19-1 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Cash-flow statements Chapter 19

19-2 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Learning objectives Understand the New Zealand accounting requirements relating to the disclosure of information about an organisation’s cash flows Understand how to construct a cash-flow statement in conformity with NZ IAS 7 (Continues)

19-3 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Learning objectives (cont.) Understand how the statement of cash flows provides information that is a useful complement to the balance sheet (statement of financial position) and the income statement (statement of financial performance) Understand how we define ‘cash’ and ‘cash equivalents’ for the purposes of a cash-flow statement and understand that these definitions mean that cash-flow statements address transactions beyond those involving merely ‘cash ’ (Continues)

19-4 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Learning objectives (cont.) Understand the differences between cash flows from operations, cash flows from investing, and cash flows from financing activities Be aware of the various supporting notes that must accompany a cash-flow statement

19-5 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Introduction to cash-flow statements Governed by NZ IAS 7 ‘Cash Flow Statements’ Predecessor was FRS-10 ‘Statement of Cash Flows’, operative from 1 July 1994 Minimal differences between requirements of FRS-10 and those of NZ IAS 7

19-6 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Comparison with other financial statements Balance sheet (statement of financial position) – Shows financial position at a certain date Income statement (statement of financial performance) – Shows profit or loss that has been generated for a period of time using accrual accounting Cash-flow statement – Explains the movements in cash and cash equivalents for a given period – Provides a reconciliation of opening and closing total of cash and cash equivalent balances appearing in the balance sheet – Indicates sources of cash in terms of cash flows from operations, investing, and from financing (Continues)

19-7 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Comparison with other financial statements (cont.) Purpose of the cash-flow statement Assists in assessing the ability of the company or economic entity to: – generate cash flows – meet financial commitments as they fall due, including servicing of borrowings and payment of dividends – fund changes in the scope and/or nature of its activities – obtain external finance (Continues)

19-8 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Comparison with other financial statements (cont.) Purpose of the cash-flow statement (cont.) By having knowledge of both cash flows and accrual of profits/losses, investors are likely to be better able to assess the performance and viability of the reporting entity Argued to be more reliable than profit data as profit data typically based on numerous subjective and sometimes ‘creative’ judgments Cash-flow data tends to be more ‘factual’ or ‘objective’ (Continues)

19-9 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Comparison with other financial statements (cont.) Purpose of the cash-flow statement (cont.) Considered by many to be more understandable to users, to give rise to fewer problems with key terms, and to provide greater comparability between companies Cash flows from operations to be considered to be a superior performance measure and useful in assessing liquidity and solvency

19-10 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Defining ‘cash’ and ‘cash equivalents’ Objective of NZ IAS 7 ‘Cash flow statements’ is: to require the provision of information about the historical changes in cash and cash equivalents of an entity by means of a cash-flow statement, which classifies cash flows during the period from operating, investing and financing activities (Continues)

19-11 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Defining ‘cash’ and ‘cash equivalents’ (cont.) NZ IAS 7 requires the cash-flow statement to provide information about ‘cash’ and ‘cash equivalents’ Cash flows — inflows and outflows of cash and cash equivalents Cash — cash on hand (notes and coins held) and demand deposits (deposits on call with a financial institution) (Continues)

19-12 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Defining ‘cash’ and ‘cash equivalents’ (cont.) Cash equivalents – Highly liquid investments with short periods to maturity that are readily convertible to cash on hand at the investor’s option and are subject to an insignificant risk of changes in value – Borrowings that are integral to the cash management function and are not subject to a term facility (Continues)

19-13 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Defining ‘cash’ and ‘cash equivalents’ (cont.) ‘Cash’ in the cash-flow statement May relate to the total of a number of accounts shown in the balance sheet or accompanying notes May include cash at bank, bank overdrafts, short-term money market deposits, bank bills NZ IAS 7 requires that the amount of ‘cash’ and ‘cash equivalents’ as at the end of the financial year as presented in the cash-flow statement be reconciled (by way of a note to the financial statements) to the related items in the balance sheet (refer to Exhibit 19.2, p. 808) (Continues)

19-14 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Defining ‘cash’ and ‘cash equivalents’ (cont.) ‘Cash equivalents’ in the cash-flow statement NZ IAS 7 (par. 7) –Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For an investment to qualify as a cash equivalent it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value. Therefore, an investment normally qualifies as a cash equivalent only when it has a maturity of, say, three months or less from the date of acquisition (Continues)

19-15 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Defining ‘cash’ and ‘cash equivalents’ (cont.) ‘ Cash equivalents’ in the cash-flow statement (cont.) Also required to disclose policy adopted by organisation for determining which items are classified as ‘cash’ in the statement of cash flows Explicit disclosure of this policy to assist users in understanding the cash-flow statement (Continues)

