CHAPTER 10: PAS 7 Statement of Cash Flows

Statement of Cash Flows (reflect only the cash)

A statement of cash flows is a component of financial statements summarizing the operating, investing
and financing activities of an entity.

Operating Activities // income statement

Operating activities are the cash flows derived primarily from the principal revenue producing activities
of the entity.

Examples of cash flows from operating activities are:

a. Cash receipts (increase cash) from sale of goods and rendering of services
b. Cash receipts from royalties, rental, fees, commissions and other revenue
c. Cash payments to suppliers for goods and services
d. Cash payments (decrease your cash) for selling, administrative and other expenses
e. Cash receipts and cash payments of an insurance enterprise for premiums and claims, annuities
and other policy benefits
f. Cash payments or refund of income taxes unless they can be specifically identified with
financing and investing activities
g. Cash receipts and payments for securities held for dealing or trading purposes

Investing Activities

Investing activities are the cash flows derived from the acquisition and disposal of long-term assets and
other investments not included in cash equivalent.

As a simple guide, investing activities include cash flows from transactions involving nonoperating
assets.

Examples of cash flows from investing activities are:

a. Cash payments to acquire property, plant and equipment, intangibles and other long-term
assets
b. Cash receipts from sales of property, plant and equipment, intangibles and other long-term
assets
c. Cash payments to acquire equity or debt instruments of other entities and interests in joint
ventures (current and long-term investments)
d. Cash receipts from sales of equity or debt instruments of other entities and interests in joint
venture
e. Cash advances and loans to other parties (other than advances and loans made by financial
institution)
f. Cash receipts from repayment of advances and loans made to other parties
g. Cash payments for future contract, forward contract, option contract and swap contract
h. Cash receipts from future contract, forward contract, option contract and swap contract
Financing Activities

Financing activities are the cash flows derived from the equity capital and borrowings of the entity.

In other words, financing activities are the cash flows that result from transactions:

a. Between the entity and the owners – equity financing

b. Between the entity and the creditors – debt financing

As a simple guide, financing activities include the cash flows from transactions involving nontrade
liabilities and equity of an entity.

Examples of cash flows from financing activities are:

a. Cash receipts from issuing shares or other equity instruments, for example, issuance of ordinary
and preference shares
b. Cash payments to owners to acquire or redeem the enterprise’s shares, for example, payment
for treasury shares
c. Cash receipts from issuing debentures, loans, notes, bonds, mortgages, and other short or long-
term borrowings
d. Cash payment for amounts borrowed
e. Cash payments by a lessee for the reduction of the outstanding principal lease liability

Cash payments to settle obligations such as trade accounts and notes payable, income tax payable,
accrued expenses and similar items are operating activities, not financing activities.

Interest

PAS 7, paragraph 33, provides that interest paid and interest received shall be classified as operating
cash flows because they enter into the determination of net income or loss.

Alternatively, interest paid may be classified as financing cash flows because it is a cost of obtaining
financial resources.

Alternatively, interest received may be classified as investing cash flow because it is a return on
investment.

For a financial institution, interest paid and interest received are usually classified as operating cash
flows.

Dividends

PAS 7, paragraph 33, provides that dividend received shall be classifies as operating cash flow because it
enters into the determination of net income.

Alternatively, dividend received may be classified as investing cash flow because it is a return on
investment.

PAS 7, paragraph 34, provides that dividend paid shall be classified as financing cash flow because it is a
cost of obtaining financial resources.
Alternatively, dividend paid may be classified as operating cash flow in order to assist users to
determine the ability of the entity to pay dividends out of operating cash flows.

The classification of dividend received and dividend paid as either operating, investing or financing
activity shall be made on a consistent basis from period to period.

Illustration – Operating Activities

Simple Company reported the following comparative statement of financial position and income
statement for 2019.

