Statements of cash flows were examined as section-C questions in the November 2010, May 2011 and August 2011 F1 papers, so they are clearly here to stay. Finding a logical way to tackle these is essential, therefore, so in this article I will work through question 4(a) of the May 2011 paper to demonstrate my recommended approach (the question is available to download free via your “My CIMA” account on www.cimaglobal.com).
Step one: analyse the requirement and additional information
The first thing to do is read the requirement. This may sound obvious, but it is surprising how many candidates calculate the wrong things using the wrong dates. In this question the requirement is to “prepare a statement of cash flows, using the indirect method, for OP for the year ended 31 March 2011”.
Next, skim-read the additional information pro- vided in the question – that is, anything other than the financial statements. As you do this, put a mark next to items in the financial statements that are affected by these extra details. For example, the additional information provided in (iii) – “Plant and equipment disposed of during the year had a net book value of $11,000 (cost $45,000). The loss on disposal of $6,000 is included in cost of sales” – has an effect both on the cost of sales and on plant and equipment, so it will probably require a work- ing in your answer. Put a mark next to these items in the financial statements.
Step two: construct your pro forma
Next you need to set out the pro forma statement of cash flows with the headings required by IAS7. You should leave plenty of space here. Ideally, you should use three or more sheets of paper: one for the main statement, one for the notes to the state- ment of cash flows, if required (although they aren’t in this case), and one to show your calculations. Leave some blank lines in the pro forma for items that you might have forgotten at this stage, so that you can insert these more easily later as you work through the question and remember them.
It is essential to know the pro formas well, so that you can draw them up quickly and accurately. Note that this question requires the indirect method, so do ensure that you construct the cor- rect pro forma to satisfy the requirement.
Step three: tackle the statement of financial position
Once you have the pro forma set up, you can start working your way through the statement of finan- cial position, moving the figures to the pro forma or your workings as you go. Tick off the numbers as you transfer them. This method helps you to score as many of the easy marks available as pos- sible immediately, before you even start dealing with the more difficult elements.
As a general rule, items that are affected by the additional information (which you made marks next to in step one) should usually go to the work- ings, because you will probably need to make a calculation using these. The rest of the figures can go straight to the statement of cash flows. You can ignore retained earnings at this stage, because this figure is dealt with during the calculation of divi- dends paid.
In this particular question, the property, plant and equipment (PPE) calculation looks as though it could be a lot of work. We already know that there is additional information about PPE to deal with, so we shall leave it for now and get the other easier numbers down first. The same goes for the figure for other provisions: ignore this calculation for now and come back to it in step five.
Also carefully review the dates above the col- umns of numbers. Don’t get the years the wrong way round – it’s a common mistake.
Step four: tackle the statement of comprehensive income
At this point you should already have the backbone of a pass mark for this question, with most of your workings set up and several figures inserted into the pro forma. Now it’s time to look at the state- ment of comprehensive income. Many of the num- bers in this statement are not needed, but we know we’ll definitely need the profit before tax, the finance cost and the tax charge in the cash flow from operations reconciliation, so start with these first. Remember that the finance cost goes in two
| 1: OP’s stateMent OF cash FlOws FOr the year ended 31 March 2011 | | | $000 | $000 | | Cash flows from operating activities | | | | Profit before taxation | 1,089 | | | Finance cost | 15 | | | Profit / loss on disposal | | | | [Leave some lines here for additional items] | | | | Operating profit before working capital changes | | | | Decrease in inventories [450 - 446] | 4 | | | Increase in receivables [310 - 380] | (70) | | | Increase in payables [95 - 150] | 55 | | | Cash generated from operations | | | | Interest paid | | | | Income taxes paid | | | | Net cash from operating activities | | | | | | | | Cash flows from investing activities | | | | Purchase of property, plant and equipment | | | | Proceeds of sale of property, plant and equipment | | | | Development expenditure | | | | Net cash used in investing activities | | | | | | | | Cash flows from financing activities | | | | Dividends paid | | | | Proceeds from equity share issue [400 - 200] + [200 - 100] | 300 | | | Repayment of long-term borrowings [250 - 100] | (150) | | | Net cash used in financing activities | | | | | | | | Net increase in cash and cash equivalents | | | | Cash and cash equivalents at 1 April 2010 | | 35 | | Cash and cash equivalents at 31 March 2011 | | 69 |
places: the cash flow from operations reconcilia- tion and the interest paid working.
After you have completed this step, you should have an answer that looks something like table 1 and the following partial workings:
Working 1: property, plant and equipment [Tip: leave a blank page to complete this working later. You can see from the additional information that you read in step one that more than one T-account will be required. It’s more sensible to work on these towards the end.]
