Accounting: Cash Flow Statement: Preparation of Cash Flow Statement (For CBSE, ICSE, IAS, NET, NRA 2022)

Doorsteptutor material for competitive exams is prepared by world's top subject experts: get questions, notes, tests, video lectures and more- for all subjects of your exam.

There are two methods which are useful and give the same result in preparing cash flow statement. Those are direct and indirect methods. These two methods can be understood using an illustration given below.

Example:

From the summarized cash account of ABC Limited (Ltd.) prepare cash flow statement for the year ended 31st December 2006 in accordance with AS-3 (Revised) using the direct method and indirect method. The company does not have any cash equivalents:

Summarized Cash a/C

Table Supporting: Summarized_Cash_Ac
ParticularsAmount (₹ 000)ParticularsAmount (₹ 000)
Balance on 1.1. 200650Payment to Suppliers2000
Issue of equity shares300Purchase of fixed assets200
Receipts from customers2800Overhead expenses200
Sale of fixed assets100Wages and salaries100
Taxation250
Dividend50
Repayment of Bank Loan300
Balance on 31.12. 2006150
32503250

Additional information: Net profit before tax for the yea 2006 was Rs500000.

Solution:

Cash flow statement of ABC Ltd for the year ended 31st December 2006 (Indirect method)

Table Supporting: Summarized_Cash_Ac
₹ 000₹ 000
A. Cash flows from operating activities
Net profit before tax500
Income tax paid(250)
Net cash from operatingactivities250
B. Cash flows from investing activities
Purchase of fixed assets for cash(200)
sale of fixed assets100
Net cash used in investing activities(100)
C. Cash flows from financing activities
Proceeds from issue of equity shares300
Payment of bank loan(300)
Dividend paid(50)
Net cash used in financing activities(50)
Net increase in cash (A + B + C)100
i.e.. Net cash fromactivities

Cash flow statement of ABC Ltd for the year ended 31st December 2006 (Indirect method)

Table Supporting: Summarized_Cash_Ac
₹ 000₹ 000
A. Cash flows from operating activities
Cash receipts from customers2800
Cash payments to suppliers(2000)
Cash paid for wages and salaries(100)
Cash paid for overheadexpenses(200)
Income tax paid(250)
Net cash from operatingactivities250
B. Cash flows from investing activities
Purchase of fixed assets for cash(200)
Proceeds from sale of fixed assets100
Net cash used in investing activities(100)
C. Cash flows from financing activities
Proceeds from issue of equity shares300
Payment of bank loan(300)
Dividend paid(50)
Net cash used in financing activities(50)
Net increase in cash (A + B + C)100
i.e.. Net cash fromactivities
Cash at the beginning50
Cash at the end150

Treatment of Special Items

Payment of interim dividends:

  • The amount of interim dividend paid during the year is shown as outflow of cash in cash flow statement.
  • It will be added back to the profits for the purpose of calculating cash provided from operating activities.
  • No adjustment is necessary if the cash provided from operating activities is calculated on the basis of revised figure of net profit.

Proposed dividend: Dividend is fixed after general meeting. This is a non-operating item so it should be added back to current year՚s profit and payments.

Share Capital:

  • Increase in share capital is cash inflow.
  • Redemption of preference share capital is cash outflow.
  • Issue of bonus shares does not cause any cash flows.

Purchase or sale of fixed assets: Cash flows drawn from comparative balance sheet at two dates. Based on that we derive whether a particular fixed asset has been purchased or sold during the year. Purchased asset is cash outflow and sale is inflow.

Provision for Taxation: It is a non-operating expense. So it should not be allowed to reduce the cash provided from operating expenses. If the profit is given after tax provisions for tax should be added back to the current year profit. In the cash flow statement, the tax paid would be recorded separately as an outflow of cash. Sometimes, the only information available about provision for taxation is two figures appearing in the opening balance sheet and closing balance. Tax in opening balance sheet is treated as cash outflow and tax provision in closing balance is treated as non-cash item and added back to the net income.

Example:

ThefollowingrelevantInformationisobtainedfromthebookofVenugopalanLimited (Ltd.) .

Table Supporting: Treatment_of_Special_Items
Liabilities20062007
Provision for Taxation

The amount of tax paid during 2007 amounted to ₹ 40000. How would you deal with this item presuming to be noncurrent? You are also given netprofitaftertaxationwas ₹ 80000.

Solution:

Table Supporting: Treatment_of_Special_Items
Dr.Cr.
ParticularsAmount

ParticularsAmount ₹
Bank (payment)40,000Balance b/d50000
Balance c/d70000Profit and loss A/c60000
(Balances Figure)
110000110,000
  1. ₹ 40000isanoutflowofcash
  2. Cashprovidedfromoperatingactivitieswillbecalculatedas

Net Incomeaftertaxation

Add: Provisionfortaxationtreatedasnon-cashexpense

Limitations of Cash Flow Statement

  • It is very difficult to precisely define the term ′ cash
  • There are controversies over a number of items like cheques, stamps, postal orders etc. to be included in cash or not.
  • As the present business moves from the cash basis to accrual basis, the prepaid and credit transactions might be represented an increase in working capital and it would be misleading to equate net income to cash flow because a number of non cash items would affect the net income.

Developed by: