Cash Flow Statements

 Accounting Standard (AS) 3

 Cash Flow Statements

 (This Accounting  Standard includes paragraphs  set in bold italic type and plain type, which have equal authority.  Paragraphs  in bold italic type indicate  the main principles.  This Accounting  Standard  should be read  in  the  context  of  its  obje ctive  and  the  Gener al  Inst ructions contained  in part A of the Annexure  to the Notification.)

 This Accounting Standard is not mandatory for Small and Medium Sized Companies,  as defined in the Notification.  Such companies are however encouraged to comply with the Standard.

 Objective

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

 The Standard 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.

 Scope

 1.    An enterprise  should  prepare  a cash flow statement  and should present it for each period for which financial statements are presented.

2.    Users of an enterprise’s financial statements are interested in how the enterprise generates and uses cash and cash equivalents. This is the case regardless  of the nature of the enterprise’s  activities  and irrespective  of whether cash can be viewed as the product of the enterprise, as may be the case with a financial enterprise. Enterprises need cash for essentially the same reasons, however different their principal revenue-producing activities might be. They need cash to conduct their operations, to pay their obligations, and to provide returns to their investors.

Benefits of Cash Flow Information

3.    A cash flow statement, when used in conjunction with the other financial statements, provides information that enables users to evaluate the changes in net assets of an enterprise, 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.  Cash flow information is useful in assessing the ability of the enterprise to generate cash and cash equivalents and enables users to develop models to assess and compare  the present  value  of the future  cash  flows  of different enterprises. It also enhances the comparability of the reporting of operating performance  by different  enterprises  because it eliminates  the effects of using different accounting treatments for the same transactions and events.

4.    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.

Definitions

5.    The following  terms are used in this Standard  with the meanings specified:

5.1   Cash comprises  cash on hand and demand deposits with banks.

5.2   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.

5.3   Cash flows are inflows and outflows of cash and cash equivalents.

5.4   Operating  activities  are the principal  revenue-producing  activities of the enterprise  and other  activities  that are not investing  or financing  activities.

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

5.6   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.

Cash and Cash Equivalents

6.    Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For an investment to qualify as a 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. Investments in shares are excluded from cash equivalents unless they are, in substance, cash equivalents; for example, preference shares of a company acquired shortly before their specified redemption date (provided there is only an insignificant risk of failure of the company to repay the amount at maturity).

 7.    Cash flows exclude movements between items that constitute cash or cash equivalents because these components are part of the cash management of an enterprise rather than part of its operating, investing and financing activities. Cash management includes the investment of excess cash in cash equivalents.

 Presentation of a Cash Flow Statement

 8.    The cash flow statement should report cash flows during the period classified  by operating,  investing  and financing  activities.

9.    An enterprise  presents its cash flows from operating,  investing  and financing activities in a manner which is most appropriate to its business. Classification by activity provides information that allows users to assess the impact of those activities on the financial position of the enterprise and the amount of its cash and cash equivalents. This information may also be used to evaluate the relationships among those activities.

10.    A single  transaction  may  include  cash flows  that are classified differently. For example, when the instalment paid in respect of a fixed asset acquired on deferred payment basis includes both interest and loan, the interest element  is classified  under financing  activities  and the loan element  is classified under investing activities.

Operating Activities

11.    The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations of the enterprise have generated sufficient cash flows to maintain the operating capability of the enterprise, pay dividends, repay loans 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.

 12.   Cash flows from operating activities are primarily derived from the principal   revenue-producing   activities   of   the   enterprise.   Therefore, they  generally  result  from  the  transactions  and  other  events  that  enter into the determination of net profit or loss. Examples of cash flows from operating activities are:

(a)    cash receipts from the sale of goods and the rendering of services; 

(b)   cash receipts from royalties, fees, commissions and other revenue; 

(c)    cash payments to suppliers for goods and services;

(d)    cash payments to and on behalf of employees;

(e)    cash receipts and cash payments of an insurance enterprise for premiums and claims, annuities and other policy benefits;

(f)    cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities; and

(g)    cash receipts and payments relating to futures contracts, forward contracts, option contracts and swap contracts when the contracts are held for dealing or trading purposes.

13.    Some transactions, such as the sale of an item of plant, may give rise to a gain or loss which is included in the determination of net profit or loss. However, the cash flows relating to such transactions are cash flows from investing activities.

14.   An enterprise  may hold securities  and loans for dealing or trading purposes, in which case they are similar to inventory acquired specifically for resale. Therefore, cash flows arising from the purchase and sale of dealing or trading securities are classified as operating activities. Similarly, cash advances and loans made by financial enterprises are usually classified as operating activities since they relate to the main revenue-producing activity of that enterprise.

