CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS (AE 14)

LEARNING MATERIAL

UNIT NUMBER/ HEADING: STATEMENT OF CASH FLOWS

LEARNING OUTCOMES:
At the end of the unit, the students will be able to:
a. Understand the nature and purpose of a Statement of Cash
Flows;
b. Explain the concept and components of cash and cash
equivalents;
c. Classify items as operating, investing and financing;
d. Differentiate the direct method and indirect method

INTRODUCTION:
Cash is always a crucial but very useful factor in carrying out the
operations of an entity and eventually achieving the goals and objectives of
the organization. That is why it is very important for financial managers and
accountants to have a wide knowledge on the nature, sources and
management of the entity’s cash.
In this module, you will learn and understand deeper the accounting
principles for Statement of Cash Flows. You will also learn the different
business transactions that includes cash.

Activating Prior Learning

It has been argued that ‘profit’ does not always give a useful or
meaningful picture of a company’s operations. Readers of a company’s
financial statements might even be misled by a reported profit figure.

a. Shareholders might believe that if a company makes a profit after tax,

say, P100,000 then this is the amount which it could afford to pay as
a dividend. Unless the company has sufficient cash available to say in
business and also to pay a dividend, the shareholders’ expectations
would be wrong.
b. Employees might believe that if a company makes profits, it can afford
to pay higher wages next year. This opinion may not be correct. The
ability to pay wages depends on the availability of cash.
c. Survival of a business entity depends not so much on profits as on its
ability to pay its debts when they fall due. Such payments might
include ‘revenue’ items such as material purchases, wages, interest
and taxation etc., but also capital payments for new non-current
assets and the repayment of loan capital when this falls due (for
example on the redemption of debentures)

1
For these examples, it may be apparent that a company’s performance and
prospects depend not so much on the profits’ earned in a period, but more
realistically on liquidity or cash flows.

Presentation of Content

CONCEPTS OF STATEMENT OF CASH FLOWS

 Statement of cash flows is a component of financial statements

summarizing the operating, investing and financing activities of an
entity
 It provides the information about the cash receipts and cash
payments of entity during the period. It explains the nature of change
in an entity’s cash and cash equivalents.
 Frequently given as an additional statement; supplementing the
statement of financial position, statement of profit or loss and other
comprehensive income and related notes.
 Should be presented as an integral part of an entity’s financial
statements

IAS 7 Statement of Cash Flows which aims:

o to provide information to users of financial statements about the
entity’s ability to generate cash and cash equivalents.
o Requires an entity to present a statement of cash flows as an
integral part of its primary financial statements.
The standard gives the following 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
 Cash flows are inflows and outflows of cash and cash equivalents.

THE 3 CLASSIFICATION OF CASH FLOWS

1. Operating activities are the principal revenue-producing activities of
the entity and other activities that are not investng or financing
activities.
- most of the components of cash flows from operating activities will be
those items which determine the net profit or loss of the entity.
Examples are:
 Cash receipts from the sale of goods and the rendering of
services
 Cash receipts from royalties, fees, commissions and other
revenue

2
  Cash payments to suppliers for goods and services
 Cash payments to and on behalf of employees
 Cash payments for taxes
 Cash payments for interest expense
 Cash payments for other operating expenses

An entity reports cash flows from operating activities using either:

o Direct method, whereby major classes of gross cash receipts and
gross cash payments are disclosed; or
o 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.
- this is undoubtedly easier from the point of view of the
preparer of the statement of cash flows. The net profit or loss for
the period is adjusted for:
a. Changes during the period in inventories, operating
receivables and payables;
b. Non cash items, e.g. depreciation, provisions,
profits/losses on the sales of the assets
c. Other items, the cash flows from which should be
classified under the investing or financing activities
- proforma of such calculation is as follows:

Cash flows from operating activities

Profit before taxation xx
Adjustments for:
Depreciation xx
Foreign exchange loss xx
Investment income (xx)
Interest expense xx
xx
Increase in trade and other receivables (xx)
Decrease in inventories xx
Decrease in trade payables (xx)
Cash generated from operations xx
Interest paid (xx)
Income taxes paid (xx)
Net cash from operating activities xx

