Financial Accounting 2

ACC203 Financial Accounting 2

Workshop 3 Statement of Cash Flows

COMMONWEALTH OF AUSTRALIA Copyright Regulations 1969

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Material adapted from Financial reporting in Australia / Janice Loftus, Ken Leo, Sorin Daniliuc, Noel Boys, Belinda Luke, Hong Ang, Karyn Byrnes. Second edition.

John Wiley & Sons Australia, Ltd

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Learning objectives

1. Explain the purpose of a statement of cash flows 2. Classify cash inflows and outflows into operating,

investing and financing activities 3. Contrast the direct and indirect methods of

presenting cash flows from operating activities 4. Prepare a statement of cash flows

Learning objectives

1. Explain the purpose of a statement of cash flows 2. Define cash and cash equivalents 3. Classify cash inflows and outflows into operating,

investing and financing activities 4. Contrast the direct and indirect methods of

presenting cash flows from operating activities 5. Prepare a statement of cash flows

Class Discussion

An entity may report significant profits over a number of successive years and still experience negative net cash flows from its operating activities. How can this happen?

What is a Cash flow Statement?

A cash flow statement reports the entity’s cash movement over a period of time.

What does cash include?

Cash in hand

Cash at bank

Cash equivalents

Purpose of a statement of cash flows

• The statement of cash flows can assist investors, creditors and other users of financial statements to evaluate: – The entity’s ability to generate cash and cash

equivalents – The entity’s ability to affect the amount, timing and

certainty of generating future cash flows – The entity’s need to utilise cash and cash equivalents.

• The classification of cash flows as arising from operating activities, investment activities and finance activities is useful in analysing the movement in cash and cash equivalents during the period.

Source: Loftus et al. (2018), p. 690

Purpose of a statement of cash flows

• When used in conjunction with other financial statements, information about cash flows assists users of financial statements to: – Predict future cash flows – Evaluate an entity’s financial structure (including

liquidity) and its ability to meet its obligations and to pay dividends

– Understand the reasons for the difference between profit or loss for a period and the net cash flow from operating activities

– Compare the operating performance of different entities

Source: Loftus et al. (2018), p. 690

Class Activity

• What is the purpose of a statement of cash flows? • How might a statement of cash flows be used?

Learning objectives

1. Explain the purpose of a statement of cash flows 2. Classify cash inflows and outflows into operating,

investing and financing activities 3. Contrast the direct and indirect methods of

presenting cash flows from operating activities 4. Prepare a statement of cash flows

Classifying Cash Flow Activities

Operating

Principal revenue- producing activities

Income and expense accounts

Investing

Acquisition and disposal of long-

term assets

Non-current asset accounts

Financing

Result in changes in the size and composition of

contributed equity and borrowings

Non-current liabilities and owner’s equity

accounts

Source: Para. 6, AASB 107

Classifying Cashflow Activities

Source: Hongren et al. (2012), p.669

Class Activity

• Explain the required classifications of cash flows under AASB 107/IAS 7.

Class Activity

Complete the table below: (a) Tick the first column if the item is not a cash flow. (b) If the item is a cash flow, write the amount in the

appropriate category (operating, investing or financing). Show outflows using brackets or –ve sign.

(c) Calculate the total cash inflow (outflow) for each of the activity categories (operating, investment, financing)

Class Activity This month’s transactions Not a cash

flow Operating activity

Investing activity

Financing activity

Received $1,000 cash for services to be provided next period Borrowed $5000 from bank—long term loan Credit sales $600 Paid wages $200 owing from last month Telephone owing $130 for this month Bought furniture for $2,000 cash Cash sales $3,000 Paid shop insurance for next month $500 Signed a service agreement with a govt dept. for next year TOTAL NET CASH FLOW for each category (and total inflow/(outflow) for the period) = $6,300

