ACCT 6010 Advanced Financial Reporting
Class 7: Consolidated Cash Flow
The University of 1
Learning Objectives
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Learning Objectives: After completing this topic, students should be able to
Chapter section(s)
1. Describe and apply the definition of cash in AASB 107
2. Classify cash flows
3. Calculate cash flows using the account reconstruction or equation methods
7.3.3, 7.4.2
4. Evaluate the relative merits of the direct and indirect methods of reporting cash from operations, especially in the group context.
5. Prepare a consolidated statement of cash flows where a subsidiary has been acquired during the period using both the direct and indirect methods.
6. Prepare the required note disclosures, including those relating to the acquisition of a subsidiary.
7.3.2, 7.3.4, 7.4.2
7. Explain how consolidated cash flow information may be useful for economic decision making and performance evaluation.
7.1, 7.2.3
The University of 3
LS Class 7 1
– AASB107 – AASB1054
– Arthuretal.Chapter7(allsections). Course Pack
– Tergesen
– Krishnan and Largay (abstract) – Clinch et. al (abstract)
– Arthur et. al (abstract) Videos
– Cashflowvideo1(CanvasModuleClass7)
– Cashflowvideo2(CanvasModuleClass7) The University of 4
1. Introduction
The demand for cash flow statements
(text reference section 7.1.1)
– Reduction in scope for opportunism? vReferarticle byGordon.
– Early warning sign / guide to solvency?
– May be useful to understand the relationship
between cash flows and profits.
– Indirect method disclosure (face of
statement)
– Footnote reconciliation an Australian requirement if using direct method
The University of 6
LS Class 7 2
1. Introduction
Financial analysis using cash flows
Examples of cash flow ratios – Interest or dividend cover
(CFFO before interest and tax) / interest; CFFO / dividends
– Cash from customers / operating revenue; – Operating cash flow to total liabilities:
Cash flow from continuing operations____ (average current liabilities+ long-term debt)
– Quality of income
– CFFO / Operating income
Provides insight into the utility of a number of ratios
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2. Cash Flows
2.1 What are cash flows? [text reference 7.2.1] Inflows and outflows of cash and cash equivalents.
– Definition of cash
Cash on hand and demand deposits
– Cash equivalents [AASB 107.6]
short-term, highly liquid investments that are:
(i) readily convertible to known amounts of cash; and
(ii) subject to an insignificant risk of changes in value.
– What is short term? Three months or less [AASB 107.7] – Includes certain bank overdraft balances [AASB 107.8]
Ø Refer to the Bluescope Steel Ltd’s annual report disclosures of CCE (Note 15)
The University of 8
LS Class 7 3
2. Classification of Cash Flows
AASB 107.10 [text reference 7.2.2]
Three classifications: [Refer AASB 107.6 for definitions]
i. Operating ii. Investing iii. Financing
– These classifications are mandatory – Sub-classifications are possible
IFRS / US GAAP point of difference
Under US GAAP interest received and paid and dividends received are classified as operating cash flows
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2. Classification of Cash Flows
IASB – Staff paper July 2010
Proposed new cash flow (and SFP) categories
– Operating
– Financing
– Income taxes
– Discontinued Operations
– Multi-category
The University of 10
LS Class 7 4
3. Disclosures
[text reference: 7.2.3]
3.1 Components of Cash and Cash Equivalent (CCE)
Disclose: [AASB 107.45]
(a) Components of CCE; and
(b) Reconciliation of the amount of CCE at the end of the financial
year in the CFS with items in the Statement of Financial Position
vRefer: AASB 107 illustrative example A , Note #3
3.2 Non-Cash Transactions [AASB 107.43]
Disclose (material) non-cash financing and investing transactions
vRefer: AASB 107 illustrative example A , Note #2
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3. Disclosures
3.3 Acquisition of subsidiaries and other business units [AASB 107.39 & 40] [text reference: 7.2.3]
Disclose aggregate: – purchase price;
• proportion of price in cash;
• amounts of cash held by entities acquired;
• amounts of other assets and liabilities acquired summarised by major class.