3
 It is important to understand why certain items are added and others
subtracted. Note the following:
a. Depreciation is not a cash expense but is deducted in arriving at
profit. It makes sense, therefore, to eliminate it by adding it back.
b. By the same logic, a loss on a disposal of a non-current asset (arising
through under provision of depreciation) needs to be added back and
a profit deducted.
c. An increase in inventories means less cash – you have spent cash on
buying inventory.
d. An increase in receivables means the company’s debtors have not paid
as much, and therefore there is less cash
e. If we pay off payables, causing the figure to decrease, again we have
less cash.
2. Investing Activities are the acquisition and disposal of long-term assets
and other investments not included in cash equivalents. Examples are:
 Cash payments to acquire property, plant and equipment,
intangibles and other non-current assets, including those relating
to capitalized development costs and self-constructed property,
plant and equipment
 Cash receipts from collections of notes receivable
 Cash receipts from sales of property, plant and equipment,
intangibles and other non-current assets
 Cash payments to acquire shares or debentures of other entities
 Cash receipts from sales of shares or debentures of other entities
 Cash advances and loans made to other parties
 Cash receipts from the repayment of advances and loans made to
other parties
3. Financing activities are activities that result in changes in the size and
composition of the contributed equity and borrowings of the equity.
Examples are:
 Cash proceeds from issuing shares
 Cash payments to owners to acquire or redeem the entity’s
sharea
 Cash proceeds from issuing debentures, loans, notes, bonds,
mortgages and other short or long-term borrowings
 Principal repayments of amounts borrowed under leases.
(amounts as financing acitivities are repayment of the principal
while payment of interest will be shown under operating
activities)

Other matters
 Trading securities

4
 o Cash flows arising from the purchase and sale of dealing or trading
securities are classified as operating activities. Similarly, with cash
advances and borrowings made by financial institutions since they
relate to the main revenue producing activity.
 Interests
o Interest paid and interest received shall be classified as operating
cash flows. Alternatively, interest paid may be classified as financing
cash flow as it is a cost of borrowing funds, while interest received
may be classified as investing as a return on investment.
 Dividends
o Dividend received shall be classified as operating cash flow,
alternatively, may be classified as investing cash flow because it is a
return on investment.
o Dividend paid shall be classified as financing cash flow because it is
a cost of obtaining financial resources, alternatively, may be
classified as operating cash flow.
 Income taxes
o Separately disclosed as cash flows from operating activities unless
they can be specifically identified with investing and financing
activities.

PROBLEM ILLUSTRATION
Illustration 1
Riverdale Company provided the following data for the current year:
a. Purchased a building for 1,200,000
Paid 400,000 and signed a mortgage with the seller for the remaining
balance.
b. Executed a debt-equity swap and replaced a 600,000 loan by giving
the lender ordinary shares worth 600,000 on the date swap was
executed.
c. Purchased land for 1,000,000. Paid 350,000 and issued ordinary
shares worth 650,000.
d. Borrowed 550,000 under a long-term loan agreement
Used the cash from the loan proceeds to purchase additional
inventory of 150,000, to pay cash dividend 300,000 and increase cash
balance of 100,000

Compute for the cash inflow and outflow from Operating, Investing and
Financing activities.
Step 1: Identify if transactions are cash or noncash transactions
a. Cash 400,000 Noncash 800,000
b. Noncash
c. Cash 350,000 Noncash 650,000
d. Cash 550,000
Step 2: Identify the cash transactions as inflow or outflow
a. Outflow 400,000
b. NA
c. Outflow 350,000

5
 d. Inflow 550,000 Outflow 450,000

Step 3: Identify what kind of activity is the cash transaction

a. Investing
b. NA
c. Investing
d. Financing and Operating
Step 4: Combine the same group of activities and compute for the net
cash provided or (used).
Operating:
Purchase of inventory (150,000)

Net cash used in Operating activity (150,000)

Investing:
Purchase of building (a) (400,000)
Purchase of land (c) (350,000)
Net cash used in Investing activities (750,000)
Financing:
Proceeds of long-term loan (d) 550,000
Payment of dividends (d) (300,000)
Net cash provided by financing activities 250,000

Observe the following:

1. A transaction may result to one or more kind of activity, refer to
transaction (d), affecting both financing and operating.
2. A transaction may be classified as both cash and noncash transaction,
refer to transaction (a) and (c), and again only cash transactions are
taken into consideration.
3. Purchase and payments are negative or deductions while proceeds or
receipts are positive or additions.

