Transcript for:
Understanding Cash Flow Statements and AS3

hi everyone welcome back to sahab Academy today in this video we're going to start this new chapter of CA inter Advanced accounts cash flow statements and we also going to cover as3 okay so understand this chapter is not a difficult chapter I would say it's a medium chapter right because understand in CA intermediate you have lots of adjustments right so you will be able ble to do those adjustment only when you understand the basic silly silly things about this chapter the basic things which you know all the teachers might not teach you and that's what I'm here for I will teach you every silly things that you must know so that you can perfectly answer the questions of cash flow statements okay so that is what we're going to do in this video bit by bit we're going to cover everything and then in the coming videos we'll solve problems right now only the concept the technique the format and all the silly Basics that you must need for this chapter okay that's what we're going to cover so let's start and let's understand cash flow statements now before moving on to the concept of cash flow statement first let's just talk about the scope of applicability because it's very important if you're studying something then you need to know to whom it's applicable to whom this accounting standard is applicable so that's what we are going to understand see as3 says it is mandatory for all Enterprises to follow this accounting standard except small and medium companies smc's and if you're talking about non-corporate then you all know that non-corporate entities are divided into three different levels for applicability of accounting standards level one level two and level three so level two and level three are also Exempted non-corporate entities but level one has to follow they have to apply this accounting standard and as well as non small and medium company okay they also have to prepare but this is what small and medium company these are the ones that are Exempted is that clear fine but what the company's access company's access all the companies must prepare the cash flow statement except 1 person company small company dominant company and private company which is a startup okay only for startup it is Exempted but it is recommended for all of them to prepare cash flow statement is that clear and then sebi talks about listed companies that they have to follow a certain method to prepare cash flow statement don't worry we will learn this method and everything just understand that listed companies have to prepare the cash flow statement by indirect method okay right so this was the scope of applicability is it clear now let's get back to the concept of cash flow statement now see here we have the con concept of cash flow statements it's really simple first you need to know the meaning of each of these three terms properly cash doesn't only mean hard cash it means a box of three things cash in hand and cash at bank or any financial institution and it should be repayable on demand if we go to the bank or that financial institution immediately we should be able to withdraw that into Hard Cash okay and then there is cash equivalent what does that mean it means any short-term investment that is equal to cash is that clear now what does that mean in detail we'll discuss okay so just understand cash doesn't only mean cash it means a box of three things is that clear okay and then what do you mean by flow flow means increase or decrease okay or I can say technically in the language of this chapter uh how cash has been generated and cash has been utilized is that clear how it has been generated and utilized fine that's what flow means changes increase or decrease statement is summary okay so cash flow statement is nothing but a summary of cash flow fine now if you can see over here I have made this diagram of a statement in which I have three colors over here why why three different sections I have made over here because understand in this cash flow statement the cash flows the inflow and the outflow right the receipt and the payment these will be classified into three different activities cash flow from operating activities cash flow from investing activities and cash flow from financing activities we'll study about them in detail right now I'm just giving you an overview and then at last in the cash flow statement what will be there there will be the balance of cash cash balance in the beginning and cash balance at the end okay don't worry I will show you the format everything we'll discuss right now you are just getting an overview so the company will prepare this additional statement along with balance sheet and statement of profit and loss right and it will be given to the users of financial statement for them this is prepared why so that users of financial statements can understand the company better they can understand how company generates and uses the cash okay what's the source of the cash and how this cash has been utilized in the company and they will be able to determine the future requirement of the cash okay and they will also come to know whether the company is able to generate the cash or not right so based on all of this they will be able to make an assessment that's called as liquidity and solvency assessment which is very important now what is this liquidity and solvency assessment understand liquidity means the company has enough cash to pay its short-term expenses it can meet its short-term obligations company can survive okay and solvency means what solvency means you know the company can uh pay its debt when it falls due for example if the company has taken loans company has raised money by issuing loan notes or you know debentures then when they will mature it has to be repaid the money isn't it the loan has to be repaid the debentures needs to be redeemed so if the company's able to do that then that's called the company is solvent if it can't then the company is insolvent is that clear right and you need to understand how important cash is even if the company is earning profit that doesn't mean the company will survive the company is liquid and Company is solvent no even if the company is making profit still the company can go bankrupt why is that so because understand cash is the blood of any business see cash is very important if you want to operate your company you have to pay salaries you have to pay all the utilities bills the overheads the rent electricity bill the fuel expenses the transportation expenses advertisement expenses all these expenses you have to incur right you have to purchase the supplies isn't it then only you'll be able to operate your business and then you have to pay your obligations as as well if you have taken any liabilities any bank loan all those also you have to pay the liabilities whenever they fall due otherwise you know you know they can take your company to the court the credit ARs and all right and then you have to provide return to your investors you have to pay dividend to your shareholders and then you have to uh pay interest to debenture holders if you have raise money through debt isn't it and then you have to expand your company as well you have to purchase non-current asset you have to open new divisions you have to grow your company then only your share price will increase isn't it and you have to make overall profit also to make profit you need cash otherwise you can't run your company believe me okay you must have watched Shark Tank right on there the entrepreneurs they come and they say that they don't have Runway right what does that mean they don't have cash they have just 6 months of Runway left three months of Runway left what does that mean it means they don't have cash right so cash is very important for the company to survive so that is why you know cash flow statement is prepared so that the users of financial statements can see how well the company is performing from the statement of profit and loss the users of financial statement will understand only the profitability of the company not the liquidity of the company the liquidity of the company will be only understood when they see the cash flow statement is the is that clear right let's just take a simple example let's just say you have opened a new shop okay today you started the business let's just say first customer came and you sold let's just say he's your friend only you sold him on credit okay you sold him on credit the goods and let's just say you have made a profit of how much 10,000 rupees okay so let's just say immediately you preparing income statement I mean you're not preparing income statement but imaginary let's just say if you're preparing income statement statement of profit and loss then you finding that on acral basis you have recorded your friend as a what as a receivable and you have recorded the revenue you have got the gross profit then the net profit so the profit is 10,000 rupees so if you open your cash drawer do you have 10,000 over there no you don't have 10,000 10,000 you will receive after a month or so isn't it when your friend will pay you right now you don't have any cash but you have a profit of 10,000 what is that profit that's just book Profit just on acral basis you have to understand statement of profit and loss income statement is prepared on acral basis and cash flow statement is prepared on cash basis so if you prepared your cash flow statement then no cash flow has happened in your business there is no inflow of cash zero cash you have do you understand let just say your father comes and he asks you how much you have earned you will say 10,000 profit I have made I have sold this but you don't have anything to show isn't it you don't have any cash to show to your father right do you understand that's the thing okay so that's why cash flow statement is very important fine now let's understand the meaning of cash in very much detail see here cash means a box of three things cash in hand cash at bank or fi and cash equivalent okay so let's understand this in detail see here cash in hand and demand deposits with bank bank or Fi Fi means financial institution what are these demand deposits as I told you if you have deposited the money in the bank or any financial institution and those are repayable on demand demand deposits which means if you go to the bank right now you should be able to immediately withdraw it and get hard cash so that's called as demand deposits with bank or fi is that clear okay so cash includes these two things and cash equivalent as well what is this cash equivalent you have to look into the as3 how as3 has defined it as3 has said that cash equivalent are nothing but shortterm highly liquid Investments readily convertible into known amount of cash and subject to insignificant risk that's what as3 says and shortterm means the maturity period of those short-term investment should be less than 3 months or less than or equal to 3 months from the date of acquisition is that clear for example you have made a fixed deposit of 2 months fixed deposit of 3 months then that's a cash equivalent why is that so because the definition says that highly liquid investment any time you should be able to you know sell it is that clear and then readily convertible into known amount of cash so you should be able to know the amount that going to fetch in the advance only because you know it should have very little risk it happens in case of government securities there is no fluctuation at all right very low risk is there so that is why you know it is a cash equivalent the government security which have a maturity period of less than or equal to 3 months is that clear these two are the best examples fine you understood cash equivalent also it's really easy okay now let's talk about cash flow you understood what is cash flow right there are two types of cash flow either there is Cash inflow or cash outflow inflow means what money is coming in receipt okay and outflow means money is going out right is that clear of what of cash and cash equivalent of that box we are talking about of that box we are talking about is that clear any transaction which does not result in cash flow should not be reported in the cash flow statement yes understand I told you in the the beginning only cash flow statement is prepared not on acral basis it is prepared on cash basis any transaction which affects the cash balance which causes the inflow or outflow will be shown in cash flow statement and simple funa is there okay simple funa is there remember this it's a golden tip whatever that goes in our cash book okay in cash account or bank account that will also go in cash flow statement remember this whenever if you feel if you are looking at the question and if you feel whether I have to take this or not in the cash flow statement then just think whether it will go in cash or bank account or not if it is yes then you have to take it in cash flow statement as well is that clear okay now depreciation now what is depreciation depreciation is nothing but what decrease in the value of asset right we expense the asset first purchase the asset outflow happen purchase of an asset that's an outflow but in the next years in the following years five or 10 years we are charging the depreciation we are decreasing the value of an asset that just happens in the books isn't it in the income statement we charge that the asset as an expense part by part so it's called depreciation because of that there is no cash flow no cash is decreasing or increasing because of depreciation so depreciation will not come in in the cash flow statement is that clear it is not a part of cash flow is it clear okay so whatever goes into the cash or bank account also goes into the CFS okay cash flow statement and remember another golden tip which you will be able to relate when we'll solve the question and everything remember whole family will sit together in cash flow statement and let me tell you there are three families okay there is operating family investing family and financing family and remember whole family will sit together okay we will relate to this in the you know later Concepts fine and then one more thing that is very important remember I told you cash is a box of three things cash in hand demand deposits with bank or fi and cash equivalent this is a box understand any movement that happens among these three elements is not a cash flow cash flow is money is coming in the business and going out of the business but anything that happens within the cash only is not a cash flow okay if you have purchased any asset then you have paid money to a third party right you have paid money to a third party and that movement is different isn't it but if there is any movement within these three elements for example you have withdrawn cash right so money in your cash draw has increased and in bank it has decreased so the movement is happening within the Box only cash in hand is increasing demand deposit with bank is decreasing right let just say you have deposited cash what happens bank balance increases and then cash drawer balance decreases so movement is happening within the Box these movements will not be tracked by the cash flow statement okay if you have purchased any asset if you have paid dividend if you have received rent income if you have paid rent these are the transaction which will be recorded in cash flow statement not this okay not the movement within the Box movement within the box is irrelevant is that clear because it's cash only we have it with us is that clear if you have purchased any cash equivalent still you are paying the money to the third party but still understand cash in hand is decreasing cash equivalent is increasing isn't it so movement is happening over here only increase decrease decrease increase within the box it's irrelevant is is that clear this will not be recorded this is not a cash flow okay so you have to understand what is a cash flow cash flow is inflow and outflow receipt and payment of cash and cash equivalent something that should happen outside this box is that clear simple now let's understand classification of cash flows now see here we have the classification of cash flows the cash flows are classified into operating activities investing activities and and financing activity okay these three different categories are there now why do we have these three different categories see it's really simple in the beginning only I told you that see whatever that impacts the cash whatever transaction or event that impacts the cash which causes the cash flow receipt or payment then we have to report that transaction in the cash flow statement right so just visualize how many transaction will be there so many trans actions right so that is why if we just list them out plus minus plus minus plus as the inflow and minus as the outflow then it would not make much more sense to the users of financial statements it'll be same like cash or bank account so that is why they thought you know that we should organize the cash flow statement into three different sections or informally I call them as three different families operating family investing family and financing family right and that's how all the cash flows will be classified so as you can see we have three different categories right three different families I call them operating activities investing activities and financing activities so first you have to understand what each of these activities mean okay then only you'll be able to classify properly the transactions in which activity they fall in because that's very important okay so let's see first we have operating activities operating activities means the activities which are main Revenue generating activities of an Enterprise okay whatever receipts and payments happen to generate the revenue to do the main operation of the company those are operating activities that's number one and then the second thing is you have to understand whatever transaction which affects the cash and doesn't fall into these two categories which doesn't fall into investing and financing then automatically that becomes operating activity cash flow from operating activity is that clear simple so now let's just see certain examples and you'll understand see here sale of goods and services this is main activity of the business selling goods and services yeah generating Revenue so that would be an operating activity if you have received any fees royalties commission that will also be an operating activity okay and then if you are purchasing of course you will purchase right paid to suppliers of goods and services that would also be an operating activity so whatever that is main operation of the business and whatever that is related with that that would be an operating activity to run the company what you have to do you have to pay the rent you have to pay the electricity you have to pay the salaries and wages yeah all the employee benefit expenses all these are what operating expenses which will be operating activity okay any cash flow happens because of this whether money has been received or paid related with this it will be operating activity you have paid income tax to the government or you have got refund from the government then that will also be what operating activity is that clear is it simple but then there are certain taxes which are related with other activities for example if you sell a long-term asset right a building and this transaction selling a long-term asset a PPE is called as what investing activity let me tell you so the tax which you pay on that the gain which you have made yeah long-term capital gain tax that will also be called as investing activity now you'll wonder why income tax is operating activity why not that long-term capital gain tax also you have to understand I told you in the golden tip that the whole family sits together long-term capital gain tax is related with the transaction that is of investing so long capital gain tax is also of that same family they are related is that clear that's how you have to see things whatever is related it becomes a family and it's of investing in this case is that clear the whole family will sit together the sale of building is investing activity the tax that is paid that's also investing activity is it clear okay so you understood operating activity and then it will become more clear to you okay now investing activity what is investing activity see any outflows to acquire resources yeah assets for generating future cash flows and incomes are called as investing activity for example you have purchased a building you have sold a building you have purchased shares of any other company you have purchased debentures of any other company bonds of any other company you're investing the money over here so if you're investing then obviously you will generate income in future isn't it either you will sell it right that's different but that's also investing activity and you will generate income also isn't it if you have purchased a building and just rented it out then what happens you will get rent so that rent received is an investing activity because it's related with the building is that clear similarly if you have invested in Securities and shares you will get what you'll get interest and dividend so that is also investing activity dividend received interest received is that clear see here why is that so because they are of the same family if you're investing in shares and that is investing activity then on those shares if you're getting dividend that is of the same family the whole family will sit together that's also investing activity is that clear simple and then we have financing activity financing activity means anything that is related with the capitals and borrowings if you have issued any Equity shares if you have bought brought back any Equity shares then that's financing activity yeah because of this cash flow happens you know right when we issue Equity shares what happens we get money when we buy back shares what happens we have to pay money and that to very extra money right very premium we have to pay and then bonus issue is bonus issue of financing activity tell me no why not because in bonus issue we do not receive any money there