Ø Refer AASB 107 illustrative example A , Note #1
Ø Bluescope Steel Ltd Annual report – Business Combinations (Note 20)
The University of 12
LS Class 7 5
4. Presentation of Operating Cash Flows [text reference: 7.2.3]
AASB 107 allows use of either direct or indirect method [AASB107.18] – PreviouslyinAustraliathedirectmethodwasmandatory
– IASBDiscussionPaper[Oct2008]:Proposeduseofdirectmethod(only)
4.1 Direct method [AASB 107.18(a)]
– Presentsoperatingcashflowsbydeductinggrossoutflowfromgross
– Australianrequirementthatifusingthedirectmethodmustdisclosea
reconciliation between profit and operating cash flows [AASB 1054.16] 4.1 Indirect method [AASB 107.18(b)]
– Presentsoperatingcashflowsbyremovingfromprofitnon-cashitems,the
changes in accruals and the transactions classified as investing and financing activities. If using direct method, Australian firms must provide a reconciliation of CFO with profit (or loss) [AASB 1054.16]
Ø Refer AASB 107 Appendix A for examples of both methods of disclosure.
Ø Refer to BSL’ CFS – which method is used to disclose cash from operations?
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4.2 Indirect Method [Text reference: 7.3.4]
How to convert profit to cash flow – the reconciliation process: (1) Eliminate non-cash revenues and expenses;
(2) Remove revenues and expenses that are not classified as part of
“operating activities”;
(3) Adjust revenues and expenses to remove the effects of the accrual process:
– Depreciation and other non-cash expenses are added back to profit
– Increases in non-cash current assets result in less cash flow from
operations, so such increases are deducted from profit.
– Decreases in non-cash current assets result in more cash flow from
operations, so such decreases are added back to profit.
– Increases in current liabilities result in more cash flow from operations, so
such increases are added back to profit.
– Decreases in current liabilities result in less cash flow from operations, so
such decreases are deducted from profit.
v Refer to the BSL’s cash flow reconciliation (Note 15).
The University of 14
LS Class 7 6
5. The consolidation issues
[text reference: 7.4]
Acquisition (or disposals) of subsidiaries will require:
– calculation of the cash used or acquired as a result of the acquisition (or disposal); and
– that the balances of the subsidiary acquired (or disposed of) be ‘factored in’ to the calculation of the cash flows when reconstructing notional consolidated ledger accounts.
– Reconciling items that take the form of movement of working capital (accrual) accounts are adjusted for the effects of acquisition (or disposal) of entities during the reporting period.
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5.1 Acquisition of a Subsidiary
Direct cash flow
– Classified as “cash flow from investing activities” – Cash outflow if:
Cash used to purchase subsidiary > cash acquired
– Cash inflow if:
Cash acquired > cash used in purchase
The University of 16
LS Class 7 7
5.1 Acquisition of a Subsidiary (cont.)
Cash used to purchase subsidiary:
=Cash amount (if any) of consideration
Cash acquired:
= Balance of “cash” in subsidiary (at date of acquisition)
[AASB 107.42]
The University of 17
5.1 Acquisition of a Subsidiary (cont.).
Impact on other items in the statement:
Cash flow from operating activities
– Whenreconstructingnotionalconsolidatedaccountsitisnecessary to include adjustments relating to the acquisition of the subsidiary. • Type of ‘double counting problem’
The University of 18
LS Class 7 8
5.1. Acquisition of a Subsidiary (cont.).
E.g., cash receipts from customers
Accounts receivable (X Ltd group)
1/1/20X1 (consolidated) 31/12/20X1 (consolidated) Sales 20X1 (consolidated)
10,000 12,000 55,000
During the 20X1 year the X Ltd group acquired C Ltd.
At the date of acquisition, the accounts receivable balance of C Ltd was $4,000. FV was = $4,000.