Investing Activities

15.   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. Examples of cash flows arising from investing activities are:

(a)   cash payments  to acquire fixed assets (including  intangibles).These payments include those relating to capitalised research and development costs and self-constructed fixed assets;

(b)   cash receipts from disposal of fixed assets (including intangibles); (c)   cash payments to acquire shares, warrants or debt instruments of other  enterprises  and interests  in joint  ventures  (other  than payments for those instruments considered to be cash equivalents and those held for dealing or trading purposes);

(d)   cash receipts from disposal of shares, warrants or debt instruments of other enterprises  and interests in joint ventures (other than receipts from those instruments considered to be cash equivalents and those held for dealing or trading purposes);

(e)   cash  advances  and loans  made  to third  parties  (other  than advances and loans made by a financial enterprise);

(f)   cash receipts from the repayment of advances and loans made to third  parties  (other  than  advances  and loans  of a financial enterprise);

(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; and

(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.

16.    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.

Financing Activities

17.   The separate disclosure of cash flows arising from financing activities is important because it is useful in predicting claims on future cash flows by providers of funds (both capital and borrowings) to the enterprise. Examples of cash flows arising from financing activities are:

(a)    cash proceeds from issuing shares or other similar instruments; 

(b)    cash proceeds from issuing debentures, loans, notes, bonds, andother short or long-term borrowings; and

(c)    cash repayments of amounts borrowed.

Reporting Cash Flows from Operating Activities

18.   An enterprise  should report cash flows from operating  activities using either:

(a)   the direct method, whereby major classes of gross cash receipts and gross cash payments  are disclosed;  or

(b)    the indirect method, whereby net 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.

19.    The direct  method  provides  information  which  may be useful  in estimating future cash flows and which is not available under the indirect method  and is, therefore,  considered  more appropriate  than the indirect method. Under the direct method, information about major classes of gross cash receipts and gross cash payments may be obtained either:

(a)    from the accounting records of the enterprise; or

(b)    by adjusting sales, cost of sales (interest and similar income and interest expense and similar charges for a financial enterprise) and other items in the statement of profit and loss for:

i)    changes  during the period in inventories  and operating receivables and payables;

ii)    other non-cash items; and

 iii)   other items for which the cash effects  are investing  or financing cash flows.

20.   Under the indirect method, the net cash flow from operating activities is determined by adjusting net 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, and unrealised foreign exchange gains and losses; 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 operating revenues and expenses excluding non-cash items disclosed in the statement of profit and loss and the changes during the period in inventories and operating receivables and payables.

Reporting Cash Flows from Investing and Financing Activities

21.   An enterprise should 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 described  in paragraphs 22 and 24 are reported on a net basis.

Reporting Cash Flows on a Net Basis

22.    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 enterprise; and

(b)    cash receipts and payments  for items in which the turnover is quick, the amounts are large, and the maturities are short.

23.    Examples of cash receipts and payments referred to in paragraph 22(a) are:

(a)    the acceptance and repayment of demand deposits by a bank; 

(b)    funds held for customers by an investment enterprise; and

(c)    rents collected  on behalf of, and paid over to, the owners of properties.

 Examples of cash receipts and payments referred to in paragraph 22(b) are advances made for, and the repayments 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.

24.    Cash  flows  arising  from  each  of the following  activities  of a financial enterprise 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  of deposits  with and withdrawal  of deposits from other financial  enterprises;  and

(c)    cash  advances  an d  l oans  made  to  cu stom ers  and  th e repayment  of those advances  and loans.

Foreign Currency Cash Flows

25.   Cash flows arising from transactions in a foreign currency should be recorded  in an enterprise’s  reporting  currency  by applying  to the foreign  currency  amount  the exchange  rate  between  the reporting currency and the foreign currency at the date of the cash flow. A rate that approximates the actual rate may be used if the result is substantially the same as would arise if the rates at the dates of the cash flows were used.  The  effect  of changes  in exchange  rates  on  cash  and  cash equivalents held in a foreign currency should be reported as a separate part of the reconciliation  of the changes in cash and cash equivalents during the period.

26.   Cash flows denominated in foreign currency are reported in a manner consistent with Accounting Standard (AS) 11, The Effects of Changes in Foreign  Exchange  Rates. This 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.

27.   Unrealised gains and losses arising from changes in foreign 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 cash flow statement 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.

Extraordinary Items

28.   The cash flows associated with extraordinary items should be classified as arising from operating, investing or financing activities as appropriate  and separately  disclosed.

29.    The cash flows associated  with extraordinary  items are disclosed separately as arising from operating, investing or financing activities in the cash flow statement, to enable users to understand their nature and effect on the present and future cash flows of the enterprise. These disclosures are in addition to the separate disclosures of the nature and amount of extraordinary items required by Accounting Standard (AS) 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies.

Interest and Dividends

30.   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  in the case of a financial  enterprise should be classified  as cash flows arising from operating  activities.  In the case of other enterprises, 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.