is no cash flow in bonus issue what happens we just convert reserves into shares right so it's just a book entry we just convert the reserves into uh this thing shares there is no cash flow so bonus issue will not come under cash flow statement is that clear right and then issue and Redemption of debentures or bonds is also a financing activity okay because we are raising Finance through debt and if you're are repaying that that is also a financing activity and then bank loan if you have taken any bank loan then that's also a financing activity because we get money right we get get Finance from the bank and then we have to repay that also so repayment of bank loan will also be financing activity Now understand if we are issuing shares what we have to do we have to pay dividends so that is that is related so that would also be financing activity the whole family sits together and then if we are issuing debentures or bonds then on those debentures and bonds we must pay interest every year you all know this right we have to pay the interest so that interest paid will also be financing activity is that clear simple so that's the thing and then on the bank loan also we'll have to pay the interest is it clear simple so these are what financing activity now let me tell you for example let's just say we have given a loan to our employee we have given loan to our employee then what is that if we have provided a loan to our employee then you have to understand employee is related with operating isn't it the salaries we pay he's related with operating isn't it the employee so the loan that we give to the employee advance that is given to employee yeah the loan that is also operating activity you might think it is investing activity because you know we are lending the money normally if we lend the money to any third party for example our subsidiaries then that would become investing activity because we have given a loan and then we'll earn interest right so that's investing activity but if we give loan to the people who are related with our operation the employees right the datar the what do you say uh the suppliers then it would be related with operating activity is it clear because those people are related with operations fine so that's the thing so you understood this now all these example which I gave you these are for nonfinancial Enterprise for non-financial Enterprise normal company there are companies which deals in financial products right Banks nbfcs right investment management company hedge funds all these are what Financial Enterprises so for them the examples are different but this thing is same only the meaning of operating activity investing activity and financing activity will be same but the examples are not this examples will be different okay so let's understand about uh the financial Enterprises okay so see here the first thing is you have to understand if you see any question then always assume in the question you have got non-financial Enterprise a normal company but if they specifically mention it is a financial Enterprise then only you have to solve according to that okay so now see here I wanted to explain you this treatment of interest and dividends just now we saw saw that interest received is investing activity interest paid is financing activity dividend received is investing activity and dividend paid is financing activity isn't it see here interested dividend received we are getting it because we have invested so it's investing activity okay and then interest paid and dividend paid is financing activity because we have raised the finance so we are paying the interest we are paying the dividend is that clear these are for non-financial Enterprise yeah that's what I have written over here interest receive investing dividend receive investing interest paid dividend paid financing financing clear but when it comes to financial Enterprise whose main business is just taking the loan giving the loan buying the shares selling the shares right like investment management company Banks nbfcs etc for them for them interest receive means it's a normal thing okay it's a normal thing so that would be operating activity it's related with their operation only that's the main item in which they dealing the financial products the financial assets right so interest paid operating activity dividend received operating activity okay just the dividend paid will be financing for financial Enterprise also okay dividend paid will be same only because these companies will also issue Equity shares and they will raise Finance so on that Finance they are paying dividend that's financing activity only is that clear okay there is no change in that this can't be operating this will be financing only just remember that dividend paid will always be financing but interest received interest paid dividend received these three things can become operating if we have a financial Enterprise is it clear simple so see here unless otherwise stated in the question always assume in the question you have got non-financial Enterprise is it clear now see here let me just show you some more cash flows about the uh Financial Enterprise see for financial Enterprise the following cash flows for example let just say Bank okay the following cash flows will be part of operating activities what cash flows loan that is given to the customer yeah the loan Advan to the customer will be a operating activity because for Bank it is their operation that's the main you know product in which they dealing isn't it giving the loan and then you know getting the loan back earning the interest so loan repaid by customer that's also an operating activity fine and then the deposit which they accept and they repay that's also an operating activity so because of this cash flow is happening right so in cash flow these transaction has to be classified under operating activity is that clear and interest paid and received as I said over there only yeah interest paid and interest received will be operating operating only clear and dividend received will will be also operating but dividend paid will be financing is it clear you understood this simple right treatment of interest and dividend so you have understood right now how we have to classify the cash flows yeah now let's just see the methods of preparing cash flow statement now see here we have methods of preparing cash flow statement it's really simple we have two methods direct method and indirect method and believe me both of them are same only it's just that in indirect method only small difference is there that is cash flow from operating activities will be computed in a different way that's all rest everything is same only the entire format is same just operating activity you know it can be calculated by way of direct method or by way of indirect method is that clear rest investing activity and financing activity will be calculated with the direct method only here also here also is that clear so the entire format and everything is same it's just the format differs in case of operating activity is that clear so that is why what we're going to do is we going to just focus on the direct method first and then we'll move on to the indirect method okay so see what is direct method direct method is really simple it's also known as pick and drop method why pick and drop see in the question they will give you gross receipts and gross payments basically a summary of cash account in cash account what will be there there will be lots and lots of individual chronological transaction right so from that we can't make cash flow statement it'll be very difficult so the question will give you gross receipt and gross payment how much tax we have paid how much rent we have paid how much operating expenses we have paid right and then they will tell you uh how much cash we have received from our dears how much cash we have paid to our suppliers all these information will be given to you you have to just look into that summary and identify where those gross receipts and payments will go will it go in operating will it go in investing will it go in financing right rent paid it will go in operating rent received it'll go in investing okay like that you have to just classify and over okay and then at last what you will do you will add up all the cash flows from these activities you will get net increase or decrease and then you will take what opening balance of cash and cash equivalence and then closing balance of cash and cash equ Valance don't worry we'll see the format you'll understand it's really simple okay nothing is there indirect method the problem comes in indirect method only because operating activities will be calculated in a different way but that also we will solve by studying very Basics and everything right okay so now see here let me just show you the steps involved in the preparation of cash flow statement see first what we need to do is we need to calculate the cash flow from operating activities right this figure this figure can be positive as well as negative okay if it is positive that means we have received this much money from operating activities if it is negative that means that much money has been used because of operating activities okay and this figure this first figure for this only there is the method direct method or indirect method rest these steps are same whether the question tell you solve through direct method or indirect method Step 2 3 4 5 6 will remain same only there is no difference the direct method or indirect method only for the calculation of cash flow from operating activities is it clear is that clear to you simple okay so the same way in the step two you will calculate the cash flow from investing activities but here only direct method pick and drop that's all for financing activities also the same way pick and draw okay cash flow from financing activities and here also the answers can be negative as well as positive these figures positive means we have generated cash okay we have earned cash we have received cash and if it is negative means the cash has been utilized is that clear that much cash has been utilized is that clear so these are net cash flows okay net cash flow from financing activity and then you will add all these three up for example let just say let just say 100 100 100 okay positive so that's equal to 300 what is this step four calculate the net increase or decrease in cash and cash equivalence I told you from operating we have got 100 rupees from investing we have got 100 rupees from financing we have got 100 rupees so in total in this current year what you have got you have got 300 rupees that's the interpretation simple interpretation 300 increase has happened because of the cash flows okay 300 rupees you have received if this is negative then it's called decrease this much money we have lost in the current year in net in net this much money we have utilized okay that's what it means so let's just say 300 positive is there over here then what you will take over here calculate the cash and cash equivalent at the beginning of the period it will be given to you in the question you will take it let just say you had 500 cash in the beginning of the year on the first day of the year so 300 you have earned in the current year 500 you had from the beginning right right so the closing balance will be how much 300 + 500 the closing balance will be 800 is that clear 300 you have received in net I'm talking about and 500 you had from the beginning so 800 you have at last and this 800 will be mostly given in the question the closing balance of cash and cash equivalence so you'll be able to verify your answer whether at last your figure is coming right or wrong okay and then you can also some do some adjust if let's just say the answer is not matching up then you'll come to know you have made a mistake and you will see you will check again and you'll come to know okay this was not supposed to go like this and all and you'll be able to you know modify your answer is that clear this is how it is this is how you have to prepare the cash flow statement it doesn't matter whether it's direct or indirect that matters only for operating activities only this figure calculation okay is that clear so this is the universal mini format of cash flow statement is that clear simple okay 300 then you'll add this it will become this step four plus step five step four plus step five that's equal to step six clear simple now let's see the actual format of the direct method now see here we have the actual format of cash flow statement under direct method okay so what did I tell you it's nothing but pick and drop method right so see here first we'll start from operating activities okay this is the order cash flow from operating activities first what you will take cash received from sale of goods really simple it will given to you in the question just take it right cash received from trade receivables that means from dears how much money you have received so that will come over here the first one is Cash sales the second one is of the credit sales how much money you have received and then the third one is Cash received from sale of services okay that's the same thing I mean sale of goods sale of services same thing clear okay and then you know you will subtract all the payments that you are making pay for cash purchases so whatever money that you have paid to purchase the goods on cash basis that you will take and then payment to trade payables let just say you have purchased from your supplier on credit and now you're making the payment then that's called payment to trade payables right and then payment for operating expenses so whatever operating expenses you pay such as rent paid electricity paid yeah and then uh advertisement expenses salaries paid any employee benefit expenses all these are what operating expens expenses telephone bill so all these are you know operating expenses is that clear in the bracket I have given certain examples over there so understand okay in cash flow statement what you will do you have only two things over here either you have inflow or you have outflow so just remember the Golden Rule if it is inflow you will add if it is outflow then you will subtract is that clear that's what you have to do simply so see here inflow I have added and outflow I have to subtract Okay so I'm taking first in the inner column and then I will add it up and take it in outer column as a negative and subtract from the above figure is it clear simple okay then see payment for wages and salaries income tax paid I've told you income tax is what income tax is an operating activity right and any refund also you got that's also an operating activity so what are we going to do is in the format when we take the income tax let just say for example income tax paid is let just say 100,000 1 lakh okay 1 lakh but let's just say we have got refund of 10,000 so how much you will take over here will you take 1 lakh no you will take 90,000 1 lakh minus refund 1 lakh minus refund 10,000 that's equal to 90,000 990,000 figure you will take because that's the net income tax you have paid okay you will take a net figure is it clear let just say for example 10,000 tax you have paid and 2,000 rupes you have got refund so you will take 8,000 ,000 over here is it clear simple income tax paid is a uh cash flow from operating activity fine so let just see the above figure is let just say 50,000 over here and all these less is equal to 30,000 so 50,000 minus 30,000 that's equal to 20,000 that would be called as you know net cash uh from operating activities is it clear but if there are any extraordinary items let's just say for example you have received Insurance claim from you know insurance company on account of loss of goods by fire loss of goods by fire or stock by fire then that's an extraordinary item which is related with operating activity goods are operating activity isn't it yeah and then any proceed like just say you haveed from earthquake disaster settlement that's also uh what do you say related with operating activity so you will you know add or subtract based on what it is if it is leg just say receipt then you will add if it is payment then you will subtract I told you know the golden rule is if it is inflow you have to add if it is outflow then you have to subtract is it clear this is how you have to do it okay 1,000 leges proceeds you have received from earthquake disaster settlement so you will add 20,000 + 1 that's equal to 21,000 net cash from operating activities you have got a positive figure that means because of operation our company in net has received this much cash 21,000 is it clear if it was negative then we say net cash used in operating activity is it clear this is how you have to write it fine okay now after this operating activities is over now we'll move on to the cash flow from investing activity now cash flow from investing activity what will come over here we have already discussed purchase and sale of fixed assets right purchase of fixed asset and then if you selling the fixed asset then sale value you will take remember that you have to take whatever that is affecting the cash how much cash we receive how much cash we've paid that's what matters okay you will not take cost of fixed asset you have to take Cost Plus The Profit which you have earned or you have to if you have incurred a loss then you have to subtract the loss so that is how you have to take you have to take the sale value and then see purchase of long-term investment yeah sale of long-term investment interest which you have received dividend which you have received all this is investing activity isn't it you getting interest you're getting dividend because you invested you're getting rental income because you purchased a flat or a building like that is it clear that's how it is fine and then you will add up all of this okay and here see purchase is there purchases will be negative so that you will have to subtract is it clear inflow will be added outflow will be subtracted as simple as that and then see the figure will come over here net cash from or used if it is positive that means we have generated you can also say net cash generated or net cash from investing activities if it is negative net cash used in investing activities is it clear right and then after this you have to do the financing activities see here cash flow from financing activities you have to write the heading and you have to go on taking whatever cash flows you have related with financing activities proceeds from issuance of share Capital yeah you are issuing the shares you'll be receiving the money so that's a plus proceeds from long-term borrowings you have issued debentures so you will plus over here repayment of long-term borrowing let just say you have redeemed some debentures which are maturing this year so that will be uh what do you say subtracted over here like just say you have repaid some loan this year then that will also be subtracted over here because that's an outflow Redemption of preference shares outflow so that will be subtracted over here if you have issued preference Shar that will be added buyb of shares again outflow it will be subtracted interest paid outflow you have to subtract dividend paid outflow you have to subtract is that clear that's how you have to do it's really simple it's not difficult fine and then you will add up all of that that will become net cash from or used in financing activities if it's positive then it's from if it is negative that means that much money has been utilized in net by financing activities is it clear that's the inter interpretation and then finally what you will do finally see here you will add up this net cash from operating activities net cash flow from investing activities and net cash flow from financing activities a okay see here A plus b plus C all these three figures net cash you have to add and you have to take it over here let's just say for example 10,000 10,000 10,000 are there okay so net increase will come in cash and cash equivalent 30,000 I explained in the mini format here the same thing is happening that same thing you have to do okay net increase if it is negative then we call it as net decrease in cash and cash equivalent in the current year this much increase or decrease happened and then you will take the opening balance of cash and cash equivalent which will be given to you or maybe you might have to calculate that okay if it's not given it can happen but it will be very simple don't worry when you'll solve the problem you'll understand all that okay and then cash and cash equivalent at the end of the period you have to take in the current year I just told you 30,000 you know increase has happened let just say in the beginning there was 10,000 cash balance so 30 + 10 that's equal to 40,000 so closing balance will be 40,000 and if you'll see in the balance sheet which is given to you or the information that is given to you there you will find the ending balance mostly will be given to you so you can confirm and verify your answer okay but still you can make mistake okay even if you verify this because you might you know uh just Shuffle the things from one activity to another activity and overall the net effect will be same only so that can also happen so you have to be careful while preparing the cash flow statement don't worry when you'll practice lots of some you'll get better first you need the concept Clarity concept Clarity understanding and the silly Basics okay that's why people mess up in this uh cash flow statement because they mess up the basics okay so do you understand this direct method format if you have any doubt in this format please ask just take a screenshot and you know message me in Instagram okay so this is the direct method okay operating activities investing activities and then here you have financing activities and here what you do you take net increase decrease opening balance of cash and closing balance of cash that's all that's what a cash flow statement is now in indirect method what will happen in indirect method let me tell you this will remain the same the same format this is also same format no change at all this also same format no change at all the only change will be this okay operating