Chapter 7
Statement of cash flows

Chapter 7
Statement of cash flows

1 INTRODUCTION

A statement of cash flows provides useful information about an entity's activities in generating cash to repay debt, distribute dividends or reinvest to maintain or expand operating capacity; about its financing activities, both debt and equity; and about its investing and spending of cash. This information, when combined with information in the rest of the financial statements, is useful in assessing factors that may affect the entity's liquidity, financial flexibility, profitability and risk.

Section 7 – Statement of Cash Flows – is based on the equivalent IFRS standard IAS 7 – Statement of Cash Flows. However a number of the explanatory paragraphs within IAS 7 have not been incorporated into Section 7 of FRS 102.

The statement of cash flows required provides information about the changes in cash and cash equivalents for a reporting period, classifying these between operating activities, investing activities and financing activities. [FRS 102.7.1].

2 COMPARISON BETWEEN SECTION 7 AND IFRS

Apart from the scope exemptions discussed at 2.1 below, Section 7 of FRS 102 is essentially the same as IAS 7. However, a number of the explanatory paragraphs from IAS 7 have been excluded. The paragraphs that have been excluded generally provide further detail, although applying Section 2 – Concepts and Pervasive Principles – could well lead a preparer of the financial statements to the same answer under FRS 102 in most situations. The principal differences are discussed at 2.1 to 2.3 below.

2.1 Entities exempt from preparing a statement of cash flows

There are no exemptions from preparing a statement of cash flows in IAS 7.

In contrast, FRS 102 allows the following entities an exemption from preparing a statement of cash flows:

  • qualifying entities (see Chapter 3);
  • mutual life assurance companies;
  • retirement benefit plans; and
  • investment funds meeting certain conditions. [FRS 102.1.12(b), FRS 102.7.1A].

Additionally, a financial institution that undertakes the business of effecting or carrying out insurance contracts should include the cash flows of their long-term business only to the extent of cash transferred and available to meet the obligations of the company or group as a whole. [FRS 102.7.10E].

A small entity is not required to comply with Section 7 even if it does not apply Section 1A – Small Entities. [FRS 102.7.1B]. However, a small entity may be required to prepare a statement of cash flows by an applicable Statement of Recommended Practice (SORP), for example small charities with gross income exceeding £500,000 are required by the Charities SORP (FRS 102) to prepare a cash flow statement (see Chapter 5 at 7.1). [FRS 102.3.1B].

2.2 Presentation using the indirect method

IAS 7 allows an alternative presentation for the indirect method whereby the net cash flow from operating activities may be presented 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. [IAS 7.20].

This alternative presentation option is not available under Section 7.

2.3 Cash flows of discontinued operations

IFRS 5 – Non-current Assets Held for Sale and Discontinued Operations – requires an entity to disclose the net cash flows attributable to the operating, investing and financing activities of discontinued operations. These disclosures can be presented either on the face of the statement of cash flows or in the notes. Disclosure is not required for disposal groups that are newly acquired subsidiaries which are classified as held for sale on acquisition in accordance with IFRS 5. [IFRS 5.33(c)].

FRS 102 does not contain any requirements to make disclosures in respect of cash flows from discontinued operations. However, aggregate cash flows arising from obtaining or losing control of subsidiaries or other businesses are shown separately within investing activities. [FRS 102.7.10].

3 THE REQUIREMENTS OF SECTION 7 FOR A STATEMENT OF CASH FLOWS

Section 7 specifies how entities report information about the historical changes in cash and cash equivalents and has a relatively flexible approach, which allows them to be applied to all entities including financial institutions. This flexibility can be seen, for example, in the way entities can determine their own policy for the classification of interest and dividend cash flows, provided that they are separately disclosed and this is applied consistently from period to period. Additional disclosure is encouraged where this provides information on an entity's specific circumstances.

3.1 Scope

Section 7 is not mandatory for entities that are ‘qualifying entities’ (see Chapter 3). In substance, this means that most subsidiaries, regardless of the percentage of voting rights controlled within a group, and parents that also prepare publicly available consolidated financial statements, will not need to prepare a statement of cash flows in their individual financial statements. However, a qualifying entity that prepares consolidated financial statements will have to prepare a statement of cash flows in those consolidated financial statements.

The following entities are also not required to produce a statement of cash flows:

  • mutual life assurance companies;
  • retirement benefit plans; or
  • investment funds that meet all of the following conditions:
    • substantially all of the entity's investments are highly liquid;
    • substantially all of the entity's investments are carried at market value; and
    • the entity provides a statement of changes in net assets. [FRS 102.7.1A].

A financial institution that undertakes the business of effecting or carrying out insurance contracts (other than mutual life assurance companies scoped out above) should include the cash flows of their long-term business only to the extent of cash transferred and available to meet obligations of the company or group as a whole. [FRS 102.7.10E].

A small entity is not required to prepare a cash flow statement. [FRS 102.7.1B, FRS 102.1A.7]. This exemption applies even if the small entity does not use the small entities accounting regime in Section 1A. However, a small entity may be required to prepare a statement of cash flows by an applicable SORP, for example, small charities with gross income exceeding £500,000 are required by the Charities SORP (FRS 102) to prepare a cash flow statement (see Chapter 5 at 7.1). [FRS 102.3.1B].

