ACCA F3 (INT) Financial Accounting - 2010 - Study text - Emile Woolf Publishing
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Chapter 14: Statements of cash flows
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subtract the increase in receivables during the period (= the amount by which
closing receivables exceed opening receivables), or
add the reduction in receivables during the period (= the amount by which
opening receivables exceed closing receivables).
Prepayments in the opening and closing statement of financial position should be
included in the total amount of receivables.
4.4 Changes in inventory
Purchases in a period differ from the cost of sales by the amount of the increase or
decrease in inventories during the period. If all purchases were paid for in cash, this
means that cash payments and the cost of sales (and profit) would differ by the
amount of the increase or decrease in inventories.
Example: inventory
A company had inventory at the beginning of the year of $5,000 and at the end of
the year the inventory was valued at $3,000. During the year, sales were $50,000 and
there were no receivables at the beginning or end of the year. Purchases were
$28,000, all paid in cash. The operating profit for the year was $20,000, calculated as
follows:
$
Openinginventory 5,000
Purchasesintheyear(allpaidincash) 28,000
33,000
Closinginventory (3,000)
Costofsales 30,000
Sales 50,000
Operatingprofit 20,000
The cash flow from operations is calculated as follows:
$
Cashfromsalesintheyear 50,000
Purchasespaidincash 28,000
Cashflowfromoperations 22,000
The cash flow is $2,000 more than the operating profit, because inventory was
reduced during the year by $2,000.
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The rule: adjusting from operating profit to operating cash flows to allow for
changes in inventory
When the value of inventory goes up between the beginning and end of the year,
cash flows from operations are less than operating profit by the amount of the
increase.
When the value of inventory goes down between the beginning and end of the
year, cash flows from operations are more than operating profit by the amount
of the reduction.
In a statement of cash flows presented using the indirect method, the adjustment for
inventories is therefore:
subtract the increase in inventories during the period (= the amount by which
closing inventory exceeds opening inventory), or
add the reduction in inventories during the period (= the amount by which
opening inventory exceeds closing inventory).
4.5 Changes in trade payables
Payments for purchases in a period differ from purchases by the amount of increase
or decrease in trade payables during the period.
Example: trade payables
A company had no inventory and no receivables at the beginning and end of the
year. All its sales are for cash, and sales in the year were $50,000. Its purchases are
all on credit. During the year, its purchases were $30,000. Trade payables at the
beginning of the year were $4,000 and trade payables at the end of the year were
$6,500.
The operating profit for the year was $20,000 ($50,000 – $30,000)
$
Tradepayablesatthebeginningoftheyear 4,000
Purchasesintheyear 30,000
34,000
Tradepayablesattheendoftheyear (6,500)
Cashpaidtosuppliers 27,500
Cashfromsales 50,000
Cashflowfromoperations 22,500
The cash flow is $2,500 more than the operating profit, because trade payables were
reduced during the year by $2,500.
Chapter 14: Statements of cash flows
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The rule: adjusting from operating profit to operating cash flows to allow for
changes in trade payables
When trade payables go up between the beginning and end of the year, cash
flows from operations are more than operating profit by the amount of the
increase.
When trade payables go down between the beginning and end of the year, cash
flows from operations are less than operating profit by the amount of the
reduction.
In a statement of cash flows presented using the indirect method, the adjustment for
trade payables is therefore:
add the increase in trade payables during the period (= the amount by which
closing trade payables exceed opening trade payables), or
subtract the reduction in trade payables during the period (= the amount by
which opening trade payables exceed closing trade payables).
Accruals in the opening and closing statement of financial position should be
included in the total amount of trade payables.
However, deduct interest payable and tax payable from opening and closing
payables, if the total for payables includes these items.
4.6 Summary of the rules for working capital changes
The rules for working capital adjustments in a statement of cash flows (indirect
method) may be summarised as follows.
Statement of cash flows:
Adjustments to get from profit before tax to cash flow from operations
Increase in trade and other receivables
Subtract
Increase in inventory
Subtract
Increase in trade payables Add
Decrease in trade and other receivables Add
Decrease in inventory Add
Decrease in trade payables
Subtract
This applies to the indirect method of presenting a statement of cash flows, not to the
direct method.
Example
A company made an operating profit before tax of $16,000 in the year just ended.
Depreciation charges were $15,000. There was a gain of $5,000 on disposals of non-
current assets and there were no interest charges. Values of working capital items at
the beginning and end of the year were:
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Receivables Inventory Tradepayables
Beginningoftheyear $9,000 $3,000 $4,000
Endoftheyear $6,000 $5,000 $6,500
Taxation paid was $4,800.