activity will be computed in a different way from profit will go to you know cash flow from operating activities okay backward calculation will happen in case of indirect method indirectly we will go to the cash flow from operating activities so let's understand now the indirect method now see here we have our second method of preparing cash flow statement it's really simple believe me it's not difficult it seems complicated because it is little bit lengthy and we are calculating from a different way okay but don't worry we'll go slow we'll understand bit by bit everything and believe me at the end of this video you will feel how simple this method is okay so how and what will happen in this indirect method see in this indirect method we are going to calculate cash flow from operating activities in a different way that's all rest investing activities and financing activities the same way pick and drop method direct method only okay so if I show you the mini format yeah which I have shown you earlier I've told you in the indirect method only this first step yeah this figure will be calculated by way of indirect method a different way rest everything Step 2 3 4 5 6 remain the same the same way you have to do as what we have seen in the direct method is that clear pick and drop for the investing and financing activi and then here net increase or decrease opening balance closing balance is that clear no difference at all if you see the detailed format of direct method see investing activities the same format financing activities the same format this also same just operating activities will be done differently is that clear so now let's understand how we are going to calculate the cash flow from operating activities in a different way see here we are going to start from the profit figure from profit it we are going to reach to cash flow from operating activities but how that will happen that's the entire game and that's what I'm going to teach you what are the steps that you need to follow so that your profit will get converted into cash flow from operating activities you just have to add something and you have to subtract something okay so now understand in the question what will happen is you'll not just have a single profit okay in different questions a different sort of profit will be given to you what does that mean different sort of profit it means there are three different types of profit there is net profit before tax there is net profit after tax there is profit after all the adjustment and appropriation okay which is called as retain profit or the reserves and surplus figure right that's what it is fine so you see over here profit can be of three types net profit before tax net profit after tax or retained earnings any one of these will be given to you in the question you have to understand if net profit before tax is given then your work becomes easier yeah your solution becomes easier so first priority we give it to net profit before tax but if that's not available in the question you have to look for net profit after tax whether that's available if it's available then good if it's not available then lastly there must be retained earnings given in the question okay they might say profit after after all adjustment you have to understand they are talking about retained earnings okay or maybe they will not say that also they will just give you the balance sheet and opening balance of pnl and closing balance of pnl so what you're going to do you are going to calculate the retained earnings simply by taking closing balance minus opening balance okay closing balance minus opening balance and you will get how much profit you have earned in the current year after all adjustment and you know appropri creation okay that's what you will get retained earnings is it clear fine this will be the formula you'll be applying it's really simple when we'll solve the question you will understand and you'll see how we do that right okay so that is what is indirect method from profit we going to go to cash flow from operating activities fine and for investing and financing activities as I said the same direct method is there nothing different okay the same way you have to do it as we have seen the direct method format right so this is what is indirect method now you have to understand see how we have calculated this profit yeah from where do we get this profit we get this from statement of profit and loss or profit and loss account isn't it yes so you have to understand in statement of profit and loss you know you know it's prepared on acral basis statement of profit and loss is prepared on acral basis that means it includes cash items as well as non-cash items for example depreciation is a non-cash item yeah it is debited to statement of profit and loss what does that mean debited to statement of profit and loss it means you know debited means subtracted in profit and loss okay it's an expense right depreciation it is subtracted in statement of profit and loss to calculate profit or loss yes debited means subtracted credited means added in the language of statement of profit and loss is it clear okay and cash items are also included in statement of profit and loss for example the rent you have received it's a cash item interest you have received it's a cash item right for example let just say rent you have paid it's a cash item dividend you have received it's a cash item do you understand this all these items have gone in statement of profit and loss cash item as well as non-cash item whereas in cash flow statement what do we do I've told you in cash flow statement only those items will go which causes the cash flow right I have given you the golden tip whatever that goes in the cash or bank account also goes in the cash flow statement cash flow statement is prepared on the cash basis the entire game is on the cash okay so here depreciation will not go right depreciation will not go in cash flow statement bonus issue will not go over here why not because it is not causing any cash flow there is no inflow or outflow because of bonus issue because of depreciation uh for example preliminary expenses return off all these are non-cash items do you you understand this this is the difference so if you want to go from profit to cash flow from operating activities then what you have to do just think just visualize just think what you have to do whatever non-cash items are there those non-cash items should be eliminated so that we can reach to cash flow from operating activities do you understand this okay is it clear yes we have to change from approval basis to cash basis so we have to make those changes whatever non-cash items are there we have to eliminate that we have to reverse that but let me ask you how you will reverse how you will reverse it's really simple to reverse what you have to do first you have to see whether it is debited or credited in profit and loss account in statement of profit and loss debited means subtracted credited means added this is what has happened previously in cash flow statement you want a reverse so you will just do opposite you will just do opposite whatever that is subtracted you will add whatever that is you know added credited you will subtract is that clear just reversal you will have to do of noncash items fine okay then one more thing understand in profit and loss statement everything has gone do you understand this in profit and loss statement to calculate the profit or loss for the year what have we done profit or loss is of the whole company so all the items have gone into that by all the items I mean items relating with operation items relating with investing items relating with financing all the items have gone in the income statement see interest received dividend received is related with what it is related with investing activities it is related with investing activities but when we prepared income statement when we paid statement of profit and loss we took the interest received dividend received rent received all in the statement of profit and loss right but that is not of operating activity that is of investing activity while preparing investing activity we'll do pick and drop and we will take interest receive dividend received directly here okay cash flow from investing activity in that format but in this conversion what we need to do already inter received dividend received is there over here so what we have to do we have to reverse that also we have to reverse that also understand interest received dividend received rent received these are indirect incomes and of nonoperating these are of investing family Outsiders our family is this only this is the operating family right so Outsiders are there these are The Outsiders which are sitting in the income statement we have to convert that so we will eliminate these Outsiders we are going to kick this Outsiders yeah who are these interest received dividend received rent received right so we are going to eliminate them we are going to reverse them how how how are we going to do that tell me how are we going to do that simple these are incomes which were credited in statement of profit and loss yeah they were added these are incomes so if you want to eliminate I've told you whatever is credited in income statement in profit and loss that means it was added to reverse you have to subtract in cash flow is that clear that is what you will have to do so I explained you just now two things the first is I explained you reversal of non-cash whatever that is non-cash reverse that whatever that is you know of nonoperating nonoperating you have to eliminate that they are not of our family they are not of operating family they are of investing family maybe fin financing family so we have to just kick them out from the profit figure that's what we have to do then only we will be able to reach to cash flow from operating activities is it clear okay so see here let me just show you more differences between statement of profit and loss and cash flow statement see in statement of profit and loss see only Revenue nature items will come income and expenses that's all in statement of profit and loss what do we take we take only Revenue nature items the incomes of the current year and the expenses of the current year isn't it yes but in the cash flow statement it's not like that we don't just take income and expenses we take everything all the elements of financial statements we take asset liability equity income and expense whatever that impacts the cash isn't it you just don't take you know uh what do you say advertising paid or rent paid or salary paid no if we have issued Equity shares and we are receiving money that also goes over here that's an equity right that also goes in cash flow statement if you have redeemed any liability that also comes over here right everything comes over here in cash flow statement whatever that impacts the cash that will come in cash flow statement is it clear okay and statement of profit and loss what is the objective over here the objective is statement of profit and loss shows us the financial performance of the company yeah for the period yeah for the year how much profit or loss we have made whereas the cash flow statement shows us the liquidity position how much cash does the company has and how the cash has you know moved the movement of cash over the period that also we get to know from the cash flow statement okay that's the objective fine and another one small difference I want to explain you understand most of the students get confused in this right see understand in statement of profit and loss when we see tax over there tax expense what is that tax expense that tax expense is current year provision that we have made for tax okay it's a provision it's a non-cash thing because of that there is no cash flow it's just a book entry just a provision that we have made we have provided for tax whereas in cash flow statement this is reversed this doesn't matter to us in cash flow statement we don't take this yeah let me just show you the direct method in direct method what did we do in direct method see we just you know subtracted income tax paid by taking net of refund yeah this is tax paid that is what we take in cash flow statement we don't take income tax provision income tax provision yeah this provision for tax is what this is non-cash item okay we are not paying anything in this this is just a book entry so we reverse this okay this is an expense in statement of profit and loss so it has been subtracted it has been debited so how we are going to reverse tell me something is debited which means subtracted how we are going to reverse to reverse we have to add back do you understand I'm going to keep using this term reverse reverse eliminate reverse eliminate you have to understand now what I'm talking about whatever that has happened in statement of profit and loss reverse means just do opposite so that the effect will be nullified is that clear right understood now in cash flow statement we take tax that is paid it can also be advanced tax which we'll learn in a separate video the Advanced Tax process and everything right now just simple uh adjustment we are going to consider okay tax paid so tax paid means how much tax we have paid yeah the cash is actually paid to the government so that's what we going to consider in cash flow statement okay you understood the difference between statement of profit and loss and cash flow statement right and I told you how we are going to go from profit to cash flow from operating activities two things I told you the first first eliminate non-cash reverse non-cash okay the second thing I told you that whatever Outsiders are there Outsiders means the items which are of different family of investing family financing family you all know they can't be in our family on our table so we have to just kick them out we have to eliminate nonoperating items is that clear do you understand this easy now let me just show you the format of statement of profit and loss so that you can understand how it all happens see here this is not the exact format as per the company's act but you can understand here see first what happens first we take Revenue we subtract direct expenses like yeah trading account happen first right and then we get gross profit isn't it yes so from gross profit what do we do we add all indirect incomes and we subtract all indirect expenses we get net profit before tax right so what is included in indirect income and indirect expenses do you know yes you know indirect expenses means depreciation rent paid electricity paid stationary paid right all these items will come marketing expenses right interest that we have paid all these are indirect expenses fine and indirect income means that rent we have received right and then any indirect income for example let just say we invested in any company we got interest yeah interest received dividend received yeah all those are indirect incomes so you understand statement of profit and loss has been prepared for the whole organization in this what do you have you have all the items yeah you have operating items you have investing items you have financing items everything has gone into this right so from this we have to go to where we have to go to cash flow from cash flow from operating activities right so here what is sitting investing items and financing items are sitting over here so that you have to reverse we call them as Outsiders we call them as Outsiders okay non-operating is that clear so those Outsiders we have to kick them out because here we just need operating family our family so whoever are there from outside Outsider just kick them out you have to reverse that fine and then here there are also non-cash such as depreciation I told you right such as for example preliminary expenses return off so all that also we have to kick them off is that clear right so non-cash we have to remove move and outs Outsiders also we have to kick out right okay then see what happens in statement of profit and loss is yeah after getting net profit before tax we subtract the tax provision not the tax paid in statement of profit and loss we always take the tax provision this is a basic silly basic that everyone needs to know and most of the students don't know this right here we don't take tax paid here we take tax provision okay how much provision we have created in the current year is it clear simple understood after subtracting that we get net profit after tax okay and then we do the appropriation what appropriation what do you mean by that appropriation means distribution okay any preference dividend we have paid it will be subtracted any dividend final dividend we have declared then it will be subtracted any interim dividend we have paid yeah the dividend that is given between two AGM which is decl and paid in the current year that will also be subtracted over here and any transfer to reserves if we have made for example we have transferred to crra we have transferred to General Reserve or we have transferred to any other Reserve that will also be subtracted over here okay and then let just say for example we have redeemed debentures and preference shares at a premium then we have to pay that extra amount right so that extra amount is a loss for the company you all know and that loss is called as premium on Redemption of debenture or preference shares isn't it so that also needs to be written off so when it's written off we write that off through pnl if it has been written off through pnl that means it will be you know coming over here it's an appropriation it will be deducted over here so then we will get what the profit that is left after all the adjustment yeah in the final accounts after all the Appropriations we get this figure which is called as retained earnings then what happens of this figure do you know this figure goes in balance sheet this figure goes in balance sheet in balance sheet already you will have retained earnings which is the accumulated profit from the past five years six years and all okay that balance will be there to that balance you add this current year balance after all adjustment that is what you do okay do you understand this this is what happens in final accounts yeah when you prepare financial statements you need this basic then only you can understand cash flow statement right is this clear to you the basics of statement of profit and loss in the profit thing okay now I told you what we need to do in indirect method from profit we have to to go to cash flow from operating activities right and I told you two things first we have to reverse non-cash the second thing I told you we have to reverse non-operating whatever that is of different family we have to kick them out okay whatever that is related with investing kick them out whatever that is related with financing kick them out is that clear okay that's what you have to do so to do this we have you know three starting points in indirect method we have three different profits three different starting points okay see we have net profit before tax net profit after tax or retained earnings the first priority we give to net profit before tax if you have net profit before tax then you can start from over here in the indirect method format okay in the cash flow if you start from over here just just think if you start from over here do you have to reverse these things do you have to reverse tax provision do you have to reverse the appropriation no you don't have to reverse that you are standing over here net profit before tax just reverse what just reverse these things okay whatever that is of not operating yeah non-operating and non-cash which are included over here in the pnl account yeah only revers that that much is enough okay that much is enough is that clear yeah but let's just say for example if this is not given in the question in the question you have net profit after tax and after extraordinary item or maybe just after tax then what you will do if that is the case then you are starting from over here this is your starting point so you have to reverse the tax provision tax provision is an expense it has been what it has been debited in profit and loss yeah it has been deducted you'll have to reverse by reversing we mean we have to do opposite we will have to add isn't it so we'll have to reverse the tax provision and then we have to reverse this also in this indirect incomes and expenses whatever that is of non-cash and non-operating we have to reverse that do you understand the logic okay how we have to go are you getting the proper overview right now yeah so see here if this is also not available let just say the second priority which we give to net profit after tax this is also not available in the question then what you will do then you will have no option left you will have to start from the last thing that is the retained earnings but this can also Al be not given in the question directly sometime they will say profit after all adjustment then you can understand okay retained earnings is given but if they are not saying something like this they have just given you the balance sheet then you know if this balance sheet is given what I will do I will go in reserves and surplus I will find profit and loss balance right two balances will be given of previous year and current year so you will take the closing balance and opening balance okay and you will subtract closing balance minus opening balance closing balance means the current year balance will be given over there and opening balance means what the previous year's closing balance will become opening balance of current year okay so that is what you have to do 2022 minus 2021 like that okay for example right now 2020 you know 4 minus 2023 that's what you will do is it clear closing balance minus opening balance you will get the retained earnings of the current year after all the adjustment after all the appropriation you will get this figure when you get this figure what you need to do you have to start reversing everything everything you have to reverse okay sometimes students get confused you know they think why are we adding back the tax sometimes and sometimes we are not adding back the tax yeah sometime we are reversing the uh you know transfer to