Preparing the group statement of cash flows for students
Students attempting financial reporting papers will need an awareness of the concept of the statement of cash flows. Under IFRS, IAS 7 Statement of Cash Flows deals with principles underlying the preparation of such a financial statement. It is worth mentioning at this point that the statement of cash flows forms part of the primary financial statements of a reporting entity, and therefore it is given equal prominence to that of the statement of profit or loss (income statement) and statement of financial position.
The logic behind the statement of cash flows is to enable the user of the financial statements to understand how a reporting entity has both generated cash in an accounting period and how the entity has spent that cash. The principles in IAS 7 require various cash flows to be classified according to activity and IAS 7 stipulates three types of activity: operating activities, investing activities and financing activities.
Operating activities are the day-to-day, revenue-producing activities of the business that are not investing or financing activities. It follows, therefore, that this activity is essentially a ‘default’ category encompassing all cash flows that do not fall within the classification of ‘investing’ or ‘financing’.
Investing activities are those activities which involve the acquisition and disposal of long-term assets, such as the acquisition and disposal of non-current assets and the acquisition and disposal of a subsidiary.
Financing activities are those activities which change the equity and borrowing composition of a company. For example, a reporting entity may issue additional shares during the accounting period and such cash flows arising from the share issue will be classified as a financing activity.
When students progress to more advance studies, they must understand the basic mechanisms of how the statement of cash flows is prepared. Once this knowledge is sewn up, students can then move on to the more complex statement of cash flows, which is the consolidated statement of cash flows.
Consolidated statement of cash flows
In addition to the individual financial statements that members of a group will prepare, the parent company will also prepare consolidated financial statements. Again, it is important to understand at the outset the principal objective of consolidated financial statements which is to show the results of the group in line with its economic substance – that of a single reporting entity.
The group statement of cash flows is prepared from the consolidated financial statements and as such reflects the cash flows of the group. Students often have concerns when it comes to preparing the consolidated statement of cash flows; however, the principles underpinning the group statement of cash flows is essentially the same as preparing a statement of cash flows at individual company level. The issue students need to appreciate is that when a group statement of cash flows is being prepared, there are additional cash flows to consider, such as:
- Dividends paid out to non-controlling interests
- Dividends received from equity accounted investees, such as associates
- Cash flows arising from the acquisition or disposal of subsidiary companies
I will consider each of the above three additional cash flows as follows.
Dividends paid to non-controlling interests
There are various transactions that affect non-controlling interests (NCIs) (remember non-controlling interests are the additional investors who hold the remainder of the shares in the subsidiary company), such as:
- Proposed dividends to NCIs
- NCIs share of foreign exchange losses
- NCIs share of after-tax profit
- NCIs share of any revaluation gains/losses
The dividend paid to NCIs can be calculated as a balancing figure by way of a control account (or a ‘T’ account if you prefer) as follows:
|
Debit |
Credit |
|
|
Opening NCI balance b/f |
X |
|
|
Dividend proposed |
X |
|
|
Share of profit after tax |
X |
|
|
Share of revaluation gain |
X |
|
| Share of foreign exchange loss |
X |
|
|
Dividends paid |
X* |
|
|
Closing NCI balance c/f |
Y |
_ |
|
X |
X |
|
|
Closing balance c/f (proof): NCI |
X |
|
|
Proposed dividend to NCIs |
X |
|
|
X |
||
|
* = balancing figure |
Dividends received from associates and joint ventures
Again, the calculation of dividends received from associates and joint ventures can be calculated using a control account (or ‘T’ account if you prefer):
|
Debit |
Credit |
|
|
Fixed asset investment b/f |
X |
|
|
New shares issued |
X |
|
|
Share of profit after tax |
X |
|
|
Dividends received from assoc. |
X* |
|
|
Closing balance c/f |
Y |
|
|
X |
X |
|
|
Closing balance c/f (proof): |
||
|
Fixed asset investment c/f |
X |
|
|
Dividend due from associate |
X |
|
|
X |
||
|
* = balancing figure |
Worked example
Extracts from the financial statements of Alicia Co for the year ended 31 December 2012 are as follows:
|
Statement of Financial Position |
2012 $,000 |
2011 $,000 |
|
Net assets in associate |
300 |
280 |
|
Proposed dividend to parent |
60 |
65 |
|
Proposed dividend to NCI |
4 |
8 |
|
Non-controlling interests |
54 |
34 |
|
Statement of profit or loss |
||
|
Income from associate |
24 |
|
|
Non-controlling interest |
(45) |
|
|
Statement of changes in equity |
||
|
Dividends on ordinary shares |
(95) |
You are required to show how the above items will be dealt with in the statement of cash flows of Alicia Co.
Solution
|
$,000 |
||
|
Dividend from associate (W1) |
4 |
|
|
Dividend paid to NCIs (W2) |
(29) |
|
|
Equity dividend paid (W3) |
(100) |
|
|
Workings: |
Debit |
Credit |
|
W1: |
||
|
Net assets in associate b/f |
280 |
|
|
Share of profit |
24 |
|
| Dividend received (bal figure) |
4 |
|
|
Balance c/f |
300 |
|
|
304 |
304 |
|
Acquisition and disposal of subsidiary undertakings
The key to dealing with the cash flows that arise as a result of an acquisition or a disposal of a subsidiary undertaking is to deal with it in a logical manner. Such issues are faced in a higher level financial reporting paper and there are some important issues to keep in mind as I discuss below.
Parent acquires a subsidiary in the period
When calculating the operating cash flows, remember to subtract inventory, receivables and payables etc at the date of acquisition from the movement on these items.
Parent disposes of a subsidiary in the period
When calculating the operating cash flows, remember to add inventory, receivables and payables etc at the date of acquisition from the movement on these items.
When comparing the group statements of financial position, each of the individual net assets of a subsidiary that has been acquired, or disposed of, in the accounting period must be excluded. This is because the overall net cash effect has already been dealt with as a purchase of a subsidiary and net cash (or overdraft) acquired.
Worked example
Lucas Co acquired Gabriella Co for $22m during the year to 31 December 2012. The terms of the acquisition included consideration of 3 million 25c shares with a market value of $4 each. The balance was paid in cash.
On the date of acquisition, the net assets of Gabriella were as follows:
| Net assets acquired |
$,000 |
| Tangible non-current assets |
13,000 |
| Inventories |
8,995 |
| Trade and other receivables |
14,280 |
| Cash at bank |
2,830 |
| Trade and other payables |
(23,224) |
| Bank overdraft |
(5,182) |
| Non-controlling interests |
(5) |
|
10,694 |
You are required to show how the above will be dealt with in the group statement of cash flows.
Solution
|
The Lucas Group |
|
|
Group Statement of Cash Flows (Extract) |
|
|
as at 31 December 2012 |
$,000 |
|
Investing activities: |
|
|
Purchase of subsidiary |
(10,000) |
|
Overdraft acquired on acquisition |
(2,352) |
|
(5,182 less 2,830) |
|
| Notes to the Group Statement of Cash Flows (Extract) |
$,000 |
|
Net assets acquired: |
|
|
Tangible non-current assets |
13,000 |
|
Inventories |
8,995 |
|
Trade and other receivables |
14,280 |
|
Cash at bank |
2,830 |
|
Trade and other payables |
(23,224) |
|
Bank overdraft |
(5,182) |
|
Non-controlling interests |
(5) |
|
10,694 |
|
|
Goodwill (balancing figure) |
11,306 |
|
22,000 |
|
|
Satisfied by: |
|
|
Shares allotted (3,000 x $4) |
12,000 |
|
Cash (balancing figure) |
10,000 |
|
22,000 |
Worked example
Now assume that the pre-tax profit of the Lucas Group for the year was $20m. Included in the pre-tax profit are depreciation charges of $3.2m and in the year the Lucas Group sold an item of machinery with a net book value of $1.1m for $1m. The statement of financial position extracts are as follows:
|
2012 |
2011 |
|
|
$,000 |
$,000 |
|
|
Tangible non-current assets |
165,110 |
143,228 |
|
Inventories |
92,113 |
60,142 |
| Trade and other receivables |
45,687 |
23,164 |
|
Trade and other payables |
75,897 |
41,231 |
You are required to show the impact of the above on the group statement of cash flows.
