Notes on Cash Flow Statements and AS3

Introduction

• New chapter for CA Inter: Cash Flow Statements and AS3
• Medium-level chapter with many adjustments
• Focus on silly basic things to understand adjustments

Scope of Applicability

• Accounting Standard AS3 is mandatory for:
  • All Enterprises except small and medium companies (SMCs).
  • Non-corporate entities divided into three levels:
    • Level 1: Must follow AS3.
    • Level 2 & 3: Exempted.
  • Companies must prepare cash flow statements except for:
    • One-person companies
    • Small companies
    • Dominant companies
    • Private companies (startups are exempted but recommended)
• SEBI mandates listed companies to use the indirect method for cash flow statements.

Concept of Cash Flow Statement

• Cash:
  • Cash includes:
    • Cash in hand
    • Cash at bank
    • Cash equivalents (short-term investments)
• Flow:
  • Refers to cash inflows and outflows.
• Statement:
  • Summary of cash inflows and outflows for a specific period.

Classification of Cash Flow Activities

1. Operating Activities:
   • Revenue-generating activities.
   • Includes receipts/payments related to core business operations.
   • Examples: Cash received from sales, cash paid to suppliers, salaries, rent.
2. Investing Activities:
   • Involves acquiring and disposing of long-term assets.
   • Examples: Purchase/sale of fixed assets, investments in securities.
3. Financing Activities:
   • Involves raising and repaying capital.
   • Examples: Issuing shares, borrowing, paying dividends.

Importance of Cash Flow Statement

• Helps understand how well a company generates and uses cash.
• Important for liquidity and solvency assessments:
  • Liquidity: Ability to meet short-term obligations.
  • Solvency: Ability to meet long-term obligations.

Cash Flow Preparation Methods

• Direct Method:
  • Summarizes cash receipts and payments directly.
• Indirect Method:
  • Starts with net income and adjusts for changes in balance sheet accounts to derive cash from operating activities.

Key Adjustments and Their Treatments

1. Depreciation:
   • Non-cash expense, do not include in cash flow statement.
2. Cash Equivalents:
   • Movements within cash and cash equivalents are not considered cash flows.
3. Investing and Financing Activities:
   • Adjust cash flow statements based on equity and debt transactions.
4. Grants Received:
   • For capital projects: add as investing activity.
   • For revenue expenses: add as operating activity.
5. Interest Paid/Received:
   • Interest paid is financing activity; adjust in operating activities if it impacts profit.
6. Dividends Paid:
   • Cash outflow from financing activities.
7. Bonus Shares:
   • Non-cash transaction, does not appear in cash flow statement.

Conclusion

• Comprehensive understanding of cash flow statements requires grasping the basic concepts and knowing how to classify various transactions.
• Preparation methods should be understood, focusing on the indirect method first before moving to the direct method.
• All adjustments need to be meticulously documented and their impacts understood for correct cash flow reporting.