19-16 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Defining ‘cash’ and ‘cash equivalents’ (cont.) ‘Cash equivalents’ in the cash-flow statement (cont.) For an item to be considered to be a ‘cash equivalent’ it must be highly liquid and be used as part of the cash management of the company Result — cash equivalent in one entity might not be a cash equivalent in another Depends on the respective cash-management programs adopted — bank and non-bank bills (highly liquid investments) typically meet the definition of cash Account items such as accounts receivable, accounts payable, any borrowings subject to a term facility or equity securities would be excluded from cash equivalents

19-17 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Classification of cash flows NZ IAS 7 requires that cash flows be classified into those relating to: – operating activities  the principal revenue-producing activities of the entity and other activities that are not investing and financing activities i.e. relate to the provision of goods and services, and other activities that are neither financing nor investing activities (refer to definitions of financing and investing) – investing activities  the acquisition and/or disposal of long-term assets (including property, plant and equipment) and other investments (such as securities) not included in cash equivalents – financing activities  relating to changing the size and/or composition of the financial structure of the entity, including equity and borrowings not following within the definition of cash

19-18 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Format of cash-flow statement Appendix to NZ IAS 7 provides a suggested format – Refer to Exhibit 18.3 (p. 652 of the text) – Cash flows from operating activities disclosed first, followed by investing and financing Prior-year comparisons required Some items ordinarily considered operating items for income statement purposes might not be treated the same for cash-flow purposes and vice versa (e.g. interest paid) (Continues)

19-19 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Format of cash-flow statement (cont.) Cash flows from operating activities Receipts from customers Payments to suppliers and employees Dividends received Cash generated from operations Interest paid Income taxes paid (Continues)

19-20 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Format of cash-flow statement (cont.) Cash flows from investing activities Acquisition of subsidiary X, net of cash acquired Purchase of property, plant and equipment Proceeds from sale of equipment Interest received Dividends received (Continues)

19-21 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Format of cash-flow statement (cont.) Cash flows from financing activities Proceeds from issue of shares Proceeds from borrowings Repayment of borrowings Dividends paid (Continues)

19-22 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Format of cash-flow statement (cont.) Number of items to be separately disclosed (NZ IAS 7, par. 31): Interest and other items of a similar nature received Dividends received Borrowing costs, including interest and other costs of finance paid Dividends paid Income taxes paid (Continues)

19-23 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Format of cash-flow statement (cont.) Additional issues Cash flows from operating activities to be disclosed using the direct method — relevant cash inflows and outflows reported in gross terms rather than in net terms (NZ IAS 7, par. 18) An entity to report separately major classes of gross receipts and gross payments arising from investing and financing activities rather than as net amounts (NZ IAS 7, par. 21) — exceptions noted in pars 22 and 24 A reconciliation of cash flows from operating activities with net profit or loss as reported in income statement (NZ IAS 7, par. 20.1) (Continues)

19-24 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Format of cash-flow statement (cont.) Reconciliation of operating profit with net cash flows from operating activities – Items that might cause a difference include:  depreciation and amortisation  increases/decreases in accounts receivable and payable, interest payable and receivable, accrued expenses, income tax payable, deferred taxes payable, prepaid expenses, inventories  loss/gain on sale of plant and equipment  Refer to Table 19.1, p. 812 for an example, and to Exhibit 19.4, 'Reconciliation of cash flows from operations to net profit', p. 814 (Continues)

19-25 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Format of cash-flow statement (cont.) Non-cash financing and investing activities NZ IAS 7 requires that information about transactions and events that do not result in cash flows during the financial year but affect assets and liabilities that have been recognised are to be disclosed in the accounts or the consolidated accounts where the transactions and other events: – involve parties external to the entity; and – relate to financing and investing activities Refer to NZ IAS 7, par. 43 (Continues)

19-26 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Format of cash-flow statement (cont.) Examples of non-cash financing and investing transactions – Conversions of liabilities to equity – Acquisitions of entities by means of an equity issue – Acquisitions of assets by assumption of directly related liabilities such as purchase of a building by incurring a mortgage to the seller – Acquisitions of assets by entering into finance leases – Exchange of non-cash assets or liabilities for other non-cash assets or liabilities Refer to Exhibit 19.5, 'Note relating to non-cash financing and investing activities', p. 815 (Continues)

19-27 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Format of cash-flow statement (cont.) NZ IAS 7 suggests that information should be disclosed about the external financing arrangements of the entity – Additional information may be relevant to users in understanding the financial position and liquidity of an entity. Disclosure of this information, together with a commentary by management, is encouraged and may include the amount of undrawn borrowing facilities that may be available for future operating activities and to settle capital commitments, indicating any restrictions on the use of these facilities (NZ IAS 7, par. 30) Refer to Exhibit 19.6, p. 816 for an example of a ‘financing facility’ note

19-28 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Calculating cash inflows and outflows Cash flows from operating activities Cash receipts from customers – sales + beginning receivables – ending receivables – bad debts expense (where bad debts are written off directly against debtors) – transfer from provision for doubtful debts (where debts that have previously been considered doubtful have subsequently proven uncollectable) – any discounts that may have been given to customers for early payment Refer to Worked Example 19.1, 'Calculating cash received from customers', p. 817 (Continues)

