MEANING OF KEY TERMS USED IN THE CHAPTER

1. Cash Flow Statement

It is the statement that shows flow of Cash and Cash Equivalents during the period under report.

2. Cash Flows
These are the inflows (receipts) and outflows (payments) of Cash and Cash Equivalents.

3. Cash
It comprises of Cash on Hand and demand deposits with banks.

4. Cash Equivalents
These are short-term, highly liquid investments that are readily convertible into known amount of cash
and which are subject to an insignificant risk of change in value. An investment normally qualifies as
cash equivalent only when it has short maturity period of, say, three months or less from the date
of acquisition, i.e., purchase.
Short-term Investments and Marketable Securities are taken as Cash and Cash Equivalents.
Cash equivalents are held for the purpose of meeting short-term cash commitments rather than
for investment or other purposes.

5. Operating Activities
These are the principal revenue producing activities of the enterprise and other activities that are not
Investing or Financing Activities.

6. Investing Activities
These are activities of acquisition and disposal of long-term assets and other investments not
included in cash equivalents.

7. Financing Activities
These are the activities that result in change in the size and composition of the owner’s capital
(including preference share capital in the case of a company) and borrowings of the enterprise.
Bank Overdraft and Cash Credit are taken as Short-term Borrowings. Thus, they are shown under
Financing Activities.

S U M M A RY O F T H E C H A P T E R

• Cash Flows are the inflows and outflows of Cash and Cash Equivalents.

• Cash Flow Statement is a statement that shows the flow of Cash and Cash Equivalents during a period.
This statement shows the net increase or net decrease of Cash and Cash Equivalents under each activity
(operating/investing/financing) and collectively.

• When does the Flow of Cash Arise?

Cash Flow arises when the net effect of transactions is either to increase or to decrease the amount of
Cash or Cash Equivalents.
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• Cash means Cash in Hand and Demand Deposits with Bank.

• Cash Equivalents: Cash Equivalents are short-term, highly liquid investments that are readily convertible
into known amount of cash and which are subject to an insignificant risk of change in value. An investment
normally qualifies as cash equivalent only when it has a short maturity of, say, three months or less from
the date of acquisition.
Examples of Cash Equivalents are: (a) Treasury bills, (b) Commercial papers, (c) money market funds and
(d) Investment in Preference Shares redeemable within three months can also be taken as cash equivalents
if there is insignificant risk of change in its value.
Cash Equivalents also include Bank, Short-term Investments and Marketable Securities.

• Operating Activities: Operating Activities are the principal revenue producing activities of the enterprise
and other activities that are not investing or financing activities.

• Investing Activities: Investing Activities are the acquisition and disposal of long-term assets and other
investments not included in cash equivalents.

• Financing Activities: Financing Activities are the activities that result in change in the size and composition
of the owners’ capital (including Preference Share Capital in the case of a company) and borrowings of
the enterprise.

Notes: • Bank Overdraft and Cash Credit are Short-term Borrowings. They are shown under Financing
Activities in Cash Flow Statement.

• Current Investment is a part of Working Capital.

• Short-term Investment and Marketable Securities are part of Cash Equivalents.

• Proposed Dividend (also called final dividend) is the dividend proposed by the Board of Directors
of the company but it is paid only after it is approved, i.e., declared by the shareholders. Shareholders
have the power to approve it, not approve it or approve it at a lower rate. In effect, declaration of final
dividend is contingent on approval by the shareholders. Proposed Dividend is not accounted and shown
as short-term provision in the Balance Sheet because it is prescribed by revised Accounting Standard–4,
Contingencies and Events Occurring After the Balance Sheet Date that Proposed Dividend should
not be provided in the books of account but should be shown in the Notes to Accounts.

Since, declaration and payment of dividend is contingent upon approval of the shareholders, it becomes
a liability only after being approved by the shareholders. As a result, it will be accounted in the books of
account in the next year after it is approved by the shareholders. It means Proposed Dividend for the current
year will be approved by the shareholders in the next year and thereafter it will be paid. Whereas Proposed Dividend
for the previous year will be approved by the shareholders in the current year and will be paid in the current year.

Dividend is an appropriation of profit and not a charge. Therefore, it is debited to Surplus, i.e., Statement
of Profit and Loss by passing the following entry:

Surplus, i.e., Balance in Statement of Profit and Loss A/c ...Dr.

To Dividend Payable A/c
(Being the dividend declared)
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 The effect of this is as follows:
(i) Proposed Dividend for previous year is shown as outflow of cash assuming that the shareholders
have approved the proposed dividend as was recommended;
(ii) No effect is given to Proposed Dividend for the current year as it is not provided for.

Dividend paid is debited to Dividend Payable Account and balance, if any is retained in ‘Dividend Payable
Account’ or may be transferred to ‘Unpaid Dividend Account’ which is shown in the Balance Sheet as Other
Current Liabilities under Current Liabilities.

Dividend paid during the year, whether out of Dividend Payable Account or Unpaid Dividend Account,
is shown as Outflow of Cash (Cash Used) under Cash Flow from Financing Activities.

• Preparation of Cash Flow Statement: Cash Flow Statement is prepared following the steps as under:

Step 1: Compute Cash Flow from Operating Activities, which may be positive or negative.

Step 2: Compute Cash Flow from Investing Activities, which may be positive or negative.

Step 3: Compute Cash Flow from Financing Activities, which may be positive or negative.

Step 4: The cash flows under each activity, i.e., Operating Activity, Investing Activity and
Financing Activity as computed in Steps 1, 2 and 3 are shown in Cash Flow Statement and net
flow is determined. This will be Net Increase or Decrease in Cash and Cash Equivalents.

Step 5: Add Opening Balance of Cash and Cash Equivalents to cash flows as arrived at in Step 4.

Step 6: The amount so determined should be equal to Balance of Cash and Cash Equivalents at the
end of the year.

TREATMENT OF MISCELLANEOUS EXPENDITURE

Miscellaneous Expenditure such as Loss on Issue of Debentures, Discount on
Issue of Debentures, Underwriting Commission, Preliminary Expenses are written
off in the year in which they are incurred from Securities Premium (if it exists) or
from Statement of Profit and Loss.