STATEMENT OF CASH FLOWS

Learning Objectives

At the end of this chapter, reader should be able to understand the following:

- concept of cash flows as stipulated by IFRS,

- preparation of the statement of cash flows using the direct and indirect method of
computation
- distinguish between cash flow and profitability
- enumerate the limitations of the statement of cash flows

Introduction

IAS 7 of the International Financial Reporting Standards requires a business entity to present
a statement of cash flows, which is part of the primary financial statement. In the preparation
of the financial reports, two accounting bases are used; the cash basis and the accrual basis.
The cash basis is that basis of accounting that recognizes revenue in the period in which cash
is received from customers, and expenses are reported when cash is paid out, while the
accrual basis of accounting recognizes revenues when they are earned i.e. when transactions
occur without recourse to collection of cash or any other means of payment and recognizes
expenses in the period when benefits are received and not when payment is made. Most
organizations due to the matching concept adopt the accrual basis of accounting. However, to
evaluate the inflow and outflow of cash within the organization, the statement of cash flows
is presented. IAS 7 of the International Financial Reporting Standards requires the
preparation of the statement of cash flows. This is the only statement that ignores the accrual
basis and is prepared using the cash basis. All other financial statements follow the accrual
principle.

The statement of cash flows shows how much cash a company is able to generate during the
reporting period and source of cash. It shows how well the company is able to increase sales
and generate more cash from operating activities, determines if the cash generated was from
the sales of property or other investments, or cash was increased from the sale of shares, loan
from banks or other financing activities. This statement also shows how the cash generated
was utilized. Statement of cash flows gives information about the changes in cash and cash
equivalents of an entity. Cash comprises of cash in hand or cash at bank, while cash
equivalents are short term investments that can be easily converted to a known amount with
little or no risk of change in value.

Benefits of statement of cash flows

The following are the benefits of the statement of cash flows

1. The statement of cash flows shows the ability of a company to generate cash.
2. It helps investors diagnose the liquidity level of the company under review
3. It is not easily manipulated due to the fact that the accrual concept is ignored
4. The statement shows how much cash is generated and the source of the fund.
Limitation of statement of cash flows

The following are the limitations of the statement of cash flows:

1. It only disclose cash and cash equivalent transactions, while non cash transactions
which may help investors in their decision making process is ignored.
2. It cannot be used to assess the profitability of a firm, due to the omission of non cash
transactions.
3. It is prepared using the historical cost approach, thus cannot be used for future
projection and prediction.
4. Inter-firm comparison cannot be done using the statement of cash flows

Differences between cash flows and profits

An entity may be liquid and not profitable, while an entity may be profitable and not liquid
however, these two are the major objectives of every business entity.

Cash flows explains the movement of cash in and out of the company. It enumerates the
liquidity of a company and its ability to meet up with its short term objectives, while
profitability is the difference in income over expenses.

Profitability evaluates all transactions irrespective of whether cash was received or not i.e.
accrual basis, while cash flows only considers transactions that involve the exchange of cash
and cash equivalents.

A company that has declared profit during a financial year may have low cash balance at the
end of the year than at the beginning which is a sign of illiquidity. Some of the factors which
may lead to the discrepancies between cash flow and profitability include:
1. Timing difference between when sales are made and when cash is collected from the
customers.
2. Repayment of loan in the reporting period. When loan is repaid, only the interest is
charged against the statement of comprehensive income, while the cash position will
be affected by both the interest paid and the principal repayment.
3. The purchase of non-current asset does not affect the statement of comprehensive
income, except the depreciation for the year, while the cost of purchasing the non-
current asset affects the statement of cash flows.
4. Prepayments i.e. payments made in advance for benefits yet to be enjoyed by the
company is taken wholly in the year such payments are made in the statement of cash
flows while the statement of comprehensive income only considers the bill for the
current year.

Classification of cash flows

IAS 7 stipulates that cash should be classified and reported into operating, financing and
investing activities.

10.5.1 Operating activities: These are the principal revenue-producing activities of the
company. They form the day to day operations of the company for which the company is set
up principally. This is the most important aspect of any business entity, because it shows the
ability of the company to generate cash by its own activities, rather than by external financing
or investments in other entities.

Cash flows from operating activities comprises of the inflow and outflow of cash from
operating activities of the company. The component of this varies from company to company
depending on the nature of operations. For example, manufacturing company would report
advance given for the acquisition of PPE as investing activity, but the bank would report
similar advance as an operating activity based on its specific purpose.

However, operating activities generally result from profit making activities and the examples
are:

 Cash receipts from the sale of goods and the rendering of services;
 Cash receipts from royalties, fees, commissions and other revenue;
 Cash received from customers;
 Cash payments to suppliers for goods and services;
 Cash payments to and on behalf of employees;
 Cash receipts and cash payments of an insurance entity for premiums and claims,
annuities and other policy benefits;
 Cash payments or refunds of income taxes unless they can be specifically identified
with financing and investing activities; and
 Cash receipts and payments from contracts held for dealing or trading purposes.