3.2 Terms used by Section 7

The following terms are used in Section 7 with the meanings specified: [FRS 102 Appendix I]

Term Definition
Cash Cash on hand and demand deposits.
Cash equivalents Short term, highly liquid investments that are readily convertible to known amounts of cash and that are subject to an insignificant risk of changes in value.
Cash flows Inflows and outflows of cash and cash equivalents.
Financing activities Activities that result in changes in the size and composition of contributed equity and borrowings of the entity.
Investing activities The acquisition and disposal of long-term assets and other investments not included in cash equivalents.
Operating activities The principal revenue-producing activities of the entity and other activities that are not investing or financing activities.
Statement of cash flows Financial statement that provides information about the changes in cash and cash equivalents of an entity for a period, showing separately changes during the period from operating, investing and financing activities.

3.3 Cash and cash equivalents

Since the purpose of the statement of cash flows is to provide information about changes in cash and cash equivalents, the definitions of cash and cash equivalents given in the Glossary of FRS 102 (see 3.2 above) are essential to its presentation. It is important to understand the reporting entity's cash management policies, especially when considering whether balances should be classified as cash equivalents. Section 7 states that cash equivalents (which may include some short-term investments) are:

  • short-term;
  • highly liquid;
  • readily convertible into known amounts of cash; and
  • subject to an insignificant risk of changes in value. [FRS 102.7.2].

Further guidance is provided on the components of cash equivalents by stating that an investment normally qualifies as a cash equivalent only when it has a short maturity of three months or less from the date of acquisition. Bank overdrafts are normally considered financing activities unless they are repayable on demand and form an integral part of an entity's cash management, in which case they are a component of cash and cash equivalents. [FRS 102.7.2].

In practice, however, determining the components of cash equivalents can be difficult. This is discussed further at 3.3.1 to 3.3.3 below.

An entity must disclose the components of cash and cash equivalents and present a reconciliation of the amounts in the cash flow statement to the equivalent amounts in the balance sheet. [FRS 102.7.20]. This reconciliation is needed because the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (SI 2008/410) (the Regulations) require the separate presentation of cash at bank and in hand on the face of the balance sheet. Banking Entities that apply Schedule 2 formats must include as cash only balances at central banks and loans and advances to banks repayable on demand within cash on the balance sheet. [FRS 102.7.20A].

FRS 102 states that a complete set of financial statements should include in the notes a summary of significant accounting policies, which would include a policy on how the entity determines cash equivalents. [FRS 102.3.17(e)]. These cash equivalents would need to meet the four conditions shown above to qualify as a cash equivalent, namely that they are short term, highly liquid investments that are readily convertible to known amounts of cash and that are subject to an insignificant risk of changes in value.

The effect of any changes in the policy for determining components of cash and cash equivalents, for example, a change in the classification of financial instruments previously considered to be part of an entity's investment portfolio, should be reported under Section 10 – Accounting Policies, Estimates and Errors. [FRS 102.10.11(d)]. This would require comparatives to be restated and additional disclosures given, including the reasons for the change in policy.

On the contrary, if an entity changes the purpose for which it holds certain investments, for example a deposit which was previously held for short term cash management is now held in order to generate an investment return, this would be considered a change in facts and circumstances, which would be accounted for prospectively. In these circumstances, the reclassification out of cash and cash equivalents would appear as a reconciling item in the cash flow statement, rather than as an investing cash outflow.

3.3.1 Short-term investments

As discussed at 3.3 above, 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. Normally only an investment with a short maturity of, say, three months or less from the date of acquisition qualifies as a cash equivalent. Whilst Section 7 does not address the matter, it would seem logical that equity instruments will not normally meet the definition of cash equivalents as they have no maturity date and are usually exposed to a not insignificant risk of changes in value. One exception to this is where an equity instrument is a cash equivalent in substance, such as redeemable preference shares acquired within a short period to their maturity date.

When the standard refers to a ‘known amount of cash’ it means that the amount should be known or determinable at the date on which the investment is acquired. Accordingly, traded commodities, such as gold bullion, would not normally be expected to be cash equivalents because the proceeds to be realised from such commodities is determined at the date of disposal rather than being known or determinable when the investment is made.

3.3.2 Money market funds

Entities commonly invest in money market-type funds (MMF) such as an open-ended mutual fund that invests in money market instruments like certificates of deposit, commercial paper, treasury bills, bankers' acceptances and repurchase agreements. Although there are different types of money market funds, they generally aim to provide investors with a low-risk, low-return investment while preserving the value of the assets and maintaining a high level of liquidity. The question then arises as to whether investments in such funds can be classified as cash equivalents.

As noted below, entities may consider the underlying investments of the fund when assessing the significance of the risk of changes in value, however when determining whether classification as a cash equivalent is appropriate, the unit of account is the investment in the money market fund itself.

In order to meet the definition of a cash equivalent, an investment must be short term; highly liquid; readily convertible to a known amount of cash; and subject to insignificant risk of changes in value. Section 7 considers a maturity date of three months or less from the date of acquisition to be short-term in the context of maturity, however money market funds generally do not have a legal maturity date. However, if the investments are puttable and can be sold back to the fund at any time, they may meet the short term criterion.