reserves and dividends sometime we are not reversing them what's the issue over here yeah they get confused like this you have to understand you need to know from where you are starting if you're starting from retain earnings you have to reverse everything all the appropriation you have to reverse the tax you have to reverse provision as well as refund both the things okay because refund we are going to consider that at last is it clear in operating only so that is why provision and refund both you have to reverse okay and then whatever non-cash and non-operating you have that also you have to reverse is it clear do you understand this statement of profit and loss is preped on acral basis it includes cash items as well as non-cash items yeah it will be sitting over here tax provision is also non-cash and here also you'll have some non-cash items so all that you have to reverse if you start from over here everything you have to reverse if you start from second priority yeah net profit after tax you don't need to reverse the appropriation but you have to reverse provision and this but if you start from the first priority yeah then you don't need to reverse tax you don't need need to reverse this just reverse the non-cash and non-operating that is sitting over here is it clear so the trick of indirect method is really simple see three steps of indirect method first you will do reverse of non-cash items okay let me just show you non-cash items see non-cash items for example depreciation amortization provision for tax foreign exchange laws preliminary expenses return off all these are non-cash items right in direct method we just do not consider that yeah in direct method yeah we just don't consider that we just ignore them but in indirect method we must reverse them we must reverse them how do you reverse if they have been previously taken to pnl that means they are sitting over here non-cash items yeah they are not of our family we have to kick them out non-cash items I mean they are not the family of cash flow only non-cash items so in pnl they must have been debited or they must have been credited either they have been you know subtracted or added so to reverse what you will do to reverse you will you know add if it is subtracted you will subtract if it is added previously that's how you reverse so I will be keep on saying this okay reverse eliminate you have to understand what I'm talking about whatever that has happened reverse means doing opposite of that is it clear fine so we will reverse non-cash but there is one small thing okay do not reverse non-cash items which are of operating nature okay bad debts discount allowed discount received or stock valuation all these are non-cash items okay but we will not reverse them because reversing is waste of time because if you reverse or not the end effect is same only that's why we'll just ignore them but if you get an McQ or any question where they ask treatment of bad debts then you have to say that you know it will be reversed it's a non-cash item fine but while solving the question we'll just ignore them is that clear okay those are non-cash items so we have to reverse non-cash only of non-operating nature operating nature non-cash items we will not reverse okay that's the first step of indirect method then the second step is what second step is get rid of Outsiders as I told you here in indirect income and indirect expenses what is sitting over here people from other family interest received is of investing family dividend received rent received is of investing family which are sitting in indirect incomes we have to reverse them how you will reverse it is added normally so do opposite you will subtract interest received subtract dividend receip subtract rent rece received is that clear simple yeah that's what get rid of Outsiders yeah and then in indirect expense you can have interest paid dividend paid is an appropriation item interest paid can come over here indirect expense so what you are going to do it is subtracted normally you have to reverse that because it's of different family it's a financing family we can't keep it in operating right so we have to eliminate it we have to reverse normally it is subtracted what we're going to do we're going to add it back interest paid is is it is it clear get rid of Outsiders send them to their own family what does this mean send them to their own family it means it means when you will prepare investing activity and financing activity they are always prepared according to the direct method so just directly you are going to pick interest received investing activity dividend received investing like that that's what it means send them to their own family okay we'll consider those items in their own heads is it clear okay and then we have something called as changes in work working capital okay see what happens is there are certain items okay certain items which do not impact the profit and loss okay but they affect the cash flow they don't come through profit and loss for example the cash that we receive from dears those items right so what we do is you know we just consider changes in those items working capital means current asset minus current liabilities so what we do is you know whatever current assets and current liabilities we have of operating nature we just see the change in that for example opening balance was 10,000 closing balance is uh 15,000 of current asset I'm talking about okay of debt receivables so 5,000 increases happened so what do we do we just subtract in the cash flow statement in indirect method why what's the logic we'll understand the logic but right now just understand the shortcut asset and cash are negatively related whenever asset increases cash decreases yeah as I told you 5,000 increase happened in current asset we have to just subtract yeah asset increase cash decrease if asset decrease cash increases okay and with liability and cash they are positively related when liability increases cash increases when liability decreases cash decreases for example there is trade payables opening balance was 7,000 closing balance was 3,000 so decrease of 4,000 has happened so what you're going to do liability decrease cash also decrease you're going to subtract that is that clear that's how you have to do it so these three things you have to do reverse non-cash get rid of Outsiders and changes in WC working capital okay we'll discuss each of these things okay working capital and all don't worry but right now let's just see the format the detail format of uh cash flow statement of indirect method then you will understand better okay now see here we have the detailed format of indirect method and remember indirect method is only for cash flow from operating activities rest everything is same only okay right so let's begin first we start from where I've told you we have three starting points so now to understand the format we are starting from the third priority okay and then I will explain you how we can reach over here and here okay everything so if we are starting from retained earnings in the question if they say profit after all adjustments directly we can reach at this figure you see this 3x right directly over here but if they don't say that the question is silent you have to look into the balance sheet they will give you opening and closing balance of pnl right so what you have to do closing balance of pnl minus opening balance of pnl okay you will get the retained profit after all adjustments of the current year right profit of the current year after all adjustments right yeah then you have to reverse what if you have this item what you have to do next tell me you will reverse all the appropriation right you will reverse all the appropriation interim dividend paid any dividend that you have declared any transfer that you have made to reserves premium on Redemption return off all those items you are going to reverse okay what does reversal means whatever that has happened previously in statement of profit and loss you will just do opposite okay that's what you will do is it clear okay appropriation reversal understood sir moving on then after doing this where you will reach you will reach at net profit after tax after the reversal of appropriation you have reached at the second priority right then what you need to do tax provision I've told you you have to reverse the tax provision because it's a non-cash there is no cash flow happened because of it and refund of tax even if cash flow has happened that also you have to reverse okay so see add provision for tax provision of for tax is normally subtracted previously it has been subtracted in statement of profit and loss right so now you will add we are doing reverse reverse elimination is it clear so we have to do opposite Okay add provision for tax and if there is any ref refund then we will subtract the refund because normally what happens refund is added in statement of profit and loss isn't it I mean refund is added so we are going to subtract refund of tax is it clear simple understood then moving on extraordinary items now what are extraordinary items understand extraordinary items means something that is not ordinary in nature okay that is completely different from what do you say ordinary activities of business for example loss due to earthquake for example we have received Insurance claim okay maybe for example we have paid a penalty okay we have lost a lawsuit or maybe we have won a lawsuit and we have received the compensation all these are extraordinary items which happen very rarely they do not recur in nature okay they are not recurring in nature is that clear those are extraordinary items so what we have to do of that we have to just simply reverse all Extraordinary items whatever that were taken to pnl all those we have to reverse is that clear previously whatever that has gone in the statement of profit and loss okay all that we have to reverse is it clear yes understood then what we have to do then we will reach at net profit before tax and before extraordinary items okay over here npbt we have reached over here okay if you have seen other lectures then you might have seen they already start their indirect method from over here right and they do this thing as a working note but we are not going to do that we are going to do everything all together is that clear so right now we have reached over here net profit before tax is it clear net profit before tax and extraordinary items now what we have to do tell me we have to do what we have to reverse non-cash like depreciation preliminary expenses return off amortization yeah we have to reverse non-cash items fine so see here reverse non-cash and non-operating items non-cash and non-operating depreciation amortization discount on issue of debenture gain on sale of land loss on sale of machinery and foreign exchange loss all these are what non-cash and non-operating is it clear okay so all this you will reverse whatever that was added you will subtract whatever that was subtracted you will add you know right how you will do the reversal see this is how you have to do the reversal whatever that is debited in pnl which means subtracted you will add that whatever that is credited in pnl that means whatever that was added you will subtract okay that's how you will reverse is it clear reversal of non-cash is it difficult indirect method no it's not difficult you just have to understand the basics okay once you get the whole overview and we'll simplify it it will be really simple for you don't worry okay so when we'll reverse the non-cash then what do we have we have to get rid of Outsiders non-operating items non operating items which are are going to go into the different family okay see here reverse items to be considered in other heads so what are the item that are going to be considered in other heads for example interest received dividend received rent received these are of investing family but but they have been taken to statement of profit and loss previously as an indirect income right so we'll have to reverse we'll have to subtract all of that why subtract because they were added previously now we have to subtract or I can say they were credited previously in statement of profit and loss now I have to subtract I have to reverse okay so see interest received yeah interest income interest paid dividend income all this you will have to reverse and when you will prepare the cash flow from investing and financing at that time you have to take interest income will be investing activity dividend income will be investing activity rent income will be investing activity and then interest expense will be fin financing activity okay that's what I said now get rid of Outsiders Kick The Outsiders and send them to their own family when we will prepare cash flow from investing and financing at that time we will consider that over there is it clear understood moving on then what we're going to get after doing that we are going to get to operating profit before working capital changes yeah we are this close to get to the cash flow from operating activities we have to consider now what working capital changes yeah I've told you there are some items which do not impact profit but they affect the cash flow or WIS vers can also happen right so we have a trick over here asset is negatively related to cash and liabilities are positively related to cash okay so for current asset and current liabilities we see the changes opening balance and closing balance We compare and we see whether it has increased or decrease if current assets have been increased we subtract if current assets have been decreased we we add if current liabilities have been increased we add if current liabilities have been decreased we subtract that's what we do okay so see here in the format how we have to present it effect for changes in working capital increase in current asset decrease in current asset increase in current asset will be subtracted decrease in current asset will be added as I said assets are negatively related with cash inversely proportional also you can say and then current liabilities are posi L related with cash or directly proportional with cash if current liabilities increases cash also increases you have to add if current liabilities decreases cash also decreases so you have to subtract that's how you have to do it this is a trick this is a trick the actual logic will discuss later okay fine so that's the thing and then after doing that what you will get you will get cash generated from operations okay cash generated from operations and then you will subtract the tax speed the same way how you did in direct method in direct method what did you do in operating activity see at last you subtracted tax paid net of refund yeah the same way you will have to do over here last you will have to subtract the tax paid so you have to understand you reverse the provision that's non-cash item but at last you consider the tax that is the actual tax paid these two things are different I told you now in statement of profit and loss we have current provision for tax this we reverse in cash flow statement this is not considered this is just reversed in cash flow statement we consider the tax paid what is that mean we consider the tax paed it means we subtract the tax paed okay but now we'll take net of refund for example let just say tax paed is 10,000 and we have got refund of 2,000 so we will take over here 8,000 10 minus 2 that's 8,000 for example let just say one lakh tax we have paid 5,000 refund we have got so 95,000 you are going to take is it clear and understand first you have to reverse the tax because understand I mean refund of tax also you have to reverse why because we have to reach at net profit before tax and extraordinary item now that is why we have to reverse and then separately at last we'll have to show the uh tax paid and then the refund as a net clear okay understood then we'll get cash flow before extraordinary items you remember extraordinary items also above we have reversed but now there is a difference you know most of the the teachers don't teach this understand in the beginning we reverse all Extraordinary items that has impacted the profit and loss statement right that has gone into profit and loss statement then at the below what do we do at the below you have to understand here we add or subtract the extraordinary items which are relating to operating activities and which have caused a cash flow which have caused a cash flow for example loss due to Earth Quake okay that's an extraordinary item maybe it has been taken to pnl so you reverse that above and let's just say you have also received an insurance claim because of that okay proceeds from earthquake disaster settlement okay so here you will reverse both the things okay reverse you know the loss due to earthquake and then the insurance claim received also okay but here what you will have to do you will consider only proceeds from earthquake disaster settlement because in cash flow you can only have cash flows you can't have just loss and all is that clear non-cash items cannot exist in cash flow in cash flow the entire game is on cash flow is it clear in cash flow statement the entire game is on cash flow fine okay now another example let's just say for example you have received Insurance claim there was a fire in your uh go down or in your office or somewhere so your stock was destroyed okay for that you have received Insurance claim and your non-current fixed asset PPE was also destroyed for that also you have have received Insurance claim so just tell me both of these things will be reversed no doubt will be reversed over here because the effect has gone in pnl so you will reverse both of the things over here at the top but in the below at the below see Insurance claim which you have received on account of stock is an operating extraordinary item it's of operating nature that you will add over here you have received money right from insurance company in relating to the stock that was destroyed by fire but the money which you have received on account of damaged PPE yeah your fixed asset which was destroyed that money you can't take over here that money you will take in the investing activity when you will prepare the format of investing activity the format is same only now at last you have to add over here Insurance claim received on account of loss of uh PPE by fire damage of pp by fire you have to add over here is that clear because extraordinary item that is related with this activity this is very important you have to understand these minute simple things okay and only receipt and payment are considered in cash flow statement right loss due to just earthquake that will not come over here is that clear that will be just reversed and that's it fine proceeds from earthquake disaster settlement we getting money so that will come clear understood extraordinary item thing is finished we have understood that okay moving on net cash from or used in operating activities everything is over over right this is the entire format of indirect method hope you have understood this it was difficult no it's not difficult at all it's really simple what did we do first we started with the retain earning figure right we didn't have it we went in balance sheet closing balance minus opening balance of pnl we got that then we reversed all the appropriation all this thing right then we reverse provision for tax and refund of tax right we reached at net profit before tax after reversing extraordinary items as well yeah we reached over here npbt net profit before tax and before extraordinary items then we did what we reverse non-cash of nonoperating nature non-cash of nonoperating Nature and then we get rid of Outsiders as well yeah we got rid of Outsiders as well see reverse non-cash and non-operating items like depreciation amortization discount on issue of debenture and all and then we reversed items to be considered in other heads like interest income interest expense rental income dividend income all these then we reached operating profit before working capital changes right and then we gave the effect of changes in working capital which I explained you just have to follow this trick okay while solving the question you will not think about the logic just this trick and just do this okay all right and then see cash generated from operations we got and then the tax paid which you have to take as net of refund and then you have to consider the extraordinary items relating to operating activities and cash flow should happen of that okay not just loss you will consider is that clear then finally you will get net cash flow from operating activities after doing all this where you have reached you are done with the step one you are done with the step one you have got this figure let just say here you have got 79,000 so 79,000 will come over here is it clear and and then you will calculate cash flow from investing activities cash flow from financing activities the same format the same thing you will do this this no difference at all directly this this okay one lakh one lakh so 2 lak 79,000 will come over here net increase in cash and cash equivalent 2 lakh 79 79 1 lakh 1 lakh for example 2 lakh 79 let's just say cash and cash equivalent at the beginning you had 1 lakh Okay so 2 l79 plus 1 lakh you had in the beginning so your cash at the end became 379,000 is it clear simple and straightforward okay 79 1 lakh 1 lakh 2 lakh 79 plus 1 lak 3 l79 is it clear this is the entire format of indirect method really simple and straightforward now we have to see the adjustment so let's start one by one seeing most of the adjustment that we can cover in this video okay now see here we have the concept of working capital changes that we do only in indirect method and you know the trick already current assets are negatively related with cash and current liabilities are positively related with cash with this trick only you solve in the you know indirect method in this format yeah you give the effect of changes in working capital over here you all know how to do this but you don't know the logic see it's really simple working capital is nothing what current assets minus current liabilities okay and then there are some items okay which