Investing activities: These are activities engaged in by a business entity outside the
operational activities of the company. These activities are engaged in to either boost
production or generate other sources of income outside the day to day operations of the
company. Investment activities may include the acquisition and disposal of long-term assets
which may help boost production, and other investments not included in the operating
activities.

Examples of cash flows classified in investing activities are:

 Cash payments to acquire property, plant and equipment, intangibles and other long-
term assets (including capitalized development costs and self-constructed PPE);
 Cash receipts from sales of PPE, intangibles and other long-term assets;
 Cash payments to acquire and cash receipts from sales of equity or debt instruments
of other entities and interests in joint ventures (but not for trading or dealing
purposes);
 Cash advances and loans made to other parties, and cash receipts from their
repayment (other than advances and loans made by a financial institution – these
would go to operating part);
 Cash payments for and cash receipts from various derivative contracts except when
the contracts are held for dealing or trading purposes, or the payments are classified as
financing activities.
Financing activities: These are activities that relate to the generation of fund and disposal of
fund towards the expansion of the capital base of a business entity. These are activities that
affect the financial structure of any business venture, either in the form of equity or debt.
Financing activities are activities that result in changes in the size and composition of the
contributed equity and borrowings of the entity.

Examples of cash flows arising from financing activities are:

 Cash proceeds from issuing shares or other equity instruments;

 Cash payments to owners to acquire or redeem the entity’s shares;
 Cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other
short-term or long-term borrowings;
 Cash repayments of amounts borrowed; and
 Cash payments by a lessee for the reduction of the outstanding liability relating to a
finance lease.

Cash flows from investing and financing activities shall always be reported GROSS, so no
netting off.

It means that you cannot present the cash paid to acquire some vehicle and cash received
from sale of some other vehicle in 1 line – instead, you must present these cash flows
separately in 2 lines.

However, IAS 7 gives 2 exceptions where transactions can be presented net:

 Cash receipts and payments on behalf of customers when the cash flows reflect the
activities of the customer rather than those of the entity.

For example, some real estate company can collect rents from tenants and pay them
over to the property owners.

 Cash receipts and payments for items in which the turnover is quick, the amounts are
large, and the maturities are short.

For example, changes in principal amounts relating to credit card customers.

Also, financial institutions can report certain transactions on the net basis.
Interest and dividends received and paid may be classified as operating, investing, or
financing cash flows, provided that they are classified consistently from period to period

Cash flows arising from taxes on income are normally classified as operating, unless they can
be specifically identified with financing or investing activities

Foreign currency

When there are foreign currency cash flows, then you need to translate them to your
functional currency by applying the exchange rate at the date of the cash flow.

However, be careful at the closing, because unrealized year-end foreign exchange gains or
losses are NOT cash flows. If they relate to your cash or cash equivalents, then you should
present these amounts in the separate line in the final reconciliation.

Interest and dividends

Cash flows from interest and dividends received and paid shall be presented separately and
consistently from period to period.

In fact, you have a choice here for each of these items:

 Interest and dividends paid can be classified either as operating cash flow, or
financing cash flow.
 Interest and dividends received can be classified either as operating cash flow, or
investing cash flow.

Either way you choose, it’s OK, but it must be done consistently in each reporting period.

Taxes on income

Basically, cash flows arising from income taxes are classified as cash flows from operating
activities.

But if you can specifically identify these taxes with financing or investing activities, then you
should report your cash flows from taxes in these parts.

Investments

When there are investments in subsidiaries, associates and joint venture, then reporting cash
flows to and from these investments really depends on the accounting method used.
Furthermore, when the equity or cost method is used, then only the cash flows between the
parent company and the subsidiary should be included in the cash flow statement (dividends
or advance)

