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Chapter 20
Cash-flow statements
20.1 Pursuant to AASB 107, the three types of activities reported on the statement of cash flows
are described as follows:
Financing activities are activities that result in changes in the size and composition of
the contributed capital and borrowings of the entity.
Investing activities are the acquisition and disposal of long-term assets and other
investments not included in cash equivalents.
Operating activities are the principal revenue-producing activities of the entity and
other activities that are not investing or financing activities.
Each type of cash flow provides important information. For example, it would be hoped that
in the longer term, the majority of the firms cash flows would be generated by its operating
activities. Knowledge about the investing activities of the firm provides information about the
growth or contraction in the asset base of the company and this may be particularly important
when considering future cash flows and prospects. Cash flows relating to financing activities
will show how the financial structure has changed and this may be particularly important in
considering potential changes in the risk of the entity, and the associated changes in expected
returns.
20.3 The Objective of AASB 107 is identified in the accounting standard 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 cash flow
statement which classifies cash flows during the period from operating, investing
and financing activities.
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.
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7. Cash equivalents are held for the purpose of meeting short-term cash commitments
rather than for investment or other purposes. For an investment to qualify as a cash
equivalent it must be readily convertible to a known amount of cash and be subject
to an insignificant risk of changes in value. Therefore, an investment normally
qualifies as a cash equivalent only when it has a short maturity of, say, three months
or less from the date of acquisition. Equity investments are excluded from cash
equivalents unless they are, in substance, cash equivalents, for example in the case of
preferred shares acquired within a short period of their maturity and with a specified
redemption date.
20.4 The following are cash equivalents: deposits that are available at call (d); deposits on the
money market that are available at two months notice (e); and a bank overdraft (f).
20.5 The argument that cash-flow data might be more reliable than profit-related data is based on
the view that the determination of profits relies upon many professional judgements, such
that different teams of accountants would rarely calculate the same profit or loss figure for
the same entity. Profit can also be manipulated. By contrast, cash and cash equivalents are
more objectively determined and less susceptible to manipulation. However, it is debatable
whether cash-flow data is more relevant than profit-based data. This is a good opportunity to
consider the issue of relevance versus reliability.
20.6 This question will be useful for stimulating debate among students. Cash-flow data and
accounting-profit data serve different purposes. Arguably, in assessing financial performance,
accounting profits provide a superior measure. Profit takes into account the inflows and
outflows of economic benefits. Cash flows only consider inflows and outflows of cash and
cash equivalents. The flow of cash does not necessarily equate to inflow of net assets to an
entity. For example, we may sell land for cash at a price equal to its book value. Although
there is an inflow of cash, the net assets of the entity would remain unchanged. Nevertheless,
for determining the solvency and cash management of a reporting entity, a statement of cash
flows, and its supporting notes, is a useful complement to the income statement and balance
sheet.
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Cash equivalents are described as 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 can sometimes be difficult to determine what
constitutes a cash equivalent of a company. Consider the argument presented in the
newspaper article on page 701 of the textbook.
(iv) Reconciling the cash flows from operations with the net profit
Unless a systematic approach such as a spreadsheet is used, it is easy to omit relevant
items from the reconciliation.
Thus, whilst cash flow statements are useful for reviewing the cash position of companies,
they must be reviewed carefully and in conjunction with other financial information.
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cash provided from operations, any increase in the provision would be added to net
profits after tax (and any decrease would be deducted).
20.9 The Accounting Standard requires that the following be disclosed (by way of a note):
(i) information about transactions and other events that do not result in any cash flows
during the financial year but affect assets and liabilities that are recognised must be
disclosed in the financial report where the transactions or other events involve parties
external to the entity and relate to the financing or investing activities of the entity.
Specifically, paragraph 43 states:
Investing and financing transactions that do not require the use of cash or cash
equivalents shall be excluded from a cash-flow statement. Such transactions
shall be disclosed elsewhere in the financial report in a way that provides all the
relevant information about these investing and financing activities.
(ii) the policy adopted for determining which items are classified as cash and cash
equivalents in the statement of cash flows. Specifically, paragraph 46 of AASB 107
states:
(iii) a reconciliation of the amount of cash at the end of the financial year to the related
items in the balance sheet. Specifically, paragraph 45 of AASB 107 states:
An entity shall disclose the components of cash and cash equivalents and
shall present a reconciliation of the amounts in its cash-flow statement with
the equivalent items reported in the balance sheet.
