PAS 7

STATEMENT OF
CASH FLOWS
Introduction

PAS 7 prescribes the requirements in the

presentation of statement of cash flows.

The statement of cash flows provides

information about the sources and utilization
(i.e., historical changes) of cash and cash
equivalents during the period.
Definition of terms

• Cash comprises cash on hand and cash in bank.

• Cash equivalents are “short-term, highly liquid investments that

are readily convertible to known amounts of cash and which are
subject to an insignificant risk of changes in value”.(PAS 7.6)

Only debt instruments acquired within 3 months or less before

maturity date can qualify as cash equivalents:
a. 1-year treasury bill acquired 3 months before maturity date
b. 90-day money market instrument or commercial paper
c. 3-month time deposit

• Cash flows include inflows (sources) and outflows (uses) of cash

and cash equivalents.
When used in conjunction with the rest of the financial statements, the
statement of cash flows helps users assess:
a. The ability of the entity to generate cash and cash equivalents;
b. The timing and certainty of the generation of cash flows; and
c. The needs of the entity to utilize those cash flows.

The statement of cash flows may also provide information on the

quality of earnings of an entity. An entity may report profit under the
accrual basis but suffers negative cash flows from its operating
activities. This may provide indicators of, among other things,
difficulty in collecting accounts receivable.

As the statement of cash flows can only be prepared on a cash basis, it

enhances inter-comparability among different entities because it
eliminates the effects of using different accounting treatments for the
same transactions and events.
Classification of cash flows

The statement of cash flows presents cash

flows according to the following
classifications:

1. Operating activities
2. Investing activities
3. Financing activities
Operating activities

“Cash flows from operating activities are primarily derived from the principal
revenue-producing activities of the entity.” (PAS 7.14)

Operating activities usually include cash inflows and outflows on items of

income and expenses, or those that enter into the determination of profit or
loss (i.e., included in the income statement).

Examples of cash flows from operating activities:

a. Cash receipts from the sale of goods, rendering of services, or other
forms of income
b. Cash payments for purchases of goods and services
c. Cash payments for operating expenses, such as employee benefits,
insurance, and the like, and payments or refunds of income taxes
d. Cash receipts and payments from contracts held for dealing or trading
purposes
Special items included in operating activities

⮚ Cash flows from buying and selling held for trading securities (whether
financial assets or financial liabilities) are classified as operating
activities. Held for trading securities are similar to inventories in the sense
that they are acquired specifically for resale.

⮚ Some entities, in the ordinary course of their activities, routinely

manufacture or acquire items of property, plant and equipment to be held
for rental to others and subsequently transfer these assets to inventories
when they cease to be rented and become held for sale. For these entities,
cash flows from the acquisition, rentals and subsequent sale of such assets
are considered operating activities. The proceed from the sale of such
assets are recognized as revenue.

⮚ Loan transactions of financial institutions (e.g., banks) are operating

activities because they relate to the main revenue producing activity of a
financial institution.
Investing activities

Investing activities involve the acquisition and disposal of

noncurrent assets and other investments. Examples include:

a. Cash receipts and cash payments in the acquisition and disposal

of property, plant and equipment, investment property,
intangible assets and other noncurrent assets
b. Cash receipts and cash payments in the acquisition and sale of
equity or debt instruments of other entities (other than those that
are classified as cash equivalents or held for trading)
c. Cash receipts and cash payments on derivative assets and
liabilities (other than those that are held for trading or classified
as financing activities)
d. Loans to other parties and collections thereof (other than loans
made by a financial institution)
Financing activities

Financing activities are those that affect the entity’s equity capital and
borrowing structure. Examples include:

a. Cash receipts from issuing shares or other equity instruments and

cash payments to redeem them
b. Cash receipts from issuing notes, loans, bonds and mortgage payable
and other short-term or long-term borrowings, and their repayments
c. Cash payments by a lessee for the reduction of the outstanding
liability relating to a lease. (PAS 7.17)

Cash flows on trade payables, accrued expenses and other operating

liabilities are classified as operating activities and not financing activities.
Only cash flows on non-operating or non-trade liabilities are included as
financing activities.
Remember the following:

1. Operating activities affect profit or loss

2. Investing activities affect non-current assets other investments

3. Financing activities affect borrowings and equity

Cash flows excluded from the activities sections

⮚ Cash flows on movements between “cash” and “cash equivalents” are not
presented separately because these are part of the entity’s cash
management rather than its operating, investing and financing activities.
⮚ Bank overdrafts that cannot be offset to cash are presented as financing
activities. Those that can be offset to cash (or are part of the entity’s cash
management) forms part of the balance of cash and cash equivalents and
therefore not presented separately in the activities sections.
⮚ Cash flows denominated in a foreign currency are translated using the spot
exchange rate at the date of the cash flow. Exchange differences are not
cash flows. “However, the effect of exchange rate changes on cash and
cash equivalents held or due in a foreign currency is reported in the
statement of cash flows in order to reconcile cash and cash equivalents at
the beginning and the end of the period.” (PAS 7.28) The amount of
reconciliation is reported separately from the operating, investing and
financing activities.
General concept in the preparation of statement of
cash flows

The statement of cash flows is prepared using cash basis.

Under the cash basis of accounting, income is
recognized only when collected and expenses are
recognized only when paid, rather than when these items
are earned or incurred.

