Accounting case study: Statement of Cash Flows (IAS 7)
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TOC o “1-3” h z u Introduction PAGEREF _Toc386518425 h 3The Statement of Cash Flows PAGEREF _Toc386518426 h 3Objective, use and purpose of International Accounting Standard 7 (IAS 7) PAGEREF _Toc386518427 h 3Key Terms PAGEREF _Toc386518428 h 4Operating Activities PAGEREF _Toc386518429 h 4Investing Activities PAGEREF _Toc386518430 h 4Financing Activities PAGEREF _Toc386518431 h 5Calculating Net Cash Flow from Operating Activities PAGEREF _Toc386518432 h 5Direct method PAGEREF _Toc386518433 h 5Indirect approach PAGEREF _Toc386518434 h 6Treating peculiar items PAGEREF _Toc386518435 h 6Evaluation PAGEREF _Toc386518436 h 7References PAGEREF _Toc386518437 h 9
Introduction
Financial statements should be prepared frequently so that the financial position of the company can be noted and if corrections need to be made it is much easier to make them (International Accounting Standards Board 2010, 2). There are various financial statements that are prepared periodically. They include the consolidated statements of Earnings, The balance sheet and the statement of cash flows. The IAS 7 requires that the business organization presents the Statement of Cash Flows together with other primary statements.
The Statement of Cash FlowsThe Statement of Cash Flows is used to show, trace and track the movements of cash and the cash equivalents in an entity over a given period. The focus is on the movements of cash held at hand, in banks, in short term liquid instruments and any investments in demand deposits. The cash equivalents that are listed in the Statement of Cash Flows should be easily and readily convertible without any significant fall in the current value. The standard maximum maturity date for cash equivalent is three months. The IAS 7, 7-8 require that overdrafts payable on demand and equity investments with substance of a cash equivalent such as preferences shares acquired by an entity three months to the date of redemption be included in the Statement of Cash Flows.
Objective, use and purpose of International Accounting Standard 7 (IAS 7)
The IFRS Board defines the objective of IAS 7 as, “the objective of this Standard 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 flow which classifies cash flows during the period from operating, investing and financing activities” (International Accounting Standards Board 2012, 1).
The purpose of the IAS 7 is to analyze and present any change that have occurred to cash and cash equivalents in an entity during a given period. The statement outlines the changes in the most liquid assets such as cash, demand deposits and money market instruments that can be liquidated in less than three months.
Key TermsThere are 3 sections in the cash flow statement as per the IAS 7, 10 are the cash flows from operating, investing and financing activities.
Operating Activities The cash flows from operating activities which deals with flows of all cash from operations such as the sale of goods and services less the cost of the those goods if the difference is positive then the business is going up and vice versa (Cross 2012, 20). The operating activities form the base of revenue generation in many companies. The segment reflects cash (inflow) received from the customers for good supplied or services rendered. The segment also has cash (outflow) paid to suppliers as well we the employees.
Investing Activities
Cash flows from investing activities entail the amount of cash that has been used to purchase capital goods for investment purposes. The section reflects the movements of cash as a result of either acquisition or disposals of investments that generate income to the entity. After a period of time the equipment will depreciate thus generating a depreciation expense. If re – investment occurs the high inflows are registered and the reverse is true.
Financing ActivitiesCash Flow from Financing Activities includes inflow of cash that is generated from outside financing activities such as selling of bonds and stock shares. Paying a loan and dividend payments in this case will be cash out flow. The financing activities entail actions that change the equity capital and the company’s borrowing structures.
Calculating Net Cash Flow from Operating Activities
The calculation Net Cash Flow from Operating Activities can be done in two ways. The approaches are direct and indirect methods.
Direct method
The direct method is mainly used in the calculation of the Net Cash Flow from Operating Activities (Walton 2009, 56). The direct method shows each of the classes of gross cash payments and receipts. The Net Cash Flow from Operating Activities can be calculated as shown below;
Cash received from sales (clients)xxxx
Cash paid for supplier’sxxxxCash payments to employeexxxx
Cash payments for other operating expenses xxxx
Interest paid xxxx
Income taxes payments xxxx
Net Cash Flow from Operating Activitiesxxxx/ (xxxx)
Indirect approach
The indirect approach entails adjustments of the accrual basis net profit/ loss to reflect the noncash events. The Net Cash Flow from Operating Activities is calculated using the indirect approach as shown below;
Earnings before interest and income taxes xxxx
Depreciation expenses (added back)xxxx
Amortization of goodwill (added back)xxxx
Increases in receivables xxxx
Decreases in stock xxxx
Increases in payables xxxx
Interest expense xxxx
Deduct accrued interests, not paid xxxxInterest paid xxxx
Paid Income taxesxxxx
Net cash from operating activities xxxxx/ (xxxxx)
Treating peculiar items
The IAS 7 has certain provisions in the classifications of the different elements of the cash flow statement. Cash movements from the interests and dividends may fall in any of the above classifications provided the classification is consistent for each of the periods, IAS 7, 31 (International Accounting Standards Board 2012, 2). The cash movements from taxes’ income fall under the operating activities, unless the items can be directly related to either financing or investing activities; IAS 7, 35((International Accounting Standards Board 2012, 2).
