Accounting Standard (AS) 3, Cash Flow Statement (Revised)
Cash Flow Statement deals with the provision of information about the historical changes in cash and cash equivalents of an enterprise by means of a cash flow statement which classifies cash flows during the period from operating, investing and financing activities.
Cash comprises cash on hand and demand deposits with banks.
Cash equivalents are short term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value.
Cash flows are inflows and outflows of cash and cash equivalents.
Operating activities are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities.
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 owners’ capital (including preference share capital in the case of a company) and borrowings of the enterprise.
Methods of preparing Cash Flow Statement
In this method major classes of gross cash receipts and gross cash payments are disclosed.
Under this method, the following adjustment to reported net profit or loss to be made:
- Effects of transactions of non-cash nature.
- Deferrals in accruals of past or future operating receipt or payments.
- Changes in current assets and liabilities
- Income & expenses associated with investing and financing cash flows.
Loans/Advances Given and Interests Earned
- Loans and advances given and interests earned on them in the ordinary course of business are operating cash flows for financial enterprises.
- Loans and advances given and interests earned on them are investing cash flows for non-financial enterprises.
- Loans and advances given to subsidiaries and interests earned on them are investing cash flows for all enterprises.
- Loans and advances given to employees and interests earned on them are operating cash flows for all enterprises.
- Advance payments to suppliers and interests earned on them are operating cash flows for all enterprises.
- Interests earned from customers for late payments are operating cash flows for non-financial enterprises.
Loans/Advances Taken and Interests Paid
- Loans and advances taken and interests paid on them in the ordinary course of business are operating cash flows for financial enterprises.
- Loans and advances taken and interests paid on them are financing cash flows for non-financial enterprises.
- Loans and advances taken from subsidiaries and interests paid on them are financing cash flows for all enterprises.
- Advance taken from customers and interests paid on them are operating cash flows for non-financial enterprises.
- Interests paid to suppliers for late payments are operating cash flows for all enterprises.
- Interests taken as part of inventory costs in accordance with AS 16 are operating cash flows.
Investments Made and Dividends Earned
- Investments made and dividends earned on them in the ordinary course of business are operating cash flows for financial enterprises.
- Investments made and dividends earned on them are investing cash flows for non-financial enterprises.
- Investments in subsidiaries and dividends earned on them are investing cash flows for all enterprises.
Dividends paid are financing cash outflows for all enterprises
- Tax paid on operating income is operating cash outflows for all enterprises
- Tax deducted at source against income are operating cash outflows if concerned incomes are operating incomes and investing cash outflows if the concerned incomes are investment incomes, e. g. interest earned.
- Tax deducted at source against expenses are operating cash inflows if concerned expenses are operating expenses and financing cash inflows if the concerned expenses are financing expenses, e. g. interests paid.
Insurance Claims Received
- Insurance claims received against loss of stock or loss of profits are extraordinary operating cash inflows for all enterprises.
- Insurance claims received against loss of fixed assets are extraordinary investing cash inflows for all enterprises.
AS 3 requires separate disclosure of extraordinary cash flows, classifying them as cash flows from operating, investing or financing activities, as may be appropriate.
Profit or loss on disposal of fixed assets
Profit or loss on sale of fixed asset is not operating cash flow. The entire proceeds of such transactions should be taken as cash inflow from investing activity.
Reporting Cash Flows on Net Basis
Cash flows from the following operating, investing or financing activities may be reported on a net basis:
- Cash receipts and payments on behalf of customers, e.g. cash received and paid by a bank against acceptances and repayment of demand deposits.
- Cash receipts and payments for items in which the turnover is quick, the amounts are large and the maturities are short, e.g. purchase and sale of investments by an investment company.
AS 3 permits financial enterprises to report cash flows on a net basis in the following three circumstances:
- Cash flows on acceptance and repayment of fixed deposits with a fixed maturity date.
- Cash flows on placement and withdrawal deposits from other financial enterprises.
- Cash flows on advances/loans given to customers and repayments received therefrom.
Interest and Dividends
Cash flows from interest and dividends received and paid should each be disclosed separately. Cash flows arising from interest paid and interest and dividends received should be classified as cash flows arising from operating activities.
Cash flows arising from interest paid should be classified as cash flows from financing activities while interest and dividends received should be classified as cash flows from investing activities. Dividends paid should be classified as cash flows from financing activities.
Investing and financing transactions that do not require the use of cash or cash equivalents, e.g. issue of bonus shares, should be excluded from a cash flow statement. Such transactions should be disclosed elsewhere in the financial statements in a way that provides all the relevant information about these investing and financing activities.
The aggregate cash flows arising from acquisitions and disposals of subsidiaries or other business units should be presented separately and classified as cash flow from investing activities.
The cash flows from disposal and acquisition should not be netted off.
An enterprise should disclose, in aggregate, in respect of both acquisition and disposal of subsidiaries or other business units during the period each of the following:
- The total purchase or disposal consideration; and
- The portion of the purchase or disposal consideration discharged by means of cash and cash equivalents.
Exchange Gains and Losses
The foreign currency monetary assets (e.g. balance with bank, debtors etc.) and liabilities (e.g. creditors) are initially recognised by translating them into reporting currency by the rate of exchange transaction date. On the balance sheet date, these are restated using the rate of exchange on the balance sheet date. The difference in values is exchange gain/loss. The exchange gains and losses are recognised in the statement of profit and loss.
The change in cash or cash equivalents due to exchange gains and losses are not cash flows. This being so, the net increases/decreases in cash or cash equivalents in the cash flow statements are stated exclusive of exchange gains and losses.
AS 3 requires an enterprise to disclose the amount of significant cash and cash equivalent balances held by it but not available for its use, together with a commentary by management.
AS 3 encourages disclosure of additional information, relevant for understanding the financial position and liquidity of the enterprise together with a commentary by management. Such information may include:
- 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; and
- The aggregate amount of cash flows required for maintaining operating capacity, e.g. purchase of machinery to replace the old, separately from cash flows that represent increase in operating capacity, e.g. additional machinery purchased to increase production.