Typically, investments in money market funds are redeemed directly with the fund, therefore in assessing liquidity of the investment, focus should be on the liquidity of the fund itself. In making this assessment, entities should consider the nature of any redemption restrictions in place as these may prevent the redemption of the investment in the short term. Alternatively, if a money market fund investment is quoted in an active market, it might be regarded as highly liquid on that basis.

The short-term and highly liquid investment must also be readily convertible into known amounts of cash which are subject to an insignificant risk of changes in value. [FRS 102.7.2].

To determine that the potential change in value of an investment in a money market fund is insignificant, an entity has to be able to conclude that the range of possible returns is very small. This evaluation is first made at the time of acquiring the investment and reassessment is required if the facts and circumstances change. The evaluation will involve consideration of factors such as the maturity of the underlying investments of the fund; the credit rating of the fund; the nature of the investments held by the fund (i.e. their fair values are not subject to volatility); the extent of diversification in the portfolio (which would normally need to be very high); the investment policy of the fund; and any mechanisms by the fund to guarantee returns (for example by reference to short-term money market interest rates).

Investments are often held for purposes other than to act as an integral part of an entity's cash management. It is therefore important, even where the criteria above are met, to understand why the entity has invested in a particular money market fund. Where an investment otherwise satisfies the criteria in paragraph 2 of section 7, but does not form an integral part of an entity's cash management, it should not be classified as a cash equivalent.

Substantial judgement may be required in assessing whether an investment in money market funds can be classified as a cash equivalent. As noted at 3.3 above, entities are required to disclose the policies adopted in determining the composition of cash equivalents and, where relevant, this should include the policy applied and judgements made in classifying investments in money market funds.

3.3.3 Investments with maturities greater than three months

An investment qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition. [FRS 102.7.2]. Therefore, an investment with a term on acquisition of, say, nine months is not reclassified as a cash equivalent from the date on which there is less than three months remaining to its maturity. If such reclassifications were permitted, the statement of cash flows would have to reflect movements between investments and cash equivalents. This would be misleading because no actual cash flows would have occurred.

An entity might justify including in cash equivalents a fixed deposit with an original term longer than three months if it effectively functions like a demand deposit. Typically, a fixed deposit will carry a penalty charge for withdrawal prior to maturity. A penalty will usually indicate that the investment is held for investment purposes rather than for the purpose of meeting short-term cash needs. However, some fixed deposits carry a penalty whereby the entity will forego the higher interest that it would have received if held to maturity, but would still receive interest at a prevailing demand deposit rate. In this case, it may be arguable that there is effectively no significant penalty for early withdrawal, as the entity receives at least the same return that it otherwise would have in a demand deposit arrangement. Where an entity classifies such an investment as a cash equivalent, on the basis that it is held for meeting short-term cash needs, then interest should be accrued on a consistent basis. In this example, the entity should consider accruing interest receivable at the demand deposit rate, thus reflecting their expectation that the deposit will be withdrawn before its maturity date.

3.3.4 Restrictions on the use of cash and cash equivalents

As discussed at 3.13 below, an entity must disclose, together with a commentary by management, the amount of significant cash and cash equivalent balances held by the entity that are not available for use by the entity. [FRS 102.7.21]. The nature of the restriction must be assessed to determine if the balance is ineligible for inclusion in cash equivalents because the restriction results in the investment ceasing to be highly liquid or readily convertible. For example, when an entity covenants to maintain a minimum level of cash or deposits as security for certain short term obligations, and provided that no amounts are required to be designated for that specific purpose, such balances could still be regarded as cash equivalents, albeit subject to restrictions, as part of a policy of managing resources to meet short-term commitments.

However, an entity may be required formally to set aside cash, for example by way of a deposit into an escrow account, as part of a specific project or transaction, such as the acquisition or construction of a property. In such circumstances, it is necessary to consider the terms and conditions relating to the account and the conditions relating to both the entity's and counterparty's access to the funds within it to determine whether it is appropriate for the deposit to be classified as cash equivalents.

3.4 Information to be presented in the statement of cash flows

The statement of cash flows reports inflows and outflows of cash and cash equivalents during the period classified under:

  • operating activities (see 3.5 below);
  • investing activities (see 3.6 below); and
  • financing activities (see 3.7 below). [FRS 102.7.3].

This classification is intended to allow users to assess the impact of these three types of activities on the financial position of the entity and the amount of its cash and cash equivalents. Although the presentation is not required to follow this layout, we would expect it to be followed in practice. Comparative figures are required for all items in the statement of cash flows and the related notes. [FRS 102.3.14].

Section 7 provides no guidance on how to report different types of cash flows arising from a single transaction. However, there is no prohibition on split presentation so, 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 classified as a financing activity.

3.5 Reporting cash flows from operating activities

Operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities. [FRS 102.7.4, Appendix I]. This means that operating is the ‘default’ category, with all cash flows that do not fall within either the investing or financing classifications being automatically deemed to be operating.

