Accounting case study: Statement of Cash Flows (IAS 7)

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Table of Contents

Introduction. 3

The Statement of Cash Flows. 3

Objective, use and purpose of International Accounting Standard 7 (IAS 7). 3

Key Terms. 4

Operating Activities. 4

Investing Activities. 4

Financing Activities. 5

Calculating Net Cash Flow from Operating Activities. 5

Direct method. 5

Indirect approach. 6

Treating peculiar items. 6

Evaluation. 7

References. 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 includethe 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 Flows

The 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 maturitydate 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 (IAS7)

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 Terms

There 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 Activities

Cash 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’s                                                          xxxx

Cash payments to employee                                                   xxxx

Cash paymentsfor other operatingexpenses                xxxx

Interest paid                                                                            xxxx

Income taxes payments                                                           xxxx

Net Cash Flow from Operating Activities                           xxxx/ (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)                               .............