(iv) a summary of the used and unused loan facilities of the entity and the extent to which
these can be continued or extended. Specifically, paragraph 50 of AASB 107 states:
(v) the amount of cash held that is not available for use and the nature of the restrictions
placed upon the use of the cash. Specifically, paragraph 48 of AASB 107 states:
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An entity shall disclose, together with a commentary by management, the
amount of significant cash and cash equivalent balances held by the entity
that are not available for use by the group.
(vi) A reconciliation of cash flows arising from operating activities to profit or loss shall be
disclosed in the financial report.
20.10 (a) The main criticism is that the definition of cash and cash equivalents is too narrow
and should include bullion holdings.
To the extent that gold bullion is readily convertible to cash, then the criticism may be
valid. However, it is not clear from a reading of AASB 107 that gold bullion would
definitely have to be excluded from cash equivalents. The entity, however, would
need to be able to demonstrate that gold bullion is highly liquid, and is used in the
entitys cash management function on a day-to-day basis.
20.11 This question can be answered by using either the t-account approach or the equations
approach.
The following t-accounts are in $000
Sales Accounts receivable Provision for doubtful debts
A/c Op. A/c
Rec. 400 bal. 90 rec. 6 Op. bal. 9
Clos. Dd
Sales 400 Prov. dd 6 bal. 8 expense 5
Discounts 10 14 14
CASH 394
Clos. bal. 80
490 490
Alternatively, we can determine the cash flows from debtors using an equation, as shown
below.
Cash receipts from customers = $400 000 (Sales) + $90 000 (beginning receivables)
$80 000 (ending receivables) $6 000 (transfer from provision for doubtful debts which
equals opening balance of the provision plus the doubtful debts expense less the closing
balance of the provision) $10 000 (discounts that may have been given for early payment) =
$394 000.
20.12 This question can be answered by using either the t-account approach or the equations
approach.
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The following t-accounts are in $000
20.13 This question can be answered by using either the t-account approach or the equations
approach.
The original cost of the asset that was disposed is determined by adding the accumulated
depreciation pertaining to the asset ($40 000, as determined above) to the written down
value of the disposed asset ($90 000, which was provided in the question) to give an original
cost of $130 000.
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20.14 (i) Receipts from customers
We need to reconstruct the provision for doubtful debts and accounts receivable.
The cumulative entry to record sales would be:
Accrued salaries
CASH 26 Op. bal. 18
Clos. bal. 22 Salaries 30
48 48
At this stage we can now determine the total cash flows from operations as:
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Cash flows from investment activities
Plant and equipment
The journal entries for the disposal of the plant and equipment can be summarised as:
As Plant increased by $10 000, $30 000 must have been acquired during the period
(this is given in the question), as reconciled below:
We are now able to present a cash flow statement for XYZ Ltd.
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XYZ Limited
Statement of Cash Flows
for the year ended 30 June 2010
$000
Cash flows from operating activities
For XYZ, two notes must accompany the Cash Flow Statement, these being:
$000
Net profit 35
Depreciation 10
Decrease in provision for doubtful debts (5)
Increase in accounts receivable (20)
Increase in inventories (20)
Increase in trade creditors 10
Increase in accrued expenses 4
Net cash provided from operating activities 14
2010 2009
$000 $000
For the purposes of the statement of cash flows,
cash includes:
Cash 144 139
Bank overdraft 20 19
24 120
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20.15
S Limited
Statement of Cash Flows
for the Year Ended 30 June 2010
$000 $000
$000
Net profit 264
Depreciation 216
Increase in provision for doubtful debts 24
Increase in income taxes payable 36
(Increase)/decrease in accounts receivable (144)
(Increase)/decrease in inventories (24)
Increase/(decrease) in trade creditors (24)
Increase in accrued expenses 6
(Increase)/decrease in future income tax benefit (10)
Net cash provided from operating activities 344
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Workings:
In this question some expenses are transacted for on a cash basis (electricity, rates, and
interest). For those accounts which involve accruals, it is necessary to calculate the cash flow,
by taking into account the opening and closing accrual as well as the expense in the income
statement. This is done below.
Accounts receivable
Accounts Receivable
S Ltd commenced the year with $216 000 of inventory. After using $576 000 of this
inventory it had a closing inventory balance of $240 000. This means that $600 000
must have been purchased.
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Inventory account
Trade creditors
Given that trade creditors had an opening balance of $192 000, there were purchases
of $600 000 (above), and there was a closing balance of $168 000, $624 000 must
have been paid in cash.
Trade creditors account
(iv) Taxation
The profit before tax using accounting rules was $472 000. The taxable income for
the year (that is, the profit that is calculated using taxation rules) is calculated after
adding back to accounting profit the building depreciation of $48 000 (which is not
tax deductible in 2010 or any other yearit is a permanent difference). In
determining taxable income we also have to add back the doubtful debts expense and
then subtract the actual doubtful debts write-off against debtors (for tax purposes
only the write-off against debtors is deductible and not the actual doubtful debt
expense). Hence we are adding back $96 000 and subtracting $72 000 (that is, adding
back a net amount of $24 000 which is the increase in the provision). Taxable income
therefore is:
There is a temporary difference caused due to the provision for doubtful debts and
this temporary difference creates a deferred tax asset. Using a tax rate of 40%, the
accounting entries to account for tax pursuant to AASB 112 (see Chapter 17) and to
the nearest $000 are:
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Dr Income tax expense (40% of $544 000) 218 000
Cr Income tax payable 218 000
(i) Land
A reconciliation of the movements in land shows that no land was acquired for cash.
There was a revaluation, and an exchange of shares in the company for land. The
entries would have been:
The journal entries for the disposal of the plant and equipment can be summarised as:
Dr CASH 72 000
Dr Accumulated depreciation 168 000
Cr Plant and equipment 240 000
As plant and equipment increased by $48 000, despite the disposal above, $288 000
must have been acquired in the year.
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Accumulated depreciation
Payment for property, plant and equipment ((ii) above) (288 000)
Proceeds from sale of plant ((ii) above) 72 000
Total (216 000)
A reconciliation of movements in share capital would show that there have been no issues for
cash.
The only cash flow from financing relates to $24 000 from long-term loans.
20.16
T Pty Limited
Statement of Cash Flows
for the Year Ended 30 June 2010
$000
Cash flows from operating activities
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Proceeds from sale of property, plant and equipment 20
Payments for non-trading investments (438)
Net cash flows from investing activities (418)
Note 1: Reconciliation of net cash flows from operating activities to net profit
During the year, the company acquired additional investmentsconsideration for the
purchase of the investment in associated company, Squash Pty Ltd, being 500 000 shares at
$1.50 each plus $250 000 in cash; and other investments acquired for $80 000 for
consideration of tennis equipment.
Plant and equipment, under finance lease, was acquired with a fair value of $25 000.
Workings:
We need to reconstruct the provision for doubtful debts and accounts receivable.
The cumulative entry to record sales would be:
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As the closing balance of doubtful debts increased by $30 000, $5000 must have been
written-off against debtors. A reconciliation of accounts receivable shows a cash collection of
$31 056:
Purchases of inventory
XYZ Ltd commenced the period with $2 486 000 of inventory. After using $28 205 000
(COGS), writing-off $50 000, and exchanging $80 000 for some investments, it had a closing
balance of $2 774 000. This means that $28 623 000 of inventory must have been purchased.
Given that trade creditors had an opening balance of $1 483 000, there were purchases of
$28 623 000 (above), and there was a closing balance of $1 637 0000, $28 469 000 must
have been paid in cash. This is shown in the following t-accounts.
Accrued expenses
Given the information in the question, it is assumed that rent is accrued to accruals. If the
opening balance of accruals is $1 110 000, rent expenses totalled $600 000, and the closing
balance was $1 575 000, then $135 000, must have been paid.
Accruals
CASH 135 Op. bal. 1 110
Clos. bal. 1 575 Salaries 600
1 710 1 710
If the opening balance of the provision is $298 000, salary and wages expenses totalled
$1 324 000, and the closing balance was $205 000, then $1 417 000, must have been paid.
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Provision for employee entitlements
CASH 1 417 Op. bal. 208
Clos. bal. 205 Salaries 1 324
1 622 1 622
It has been assumed that finance charges of $7000 were paid as incurred. It is not clear what
the prepayments relate to, but it will be assumed that they relate to some employee salaries.
At this stage we can now determine the total cash flows from operations as:
Receipts from customers 31 056
Payments to suppliers (28 469)*
Payments for accrued expenses (135)*
Employee-related payments (1 417)*
Prepayments (115)*
Finance charges (7)
Dividends 51
Tax payments (65)
Interest payments (315)
584
* These numbers are added together to give $30 136, which is shown on the statement of
cash flows.