Cash flows from operating activities generally result from transactions and other events that enter into the determination of profit or loss. Examples include:

  • cash receipts from the sale of goods and the rendering of services;
  • cash receipts from royalties, fees, commissions and other revenue;
  • cash payments to suppliers for goods and services;
  • cash payments to and on behalf of employees;
  • cash payments or refunds of income tax, unless they are can be specifically identified with financing and investing activities;
  • cash receipts and payments from investments, loans and other contracts held for dealing or trading purposes, which are similar to inventory acquired specifically for resale; and
  • cash advances and loans made by financial institutions. [FRS 102.7.4].

An example of an item that enters into the determination of profit or loss that is not usually an operating cash flow is the proceeds from the sale of property, plant and equipment, which are usually included in cash flows from investing activities. [FRS 102.7.4].

Cash flows from operating activities may be presented using either:

  • the indirect method; or
  • the direct method. [FRS 102.7.7].

FRS 102 does not express a preference for the method to be used.

3.5.1 Indirect method

Under the indirect method, an entity presents a reconciliation determining the net cash flow from operating activities by adjusting a measure of profit or loss disclosed in the statement of comprehensive income (or separate income statement if presented) for the effects of:

  • changes during the period in inventories and operating receivables and payables;
  • non-cash items such as depreciation, provisions, deferred tax, accrued income/(expenses) not yet received/(paid) in cash, unrealised foreign currency gains and losses, undistributed profits of associates, and non-controlling interests; and
  • all other items for which the cash effects relate to investing or financing activities. [FRS 102.7.8].

Prior to the Amendments to FRS 102 Triennial review 2017 – Incremental improvements and clarifications (Triennial review 2017), cash flow statements prepared using the indirect method should have used profit after tax as a starting point.1 While we expect some companies will continue to follow this approach, other measures of profit which appear as subtotals on the income statement, such as operating profit or profit before tax, may be used.

The reconciliation of net cash flows from operating activities may be presented either on the face of the cash flow statement or in a note.2

3.5.2 Direct method

The direct method arrives at the same value for net cash flow from operating activities, but does so by disclosing major classes of gross cash receipts and gross cash payments. Such information may be obtained either:

  • from the accounting records of the entity (essentially based on an analysis of the cash book); or
  • by adjusting sales, cost of sales and other items in the statement of comprehensive income (or income statement if presented) 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. [FRS 102.7.9].

3.6 Reporting cash flows from investing activities

Unless a net presentation is permitted under FRS 102 (see 3.8 below), an entity should present separately major classes of gross cash receipts and gross cash payments arising from investing and financing activities. [FRS 102.7.10].

Investing activities are defined as the acquisition and disposal of long-term assets and other investments not included in cash equivalents. [FRS 102.7.5]. This separate category of cash flows allows users of the financial statements to understand the extent to which expenditures have been made for resources intended to generate future income and cash flows. Cash flows arising from investing activities include:

  • payments to acquire, and receipts from the sale of, property, plant and equipment, intangibles and other long-term assets (including payments relating to capitalised development costs and self-constructed property, plant and equipment);
  • payments to acquire, and receipts from the sale of, equity or debt instruments of other entities and interests in joint ventures, including the net cash flows arising from obtaining or losing control of subsidiaries or other businesses (other than payments and receipts for those instruments considered to be cash equivalents or those held for dealing or trading purposes);
  • advances and loans made to, and repaid by, other parties (other than advances and loans made by a financial institution); and
  • payments for, and receipts from, futures contracts, forward contracts, option contracts and swap contracts, except when the contracts are held for dealing or trading purposes, or the cash flows are classified as financing activities.

When a contract is accounted for as a hedge, an entity should classify the cash flows of the contract in the same manner as the item being hedged. [FRS 102.7.5].

3.7 Reporting cash flows from financing activities

Financing activities are defined as those activities that result in changes in the size and composition of the contributed equity and borrowings of the entity. [FRS 102.7.6].

Cash flows arising from financing activities include:

  • proceeds from issuing shares or other equity instruments;
  • payments to owners to acquire or redeem the entity's shares;
  • proceeds from issuing, and outflows to repay, debentures, loans, notes, bonds, mortgages and other short or long-term borrowings; and
  • payments by a lessee for the reduction of the outstanding liability relating to a finance lease. [FRS 102.7.6].

Major classes of gross receipts and gross payments arising from financing activities should be reported separately, except for those items that are permitted to be reported on a net basis, as discussed at 3.8 below. [FRS 102.7.10].

3.8 Reporting cash flows on a net basis

In general, major classes of gross receipts and gross payments should be reported separately, except to the extent that net presentation is specifically permitted. [FRS 102.7.10]. Operating, investing or financing cash flows may be reported on a net basis if they arise from:

  • cash flows that reflect the activities of customers rather than those of the entity and are thereby made on behalf of customers; or
  • cash flows that relate to items in which the turnover is quick, the amounts are large, and the maturities are short. [FRS 102.7.10A].

Examples of cash receipts and payments that reflect the activities of customers rather than those of the entity include:

  • the acceptance and repayment of demand deposits by a bank;
  • funds held for customers by an investment entity; and
  • rents collected on behalf of, and paid over to, the owners of properties. [FRS 102.7.10B].

