Guide to Accounting Standard 3 | Cash Flow Statement

Table of contents

1. Introduction
2. Objective and Benefits of Cash Flow
3. Scope
4. Definitions
5. Presentation of Cash Flow Statement (CFS)
6. How does the Presentation of CFS Help the Users of Financial Statements?
7. Presentation of Cash Flows from OPERATING Activities
8. Other Important Points
9. Disclosure
10. Example of Cash Flow Statement: Source – AS 3 Appendix (Modified)

Check out Taxmann's Accounting Standards Made Easy which is a self-learning study material providing the subject matter in simple & lucid language with a step-by-step approach. It provides a conceptual understanding of each point with 500+ detailed examples & diagrammatic presentations.

CA-Inter | Nov. 2023 Exam

1. Introduction

Cash flow Statement (CFS) is an additional information provided to the users of accounts in the form of a statement, which reflects the various sources from where cash was generated (inflow of cash) by an enterprise during the relevant accounting year and how these inflows were utilised (outflow of cash) by the entity. This information is very useful to the users of financial statements to ESTIMATE future inflows & outflows of cash and accordingly this can be used for their economic decisions.

Say, opening & closing cash & bank balances of X Ltd. are ` 20 crore and ` 35 crore respectively and Y Ltd. opening and closing balances are ` 20 crore and ` 30 crore respectively. Generally, you may think that X Ltd. is maintaining better cash balance comparatively and it has good cash generating capacity.

But if we get into the details of the cash transactions during the year – X Ltd. earned ` 2 crore from its regular operations (business) and the balance of ` 13 crore is borrowed in the last minute. Whereas Y Ltd. earned cash profits of ` 10 crore which is exactly the difference between opening and closing cash balances. I think your understanding is changed after looking into the details. This is the main objective of preparation of CFS by the entities.

2. Objective and Benefits of Cash flow

Cash flow statement helps the users to assess the entities

• Ability to generate cash & cash equivalents;
• Utilisation of the cash flows;
• Timing, nature and certainty of generation of future cash flows; and
• The changes in the capital structure.

3. Scope

• Every entity should prepare and present cash flow statement along with its financial statements.
• This Standard is applicable to Level I entities and Companies OTHER THAN Small and Medium Companies.

Dive Deeper:
Disclosure Requirements under AS 3 | Cash Flow Statements

4. Definitions

Cash: Cash includes cash in hand, cash at bank & demand deposits with banks;

Demand deposits mean deposits which can be withdrawn without prior notice and penalty charges. Generally long-term deposits are placed for a specific period in banks and these cannot be withdrawn without penalty, hence it cannot be classified as cash.

Cash equivalents: An asset can be called as a cash equivalent when it satisfies the following conditions:

1. Short-term & highly liquid investments which are readily convertible into cash; and
2. Conversion into cash is subject to insignificant risk of changes in value; (i.e. Insignificant loss because of conversion)

Short-term investment is an investment which has a maturity of three months or less from the date of acquisition.

E.g. Treasury bills, Government securities having maturity within 3 months from the date of acquisition (These items are redeemed at the same amount without any default – insignificant risk of change in value). Preference shares acquired also can be cash equivalent only when the entity acquired 3 months before their specified redemption date and subject to insignificant risk of failure of the company to repay the amount at maturity.

Cash flows: Means inflow & outflow of cash & cash equivalents;

5. Presentation of Cash Flow Statement (CFS)

As per the standard, CASH ACTIVITIES of an entity are classified into three. The classification is based on the nature of business of the entity.

Broadly CFS is presented in the following manner.

5.1 Cash flow statement of X Ltd. for the year ended 31-3-20XX

6. How does the Presentation of CFS Help the Users of Financial Statements?

It helps the users in many ways while taking economic decisions. Benefits of classification from each activity are described as follows:

Operating activities

• To forecast future cash flows from its regular operations;
• To determine the sufficiency of cash flows for payment of dividends, repayment of loans and make new investments without going for external financing;

Investment activities

• Help the users to estimate the future operating cash flows because of the current year investing activities and other income from the investment activities.
• E.g. if an entity purchases plant or fixed assets during the year, user can forecast an increase in operating cash flows & if an entity invested in shares or other securities, the user can forecast the future cash flows by way of other income from such investments (dividend, interest, etc).

Financing activities

• • It is useful to predict future claims by providers of funds by way of dividend, interest, etc.

7. Presentation of Cash Flows from OPERATING Activities

Operating activities can be presented in TWO ways. They are

1. Direct method;
2. Indirect method.

The standard gives an option to the entity in presentation of operating activities i.e. it can present either in direct method or indirect method. Presentation of operating cash flows under indirect method is more popular in practice.

7.1 Direct Method

Under the direct method, the entity gives information about major classes of

• Gross cash receipts; and
• Gross cash payments.

Gross cash receipts or payments of the entity can be obtained from either:

(a) Cash/bank book; or

(b) Alternatively non-cash and non-operating items (i.e. investing or financing items) can be eliminated from P&L statement;

See the format of cash flows from operating activities under direct method:

7.2 Indirect Method

Under this method, the net cash flows from operating activities are determined by adjusting (add/ less) profit or loss before tax and before extraordinary/exceptional items with:

(a) Non-cash items such as depreciation, provisions, goodwill written off, etc

(b) Non-operating items i.e. investing or financing items which are considered in calculation of profit or loss before tax – such as interest receipt or payment, dividend receipt in case of non-financing entity, etc.;

(c) Changes in inventories and operating receivables and payables;

(d) Actual income-tax payment;

(e) Receipts/payments from extraordinary/exceptional items.