Assets 2019 2018

Cash 3,000,000 2,000,000

Accounts receivable 940,000 350,000
Inventory 175,000 100,000
Prepaid insurance 15,000 20,000
Property, plant and equipment 2,000,000 2,000,000
Accumulated depreciation (550,000) (500,000)
Patent 40,000 50,000

Total assets 5,620,000 4,020,000

Liabilities and Equity

Accounts payable 170,000 150,000

Accrued salaries payable 25,000 10,000
Accrued interest payable 10,000 15,000
Income tax payable 350,000 250,000
Unearned rent income 10,000 40,000
Mortgage payable 500,000 500,000
Share capital 2,000,000 2,000,000
Retained earnings 2,555,000 1,055,000

Total liabilities and equity 5,620,000 4,020,000

 Income Statement
Year ended December 31, 2019

Sales 6,500,000
Cost of goods sold:
Inventory – January 1 100,000
Purchases 3,200,000

Goods available for sale 3,300,000

Inventory – December 31 (175,000) 3,125,000

Gross income 3,375,000

Rent income 80,000

Total income 3,455,000

Expenses:
Salaries 950,000
Insurance 40,000
Other expenses 500,000
Depreciation 50,000
Amortization of patent 10,000
Interest expense 55,000 1,605,000
Income before tax 1,850,000
Income tax 350,000

Net income 1,500,000

Direct Method

PAS 7, paragraph 18, provides that an entity shall report cash flows from operating activities using either
the direct method or indirect method.

The direct method shows in detail or itemizes the major classes of gross cash receipts and gross cash
payments.

The cash receipts are listed one by one, the cash payments are listed one by one, and the difference
represents the net cash flows from operating activities.

In essence, the direct method is the “cash basis” income statement.

Computations under the Direct Method

1. Accounts receivable – 2018 350,000

Sales 6,500,000
Total 6,850,000
Accounts receivable – 2019 (940,000)
Collections from customers 5,910,000

2. Rent income 80,000

Unearned rent income – 2019 10,000
 Total 90,000
Unearned rent income – 2018 (40,000)
Rent received 50,000

3. Accounts payable – 2018 150,000

Purchases 3,200,000
Total 3,350,000
Accounts payable – 2019 (170,000)
Payments to merchandise creditors 3,180,000

4. Salaries 950,000
Accrued salaries payable – 2018 10,000
Total 960,000
Accrued salaries payable – 2019 (25,000)
Salaries paid 935,000

5. Insurance 40,000
Prepaid insurance – 2019 15,000
Total 55,000
Prepaid insurance – 2018 (20,000)
Payment for insurance 35,000

6. Other expenses paid 500,000

7. Interest expense 55,000

Accrued interest payable – 2018 15,000
Total 70,000
Accrued interest payable – 2019 (10,000)
Interest paid 60,000

8. Income tax 350,000

Income tax payable – 2018 250,000
Total 600,000
Income tax payable – 2019 (350,000)
Payment for income tax 250,000

Direct Method – Operating Activities

Cash received from customers 5,910,000

Rent received 50,000
Cash payments to merchandise creditors (3,180,000)
Salaries paid (935,000)
Insurance paid (35,000)
Other expenses paid (500,000)

Cash generated from operations 1,310,000

Interest paid (60,000)
Income tax paid (250,000)
Net cash provided by operating activities 1,000,000

PAS 7, paragraph 32, provides that interest paid is disclosed separately whether it has been recognized
in profit or loss or capitalized.

Paragraph 35 provides that income tax paid is also disclosed or presented separately.

Observe that the depreciation of P50,000 and amortization of P10,000 do not appear in the statement of
cash flows using the direct method.

The reason is that these are noncash expenses or expenses not requiring use of cash.

PAS 7, paragraph 19, provides that entities are encouraged to report cash flows from operating activities
using the direct method.

Indirect Method

The indirect method means that the net income or loss is adjusted for the effects of transactions of a
noncash nature, any deferrals or accruals of past or future operating cash receipts and payments, and
items of income or expense associated with investing and financing activities.

The indirect method of presenting the cash flow from operations begins with the accrual basis net
income and applies a series of adjustments to convert the income to a cash basis.

The following general guidelines are offered for the adjustments of net income to cash basis:

1. All increases in trade noncash current assets are deducted from the net income.
2. All decreases in trade noncash current assets are added to net income.
3. All increases in trade current liabilities are added to net income.
4. All decreases in trade current liabilities are deducted from net income.
5. Depreciation, amortization and other noncash expenses are added back to net income to
eliminate the effect they had on net income.
6. Any gain on disposal of property or gain on early retirement of nontrade liabilities is included in
net income but it is a nonoperating item. Thus, this is deducted from net income.
7. Any loss on disposal of property or loss on early retirement of nontrade liabilities is deducted
from net income but thus is a nonoperating item Thus, this is added back to net income.
8. Other noncash income or gain is deducted from net income and other noncash expense or loss
is added to net income to eliminate the effect on net income.