Other transactions where the entity is acting as an agent or collector for another party would be included in the category of cash receipts and payments that reflect the activities of the customers rather than those of the entities, such as the treatment of cash receipts and payments relating to concession sales.

Examples of cash receipts and payments in which turnover is quick, the amounts are large and the maturities are short include advances made for and the repayment of:

  • principal amounts relating to credit card customers;
  • the purchase and sale of investments; and
  • other short-term borrowings, such as those with a maturity on draw down of three months or less. [FRS 102.7.10C].

Financial institutions may report certain cash flows on a net basis. [FRS 102.7.10D]. These cash flows are:

  • cash receipts and payments for the acceptance and repayment of deposits with a fixed maturity date;
  • the placement of deposits with and withdrawal of deposits from other financial institutions; and
  • cash advances and loans made to customers and the repayment of those advances and loans. [FRS 102.34.33].

3.9 Foreign currency cash flows

Cash flows arising from transactions in a foreign currency should be reported in the entity's functional currency in the statement of cash flows by applying the exchange rate between the functional currency and the foreign currency at the date of the cash flow or an exchange rate that approximates the actual rate (for example, a weighted average exchange rate for the period). [FRS 102.7.11]. Similarly, the cash flows of a foreign subsidiary should be translated using the exchange rate between the group's presentation currency and the foreign currency of the subsidiary at the date of the cash flow or at an exchange rate that approximates the actual rate. [FRS 102.7.12].

Unrealised gains and losses arising from changes in foreign currency exchange rates are not cash flows. However, to reconcile cash and cash equivalents at the beginning and the end of the period, the effect of exchange rate changes on cash and cash equivalents held or due in a foreign currency must be presented in the statement of cash flows. Therefore, an entity should remeasure cash and cash equivalents held during the reporting period (such as amounts of foreign currency held and foreign currency bank accounts) at period-end exchange rates. The entity should present the resulting unrealised gain or loss separately from cash flows from operating, investing and financing activities. [FRS 102.7.13]. This is illustrated in the example at 3.17 below.

3.10 Interest and dividends

An entity is required to disclose separately cash flows from interest and dividends received and paid, and their classification as either operating, investing or financing activities should be applied in a consistent manner from period to period. [FRS 102.7.14].

Interest paid can either be classified as an operating cash flow (because it is included in profit and loss) or as a financing cash flow because it is a cost of obtaining financial resources.

Interest and dividends received can either be classified as operating cash flows, as they are included in profit and loss, or they may be classified as investing cash flows because they represent returns on investments. [FRS 102.7.15].

Dividends paid can either be classified as a financing cash flow (because they are a cost of obtaining financial resources) or as a component of cash flows from operating activities because they are paid out of operating cash flows. [FRS 102.7.16].

The flexibility in the above paragraphs of Section 7 means that all of these treatments are equally acceptable. Nevertheless, it could be argued that entities which do not include interest or dividends received within revenue should not include interest or dividends in operating cash flows because cash flows from operating activities are primarily derived from the principal revenue-producing activities of the entity. [FRS 102.7.4]. On this basis, interest paid would be a financing cash flow and interest and dividends received classified as investing cash flows. [FRS 102.7.15]. Such entities would also treat dividends paid as a financing cash flow, because they are a cost of obtaining financial resources. [FRS 102.7.16].

3.11 Income tax

Cash flows arising from taxes on income should be separately disclosed within operating cash flows unless they can be specifically identified with investing or financing activities. Where tax cash flows are allocated over more than one class of activity, FRS 102 requires that the total amount of taxes paid be disclosed. [FRS 102.7.17]. It is possible to match elements of tax expense to transactions for which cash flows are classified under investing or financing activities. However, taxes paid are usually classified as cash flows from operating activities because it is often impracticable to match tax cash flows with specific elements of tax expense and because those tax cash flows may arise in a different period from the underlying transaction.

3.12 Non cash transactions

Non-cash transactions only ever appear in a statement of cash flows as adjustments to profit or loss for the period when using the indirect method of presenting cash flows from operating activities (as discussed at 3.5.1 above). Investing and financing transactions that do not involve cash or cash equivalents are always excluded from the statement of cash flows. Disclosure is required elsewhere in the financial statements in order to provide all relevant information about these investing and financing activities. [FRS 102.7.18]. Examples of such non-cash transactions include:

  • acquiring assets by assuming directly related liabilities or by means of a finance lease;
  • issuing equity as consideration for the acquisition of another entity; and
  • the conversion of debt to equity. [FRS 102.7.19].

Asset exchange transactions and the issue of bonus shares out of retained earnings are other examples of investing and financing transactions that do not involve cash or cash equivalents but require disclosure.

3.13 Disclosure of cash and cash equivalents not available for use

The amount of significant cash and cash equivalent balances held by the entity that are not available for use by the entity should be disclosed, together with a commentary by management. [FRS 102.7.21]. These restrictions may be due to foreign exchange controls or legal restrictions.

3.14 Direct cash flows arising from insurance contracts

FRS 103 – Insurance Contracts – requires that, when an insurance entity presents its operating cash flows using the direct method, it should separately disclose cash flows arising from insurance contracts. [FRS 103.4.5(a)].

