Apr

26

FRS 102: The cash flow statement

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accountancyThis is the fourth in a series of articles that considers the accounting and disclosure requirements contained in FRS 102 The Financial Reporting Standard applicable in the United Kingdom and Republic of Ireland and which becomes mandatory for companies within its scope for accounting periods commencing on or after 1 January 2015 with the objective of assisting practitioners understand the requirements of the new UK GAAP.

Previous articles have examined the differences between UK GAAP in its current form and FRS 102 requirements.  This article examines the statement of cash flows as dealt with in Section 7 to FRS 102 and hereonin is referred to in its UK terminology as the ‘cash flow statement’.

Classifications of cash flows

Current FRS 1 Cash Flow Statements requires reporting entities that are preparing a cash flow statement to prepare the statement under several cash flow classifications as follows:

  • Operating activities
  • Dividends from joint ventures and associates
  • Returns on investments and servicing of finance
  • Taxation
  • Capital expenditure and financial investments
  • Acquisitions and disposals
  • Equity dividends paid
  • Management of liquid resources
  • Financing

Section 7 to FRS 102 requires the cash flow statement to be prepared using only three cash flow classifications:

  • Operating activities
  • Investing activities
  • Financing activities

Operating activities are the day-to-day revenue-producing activities that are not investing or financing activities.  This category is essentially a ‘default’ category which encompasses all cash flows that do not fall within investing or financing classifications.  Section 7.4 to FRS 102 gives various examples of cash flows arising from operating activities as follows:

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

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

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

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

(e)   Cash payments or refunds of income tax, unless they can be specifically identified with financing and investing activities;

(f)     Cash receipts and payments from investments, loans and other contracts held for dealing or trading purposes, which are similar to inventory acquired specifically for resale; and

(g)    Cash advances and loans made to other parties by financial institutions.

A notable difference here is in relation to corporation tax.  Corporation tax paid during a year would be included in the taxation line under FRS 1.  However, under Section 7, it is included within operating activities provided that corporation tax is not attributable to any investing or financing activities.

Investing activities are those activities which involve the acquisition and disposal of long-term assets – for example monies used for the purchase of fixed assets and cash receipts from the disposal of such assets.  In addition to cash payments to acquire, and cash receipts in respect of the disposal, of fixed assets, paragraph 7.5 to FRS 102 gives further examples of activities that would typically fall under investing activities:

  • Cash payments to acquire equity or debt instruments of other entities and interests in joint ventures (other than payments for those instruments classified as cash equivalents or held for dealing or trading);
  • Cash receipts from sales of equity or debt instruments of other entities and interests in joint ventures (other than receipts for those instruments classified as cash equivalents or held for dealing or trading);
  • Cash advances and loans made to other parties (except those made by financial institutions);
  • Cash receipts from the repayment of advances and loans made to other parties;
  • Cash payments for futures contracts, forward contracts, option contracts and swap contracts, except when the contracts are held for dealing or trading, or the payments are classified as financing activities; and
  • Cash receipts from futures contracts, forward contracts, option contracts and swap contracts, except when the contracts are held for dealing or trading, or the receipts are classified as financing activities.

Financing activities are those activities that change the equity and borrowing composition of the company.  This can include the cash proceeds received by the company for issuing additional shares or the proceeds received from the raising of a loan.  In addition to funds received for issuing shares and raising loans, paragraph 7.6 to FRS 102 includes examples of cash flows that would appear under financing activities as follows:

  • Cash payments to owners to acquire or redeem the entity’s shares;
  • Cash proceeds from issuing debentures, 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 equivalents

Consider the following example:

Company A Limited has an accounting year-end of 31 December 2015 and is reporting under FRS 102.  The company has a bank overdraft that it has used at the end of the accounting period due to a large customer requiring additional extensions of credit.  At the year-end the overdraft amounted to £120,000 net of outstanding cheques and lodgements.  The directors consider that this overdraft forms an integral part of Company A’s cash management. The agreed overdraft facility is £200,000 and this facility has just been renewed by the company’s bankers who are satisfied with the performance of the company over the accounting period. The terms of the overdraft are that it is repayable on demand and will be reviewed on 2 January 2016.  The finance director has included the bank overdraft within financing activities as he considers the overdraft to be similar to the entity’s existing borrowings.The term ‘cash equivalents’ is mentioned a number of times in Section 7 and is defined in paragraph 7.2 as follows:‘Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and that are 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. Bank overdrafts are normally considered financing activities similar to borrowings.  However, if they are repayable on demand and form an integral part of an entity’s cash management, bank overdrafts are a component of cash and cash equivalents.’Because Company A’s overdraft is repayable on demand and is considered to form an integral part of the company’s cash management, it should be treated as a component of cash and cash equivalents.