Continuing the Illustration, the changes in current assets and current liabilities are summarized as
follows:

2019 2018 Increase (Decrease)

Accounts receivable 940,000 350,000 590,000

Inventory 175,000 100,000 75,000
Prepaid insurance 15,000 20,000 (5,000)
Accounts payable 170,000 150,000 20,000
Accrued salaries payable 25,000 10,000 15,000
Accrued interest payable 10,000 15,000 (5,000)
Income tax payable 350,000 250,000 100,000
Unearned rent income 10,000 40,000 (30,000)

Indirect Method – Operating Activities

Net income 1,500,000

Increase in accounts receivable (590,000)
Increase in inventory (75,000)
Decrease in prepaid insurance 5,000
Increase in accounts payable 20,000
Increase in accrued salaries payable 15,000
Decrease in accrued interest payable (5,000)
Increase in income tax payable 100,000
Decrease in unearned rent income (30,000)
Depreciation 50,000
Amortization of patent 10,000

Net cash provided by operating activities 1,000,000

Comprehensive Illustration

Illustrar Company provided the following statement of financial position at year-end and other financial
data relating to activities during the current year:

2019 2018

Cash and cash equivalent 600,000 200,000

Accounts receivable, net of allowance 1,100,000 1,040,000
Notes receivable – trade 150,000 200,000
Inventory 1,200,000 1,360,000
Prepaid expenses 110,000 120,000
Investment in equity securities, at cost 300,000 500,000
Property, plant and equipment 3,400,000 2,000,000
Accumulated depreciation (900,000) (600,000)

5,960,000 4,900,000

Accounts payable 880,000 840,000

Notes payable – trade 60,000 240,000
Accrued expenses 100,000 330,000
Note payable – bank (short term debt) 400,000 --
Share capital, P100 par 3,000,000 2,400,000
Share premium 530,000 400,000
Retained earnings 990,000 790,000
Treasury shares, at cost -- (100,000)

5,960,000 4,900,000
The statement of retained earnings for the year ended December 31, 2019 showed the following:

Retained earnings – January 1 790,000

Net income for 2019 1,000,000

Total 1,790,000
Cash dividend paid (800,000)

Retained earnings – December 31 990,000

Additional Information

 The entity sold an investment in equity securities for P240,000 cash. There were no other
transactions affecting the investment in equity securities.
 Land was purchased in the current year for P1,200,000, paying P1,000,000 cash and issuing
P200,000 share capital at par value.
 Equipment costing P200,000 and having a carrying amount of P80,000 was sold for P60,000
cash.
 Equipment of P400,000 was purchased for cash.
 The entity borrowed P400,000 from a bank to be paid June 30, 2020.
 Share capital with par value of P400,000 was issued for cash at a premium of P100,000.
 The treasury shares were reissued for P130,000 cash.
 The patent was fully amortized.

Basic Guidelines

a. Operating activities include the cash effects of transactions that enter into the determination of
net income.
b. Investing activities include the cash effects of transactions involving nonoperating assets.
c. Financing activities include the cash effects of transactions involving nontrade liabilities and
equity.

The cash effect of the properly numbered original entries is summarized as follows:

Operating Investing Financing

1. Net income 1,000,000

2. Payment of cash dividend (800,000)
3. Increase in accounts receivable (60,000)
4. Decrease in notes receivable 50,000
5. Decrease in inventory 160,000
6. Decrease in prepaid expenses 10,000
7. Sale of investment 240,000
Gain on sale of investment (40,000)
8. Payment for land (1,000,000)
9. Purchase of equipment (400,000)
10. Sale of equipment 60,000
Loss on sale of equipment 20,000
11. Depreciation 420,000
12. Amortization of patent 80,000
13. Increase in accounts payable 40,000
14. Decrease in notes payable (180,000)
15. Decrease in accrued expenses (230,000)
16. Proceeds from bank notes payable 400,000
17. Issuance of share capital 500,000
18. Reissuance of treasury shares ________ _________ 130,000

Net cash provided (used) 1,270,000 (1,100,000) 230,000

Preparation of Statement of Cash Flows

The formal statement of cash flows can now be prepared from the preceding summary of operating,
investing and financing activities.