Required
Calculate the amount of cash generated from operations, as it would be shown in a
statement of cash flows using the indirect method.
Answer
$ $
Cashflowsfromoperatingactivities
Profitbeforetaxation 16,000
Adjustmentsfor:
Depreciationandamortisationcharges 15,000
Gainsondisposalofnon‐currentassets (5,000)
26,000
Decreaseintradeandotherreceivables 3,000
Increaseininventories (2,000)
Increaseintradepayables 2,500
Cashgeneratedfromoperations 29,500
Taxationpaid(taxonprofits) (4,800)
Netcashflowfromoperatingactivities24,700
Exercise 2
During Year 1, a company made a profit before taxation of $60,000. Depreciation
charges were $25,000 and there was a gain on the disposal of a machine of $14,000.
Interest charges and payments of interest in the year were the same amount,
$10,000. Taxation payments were $17,000.
Values of working capital items at the beginning and end of the year were:
Receivables Inventory Trade payables
Beginning of the year $32,000 $49,000 $17,000
End of the year $27,000 $53,000 $11,000
Required
Calculate the net cash from operating activities, as it would be shown in a statement
of cash flows (indirect method).
Chapter 14: Statements of cash flows
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Operational cash flows and the direct method
Cash from sales
Cash paid for wages and salaries
Cash paid for materials supplies
Cash paid for other expenses
5 Operational cash flows and the direct method
The format for the direct method of presenting a statement of cash flows is as
follows:
Statementofcashflows:directmethod $
Cashflowsfromoperatingactivities
Cashreceiptsfromcustomers 348,800
Cashpaymentstosuppliers (70,000)
Cashpaymentstoemployees (150,000)
Cashpaidforotheroperatingexpenses (30,000)
Cashgeneratedfromoperations 98,800
The task is therefore to establish the amounts for cash receipts and cash payments.
In an examination, you might be expected to calculate any of these cash flows from
figures in the opening and closing statements of financial position, and the income
statement.
You might be required to calculate:
the cash flows from sales, from opening and closing receivables and the value of
sales in the income statement, and
the cash payments from opening and closing payables or accruals, and the cost
of sales or expenses in the income statement
5.1 Cash from sales
The cash receipts from sales during a financial period can be calculated as follows:
Source of
information
$
Trade receivables at the beginning of the year Statement of
financial position A
Sales in the year Income statement B
A + B
Trade receivables at the end of the year Statement of
financial position (C)
Equals: Cash from sales during the year (A + B – C)
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Note: ‘Income statement’ means either an income statement or the ‘profit and loss’
section of a statement of comprehensive income.
5.2 Cash paid for wages and salaries
Cash payments for wages and salaries can be calculated in a similar way.
Source of
information
$
Accrued wages and salaries at the beginning of
the year
Statement of
financial position A
Wages and salaries expenses in the year Income statement B
A + B
Accrued wages and salaries at the end of the
year
Statement of
financial position (C)
Equals: Cash paid for wages and salaries (A + B – C)
5.3 Cash paid for materials supplies
To calculate the amount of cash paid to suppliers, you might need to calculate first
the amount of material purchases during the period.
Source of
information
$
Closing inventory at the end of the year Statement of
financial position A
Cost of sales Income statement B
A + B
Opening inventory at the beginning of the year Statement of
financial position (C)
Equals: Purchases in the year (A + B – C)
Having calculated purchases from the cost of sales, the amount of cash payments for
purchases may be calculated from purchases and opening and closing trade
payables.
Source of
information
$
Trade payables at the beginning of the year Statement of
financial position
D
Purchases in the year (as above) Income statement E = (A + B – C)
D + E
Trade payables at the end of the year Statement of
financial position (F)
Equals: Cash paid for materials (D + E – F)
Chapter 14: Statements of cash flows
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5.4 Cash paid for other expenses
Other expenses in the income statement usually include depreciation charges, which
are not cash flows. Depreciation charges should therefore be excluded from other
expenses when calculating cash payments.
Cash payments for other expenses can be calculated as follows.
Source of
information
$
Payables for other expenses at the beginning of
the year
Statement of
financial position
A
Other expenses in the year, excluding
depreciation and amortisation Income statement B
A + B
Payables for other expenses at the end of the
year
Statement of
financial position (C)
Equals: Cash paid for other expenses (A + B – C)
Payables for other expenses should exclude accrued wages and salaries, accrued
interest charges and taxation payable.
Example
The following information has been extracted from the financial statements of
Hopper Company for the year ended 31 December Year 7.
