,000 on its income

statement. To determine the cash paid for operating expenses, it
must adjust this amount for any changes in
 prepaid expenses and
 accrued expenses payable.

23-33 LO 3
 Operating Activities — Direct Method
Prepaid Expenses
1/1/20 Balance 0

12/31/20 Balance 8,000

Accrued Expenses Payable

1/1/20 Balance 0

12/31/20 Balance 20,000

Operating expenses €160,000

Add: Increase in prepaid expenses 8,000
Deduct: Increase in accrued expenses payable 20,000
Cash payments for operating expenses €148,000
23-34 LO 3
 Operating Activities — Direct Method

The income statement for Drogba shows income tax expense of

€48,000. Cash paid for income taxes is computed by taking the
expense and adjusting by the change in the payable.

Income Tax Payable

1/1/20 Balance 0
Payments for income tax 48,000 Income tax expense 48,000

12/31/20 Balance 0

23-35 LO 3
 ILLUSTRATION 23.25
Accrual Basis to Cash Basis

23-36 LO 3
 Operating Activities — Direct Method

When companies use the direct method they are required to

provide in a separate schedule the reconciliation of net income to
net cash provided by operating activities.

23-37 LO 3
 2. Indirect (reconciliation) method

• Indirect (reconciliation) method. A method that derives the

net cash provided by or used in operating activities by adjusting
profit (loss) for the effects of transactions of a non-cash
nature, any deferrals or accruals of past or future operating
cash receipts or payments, and items of income or expense
associated with investing or financing activities.

• In other words, the indirect method adjusts NI for items that

affected reported NI but did not affect cash.

• To compute NCF from operating activities, a company adds

back non-cash charges (expenses) in the IS to NI and deducts
non-cash credits (revenues).
 Illustrations-1—Tax Consultants Inc.

 The company started on January 1, 2016, when it

issued 60,000 shares of $1 par value common stock for
$60,000 cash.

 The company rented its office space, furniture, and

equipment, and performed tax consulting services
throughout the first year.

 The comparative B/S at the beginning and end of the

year 2016 and I/S of the year appear in the following
slide.
23-39
23-40
23-41
 Step 1: Determine the Change in Cash

 To prepare a statement of cash flows, the first step is to

determine the change in cash.

 Tax Consultants had no cash on hand at the beginning of

the year 2016.

 It had $49,000 on hand at the end of 2016.

 Thus, cash changed (increased) in 2016 by $49,000

23-42
 Step 2: Determine Net Cash Flow from Operating
Activities
 Under the accrual basis of accounting, net income is not equal
to net cash flow from operating activities. (NI  NCF)

 To arrive at net cash flow from operating activities, a company

must determine revenues and expenses on a cash basis.

 It does this by eliminating the effects of income statement

transactions that do not result in an increase or decrease in
cash.

 In this chapter, we use the term net income to refer to accrual-

based net income
23-43
 A. Increase in Accounts Receivable (A/R).

• Tax Consultants’ A/R increased by $36,000 (from $0 to

$36,000) during the year.

• To adjust net income to net cash provided by operating

activities, Tax Consultants must deduct the increase of
$36,000 in A/R from net income.

• Therefore, the company adds to net income the amount of

the decrease in A/R to arrive at net cash provided by
operating activities.

23-44
 B. Increase in Accounts Payable(A/P )

 When A/P increase during the year, expenses on an

accrual basis exceed those on a cash basis. Why?

 Because Tax Consultants incurred expenses, but

some of the expenses are not yet paid.

 To convert net income to net cash flow from

operating activities, Tax Consultants must add
back the increase of $5,000 in A/P to net income.

23-45
 Adjustment (conversion) of NI to NCF

 As a result of the A/R and A/P adjustments, Tax

Consultants determines net cash provided by
operating activities is $3,000 for the year 2016.

23-46
 Step 3: Determine NCF from Investing and
Financing Activities

 For example, an examination of the remaining balance sheet accounts for

Tax Consultants shows increases in both common stock (CS) and retained
earnings (RE).

 The CS increase of $60,000 resulted from the issuance (a receipt of cash

from a financing activity. ) of common stock for cash.

 Two items caused the RE increase of $20,000:

1. Net income of $34,000 increased retained earnings.
2. Declaration of $14,000 of dividends decreased retained earnings.

23-47
23-48
 Interpretation
 As indicated in the statement of cash flow, the $60,000
increase in common stock results in a financing activity
cash inflow.

 The payment of $14,000 in cash dividends is a financing

activity outflow of cash.

 The $49,000 increase in cash reported in the statement

of cash flows agrees with the increase of $49,000 shown
in the comparative balance sheets as the change in the
Cash account.
23-49
 Illustration-2: Tax Consultants Inc.—2017

23-50
 Illustration: Tax Consultants Inc.—2017

23-51
 Solution

Step 1: Determine the Change in Cash.

