Lecture 6 ifa1 2011(1)
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Transcript of Lecture 6 ifa1 2011(1)
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IFA1 lecture 6
Chapter 14
Statement of cash flow construction
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Chapter 14 Statement of cash flows construction
Financial Accounting and Reporting - A Global Perspective (third edition)
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List of topics1 Limit of traditional financial statements
2 Usefulness of the statement of cash flows
3 Contents of the activities
4 Calculating cash flows from operating activities
5 Cash and cash equivalents
6 Example of a statement of cash flows
7 Operating cash flow – indirect method
8 Operating cash flow – direct method
9 Cash flow from investing activities
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10 Cash flows from financing activities
11 Non-cash investing and financing transactions
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1 Limit of the traditional financial statements
• Statement of financial position (Balance sheet) = static view of the financial structure/position
• Income statement = a dynamic view of the business activity
• No dynamic view of the financial structure, (changes in the structure in general, and changes in cash in particular)
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Statement of cash flows
• To meet these information needs: the statement of cash flows
• See chapter 3
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Table 14.1 Statement of cash flows structure
The statement of cash flows classifies cash flows in three categories of activities: operating, investing and financing
Net cash provided by/used in operating activities A Net cash provided by/used in investing activities B Net cash provided by/used in financing activities C Net increase/decrease in cash and cash equivalents D = A + B + C Cash and cash equivalents at beginning of year E Cash and cash equivalents at end of year F = D + E
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2 Usefulness of the statement of cash flows
• The importance of cash
• Cash is objective
• A valuable forecasting tool
• Developments in international practice (see Appendix 14.1)
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3 Contents of the activities (1/2)
• Clear partitioning of the statement of cash flows between the various ‘activities’ is vital
• The classification of certain operations is sometimes difficult
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Contents of the activities (2/2)
• Operating activities: derived from the main or core revenue-producing activities of the enterprise.
• Investing activities
• Financing activities
• See Table 14.2 and Appendix 14.2
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Table 14.2 Classification of cash flows
Activities Cash inflows (receipts) Cash outflows (payments) Operating activities Sale of goods and rendering of
services to customers Royalties, fees, commissions and
other revenues Interests on loans and investments
Purchase of goods and services Salaries, fringe benefits and social
expenses Taxes Interests on borrowings
Investing activities Sale of fixed assets (intangible, tangible, financial – securities which are not cash equivalents)
Receipt of repayment of loans and advances
Purchase of long-lived assets (intangible, tangible, financial – i.e., long-term securities which are not cash equivalents)
Loans and advances made
Financing activities Proceeds from issuing new shares Proceeds from selling own shares Proceeds from issuing new debt
Repurchase of own shares Repayment of debts Payment of dividends
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Table 14.3 Differences in classification of five flows of cash
Interests paid Interests received
Dividends paid
Dividends received
Taxes paid
IASB OPE or FIN OPE or INV OPE or FIN OPE or INV OPE or INV or FIN
USA OPE OPE FIN OPE OPE
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4 Calculating cash flows from operating activities
• ‘Cash flows from operating activities’ (= ‘Operating cash flows’ = ‘Cash flows from operations’)
• Two methods:– direct– indirect
• Most standards recommend the direct method while allowing the indirect method
• The vast majority of businesses report cash flows from operating activities using the indirect method, which is much simpler
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Figure 14.1 Reporting cash flows from operating activities
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5 Cash and cash equivalents
• Definitions: – Cash comprises cash on hand 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 (IAS 7)
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6 Example of a statement of cash flows (1/4)
Source of the information
Cash flow from operating activities (indirect method) (gross amounts)
Net income/loss ± IS X2 Adjustments to reconcile net income/loss to net cash provided by/used in operating activities
Depreciation and amortization + IS X2 Gain/loss on sale of fixed assets ± IS X2 Potential cash flow =
Changes in operating assets and liabilities Change in accounts receivable (gross amount) ± BS X1/X2 Change in inventories (gross amount) ± BS X1/X2 Change in prepaid expenses ± BS X1/X2 Change in accounts payable and accrued expenses ± BS X1/X2 Net cash provided by/used in operating activities = (A) = IS: Income Statement - BS: Balance Sheet - AI: Additional Information
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Table 14.4 Example of a statement of cash flows (2/4)
Source of the information
Cash flow from operating activities (indirect method) (net amounts) Net income/loss ± IS X2 Adjustments to reconcile net income/loss to net cash provided by/used in operating activities
Depreciation and amortization (excluding those applying to current assets [inventories and accounts receivable])
+ IS X2
Gain/loss on sale of fixed assets ± IS X2 Potential cash flow =
Changes in operating assets and liabilities Change in accounts receivable (net amount) ± BS X1/X2 Change in inventories (net amount) ± BS X1/X2 Change in prepaid expenses ± BS X1/X2 Change in accounts payable and accrued expenses ± BS X1/X2 Net cash provided by/used in operating activities = (A) =
IS: Income Statement - BS: Balance Sheet - AI: Additional Information.
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Table 14.4 Example of a statement of cash flows (3/4)
Source of the information
Cash flow from operating activities (direct method) Cash received from customers + IS X2 & BS X1/X2 Cash paid to suppliers* - IS X2 & BS X1/X2 Cash paid to employees* - IS X2 & BS X1/X2 Cash dividend received + IS X2 & BS X1/X2 Other operating cash receipts + IS X2 & BS X1/X2 Other operating cash payments - IS X2 & BS X1/X2 Interest paid in cash - IS X2 & BS X1/X2 Income taxes paid in cash - IS X2 & BS X1/X2 Net cash provided by/used in operating activities = (A) =
IS: Income Statement - BS: Balance Sheet - AI: Additional Information * These two lines are often merged.
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Table 14.4 Example of a statement of cash flows (4/4)
Source of the information
Cash flows from investing activities Purchases of long-lived assets - BS X1/X2 & AI X2 Proceeds from sale of long-lived assets + IS X2 & AI X2 Loans granted - BS X1/X2 & AI X2 Repayment of loans + BS X1/X2 & AI X2 Net cash provided by/used in investing activities = (B) = Cash flows from financing activities Proceeds from issuance of long-term debt + BS X1/X2 & AI X2 Proceeds from issuance of shares + BS X1/X2 & AI X2 Dividends paid - BS X1/X2 & AI X2 Payment on long-term debt - BS X1/X2 & AI X2 Payment on reduction of share capital (repayment of shares) - BS X1/X2 & AI X2 Net cash provided by/used in financing activities = (C) = Net increase in cash and cash equivalents = (A) + (B) + (C) = (D) = Cash and cash equivalents at beginning of year = (E) Cash and cash equivalents at end of year = (F) = (E) + (D)
IS: Income Statement - BS: Balance Sheet - AI: Additional Information.
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Table 14.5 Liszt
company Comparative
balance sheets
000 CU X2 X1 Changes (X2 – X1)
Assets Fixed assets Tangible assets Equipment (gross) 615 460 155 Accumulated depreciation -116 -70 -46 Equipment (net) 499 390 109 Financial assets (loans granted) 115 174 -59 Total fixed assets 614 564 50 Current assets Inventory 144 100 44 Accounts receivable 44 63 -19 Cash and marketable securities 25 15 10 Prepaid expenses* 4 7 -3 Total current assets 217 185 32 Total assets 831 749 82 Shareholders’ equity and liabilities Shareholders’ equity Share capital 282 200 82 Share premium 198 115 83 Retained earnings/Reserves 124 122 2 Net income of the period (before appropriation)
9 10 -1
Total shareholders’ equity 613 447 166 Liabilities Long-term liabilities (loans received and bonds)
155 245 -90
Current liabilities Accounts payable 62 54 8 Income taxes payable 1 3 -2 Total current liabilities 63 57 6 Total liabilities 218 302 -84 Total shareholders’ equity and liabilities 831 749 82 * Related to ‘Other operating expenses’
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Table 14.6 Liszt company - Income statement
000 CU Sales 800 Cost of merchandise sold -570 Gross profit 230 Depreciation expense -60 Other operating expenses -162 Operating profit 8 Interest expense -15 Investment income 18 Gain on sale of equipment 3 Profit before taxes 14 Income taxes -5 Net profit 9
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Additional information (1/2)
- Equipment was purchased for 175
- Equipment with an original cost of 20 and accumulated depreciation of 14 was sold for 9
- No new loan were either granted or obtained
- 135 was raised from the issue of shares in cash (share capital of 66 plus share premium of 69)
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Additional information (2/2)
- Bonds were converted into capital for 30 (share capital for 16 and share premium for 14)
- Bonds were repaid at face (nominal) value at maturity for 60
- Dividends (relating to net income of X1) were paid in cash for 8
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7 Operating cash flow – Indirect method
• Commonly used method
• Important concepts: – non-cash items– potential cash flow
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Figure 14.2 Cash and non-cash items in the income statement
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Potential cash flow
• Potential cash flow = Cash revenues - Cash expenses
or
• Potential cash flow = Net income + Non-cash expenses - Non-cash revenues
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Gain on sale of equipmentSales price 9Original cost 20Accumulated depreciation - 14Book value 6 -6Gain on sale 3
Operating activities . Net income (including Gain on sale) 3 (…)
Investing activities . Proceeds from sale of equipment 9 (…)
To avoid double counting of the gain on sale of fixed assets
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Changes in inventories, receivables and payables
• Potential cash flow: adjusted by the amount of changes in inventories, receivables and payables
• For inventories, same principle as for receivables: an increase has a negative impact on cash and a decrease has a positive impact on cash
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Table 14.7 Sign of changes in assets and liabilities
Important table for changes in inventories, receivables and payables