$
Sales 1,280,000
Costofsales (400,000)
Grossprofit 880,000
Wagesandsalaries (290,000)
Otherexpenses(includingdepreciation$25,000) (350,000)
240,000
Interestcharges (50,000)
Profitbeforetax 190,000
Taxonprofit (40,000)
Profitaftertax 150,000
Extracts from the statements of financial position:
At1January
Year7
At31December
Year7
$ $
Tradereceivables 233,000 219,000
Inventory 118,000 124,000
Tradepayables 102,000 125,000
Accruedwagesandsalaries 8,000 5,000
Accruedinterestcharges 30,000 45,000
Taxpayable 52,000 43,000
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Required
Present the cash flows from operating activities as they would be presented in a
statement of cash flows:
using the direct method
using the indirect method.
Answer
Workings: direct method
Cashfromsales
$
Tradereceivablesat1JanuaryYear7 233,000
Salesintheyear 1,280,000
1,513,000
Tradereceivablesat31DecemberYear7 (219,000)
Cashfromsalesduringtheyear 1,294,000
Cashpaidforwagesandsalaries
$
Accruedwagesandsalariesat1JanuaryYear7 8,000
Wagesandsalariesexpensesintheyear 290,000
298,000
Accruedwagesandsalariesat31DecemberYear7 (5,000)
Cashpaidforwagesandsalaries 293,000
Purchases
$
Closinginventoryat31DecemberYear7 124,000
Costofsales 400,000
524,000
Openinginventoryat1JanuaryYear7 (118,000)
Purchasesintheyear 406,000
Cashpaidformaterialssupplies
$
Tradepayablesat1JanuaryYear7 102,000
Purchasesintheyear(asabove) 406,000
508,000
Tradepayablesat31DecemberYear7 (125,000)
Cashpaidformaterials 383,000
Cash paid for other expenses is the amount for expenses in the income statement
after deducting the depreciation charge: $350,000 - $25,000 = $325,000.
Chapter 14: Statements of cash flows
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Interestandtaxpayments TaxInterest
$ $
Liabilityatthebeginningoftheyear 52,000 30,000
Taxationcharge/interestchargefortheyear 40,000 50,000
92,000 80,000
Liabilityattheendoftheyear (43,000) (45,000)
Taxpaid/interestpaidduringtheyear 49,000 35,000
Statementofcashflows:directmethod
$
Cashflowsfromoperatingactivities
Cashreceiptsfromcustomers 1,294,000
Cashpaymentstosuppliers (383,000)
Cashpaymentstoemployees (293,000)
Cashpaidforotheroperatingexpenses (325,000)
Cashgeneratedfromoperations 293,000
Taxationpaid(taxonprofits) (49,000)
Interestchargespaid (35,000)
Netcashflowfromoperatingactivities 209,000
Statementfofcashflows:indirectmethod $
Cashflowsfromoperatingactivities
Profitbeforetaxation 190,000
Adjustmentsfor:
Depreciationandamortisationcharges 25,000
Interestchargesintheincomestatement 50,000
265,000
Decreaseinreceivables(233,000–219,000) 14,000
Increaseininventories(124,000–118,000) (6,000)
Increaseintradepayables
(125,000+5,000)–(102,000+8,000)
20,000
Cashgeneratedfromoperations 293,000
Taxationpaid (49,000)
Interestchargespaid (35,000)
Netcashflowfromoperatingactivities 209,000
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Cash flows from investing activities
Cash paid for the purchase of non-current assets
Cash from disposals of non-current assets
6 Cash flows from investing activities
The second part of a statement of cash flows, after cash flows from operating
activities, is cash flows from investing activities.
This section of the statement of cash flows includes interest received and dividends
received on investments. However, for the purpose of the examination, the most
important items in this part of the statement are cash paid to purchase non-current
assets and cash received from the sale or disposal of non-current assets.
6.1 Cash paid for the purchase of non-current assets
You might be required in the examination to calculate the amount spent on the
purchase of non-current assets, to include in the section on ‘Cash flows from
investing activities’. In an examination question, you may be given the following
information to make this calculation:
non-current assets at the beginning of the year (at cost or valuation, or at net
book value)
non-current assets at the end of the year (at cost or valuation, or at net book
value)
the depreciation charge for the year
information about disposals of non-current assets during the year
information about the revaluation of non-current assets during the year.
When there are no disposals or revaluations during the year
When there are no disposals or revaluations of non-current assets during the year,
purchases of non-current assets (normally assumed to be the amount of cash paid
for these purchases) may be calculated as:
non-current assets at cost at the end of the year minus non-current assets at cost
at the beginning of the year, or
non-current assets at net book value (NBV) at the end of the year minus non-
current assets at NBV at the beginning of the year, plus the depreciation charge
for the year.