PAS 7 Statement of Cash flows

Objective of PAS 7

The objective of this standard is to require the provision of information about the historical
changes in cash and cash equivalents of an entity by means of a statement of cash flows which
classifies cash flows during the period from operating, investing and financing activities.

Scope of PAS 7

PAS 7 requires all entities to present a statement of cash flows since all entities need cash for
essentially the same reasons however different their principal revenue-producing activities
might be. They need cash to conduct their operations, pay their obligations, and to provide
returns to their investors

PAS 7 governs the preparation of a statement of cash flows. Entities shall prepare a statement
of cash flows in accordance with the requirements of PAS 7 and shall present the statement of
cash flow as an integral part of its financial statements for each period for which financial
statements are presented.

Basic Concepts

What makes a statement of cash flows valuable and useful?

Information about the cash flows of an entity is useful in providing users of financial statements
with a basis to assess the ability of the entity to generate cash and cash equivalents and the
needs of the entity to utilise those cash flows. The economic decisions that are taken by users
require an evaluation of the ability of an entity to generate cash and cash equivalents and the
timing and certainty of their generation.

Users of an entity’s financial statements are interested on how the entity generates and uses
cash and cash equivalents. This is the case regardless of the nature of the entity’s activities and
irrespective of whether cash can be viewed as the product of the entity, as may be the case
with a financial institution

Information that a statement of cash flows provide

A statement of cash flows, when used in conjunction with the rest of the financial statements,
provide information that enables users to evaluate the changes in net assets of an entity, its
financial structure (including its liquidity and solvency) and its ability to affect the amounts and
timing of cash flows in order to adapt to changing circumstances and opportunities.

Beneficial uses of information provided by a statement of cash flows

Cash flow information is useful in assessing the ability of the entity to generate cash and cash
equivalents and enables users to develop models to asses and compare the present value of the
future cash flows of different entities. It also enhances the comparability of the reporting of
operating performance by different entities because it eliminates the effects of using different
accounting treatments for the same transactions and events.

Historical cash flow information is often used as an indicator of the amount, timing and
certainty of future cash flows. It is also useful in checking the accuracy of past assessments of
future cash flows and in examining the relationship between profitability and net cash flow and
the impact of changing prices.

What compromises cash? What are cash equivalents?

Cash compromises cash on hand and demand deposits. A demand deposit is an account with a
bank or other financial institution that allows the depositor to withdraw his or her funds from
the account without warning or with less than seven days’ notice. Demand deposits can be on a
checking or a savings account, and withdrawals can be made either from an ATM or from the
bank’s cashier.

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. Cash
equivalents are held for the purpose of meeting short-term cash commitments rather than for
investment or other purposes.

When do investments qualify as cash equivalents?

For an investment to qualify as cash equivalent it must be readily convertible to a known

amount of cash and be 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.

Do equity investments qualify as cash equivalents?

Generally, equity investments are excluded from cash equivalents. Having no maturity, equity
investments generally are not considered as short term investment and are readily convertible
to a known amount of cash and are subject to an insignificant risk of changes in value. However,
some equity investments are actually cash equivalents in substance and should be classified as
such. An example would be preferred shares acquired within a short period of their maturity
and with a specified redemption date.

What are bank overdrafts? Do bank overdrafts form part of cash and cash equivalent?
An overdraft is an extension of credit from a lending institution that is granted when an account
reaches zero. The overdraft allows the account holder to continue withdrawing money even
when the account has no funds in it or has insufficient funds to cover the amount of the
withdrawal. A bank overdraft does not actually result in cash flowing into a business. It actually
represents a bank borrowing.

Bank borrowings are generally conserved to be financing activities and do not form part of cash
and cash equivalents. However, in some countries, bank overdrafts which are repayable on
demand form an integral part of an entity’s cash management. In these circumstances, bank
overdrafts are included as a component of cash and cash equivalents. A characteristic of such
banking arrangements is that the bank balance often fluctuates from being positive to
overdrawn.

What disclosures should entities make concerning cash and cash equivalents?

An entity shall disclose the components of cash and cash equivalents and shall present a
reconciliation of the amounts in its statement of cash flows with the equivalent items reported
in the statement of financial position.