Solution
|
$,000 |
$,000 |
|
|
Profit before tax |
20,000 |
|
|
Loss on disposal of machine |
100 |
|
|
Depreciation charge |
3,200 |
|
|
Increase in inventory (92,113 – (60,142 + 8,995)) |
(22,976) |
|
| Increase in receivables (45,687 – (23,164 + 14,280)) |
(8,243) |
|
|
Increase in payables (75,897 – (41,231 + 23,224)) |
11,442 |
|
|
3,523 |
||
|
Investing activities |
||
|
Purchase of non-current asset (W1) |
(13,182) |
|
|
Sale of non-current asset |
1,000 |
(12,182) |
|
Purchase of subsidiary |
(10,000) |
|
|
Overdraft acquired with sub. |
(2,352) |
(12,352) |
|
W1: |
||
|
Opening balance b/fwd |
143,228 |
|
|
Subsidiary acquired |
13,000 |
|
|
Depreciation charge |
(3,200) |
|
|
Disposals |
(1,100) |
|
|
Balance c/fwd |
(165,100) |
|
|
Additions = balancing figure |
13,182 |
The above worked examples for subsidiaries concentrated on the acquisition of a subsidiary during an accounting period. It is not uncommon for parent companies to dispose of a subsidiary and the cash effects of such disposals will affect the group statement of cash flows.
Worked example
Alex Inc has held a 75% investment in James Inc for several years. On 31 December 2012, Alex Inc disposed of the investment in its entirety for $1.5 million in cash.
Extracts from James’s statement of financial position are as follows:
|
$,000 |
|
|
Inventories |
489 |
|
Receivables |
525 |
| Cash at bank |
110 |
The consolidated statement of financial position for the Alex Group as at 31 December 2012 include:
|
2012 |
2011 |
|
|
$,000 |
$,000 |
|
|
Inventories |
1,645 |
1,983 |
|
Receivables |
4,385 |
4,662 |
|
Cash |
410 |
165 |
You are required to show how the disposal of the investment in James Inc will affect the statement of cash flows for Alex Inc for the year ended 31 December 2012.
Solution
Alex Group Inc
Group statement of cash flows (extract)
for the year ended 31 December 2012
|
$,000 |
|
| Profit before tax |
X |
| Increase in inventories (1,645 + 489 – 1,983) |
(151) |
| Increase in receivables (4,385 + 525 – 4,662) |
(248) |
| Net cash from operating activities |
X |
| Acquisitions and disposals: | |
| Disposal of subsidiary |
1,500 |
| Net cash disposed of in subsidiary |
(110) |
| Notes to the Group Statement of Cash Flows (extract) | |
| Net assets disposed of: | |
| Inventories |
489 |
| Receivables |
525 |
| Cash |
110 |
| Non-controlling interests |
(X) |
| Profit / (loss) on disposal |
X/(X) |
|
1,500 |
|
| Satisfied by: | |
| Cash |
1,500 |
Conclusion
This article has considered the preparation of a group statement of cash flows using a step-by-step approach in order to aid students understand the steps required. It is important that question practise includes an appropriate level and number of exam standard questions (attempted under exam conditions). With adequate preparation and an understanding as to why and how figures are included in the group statement of cash flows, students should comfortably pass any examination question requiring the preparation of a group statement of cash flows.
Category: Accounting and standards