 To prepare a statement of cash flows from the

available information, the first step is to determine the
change in cash.

 As indicated from the information presented in the

previous slides, cash decreased by $12,000 ($49,000 –
$37,000).

23-52
 Step 2: Determine Net Cash Flow from Operating
Activities

 Using the indirect method, we adjust net income of $134,000 on

an accrual basis to arrive at net cash flow from operating
activities.

1. Decrease in Accounts Receivable.

 A/R decreased during the period because cash receipts (cash-
basis revenues) are higher than revenues reported on an accrual
basis.

 To convert NI to net cash flow from operating activities, the

decrease of $10,000 in A/R must be added to net income.
23-53
 2. Increase in Prepaid Expenses.
 When prepaid expenses (assets) increase during a period, expenses on
an accrual-basis income statement are lower than they are on a cash
basis income statement.

 The reason: Tax Consultants has made cash payments in the current
period, but expenses (as charges to the income statement) have been
deferred to future periods.

 To convert net income to net cash flow from operating activities, the
company must deduct from net income the increase of $6,000 in
prepaid expenses.

 An increase in prepaid expenses results in a decrease in cash during the

23-54
period.
 3. Increase in Accounts Payable.

 Like the increase in 2016, Tax Consultants must add the

2017 increase of $35,000 in accounts payable to net
income, to convert to net cash flow from operating
activities.

 The company incurred a greater amount of expense

than the amount of cash it disbursed.

23-55
 4. Depreciation Expense (Increase in Accumulated Depreciation).

 The purchase of depreciable assets is a use of cash,

shown in the investing section in the year of acquisition.

 Tax Consultants’ depreciation expense of $21,000 (also

represented by the increase in accumulated depreciation)
is a noncash charge; the company adds it back to net
income, to arrive at net cash flow from operating
activities.

 The $21,000 is the sum of the $11,000 depreciation on the

building plus the $10,000 depreciation on the equipment.
23-56
 Computation of NCF from Operating Activities.

23-57
 Step 3: Determine NCF from Investing and
Financing Activities.
 Increase in Land. As indicated from the change in the
Land account, the company purchased land of $70,000
during the period. This transaction is an investing
activity, reported as a use of cash.
 Increase in Buildings and Related Accu. Depn. Tax
Consultants acquired an office building using $200,000
cash. This transaction is a cash outflow, reported in the
investing section.
 The $11,000 increase in accu depn results from
recording depreciation expense on the building. As
indicated earlier, the reported depreciation expense has
no effect on the amount of cash.
23-58
 Increase in Equipment and Related Accumulated
Depreciation.
An increase in the equipment of $68,000 resulted because the
company used cash to purchase equipment.

This transaction is an outflow of cash from an investing activity.

The depreciation expense entry for the period explains the
increase in Accumulated Depreciation—Equipment.

 Increase in Bonds Payable.

The Bonds Payable account increased by $150,000. Cash received
from the issuance of these bonds represents an inflow of cash
from a financing activity.

23-59
 Increase in Retained Earnings.

 Retained earnings increased $116,000 during the year.

 Two factors explain this increase.

(1) Net income of $134,000 increased retained earnings, and

(2) dividends of $18,000 decreased retained earnings.

 As indicated earlier, the company adjusts net income to

net cash provided by operating activities in the operating
activities section.
 Payment of the dividends is a financing activity that
involves a cash outflow.
23-60
23-61
 Illustration-3: Tax Consultants Inc.—2018

23-62
 Illustration-3: Tax Consultants Inc.—2018

23-63
 Illustration-3: Tax Consultants Inc.—2018

Additional Information:

A. Operating expenses include depreciation expense of $33,000 and

expiration of prepaid expenses of $2,000.
B. Land was sold at its book value for cash.
C. Cash dividends of $55,000 were declared and paid.
D. Interest expense of $12,000 was paid in cash.
E. Equipment with a cost of $166,000 was purchased for cash. Equipment
with a cost of $41,000 and a book value of $36,000 was sold for $34,000
cash.
F. Bonds were redeemed at their book value for cash.
G. Common stock ($1 par) was issued for cash.

Required: Prepare a cash flow statement at the end of 2018

23-64
Illustration-4
The following additional information is relevant to the preparation of the
statement of cash flows:

1. Equipment with a net book value of €7,500 and original cost of

€10,500 was sold for €7,500.
2. All sales made by the company are credit sales.
3. The company received cash dividends (from investments) amounting
to €3,000, recorded as income in the statement of comprehensive
income for the year ended December 31, 20XX.
4. The company declared and paid dividends of €12,000 to its
shareholders.
5. Interest expense for the year 20XX was €2,000, which was fully paid
during the year. All administration and selling expenses incurred were
paid during the year 20XX.
6. Income tax expense for the year 20XX was provided at €4,000, out of
which the company paid €2,000 during 20XX as an estimate.

