The Statement of Cash Flows

Statement of Cash Flows

IAS 7.10 requires an entity to analyse its cash inflows and outflows into three categories:

  • Operating;
  • Investing; and
  • Financing.

IAS 7.6 defines these as follows:

Operating activities are the principal revenue producing activities of the entity and other activities that are not investing or financing activities.’

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 entity.’

1. Operating activities

It is often assumed that this category includes only those cash flows that arise from an entity’s principal revenue producing activities.

However, because cash flows arising from operating activities represents a residual category, which includes any cashStatement of cash flows flows that do not qualify to be recorded within either investing or financing activities, these can include cash flows that may initially not appear to be ‘operating’ in nature.

For example, the acquisition of land would typically be viewed as an investing activity, as land is a long-term asset. However, this classification is dependent on the nature of the entity’s operations and business practices. For example, an entity that acquires land regularly to develop residential housing to be sold would classify land acquisitions as an operating activity, as such cash flows relate to its principal revenue producing activities and therefore meet the definition of an operating cash flow.

2. Investing activities

An entity’s investing activities typically include the purchase and disposal of its intangible assets, property, plant and equipment, and interests in other entities that are not held for trading purposes. However, in an entity’s consolidated financial statements, cash flows from investing activities do not include those arising from changes in ownership interest of subsidiaries that do not result in a change in control, which are classified as arising from financing activities.

It should be noted that cash flows related to the sale of leased assets (when the entity is the lessor) may be classified as operating or investing activities depending on the specific facts and circumstances.

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Note 1 Cash and cash equivalents

Definition of cash and cash equivalents

IAS 7.6 includes the following definitions:

Cash’:

  • Cash on hand (physical currency held), and
  • Demand deposits.

Cash equivalents’:

  • 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.

IAS 7.7 then notes that cash equivalents are held for the purpose of meeting short term cash commitments rather than for investment or other purposes. IAS 7.7 also notes that:

‘…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.’

Demand deposits

Demand deposits are not defined in IFRS. However, in order to qualify as cash, the related balance needs to have the same liquidity as cash itself, and so funds on ‘demand deposit’ need to be capable of being withdrawn at any time without penalty.

In general, deposits which can be withdrawn without penalty within 24 hours, or one working day, are regarded as being demand deposits. These include amounts deposited at financial institutions (such as funds in a bank current account), and may extend to cover deposits at non-financial institutions such as legal advisers, if funds are held for client in separate and designated accounts that can be called upon by the client at any time.

If a deposit does not qualify to be regarded as cash, it may qualify to be classified as a cash equivalent.

Consider this!

Questions arise about whether investments that can be withdrawn on demand (e.g. money market funds) could qualify to be regarded as cash equivalents.

In general, this is possible, but only in very limited circumstances.

This is because, in addition to the existence of the demand feature, all of the other requirements of IAS 7 need to be met. An interest bearing deposit at a financial institution might result in the amount of cash that would be received being known, and there might be an insignificant risk of changes in value (in particular in the current low interest rate environment), even if there is an early withdrawal penalty.

However, it is also necessary for it to be demonstrated that the investment is being held for the purpose of meeting short-term cash commitments rather than for investment or other purposes (IAS 7.7).

It may be difficult to reconcile this last requirement to the characteristics of the investment, particularly as its maturity (excluding the demand feature) increases.

Short term maturity

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Better Communication in Financial Reporting

Better Communication in Financial Reporting

Better Communication in Financial Reporting is an IFRS.org initiative to focus financial reporting on users. There is a general view that financial reports have become too complex and difficult to read and that financial reporting tends to focus more on compliance than communication. See also narrative reporting as a discussion on alternative ways of reporting.

At the same time, users’ tolerance for sifting through information to find what they need continues to decline.

This has implications for the reputation of companies who fail to keep pace. A global study confirmed this trend, with the majority of analysts stating that the quality of reporting directly influenced their opinion of the quality of management.

To demonstrate what companies could do to make their financial report more relevant, there are several suggestions to ‘streamline’ the financial statements to reflect some of the best practices that have been emerging globally over the past few years. In particular:

  • Information is organized to clearly tell the story of financial performance and make critical information more prominent and easier to find.
  • Additional information is included where it is important for an understanding of the performance of the company. For example, we have included a summary of significant transactions and events as the first note to the financial statements even though this is not a required disclosure.

Improving disclosure effectiveness

Terms such as ’disclosure overload’ and ‘cutting the clutter’, and more precisely ‘disclosure effectiveness’, describe a problem in financial reporting that has become a priority issue for the International Accounting Standards Board (IASB or Board), local standard setters, and regulatory bodies. The growth and complexity of financial statement disclosure is also drawing significant attention from financial statement preparers, and more importantly, the users of financial statements.

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Financing activities

Financing activities - Activities that result in changes in the size and composition of the contributed capital and borrowings of the entity.

Financial asset

A financial asset is a tangible liquid asset that gets its value from a contractual claim. Cash, stocks, bonds, bank deposits and the like are some examples.

Non-current asset

A non-current asset is an asset that is not expected to turn to cash within one year of date shown on a company's statement of financial position

Notes to the financial statements

Notes to the financial statements that contain information in addition to the statement of financial position, of financial performance, of changes in equity

Control Joint control Significant influence

This is a discussion on IFRS 10 – IFRS 12 Control Joint control Significant influence and the accounting applied. It is added with some other logical IFRS topics: the fair value option and the other investments (no control, no joint control and no significant influence), which is depicted in the following schedule:

Control Joint control Significant influence

It is building up from investment, as the smallest investment by one entity in an other entity, which is what it is, the investment in a third party entity (without any power), through significant influence by one entity in an other entity (with power to participate in decisions), through joint control by one entity in an other entity (with power shared between parties (unanimous consent or collective control) … Read more