 the exchange rate used for translation of transactions denominated in a foreign

currency should be the rate in effect at the date of the cash flows [IAS 7.25]
 cash flows of foreign subsidiaries should be translated at the exchange rates prevailing
when the cash flows took place [IAS 7.26]
 as regards the cash flows of associates, joint ventures, and subsidiaries, where the
equity or cost method is used, the statement of cash flows should report only cash
flows between the investor and the investee; where proportionate consolidation is
used, the cash flow statement should include the venturer's share of the cash flows of
the investee [IAS 7.37]
 aggregate cash flows relating to acquisitions and disposals of subsidiaries and other
business units should be presented separately and classified as investing activities,
with specified additional disclosures. [IAS 7.39] The aggregate cash paid or received
as consideration should be reported net of cash and cash equivalents acquired or
disposed of [IAS 7.42]
  cash flows from investing and financing activities should be reported gross by major
class of cash receipts and major class of cash payments except for the following cases,
which may be reported on a net basis: [IAS 7.22-24]
o cash receipts and payments on behalf of customers (for example, receipt and
repayment of demand deposits by banks, and receipts collected on behalf of
and paid over to the owner of a property)
o cash receipts and payments for items in which the turnover is quick, the
amounts are large, and the maturities are short, generally less than three
months (for example, charges and collections from credit card customers, and
purchase and sale of investments)
o cash receipts and payments relating to deposits by financial institutions
o cash advances and loans made to customers and repayments thereof
 investing and financing transactions which do not require the use of cash should be
excluded from the statement of cash flows, but they should be separately disclosed
elsewhere in the financial statements [IAS 7.43]
 entities shall provide disclosures that enable users of financial statements to evaluate
changes in liabilities arising from financing activities [IAS 7.44A-44E]*
 the components of cash and cash equivalents should be disclosed, and a reconciliation
presented to amounts reported in the statement of financial position [IAS 7.45]

The amount of cash and cash equivalents held by the entity that is not available for use by the
group should be disclosed, together with a commentary by management [IAS 7.48]

Methods

IAS 7 states that two methods are acceptable for the determination of the cash flows from
operating activities. These methods are the direct method and the indirect method.

Direct method

 The direct method shows each major class of gross cash receipts and gross cash
payments. Under this method, the organization bases its report on the gross receipts
and payments from the various sources that are directly related to its operating
activities. The operating cash flows section of the statement of cash flows under the
direct method would appear something like this:

Cash receipts from customers xxxxxx

Cash paid to suppliers xxxxx
Cash paid to employees xxxxx
Cash paid for other operating expenses xxxxx
Interest paid xxxxx
Income taxes paid xxxxx Xxxxxx
Net cash from operating activities Xxxxxx

Indirect method
The indirect method adjusts accrual basis net profit or loss for the effects of non-cash transac-
tions. This method starts with the reported profit, making adjustments for non-cash
transactions. Under this method, adjustments are made for the following:

1. Gain or loss on the disposal of non-current assets for the year

2. Changes that occur in inventory, trade and other receivables and trade payables
between the beginning and the end of the year.
3. Interest paid or finance cost
4. Income tax expense
5. Income tax paid

The operating cash flows section of the statement of cash flows under the indirect method
would appear something like this:

Profit before interest and income taxes xxxxx

Add back depreciation xxxxx
Add back impairment of assets xxxxx
Increase in receivables xxxxx
Decrease in inventories xxxxx
Increase in trade payables xxxxx
Interest expense xx,xxx
Less Interest accrued but not yet paid xx,xxx
Interest paid xx,xxx
Income taxes paid xx,xxx
Net cash from operating activities xx,xxx

For operating cash flows, the direct method of presentation is encouraged, but the indirect
method is preferred by IAS 7.

Preparation of Statement of Cash flow

The preparation of the statement of cash flow is prepared in accordance with IAS 7 using
either the direct or the indirect method.

Illustration 1

USMAN Plc.
 Statement of Profit or Loss and Other Comprehensive Income for the year ended 31
December 2013
N‘000 N‘000
Revenue 1,600,000
Interest income 10,000
Gain on sale of plant 8,000 .
1,618,000
Expenses:
Cost of sales 960,000
Wages and salaries expenses 240,000
Depreciation on plant and equipment 50,000
Interest expense 8,000
Other expenses 152,000 (1,410,000)
Profit before tax 208,000
Income tax expense (60,000)
Profit for the year 148,000
Other comprehensive income:
Gain on available for sale Investment 4,000
Income tax (1,200) 2,800 .
Total comprehensive income for the year 150,800 .

USMAN Plc.
Comparative Statements of Financial Position as at:
31 Dec. 31 Dec. Increase/
2013 2012 (Decrease)
N‘000 N‘000 N‘000
Cash at bank 113,100 120,000 (6,900)
Accounts receivable 158,000 140,000 18,000
Inventory 140,000 130,000 10,000
Prepayments 19,000 16,000 3,000
Interest receivable 200 300 (100)
Plant and equipment 330,000 300,000 30,000
Investment (Available for 28,000 24,000 4,000
sale)
Intangible assets 30,000 - 30,000
818,300 730,300 88,000
Accounts payable 90,000 84,000 6,000
Wages and salaries 10,000 8,000 2,000
payable
Accrued interests 400 - 400
Other expenses payable 3,600 6,000 (2,400)
Current tax payable 32,000 28,000 4,000
Deferred tax liability 17,200 10,000 7,200
Long-term borrowings 140,000 120,000 20,000
Share capital 400,000 400,000 -
Retained earnings 122,300 74,300 48,000
Available for sale reserve 2,800 - . 2,800
818,300 730,300 88,000
Additional information extracted from the company’s records are:
(i) Plant which had a carrying amount of N20,000,000 was sold for N28,000,000 cash and
new equipment was purchased for N100million.
(ii) Intangibles valued at N30,000,000 were acquired for cash.
(iii) Borrowings of N20,000,000 were made during the year and received in cash.
(iv) Dividends paid in cash amounted to N100,000,000.
Required:
Prepare Statement of Cash Flows for USMAN Plc for the year ended 31 December 2013 in
accordance with IAS7 using direct method. (20 Marks) (ICAN Nov. 2014)