Illustrar Company
Statement of Cash Flows
Year ended December 31, 2019

Cash flows from operating activities:

Net income 1,000,000
Increase in accounts receivable (60,000)
Decrease in notes receivable 50,000
Decrease in inventory 160,000
Decrease in prepaid expenses 10,000
Gain on sale of investment (40,000)
Loss on sale of equipment 20,000
Depreciation 420,000
Amortization of patent 80,000
Increase in accounts payable 40,000
Decrease in notes payable (180,000)
Decrease in accrued expenses (230,000)

Net cash provided by operating activities 1,270,000

Cash flows from investing activities:

Sale of investment 240,000
Sale of equipment 60,000
Purchase of land (1,000,000)
Purchase of equipment 400,000

Net cash used in investing activities (1,100,000)

Cash flows from financing activities:

Cash received from bank loan 400,000
Issuance of share capital 500,000
Reissuance of treasury shares 130,000
Payment of cash dividend (800,000)
 Net cash provided by financing activities 230,000

Increase in cash and cash equivalents 400,000

Add: Cash and cash equivalents – January 1 200,000

Cash and cash equivalents – December 31 600,000

Alternative Approach

Susan Company provided the following comparative statement of financial position and additional
information necessary for the preparation of a statement of cash flows for the year ended Decemeber
31, 2019.

2019 2018

Cash and cash equivalents 1,150,000 880,000

Accounts receivable, net of allowance 820,000 950,000
Inventory 1,180,000 1,100,000
Prepaid expenses 40,000 60,000
Property, plant and equipment 4,000,000 2,000,000
Accumulated depreciation (880,000) (540,000)
Patent 450,000 500,000

6,760,000 4,950,000

Accrued expenses 120,000 110,000

Accounts payable 540,000 600,000
Note payable – 60-day bank loan 600,000 800,000
Note payable – 5-year loan 1,000,000 --
Share capital 3,000,000 2,500,000
Share premium 700,000 200,000
Retained earnings 1,040,000 740,000
Treasury shares (240,000) --

6,760,000 4,950,000

Additional information during 2019

 The net income is P1,000,000.

 The cash dividend of P700,000 is declared and paid.
 Equipment is purchased for cash of P2,000,000.
 All notes payable represent bank loans.
 Shares of 5,000 with par value of P100 are issued at P200 per share.
 Treasury shares are purchased for P240,000 cash

The approach is simply to copy the comparative statement of financial position and analyze the changes
into operating, investing and financing activities (see analysis on next page).
 Susan Company
Statement of Cash Flows
Year ended December 31, 2019

Cash flows from operating activities:

Net income 1,000,000
Decrease in accounts receivable 130,000
Increase in inventory (80,000)
Decrease in prepaid expenses 20,000
Depreciation 340,000
Amortization of patent 50,000
Increase in accrued expenses 10,000
Decrease in accounts payable (60,000)

Net cash provided by operating activities 1,410,000

Cash flows from investing activities:

Purchase of equipment (2,000,000)

Cash flows from financing activities:

Proceeds of 5-year bank loan 1,000,000
Issuance of share capital 1,000,000
Payment of 60-day bank loan (200,000)
Payment of cash dividend (700,000)
Purchase of treasury shares (240,000)

Net cash provided by financing activities 860,000

Increase in cash and cash equivalents 270,000

Add: Cash and cash equivalents – January 1 880,000

Cash and cash equivalents – December 31 1,150,000

 Cash provided (used)

2019 2018 Operating Investing Financing

Cash 1,150,000 880,000

Accounts receivable, net of allowance 820,000 950,000 130,000
Inventory 1,180,000 1,100,000 (80,000)
Prepaid expenses 40,000 60,000 20,000
Property, plant and equipment 4,000,000 2,000,000 (2,000,000)
Accumulated depreciation (880,000) (540,000) 340,000
Patent 450,000 500,000 50,000

6,760,000 4,950,000

Accrued expenses 120,000 110,000 10,000

Accounts payable 540,000 600,000 (60,000)
Note payable, 60-day bank loan 600,000 800,000 (200,000)
Note payable, 5-year loan 1,000,000 -- 1,000,000
Share capital 3,000,000 2,500,000 500,000
Share premium 700,000 200,000 500,000
Retained earnings 1,040,000 740,000 1,000,000 (700,000)
Treasury shares (240,000) -- (240,000)

6,760,000 4,950,000 __ __ _

Net cash provided (used) 1,410,000 (2,000,000) 860,000

CHAPTER 17: STATEMENT OF CASH FLOWS

PROBLEMS

Problem 1

Mahogany Company had the following account balances for the current year:

December 31 January 1
Accounts payable 500,000 700,000
Inventory 300,000 450,000
Accounts receivable 800,000 750,000

All purchases of inventory were on account.

