OBJECTIVES

• Information about the cash flows of an enterprise is useful in providing users of financial statements with a basis to assess the ability of the enterprise to generate cash and cash equivalents and the needs of the enterprise to utilise those cash flows.
• The economies decisions that are taken by users require an evaluation of the ability of an enterprise to
• generate cash and cash équivalents and the timing and certainty of their generation.
• The Statement deals with the provision of information about the historical changes in cash and cash equivalents of an enterprise by means of a cash f low statement which classifies cash flows during the period from operating, investing and financing activities.

SCOPE OF AS - 3:

1. Enterprises whose equity or debt securities are listed on a recognized stock exchange.
2. Enterprises in the process of issuing equity or debt securities that will be listed as evidenced by the board of directors resolutions.
3. All other commercial industrial and business reporting enterprises, whose turnover for the accounting period exceeds Rs.50 crores.

Cash Flow Statement

CASH AND CASH EQUIVALENTS:

Cash comprises cash on hand and demand deposits with banks.

Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value. 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 short maturity of, say, three months or less from the date of acquisition. Investments in shares are excluded from cash equivalents unless they are, in substance, cash equivalents; for example, preference shares of a company acquired shortly before their specified redemption date (provided there is only an insignificant risk of failure of the company to repay the amount at maturity).

CASH FLOWS:

Cash flows are inflows and outflows of cash and cash equivalents. Cash flows exclude movements between items — constitute cash or cash equivalents because these components are part of the cash management of an enterprise rather than part of its operating, investing and financing activities. Cash management includes the investment of excess cash in cash equivalents.

PRESENTATION OF A CASH FLOW STATEMENT:

The cash flow statement should report cash flows during the period classified by-.

Operating Activities: are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities.

Investing Activities: are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.

Financing Activities: are activities that result in changes in the size and composition of the owners capital (including preference share capital in the case of a company and borrowings of the enterprise.

An enterprise presents its cash flows from operating, investing and financing activities in a manner which is most appropriate to its business. Classification by activity provides information that allows users to assess the impact of  those activities on the financial position of the enterprise and the amount of its cash and cash equivalents. This information may also be used to evaluate the relationships among those activities.

OPERATING ACTIVITIES:

The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations of the enterprise have generated sufficient cash flows to maintain the operating capability of the enterprise, pay dividends, repay loans, and make new investments without recourse to external sources of financing. Information about the specific components of historical operating cash flows is useful, in conjunction with other information, in forecasting future operating cash flows.

Cash flows operating activities are primarily derived from the principal revenue- producing activities of the enterprise. Therefore, they generally result from the transactions and other events that enter into the determination of net profit or loss. Examples of cash flows from operating activities are:

(a)        Cash receipts from the sale of goods and the rendering of services;

(b)        Cash receipts from royalties, fees, commissions, and other revenue;

(c)        Cash payments to suppliers for goods and services;

(d)        Cash payments to and on behalf of employees;

(e)        Cash receipts and cash payments of an Insurance enterprise for premiums and claims, annuities and other policy benefits;

(f)        Cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities.

• Some transactions, such as the sale of an item of plant, may give rise to a gain or loss which is included in the determination of net profit or loss. However, the cash flows relating to such transactions are cash flows from investing activities.
• An enterprise may hold securities and loans for dealing or trading purposes, in which case they are similar to inventory acquired specifically for resale. Therefore, cash flows arising from the purchase and sale of dealing or trading securities are classified as operating activities.
• Similarly, cash advances and loans made by financial enterprises are usually classified as operating activities since they relate to the main revenue-producing activity of that enterprise.

INVESTING ACTIVITIES:

The separate disclosure of cash flows arising from investing activities is important because the cash flows represent the extent to which expenditures have been made for resources intended to generate future income and cash flows. Examples of cash flows arising from investing activities are:

(a)        Cash payments to acquire fixed assets (including intangibles). These payments include those relating to capitalized research and development costs and self-constructed fixed assets;

(b)        Cash receipts from disposal of fixed assets (including intangibles);

(c)        Cash payments to acquire shares, warrants, or debt instruments of other enterprises and interests in joint ventures (other than payments for those instruments considered to be cash equivalents and those held for dealing or trading purposes);

(d)        Cash receipts from disposal of shares, warrants, or debt instruments of other enterprises and interests in joint ventures (other than receipts from those instruments considered to be cash equivalents and those held for dealing or trading purposes);

(e)        Cash advances and loans made to third parties (other than advances and loans made by a financial enterprise);

(f)        Cash receipts from the repayment of advances and loans made to third parties (other than advances and loans of a financial enterprise);

(g)        Cash payments for futures contracts, forward contracts, option contracts, and swap contracts except when the contracts are held for dealing or trading purposes, or the payments are classified as financing activities.