Learning objectives

1. Explain the purpose of a statement of cash flows 2. Classify cash inflows and outflows into operating,

investing and financing activities 3. Contrast the direct and indirect methods of

presenting cash flows from operating activities 4. Prepare a statement of cash flows

Format of the statement of cash flows

Format of the statement of cash flows

• Reporting cash flows from operating activities – AASB 107/IAS 7 provides that cash flows from

operating activities may be reported using one of two methods:

– The direct method — whereby major classes of gross cash receipts and gross cash payments are disclosed (Individual Account Adjustment)

Format of the statement of cash flows

• The indirect method — whereby profit or loss is adjusted 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 cash flows. (Lump amount – individual adjustment)

Format of the statement of cash flows

• Reporting cash flows from investing and financing activities – Paragraph 21 of AASB 107/IAS 7 requires separate

reporting of the major classes of gross cash receipts and gross cash payments arising from investing and financing activities, except for certain cash flows that may be reported on a net basis.

– If an entity borrows money to repay another long-term loan, it must report a gross financing cash inflow for the amount borrowed and gross financing cash outflow for the repayment of the original loan.

Format of the statement of cash flows

• Reporting cash flows on a net basis – AASB 107/IAS 7 allows the following cash flows to be

reported on a net basis: • Cash receipts and payments on behalf of

customers when the cash flows reflect the activities of the customer rather than those of the entity; and

• Cash receipts and payments for items in which the turnover is quick, the amounts are large, and the maturities are short.

Class Activity

• Explain the differences between the presentation of cash flows from operating activities under the direct method and their presentation under the indirect method. Do you consider one method to be more useful than the other? Why?

Learning objectives

1. Explain the purpose of a statement of cash flows 2. Define cash and cash equivalents 3. Classify cash inflows and outflows into operating,

investing and financing activities 4. Contrast the direct and indirect methods of

presenting cash flows from operating activities 5. Prepare a statement of cash flows

Preparing a statement of cash flows

• Unlike the statement of financial position and statement of profit or loss and other comprehensive income, the statement of cash flows is not prepared from an entity’s general ledger trial balance.

• Preparation requires information to be compiled concerning the cash inflows and cash outflows of the relevant entity over the period covered by the statement.

Preparing a statement of cash flows

• Cash flows from operating activities • Ascertaining the net cash flows from operating activities

is the first step in preparing a statement of cash flows. • The process used varies according to whether the direct

or the indirect method of disclosure is used. – Determining cash receipts from customers – Determining interest received – Determining cash paid to suppliers and employees

Class Activity Use the following information and prepare a Statement of Cash Flows for the month. What does this Cash Flow Statement reveal about the firm? Bank balance, beginning of month $10,000 Bank balance, end of month $64,000 Proceeds from loan (borrowing) $30,000 Receipts from customers $156,000

Proceeds of sale of motor vehicle $16,000 Cash drawings $10,000 Inventory purchased for cash $70,000 Miscellaneous expenses paid $6,000

Tax paid $5,000 Interest paid $3,000 Wages paid $54,000

Class Activity

The 2017 comparative balance sheet and income statement of Mickelson Ltd follow:

Mickelson Ltd Comparative Balance Sheet

as at 31 December 2017 and 2016 2017 2016

Current assets Cash and cash equivalents 26 700 15 600 Accounts Receivable 26 500 25 300 Inventories 79 900 91 900 Non-currents assets Land 35 500 11 000 Equipment 123 480 108 840 Accumulated depreciation - equipment (20 580) (18 140) Total assets 271 500 234 500

Current liabilities Accounts payable 35 600 30 500 Accrued liabilities 28 900 30 600 Non-current liabilities Bill payable 77 000 103 000 Total Liabilities 141 500 164 100

Net Assets 130 000 70 400

Shareholders’ equity Ordinary share capital 88 200 64 300 Retained earnings 41 800 6 100