Solution
USMAN PLC.
STATEMENT OF CASHFLOW FOR THE YEAR ENDED 31 DECEMBER 2013
NOTES N’000 N’000
CASHFLOW FROM OPERATING ACTIVITIES:
Cash Receipts from customers (1) 1,582,000
Cash paid to supplier and employers (2) (1,359,400)
Cash generated from operations 222,600
Interest Received (3) 10,100
Interest paid (4) (7,600)
Income Tax paid (5) (50,000)
Net cash from operating activities 175,100
Cash flow from investing activities:
Purchase of intangibles (30,000)
Purchase of plant (100,000)
Proceeds from sale of plant 28,000
Net cash used in Investing Activities (102,000)
Cash flow from Financing Activities:
Proceeds from borrowing 20,000
Dividends paid (100,000)
Net cash used in Financing Activities (80,000)
Net Decrease in cash and Equivalents (6,900)
Cash and Cash equivalent at the beginning of the year 120,000
Cash and cash equivalent at the end of the year 113,100
Notes:
1. Cash Receipts from customers:
N’000
Revenue 1,600,000
Beginning account receivable 140,000
1,740,000
Ending account receivable (158,000)
Cash receipts from customer 1,582,000

OR
ACCOUNT RECEIVABLES
 N’000 N’000
Opening bal 140,000 Cash receipts 1,582,000
Sales Revenue 1,600,000 Closing bal 158,000
1,740,000 1,740,000

2a. Payment to Suppliers for Purchases:

N’000
Cost of sales 960,000
Increase in inventory 10,000
970,000
Increase in account payables (6,000)
Payment for purchases 964,000

Payment for other services

Other expenses 152,000
Increase in prepayments 3,000
Decrease in other expenses payable 2,400
157,400

(c) Payment to employees

Wages and salaries expenses 240,000
Increase in wages and salaries payable (2,000)
238,000

(d) Summary of total payment to suppliers and employees:

For purchases 964,000
For services 157,400
For salaries and wages 238,000
1,359,400

3) Interest received:
Interest revenue –increase in interest receivable or decrease in interest
receivable = N10,000,000 + N100,000 = N10,100,000

(4) Interest paid: N’000

Interest expenses 8,000
Decrease in accrued interest 400
7,600

(5) Income Tax paid:

Beginning balance 28,000
Income tax expenses 54,000
Income tax paid (50,000)
Ending balance 32,000

(a) Deferred Tax

N’000 N’000
 Balance c/d 17,200 Bal b/d 10,000
Tax on OCI 1,200
Income tax expenses 6,000
17,200 17,200

N’000
OCI = Other Comprehensive Income
(b) Income Tax expenses 60,000
Less: Deferred Tax (5a) 6,000
54,000

Illustration 2
Galadanci Plc. is a telecommunications company operating in Nigeria. The management of
the company presented the following summarised financial statements for the years ended 31
December, 2013 and 2014.

Statements of Profit or Loss and Other Comprehensive Income for the year ended
2014 2013
N’billion N’billion
Revenue 2,430 1,638
Cost of sales (1,701) (983)
Gross profit 729 655
Administrative costs (311) (180)
Distribution costs (207) (117)
Finance costs (36) (6)
Profit before taxation 175 352
Income tax expense (54) (102)
Profit for the year 121 250

Statements of financial position as at 31 December

2014 2013
N’billion N’billion N’billion N’billion
Assets:
Non-current assets:
Property, plant & equipment 612 369
Intangible assets 270 180
Investment in shares of Papanga Plc. at
Cost 207 Nil
1,089 549
Current assets:
Inventory 120 100
Trade receivables 150 70
Other receivables Nil 270 110 280
Total assets 1,359 829
Equity & liabilities:
Equity shares of N1 each 390 225
Retained earnings 340 270
730 495
Non-current liabilities:
10% secured loan notes 80 80
12% secured loan notes 260 340 Nil 80
Current liabilities:
Bank short term loan 49 10
Trade payables 190 140
Income tax payable 50 289 104 254
Total equity & liabilities 1,359 829
The following additional information is relevant for the year ended 31 December,
2014:
(i) Galadanci Plc. acquired 60% interests in the equity shares of Papanga Plc.
which is into commercial rice production in order to diversify its business
portfolio and take advantage of the favourable incentives in agriculture
recently announced by the Federal Government of Nigeria.
(ii) Galadanci Plc. increased its mobile telephone subscriber based and average
revenue per user.
(iii) No dividends were received from Papanga Plc. and the value of its shares had
not increased during the year ended 31 December, 2014.
Required:
Prepare Galadanci Plc’s Cash Flows from operating activities using the indirect
method in accordance with 1AS 7 on Statement of Cash Flows. (ICAN May, 2015)