See the below format of cash flows from operating activities under indirect method:

Reporting Cash Flows from Investing and Financing Activities

An entity should report separately major classes of gross cash receipts and gross cash payments arising from investing and financing activities, except in the following cases

(a) Cash receipts and payments on behalf of customers when the cash flows reflect the activities of the customer rather than those of the entity; like rent collected on behalf and paid to the owner of the properties; This is not the cash flow of the entity so present on net basis and Acceptance and repayment of demand deposits by bank; (bank point of view);

(b) Cash receipts and payments for items in which the turnover is quick, the amounts are large, and the maturities are short like advances made or received for purchase or sale of investment.

8. Other Important Points

(1) Income-tax

• Income-tax payment should be separately disclosed under operating activities. In general, it is NOT practicable to separate tax payments between operating and other than operating activities.
• If it is practicable to separate the tax payments among different activities, it should be separated and presented accordingly under the respective activity.

(2) Cash flows in foreign currency

Receipts and payments of foreign currencies should be converted into the reporting currency (i.e. Rupees in India) using the exchange rate on the date of cash flow. Entities can use any rate which approximates to the actual rate.

UNREALISED foreign exchange gain or loss are non-cash items, hence excluded from cash flow statement.

Extraordinary/exceptional items

The cash flows from extraordinary/exceptional items should be disclosed separately under appropriate activities based on the nature of cash flows.

(3) Loans/Advances given and Interests earned

(a) in the ordinary course of business are operating cash flows for financial enterprises.

(b) on them are investing cash flows for non-financial enterprises.

(c) L&A given to subsidiaries and interests earned on them are investing cash flows for all enterprises.

(d) L&A given to employees and interests earned on them are operating cash flows for all enterprises.

(e) Advance payments to suppliers and interests earned on them are operating cash flows for all enterprises.

(f) Interests earned from customers for late payments are operating cash flows for non-financial enterprises.

(4) Loans/Advances taken and Interests paid

(a) For Financial enterprises (in the ordinary course of business) – Operating cash flows;

(b) For non-financial enterprises– Financing cash flows.

(c) From subsidiaries and interests paid on them are financing cash flows for all enterprises.

(d) From customers and interests paid on them are operating cash flows for non-financial enterprises.

(e) Interests paid to suppliers for late payments are operating cash flows for all enterprises.

(f) Interests taken as part of inventory costs in accordance with AS 16 are operating cash flows.

(5) Investments made and dividends earned

(a) For Financial enterprises (in the ordinary course of business) – Operating cash flows;

(b) For non-financial enterprises– Investing cash flows.

(c) Investments in subsidiaries and dividends earned on the mare investing cash flows for all enterprises.

(6) Non-cash items

Even though non-cash transactions have a direct impact on financial statements, they are excluded from the CFS. These transactions should be disclosed elsewhere in the financial statements (notes on accounts) to provide all the relevant information about these investing and financing activities.

Examples of non-cash items:

1. Conversion of debt into equity;
2. Issue of shares/securities on acquisition of an entity;
3. Acquisition of assets by taking other directly related liabilities, etc.

(7) Insurance claims received

(a) Insurance claims received against loss of stock or loss of profits are extraordinary operating cash in flows for all enterprises.

(b) Insurance claims received against loss of fixed asset are extraordinary investing cash in flows for all enterprises.

9. Disclosures

• Disclose the components of cash and cash equivalents;
• Present a reconciliation of cash and cash equivalents in the CFS with the equivalent items reported in the balance sheet;
• The amount of significant cash and cash equivalent balances held by the enterprise those are NOT available for use by it and management’s comment should be added to that.
• Any additional information may be relevant to users in understanding the financial position and liquidity of an enterprise.

10. Example of cash flow statement: Source – AS 3 Appendix (Modified)

Balance sheets of X Ltd. for the year ended 2018 & 2017. (Amount in Rupees)

Additional information of CY (2018):

(a) An amount of ` 250 was raised from the issue of share capital and a further ` 250 was raised from long-term borrowings.

(b) Interest expense was ` 400 of which ` 170 was paid during the period. ` 100 relating to interest expense of the previous year was also paid during the period.

(c) Dividends paid were ` 1,200.

(d) Tax deducted at source on dividends received (included in the tax expense of 300 for the year) amounted to ` 40.

(e) During the period, the enterprise acquired fixed assets for `350. The payment was made in cash.

(f) Plant with original cost of `80 and accumulated depreciation of ` 60 was sold for ` 20.

(g) Sundry debtors and sundry creditors include amounts relating to credit sales and credit purchases only.

Statement of Profit and Loss for the period ended 31.12.2018

Suggested answer as per AS 3

Direct Method Cash Flow Statement

Indirect Method Cash Flow Statement

Note 1: Cash and Cash Equivalents

Cash and cash equivalents consist of cash on hand and balance with banks, and investments in money-market instruments. Cash and cash equivalents included in the cash flow statement comprise the following balance sheet amounts:

Working Notes: (These working notes do not form part of notes on accounts)

WN # 1: Cash received from customers

WN #2: Cash paid to suppliers and employees

WN #3: Income-tax payment

Note: Out of `900 tax payment, `40 is related to TDS on dividends received (investing activity) is included in cash flows from investing activities and the balance of `860 is included in cash flows from operating activities.

WN # 4: Long-term borrowings made and repaid during the year

WN # 5: Interest paid during the year