3.15 Cash flows arising from the exploration of mineral resources

As discussed in Chapter 31 at 3.1, an entity applying FRS 102 which is engaged in the exploration for and/or evaluation of mineral resources must apply IFRS 6 – Exploration for and Evaluation of Mineral Resources. IFRS 6 requires that an entity discloses the amounts of operating and investing cash flows arising from the exploration for and evaluation of mineral resources. [IFRS 6.24(b)].

3.16 Analysis of changes in net debt

The Triennial review 2017 introduced a requirement for entities to disclose an analysis of changes in net debt in the period.

Net debt consists of the borrowings of an entity, together with any related derivatives and obligations under finance leases, less any cash and cash equivalents. [FRS 102 Appendix I].

The analysis should show changes in net debt from the beginning to the end of the reporting period, separately showing those movements resulting from:

  • the cash flows of the entity;
  • the acquisition and disposal of subsidiaries;
  • new finance leases entered into;
  • other non-cash changes; and
  • the recognition of changes in market value and exchange rate movements.

No comparative analysis need be provided for prior periods.

When several balances (or parts thereof) from the statement of financial position have been combined to form the components of opening and closing net debt, sufficient detail should be given to enable users to identify these balances. [FRS 102.7.22].

The example at 3.17 below demonstrates one way in which the analysis of changes in net debt could be provided.

3.17 Example statement of cash flows using the indirect method

The following is an example of a statement of cash flows and related notes prepared using the indirect method.

Group statement of cash flows
20X1 20X0
£000 £000
Net cash (outflow)/inflow from operating activities (859) 3,964
Investing activities
Dividends from joint venture 700 545
Dividends from associates 135 105
Interest received 993 345
Dividends received 200 160
Payments to acquire intangible fixed assets (575) (1,010)
Payments to acquire tangible fixed assets (11,423) (3,110)
Receipts from sales of tangible fixed assets 8,625 2,765
Payments to acquire investments (465) (230)
Receipts from sales of investments 125 –
Proceeds from sale of subsidiary undertaking (net of cash & cash equivalents disposed of) 2,172 –
Purchase of subsidiary undertaking (net of cash & cash equivalents acquired) (270) –
Net cash flow from investing activities 217 (430)
Financing activities
Dividends paid to non-controlling interests (30) (30)
Dividends paid to preference shareholders (175) (175)
Interest paid (973) (1,075)
Interest element of finance lease rental payments (40) (50)
Issue costs on new long-term loans (50) (56)
Issue of ordinary share capital 175 –
Share issue costs (100) –
Purchase of own shares (1,700) –
Share purchase costs (100) –
New long-term loans 4,660 4,500
Repayment of long-term loans (500) –
Repayments of capital element of finance leases and hire purchase contracts (370) (243)
Equity dividends paid (1,431) (1,170)
Net cash flow from financing activities (634) 1,701
(Decrease)/Increase in cash and cash equivalents (1,276) 5,235
Effect of exchange rates on cash and cash equivalents (120) (78)
Cash and cash equivalents at 1 January 7,560 2,403
Cash and cash equivalents at 31 December 6,164 7,560
 
Notes to the statement of cash flows
Reconciliation of profit to net cash (outflow)/inflow from operating activities
20X1 20X0
£000 £000
Group profit for the year before taxation 8,694 7,547
Adjustments to reconcile profit for the year to net cash flow from operating activities
Loss on revaluation of investment properties 350 474
Depreciation and impairment of tangible fixed assets 5,590 2,610
Amortisation of development expenditure 125 40
Amortisation of patents 50 10
Amortisation of goodwill 160 25
Share-based payment 412 492
Difference between pension charge and cash contributions (46) (196)
Increase in provision for maintenance warranties 200 50
Increase in provision for National Insurance contributions on share options 4 4
Provision for maintenance warranties utilised (219) (25)
Deferred government grants released (1,012) (530)
Share of income from associates and joint ventures (2,910) (1,262)
(Profit)/loss on disposal of tangible fixed assets (1,250) 850
Loss on disposal of fixed asset investments 350 –
Loss on sale of discontinued operations 2,037 –
Net finance costs 167 820
Working capital movements
Increase in debtors (4,475) (2,694)
Increase in stocks (4,332) (2,529)
Decrease in creditors (1,917) (389)
Taxation
Corporation tax paid (including advance corporation tax) (2,379) (1,218)
Overseas tax paid (458) (115)
(9,553) (3,583)
Net cash (outflow)/inflow from operating activities (859) 3,964
 
Cash and cash equivalents
Cash and cash equivalents comprise the following;
Group
At At
31 December 31 December
20X1 20X0
£000 £000
Cash at bank and in hand 5,441 69,291
Short-term deposits 1,483 2,039
6,924 11,330
Bank overdrafts (760) (3,770)
Cash and cash equivalents 6,164 7,560
Analysis of changes in net debt
Cash and cash equivalents Bank borrowings Derivatives Net debt
£000 £000 £000 £000
As at 1 January 20X1 7,560 (2,753) (180) 4,627
Cash flows (1,276) (4,160) 224 (5,212)
Interest (406) (34) (440)
Fair value changes and exchange rate movements (120) 357 419 656
As at 31 December 20X1 6,164 (6,962) 429 (369)

4 PRACTICAL ISSUES

4.1 VAT and other taxes

The presentation of VAT and other (non-income) taxes is not addressed in FRS 102 (or IAS 7).