Solution:
GALADANCI PLC.
STATEMENT OF CASHFLOWS FOR
THE YEAR ENDED 31 DECEMBER, 2014 (INDIRECT METHOD)
N’bn N’bn
OPERATING ACTIVITIES:
Profit before taxes 175
Adjustment for non-cash and non-operating items
Depreciation of property, plant & equipment -
Amortisation of intangible assets -
Finance cost 36 36
Movement in working capital:
Increase in inventory N (120 – 100) (20)
Increase in trade receivables N(150 – 70) (80)
Decrease in other receivables N(110 – 0) 110
Increase in trade payables N(190 – 140) 50 60
Cash flows from operating activities 271
Interest paid (36)
Tax paid (Wk 1) (108)
127
(Wk 1) Working
N’bn
Tax b/f 104
Income tax expenses (P or L) 54
Less payable bal c/f (50)
108
Illustration 3
Global Plc is an entity quoted on the Nigerian Stock Exchange.
You are provided with the following set of summarised published financial statements of the
company for the year ended September 30, 2014.

Statement of profit or loss and other comprehensive income for the year ended
September 30, 2014.
201
4
N’000
Revenue 500,000
Cost of sales (300,000)
Gross profit 200,000
Administrative expenses (29,000)
Finance cost (1,000)
Profit before taxation 170,000
Income tax expense (40,000)
Profit for the period 130,000

Statement of financial position as at September 30, 2014 with their comparative figures
2014 2013
N’000 N’000
Assets:
Non-current assets:
Property, plant and equipment 200,000 220,000
Goodwill - 10,000
Inventories 100,000 80,000
Trade receivables 75,000 60,000
Bank balances 20,000 5,000
395,000 375,000
Equity and liabilities:
Ordinary shares @ N1.25k each 10,000 8,000
Retained earnings 250,000 197,000
260,000 205,000
Non-current liabilities:
10% loan notes 10,000 -
Current liabilities:
Trade payables 60,000 90,000
Other payables 20,000 40,000
Taxation 20,000 30,000
Bank overdrafts 25,000 10,000
135,000 170,000
Total equity and liabilities 395,000 375,000

The following information is relevant:

i. During the financial year, the company paid dividend of N87,000,000 to equity holders and
this had been accounted for during the year. The current market price of the company is N10
per share.
ii. The company is planning to take a long term loan of N400,000,000 from consortium of
banks. The company’s financial statements and loan applications have already been
submitted to the bank.
Required:
a. Prepare the company’s statement of cash flows submitted to the bank in accordance with
the provisions of IAS 7. (10 Marks)
b. Comment briefly on the cash flow management strategies of Global Plc. (ICAN Nov,
2015)

SOLUTION
GLOBAL PLC
STATEMENT OF CASH FLOW
FOR THE YEAR ENDED SEPTEMBER 30, 2014
METHOD 1- USING INDIRECT METHOD
Cash flow from operating Activities
N’000 N’000
Net Profit before Taxation 170,000
Adjustments:
Depreciation 20,000
Finance Cost 1,000
Goodwill 10,000 31,000
201,000
Increase in Receivables/payables:
Increase in Taxes (20,000)
Increase in Trade Receivables (15,000)
Decrease in Trade Payables (30,000)
Decrease in other Payables (20,000) (85,000)
Taxation paid (50,000)
Interest charges paid (1,000)
Net cash inflow from operations 65,000
Investing activities Nil
Financing activities
Share Capital and Premium 12,000
Loan notes (10%) 10,000
Dividend paid (87,000) (65,000)
Net Increase /decrease in cash and
cash equivalent Nil
Opening cash and cash equivalent
Cash and Bank 5,000
Overdraft (10,000) (5,000)
Closing cash and cash equivalent 5,000

Workings #’000
1. Taxation paid
Opening balance 30,000
Per profit or loss 40,000
70,000
Less
Closing Balance (20,000)
Tax Paid 50,000

2. Capital/ share capital N’000

Increase in share capital (N10,000-N8,000) 2,000

Share premium received (wk 2.1) 10,000
12,000

2.1 Share premium received

Retained earnings B/F 197,000

Profit for the period 130,000
327,000
Closing retained earnings (250,000)
Retained earnings declared as part of
Dividend 77,000
Total Dividend paid 87,000
Share Premium paid as dividend 10,000

a. Comments

- The company has not managed its cash flows properly despite Net cash inflow of
N65,000,000 generated from operations, since the company still went ahead to pay dividend
of N87,000,000.