 

Presentation of cash and cash equivalents

Ordinarily the amount of cash and cash equivalents presented at the end of the cash flow statement will be in agreement to the amount of cash and cash equivalents reported in the company’s balance sheet at the end of the financial period.  Therefore, if this is the case, then reporting entities will not be required to present a reconciliation of amounts reported in the cash flow statement to the equivalent items that are reported in the company’s balance sheet under paragraph 7.20.

Illustration of the cash flow statement under Section 7

An illustration of how the cash flow statement could look under FRS 102 using the indirect method is shown below:

Note

2015

2014

£,000

£,000

Operating activities
Profit before tax

X

X

Adjustments

1

X

X(

Net changes in working capital

2

X

X

Income tax paid

(X)

(X)

Cash flow from operating activities

X

X

 

 

 

Investing activities

 

 

Purchase of fixed assets

(X)

(X)

Proceeds from disposal of fixed asset

X

X

Acquisition of subsidiary (net of cash)

(X)

(X)

Interest received

X

X

Cash flow from investing activities

(X)

(X)

 

 

 

Financing activities

 

 

Proceeds from issue of share capital

X

X

New loan raised

X

X

Capital repayments

(X)

(X)

Interest paid

(X)

(X)

Dividends paid

(X)

(X)

Cash flow from financing activities

(X)

(X)

 

 

 

Net change in cash and cash equivalents

X

X

Cash and cash equivalents at start of year

X

X

Cash and cash equivalents at the end of the year

3*

X

X

 

* A note reconciling the cash and cash equivalents reported in the cash flow statement to the cash and cash equivalents reported in the balance sheet will not be required if these amounts are identical to the amount similarly described in the balance sheet.

Dividends and interest

Under FRS 1, dividends paid are disclosed in the cash flow statement under ‘Equity dividends paid’.  However, Section 7 to FRS 102 considers both dividends and interest as either operating or financing cash flows.  In general, paragraph 7.14 requires a company to present cash flows from interest and dividends both paid and received separately and consistently from one period to the next as either operating, investing or financing cash flows.

Interest paid and interest and dividends received could be classified by a client as operating cash flows because they are included in profit or loss.  Alternatively, they may be classified as financing cash flows if they are costs of obtaining financial resources or are returns on investments.

Dividends paid to shareholders may be classed as financing activities (as shown in the illustrative cash flow statement above) because they are a cost of obtaining financial resources.  However, FRS 102 does permit an entity to classify dividends paid as a component of cash flows from operating activities on the grounds that they are paid out of operating cash flows.

Conclusion

The cash flow statement is one of the primary financial statements under FRS 102 that is going to need a lot of thought devoted to it in terms of classifications as cash flows as there are significantly less cash flow classifications under Section 7 than there are under current FRS 1.  Whilst many software programmes will be able to handle the change relatively easily, practitioners will need to ensure the cash flow classifications for various transactions are correct – particularly in the year of conversion.

Category: Accounting and standards

About the Author ()

Steve Collings is the audit and technical director at Leavitt Walmsley Associates Ltd and the author of 'Interpretation and Application of International Standards on Auditing'. He is also the author of 'IFRS For Dummies' and 'The AccountingWEB Guide to IFRS'. More about Steve's publications can be found by clicking on the 'Published Work' tab on the homepage. Steve is also a regular contributor of articles to www.accountingweb.co.uk, the UK's largest resource for professional accountants on a free subscription basis and is a member of the Society of Authors. Steve is an Editorial Board member for Wiley Insight IFRS and sits on the AAT's Financial Reporting Technical Panel. In 2011 Steve was named 'Accounting Technician of the Year' at the British Accountancy Awards and won 'Outstanding Contribution to the Accountancy Profession' by the Association of International Accountants in 2013. Follow Steve on Twitter - @stecollings

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