Cash Flow Statement: Calculating Cash from Operations (Direct & Indirect Methods), Lecture notes of Accounting

Download Cash Flow Statement: Calculating Cash from Operations (Direct & Indirect Methods) and more Lecture notes Accounting in PDF only on Docsity!

CASH FLOW STATEMENT

 DR.NARESH KUMAR

 HOD COMMERCE

CASH FLOW STATEMENT

As per para 5 of Accounting Standard – 3 (Revised), cash flows are inflows and outflows of cash and cash equivalents.

 Though cash flow statement, an attempt is being made to

focus on cash and cash equivalents.

 Inflows (sources) may be due to issue of share capital, sale

of fixed assets, sale of investments, etc.

 Outflow (usage) may be due to purchase of fixed assets,

redemption of preference shares or debentures, etc.

 Difference between Inflows and outflows of cash and cash

equivalents is termed as net increase or decrease in cash and cash equivalents as the case may be.

PREPAARATION OF CASH FLOW STATEMENT

According to Accounting Standard – 3 (Revised), following four steps are required:

I. Calculation of Cash Flows from Operating

Activities.

II. Calculation of Cash Flows from Investing

Activities.

III.Calculation of Cash Flows from Financing

Activities.

IV.Calculation of net increase/decrease in cash and

cash equivalents.

I. Calculation of Cash Flow from Operating Activites Cash flows from operating activities can be computed with the help of Income Statement of the current year, comparative Balance Sheets and the relevant additional information. As per AS – 3 (Revised), the following types activities can be regarded as cash flow from operating activities:  Cash received from the sale of goods or rendering some services;  Cash received from royalties, fees, commission and other revenue;  Cash paid to suppliers for goods or services;  Cash paid to employees or behalf of employees;  Cash received or paid to insurance companies for premiums claims, annuities or other policy benefits;  Cash paid as income tax or refund of income tax unless, they can be specifically identified with financing or investing activities; and  Cash received or paid for future contracts, forward contracts, option contracts and swap contracts, when these are held for dealing or trading purpose.

Step (i) Calculation Cash Receipts from Sales N N Cash Sales xxx xxx Credit Sales xxx xxx Add: Opening Debtors and B/R xxx xxx Less: Closing Debtors and B/R xxx xxx Total Cash realized from sales xxx xxx Step (ii) Calculation of Cash Paid to Suppliers Cost of goods sold xxx xxx Add: Closing Stock xxx xxx Less: Opening Stock xxx xxx Total Purchases xxx xxx Add: Opening Creditors & B/P xxx xxx Less: Closing Creditors & B/P xxx xxx Cash paid to Suppliers xxx xxx

Step (iii) Calculation of Cash paid for any Expenses N N Expenses xxx xxx Add: O/S Expenses in the beginning xxx xxx Less: O/S Expenses at the end xxx xxx Cash paid for Expenses xxx xxx Problem: From the following information available from the books of X ltd. Compute cash from operating activities. Income Statement For the year ending 31st^ March, 2012 Sales N 18, Less: Cost of goods sold N 12, Gross margin N 5, Less: S & D Expenses N 2, Salaries N 1, Depreciation of Plant N 500 N 3, Net margin N 2,

Solution: Calculation of Cash Flow from Operating Activities (Direct Method) N Cash Receipts from Customers 18, Less: Cash paid to suppliers and Employees 15, Net Cash from Operating Activities 2, Working Notes: a) Cash receipts from Customers: Sales during the year 18, Add: Opening Debtors 1, Opening B/R 2,000 3, 21, Less: Closing Debtors 1, Closing B/R 1,500 3, Cash receipt from customers 18,

b) Cash paid to Suppliers and Employees

• Cost of goods sold 12,
• Operating Expenses (S & D + Salary) 3, - 15,
• Add: Opening Creditors 1, - Opening B/P - O/S Salary 1, - Closing Stock 800 3, - 18,
• Less: Closing Creditors 1, - Closing B/P - Salary at the end - Opening Stock 1,000 3,
  • Cash paid to Suppliers & employees 15,

Cash Flows from Operating Activities (Indirect Method) PARTICULARS (^) AMOUNT N

Net Profit before interest, tax and extraordinary items xxx

Adjustment for:

Depreciation xxx

Loss on sale of fixed assets xxx

Provision for contingencies xxx

Provision for retirement benefits xxx

Profit on sale of investment/fixed assets (xxx)

Interest received (xxx)

Operating profit before working capital changes xxx

Add: Decrease in current assets xxx

Add: Increase in current liabilities xxx

Less: Increase in current assets Less: Decrease in current liabilities

(xxx) (xxx)

Cash generated from operations xxx

Tax paid (xxx)

Cash flows before extraordinary items xxx

± Extra ordinary items xxx

NET CASH FROM OPERATING ACTIVITIES xxx

b) Amortization of Intangible assets, viz., Goodwill, Trade Marks, Patents, etc.:

 This amortization of intangible assets reduces the net profit but do not affect the cash flow in any way. So to calculate cash flows from operating activities, the value of amortization of assets should be added back to net profit.

c) Fictitious Assets written off, e.g., preliminary expenses:

 These also have nothing to do with the cash flows but reduce the net profit. So these expenses should be added back for the computation of cash flow from operating activities.

d) Profit or loss on sale of fixed assets:

 Profit or loss on sale of fixed assets should be added back or deducted respectively, to the net profit figure, so that cash flow from operating activities can be computed.

In case, a fixed assets is sold during the year following treatment should be accounted for:

(i) Calculate the depreciation charged on the assets during the year by preparing “Accumulated Depreciation Account” to be added to the net income for the year before adjustment.

(ii) Calculate amount of profit or loss on the sale of the part of that fixed assets which shall either of subtracted or add respectively to the net income for the year before adjustment.

(iii) Amount of cash received on sale of asset must be added under the head “Cash Flow from Investing Activities”

(iv) Amount of cash paid (if any) on purchase of fixed assets must be subtracted from investing activities.

TREATMENT OF SOME SPECIAL ITEMS

1. Treatment of Interest:

(a)If it is financial enterprise: Cash flows from

interest paid and interest received should be

treated as Cash Flows from Operating Activities.

(b)If it is other than financial enterprise: Cash

flows from interest paid should be treated as

Cash Flows from Financing Activities while

interest received should be treated as Cash Flows

from Investing Activities.

NOTE: Interest on calls-in-arrears is a cash flow

from financing activities.

2. Treatment of Dividend:

(i) If it is a financial enterprise: Cash flows from

dividend received should be treated as cash flows

from Operating Activities, while cash flows from

dividend paid should be treated as cash flows

from Financing Activities.

(ii)If it is other than financial enterprise: Cash

flows from dividend received should be treated

as cash flows from Investing Activities, while

cash flows from dividend paid should be treated

as cash flows from Financing Activities.

NOTE: Dividend paid should always be treated

in Cash Flows from Financing Activities.