An entity shall also disclose the policy which it adopts in determining the composition of cash
and cash equivalents.

Presentation of a statement of cash flows

How are cash flows classified in the statement of cash flows?

The statement of cash flows shall report cash flows cash flows during the period classified by
operating, investing and financing activities.

Operating activities are the principal revenue-producing activities of the entity and other
activities that are not investing or financing activities. They generally result from transactions
and other events that enter into the determination of profit or loss.

Investing activities are the acquisition and disposal of long term assets and other investments
not included in cash equivalents.

Financing activities are activities that result in changes in the size and composition of the
contributed equity and borrowings of the entity.

How are cash flows presented in the statement of cash flows?

An entity presents its cash flows from operating, investing and financing activities in a manner
which is most appropriate to its business. A single transaction may include cash flows that are
classified differently. For example, when the cash repayment of a loan includes both interest
and capital, the interest element may be classified as an operating activity and the capital
element is classified as a financing activity.

What is the significance of classifying cash flows as operating activity, investing activity, or
financing activity?

Classification by activity provides information that allows users to assess the impact of those
activities on the financial position of the entity and the amount of its cash and cash equivalents.

The amount of cash flows arising from operating activities is a key indicator of the extent to
which the operations of the entity have generated sufficient cash flows to repay loans, maintain
the operating capability of the entity, pay dividends and make new investments without
recourse to external sources of financing. Information about the specific components of
historical operating cash flows is useful, in conjunction with other information, in forecasting
future operating cash flows.

The separate disclosure of cash flows arising from investing activities is important because the
cash flows represent the extent to which expenditures have been made for resources intended
to generate future income and cash flows. Only expenditures that result in a recognized asset in
the statement of financial position are eligible for classification as investing activities.

The separate disclosures of cash flows arising from financing activities is important because it is
useful in predicting claims on future cash flows by providers of capital to the entity.

Do investments in cash equivalents results in cash flows arising from investing activities?

No. cash flows are inflows and outflows of cash equivalents. Cash flows exclude movements
between items that constitute cash or cash equivalents because these components are part of
the cash management of an entity rather than part of its operating, investing and financing
activities. Cash management includes the investment of excess cash in cash equivalents.

Examples of cash flows arising from operating activities are:

a. Cash receipts from the sale of goods and the rendering of services;
b. Cash receipts from royalties, fees and commissions and other revenue;
c. Cash payments to suppliers for goods and services;
d. Cash payments to and behalf of employees;
e. Cash payments or refunds of income taxes unless they can be specifically identified with
financing and investing activities;
f. Cash receipts and payments from contracts held for dealing or trading purposes; and
 g. Cash payments to manufacture or acquire assets held for rental to others and
subsequently held for sale, and cash receipts from rents and subsequent sales of such
assets

Examples of cash flows arising from investing activities are:

a. Cash payments to acquire property, plant and equipment, intangibles and other long
term assets. These payments include those relating to capitalized development costs
and self-constructed property, plant and equipment
b. Cash receipts from sales of property, plant and equipment, intangibles and other long-
term assets;
c. Cash payments to acquire entity or debt instruments of other entities and interests in
joint ventures (other than payments for those instruments considered to be cash
equivalents or those held for dealing or trading purposes);
d. Cash receipts from sales of equity or debt instruments of other entities and interests in
joint ventures (other than receipts for those instruments considered to be cash
equivalents and those held for dealing or trading purposes);
e. Cash advances and loans made to other parties (other than advances and loans of a
financial institution);
f. Cash receipts from repayment of advances and loans made to other parties (other than
advances and loans of a financial institution.);
g. Cash payments for futures contracts, forward contracts, option contracts and swap
contracts except when the contracts are held for dealing or trading purposes, or the
payments are classified as financing activities;
h. Cash receipts from futures contracts, forward contracts, option contracts and swap
contracts except when the contracts are held for dealing or trading purposes, or the
receipts are classified as financing activities.

Examples of cash flows arising from financing activities are:

a. Cash proceeds from issuing shares or other equity instruments;

b. Cash payments to owners to acquire or redeem the entity’s shares;
c. Cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short
term or long term borrowings;
d. Cash repayments of amounts borrowed; and
e. Cash payments by a lessee for the reduction of the outstanding liability relating to a
lease.