impacts the cash but not the profit and loss statement that is why you know what we have to do is you know the related current assets and current liabilities which are there we take them yeah only operating current assets and current liabilities okay not all not all only current assets and current liabilities which are of operating nature yeah we take them and we see the opening balance and cl closing balance of those opening balance means what and closing balance means what understand properly closing balance means you will find that in the current year balance sheet closing balance opening balance means the previous year's balance sheet closing balance will become opening balance in this current year okay so let just say for example datar are there which are 7,000 and that's opening balance and then closing balance is let just say 2,000 so what has happened dats have decreased by 5,000 decrease of current asset by 5,000 current asset is negatively related with cash if it is decreasing then cash flow positive impact and here what you have to do in the format here you have to write decrease in current asset 5,000 plus you have to add is it clear this is what you have to do okay but you have to take only operating current asset and current liabilities like for example Bill receivable Bill payable trade payable trade receivable okay inventory all these are of operating nature you have to ignore certain current assets and current liabilities which are of nonoperating nature okay and you also need to ignore this provision for tax why provision for tax you said tax is related with operation understand provision for tax is separately considered everywhere yeah here I mean provision for tax is separately considered see we reverse provision for tax and then at last we pay the tax over here so that is why we do not consider the changes in provision for tax in the working capital changes okay is that clear we open a separate Ledger account for this if there are any adjustment or any extra information regarding provision for tax okay separate Ledger account will be open and they will do the adjustment of that I will teach you it's really simple and then there is also dividend payable which is a current liability provision for tax is also current liability still you have to ignore both of these things dividend payable for this also we will open a ledger account if there are any adjustment and all it will not be considered in working Capital changes okay it's and it's a part of financing activity dividend payable isn't it yes and then you have cash and cash equivalent Now understand cash and cash equivalent is what it appears at last in the format of cash flow statement isn't it see here opening balance and closing balance so this is where it will come okay you will not consider that in working capital changes cash and cash equivalent is it clear simple and then there are certain other nonoperating current assets and current liabilities which you also have to ignore such as outstanding interest outstanding interest is what interest that you have to pay right it's a current liability and it's related with financing activity so if there is any change compared to previous year and right now opening and closing balance that will be considered while preparing financing activity not right now okay not in working capital changes and same is with the interest receivable it is a part of investing activity interest that we have to receive in future okay it is ACR but not received so it's a part of investing activity and same with the dividend receivable this is also a part of investing activity okay we'll consider in investing activities not over here in working capital changes just ignore and then you have short-term borrowing short-term borrowing is part of what is part of financing activity so this also you have to ignore is that clear okay let me just show you one question of this and then you will easily understand how to do do this okay see here let me just show you see here we have one question illustration 7 from the ICI study material if you see over here unlimited balance sheet has been given 20 x0 this is previous year 20 X1 this is current year is it clear okay now see here we have current liabilities trade payables trade payable is of operating nature isn't it yes so this is opening balance this is closing balance from 2,500 it has become 4,000 it has increased by 1,500 if current liability is increasing that means positive impact on cash we have to add positive yeah it is increasing we have to add 1,500 in working capital changes is it clear simple next current liabilities see other current liabilities note number three what is this let's check in the note number three in the note number three here you have dividend payable 1,000 yeah 1,000 so what you going to do see it's dividend payable you have to completely ignore that yeah it is not related with the operation it is related with financing so completely ignore for that we have to prepare separate Ledger account and all okay ignore that short-term provision for tax see for provision also we have opening balance closing balance okay this also we have to ignore isn't it provision for tax we have to ignore we'll separately consider that we'll separately open Ledger account for that and then come to current assets in current asset you find over here current Investments are given current Investments are related with investment activity not of operating nature we can't consider it in working capital changes so what are we going to do we are going to completely ignore it fine and then inventories is of operating nature so what are we going to do we are going to see in working capital changes from 14,000 opening balance it has become 177,000 closing balance so it has increased by 3,000 inventory is a current asset if it is increasing by 3,000 that means negative impact on cash by 3,000 so we have to subtract it in working capital change is 3,000 is it clear simple same with the trade receivables what has happened from 6,000 it has become 8,000 it has increased by 2,000 so what we have to do opposite we have to subtract yeah current asset increasing negative impact on cash we have to subtract 2,000 is it clear and then we have cash and cash equivalent this we can't consider in working capital changes we have to ignore this in working capital changes what will happen of this we will take it at last if you you'll see the solution see here at last what will happen cash and cash equival at the beginning opening balance 8,500 cash and cash equivalent at the end of period yeah closing balance 4,000 yeah here we will take it not in the working capital changes in the working capital changes see here increase in trade receivable increase in inventories and increase in payables is it clear yeah all are increasing increase in current asset we have to subtract and increase in inventory we have to subtract and increase in trade payables we have to add is it clear okay so you have understood regarding this okay fine so that's the thing now sometimes what happens is see over here sometime they will not give you individual assets and liabilities sometime they will just you know directly give you increase in working capital 70,000 decrease in working capital 80,000 so what you have to do remember whenever there is increase in working capital you have to subtract okay because increase in working capital will impact negatively on on cash and decrease in working capital will impact positively on cash okay working capital is same like current assets only why is that so because understand the formula is like that working capital formula is current asset minus current liabilities when working capital will increase when current asset will increase in comparison to current liabilities or current liabilities has to decrease in that case only working capital will increase so negative impact on cash you have to subtract just remember the trick to do the questions you just have to remember the trick and do it okay you can't keep thinking about logic logic I will teach you simply once then every time you have to use the trick working capital when it will decrease when current asset decreases and current liabilities increases in that case working capital will decrease in that case what will happen positive impact will be there on cash okay so you have to add in the format okay sometime that's what will happen increase in working capital 70,000 so you will just write increase in working capital Capital 70,000 minus increase right minus decrease in working capital leg just see 1 lakh so decrease in working capital 1 lakh plus is it clear that's how you have to do it fine now what's the objective of doing this understand there are certain items you know which do not impact the profit and loss statement they will just impact the cash flow they don't come through you know profit and loss so what we do is we just see the net impact of current asset and current liabilities of operating nature and we give the effect in the in the indirect method so that what can happen so that the profit The Profit can come to cash flow from operating activities okay the goal of this adjustment is to convert profit from an acral basis to a cash basis okay that's the thing fine now we'll take two examples of datar to completely understand the logic of this and then you'll be perfectly clear with this okay let's take those examples now see here we have the example to understand the logic of working capital changes let just say for example there is increase in debt RS from 5,000 to 7,000 5,000 opening balance closing balance is 7,000 how much has increased 2,000 has increased what do we do if there's increase in current asset we just subtract in working capital changes yeah in indirect method when we calculate cash flow from operating activities yeah you all know this yeah you have just applied the trick current asset increase by 2,000 negative impact on cash by 2,000 subtract simple okay that's what we did but now what's the logic that is what we have to understand so let's just open an imaginary datar account okay with these figures datar account is an asset account asset account always have opening balance on debit closing balance on credit it's always like that so let's see see here we have datas account okay opening balance 5,000 closing balance 7,000 on the debit side CL credit side clear easy now let's just say for example from datar we have received 18,000 money how much 18,000 money so when we receive money from datar what happens datar account decreases credit means minus for datar account and debit means plus yeah that's what it is for asset accounts so dat's account got credited by 18,000 because we have received cash okay then let's try to balance this account 18,000 + 7,000 that's 25,000 and 25,000 000 on the other side as well and then 25,000 minus 5,000 that's equal to 20,000 why what is this 20,000 why dears has increased because of sales okay 20,000 it has increased because of sales we have sold Goods on credit right in the year so that's 20,000 sales okay credit sales now you have to just see this Ledger account and understand properly see 20,000 credit sales you have made okay out of this how much cash you have received 18,000 cash you have received now cash flow statement plays its entire game on cash flow entire game on cash right it doesn't see whether credit sales have happened credit purchases happened and all how much cash has been received or paid that is what is important for cash flow if we are preparing cash flow statement under direct method not indirect direct method then what will happen what will happen is see in operating activities we'll say cash received from datas from trade receivables how much what figure you will take 18,000 18,000 that's the money we have received clear okay but in indirect method what is happening indirect method what is happening we are starting from profit and going to cash flow from operating activities so this is what this is statement of profit and loss in statement of profit and loss what will go will this 18,000 go tell me if you know little bit accounts then then this will not go in statement of profit and loss this cash received from datas no it will not impact the statement of profit and loss instead what will happen is this sales will go in statement of profit and loss yeah this 20,000 sales profit and loss is saying that we have sales of 20,000 in the current year okay credit sales and there is no what do you say cash basis and statement of profit and loss it's what acral basis so statement of profit and loss is increased by 20,000 20,000 cash we have received 20,000 cash we have received that's what it is screaming who profit and loss statement but is that true no it's not true we know only 18,000 is received so what we have to do you will say we will just go to statement of profit and loss only 18,000 should be there then only it will be cash basis then only it will be cash flow from operating activities isn't it do you understand the logic see the logic is credit sales made in current year of 2000 has gone in SPL actually entire 20,000 has gone but 2,000 has gone and on that cash has not been received on that cash has not been received remaining 18,000 is fine in this remaining 18,000 is fine it has gone cash has been received it's cash basis but the 2,000 for that cash has not been received no cash has been received for this so what we have to do we have to reverse that 2,000 sales we have to reverse that 2,000 sales from profit figure from profit figure we have to subtract we have to subtract 2,000 and that's what we did with working capital changes we saw from 5,000 it has become 7,000 2,000 increase happened this we have to subtract see in working capital changes what did we do increase in current asset increase in debt hours 2,000 we subtracted in profit it got subtracted this is the net change that we are doing overall impact is this overall impact is this 20,000 sales is sitting in SPL out of that you know 18,000 is cash basis remaining 2,000 are credit sales on which cash has not been received so what we have to do we have to just simply subtract that is the logic of this is it clear okay you understood this fine now let's talk about decrease in dears okay opposite example now let's take another example of decrease in dears decrease in current asset and let's understand the logic of this so that you'll have more clarity about this working capital changes so see here we have have datar balances opening balance 5,000 and closing balance 1,000 so what has happened from opening to closing if you compare 4,000 decreases happened decrease in current asset so what do you do of it you all know current asset negatively related with cash so current asset is decreasing positive impact on cash we have to add this 4,000 isn't it add in cash flow from operating activities while doing working capital changes in indirect method yeah we do this only in indirect method okay then what's the logic of this okay we understood by the trick we have to add but what's the logic let's understand the logic by doing the same thing by opening a ledger account dears is an asset account it has debit balance debit means Plus Credit means minus opening balance always on debit side closing balance always on credit side so opening balance 5,000 two balance B byid and buy balance carried down 1,000 is it clear opening balance closing balance then let just say we have received 18,000 cash from datas okay just an imaginary figure just like that just to make you understand the logic okay by cash received 18,000 so 18 + 1 that's equal to 19,000 and 19,000 on the other side as well is it clear okay then we have find the balancing figure 19,000 minus 5,000 that's equal to 14,000 what is this 14,000 this is the credit sales that we have made in the current year okay fine now tell me how does this datar account impact the financial statements you will see it's really simple okay see here closing balance will go in balance sheet right this sales item this is what this is the what do you say credit sales made in current it's a nominal account this will go in statement of profit and loss in profit and loss account and this will go to the cash account and this has to go in where this has to go in cash flow statement if you'll see direct method in direct method it should appear over here cash received from datar trade receivable 18,000 because that's the cash that we have received from datar so it should appear over here indirect method we can easily take take it right pick and draw but but we can't take it like that in the in the indirect method because indirect method what are we doing we are starting from profit and we are doing all these Chang changes to arrive at cash flow from operating activities and you know in statement of profit and loss there's cash sales there is credit sales as well everything goes into that but we only need what we only need the cash impact we can't take all credit sales in cash flow statement okay so that's the thing so that's why we do working capital changes so see how it'll happen is the logic see it's really simple how much cash we have received 18,000 but has statement of profit and loss impacted by 18,000 no how much it has been impacted by profit and loss statement has got only 14,000 sales profit and loss statement is saying I have 14,000 I have 14,000 but is that cash is that entirely cash 14,000 is cash but is it complete no it's not complete extra 4,000 needs to be there it should be 18,000 not 14,000 14,000 has gone in statement of profit and loss already but still more 4,000 needs to go yeah still more 4,000 needs to go over there so that is why what we do we add in cash flow from operating activities simple logic okay so let's understand the whole picture see what has happened is in statement of profit and loss 14,000 has gone but that's not enough that's not cash basis that's acral basis okay whatever that has been earned in this year that is coming in statement of profit and loss 14,000 but we have received entirely 18,000 from the previous year's dears also from this 5,000 also we have received 4,000 cash okay so that 4,000 didn't go in SPL and we have to give effect of that that is why we see the net change and we do this treatment okay see cash received from data this 4,000 is of credit sales made in previous year yeah and credit sale of previous year is recorded in previous year's statement of profit and loss not in current years because profit and loss is prepared for a year okay all the current year transaction will be reflected in statement of profit and loss income and expenses not of previous year so that is why this 4,000 hasn't gone in SPL and we are giving the effect of it right now okay current year SPL has not been impacted okay it has not been impacted so we give the effect right now by adding it this inflow of 4,000 yeah already 14,000 has gone we give the impact of the remaining 4,000 so completely 18,000 will go in SPL and SPL I mean uh profit and loss statement will become on cash basis it will become on cash basis previously saying only 14,000 sales which was right it was entirely on cash but it was not complete complete is 18,000 4,000 extra needs to go is it clear that's the logic of this but you not think about all this logic and all this is just for your conceptual Clarity in the exam in the questions what you have to do you just have to do the trick is that clear okay so you have understood the logic and everything so now let's move on to the extraordinary items okay now see here we have the concept of extraordinary items it's really simple we have already discussed this while discussing the format of indirect as well as direct method so now here we are just you know looking at this and cementing in our mind because that's what happens when you see the proper notes it gets in your mind right so see extraordinary items are nothing but income and expenses that arise from events or transaction that are clearly different from ordinary activities of the Enterprise okay and these are not expected to recur frequently okay they do not happen frequently okay this happens very rarely for example loss due to earthquake it's an extraordinary item okay you have received proceeds from earthquake disaster settlement it's extraordinary item let just say for example you have filed a lawsuit and you have won the lawsuit right so you are going to get what compensation for example let just say you have lost a lawsuit then you have to pay the penalty right so all these are extraordinary item you are getting Insurance claim because of fire in fire what can happen let just say for example there was a fire in your company and because of fire your goods were destroyed now goods are related with operations of the company right it's part of operating activity so Insurance claim received this extraordinary item is related with Goods yeah so that is why this insurance claim will also become operating activity I've told you yeah the whole family sits together so you have to remember goods are of operating Family Insurance claim on Goods will also be operating family so in direct method what you need to do see understand any cash flow associated with extraordinary items should be classified as arising from operating investing financing you have to check okay what kind of extraordinary item it is yeah to which activity it relates easily you can understand fine and then you have to classify that and separate disclose it what do you mean by separately disclose it it means you know you have to take it at last if we are talking about operating activities let just say we have got a you know proceeds from earthquake disaster settlement then we will take it over here plus extraordinary item relating to operating activities okay if cash flow is happening then only you will take it over here because in cash flow statement we only you know think about cash whatever that goes in cash account will also come in cash flow statement that's the golden tip right yes so that's how simple it is but let's just say for example you have got an insurance claim because your non-current asset was destroyed by fire the Machinery any non-current asset okay fixed asset now Machinery is related with investing activity it's of investing family