The entity provided the following income statement information for the current year:

Revenue 9,800,000
Cost of goods sold (4,000,000)
Other expenses (1,300,000)
Depreciation expense (1,000,000)
Loss on sale of equipment (100,000)

Net Income 3,400,000

What is the net cash provided by operating activities?

a. 4,500,000 b. 4,400,000 c. 4,600,000 d. 4,300,000

Solution: Answer B

Net income 3,400,000

Depreciation 1,000,000
Loss on sale of equipment 100,000
Decrease in accounts payable (200,000)
Decrease in inventory 150,000
Increase in accounts receivable (50,000)

Net cash provided by operating activities 4,400,000

Problem 2

Riverside Company provided the following information for the current year:

 Purchased a building for P1,200,000. Paid P400,000 and signed a mortgage with the seller for
the remaining P800,000.
 Executed a debt-equity swap and replaced a P600,000 loan by giving the lender ordinary shares
worth P600,000 on the date the swap was executed.
 Purchased land for P1,000,000. Paid P350,000 and issued ordinary shares worth P650,000.
  Borrowed P550,000 under a long-term loan agreement.
Used the cash from the loan proceeds for purchase of additional inventory P150,000, payment
of cash dividend P300,000 and increase in the cash balance P100,000.

What amount should be reported as net cash used in investing activities in the statement of cash flows?

a. 1,200,000 b. 2,200,000 c. 400,000 d. 750,000

Solution: Answer D

Cash paid for purchase of building (400,000)

Cash paid for purchase of land (350,000)

Net cash used in investing activities (750,000)

The debt-equity swap is disclosed as a financing activity.

The borrowing of P550,000 is a cash inflow from financing.

The purchase of inventory of P300,000 is operating.

The dividend payment of P100,000 is financing.

Problem 3

Stonewall Company provided the following comparative statement of financial position at year-end:

2018 2017
Cash 1,550,000 400,000
Accounts receivable 1,400,000 950,000
Investments, at cost 200,000 350,000
Property, plant and equipment 1,800,000 1,300,000
Accumulated depreciation (600,000) (450,000)
Accounts payable 950,000 750,000
Share capital 2,500,000 1,000,000
Retained earnings 900,000 800,000

An investment was sold for P250,000 during the current year.

There were no disposal of property, plant and equipment during the current year.

The net income for the current year was P600,000.

A dividend of P500,000 was paid on December 31, 2018.

1. What amount should be reported as net cash provided by operating activities?

a. 700,000 b. 500,000 c. 400,000 d. 600,000

2. What amount should be reported as net cash used in investing activities?

a. 500,000 b. 750,000 c. 250,000 d. 400,000

3. What amount should be reported as net cash provided by financing activities?

a. 1,500,000 b. 2,000,000 c. 2,500,000 d. 1,000,000

Solution:

Question 1 – Answer C

Net income 600,000

Gain on sale of investment (100,000)
Depreciation (600,000 – 450,000) 150,000
Increase in accounts receivable (1,400,000 – 950,000) (450,000)
Increase in accounts payable (950,000 – 750,000) 200,000

Net cash provided by operating activities 400,000

Proceeds from sale of investment 250,000

Cost of investment sold (150,000)

Gain on sale of investment 100,000

Investments – 2017 350,000

Investments – 2018 200,000

Cost of investment sold 150,000

Question 2 – Answer C

Sale of investment 250,000

Purchase of property, plant and equipment (500,000)

Net cash used in investing activities (250,000)

Property, plant and equipment – 2018 1,800,000

Property, plant and equipment – 2017 1,300,000

Purchase of property, plant and equipment 500,000

Question 3 – Answer D

Issue of share capital 1,500,000

Dividend paid (500,000)

Net cash provided by financing activities 1,000,000

Share capital – 2018 2,500,000

Share capital – 2017 1,000,000

Issue of share capital 1,500,000