How are cash flows arising from securities and loans held by entities for dealing or trading
purposes classified? How about cash advances and loans made by financial institution?
Cash flows arising from the purchase and sale of dealing or trading securities are classified as
operating activities since they are similar to inventory acquired specifically for resale. Similarly,
cash advances and loans made by financial institutions are usually classified as operating
activities since they relate to the main revenue-producing activity of that entity.

Will all transactions that result in a gain or loss that is included in the recognized profit be
classified as operating activity?

No. some transactions, such as the sale of an item of plant, may give rise to a gain or loss that is
included in recognized profit or loss and the cash flows relating to such transactions are cash
flows from investing activities.

How are cash flows from contracts that are accounted for a hedge of an identifiable position
classified?

When a contract is accounted for as a hedge of an identifiable position, the cash flows of the
contract are classified in the same manner as the cash flows of the position being hedged

How should cash flows from operating activities be reported?

An entity shall report cash flows from operating activities using either:

a. Direct method, whereby major classes of gross cash receipt and gross cash payments are
disclosed; or
b. Indirect method, whereby profit or loss is adjusted for the effects of transactions of a
non-cash nature, any deferrals or accruals of past or future operating cash receipts or
payments, and items of income or expense associated with investing or financing cash
flows.

Which of the two methods is preferred by the standard?

Entities are encouraged to report cash flows from operating activities using the direct method.
The direct method provides information which may be useful in estimating future cash flows
and which is not available under the indirect method.

What information is needed and from where can it be obtained if an entity will use the direct
method of reporting cash flows from operating activities?

When using the direct method, major classes of gross cash receipts and gross cash payments
are to be disclosed. Information about major classes of gross cash receipts and gross cash
payments may be obtained either:

a. From the accounting records of the entity; or

 b. By adjusting the sales, cost of sales (interest and similar income and interest expense
and similar charges for a financial institution and other items in the statement of
comprehensive income for: changes during the period in inventories and operating
receivables and payables; other non-cash items; and other items for which the cash
effects are investing or financing cash flows.

How is the net cash flow from operating activities determined under the indirect method and
direct method?

Under the indirect method, the net cash flow from operating activities is determined by
adjusting profit or loss for the effects of:

a. Changes during the period in inventories and operating receivables and payables;
b. Non-cash items such as depreciation, provisions, deferred taxes, unrealised foreign
currency gains and losses, and undistributed profits of associates; and
c. All other items for which the cash effects are investing or financing cash flows.

Alternatively, the net cash flow from operating activities may be presented under the indirect
method by showing the revenues and expenses disclosed in the statement of comprehensive
income and the changes during the period in inventories and operating receivables and
payables.

Under the direct method, the net cash flow from operating activities is determined by getting
the difference between gross cash receipts and gross cash payments during the reporting
period.

Other Requirements

Gross versus net basis

How should cash flows from investing and financing activities be reported?

An entity shall report separately major classes of gross cash receipts and gross cash payments
arising from investing and financing activities, except to the extent that cash flows are to be
reported on a net basis as provided in the Standard. Essentially, investing and financing
activities are reported in a similar manner to the direct method of reporting operating activities.

When may cash flows from operating, investing, or financing activities be reported on a net
basis?

Cash flows arising from the following operating, investing, or financing activities may be
reported on a net basis:
 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; and
b. Cash receipt and payments for items in which the turnover is quick, the amounts are
large, and the maturities are short.

For financial institutions, cash flows arising from each of the following activities may be
reported on a net basis:

a. Cash receipts and payments for the acceptance and repayment of deposits with a fixed
maturity date;
b. The placement with and withdrawal of deposits from other financial institutions; and
c. Cash advances and loans made to customers and the repayment of those advances and
loans.

Give examples of cash receipts and payments in behalf of customers in which cash flow
reflect the activities of the customer rather than those of the entity.

Examples of such cash receipts and repayments are:

a. The acceptance and repayment of demand deposits of a bank;

b. Funds held for customers by an investment entity; and
c. Rents collected on behalf of, and paid over to, the owners of the properties.