so the insurance claim received on Machinery will also be of investing family the whole family sits together right so what you will do of this you will add it in investment activity yeah why in investing activity why are you adding investing activity because it is related with non-current asset PP is that clear and both of these are inflow so you will add fine I'm talking about direct method simple understood now what about what about indirect method indirect method also it's really simple see here first what you have to do you have to reverse all in operating activity if you start from retained earnings if you start from retained earnings yeah from here then you have to reverse everything right so you will reverse the extraordinary items also if they have previously been taken to pnl in statement of profit and loss is it clear okay so that is what you have to do isn't it in the format we have seen reverse all Extraordinary items let just say for example there was loss due to earthquake you have to reverse that there was proceeds you have got from earthquake disaster settlement you will reverse that yeah all these things Insurance claim you have got legis for example on loss of a Machinery by fire that also you will reverse over here because all these items have gone to pnl so first we reverse them if they have been added you subtract if they have been subtracted you add that's what you do reverse all Extraordinary items then what you do then what do you do then the second step is at last separately disclosure is required right yes so at last what you will do give effect of cash flow associated with extraordinary items at last separately in the activity to which it relates Now understand loss due to earthquake is non-cash right so that you will not consider over here you will just take proceeds from earthquake disaster settlement only receipt and payment you will consider at last not all Extraordinary items is it clear and it has to be operating activity only because you're considering in operating activities right so proceeds from earthquake disaster settlement is a operating item is that clear it's related with you know operating that extraordinary item fine you will add that then I told you there was also Insurance claim received on loss of a Machinery by fire what will you do of this you have reversed it at the top yes that's right but afterward what you have to do where you will consider can you consider it over here in operating no you can't so what you have to do you have to go in investing activity the same format right even for indirect method investing activity format will not change so at last you will take over here extraordinary item what item Insurance claim received on loss of a Machinery by fire you will add is it clear this is the treatment of extraordinary item really simple and straightforward this is what you have to do in indirect method two steps first reverse everything second give the effect of the extraordinary item that cash flow in the respective activity fine and in direct method what do we do in direct method explained you already just do the Second Step okay no reversal nothing directly okay pick and and drop that's what you have to do indirect method simple simple and straightforward right you have understood this okay now let's move on to the provision for tax and tax fed and let's understand that now see here we have the concept of provision for tax and tax speed and we're going to see what all adjustment can come regarding this provision for tax and how to open a ledger account and solve the adjustments okay so see it's really simple the first thing that you should know is that the tax figure that appears in state of profit and loss is not the tax paid often students think that's tax paid it's not tax paid remember this tax paid will never appear in statement of profit and loss what will appear what will appear in statement of profit and loss tax provision always remember that okay so broadly we call that as tax expense if you'll see the actual format of statement of profit and loss according to the company's act then it's tax expense now tax expense comprises of two things current tax expense and defer tax expense now defer tax expense is entirely another topic so we are not touching that you will learn more about this in as22 okay not right now right now we'll just discuss the relevant part so current tax expense what is this this is nothing but you know the provision that you have created during the financial year understand what happens is what happens is see we are earning the income in the current year right and then this income will be assessed in the next year which is the assessment year isn't it we have earned in a current year and according to income tax act it's called as previous year but this income will be taxed in the assessment year which is in the next year right and at that time when the assessment will be completed the actual tax liability will materialize how much tax we have to pay but right now you know we'll just estimate okay on estimation basis we'll create a provision which is called as provision for tax okay so current tax expenses what estimated tax liability for The Current financial year whatever provision that you have created in the current year is it clear simple understood so it's not tax paid it is the provision that we create for tax during the year fine that's what it is is it clear it's just estimated tax liability now how how do we create this it's really simple we pass this journal entry profit and loss account debit to provision for tax fine is it clear this is the interview pass provision for tax is a liability account when it gets credited it increases and profit and loss also has credit balance so we are using the profit and loss okay so it's getting debited it's decreasing isn't it so that's why profit and loss account is getting debited fine then tell me the treatment of provision for tax what did I tell you when we discuss the format what do we do of provision for tax we simply reverse it right in indirect method we just reverse it it's a non-ash item yeah we haven't paid anything it's just a book entry we have just created a provision estimated tax liability of the current year right so how and when you are going to reverse it's really simple you're going to add this to reverse because normally it is subtracted yeah normally it is subtracted so to reverse you will add back but when when you will add back only when you're start starting point in indirect method is retained earnings and net profit after tax yeah in these two cases only you will reverse that if you have got net profit before tax in the question are you going to reverse tax provision no you are not going to reverse you all know that so reverse it if your starting point is net profit after tax or retained earnings understood easy then the tax paid yeah whatever tax that is paid yeah that is what cash out flow from operating activities isn't it yes you all know this you have seen in the format also yeah in the format if I show you the indirect method format see tax paid is subtracted by taking net of refund I've already discussed that in operating activities you just deduct even in the format of direct method you just subtract right tax paid isn't it simple so that is what you have to do subtract it at last in you know operating activities it's a cash outflow same in both methods and you have to take net of refund is it clear this is the concept of provision for tax and tax paid now there can be adjustment of this so when there are adjustment what you have to do remember in cash flow statement chapter Whenever there are any adjustment of any item you have to open a ledger account in The Ledger account you know you can clearly understand what is happening okay and how cash is being impacted and that effect you can easily take in the cash flow statement okay so see here let me just show you the format of provision for tax account see here provision for tax account it's a liability account all right yes so debit means minus and credit means Plus for this account it has credit balance so opening balance will come on the credit side and closing balance will come on the debit side it's always like that for liability account is it clear okay then whatever provision you create during the year it will come on the credit side as buy profit and loss account why because understand what was the entry entry was this right provision for tax account got credited because of profit and loss yeah we created out of profit and loss the provision yes so provision for tax it increased because of what profit and loss fine so it will always come over here because you're creating the provision during the year so it is increasing it will come over here and then when the tax is paid what happens provision for tax account will decrease okay we set it off is it clear so whenever tax is paid it will come over here is it clear so there can be so many adjustments here let me just show you one adjustment first adjustment see let's just say provision for tax is given in the balance sheet okay opening balance closing balance is given what you will do opening balance will come over here closing balance will come over here is it clear then leges say in the question they have told you tax paid is such an amount right so you will take over here and then you will find balancing figure as the provision that is created during the year is it clear yeah see here open Ledger account for provision for tax find current year provision for tax as a balancing figure I've just told you how to do that let just say for example second type of adjustment you know opening balance closing balance is given you will take opening balance closing balance okay and then in the question they have told you how much provision has been created during the year current year provision for tax so you will take that over here and then what will happen this you have to find as a balancing figure okay suppose for example let see this is 4 this is 6 so 4 + 6 10 so 10 over here let just say this is three so three you have written over here it's given in the question seven would be the tax paid like that okay balancing figure open Ledger account for provision for tax find tax paid as a balancing figure is it clear then let's just say for example nothing has been said just opening and closing balance are given then what you you will do if just opening balance and closing balance are given then you will make an assumption assumption is that opening balance is paid during the year okay opening balance is paid during the year okay opening balance whatever amount you have you will take opening balance closing balance then you will assume opening balance is paid the same amount you will take and closing balance is the you know the provision that is created during the year this assumption you will use is it clear see here assume this as tax paid and assume this as current year provision for tax this we also do for dividend payable okay when we'll discuss that adjustment you'll come to know about that also is it clear this is what you have to do okay let's just say opening balance is four and closing balance is six so four is the tax paid and six is the you know current year provision also the provision created during the year fine is it clear now what is the treatment treatment you already know whatever tax we pay in both the methods we have to subtract from operating activities and then whatever provision that we create during the year not the balance sheet item whatever that we create during the year the provision for tax that we have to reverse in operating activities only in indirect method if we start from net profit after tax or retained earnings is it clear this is what you have to do okay and then here I have written see here the tax paid the income tax paid is operating activity you already know that and then I've told you if we sell any building a long-term asset which is related with investing activity isn't it then the tax paid on that the long-term capital gain tax that will also you know go in investing activity the whole family sits together right and then there used to be dividend distribution tax now it's abolished right but still I have to just explain you the concept let just say you know if company pays the dividend they are paying dividend distribution tax so dividend paid is a financing activity any tax paid on dividend distributed that will also become a financing activity is it clear yeah it's abolished now but it used to be there is that clear so that's how it is okay whole family sits together you have to see the relation and easily you can identify in which activity it falls and then refund of tax now refund of tax also is really simple I have already explained you everything in indirect method we reverse this reverse it in operating activity if you start from net profit after tax or retained earnings yeah you reverse the refund of tax and then what do you do you deduct the tax paid by considering the refund yeah when you you know subtract the tax paid in operating activities like just say tax paid is 10 and two is refund so 10 minus 2 88 you will subtract in operating activities the same treatment whatever we have discussed I'm just showing the notes over here is it clear the only new thing you understood was how to create The Ledger account is it clear right so that's all about the provision for tax and tax paid I hope you have understood this and as I said there are three adjustments in this okay there are three adjustment fine now let's go to the next adjustment now let's understand the adjustment of dividend paid you all know dividend paid is a cash outflow from financing activity right we just deduct that in financing activity but an adjustment can come on that and in the question you will find in cash flow statement question they are saying dividend payable proposed dividend dividend is paid of this much right interim dividend so all these adjustment we have to understand right now but first we need to know a little bit Basics about how the company pays the dividend so you have to understand this from the company's point of view so let's understand this see here it's really simple there are two types of dividend final dividend and interim dividend let's talk about final dividend first see what happens is board of directors they will propose the final dividend they will recommend the dividend after the date of balance sheet okay because that's when they will get to know how much profit we have made in the current year right after the date of balance sheet so this is a non adjusting event according to the as4 the revised one so that is why no accounting will happen of proposed dividend what is proposed dividend the dividend that is proposed by the board of directors what they have recommended is it clear so in the balance sheet it will just be disclosed in the notes is it clear simple understood then what happens is see after the date of balance sheet within the next 6 months yeah from the close of financial year yeah that means in the next year right dividend is of current year but in the next year now we have to do something understand within 6 months from the end of financial year AGM must be held you all know this yeah the end of financial year is when 31st March so till 30th September within this period AGM must be held so in AGM what will happen is shareholders should approve the proposed dividend whatever dividend that is recommended by the board board of directors it will be accepted by the shareholders is it clear their approval is required when they give their approval it means shareholders have declared the dividend and usually they will give the approval and they will accept the same amount only usually the same amount as proposed by the board of directors either they can reject or they can approve yeah they cannot increase the amount is it clear okay fine so dividend will be declared when dividend is declared that means the company now has to pay the dividend so we have a dividend payable dividend payable dividend has to be paid to the shareholders now so we have to do the accounting of this and understand it has to be paid within the next 30 days since the date of Declaration is it clear simple yes now what will be the entry of this see the entry is really simple you all know dividend is distribution of profit right so if it can't go inside the pnl account right it is a part of appropriation yeah if there are preference shares then preference dividend will also be given first and then the Equity Dividend chance comes right so final dividend will come over here it's a part of appropriation fine final dividend is it clear so see here pnl appropriation account debit or Surplus account Surplus account means what retained profit okay balance in pnl that we have right so you will debit either of the these two and you will credit the dividend payable a liability will be recognized that within next 30 days we have to pay this amount to the share holders is it clear so when you will see the cash flow statement question you will find in the balance sheet in other current liability they saying dividend payable so you have to understand what is that dividend payable that is the dividend that they have declared the dividend that they have declared the company has declared is it clear understood okay fine and one more thing see dividend final dividend I'm talking about dividend of 2023 will be paid in 2024 this is what happens regarding final dividend final dividend will be of a certain year and it will be declared and paid in the next year okay this is what happens fine and then we have something called as interim dividend now what is interim dividend interim dividend means a dividend that is paid between two annual general meeting okay and for interim dividend the approval of shareholders holders is not required directly the board of directors they will only declare the dividend okay there is no concept of propose and all they will directly decare the dividend board of directors it is declared and paid in the current year itself is it clear declared by board of directors and the entry is almost same only okay the same net effect is there so for both of these dividend we'll prepare only one Ledger account for for adjustment okay we'll just open dividend payable and same sort of inent will be passed and easily we can do that is that clear now let's discuss the adjustment and you'll understand how simple it is now see here we have the adjustment of dividend payable it's really simple first let's understand The Ledger account of dividend payable you all know dividend payable is a liability account so it has credit balance that means the opening balance will be on the credit side and closing balance on the debit side okay right then whatever dividend that we declar will come over here by profit and loss dividend declared in current year okay because see the General entry I showed you the general entry the general entry is pnl appropriation account or Surplus account to Dividend payable dividend payable account is getting credited you all know for liability account debit means minus credit means plus so dividend payable account is getting credited it is being increased because of pnl that's the logic okay right so that's the thing and then whatever dividend that is paid in the current year will come over here dividend payable will decrease when you pay the dividend what happens dividend payable Li ility will decrease right so dividend payable will decrease because you have made the payment that is the logic of this Ledger account okay so what you have to do is whenever there is any adjustment of dividend payable or proposed dividend you have to just open this account take the opening balance over here closing balance over here and then the question says this much dividend has been declared just take that over here find the dividend paid as a balancing figure for example let just say this is five and this is two okay and here you have 10 10 then that is declared so 5 + 10 that's equal to 15 and here also 15 15 - 2 that's equal to how much 13 13 is the dividend paid that's how you have to find out is it clear okay now what is the treatment that you do in the format see I have written already over here in direct method what do you do you just deduct in financing activity whatever dividend that is paid simple in direct method you know nothing is difficult it's really simple indir method yeah dividend paid you will take 13 as I said is it clear simple in indirect method what happens in indirect method you know first you have to do reverse sell so now what you will reverse that is what you have to understand you can't reverse both the things see understand properly what you will reverse over here in indirect method in the appropriation reversal what you will reverse you will reverse interim dividend paid okay because interim dividend paid is declared and paid in current year only right so whatever intern dividend is paid you have to reverse that over here regarding the final dividend what you have to do whatever dividend that is declared in current year whatever dividend that is declared in current year yeah only that you will reverse is it clear reverse in operating activity if you start from retained earnings and that's also very important you can't reverse all the time when you will reverse you will reverse only only when you start from retained earning figure from this yeah profit after all adjustment if you start from net profit after tax before tax you can't reverse dividend yeah because it has not been subtracted how can you reverse you can't reverse only when you start from retained earnings then only you will reverse this so the objective of preparing this account is what to know how much dividend is paid to know how much dividend is declared this we have to reverse in operating activity if we start from retain earnings and this we have to deduct in financing activity in both the methods direct or indirect we have to deduct yes now one sort of adjustment can come that is little bit tricky so that is what we are going to understand right now see here if for example let just say dividend payment in current year is not given this is not given how much dividend is paid but opening