In our view, consistent with the guidance that existed under previous UK GAAP, cash flows should be shown net of VAT and other sales taxes unless the tax is irrecoverable by the reporting entity. The net movement on the amount payable, or receivable from, the taxing authority should be allocated to cash flows from operating activities unless a different treatment is more appropriate to the particular circumstances concerned. Where restrictions apply to the recoverability of such taxes, the irrecoverable amount should be allocated to the expenditures affected by the restrictions. If this is impracticable, the irrecoverable tax should be included under the most appropriate standard heading. [FRS 1.39].

4.2 Cash flows from factoring of trade receivables

Section 7 does not address the classification of cash receipts arising from the factoring of trade receivables. In these circumstances, an entity uses a factoring structure to produce cash flows from trade receivables more quickly than would arise from normal collection from customers, generally by transferring rights over those receivables to a financial institution. In our view, the classification of the cash receipt from the financial institution depends on whether the transfer gives rise to the de-recognition of the trade receivable, or to the continued recognition of the trade receivable and the recognition of a financial liability for the funding received from the debt factor.

Only to the extent that the factoring arrangement results in the de-recognition of the original trade receivable would it be appropriate to regard the cash receipt from factoring in the same way as any other receipt from the sale of goods and rendering of services and classify it in operating activities. [FRS 102.7.4(a)]. In cases where the trade receivable is not derecognised and a liability is recorded, the nature of the arrangement is a borrowing secured against trade receivables and accordingly we believe that the cash receipt from factoring should be treated in the same way as any short-term borrowing and included in financing activities. [FRS 102.7.6(c)]. The later cash inflow from the customer for settlement of the trade receivable would be included in operating cash flows and the reduction in the liability to the financial institution would be a financing outflow. Following the same principle in Section 11 – Basic Financial Instruments – for the disclosure of income and expenditure relating to a transferred asset that continues to be recognised, [FRS 102.11.34], these two amounts would not be netted off in the statement of cash flows. However, it would be acceptable for the entity to disclose the net borrowing receipts from, or repayments to, the financial institution, if it was determined that these relate to advances made for and the repayment of short-term borrowings such as those which have a maturity period of three months or less.(see 3.8 above). [FRS 102.7.10C].

In some cases, the factoring agreement requires customers to remit cash directly to the financial institution. When the transfer does not give rise to de-recognition of the trade receivable, we believe that the later satisfaction of the debt by the customer can be depicted either;

  • as a non-cash transaction. No cash flows would be reported at the time of the ultimate de-recognition of the trade receivable and the related factoring liability; or
  • as a transaction in which the debt factor collects the receivable as agent of the entity and then draws down amounts received in settlement of the entity's liability to the financial institution. In this case the entity would report an operating cash inflow from the customer and a financing cash outflow to the financial institution.

4.3 Acquisition of property, plant and equipment on deferred terms

The purchase of assets on deferred terms can be a complicated area because it may not be clear whether the associated cash flows should be classified under investing activities, as capital expenditure, or within financing activities, as the repayment of borrowings. FRS 102 includes the following requirements:

  • when an entity acquires an asset under a finance lease, the acquisition of the asset is a non-cash transaction; [FRS 102.7.19] and
  • the payments to reduce the outstanding liability relating to a finance lease are financing cash flows. [FRS 102.7.6].

In our view, this distinction should be applied in all cases where financing is provided by the seller of the asset, with the acquisition and financing being treated as a non-cash transaction and disclosed accordingly. Subsequent payments to the seller are then included in financing cash flows. Nevertheless, if the period between acquisition and payment is not significant, the existence of credit terms should not be interpreted as changing the nature of the cash payment from investing to financing. The period between acquisition and payment would be regarded as significant if it gave rise to the seller recognising imputed interest under Section 23 – Revenue. [FRS 102.23.5]. Therefore, the settlement of a short-term payable for the purchase of an asset is an investing cash flow, whereas payments to reduce the liability relating to a finance lease or other financing transactions with the seller for the purchase of an asset should be included in financing cash flows.

4.4 Additional considerations for groups

Section 7 does not distinguish between single entities and groups, and there is no specific guidance as to how an entity should prepare a consolidated statement of cash flows. In the absence of specific requirements, cash inflows and outflows would be treated in the same way as income and expenses under Section 9 – Consolidated and Separate Financial Statements. Applying these principles, the statement of cash flows presented in the consolidated financial statements should reflect only the flows of cash and cash equivalents into and out of the group, i.e. consolidated cash flows are presented as those of a single economic entity. [FRS 102 Appendix I]. As intragroup balances and transactions are eliminated on consolidation, intragroup cash flows (such as payments and receipts for intra-group sales, management charges, dividends, interest and financing arrangements) should also be eliminated. [FRS 102.9.15]. However, dividends paid to non-controlling shareholders in subsidiaries represent an outflow of cash from the perspective of the shareholders in the parent entity. They should, accordingly, be included under cash flows from financing activities or operating activities, in accordance with the entity's determined policy for classification of dividend cash flows (see 3.10 above).

4.4.1 Acquisitions and disposals resulting in an entity obtaining or losing control

The aggregate cash flows arising from obtaining or losing control of subsidiaries or other businesses are shown separately within investing activities. [FRS 102.7.10].

Such amounts should be shown net of cash acquired on acquisition of the subsidiary or disposed of with the subsidiary. [FRS 102.7.5(c)-(d)]. FRS 102 does not explicitly require the disclosure of the cash or overdrafts acquired as part of an acquisition. However, if the cash or overdraft acquired was material it may be regarded as a major class of gross cash receipts or payments and separate presentation would be required.3

4.4.2 Settlement of amounts owed by the acquired entity

A question that sometimes arises is how to treat a payment made by the acquirer to settle amounts owed by a new subsidiary, either to take over a loan that is owed to the vendor by that subsidiary or to extinguish an external borrowing.

Payments made to acquire debt instruments of other entities are normally included under investing activities. [FRS 102.7.5]. Therefore, the payment to the vendor is classified under the same cash flow heading irrespective of whether it is regarded as being part of the purchase consideration or the acquisition of a debt. This presentation can be contrasted with the repayment of debt owed to a third party, such as a bank, by the new subsidiary after the acquisition, using funds provided by the parent, which is a cash outflow from financing activities. [FRS 102.7.6].

4.5 Cash flows in subsidiaries, associates and joint ventures

4.5.1 Dividends from associates and joint ventures

Cash dividends received from equity accounted associates and joint ventures should be classified as operating or investing activities in accordance with the entity's determined policy for other dividends received (see 3.10 above). Where the net cash inflow from operating activities is determined using the indirect method, and the measure of profit used includes the group's share of profits or losses from equity accounted investments, those amounts will appear as a non-cash reconciling item in the reconciliation of cash flows from operating activities (see 3.5.1 above).

4.5.2 Dividend payments to non-controlling interests

Dividends paid to non-controlling interest holders in subsidiaries are included under cash flows from financing activities or operating activities, in accordance with the entity's determined policy for dividends paid (see 3.10 above).

4.5.3 Group treasury arrangements

Some groups adopt treasury arrangements by which cash resources are held centrally, either by the parent entity or by a designated subsidiary. Any excess cash is transferred to the designated group entity. In some cases a subsidiary might not even have its own bank account, with all receipts and payments being made directly from centrally controlled funds. Subsidiaries record an intercompany receivable when otherwise they would have held cash and bank deposits at each period end. A question that arises is whether or not a statement of cash flows should be presented when preparing the separate financial statements of such a subsidiary given that there is no cash or cash equivalents balance held at each period end. In our view, the preparation of the statement of cash flows should be based upon the entity's actual cash flows during the period regardless of cash and cash equivalents balance held at each period end. The cash and cash equivalents may fluctuate from being positive to overdrawn or nil as the subsidiary needs cash to conduct its operations, to pay its obligations and to provide returns to its investors, or sweeps up excess cash to the designated group entity. This approach is consistent with the requirements in Section 3 – Financial Statement Presentation – that all entities should prepare a statement of cash flows which forms an integral part of the financial statements. [FRS 102.3.17].

Where the subsidiary makes net deposits of funds to, or net withdrawals of funds from the designated group entity during the reporting period, a further question arises as to how movements should be presented in the subsidiary's statement of cash flows. Normally these transactions give rise to intercompany balances. Therefore, the net deposits or net withdrawals should be shown as investing activities or financing activities, respectively.

In extremely rare cases the intercompany balances may meet the definition of cash equivalents and be regarded as short-term highly liquid investments that are readily convertible into known amounts of cash and are subject to insignificant risk of changes in value. [FRS 102.7.2]. However, in most cases such funds are transferred to the designated group entity for an indeterminate term and the fact that both the subsidiary and designated group entity are controlled by the parent company makes it difficult to conclude that the subsidiary could demand repayment of amounts deposited independently of the wishes of the parent company.

5 SUMMARY OF GAAP DIFFERENCES

The following table shows the differences between FRS 102 and IFRS.

FRS 102 IFRS
Entities exempt from preparing a cash flow statement
  • Qualifying entities;
  • mutual life assurance companies;
  • retirement benefit plans; and
  • investment funds that meet certain conditions.

In addition, financial institutions that undertake insurance contracts should include cash flows in respect of their long-term business only to the extent of cash transferred and available to meet the obligations of the company or group as a whole.

Small entities are not required to comply with the requirements of Section 7.

 No exemptions available.
Alternative presentation of indirect method Not permitted. Net cash flows from operating activities may be presented by showing revenues and expenses disclosed in the statement of comprehensive income and changes in inventories and operating receivables and payables.
Presentation of cash flows from discontinued operations No specific disclosure requirements. Net cash flows attributable to operating, investing and financing cash flows of discontinued operations should be disclosed.

References

  1. 1 Staff Education Note 1 Cash flow statements (SEN 1), FRC, December 2013, footnote 5.
  2. 2 SEN 1, FRC, December 2013, footnote 4.
  3. 3 SEN 1, FRC, December 2013, p.8.
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