Give examples of cash receipts and payments in which the turnover is quick, the amounts are
large, and maturities are short.

Examples of such cash receipts and payments are: advances made for, and the repayment of:

a. Principal amounts relating to credit card customers;

b. The purchase and sale of investments; and
c. Other short term borrowings, for example, those which have a maturity period of three
months or less

Foreign currency cash flows

How should cash flows from a foreign currency transaction be recorded?

Cash flows arising from transactions in a foreign currency shall be recorded in an entity’s
functional currency by applying to the foreign currency amount the exchange rate between the
functional currency and foreign currency at the date of the cash flow.

What exchange rate shall be used in translating cash flows of a foreign subsidiary?
The cash flows of a foreign subsidiary shall be translated at exchange rates between the
functional currency and the foreign currency at the dates of the cash flows. PAS 21, “The Effects
of Changes in Foreign Exchange Rates”, governs the translation of the cash flows of a foreign
subsidiary. The Standard permits the use of an exchange rate that approximates the actual rate.
For example, a weighted average exchange rate for a period may be used for recording foreign
currency transactions or the translation of the cash flows of a foreign subsidiary.

However, PAS 21 does not permit use of the exchange rate at the end of the reporting period
when translating the cash flows of a foreign subsidiary.

What is the treatment of the unrealized gains and losses arising from changes in foreign
currency exchange?

Unrealized gains and losses arising from the changes in foreign currency exchange rates 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. This amount is presented
separately from cash flows from operating, investing and financing activities and includes the
differences, if any, had those cash flows been reported at the end of period exchange rates.

Interests and dividends

How should interest and dividends be presented in the statement of cash flows?

Cash flows from interest and dividends received and paid shall be disclosed separately. Each
shall be classified in a consistent manner from period to period as either operating, investing or
financing activities.

The total amount of interest paid during a period is disclosed in the statement of cash flows
whether it has been recognized as an expense in profit or loss or capitalized in accordance with
PAS 23, “Borrowing Costs”

How are cash flows from interest classified?

Interest paid and interest received may be classified as operating cash flows because they enter
into the determination of profit or loss.

Alternatively, interest paid may be classified as financing cash flows because they are costs of
obtaining financial resources while interest received may be classified as investing cash flows
because they are returns on investments.

How are cash flows from dividends classified?

Dividends paid may be classified as a financing cash flow because they are a cost of obtaining
financial resources.

Alternatively, dividends paid may be classified as a component of cash flows from operating
activities in order to assist users to determine the ability of an entity to pay dividends out of
operating cash flows.

On the other hand, dividends received are classified similar to interest received. This means
that dividends received are usually classified as operating cash flows for a financial institution
and that there is also no consensus on the classification of dividends received for other entities.

As a result, dividends received may be classified as operating cash flows because they enter into
the determination of profit or loss and alternatively classified as investing cash flows because
they are returns on investments.

How do financial institutions classify cash flows from interest and dividends?

Interest paid and interest and dividends received are usually classified as operating cash flows
for a financial institution. As for dividends paid, financial institutions have the same options as
all other entities, that is, dividends paid are alternatively classified as cash flows from financing
or operating activities

Income taxes

How should cash flows arising from taxes on income be presented in the statement of cash
flows?

Cash flows arising from taxes on income shall be separately disclosed. Taxes paid are usually
classified as cash flows from operating activities. However, when it is practicable to identify tax
cash flow with an individual transaction that gives rise to cash flows that are classified as
investing or financing activities the tax cash flows is classified as an investing or financing
activity as appropriate. When tax cash flows are allocated over more than one class of activity,
the total amount of taxes paid is disclosed.

Non-cash investing and financing transactions

Give examples of non-cash investing and financing transactions:

Many investing and financing do not have a direct impact on current cash flows although they
do affect the capital and asset structure of an entity. Examples of non-cash transactions are:

a. The acquisition of assets either by assuming directly related liabilities or by means of a

lease;
 b. The acquisition of an entity by means of an equity issue; and
c. The conversion of debt to equity.

Does the statement of cash flows include non-cash transactions?