19-29 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Calculating cash inflows and outflows (cont.) Cash flows from operating activities (cont.) Classification of interest and dividends received – NZ IAS 7 (refer to par. 33) provides choice as to where interest paid and dividends and interest received are to be presented – Appendix A of NZ IAS 7 includes interest paid in operating activities but includes interest and dividends received as part of financing activities – NZ IAS 7 (par. 34) states that dividends paid are to be classified as a financing cash flow as they relate to the cost of obtaining external resources (Continues)

19-30 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Calculating cash inflows and outflows (cont.) Cash flows from operating activities (cont.) Calculation of cash received from interest revenue: – interest revenue + opening interest receivable – closing interest receivable – discount amortisation + premium amortisation Calculation of cash received from dividends: – dividend income + opening dividends receivable – closing dividends receivable Cash payment of interest: – interest expense + opening interest payable – closing interest payable – discount amortisation + premium amortisation (Continues)

19-31 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Calculating cash inflows and outflows (cont.) Cash flows from operating activities (cont.) Cash payment of income taxes: – income tax expense + opening income tax payable – closing income tax payable + opening deferred tax liability – closing deferred tax liability + closing deferred tax asset – opening deferred tax asset Note (NZ IAS 7, par. 35): – Cash flows arising from taxes on income are to be separately disclosed and classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities (Continues)

19-32 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Calculating cash inflows and outflows (cont.) Cash flows from operating activities (cont.) Cash payments to suppliers: – opening accounts payable – closing accounts payable + cost of sales + closing inventory – opening inventory – discounts given by suppliers + stock write-offs Refer to Worked Example 19.2, 'Calculating the cash payments made to suppliers', p. 821 Refer to Worked Example 19.3, 'Treatment of goods and services tax in accounts receivable and accounts payable', pp. 823–4 (Continues)

19-33 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Calculating cash inflows and outflows (cont.) Cash flows from investing activities Cash payments for non-current assets – Closing balance of non-current assets – opening balance of non-current assets + original cost of assets sold – assets acquired through non-cash transactions – revaluation increases – Need to exclude any increase in assets generated by non-cash transactions e.g. acquisition of plant by mortgage over other assets – Refer to Worked Example 19.4, 'Calculating cash flows from investing activities', p. 825 Proceeds from sale of non-current assets – Specific information about the sale transaction required — actual receipt of cash recorded in cash-flow statement, not gain or loss on sale (Continues)

19-34 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Calculating cash inflows and outflows (cont.) Cash flows from financing activities Payment of cash dividends – Dividends paid + dividends proposed + opening dividends payable – closing dividends payable Includes issue of shares, issue of debt, repayment of debt Note: To determine cash flows from the issue of equity securities, need to consider whether any share issue has been financed out of reserves (e.g. retained earnings or revaluation reserve) — if so, no related cash flow (Continues)

19-35 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Calculating cash inflows and outflows (cont.) Refer to Worked Example 19.5, 'Preparation of a cash-flow statement', pp. 826–34, comprehensive example including: – Calculation and disclosure of cash flows from operating activities – Calculation and disclosure of cash flows from investment activities – Calculation and disclosure of cash flows from financing activities – Reconciliation of net cash provided by operating activities with operating profit after tax – Note concerning non-cash financing and investing activities

19-36 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Contractual implications To date, limited information is available on the use of cash-flow data in contractual agreements Cash flows from operations would appear to provide an indication of ability to service debt – Perhaps more so than interest coverage Could argue that traditional financial ratios (current ratio, acid test ratios) are deficient in monitoring the liquidity of the organisation Has been argued that use of cash-flow data would provide an earlier indication of solvency problems than that provided by using conventional financial ratios

19-37 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Summary Cash-flow statement considered to be very useful complement to an entity’s balance sheet and income statement It provides information useful for making assessments about such things as an entity’s ability to: – generate cash flows – meet financial commitments as they fall due – finance changes in operating activities – obtain and service external debt As not based on accrual accounting, its compilation is not greatly influenced by professional judgment (Continues)

19-38 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Summary (cont.) Cash-flow statement provides a reconciliation of opening and closing cash with cash being described as ‘cash on hand’ and ‘cash equivalents’ Cash equivalents – highly liquid investments with short periods to maturity readily convertible to cash on hand at investor’s option – borrowings integral to the cash management function of the entity and not subject to a term facility Cash flows to be divided into: – operating activities – investing activities – financing activities (Continues)

19-39 Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a New Zealand Financial Accounting 3e by Grant Samkin Slides prepared by Grant Samkin and Annika Schneider Summary (cont.) Direct method to be applied: Relevant cash inflows are reported in gross terms rather than being netted off against each other NZ IAS 7 requires a number of notes to be provided, including: Reconciliation of cash balance per cash-flow statement with related balance sheet items A reconciliation of cash flows from operating activities with profit or loss as reported in income statement Material financing and investing transactions and events that do not result in cash flows Calculation of cash flows can be applied using either: equation approach; or t-account approach