and closing balances of proposed dividend and dividend payable is mentioned yeah sometime they can say proposed dividend or dividend payable mostly in the new material dividend payable only old they used to say proposed dividend right so dividend payable they will say Okay opening balance closing balance so what you will do simply see here this is how it will be given in the balance sheet all right opening and closing balance will be given to you so what you have to do is understand you have to make an assumption and it will be a rational assumption okay see understand you have to see opening balance what is this opening balance this dividend payable is from the previous year right so that means it is declared in previous year and you all know dividend has to be paid within 30 days since the date of Declaration so obviously you can clearly assume yeah you can you know rationally assume that the dividend has been paid paid in current year it must have been paid in current year right so this amount you will assume as dividend paid and the closing balance you will assume as declared in the current year right this is the rational assumption we do this assumption for provision for tax also if just opening and closing balance are given what do you do opening balance you assume that it has been paid tax paid and closing balance is the tax provision during the year fine the same sort of assumption over here also opening balance is the dividend paid and closing balance is the dividend declared so in The Ledger account if you open the Ledger account of this then what will happen opening balance closing balance you will take okay let's just say five and two the same example so you will assume five is the what this is the opening balance so opening balance you're assuming it's paid so this five will come over here five and this two will come over here two dividend declared in current year is it clear this is how it will happen Okay this is a little bit tricky adjustment that can come you have to understand that and if if interim dividend come then remember interim dividend will be declared also it will come in this figure also and it will come over here also now don't worry when we will solve the problems you'll feel this is nothing easily open the dividend payable and find out as a balancing figure and easily you can do this is that clear so that's all regarding the uh dividend payable adjustment now we have to understand about dividend income when we receive the dividend what kind of adjustment can come let's discuss that okay now see here we have dividend received adjustment it's really simple the first thing that you should be clear in your mind is that this dividend received adjustment is completely separate from dividend paid adjustment don't mix them up these two are separate things dividend paid is a financing activity divid dividend received is an investing activity all right okay so first let's understand what is the normal treatment that we have been discussing about dividend received let just say 50,000 what do we do of that while discussing the format we have talked about this so what do we do first tell me what happens in final accounts in financial statements in financial statement you will say when we prepare statement of profit and loss if we have got the dividend then we just take it in indirect income it goes inside the pnl account right is it it 50,000 it will be added as an income indirect income yes that's correct so in cash flow statement what happens while discussing the format we have discussed this if you talk about direct method what happens is directly pick and drop it's a part of investing activity we have got 50,000 dividend so dividend receive 50,000 add yeah that's what we do in investing activity what do we do in indirect method in indirect method you all know this dividend received has already gone to pnl 50,000 as an indirect income it has been added it has been credited so what do we do we reverse items to be considered in other heads it's an outsider dividend received 50,000 yeah it's of investing family sitting in operating family right now in indirect method so we just reverse it dividend income dividend receive we just reverse it how we subtract 50,000 is it clear understood easy okay and then in investing activity what do we do we will add that 50,000 I'm talking about indirect method you will do investing activity also now so you will add 50,000 clear easy clear now this is called as postacquisition dividend just now we discussed right all this that's postacquisition dividend which was credited to pnl while preparing final accounts financial statements it was a normal dividend income now in cash flow statement what do we do in indirect method we reverse in operating activity by subtracting it and we add an investing activity if we are talking about direct method then we just add an investing activity no reversal nothing yeah it's direct method is it clear okay understood we understood what we have have to do postacquisition Dividend but we still don't know what's the meaning of post acquisition dividend let me tell you see imagine there are 2 years okay there are two years so there has been AGM over here annual general meeting okay in the annual general meeting board of directors have declared I mean board of directors have proposed the dividend shareholders have declared the dividend now this dividend which has been declared you have to remember this is a final dividend and this dividend is actually of previous year this dividend is actually of previous year is it clear so if you were the owner of the shares in this complete previous year then this dividend which you have got right now in the next year this will be called as postacquisition dividend okay you are the owner of the shares in the previous year you have got the dividend it's a normal dividend income okay so that's what it is same treatment just now what we talked about right that only is it clear it can also happen see two years are there let just say in the current year only you purchase the shares in the current year only you purchase the shares before the record date so in the company record your name has come yeah the shares have been transferred to your name so you will get the dividend even though you are not the owner of the shares in the entire previous year dividend is of previous year it has been just declared and paid in the current year and you are getting the dividend but you are not the owner of the shares in the previous year you are not supposed to get the dividend actually the system is like that that you got the dividend but if we see properly you purchase the shares in the current year only you are the owner of the company yeah of the current year only not in the previous year so how can you get the dividend how can you have right on the previous year's profits you can't right so what happens is normally see the share prices in the current year will be already in reled the whole Market overall will know that dividend is going to be declared soon based on the past history of the company and price of the share has been inflated you purchased at inflated price so this is your cost of shares this is your cost of investment so if you are getting dividend of 50,000 let just say this 50,000 dividend is not your income because you are not the owner this is not your income what you will have to do then see this 50,000 which you have got the standard says you have have to deduct it from cost of investment this is not your income this is your recovery of cost you purchased at an inflated Price Right the dividend element was included in that dividend was factored in that right nobody will sell their shares at an low price they will sell at an inflated price only overall the market effect will come into the picture and it will be at inflated price so pre-acquisition dividend means that kind of dividend yeah you are not the owner of the shares in the previous year for which the dividend has been declared but you are getting the dividend because of the system okay so you have to reduce it from the cost of investment is it clear it is not your income it should be deducted from investment account in cash flow statement questions what will happen is for every adjustment you will open uh ledger accounts for investment account also if there is any adjustment you will open that and there is pre-acquisition dividend okay so at that time in the investment account what will you do you will take it on the credit side pre-acquisition dividend in the working I'm talking about yeah in the working node is it clear yeah right and it will be reduced from the cost of investment it is not your normal income so when we prepare the financial statements I'm not talking about cash flow okay when we prepare the financial State final accounts what happens this pre-acquisition dividend doesn't go over here it doesn't go it doesn't go in indirect income is it clear it doesn't go so that means that means if we are preparing cash flow statement from indirect method word then we will not reverse over here even though we have received dividend of 50,000 but previously it has not been taken to pnl now it has been reduced from cost of investment that's what has happened okay in investment account it has been deducted so it has not gone into pnl so you will not reverse then what you will do in cash flow statement tell me what you will do it's an inflow right it's a cash inflow right from investing activities so you have to consider it in investing activity reversal is not required but you have to take over here 50,000 direct or indirect you have to take it in investing activity okay pre-acquisition dividend also is it clear you have to add it is it clear understood simple but sometime what can happen wrong treatment can happen Okay this is the toughest adjustment of this that can come if wrong treatment has been done wrongly credited to pnl yeah while preparing financial statement they have done a mistake pre-acquisition dividend has been taken to pnl if that mistake has been done it is a very rare mistake but if that has been done then still you have to do reversal in operating activities under indirect method okay don't worry uh you will understand all this okay when we'll do the question fine but normally what do you get normally you get post acquisition dividend only and you have to be very clear only when the question says you have to do this pre-acquisition dividend otherwise always you have to assume it's postacquisition dividend and simple treatment you have to do it has been credited to pnl normal dividend income in indirect method two steps indirect method just this black last step is it clear okay now this is the journal entry uh for what do you say pre-acquisition and postacquisition dividend in financial you know when we prepare the financial statement that is bank account debit two investment account two pnl account yeah when we get the dividend let just say we have got 880,000 dividend out of that 50,000 is is pre and 30,000 is post so what will you do bank account debit 80,000 to investment account uh 50,000 to profit and loss 30,000 is it clear whatever that is of post that will go in profit and loss whatever that is of pre that will be deducted from the investment investment is an asset account it has debit balance we are crediting and decreasing the investment balance over there yeah the cost of investment it's like that and if you want to see the effect over here right now only uh how the treatment will be done in cash flow then understand this entire 80,000 the dividend that has been received it has to be added in investing activity because that's a cash inflow from investing activity but in indirect method what do we do we reverse the uh dividend that has been previously taken to pnl yeah how much is taken 30,000 has been taken to pnl so that we have to reverse in operating activities is it clear that's how it is done fine okay and then in the pre I mean just reduce from the cost of investment when you'll prepare the working note in cash flow statement question there you'll have to consider that okay so that's all regarding dividend received adjustment now let's see uh accumulated depreciation and depreciation adjustment okay of pp now see here we have adjustment regarding depreciation see we charge depreciation on what on property plan and Equipment yeah tangible fixed asset like Machinery Vehicles all these things right so there are different methods to calculate the depreciation that's not important for us what is important is how do we account for the depreciation there are two ways to do the accounting treatment of depreciation one is the charge method and another one is accumulated depreciation method right charge method means directly we are charging the depreciation in the asset account only everything is happening in asset account accumulated depreciation account means you must remember in CA foundation in class 11 you have learned provision for depreciation right so in that here what we do is we keep the Machinery account or the asset account PP account on original cost only we do not charge depreciation on that we open a separate account called as provision for depreciation or accumulated depreciation and we charge all the depreciation in that right all the depreciation will be collected over there and it's a contra asset account or you can think it's a liability account opposite to asset okay it has credit balance and then whenever we sell any asset then what we do in this case that also we do not consider in machiner account the asset account no we open a separate account for that called as asset disposal account okay like that it is in accumulated depreciation so now in cash flow statement question what will happen is the company can follow this also this also okay so if the company is following this method then easily you will come to know because there will not be any mention about provision for depreciation or accumulated depreciation so you will you know think this is being follow followed and you will do the treatment accordingly what is the treatment I will teach you don't worry just understand the overview right now but if you see in the question in the balance sheet or anywhere accumulated depreciation account or provision for depreciation account that means you have to understand the company which I have got in this cash flow statement question is doing this accounting treatment so I have to do you know this okay this sort of adjustment all right okay so now let's understand what happens in charge method first in charge method as I said everything is charged in the Machinery account now this asset account this PP account is what asset account right so it has debit balance debit means plus and credit means minus and debit balance it has so opening balance will be on the debit side closing balance will be on the credit side right so when you purchase the asset what happens asset increases right and you have to pay something so you will pay money to cash or bank it's purchased is it clear when you sell the asset what happens asset decreases right and you get the money sale value you get what do you get you get sale value so buy cash or Bank sold is it clear yes but when you sell what happens either you make profit or you make loss if you make profit it will come on the debit side if you make loss it will come on the credit side is it clear to profit and loss by profit and loss fine and then what will happen maybe you have purchased asset Machinery by not not paying cash you have issued bonds of your company you have issued debentures of your company maybe you have issued Equity shares of your company to the seller yeah you getting asset you are giving shares you giving debentures you are giving bonds it can happen in that case what you will do how you will do the posting in The Ledger machiner is increasing you have purchased what you have given you have given bonds you have given debentures you have given let you say Equity shares and let you say Equity shares at premium then two Equity shares and two Securities premium will also come over here is it clear I'm teaching you the logic of preparing Ledger account the basic thing okay understood all right then at the year end you have to charge the depreciation also so how do you charge the depreciation depreciation will be calculated according to the method don't worry about that you will find out mostly the depreciation as a balancing figure so how do we take the depreciation see what do we do asset decreases because of depreciation is decrease in the value of asset right so machinary account is getting decreased because of depreciation is it clear depreciation is directly charged in the asset account that's what charge method mean everything happens in asset account only is it clear right and this is the opening balance this is the closing balance opening balance on the debit side closing balance on the credit side clear you understood how to prepare the Machinery account now let me tell you how the effects of this will flow in cash flow statement first understand purchase and sale of Machinery is what is investing activity purchase of Machinery is outflow of cash and sale of Machinery is inflow of cash where it will come it will come in investing activity isn't it yes we all know that it will come in investing activity see here purchase of fixed asset proceed from sale of fixed asset it will come in investing activity see investing minus investing plus is there any doubt in that no doubt it's simple okay then loss on sale profit and sale what are these things these are non-cash items loss on sale profit on sale these items have been taken to profit and loss these items have been taken to profit and loss they are sitting see loss on sale is an indirect expense and profit on sale is an indirect income these are sitting over here what we have to do we have to reverse non-cash so we will reverse them we will reverse them okay reverse non-cash see here in the indirect method format reverse non-cash and non-operating items gain on sale of land loss on sale of Machinery you have to reverse these things is it clear loss on sale of Machinery will be added and profit on sale of Machinery will be subtracted okay you have to do opposite and you know you have reversed them is it clear okay and then whatever Equity shares bonds and debentures you have given to purchase the Machinery that will not be considered in cash flow statement because they are not affecting the cash flow you have got the machinery and you're giving the shares you're giving the bonds you're giving the debentures so where is the cash there is no cash if there is no cash then it will not go in cash flow statement simple funa is it clear okay understood then the most important part the depreciation depreciation you will mostly calculate as a balancing figure most of the figures will be given to you okay you will do everything you'll do the total and as a balancing figure you will find out the depreciation that is charged in the current year okay this figure you will get as a balancing figure mostly so you will reverse that in operating activity yeah same like loss on sale you will add it right depreciation will be added back because normally depreciation is deducted in statement of profit and loss it's an expense so now you have to add back and reverse it is it clear that's what you have to do why did we prepare this machiner account what was the reason the reason was to just know the depreciation that has been charged in the current year is it clear understood this simple now let's understand accumulated depreciation account now see here we have accumulated depreciation account it's really simple it's also known as provision for depreciation if you look into the question you find either of these two terms and all you have to understand this sort of treatment is being done and you have to prepare these ledgers to find out the figures okay so see here here what happens is here Machinery account the asset the pp account will stay at original cost you will not charge the depreciation over here you will not sell the asset over here you will not take profit or loss on sale over here what will happen here you will just have opening balance of the asset closing balance of the asset right any asset you have purchased and if you have purchased the asset it will come over here right if you have purchased the Machinery it will come over here the same way if you have purchased the Machinery by way of issuing bonds Equity shares debentures it will come over here as usual just the depreciation will not be charged over here the sale will not happen over here the profit or loss also will not come over here is it clear that's the difference so when we sell the asset what will happen when you sell the asset just remember you have to just delete the what do you say original cost of the asset that you have sold how will you delete machinary account you have to decrease by that much original cost of the asset which you have sold and you will take the name as buy asset disposal account that means you're opening a separate account called as asset disposal okay for the asset that you have sold is it clear understood the logic of this so how this account will affect the cash flow statement simple one effect will go see whatever asset you have purchased by paying cash that you have to deduct an investing activity is it clear understood then you have to prepare accumulated depreciation account it's what it's a provision for depreciation it's a contra asset account or you can say it's kind of like a liability account right it's kind of like liability account now see this is accumulated depreciation account now what will happen in this account in this account you will park all the depreciation that you have charged till the date all the depreciation will be collected over here you're not charging the uh depreciation over here now so you have to show the depreciation somewhere so here in this account it will be getting collected fine so there will be opening and closing balance of this which you'll get from balance sheet so opening balance closing balance you will take accumulated depreciation account is kind of like a liability account it's a contra asset account actually okay