Example of a Statement of Cash Flows

Direct Method

ABC Company
Statement of Cash Flows
For the month ended July 31, 2020

Cash flows from Operating Activities:

Cash received from clients P30,330
Cash paid to suppliers and employees (27,600)
Cash generated from operations 2,730
Interest paid ( 270)
Income taxes paid ( 900)
Net cash from operating activities 1,560

6
Cash flows from Investing Activities:
Purchase of property, plant and equipment (P 900)
Proceeds from sale of equipment 20
Interest received 200
Dividends received 200
Net cash used in investing activities ( 480)

Cash flows from financing activities

Proceeds from issue of share capital 250
Proceeds from long-term borrowings 250
Dividends paid* (1,290)
Net cash used in financing activities ( 790)
Net increase in cash and cash equivalents 290
Cash and cash equivalents at the beginning of period 120
Cash and cash equivalents at end of period 410

*This could also be shown as an operating cash flow

Indirect Method

ABC Company
Statement of Cash Flows
For the month ended July 31, 2020
(amounts in millions)

Cash flows from operating activities

Profit before taxation P 3,570
Adjustments for:
Depreciation 450
Investment income ( 500)
Interest expense 400
3,920
Increase in trade and other receivables ( 500)
Decrease in inventories 1,050
Decrease in trade payables ( 1,740)
Cash generated from operations 2,730
Interest paid ( 270)
Income taxes paid ( 900)
Net cash from operating activities 1,560

Cash flows from investing activities

Purchase of PPE ( 900)
Proceeds from sale of equipment 20

7
 Interest received 200
Dividends received 200
Net cash used in investing activities ( 480)

Cash flows from financing activities

Proceeds from issue of share capital 250
Procees from long-term borrowings 250
Dividends paid* ( 1,290)
Net cash used in financing activities ( 790)
Net increase in cash and cash equivalents 290
Cash and cash equivalents at beginning period 120
Cash and cash equivalents at end of period 410

*This could also be shown as an operating cash flow

Advantages of Cash Flow Accounting

The advantages of cash flow accounting are:

a. Survival in business depends on the ability to generate cash. Cash

flow accounting directs attention towards this critical issue.
b. Cash flow is more comprehensive than profit which is dependent on
accounting conventions and concepts
c. Creditors (lon adn short-term) are more interested in an entity’s ability
to repay them than in its profitability. Whereas profits might indicate
that cash is likely to be available, cash flow accounting is more direct
with its message.
d. Cash flows reporting provides better means of comparing the results
of different companies than traditional profit reporting.
e. Cash flow reporting satisifies the needs of all user
f. Cash flow forecasts are easier to prepare, as well as more useful, tha
profit forecasts
g. They can in some respects be audited more easily than accounts
based on the accruals concept

Application

TRY THIS:
I. Activity 1:
1. Refer to Illustration 1, assuming cash balance beginning is 780,000.
Compute for the ending cash balance.

8
 2. Refer to Illustration 1, assume that shares issued are sold in quoted
market, and proceeds were used in purchase of land. What could have
been the effect on operating, investing and financing activity?
3. Refer to Illustration 1, assume that the proceeds from long-term loan
(d) were use in payment of 100,000 interest expense, 300,000 cash
dividends, and 150,000 operating expenses. All transactions remain
unchanged, compute for cash provided or used in operating, investing
and financing.