Investing and financing transactions that do not require the use of cash or cash equivalents
shall be excluded from a statement of cash flows. Such transactions shall be disclosed
somewhere in the financial statement in way that provides all the relevant information about
these investing and financing activities. The exclusion of non-cash transactions from the
statement of cash flows is consistent with the objective of a statement of cash flows as these
items do not involve cash flows in the current period.

Changes in liabilities arising from financing activities

What are the disclosure requirements concerning the changes in liabilities arising from
financing activities?

An entity shall provide disclosures that enable users of financial statements to evaluate changes
in liabilities arising from financing activities, including both changes arising from cash flows and
non-cash changes. This requirement is satisfied when the following information is disclosed:

(a) Changes from financing cash flows;

(b) Changes arising from obtaining or losing control of subsidiaries or other businesses;
(c) The effect of changes in foreign exchange rates;
(d) Changes in fair values; and
(e) Other changes

Another way of satisfying the disclosure requirement for changes in liabilities arising from
financing activities is by providing a reconciliation between the opening and closing balances in
the statement of financial position for liabilities arising from financing activities together with
sufficient information to enable users of financial statements to link items included in the
reconciliation to the statement of financial position and the statement of cash flow.

In what other instance shall an entity provide similar disclosures required for changes in
liabilities arising from financial activities?

The disclosure requirements provided in the previous number also apply to the changes in
financial assets ( for example, assets that hedge liabilities arising from financial activities) if cash
flows from those financial assets were, or future cash flows will be, included in cash flows from
financing activities.

Investments in subsidiaries, associates and joint ventures1

What effect do investments in subsidiaries, associates and joint ventures have on the
preparation of a statement of cash flow?

When accounting for an investment in an associate, a joint venture or a subsidiary accounted

for by use of the equity or cost method, an investor restricts its reporting in the statement of
cash flows to the cash flows between itself and the investee, for example, to dividends and
advances. An entity that reports its interest in an associate or joint venture using the equity
method includes in its statement of cash flows the cash flows in respect of its investments in
the associate or joint venture, and distributions and other payments or receipts between it and
the associate or joint venture.

What information must entities present as regards the cash flow statement when they obtain
or lose control of subsidiaries and other businesses?

PAS 7 recognizes that an entity may acquire or dispose subsidiaries or other business units
during the year and thus requires that the aggregate cash flows from acquisitions and from
disposals of subsidiaries or other business units should be presented separately as part of the
investing activities section of the statement of cash flows. PAS 7 has also prescribed these
disclosures in respect to both acquisitions and disposals:

a. The total consideration included

b. The portion thereof discharged by cash and cash equivalents
c. The amount of cash and cash equivalents in the subsidiary or business unit acquired or
disposed
d. The amount of assets and liabilities (other than cash and cash equivalents) acquired or
disposed, summarized by major category

How should entities present cash flows between them and its subsidiaries and other
businesses?

The aggregate amount of the cash paid or received as consideration for obtaining or losing
control of subsidiaries or other businesses is reported in the statement of cash flows net of cash
and cash equivalents acquired or disposed of as part of such transactions, events or changes in
circumstances.

Cash flows arising from changes in ownership interests in a subsidiary that do not result in a
loss of control shall be classified as cash flows from financing activities unless the subsidiary is
held by an investment entity, and is required to be measured at fair value through profit or loss.

Changes in ownership in a subsidiary that do not result in a loss of control, such as the
subsequent purchase or sale by a parent of a subsidiary’s equity instruments, are accounted for
as equity transactions, unless the subsidiary is held by an investment entity and is required to
be measured at fair value through profit or loss.

Disclosures

What other information must be disclosed in the financial statements as requires by PAS 7?

The following shall be disclosed by entities together with a commentary management:

a. The amount of significant cash and cash equivalent balances held by the entity that are
not available for use by the group;
b. The amount of undrawn borrowing facilities that may be available for future operating
activities and to settle capital commitments, indicating any restrictions on the use of
these facilities;
c. The aggregate amount of cash flows that represent increases in operating capacity
separately from those cash flows that are required to maintain operating capacity; and
d. The amount of cash flows arising from the operating, investing and financing activities of
each reportable segment