Total shareholders’ equity 130 000 70 400

Class Activity

Mickelson Ltd Income Statement

for the year ended December 2017

Revenues $ $

Sales revenue 438 000

Interest revenue 8 500

Total revenues 446 500

Expenses

Cost of sales 209 200

Salary expense 72 400

Depreciation expense 14 500

Other operating expense 10 000

Interest expense 21 500

Income tax expense 19 400

Total expenses 347 000

Profit 99 500

Additionally, Mickelson Ltd purchased land of $24 500 by financing it 100% with long-term bills payable during 2017. During the year, there were no sales of land, no additional issues of bills payable and no buy-back of shares. An item of equipment was disposed of for $0. The cost and accumulated depreciation of the disposed equipment was $12 060.

Required: Prepare the 2017 cash flow statement, formatting activities by the direct method.

Yellow Submarine Ltd’s Balance Sheets at the end of June 2016 and 2017 were as follows:

Yellow Submarine Ltd. Balance Sheets as at 30 June 2017 2016 ASSETS Current Assets Accounts Receivable 200,000 107,500 Allowance for Doubtful Debts (20,000) (10,000) Inventory 305,500 182,500 485,500 280,000 Non-Current Assets Land 25,000 10,000 Buildings 60,000 60,000 Accumulated Depreciation – buildings (35,000) (30,000) Plant & Equipment 300,000 207,000 Accumulated Depreciation – plant & equipment (55,500) (27,000) 294,500 220,000 TOTAL ASSETS 780,000 500,000 LIABILITIES AND OWNERS’ EQUITY Current Liabilities Bank Overdraft 167,950 58,800 Accounts Payable 29,300 36,200 Current Tax Payable 15,000 6,000 212,250 101,000 Owners’ Equity Share Capital 385,000 300,000 Asset Revaluation Reserve 15,000 - General Reserve 85,000 50,000 Retained Profits 82,750 49,000 Total Equity 567,750 399,000 TOTAL LIABILITIES AND OWNERS’ EQUITY 780,000 500,000

Class Activity

The company’s Income Statements for the year ended 30 June 2017 and general ledger revealed the following information:

$ $ Net Sales 550,000 Cost of Goods sold 277,000 Gross Profit 273,000 Proceeds from sale of plant & equipment 47,500 Gross profit 320,500 Expenses: Carrying amount of equipment sold Salaries and wages expense

40,000 60,250

Depreciation expense - buildings 5,000 Depreciation expense - plant & equipment 38,500 Electricity expense 3,000 Bad debts expense 30,000 176,750 Net Profit before tax 143,750 Income tax expense 52,500 Net Profit after tax 91,250

Additional Information:

1. Plant and equipment which had originally cost $50,000 and had been depreciated by $10,000, was sold during the year for $47,500

2. The company pays income tax in one payment. 3. The land was revalued upwards during the year by $15,000. 4. During the year, a dividend of $22,500 was paid. Yellow Submarine Ltd classifies dividend

paid as a financing activity. 5. All purchases and sales were made on credit.

Required: Prepare a Cash Flow Statement for the year ended 30 June 2017, in accordance with AASB 107 Cash Flow Statements. Show workings.

Class Activity

References

Horngren, C., Harrison, W., Oliver, S., Best, P., Fraser, D., Tan, R. and Willett, R., (2012) Accounting. 7th edn. Australia: Pearson Higher Education, p.669.

Hoggett, J. , Medlin J., Chalmers K., Beattie C., Hellmann A. and Maxfield J., (2018) Financial Accounting 10th edn. Australia: John Wiley, pp.138-194

Loftus, J. , Ken, L., Sorin D., Boys N., Luke B., Hong A. and Byrnes K., (2018) Financial Reporting, 2nd edn. Australia: John Wiley, pp.689-735

Australian Accounting Standard Board (2015) , AASB 107 Statement of Cashflows . [Online] Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB107_08-15.pdf (Accessed 5 October 2019)

End of the Workshop