Report on International Accounting Standard (IAS) Statement of Cash Flow
Introduction
The report explains what the International Accounting Standard 7 (IAS 7) Statement of Cash Flows is and what its components stand for. Examples of these components as operating, investing, and financing activities, both inflow and outflow examples are given. Calculation of Net Cash Flow from Operating Activities is also discussed and a format given in this report. The final aspect of the purpose of International Accounting Standard 7 to Twice As Much is also discussed.
Objective and purpose of International Accounting Standard 7 (IAS 7) Statement of Cash Flows
IAS was prepared with the sole function of helping organisations prepare and present all historical data on cash flow activities or their equivalents relating to investing, operating, and financing functions of a business. According to EC Europa (2010), information on cash flows is useful in aiding users of financial information to tell whether an entity is able to generate cash and cash equivalents and whether they have the ability to utilise them. Such information in assessing the financial position of an organisation when used alongside other tools such as balance sheets and statements of comprehensive income. Besides, users are able to assess all net changes in the past on cash, the capital structure of an entity in relation to equity and debt, and the financial structure of a firm where one can assess the solvency and liquidity of a firm. Mizra (2011) noted that once all these facts are known and assessed, it would also be possible to assess whether an organisation can affect the timing and certainty of cash flows to suit its needs depending on the needs and circumstances, which can either be opportunities to invest of spend to pay necessary bills. This information can be gained when other tools such as balance sheet are used where liquidity can be used to tell whether a firm can meet its obligations that are due, especially in the short term.
The IAS 7 has the purpose of enabling users to assess the ability of an organisation to generate cash and cash equivalents in the present to meet its needs. It is possible to prepare information and apply other models that can enable it to predict the future performance of an entity using current information. This means net present and future cash flows can be compared to assess how a firm is likely to perform in the future. This is information that is useful for current managers, shareholders, and decision-makers as internal stakeholders, as well as interested investors and regulators, are external shareholders. Generated information on cash flows can be condensed into reports and models applied to enable comparability between organisations, a process that is useful to potential investors and managers. Comparability can be used for the purpose of benchmarking when reporting the performance of various organisations. The main reason for this is the IAS 7 acts as a standard tool that makes it easier to apply similar treatments across firms without the need for harmonisation and justification of financial statements from individual organisations. Besides, by being international, the document is supposed to be adopted by all organisations globally making it easier for analysts and users to compare and prepare cash flow statements and related documents with ease. Interpretation of results is also clear as the figures would mean the same regardless of where they were prepared. By its nature, a cash flow statement is a historical document that is used to tell how cash and its equivalents have changed. This means the document can be used to predict the future behaviour of cash flows.
Explanation of the key terms as per IAS 7:
Operating activities
The definition of this is that these are “principal revenue-producing activities of the entity and other activities that are not investing or financing activities.” According to Kieso et al. (2010), these are all activities that are related to the purchase and delivery of goods to the business. Cash flow from these activities involves all activities that arise from transactions that are used in the determination of the net income of an organisation. Examples of operating activities in cash inflows include the sale of goods and services, earned interest from loans, and dividends from equity securities such as treasury bills. Mirza, et al. (2011) added that cash from commissions, royalties, and fees are recorded under this classification while cash refunds or income taxes recorded can also be noted under financing and investing activities. On the other hand, cash outflows in this category would include money paid out to suppliers of goods and services or inventory to a business, salaries for employees for their services, and government taxes such as corporate, VAT, or PAYE from employees. It also includes money paid back to lenders and other expenses to a firm such as utility bills.
Investing activities
These are activities that are related to the collection of loans and making money using debts and equities of a firm. This money can be collected from assets of a firm such as plants, machinery, equipment, and property of a firm. Investments acquired and disposed of are recorded here with corresponding cash changes. Sometimes, long-lived investments that are no longer productive and useful to a firm are disposed of and new ones are acquired for the same purpose. Cash inflows from investing activities include money acquired from the sale of property, plants, equipment, machinery, and other assets of a business. Debts and equities and other equity securities can also be sold and cash acquired. The other source could be principal on loans to other businesses or organisations. These items can also be purchased or acquired and recorded as cash outflow under investing activities.