- As a result of high dividend payment the company depleted all funds generated from
operation, share premium and part of other revenue reserve.

- The company might be profitable but the profit is not reflected in its liquidity position hence
the request for additional long term loan of N400 m.

- Their bankers may not be too willing to extend the additional loan request in view of poor
state of short term liquidity which may jeopardize the long term liquidity position of the
company.

If the loan is to be granted the bank might impose conditions on the company to moderate its
dividend payment policy.

- There is no cash inflow or outflow from investing activities during the year. This is an
indication that Global Plc may have poor investment culture or that the company has sold all
its assets and money realized is shared to shareholders in form of dividend.

METHOD 2 – “USING DIRECT METHOD”

 GLOBAL PLC
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 30 SEPTEMBER 2014

Operating Activities: Notes N‟000 Cash receipts from customers 1 485,000

Cash payments to suppliers 2 (350,000)
Cash payments for operating expenses 3 (19,000)
Company income Tax paid 4 (50,000)
Cash interest paid 5 (1,000)
Net cash inflow from operating activities 6 65,000
Investing activities:
Net cash outflow from investing activities
Financing activities:
Issue of new share(including share premium) 6 12,000
10% loan notes proceeds 10,000
Dividends paid (87,000)
Net cash outflow from financing activities 65,000
Net increase/Decrease cash & cash equipment 0
Cash and cash equivalents: opening balances:
Bank balances 5,000
Bank Overdraft (10,000)
Short term investments
(5,000)
Expected closing balances agrees with actual closing balance of:
Bank balances 20,000
Bank Overdraft (25,000)
Short term investments - .
(5,000)

Workings
1. Cash receipts from customers N’000
Opening balance of accounts receivable 60,000
Add: Revenue for the year 500,000
Expected cash from customers 560,000
Deduct: Closing cash receipts from customers during the year (75,000)
Actual cash receipts from customers during the year 485,000

2. Calculation of purchase during the year N’000

Cost of sales 300,000
Add: Closing inventory 100,000
Cost of goods available for sale 400,000
Deduct: Opening inventory (80,000)
320,000
30,000
Payment in respect of Trade payable 350,000

3. Cash interest payments N’000

Opening balance of accrued interest -
Add: Interest incurred for the year 1,000
Expected interest payments 1,000
Cash payments for operating expenses N’000
 Cash expenses incurred for the year (29,000-20,000-10,000) (1,000)
Add: Closing balance of prepayments -
Opening balance of other payable 40,000
Expected payments 39,000
Deduct: Opening balance of prepayments -
Closing balance of other expenses payable (20,000)
Actual cash payments for operating expenses during the year 19,000

Company income tax paid N’000

Opening balance of income tax payable 30,000
Add: Income Tax expense for the year 40,000
Expected income tax payments 70,000
Deduct: Closing balance of income tax payable (20,000)
Actual company income tax paid during the year 50,000

6. Cash interest payments N’000

Opening balance of accrued interest -
Add: Interest incurred for the year 1,000
Expected interest payments 1,000
Deduct: Closing balance of accrued interest -
Actual interest payments during the year 1,000

Issues of new shares N’000 N’000

Closing share capital 10,000
Less operating share capital 8,000 2,000
Share Premium
Opening reserve 197,000
Add: Profit for the year 130,000
327,000
Deduct: dividend paid (87,000)
Reserve (240,000)
250,000 10,000
12,000

Illustration 4
The summarised Financial Statements for the year ended March 31, 2016 of Perfect World
Plc are as follows:

STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED MARCH 31, 2016
N’m
Revenue 19,350
Cost of Sales (9,000)
Gross Profit 10,350
Operating Expenses (4,500)
Finance Costs (1,125)
Profit Before Tax 4,725
Income Tax Expense (2,025)
Profit for the year 2,700
STATEMENT OF FINANCIAL POSITION AS AT MARCH 31
2016 2015
Non-Current Assets: N’m N’m
Property, Plant & Equipment 18,900 16,650
Current Assets
Inventories 6,750 7,200
Trade Receivables 9,900 8,100
16,650 15,300
Total Assets 35,550 31,950
Equity
Share Capital 5,400 5,400
Retained Earnings 9,900 8,550
15,300 13,950
Non-Current Liabilities
Deferred Tax 4,815 3,825
Financial Lease Liabilities 5,850 5,400
10,665 9,225
Current Liabilities
Trade Payables 5,625 4,905
Current Tax 1,013 923
Finance Lease Obligation 2,250 2,025
Bank Overdraft 697 922
9,585 8,775
Total Equity & Liabilities 35,550 31,950