Assume no bad debts, no GST.
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5.1 Acquisition of a Subsidiary (cont.).
Questions:
(a) What was the amount of receipts from customers during 20X1 for the GROUP?
– Reconstruct “notional” accounts receivable (consolidated)
(b) What will be the amount of the reconciling item “increase (decrease) in accounts receivable” if using the indirect method or for the reconciliation if using the direct method?
(c) The data does not show ownership interest. Why is this not important?
The University of 20
LS Class 7 9
5.1 Acquisition of a Subsidiary (cont.).
Several ways to look at the cash flows and balances:
CB_REC = OB_REC + sales – receipts +Acq_effect (1)
If using the direct method, rearrange equation (1) to get
Receipts = OB_rec –CB_rec + sales +Acq_effect (1A)
For the indirect method rearrange equation 1 to get:
Sales – Receipts = CB_rec – OB_rec – Acq_effect (1B)
We report as a reconciling item the difference between receipts from customers and revenue.
This is the movement in accounts receivable adjusted for the acquisition:
12- 10- 4 = -2.
A reduction of 2 is added to profit to reconcile to CFO. The University of 21
5.1 Acquisition of a Subsidiary (cont.).
Similarly:
Payments to creditors:
Opening balance
+ liability acquired on acquisition + credit purchases
– cash payments
= Closing balance
[rearrange to get:
payments = OB – CB+ acq_effect + purchases]
The University of 22
LS Class 7 10
5.1 Acquisition of a Subsidiary (cont.).
Investing cash flows
Asset purchases can be calculated from the reconstruction of “notional” consolidated ledger accounts. Using gross asset balances:
Closing balance
– Adjustment on acquisition of subsidiary (assets acquired)
+ Book value of assets sold
– Opening balance (consolidated)
= Purchase cost of assets
Is the adjustment on acquisition of subsidiary based on BV or FV of the assets?
The University of 23
5.1 Acquisition of a Subsidiary (cont.).
e.g., Plant
– Notional consolidated ledger account – Gross
Dr 1/1/09 PLANT (GROSS) 100
Purchase B Ltd 20 120
Sale of plant
Purchase new plant * 110*
The University of Sydney
LS Class 7 11
5.2 Disposal of Subsidiary
Effect on cash flow statement
Inflow of cash on sale of subsidiary =
The University of 25
cash proceeds on sale + bank overdraft of subsidiary
– cash held by subsidiary
In-class activity
ØArthur et al. E7.6 Acquisition of a subsidiary
The University of 26
LS Class 7 12
6. Evaluation of AASB 107
Strengths include:
– Significantnon-cashfinancingandinvestingtransactionsmustbe disclosed;
– Relevance of cash flows supported by empirical evidence.
vRefer for example, Clinch et al. (2002), Arthur et al. (2010)
– Cash flow disclosures have information content.
– Users are able to predict default more accurately with cash flow data.
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6. Evaluation of AASB 107
Some weaknesses:
– Does not require disclosure using the direct method.
v Refer Gordon’s (2002) explanation of the value of the direct method and Krishnan and Largay (2000), who show that direct method cash flow data is a better predictor of future cash flows than indirect method.
– Cash flow is not immune from opportunist manipulation.
v Refer Tergesen’s (2002) exposé of WorldCom’s accounting
– Opportunities to manipulate and reduce the apparent cost of
acquiring subsidiaries because subsidiary’s debt is not also disclosed.
v Refer Reilly (2008)
– Other alternatives proposed – dissection of cash flow into “core’
and ‘non-core’ cash flows.
v and Hollie (2008)
The University of 31
LS Class 7 13
What did you learn? T/F
True or False?
1 . Cash acquired in a business combination is added to the opening balance of cash in a cash flow statement.
2 . When calculating cash collected from customers, the balance of receivables acquired in a business combination is treated consistent with an increase in the opening balance of accounts receivable.
The University of 32
LS Class 7 14
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