Accordingly, only transactions that affected cash and

cash equivalents are reported in the statement of cash
flows. Non-cash transactions are excluded and disclosed
only.
Interests and Dividends

Entities (except financial institutions) may classify cash

flows on interests and dividends as follows:

Cash flows Option 1 Option 2

1. Interest income received Operating activity Investing activity

2. Interest expense paid Operating activity Financing activity

3. Dividend income received Operating activity Investing activity

4. Dividend paid to owners Financing activity Operating activity

 Option 1 Option 2
⮚ Interest income, interest expense ⮚ Interest income and dividend
and dividend income are classified income are classified as investing
as operating activities because activities because they result from
they enter into the determination investments.
of profit or loss (i.e., income and ⮚ Interest expense is classified as
expenses). financing activity because it
⮚ Dividend paid is classified as results from borrowing.
financing activity because it is a ⮚ Dividend paid is classified as
transaction with the owners and operating activity in order to assist
alters the equity structure users in assessing the entity’s
ability to pay dividends out of
operating cash flows.
⮚ Only interests and dividends received or paid in cash
are included in the statement of cash flows. For
example, dividends declared in Year 1 but paid in Year
2 are excluded from the statement of cash flows in
Year 1 and reported only in Year 2.

⮚ Only option 1 is available to financial institutions.

⮚ When answering CPA board questions wherein the

problem is silent, it is presumed that the entity uses
option 1.
Presentation

Cash flows from operating activities may be presented

using either:

a. Direct method – shows each major class of gross

cash receipts and gross cash payments; or
b. Indirect method – profit or loss is adjusted for the
effects of non-cash items and changes in operating
assets and liabilities.
Direct Method

Cash flows from operating activities:

Cash receipts from customers 500

Cash paid to suppliers (200)
Cash paid to employees (100)
Cash paid for operating expenses (120)
Cash generated from operations 80
Interest paid (10)
Income tax paid (20)
Net cash from operating activities 50
Indirect method

Cash flows from operating activities:

Profit before tax 250

Adjustments for:
Depreciation 30
Gain on sale of equipment (10)
Impairment loss 5
Interest expense 12
287
Increase in trade & other receivables (150)
Decrease in inventories 3
Decrease in trade payables (60)
Cash generated from operations 80
Interest paid (10)
Income taxes paid (20)
Net cash from operating activities 50
PAS 7 does not require any particular method; both
methods are acceptable. However, PAS 7 encourages the
direct method because it provides information that may
be useful in estimating future cash flows which is not
available under the indirect method. In practice, however,
the indirect method is more commonly used because it is
easier to apply.

Moreover, the choice between direct and indirect method

of presentation is applicable only for operating activities.
For investing and financing activities, gross cash receipts
and gross cash payments for the related transactions are
presented separately, unless they qualify for net
presentation.
Illustration 1: Statement of cash flows (Direct Method)

Entity A
Statement of cash flows
For the year ended December 31, 20x2
Cash flows from operating activities
Cash receipts from customers 4,915,000
Cash receipts for rent income 425,000
Cash receipts for interest income 15,000
Cash paid to suppliers (2,560,000)
Cash paid to insurance (95,000)
Cash paid for other expenses (690,000)
Cash generated from operations 2,010,000
Interest paid (95,000)
Income taxes paid (315,000)
Cash paid for the acquisition of held for trading securities (100,000)
Net cash from operating activities 1,500,000

Cash flows from investing activities

Cash receipt from sale of old building 260,000
Cash payment for acquisition of building (2,300,000)
Net cash used in investing activities (2,040,000)

Cash flows from financing activities

Cash proceeds from issuance of share capital 1,000,000
Cash payment for short-term loan (50,000)
Cash payment for dividends (310,000)
Net cash from financing activities 640,000

Net increase in cash and cash equivalents 100,000

Cash and cash equivalents, beginning 150,000
Cash and cash equivalents, end 250,000
 Entity A
Statement of cash flows
For the year ended December 31, 20x2
Cash flow from operating activities
Profit before tax 1,035,000
Adjustment for:
Depreciation expense 500,000
Illustration 2: Statement of cash flows (Indirect Method)

Impairment loss on goodwill 10,000

Loss on sale of building 40,000
Unrealized gain on held for trading securities (20,000)
Interest income (20,000)
Interest expense 100,000
1,645,000
Increase in accounts receivable, net (70,000)
Increase in rent receivable (15,000)
Decrease in inventory 400,000
Increase in prepaid insurance (10,000)
Increase in accounts payable 40,000
Decrease in unearned rent (10,000)
Increase in insurance payable 15,000
Interest received 15,000
Cash generated from operations 2,010,000
Interest paid (95,000)
Income taxes paid (315,000)
Cash paid for the acquisition of held for trading securities (100,000)

Net cash from operating activities 1,500,000

Cash flows from investing activities
Cash receipt from sale of old building 260,000
Cash payment for acquisition of building (2,300,000)
Net cash used in investing activities (2,040,000)
Cash flows from financing activities
Cash proceeds from issuance of share capital 1,000,000
Cash payment for short-term loan (50,000)
Cash payment for dividends (310,000)

Net cash flows from financing activities 640,000

Net increase in cash and cash equivalents 100,000
Cash and cash equivalents, beginning 150,000
Cash and cash equivalents, end 250,000
Changes in ownership interests in subsidiaries

Cash flows arising from acquisitions and disposals of

subsidiaries or other business units resulting to loss or
obtaining of control are classified as investing activities.
Those that do not result to loss or obtaining control are
classified as financing activities.
Disclosure

PAS 7 requires the following disclosures:

a. Components of cash and cash equivalents and a

reconciliation of amounts in the statement of cash
flows with the equivalent items in the statement of
financial position.
b. Significant cash and cash equivalents held by the
entity that are not available for use by the group,
together with a management commentary.