fine so it has credit balance opposite to asset okay so opening balance on the debit side closing balance on the credit side credit means plus debit means minus fine so opening balance closing balance you understood then the depreciation which we charge will come over here and mostly this will be found as a balancing figure opening balance you will take closing balance you will take if the question says uh some of the asset has been sold and this much is the depreciation of that asset charge till the date of sale you will take over here two asset disposal yeah two asset disposal what you will take whatever depreciation is there of that sold asset till the date of sale will come over here and then as a balancing figure you will find out how much depreciation has been charged in the current year is it clear current year depreciation you will get over here we prepared this accumulated depreciation account to get the current years's depreciation is it clear okay how the effect of this will flow to cash flow statement really simple you'll just get to know current year depreciation which we have to reverse in operating activity under indirect method right here this thing fine understood we understood why we prepar this Ledger account then we have asset disposal account now what is this asset disposal why do we prepare this we prepare this asset disposal account because we get to know the sale value of the asset okay how much profit or loss we have made that's why okay in asset disposal account two posting will come one from machinery and another from accumulated depreciation okay cross posting see here buy asset disposal is there it will come to Machinery original cost of the asset that you have sold okay and here two asset disposal is there depreciation till the date of sale of that sold asset okay that will flow over here by accumulated depreciation is it clear understood okay original cost of the asset and then how much depreciation till the date of sale okay since when you purchase from that date to till the date of sale that will come over there fine and then you know the sale value you have to take at what price you have sold it at what amount you have sold it it will come over here by cash or Bank the asset which you have sold fine and then as a balancing figure you will find out whether you have made profit on sale or loss on sale always remember profit will come on the debit side loss will come on the credit side is it clear understood simple right so now how the effect of this will flow in cash flow statement that is very important because that's why we are preparing this see we have sold the asset so that's the sale value we have to add in investing isn't it purchase and sale of asset will be where investing activity purchase of fixed asset proceed from sale of fixed asset fine and then the profit or loss you have to reverse in indirect method fine so this is what it is asset disposal account clear okay so that's it let's move on to the next adjustment now now see this adjustment profit on sale of an asset when it has been transfer to capital reserve okay what we have to do in cash flow statement first think about the normal treatment profit on sale of an asset just now we saw in the machiner account in the machinary account we saw profit comes on the debit side right and we take that to profit and loss that's what usually happens if it has been taken to profit and loss that means what it means in statement of pnl it is sitting in indirect income right and we are converting this to what we are converting this to cash flow from operating activities so what we have to do we have to eliminate this non-cash item isn't it so we you know reverse over here gain on sale of land profit on sale of Machinery profit on sale of building is it clear that's what we do we just simply reverse it yeah that's the usual treatment yeah reverse in operating activity now if the question says profit on sale of an asset has been transferred to capital reserve what does that mean visualize the asset account the machinary account yeah the profit is on the debit side but they have not written two profit and loss they have written two capital reserve that means the profit on sale hasn't gone to profit and loss statement it is not sitting in the indirect income over here so while doing the cash flow statement as per the indirect method you cannot reverse because profit and S sale is not included over here is it clear so what you will do if this is transferred to capital reserve nothing you will just ignore it you will just ignore it is that clear yeah it's just that when you prepare the working note in the asset account in the machiner account whatever the asset is it's just on the debit you have to write capital reserve okay just the working note fine in cash flow statement nothing will happen fine you will not reverse how can you reverse it has not gone to statement of pnl you cannot reverse is it clear yes but sale of an asset where do you consider sale of an asset do you remember it doesn't matter where it has been taken or which method it is sale of an asset has happened means what you have to do proceed from sale of fixed asset you have to take the whole sale value okay this is a normal thing not related with the adjustment is it clear okay understood next adjustment is see question can be silent on on uh sales and purchases whether they are cash or in credit is that clear in that case you have to write a note down below and you have to make an assumption that all are on credit okay if nothing is specified about cash sales or cash purchases you will assume total sales and purchases are on credit only is it clear okay now let's move on to the next adjustment now see here we have the interest adjustment okay interest paid adjustment and this is a hidden adjustment the question will not specify this the question will not tell you anything about this you have to do this in every question is it clear see in the balance sheet for example leg just see debentures are given long-term loan is given or any other loan is given and along with that rate is given okay 10% 11% 9% like that so what you have to do you have to calculate always the interest on debenture or that loan okay and you have to reverse an operating activity and you have to what deduct in financing activity because that is what you do with the interest that is paid this is interest paid adjustment okay interest paid is a financing activity that's fine we will deduct in financing activity it's a cash outflow we have paid yes now interest paid also goes where it also goes in statement of pnl isn't it it is sitting over here indirect expense interest that we have paid it's a finance cost so in indirect method yeah in indirect method what we have to do interest expense the interest that we have to paid it's an outsider we have to kick it out interest paid is usually deducted in a statement of pnl so now what we have to do we have to add yeah we have to add and reverse it is it clear reverse items to be considered in other heads that is what you have to do these two things reverse in operating activity and then you have to subtract in financing activity see in financing activity interest paid you have to subtract is it clear yeah so always you have to do this and then there are certain fake adjustment the question will talk about bad debts the question will talk about discount allowed the question will say discount received okay and then the question can say something about stock valuation all these adjustment you have to completely ignore why is that so because see the effect of this has already gone to statement of profit and loss and regarding this what we do you know we do something called as working capital changes you all know that right we take the operating current assets and current liabilities and we see the opening balance and closing balance is it increasing or decreasing yeah we compare and we see whether this current asset debts is it increasing or decreasing current liabilities for example trade payables is it increasing or decreasing right and we give the net effect in the format right over here so when we do this all the this is already considered in the net effect right so that is why we do not do any separate adjustment of this if we do any separate adjustment of this still the effect will be same only because it gets nullified over here that is why don't do all this we'll just do working capital changes is it clear yeah that is why I also told you you know in non-cash items I told you you have to reverse only what you have to reverse only non-cash item which are of non on operating like depreciation profit on sale loss on sale for example uh preliminary expenses return off discount on issue of debenture return off all these things right not not bad debt discount allowed discount received and all why because we do changes in working capital for that and the effect of that has gone to pnl already and working capital changes is enough for that is it clear okay understood now let's move on to the equity share adjustment okay how to prepare The Ledger account of Equity shares fine now see here we have Equity shares adjustment it's really simple so first you have to understand how to open the Ledger account of it what's the logic of the posting and everything and then how you have to do everything right so let's see equity share capital account is a capital account it's an equity account it has credit balance debit means minus credit means plus opening balance on the credit side closing balance on the debit side right yes and one more important thing equity share Capital account exists at face value you know regarding shares debentures preference shares what is there there is issue price there is face value there is premium isn't it so the cash plays its game on issue price okay how much cash has been received yeah and buyback price also or Redemption price isn't it how much you know cash has been paid that's the thing but the debenture account preference Share account equity share Capital account these accounts always exist on face value you have to understand the difference about this okay so see here let me just show you buy balance B byd opening balance and then here you will take closing balance right so when equity share Capital will increase let's just say in the balance sheet you have two balances opening balance closing balance let just say it has increased from opening to closing it has increased by one lakh let just say why it will increase it will increase because you have issued new shares right so equity share capital is increasing because you have issued new shares by bank is it clear now here what you will have here you will have only face value let just say for example you have issued shares worth 1 lakh rupees right so 1 lakh will appear over here face value one lakh but let just say you have issued at you know 20% premium so that 20,000 extra will not appear over here it will not come over here it will go in Securities premium account so when you will do cash flow statement you have to be very careful ful when you will take in financing activity proceeds from issuance of share Capital you have to take how much can you take one lakh over here here it's showing one lakh can you take one lakh no one lakh is just face value you have to take 1 lak 120,000 over here is it clear that's what the devil is this is the devil The Examiner he's killing you do you understand yes and then equity share Capital can also increase if you have issued bonus shares if you have issued bonus shares then Capital will increase but understand bonus issue is a non-cash thing right it's a non-cash item because because there is no cash flow behind it it's just reserves have been converted into Equity shares is it clear yes and then debenture what is this see equity share Capital can also increase if you redeem the debentures by way of conversion debenture holders are there you are supposed to pay them cash but they are convertible debentures right so you gave them Equity shares and you said cancel the debentures you have got Equity shares you are becoming Equity shareholders right this can also happen so in that case also equity share Capital will increase and debentures will be cancelled yeah to debenture holders you have given the shares is it clear so in both of these cases bonus as well as conversion of debenture into shares in both of these cases cash flow is not involved these things will not affect cash flow statement is it clear these are non-cash transaction will not affect the cash flow statement bonus issue and conversion of debentures into Equity shares fine okay understood and then I told you now here only face value will exist you have to look into Securities premium as well and 1 lakh 120 you have to take in the financing activity you will add okay you'll add right you have issued shares you're getting the cash fine so see here Shares are usually bought back at premium and also issued at premium that's what I said but in equity share Capital only face value will exist so what you have to do you have to look at the issue price which consist of face value as well as Securities premium right and that's how you have to prepare the cash flow statement by looking into those figures okay because they represent the cash now when equity share Capital will decrease let's just say opening balance closing balance is there in the balance sheet from opening balance to closing balance let just say there is a decrease of one lakh now why that decrease happen it means you have bought back it means you have bought back the equity shares by pay paying the shareholders you have to pay them right so that's what equity share Capital have been bought back it has been decreasing and cancelled because you have bought them back by paying the shareholders the money but you have to pay what can you pay the face value only no you can't pay just the face value you have to pay the price more than the market price right so that's a huge premium that you have to pay so here only face value will appear here only one lakh will appear maybe they have paid 70% premium or 60 % premium right so let just say 60% premium here only one lakh will appear the face value remaining 60,000 will be there in premium on buyback account so you have to look properly the buyback price or the ratio the percentage and take entire 1 lakh 60,000 not just one lakh 1 lakh 60,000 and deduct in financing activity otherwise The Examiner will kill you okay is that clear the devil is there see here buy back of shares how much will you take can you take one like over here just the face value no you have to take the buyback price the whole buyback amount that is 1 160,000 just for an example is it clear this is how you do the adjustment of equity share simple and straightforward it's not difficult now the same concept is there for preference shares for debentures also they will also exist at face value and if you are doing Redemption if you're issuing then same sort of situation will be there yeah we isue at premium and we buy back at premium is that clear simple you understood this if youve understood this then you have also understood the debenture and preferen share treatment also so when you'll solve the question you will be easily able to get that also right okay so now there's just uh two little adjustment so let's just see that now see here we have Grant received adjustment it's really simple Grant received means the money that we get as an assistance from the government right so there are two reason why we can get the grant the first is for capital projects right and the other one one is to meet Revenue expenses is it clear two types of Grant can be there now if we are getting for capital projects then what the ICI does is right now in the module ICI just considered that as an investing activity okay in the direct method or indirect method what will happen it will be added in investing activity right why see understand the logic is see Capital project means what we are investing in the asset yeah it's an investing activity outflow yeah we are investing in a project is that clear so any Grant received related to that that will also be an investing activity is it clear so what you have to do is see let just say for example we have received 1 lakh grand for capital projects we'll go to investing activity we'll write over here Grant receipt for Capital project one lakh is it clear direct or indirect method same treatment has to happen in investing activity fine and then see if you're doing indirect method one more step can be there if the question says that you know Grant received for Capital project has been amortized one lakh we received let just say in this year we have amortized 40,000 okay so that means it has been taken to pnl amorti mean it has been taken to pnl it has been added in pnl so now what you have to do what you have to do you have to reverse okay in indirect method yeah because it is not of operating family right grant received is of investing family just now we saw so that is what we have to do we have to reverse it's a non-operating item yeah it has been amortized over here let's just say 40,000 as I said so 40,000 you will reverse okay you will subtract is it clear that is what you will do if such Grant is amortized in pnl then Reverse by amortized amount in operating activity fine okay clear that's what you have to do regarding capital projects and then for example let just say we have received grant for Revenue expenses in that case understand you have to just add in operating activity under direct method okay because in direct method you do what pick and drop so that is why that is what you have to do in the direct method but indirect method you don't have to do anything because already it would have been going to pnl mostly it would have been going to pnl so you will not do anything is it clear if already transferred to pnl you don't need to reverse and all why why don't you need to reverse because the grant which is received to meet Revenue expenses that is already an operating item that is not an investing item so it would have gone to PN you will not do anything about it is it clear under indirect method fine clear but now there's one more opinion that Grant received can also be taken to financing activity yes that is also possible that is also correct okay if you go deep into this see before ICI also in the material used to take the grant received for Capital project as a financing activity the idea was that see we have not started spending on the what do you say the project and we have got the grant so it's like a finance that we are getting so they used to consider as a you know financing activity inflow in financing activity but right now in the latest module what the ICI is doing ICI is considering it an investing activity so that is why we will also consider it as an investing activity inflow is it clear okay so that's regarding the grant received adjustment now see here we have our last adjustment premium on Redemption of debenture or preference shares written off it's really simple will understand this is also a bit tricky for the students so you have to understand what used to happen earlier was earlier IA used to say this is an appropriation item appropriation item means in statement of profit and loss we write this uh premium or Redemption off at last yeah in the appropriation it is not part of profit and loss account fine so when we start from retained earnings figure The Profit after all adjustment in indirect method then only we used to reverse this yeah usually it is deducted so to reverse we will add it back isn't it yes and it used to happen only when we start from retained earnings see here if it is an appropriation item reverse in operating activity only if you start from retained earnings if you start from net profit after tax or before tax you didn't use to reverse it because it's part of appropriation is it clear but now if you will check the study material right now the latest one what the ICI is doing is ICI is assuming that this has been written off inside the pnl account it has been charged to profit and loss account so where is it sitting it is not sitting in the appropriation it has not been deducted in the Surplus figure no what is happening is this premium on what do you say redemption it has been charged to profit and loss it is existing over here it is sitting over here it has been deducted over here charged to profit and loss so that means that means now if you prepare indirect method Cash Flow State statement what we need to do is we will have to reverse this premium on Redemption always whether you start from third priority second priority or first priority okay where you have to take it you have to take it over here reverse non-cash and non operating items premium on Redemption of preferen sh let just say it's 5,000 premium or Redemption of debentures let just say it's 10,000 10,000 will come over here you will reverse it you'll find questions in this ICI study material regarding this okay they are taking it you know over here reverse non-cash and non-operating item is it clear fine so when it is charged to profit and loss always you have to reverse it in the operating activity in silent question ICI assumes it is charged to pnl what is charged to P pnl premium on Redemption is it clear simple and straightforward okay I hope you have understood this okay this is very simple it's not difficult and here we can conclude our concept and this format video right from the next video we can start solving the big problems on indirect method because direct method is really simple first let's just focus on indirect method direct method you will easily understand yeah so that's all for this video I hope everything is clear if you have any doubts please take screenshots and ask me in Instagram you can also comment down below right and I will upload the notes on the telegram channel so that you can properly understand and revise everything because lots of things have been covered in this video in this three-hour long video isn't it yes so yeah the notes will be very important you can go to my telegram Channel I will put the links in the description below it's sahab Academy 7 okay right so that's all see you in the next video bye