Additional Information include:

(i) Dividend paid during the year amounted to N1,350million.
(ii) Perfect World Plc finances a number (but not all) of its property plant and equipment
purchased using finance lease. During the period, property, plant and equipment which would
have cost N2,700million to purchase outright was acquired under finance lease.
(iii) There was no accrual of interest at the beginning or at the end of the year.
(iv) Depreciation charged for the year totalled N4,365million. There were no disposals of
property, plant and equipment during the year.
Required:
a. Prepare the statement of cashflows of Perfect World Plc for the year ended March 31, 2016
using indirect method.

b. Draft a Memo to the Director of Perfect World Plc summarising the major benefits that
users receive from a published statement of cash flows.
SOLUTION
PERFECT WORLD PLC
STATEMENT OF CASHFLOWS FOR THE YEAR ENDED 31 MARCH, 2016
CASHFLOWS FROM OPERATING ACTIVITIES N’m N’m
Net Profit before Tax 4,725
Adjustment for:
Depreciation 4,365
Interest Expenses 1,125
10,215
Changes in Working Capital:
Decrease in Inventories (6,750 – 7,200) 450
Increase in Trade Receivables (9,900-8,100) (1,800)
Increase in Trade Payables (5,625 – 4,905) 720
9,585
Interest Paid (1,125)
Income Tax Paid (w2) (945)
Net Cashflow from Operating Activities 7,515
CASHFLOWS FROM INVESTING ACTIVITIES
Purchase of Property, Plant & Equipment (w1) (3,915)
CASHFLOWS FROM FINANCING ACTIVITIES
Payment of Finance Lease Liabilities (w3) (2,025)
Dividend Paid (1,350) (3,375)
Net Increase in Cash and Cash Equivalents 225
Cash and Cash Equivalents at beginning of the year (922)
Cash and Cash Equivalents at the end of the year (697)

WORKINGS
W1 PROPERTY, PLANT AND EQUIPMENT(PPE)
N’m N’m
B/d – Balance 16,650 Depreciation 4,365
Additions 2,700
Cash/Bank *3,915
_____ c/d Balance 18,900
23,265 23,265

W2 INCOME TAX PAYABLE

N’m N’m
Cash/Bank (Paid) *945 B/d – DT 3,825
c/d – DT 4,815 - CT 923
- CT 1,013 P&L 2,025
6,773 6,773

W3 FINANCE LEASE LIABILITIES

N’m N’m
Cash/Bank (Paid) * 2,025 B/d > 1 year 5,400
< 1 year 2,025
< 1 year 2,250 PPE 2,700
C/d > 1 year 5,850 ___ __
 10,125 10,125

MEMO
To: Director of Perfect World Plc
From: Accountant
Date: November, 2016
Subject: Major Benefits to the Users of Financial Statement from the Publication of
Statement of Cash flows

The Users of financial statements can be basically divided into the following groups:

(i) Shareholders
(ii) Management
(iii) Creditors and Lenders
(iv) Employer

The need of the groups are not identical and hence not all benefits listed below will be
applicable to all users.

(i) Statement of Cash flows direct attention to the survival of the entity which depends on its
ability to generate cash.

(ii) Statement of Cash flows indicate the ability of an entity to repay its debts when due.

(iii) Statement of Cash flow give information which can be used in decision making and
stewardship process

(iv) They are more easily understood than statement of profit or loss that depends on
accounting conventions and concepts.

(v) It is useful in assessing the ability of the entity to generate cash and cash equivalents.

(vi) A statement of Cash flows when used in conjunction with the rest of the financial
statements provides information about liquidity and insolvency of an entity.

(vii) A statement of cash flows provides information that enables users to evaluate the
changes in net assets of an entity, its financial structure and its ability to effect the amount,
timing and certainty of cash flow.

(viii) It enhances the comparability of the reporting of operating performance by different

entities because it eliminates the effect of using different accounting treatment for the same
transaction and event.