FINANCING ACTIVITIES:

The separate disclosure of cash flows arising from financing activities is important because it is useful in predicting claims on future cash flows by providers of funds (both capital and borrowings) to the enterprise. Examples of cash flows arising from financing activities are:

(a)        Cash proceeds from issuing shares or other similar instruments;

(b)        Cash proceeds from issuing debentures, loans, notes, bonds, and other short or long-term borrowings; and

(c)        Cash repayments of amounts borrowed.

REPORTING CASH FLOWS FROM OPERATING ACTIVITIES:

An enterprise should report Cash flows from operating activities using either:

(a)        The Direct Method, whereby major classes of gross cash receipts and gross cash payments are disclosed;

(b)        The Indirect Method, whereby net profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows.

The Direct Method provides information which may be useful in estimating future cash flows and which is not available under the indirect method and is, therefore, considered more appropriate than the indirect method. Under the direct method, information about major classes of gross cash receipts and gross cash payments may be obtained either:

(a)        From the accounting records of the enterprise; or

(b)        By adjusting sales, cost of sales (interest and similar income and interest expense and similar charges for a financial enterprise) and other items in the statement of profit and loss for:

(i)         Changes during the period in inventories and operating receivables and payables;

(ii)        Other non-cash items; and

(iii)       Other items for which the cash effects are investing or financing cash flows.

Under the Indirect Method, the net cash flow from operating activities is determined by adjusting net profit or loss for the effects of:

(a)        Changes during the period in inventories and operating receivables and payables;

(b)        Non-cash items such as depreciation, provisions, deferred taxes, and unrealised foreign exchange       gains and losses; and

(c)        Ail other items for which the cash effects are investing or financing cash flows.

Alternatively, the net cash flow from operating activities may be presented under the indirect method by showing the operating revenues and expenses, excluding non-cash items disclosed in the statement of profit and loss and the changes during the period in inventories and operating receivables and payables.

REPORTENT CASH FLOWS FROM A SINGLE TRANSACTION DIFFERENTLY:

A single transaction may include cash flows that arc classified differently. For example, when the installment paid in respect of a fixed asset acquired on deferred payment basis includes both interest and loan, the interest element s classified under financing activities and the loan element is classified under investing activities.

FOREIGN CURRENCY CASH FLOWS:

Cash flows arising from transactions in a foreign currency should be recorded in an enterprise's reporting currency by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the cash flow. A rate that approximates the actual rate may be used if the result is substantially the same as would arise if the rates at the dates of the cash flows were used. The effect of changes in exchange rates on cash and cash equivalents held in a foreign currency should be reported as a separate part of the reconciliation of the changes in cash and cash equivalents during the period.

Cash flows denominated in foreign currency are reported in a manner consistent with AS 11, Accounting for the Effects of Changes in Foreign Exchange Rates. This permits the use of an exchange rate that approximates the actual rate. For example, a weighted average exchange rate for a period may be used for recording foreign currency transactions. Unrealised gains and losses arising from changes in foreign exchange rates are not cash flows. However, the effect of exchange rate changes on cash and cash equivalents held or due in foreign currency is reported in the cash flow statement in order to reconcile cash and cash equivalents at the beginning and the end of the period. This amount is presented separately from cash flows from operating, investing and financing activities and includes the differences, if any, had those cash flows been reported at the end-of- period exchange rates.

EXTRAORDINARY ITEMS:

The cash flows associated with extraordinary items should be classified as arising from operating, investing or financing activities as appropriate and separately disclosed.

The cash flows associated with extraordinary items are disclosed separately as arising from operating, investing or financing activities in the cash flow statement, to enable users to understand their nature and effect on the present and future cash flows of the enterprise. These disclosures are in addition to the separate disclosures of the nature and amount of extraordinary items required by Accounting Standard (AS) 5, Net Profit or loss for the Period, Prior Period Items, and Changes in Accounting Policies.