Financing activities
Income from an organisation or loan can be used to invest in these activities with the goal of generating income. This income and expense made for this purpose are recorded in books of accounts. Thus, the section is concerned with collecting equity from owners and using it to generate returns. Besides, it can include borrowing money from creditors and repaying it. This money is returned with interest as agreed and is recorded in books of accounts.
Examples of cash inflows in this category include the sale of equity securities and inflow from the issuance of debts using instruments such as notes and bonds. Cash outflow includes paying stockholders their dividends and expenditure to acquire long-term debt or reacquire capital stock (Accounting explanation, 2015).
It should be noted that some items belonging to investing and financing activities can also be recorded as operating activities. Such examples include the income for investing activities such as interest and dividends. Further, items under operating activities can be recorded under investing and financing activities. As was seen in the examples above, this would include gains from the sale of property and other assets belonging to an organisation.
1. Calculation of Net Cash Flow from Operating Activities
Cash Flow from Operating Activities = Net Income + Noncash Expenses + Changes in Working Capital.
The first step, as derived from the equation is getting income from income statement. This is what is left from revenue or sales after the deduction of the cost of goods sold or cost of sale, expenses, taxes, and interest owed to creditors. This figure is used to determine how much was made by a business. This is added to non-cash expenses which include depreciation and amortisation. Machinery, property, and equipment do age and lose value over time due to wear and tear. Being an incurred expense, it is added to net income as it is not charged in cash. The final consideration is working capital which is calculated from current assets less current liabilities. This is available cash for day-to-day operations in an organisation and therefore rightly names operating income. Using the indirect method of cash flow from operating activities, negative events that would be deducted include inventories and accrued interest receivable. Added to the list would be accrued interest payable and gains from the sale of the property. As stated above, the net result is added to net income, adjustments from amortisation and depreciation, deferred taxes, and a decrease in accounts receivable.
A typical presentation would be as follows:
Twice As Much Ltd
Cash Flow from Operating Activities
Indirect Method
Net income XXXX
Adjustments:
Depreciation and amortisation
Deferred taxes
Decrease in accounts receivable
Increase in inventories (XXX)
Increase in accounts payable XXX
Increase in accrued interest receivable (XXX)
Increase in accrued interest payable XXX
Gain on sale of property (XXX)
Net cash from operating activities (XXXX)
Evaluation of the Purpose and Use of the Statement of Cash Flows for Twice as Much Ltd
The organisation would gain from the document in a number of ways and to a number of users such as investors, creditors, and managers. Mulford and Comiskey (2005) outlined that the tool is useful basically in showing the inflow and outflow of cash in an organisation. When analysed and presented as a formal document, it can be used to show the ability of an organisation to generate cash in the future based on the current movement of these data. Twice As Much Ltd. will use the document to assess whether it has enough assets to generate cash flow in the future. Besides, it can be used to tell whether the firm can meet its obligations such as payment of taxes, dividends, and interest to where it is due. The firm can use the information to examine the causes of net income and operating cash and payments made by the organisation. The final usefulness is to tell the financial position of a firm by stating the position of cash and noncash items from investing and financing activities. This is because of its main function of assessing how cash is changing over time and the effects of those transactions (Albrecht, et al., 2008).
Conclusion
The report discusses what International Accounting Standard 7 is, its components, and its usefulness to an organisation. Examples from each case are also given in addition to the last part on usefulness to the firm is also discussed.
References
Accounting explanation, 2015. Classification of Cash Flows: [Online]
Albrecht, W., Stice, J., Stice, E. & Swain, M., 2008. Accounting: Concepts and Applications. New York: Cengage Learning.
EC Europa, 2010. International Accounting Standard 7 Statement of cash flows. [Online]
Kieso, D. E., Weygandt, J. J. & Warfield, T. D., 2010. Intermediate Accounting, Problem-Solving Survival Guide. New York: John Wiley & Sons.
Mirza, A. A., Holt, G. & Knorr, L., 2011. Wiley IFRS: Practical Implementation Guide and Workbook. New York: John Wiley & Sons.
Mulford, C. W. & Comiskey, E. E., 2005. Creative Cash Flow Reporting: Uncovering Sustainable Financial Performance. New York: John Wiley & Sons.
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