The IAS 7 25 requires that effective translations of currency exchanges take place to harmonize any foreign currency based transactions (Muthupandian 2008, 5). The date of the statement should act as the base rate for the currency translation in case of foreign currency dominated transactions. However, for the subsidiaries, the translations should take place using the prevailing rate on the date of the transaction.
Evaluation The purpose and use of the Statement of Cash Flows benefit to Hope Ltd
The Statement of Cash Flows is very vital for different stakeholders in an entity. From the above analysis, it is evident that the statement of cash flow is not only beneficial to the management but also to other stake holders such as the lenders, government, competitors, employees, customers among others in many ways ( Beatty, Ramesh and Weber 2002, 74).
Hope Ltd should start preparing the Statement of Cash Flows. The Statement of Cash Flows would help the company to know its liquidity status and meet the informational needs of its stakeholders (Wustemann and Wüstemann 2010, 2). For the investors of Hope Ltd, they need knowledge on where to invest their money and from the statement of cash flow it is easy to determine the most suitable place to invest expecting high returns on the investment based on net cash flows and ability to pay short term investment outcomes. In cash flow considerations, most investors are attracted to businesses that have a lot of free cash flow. Free cash flow is a sign that a business has ability to pay debt to lenders, pay dividends to shareholders, buy stock and enhance business growth. The employees of Hope Ltd need to know the stability and financial health of their employers. They want to know cash availability in order to have security in their employment. They need information about their remuneration for the current period Basu 1997, 24; Aboody and Liu 2003, 43). The short term lenders such as providers of demand bank overdrafts use the statement of cash flow to determine whether the overdrafts and interests will be paid in due time. The suppliers and trade creditors need to know the liquidity of the business in order to determine when they will be paid for the short term credit. Conclusion
Financial statements are tools that provide useful information that will be used during the decision making process by the managers of a business entity. Though the financial statements are based on historical data, the information gives the basis of the trend in the business and the business entity can easily predict the outcome of a decision they make regarding a financial decision made (Bellandi 2011, 12). The cash flow statement is a statement that shows how much cash flow in the business and how much cash flow out of the business over a given period of time in a year. Although the statement of cash flow may not provide all information to all users there are certain needs that it can meet to all users- the information on risk.
ReferencesAboody, D. and Liu, J., 2003. Earnings quality, insider trading, and cost of capital. Working Paper Series.
Basu, S., 1997. The conservatism principle and the asymmetric timeliness of earnings. Journal of Accounting & Economics, 24(1): 3-37.
Bellandi, F., 2012. The handbook to IFRS transition and to IFRS U.S. GAAP dual reporting interpretation, implementation and application to grey areas. Chichester: John Wiley.
Beatty, A., Ramesh, K. and Weber, J., 2002. The importance of accounting changes in debt contracts: The cost of flexibility in covenant calculations. Journal of Accounting and Economics, 33(2): 205-227.
Cross, M. B., 2012. The SEC speaks in 2012. New York, NY: Practising Law Institute.
International Accounting Standards Board. 2012. ‘IAS 7 Statement of Cash Flows: Technical
Summary’. [Online]. Available at: < http://www.ifrs.org/Documents/IAS7.pdf> [Accessed 28th April 2014].
International Accounting Standards Board, 2010.The Conceptual Framework for Financial Reporting. . [Online]. Available at <http://eifrs.ifrs.org/eifrs/files/319/EDU%20BOUND%20VOLUME%202012_Conceptual%20Fram ework_PART%20A_167.pdf> [Accessed 28th April 2014].
Muthupandian K., 2008. IAS 7, Statement of Cash Flows – A Closer Look. The Management Accountant, Vol. 43 No. 9.
Walton, P., 2009. An executive’s guide for moving from U.S. GAAP to IFRS. New York: Business Expert Press.
Wustemann, J. and Wüstemann, S. 2010. Why consistency of accounting standards matters: a contribution to the rules-Versus-Principles debate in financial reporting. Abacus 46 (1): 1-27.