(ix) It is also useful in checking the accuracy of past assessment of future cash flows and in
examining the relationship between profitability and net cash flows
(x) A statement of cash flows provides information that helps users to evaluate changes in the
net assets of an entity and its financial structure (including its liquidity and solvency)

Review questions with solution

Multiple Choice
1. Which of the following is a classification of cash flow?
a. Directing
b. Controlling
c. Planning
d. Monitoring
e. None of the above
2. A company has the following extract from its statement of financial position
31/12/2002 31/12/2001
#’000 #’000
Tax payable 500 1,000
The tax expense for the year 2002 is #500,000. How much is cash flow on tax during
the year
a. #500,000 inflow
b. #1,000,000 inflow
c. #500,000 outflow
d. #1000,000 outflow
e. None of the above
3. In which activity of cash flow is the issue of bonus share treated?
a. Operating activity
b. Financing activity
c. Investing activity
d. Fund raising activity
e. None of the above
4. The main reason why a company prepares a statement of cash flow is to
a. Comply with CAMA
b. Comply with FRCN Act
c. Comply with IFRS
d. Draw the sources and uses of cash during the period
e. A and B
5. When preparing statement of cash flows which of the following items cannot be
classified as investing activities?
a. Proceeds from the issue of shares and debentures
b. Dividends and interest received on investments
c. Purchase of non-current assets
d. Proceeds from sale of non-current assets
e. Purchase of investments
6. Which of the following will reduce the cash balance of a business but not the profit of
the year?
a. Wages paid
b. Rent paid
c. Dividend paid
d. Administrative expenses paid
e. None of the above
7. Which of the following will reduce the profit for the year but not the cash balance?
 i. Rent paid
ii. Dividend paid
iii. Administrative expense
iv. Depreciation
v. Impairment loss
a. i and ii
b. ii and iii
c. iii and iv
d. iv
e. iv and v
8. If a company issues 500,000 N2 shares at #2.40 per share, the effect on statement of
cash flows is that:
a. Cash flows from investing activities will increase by #1.0 million
b. Cash flows from financing activities will increase by #1.0 million
c. Cash flows from financing activities will increase by #1.2 million
d. Cash flows from investing activities will increase by #1.2 million
e. It will have no effect
9. Which cash flow activities can be prepared using either direct or indirect method?
a. Financing activities
b. Investing activities
c. Operating activities
d. All the three types of activities
e. None of the activities
10. Which of the following should be added to net profit for the purpose of constructing a
statement of cash flows using the indirect method?
a. Profit on sale of non-current assets
b. Loss on sale of non-current assets
c. Increase in inventory
d. Increase in trade receivables
e. None of the above.

Theory
1. Differentiate between cash flow and profitability
2. Identify and discuss the three classes of cash flows according to IAS 7
3. Why is the Statement of cash flows necessary
4. What is the difference between the direct and the indirect method of computing cash
flows from operating activities?
5. The transactions of a company are as follows:
For each transaction, indicate whether it is an operating, financing or investing
activity in the statement of cash flows. Indicate if it has no effect on cash flow.
Transaction Type of activity
i. Paid for acquired property
ii. Received money on shares issued to the public
iii. Paid dividends to shareholders
iv. Received dividends from outside investment
v. Took new long-term loans from UBA
vi. Paid supplier of goods
vii. Paid interest on loan
viii. Paid tax
ix. Received interest on savings
 x. Sold a motor vehicle for cash
xi. Conversion of a company’s debenture to equity
xii. Increased share capital through the issue of bonus shares
xiii. Transferred #200,000 from retained earnings to general reserve
xiv. Declared dividends of #50 per share
xv. Recognized impairment loss of #300,000
xvi. A non-current asset with net book value of #2 million is revalues aat #3 million
6. State four advantages of cash flow accounting
7. Hassan Limited’s Income Statement for the year ended 31s December 2012 and
Statement of Financial Position as at 31 December 2012 and 2011 are as follows:
Hassan Limited
Income Statement for the year ended 31st December 2012
#’m #’m
Revenue 360
Raw materials consumed 35
Staff costs 47
Depreciation 59
Loss on disposal of non-current assets 9 150
Operating profit before interest and tax 210
Interest payable 14 .
Profit before tax 196
Taxation 62
134
Hassan Limited
Statement of Financial Position as at 31 December 2012
2012 2011
#’m #’m #’m #’m
Non Current Assets (cost) 798 780
Depreciation (159) (112)
639 668
Current Assets:
Inventory 12 10
Trade receivable 38 29
Bank 24 74 28 67
Total Assets 713 735
Equity and liabilities
Share capital 180 170
Share premium 18 12
Retained earnings 358 556 257 439
Non- current liabilities
Long term loans 100 250
Current liabilities:
Trade payables 6 3
Taxation 51 57 43 46
Total equity and liabilities 713 735
Dividend paid was #33 million
During the year, the company paid #45 million for a new piece of machinery.
Required:
Prepare a statement of Cash flows for Hassan Limited for the year ended 31 December 2012
in accordance with the requirements of IAS 7, using the indirect method. (Adapted from
ICAN).

Solution to Multiple Choice Questions in the Chapter

1. E 2. D 3. E 4. D 5. A 6. C 7. E 8. C 9. C 10. B

References
Omolehinwa (2014) Foundation of Accounting: An IFRS Approach. Pumark Nig. Ltd.
Lagos.
ICAN (2014) The Pathfinder.