INTEREST AND DIVIDENDS:

Cash flows from interest and dividends received and paid should each be disclosed separately. Cash flows arising from interest paid and interest and dividends received in the case of a financial enterprise should be classified as cash flows arising from operating activities. In the case of other enterprises, cash flows arising from interest paid should be classified as cash flows from financing activities while interest and dividends received should be classified as cash flows from investing activities. Dividends paid should be classified as cash flows from financing activities.

The total amount of interest paid during the period is disclosed in the cash flow statement whether it has been recognised as an expense in the statement of profit and loss or capitalised66 in accordance with AS 10, Accounting for Fixed Assets.

Interest paid and interest and dividends received are usually classified as operating cash flows for a financial enterprise. However, there is no consensus on the classification of these cash flows for other enterprises. Some argue that interest paid and interest and dividends received may be classified as operating cash flows because they enter into the determination of net profit or loss. However, it is more appropriate that interest paid and interest and dividends received are classified as financing cash flows and investing cash flows respectively, because they are cost of obtaining financial resources or returns on investments.

Some argue that dividends paid may be classified as a component of cash flows from operating activities in order to assist users to determine the ability of an enterprise to pay dividends out of operating cash flows. However, it is considered more appropriate that dividends paid should be classified as cash flows from financing activities because they are cost of obtaining financial resources.

TAXES ON INCOME:

Cash flows arising from taxes on income should be separately disclosed and should be classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities. Taxes on income arise on transactions that give rise to cash flows that are classified as operating, investing or financing activities in a cash flow statement. While tax expense may be readily identifiable with investing or financing activities, the related tax cash flows are often impracticable to identify and may arise in a different period from the cash flows of the underlying transactions. Therefore, taxes paid are usually classified as cash flows from operating activities. However, when it is practicable to identify the tax cash flow with an individual transaction that gives rise to cash flows that are classified as investing or financing activities, the tax cash flow is classified as an investing or financing activity as appropriate. When tax cash flows are allocated over more than one class of activity, the total amount of taxes paid is disclosed.

INVESTMENTS IN SUBSIDIARIES, ASSOCIATES, AND JOINT VENTURES:

When accounting for an investment in an associate or a subsidiary or a joint venture, an investor restricts its reporting in the cash flow statement to the cash flows between itself and the investee/joint venture, for example, cash flows relating to dividends and advances.

ACQUISITIONS AND DISPOSALS OF SUBSIDIARIES AND OTHER BUSINESS UNITS:

The aggregate cash flows arising from acquisitions and from disposals of subsidiaries or other business units should be presented separately and classified as investing activities.

An enterprise should disclose, in aggregate, in respect of both acquisition and disposal of subsidiaries or other business units during the period each of the following:

• the total purchase or disposal consideration; and
• the portion of the purchase or disposal consideration discharged by means of cash and cash equivalents.

The separate presentation of the cash flow effects of acquisitions and disposals of subsidiaries and other business units as single line items helps to distinguish those cash flows from other cash flows. The cash flow effects of disposals are not deducted from those of acquisitions.

NON-CASH TRANSACTIONS:

Investing and f financing transactions that do not require the use of cash or cash equivalents should be excluded from a cash flow statement. Such transactions should be disclosed elsewhere in the financial statements in a way that provides ail the relevant information about these investing and f financing activities.

Many investing and financing activities do not have a direct impact on current cash flows although they do affect the capital and asset structure of an enterprise. The exclusion of non-cash transactions from the cash flow statement is consistent with the objective of a cash flow statement as these items do not involve cash flows in the current period. Examples of non-cash transactions are:

(a)        The acquisition of assets by assuming directly related liabilities;

(b)        The acquisition of an enterprise by means of issue of shares; and

(c)        The conversion of debt to equity

DISTINCTION BETWEEN CASH FLOW STATEMENT AND FUND FLOW STATEMENT:

LIMITATION OF CASH FLOW STATEMENT:

(a)        Cash flow statement cannot be equated with income statement since it does not take into account non-cash items. It does not reflect the net income of business.

(b)        Liquidity position reflected by projected cash flow statement does not entitle for total reliance, because it is easily influenced by such decisions as rush purchases or postponing purchases, etc.

(c)        Cash statement cannot replace income statement since both the statements perform different functions. While income statement or P/L A/c concentrates on operational profit for the period, cash statement concentrates on factors changing the cash balances.