The journal entries for the disposal of the plant and equipment can be summarised as:
There was also a revaluation of plant and equipment. The entires to record the revaluation
would be:
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Accumulated depreciation Plant and equipment
Disposal 48 Op. bal. 548 Op. bal. 768 Disposal 68
P and E 500 Deprec. exp 100 ARR 800 Accum. dep 500
Clos. bal. 100 Lease 25 Clos. bal. 1 025
648 648 1 593 1 593
Therefore, no plant and equipment was acquired for cash. There were some acquisitions of
investments during the period. Acquisition of investments would be recorded as follows:
The account investments increased from $948 000 to $1 216 000. This increase is partly
explained by the acquisition financed by the $80 000 of tennis equipment (see Additional
information part (i)). The balance of the increase ($188) is assumed to have been acquired
for cash. This gives total cash acquisition of investments of $438 000.
Repayment of borrowings
Opening (3 800)
Closing 3 500
(300)
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20.17 Cash flows from operating activities
Accounts receivable
Opening balance 60 CASH 80
Sales 60 Provision for doubtful debts 4
Closing balance 36
120 120
Inventory
Opening balance 52 Cost of goods sold 40
Accounts payable 80 Closing balance 92
132 132
Accounts payable
CASH 80 Opening balance 60
Closing balance 60 Inventory 80
140 140
Accrued wages
CASH 16 Opening balance 16
Closing balance 20 Wages 20
36 36
From customers 80
Payments to employees (16 + 20) (36)
Payments to suppliers (80)
Interest received 4
(32)
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Accumulated depreciation
Disposal 4 Opening balance 20
Closing balance 36 Expense 20
40 40
To determine the original cost of the asset disposed, we are told that the property had a
written-down value of $20 000. From the above t-account analysis we have determined that
the accumulated depreciation related to the disposed asset was $4000. Therefore, its original
cost must have been $24 000. As the property had a written-down value of $20 000, and as
Cabarita Ltd recorded a profit on sale of $8000, it must have received $28 000 from the
disposal. Therefore, total cash flows from investing activities:
In the absence of any information to the contrary, it must be assumed that the increase in
share capital of $120 000 was received in cash. There were also additional borrowings of
$60 000.
Having considered the cash flows associated with the operating, investing and financing
activities we are now in a position to compile the statement of cash flows.
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Cabarita Ltd
Statement of Cash Flows
for the year ended 30 June 2010
$000 $000
Cash flows from operating activities
To comply with AASB 112, a number of supporting notes are also required.
Note 1: Reconciliation of net cash provided by operating activities and net profit.
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Note 2: Reconciliation statement for cash as shown in the statement of cash flows.
Cash at the end of the year as shown in the statement of cash flows is reconciled to the
related items in the statement of financial position as follows:
2010 2009
$000 $000
Cash per statement of financial position 96
Bank overdraft per statement of financial position (40)
Cash as year end per statement of cash flows 96 (40)
20.18
(a) Cook the books is an expression that has been used for many years and means that
somebody has manipulated the accounting records so as to generate a predetermined
or desired result. Somebody who is involved in such an action is clearly not being
objective and hence is ignoring one of the fundamental principles of accounting. One
of the primary qualitative characteristics of accounting is reliability (which requires,
amongst other things, that the accounting process is free from bias) and hence
cooked books would not satisfy this expectation. Because many people might use
financial reports for various decisions (including retirees who are electing to invest
their savings), such an action as cooking the books is to be deplored.
(b) A reader of financial reports does not have access to the underlying records, and
hence, it would not generally be possible to determine that the books have been
cooked. Indeed, those people involved in manipulating the financial reports would
perform the manipulation in a way such that any manipulation would be very difficult
to detect. Often manipulation only becomes evident when a company subsequently
gets into financial difficulty and further investigation is performed. One safeguard,
which certainly is not infallible, is the appointment of external auditors. A large
company like Harris Scarf would have auditors appointed who are required to
provide a report about whether the financial reports comply with accounting
standards and other generally accepted accounting principles. Ideally, the auditors
work should uncover any material deviations from accepted accounting principles.
However, the auditor does not check the accuracy of every accounting entry (much
sampling and professional judgement is involved) and hence any cooking of the
books will not always come to light.
(c) It is certainly more difficult to be creative in relation to the statement of cash flows
than it is in relation to the statement of financial position or the statement of financial
performance. The statement of financial position and the statement of financial
performance are generated as a result of accrual accounting, which requires much
estimation and professional judgement. The statement of cash flow, however,
provides a reconciliation of opening and closing cashboth of which are fairly
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hard numbers which are not heavily based on judgement (there might be some
argument about whether something constitutes cash, but such arguments would
generally be limited) and which can be traced directly and fairly easily to records
provided by external parties, such as banks. There is some possibility of manipulating
the categorisation of certain cash flows (for example, classifying a cash flow as
relating to ordinary operations rather than investment activities), and perhaps
nominating something as cash when it should not bebut the ability to do this is
typically very limited.
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