Note that all figures in this example are in thousands of euros.

23-67
 Disclosures

Significant Non-Cash Transactions

Common noncash transactions that a company should report
or disclose:
1. Acquisition of assets by assuming liabilities (including
finance lease obligations) or by issuing equity securities.

2. Exchanges of non-monetary assets.

3. Refinancing of long-term debt.

4. Conversion of debt or preference shares to ordinary shares.

5. Issuance of equity securities to retire debt.

23-68 LO 4
 Use of a Worksheet

A worksheet involves the following steps.

Step 1. Enter the statement of financial position accounts and their
beginning and ending balances in the statement of financial position
accounts section.

Step 2. Enter the data that explain the changes in the statement of
financial position accounts and their effects on the statement of cash
flows in the reconciling columns of the worksheet.

Step 3. Enter the increase or decrease in cash on the cash line and at
the bottom of the worksheet. This entry should enable the totals of the
reconciling columns to be in agreement.

23-69 LO 5
 End of cash flow statement

Thank you !!

Melese Z.(MSc)

23-70
 Exercise

1. Companies are affected by a number of events and transactions, some of which have an effect
on their cash and cash equivalents, and some which do not. Following are some examples of such
events and transactions:
1. Annual payment of $100 on a finance lease obligation, $2 of which is interest
2. Acquisition of a 4100, 3%, 90-day government treasury bill
3. Payment of $25 to a pension fund trustee
4. Cash received on the maturity of the treasury bill in item 2 above
5. Annual payment of $100 on an operating lease for sales office space
6. Receipt of $10 on the sublease of excess sales office space
7. Acquisition of the company’s treasury shares at a cost of $75
8. Conversion of convertible debt into common shares
9. Payment of $30 of a portion of long-term debt reported in current liabilities along with $3
of interest
10.Costs incurred to repair a customer’s product under warranty—inventory supplies used $1;
labor paid $4

Instructions
For each item listed above
(a)identify the effect on the company’s cash and cash equivalents; and
(b)indicate how the transaction or event will be reported on the company’s statement of cash
flows, if at all, and if any special disclosures are required.

23-71
 2
72
 Facts
 ethio telecom, as part of its cash management
activities, invested 10 million birr in Ethiopian
Government treasury bill which is redeemable after
a three month period. ethio telecom has no plan to
re-invest the money after the maturity date. It rather
will deposited back to its main bank account.
 Required
 Determine how ethio telecom would treat in its cash
flow statement the cash outflows resulting from the
investment of funds in Government treasury bill and
the cash inflows resulting from the initial withdrawal
of funds from the bank.

23-72
 3. The income statement of Rodriquez SA is shown below.

23-73
Additional information:
1. Accounts receivable decreased R$310,000 during the year.
2. Prepaid expenses increased R$170,000 during the year.
3. Accounts payable to suppliers of merchandise decreased
R$275,000 during the year.
4. Accrued expenses payable decreased R$120,000 during the
year.
5. Administrative expenses include depreciation expense of
R$60,000.

Instructions
Prepare the operating activities section of the statement of cash
flows for the year ended December 31, 2022, for Rodriquez SA,
using the indirect method.

23-74
 4.

23-75
 5. 76
 Ethio telecom is preparing its cash flow statement under the direct method and
has provided this information:

Net credit sales 8,000,000

Accounts receivable, end of the year 2,500,000
Accounts receivable, beginning of the year 3,300,000
Purchases (on account) 5,000,000
Trade payable, end of the year 2,900,000
Trade payable, beginning of the year 3,000,000
Operating expenses 4,000,000
Accrued expenses, beginning of the year 700,000
Accrued expenses, end of the year 600,000
Depreciation on property, plant, and equipment 200,000
 Required
 For the purposes of the cash flow statement under the direct method, you are
required to compute the cash collections from customers, payments to
suppliers, and cash paid for operating expenses.

23-76
 6.

Preferred Shares 545,000

0
Share Premium—preferred 100,000
0
Common Shares 600,000
600,000
1.Retained
The Accumulated
Earning Depreciation account has been credited only for the depreciation
129,000
expense for the period.
66,000
2. The Retained Earnings account has been charged for dividends of $138,000 and credited
for the net income for the year.
23-77
 The income statement for 2011 is as follows:

Instructions
(a) From the information above, prepare a statement of cash
flows (indirect method) for Hartman, Inc. for the year
ended December 31, 2011.

(b) From the information above, prepare a schedule of cash

provided by operating activities using the direct method.

23-78
7. Mortonson plc has not yet prepared a formal statement of cash flows for the
2022 fiscal year. Comparative statements of financial position as of December 31,
2021 and 2022, and a statement of income and retained earnings for the year
ended December 31, 2022, are presented as follows.
Instructions

Prepare a statement of cash flows using the direct method.

Changes in accounts receivable and accounts payable relate to
sales and cost of goods sold.