Change (ending minus beginning balances)
Impact on cash
Assets Increase - Decrease + Liabilities Increase + Decrease -
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Figure 14.3 From ‘potential’ cash flow to ‘real’ cash flow from operations
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Figure 14.4 Indirect method
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Table 14.8 Cash flows from operating activities (indirect method)
Net income 9 Adjustments to reconcile net income/loss to net cash provided by/used in operating activities
Depreciation expense 60 Gain on sale of fixed assets -3 Potential cash flow 66 Adjustments to acknowledge changes in operating assets and liabilities
Change in accounts receivable 19 Change in inventories -44 Change in prepaid expenses 3 Change in accounts payable 8 Change in income taxes payable -2 Total adjustments 41 41 Net cash provided by/used in operating activities 50
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8 Operating cash flow (direct method)
• Direct method
• In reality: ‘semi-direct’ method
• Income statement items are adjusted for changes in inventories and operating receivables and payables to give cash flows
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Figure 14.5 Determination of cash flows using the semi-direct method
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Figure 14.6 From income statement to ‘real cash flow’ (to be extended to each cash item on the
income statement)
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Cash received from customers
- ‘Sales revenue’ is obtained from the income statement and flows through the ‘accounts receivable’
- The change in accounts receivable is taken from the ‘changes’ column of the comparative balance sheet
Income statement item ± Change in related balance sheet item
= Cash flow from customers
Sales revenue Change in accounts receivable Cash received from customers
800 + 19 (decrease) = 819
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Cash paid-out in relation to cost of merchandise sold (cash paid to suppliers of goods for resale)
Purchases = Change in inventory + Cost of merchandise sold614 = 44 + 570
Income statement item
± Change in related balance sheet item
= Cash flow related to the acquisition of
merchandise Purchases Change in accounts payable Cash paid out for
purchases -614 + 8 (increase) = -606
Two steps
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Cash paid for other operating expenses (cash paid to suppliers of
other operating expenses)
Income statement item ± Change in related balance sheet item
= Cash flow related to other operating expenses
Other potentially cash impacting operating
expenses
Change in prepaid expenses Cash paid out for other operating expenses
-162 + 3 (decrease) = -159
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Cash paid for interest
• In our example: no accrued interest payable on the balance sheet
• Cash outflow = interest expense: - 15
• In general, cash paid for interest = interest expense adjusted for the change in accrued interest payable
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Cash received from investment income
• No accrued interest receivable on the balance sheet
• Cash inflow = the investment income (dividends received): 18
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Cash paid for income taxes
Income statement item ± Change in related balance sheet items
= Cash flow related to taxes
Income taxes expense Change in income taxes payable Income taxes paid -5 - 2 (decrease) = -7
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Gain on sale of equipment
• The gain on sale of equipment is not included in the direct method
• See the explanation of the indirect method
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Table 14.9 Income statement items and related balance sheet items
Income statement items Related current assets Related current liabilities Sales Accounts receivable Advances received from
customers Revenues recorded in advance (unearned revenues)
Financial revenues Interests receivable Accrued interests receivable
Unearned interests
Cost of merchandise sold Inventory Advances paid to suppliers
Accounts payable
Rent expense Prepaid rent (Expenses recorded in advance)
Rent payable Accrued rent payable
Compensation and social expenses Prepaid compensation and social expenses (Expenses recorded in advance)
Compensation and social expenses payable Accrued salaries and social expenses payable
Other operating expenses Prepaid other operating expenses (Expenses recorded in advance)
Other expenses payable Accrued other expenses payable
Taxes including income taxes Prepaid taxes – prepaid income taxes (Expenses recorded in advance)
(Income) Taxes payable Accrued (income) taxes payable
Financial expenses Prepaid interests Interests payable Accrued interests payable
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Table 14.10 Cash flows from operating activities (direct method)
Cash received from customers 819Cash paid in relation to cost of merchandise sold -606Cash paid in relation to other operating expenses -159Cash paid on interest -15Cash received from investment income 18Cash paid on income taxes -7Net cash provided by/used in operating activities 50