31.   The total amount of interest paid during the period is disclosed in the cash flow statement whether it has been recognised as an expense in the statement of profit and loss or capitalised in accordance with Accounting Standard (AS) 10, Accounting for Fixed Assets.

32.   Interest paid and interest and dividends received are usually classified as operating  cash flows for a financial  enterprise.  However,  there is no consensus  on the classification  of these cash flows for other enterprises. Some argue that interest paid and interest and dividends received may be classified as operating cash flows because they enter into the determination of net profit or loss. However, it is more appropriate that interest paid and interest and dividends received are classified as financing cash flows and investing cash flows respectively, because they are cost of obtaining financial resources or returns on investments.

33.   Some argue that 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 enterprise to pay dividends out of operating cash flows. However, it is considered more appropriate that dividends paid should be classified as cash flows from financing activities because they are cost of obtaining financial resources.

Taxes on Income

34.    Cash  flows  arising  from  taxes  on income  should  be separately disclosed and should be classified as cash flows from operating activities unless they can be specifically  identified  with financing  and investing activities.

35.   Taxes on income arise on transactions that give rise to cash flows that are classified as operating, investing or financing activities in a cash flow statement. While tax expense may be readily identifiable with investing or financing activities, the related tax cash flows are often impracticable  to identify  and may arise in a different  period from the cash flows of the underlying transactions. Therefore, taxes paid are usually classified as cash flows from operating activities. However, when it is practicable to identify the tax cash flow with an individual transaction that gives rise to cash flows that are classified as investing or financing activities, the tax cash flow is classified as an investing or financing activity as appropriate. When tax cash flow are allocated over more than one class of activity, the total amount of taxes paid is disclosed.

Investments in Subsidiaries, Associates and Joint Ventures

36.   When accounting for an investment in an associate or a subsidiary or a joint venture,  an investor  restricts  its reporting  in the cash flow statement to the cash flows between itself and the investee/joint venture, for example,  cash flows relating  to dividends  and advances.

Acquisitions and Disposals of Subsidiaries and Othe Business Units

37.   The aggregate cash flows arising from acquisitions and from disposals  of subsidiaries  or other business  units should  be presented separately  and classified  as investing  activities.

38.    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:

(a)   the total purchase or disposal consideration;  and

(b)    t he  port ion  o f  t he  pur c h ase  or  di spos al  con s idera tio n discharged  by means of cash and cash equivalents.

39.   The separate presentation of the cash flow effects of acquisitions and disposals of subsidiaries and other business units as single line items helps to distinguish those cash flows from other cash flows. The cash flow effects of disposals are not deducted from those of acquisitions.

Non-cash Transactions

40.    Investing  and financing  transactions  that do not require the use of cash  or cash  equivalents  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.

41.   Many investing and financing activities do not have a direct impact on current cash flows although they do affect the capital and asset structure of an enterprise. The exclusion of non-cash transactions from the cash flow statement is consistent with the objective of a cash flow statement as these items do not involve cash flows in the current period. Examples of non-cash transactions are:

(a)    the acquisition of assets by assuming directly related liabilities; 

(b)    the acquisition of an enterprise by means of issue of shares; and 

(c)    the conversion of debt to equity.

Components of Cash and Cash Equivalents

42.    An enterprise  should  disclose  the components  of cash and cash equivalents and should present a reconciliation of the amounts in its cash flow statement with the equivalent items reported in the balance sheet.

43.   In view of the variety of cash management  practices, an enterprise discloses the policy which it adopts in determining the composition of cash and cash equivalents.

44.   The effect of any change in the policy for determining components of cash and cash equivalents is reported in accordance with Accounting Standard (AS) 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies.

Other Disclosures

45.    An enterprise  should  disclose,  together  with a commentary  by management,  the  amount  of significant  cash  and  cash  equivalent balances held by the enterprise that are not available for use by it.

46.   There are various circumstances  in which cash and cash equivalent balances held by an enterprise are not available  for use by it. Examples include cash and cash equivalent balances held by a branch of the enterprise that operates in a country where exchange controls or other legal restrictions apply as a result of which the balances  are not available  for use by the enterprise.

47.    Additional information may be relevant to users in understanding the financial position and liquidity of an enterprise.  Disclosure  of this information, together with a commentary by management, is encouraged and may include:

(a)    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

(b)    the aggregate amount of cash flows that represent increases in operating  capacity  separately  from those cash flows that are required to maintain operating capacity.

48.    The separate  disclosure  of cash flows that represent  increases  in operating capacity and cash flows that are required to maintain operating capacity is useful in enabling the user to determine whether the enterprise is investing  adequately  in the  maintenance  of its operating  capacity. An enterprise that does not invest adequately in the maintenance of its operating capacity may be prejudicing future profitability for the sake of current liquidity and distributions to owners.