II. Activity 2: Identify the transactions whether it is a cash or

noncash transaction and the kind of activity. Place an X for
identified noncash transactions, and inflow or outflow for cash
transactions. Number 1 has been answered for your reference.
Transactions Noncash Cash Activity
1. Collecting cash from customers Inflow Operating
2. Proceeds from borrowing a long-
term debt
3. Borrowing cash as working capital
4. Collection from issuance of ordinary
shares
5. Receipt of property dividends
6. Disposal of computer equipment
7. Purchase of merchandise
inventories on account
8. Payment of wages and salaries of
employees
9. Loaned money to an associate
10. Payment of cash dividends
11. Accrual of interest on short-term
loans
12. Payment of utility bills
13. Selling of stocks and bonds held for
long-term investment
14. Credit of interest income on bank
savings deposit
15. Disbursements for annual payment
on long-term loans

Feedback

Problem 1:

Moira Company provided the following information during the current year;

Dividend received P 500,000

9
Dividend paid P1,000,000
Cash received from customers P9,000,000
Proceeds from issuing share capital P1,500,000
Interest received P 200,000
Proceeds from sale of long term investments P2,000,000
Cash paid to suppliers and employees P6,000,000
Interest paid on long term debt P 400,000
Income taxes paid P 300,000
Cash balance, January 1 P1,800,000

1. What is the net cash provided by operating activities?

a. P3,000,000
b. P3,300,000
c. P2,700,000
d. P2,000,000
2. What is the net cash provided by investing activities?
a. P2,500,000
b. P2,000,000
c. P2,200,000
d. 0
3. What is the net cash provided by financing activities?
a. P1,500,000
b. P1,000,000
c. P 500,000
d. 0
4. What is the cash balance on December 31?
a. P6,300,000
b. P5,500,000
c. P4,800,000
d. P7,300,000

Problem 2:
On December 31, 2020, Pina A. Asa Company had the following balances:

Cash balance, beginning of year P1,300,000

Cash flow from financing activities P1,000,000
Cash flow from operating activities P 400,000
Cash flow from investing activities (P1,500,000)
Total shareholders’ equity, beginning of the year P2,000,000

What is the cash balance at the end of the current year?

a. P1,200,000
b. P1,600,000

10
 c. P1,400,000
d. P1,700,000

Problem 3:
Dina M. Hall Company provided the following data for the current year:

Purchase of real estate for cash P5,500,000

Cash was borrowed from bank to purchase real estate P5,500,000
Sale of investment for cash P5,000,000
Dividend paid P6,000,000
Issuance of ordinary shares for cash P2,500,000
Purchase of patent for cash P1,250,000
Payment of bank loan P1,500,000
Issuance of bonds payable for cash P3,000,000

Summary of the Unit

Statement of cash flows provides the information about the cash

receipts and cash payments of entity during the period. It explains the
nature of change in an entity’s cash and cash equivalents.
International Accounting Standards (IAS) 7 is the standard that
governs the presentation of statement of cash flows
The three classifications of cash flows are operating, investing and
financing activities
Operating activities are the principal revenue-producing activities of
the entity and other activities that are not investng or financing
activities.
The two methods to present operating activities are direct method and
indirect method
Investing activities are the acquisition and disposal of long-term
assets and other investments not included in cash equivalents
Financing activities are activities that result in changes in the size and
composition of the contributed equity and borrowings of the equity

Student’s Reflection on Learning

This part of the module will be a time for you to look back, and reflect on what
you have learned from this unit. Though, this will not be checked and
recorded, I would appreciate if you will do this wholeheartedly and with all
seriousness.

11
Answer the following questions and put your answers in the space provided.

1. Did you learn what you expect to learn?

2. How might you use what you learned in the future in your life or
profession?

References:

 Valix, C. T., Peralta, J.F & Valix C. A. M. (2020). Conceptual

Framework and Accounting Standards. Manila, Philippines: GIC
Enterprises & Co.. Inc.
 Ballada, W., & Ballada S. (2020). Conceptual Framework and
Accounting Standards. Manila, Philippines: DomDane Publishers.
 https://www.iasplus.com/en/standards/ias/ias7
 https://www.youtube.com/watch?v=NMubNKCQV0A

12