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9 Cash flows from investing activities
Beginning balance
+ Increases - Decreases = Ending balance
A + B - C = D
This A + B – C = D formula is a valuable tool for:• Checking the changes between the beginning and
ending balance sheet• Identifying one of the components, when the other
three are known
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Purchase of equipment
Beginning balance + Increases - Decreases = Ending balance Equipment (gross
value) + New equipment
purchased (at cost) - Value of equipment
sold at its original cost = Equipment (gross
value) 460 + 175 - 20 = 615
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Sale of equipment
Sales price (9) included in the statement of cash flows
Beginning balance
+ Increases - Decreases = Ending balance
Accumulated depreciation
+ Depreciation expense
- Accumulated depreciation of fixed
assets sold
= Accumulated depreciation
70 + 60 - 14 = 116
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Repayment of loan
Beginning balance + Increases - Decreases = Ending balanceLoan + New loan granted - Repayment of loan = Loan174 + 0 - ? = 115
• 174 + 0 – X = 115 X = 174 – 115 = 59
• Loans were repaid for a total amount of 59
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Table 14.11 Cash flows from investing activities
Purchase of equipment -175 Proceeds from sale of equipment 9 Repayment of loan by borrowers 59 Net cash provided by/used in investing activities -107
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10 Cash flows from financing activities
• 135 was raised from the issue of shares in cash (66 of share capital and 69 of share premium)
• Bonds were converted into capital for 30 (share capital of 16 plus share premium of 14)
• Bonds were repaid at face value at maturity for 60
• Dividends (relating to net income of X1) were paid in cash for 8
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Issuance of share capital
Beginning balance + Increases - Decreases = Ending balance Share capital + Issued - Repayment = Share capital
200 + 66 + 16 = 82 - 0 = 282 Share premium + Issued - Repayment = Share premium
115 + 69 + 14 = 83 - 0 = 198
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Table 14.12 Share issues
Share capital Issue in cash 66Issue by conversion of debts 16 135Total 82
Share premium Issue in cash 69 30Issue by conversion of debts 14Total 83
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Bonds movements
The above decrease comprise the following components:• Repayment: 60 (see additional information)• Conversion into capital: 30 (see additional
information)
Beginning balance
+ Increases - Decreases = Ending balance
Bonds + New issue - Repayment Conversion = Bonds 245 + 0 - (60 + 30) = 155
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Dividends
• Balance sheet presented before appropriation• Changes in retained earnings/reserves:
Beginning balance 31/12/X1
+ Increases (Added on 31/12/X1)
- Decreases during X2 = Ending balance 31/12/X2
Retained earnings/Reserves before income of
X1
+ Net income of year X1 - Dividends paid in year X2 or capitalization to Retained
earnings/Reserves
= Retained earnings/Reserves before income of
X2 122 + 10 - 8 = 124
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Table 14.13 Cash flows from financing activities
Proceeds from issuance of shares 135Payments on long-term debt -60Dividends paid -8Net cash provided by/used in financing activities 67
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Table 14.14 Statement of cash flows of Liszt Company Year 2 (indirect method)
Cash flows from operating activities (indirect method) Net income 9 Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense 60 Gain on sale of fixed assets -3 Potential cash flow 66 Changes in operating assets and liabilities Change in accounts receivable 19 Change in inventories -44 Change in prepaid expenses 3 Change in accounts payable 8 Change in income taxes payable -2 Total adjustments 41 Net cash provided by/used in operating activities 50 Cash flows from investing activities Purchase of equipment -175 Proceeds from sale of equipment 9 Repayment of loan 59 Net cash used in investing activities -107 Cash flows from financing activities Proceeds from issuance of shares 135 Payments on long-term debt -60 Dividends paid -8 Net cash provided by financing activities 67 Net increase in cash and cash equivalents 10 Cash and cash equivalents at beginning of year 15 Cash and cash equivalents at end of year 25
Schedule of non-cash investing and financing transactions (see section 9) Conversion of bonds into capital 30
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11 Non-cash investing and financing transactions
• Acquisition of assets either by assuming directly related liabilities or by means of a finance lease (see Chapter 12)
• Acquisition of an enterprise exclusively by means of an equity issue
• Conversion of debt to equity (see Chapter 11)
• Issuance of shares by capitalization of reserves (see Chapter 11)