| Working 2: development expenditure | | | $000 | | $000 | | | $000 | | $000 | | 31.3.10 Balance b/f | 65 | | | | | | 31.3.11 Balance c/f | 60 |
| Working 3: brand name | | | $000 | | $000 | | 31.3.10 Balance b/f | 40 | | | | | | 31.3.11 Balance c/f | 30 |
| Working 4: income taxes paid | | | $000 | | $000 | | | | 31.3.10 Balance c/f; | | | | | b/f current | 260 | | | | b/f current | 260 | | 31.3.11 Balance | | 31.3.10 Balance | | | c/f current | 250 | b/f deferred | 120 | | 31.3.11 Balance | | Tax charge per | | | c/f deferred | 130 | income statement | 280 |
| Working 5: interest paid | | | $000 | | $000 | | | | 31.3.10 Balance b/f | 20 | | 31.3.11 Balance b/f | 10 | Finance cost per | | | | | Income statement | 15 |
Step five: tackle additional information
At this point you should have gained quite a few of the easier marks available simply by drawing up the pro forma and transferring in numbers from the financial statements. You could now work through the additional information in the order presented or try the bits that you find least diffi- cult first. Exam technique is important here. You should never spend longer than the allocated time on a question. For this question you shouldn’t spend much more than 34 minutes (1.8 marks per minute x 19 marks). If you are stuck as to what to do with some of the additional information, leave it and move on. You could always return to it at the end of the exam if there’s time left.
Remember that the additional information pro- vided may need to be used in different parts of your answer. For example:
Plant and equipment disposals in (iii) will affect the cash from operations (add back the non-cash loss on sale of $6,000) and the PPE working (dis- posal of $45,000) and the proceeds from disposal in cash from investing activities (net book value less loss on disposal = proceeds of $5,000).
Development expenditure amortisation of $15,000 in (v) will affect cash from operations (add back, as it’s a non-cash movement) and should be included in the development expenditure working.
The examiner for this paper commented that many candidates left the dividends paid figure out of their answers, suggesting that students perhaps didn’t know how to deal with this aspect, so let’s look at it here. The simplest way to calculate divi- dends paid is to open a T-account for retained earn- ings, insert the opening and closing balances from the statement of financial position and the profit for the year from the statement of comprehensive income as follows:
| Working 6: retained earnings | | | $000 | | $000 | | Dividends paid | | 31.3.10 Balance b/f | 423 | | [balancing figure] | 580 | | | | 31.3.10 Balance c/d | 652 | Profit for year | 809 | | | 1,232 | | 1,232 |
The balancing figure represents the dividends paid – easy when you know how. Remember that it is profit for the year, not total comprehensive income for the year, that you need to use here. (Note that total comprehensive income includes revaluation gains/losses that are taken to the revaluation reserve, not retained earnings.)
The examiner also commented that many stu- dents were not sure what to do with the legal claim provision. Remember that the double entry to set up a provision is Dr profit or loss for the year, Cr provisions. No cash has been paid, so the only adjustment required is to add back the expense in the cash from operations reconciliation, since it is a non-cash movement.
Step six: complete your calculations
Once you have dealt with the additional informa- tion, you can finish off the workings. So balance off the T-accounts and calculate the missing figures required for the statement of cash flows. Insert these into your pro forma as you calculate them.
Step seven: complete the statement
This is the final stage. Finish off your statement of cash flows by adding up the figures in the pro forma. If you are short of time, don’t add up your state- ment of cash flows, as this is unlikely to be worth many marks.
The full answer to this question is shown in table 2, along with the following completed workings:| Working 1: property, plant and equipment | | Land – cost / valuation | | | $000 | | $000 | | 31.3.10 Balance b/d | 320 | Downward | | | Additions in year | | Valuation | 65 | | [balancing figure] | 171 | 31.3.11 Balance c/d | 426 | | | 491 | | 491 |
| 2: OP’s stateMent OF cash FlOws FOr the year ended 31 March 2011 | | | $000 | $000 | | Cash flows from operating activities | | | | Profit before taxation | 1,089 | | | Finance cost | 15 | | | Depreciation [17 + 25] – from additional information (ii) | 42 | | | Loss on disposal – from add info (iii) | 6 | | | Amortisation of development expenditure – from add info (v) | 15 | | | Impairment of brand name – from add info (v) | 10 | | | Legal provision – from add info (viii) | 40 | | | Operating profit before working capital changes | 1,217 | | | Decrease in inventories [450 - 446] | 4 | | | Increase in payables [95 - 150] | 55 | | | Cash generated from operations | 1,206 | | | Interest paid – working 5 | (25) | | | Income taxes paid – working 4 | (280) | | | Net cash from operating activities | | 901 | | | | | | | | 901 | | Cash flows from investing activities | | | | Purchase of property, plant and equipment – working 1 | 55 | | | Proceeds of sale of property, plant and equipment [11 - 6] | 5 | | | Development expenditure – working 2 | (10) | | | Net cash used in investing activities | | (437) | | | | | | Cash flows from financing activities | (580) | | | Proceeds from equity share issue [400 - 200] + [200 - 100] | 300 | | | Repayment of long-term borrowings [250 - 100] | (150) | | | Net cash used in financing activities | | (430) | | | | | | Net increase in cash and cash equivalents | 34 | | | Cash and cash equivalents at 1 April 2010 | 35 | | | Cash and cash equivalents at 31 March 2011 | | 69 |
| Buildings – cost | | | $000 | | $000 | | 31.3.10 Balance b/f | 610 | | | | Additions in year | | | | | [balancing figure] | 230 | 31.3.11 Balance c/d | 840 | | | 840 | | 840 |
| Plant and equipment – cost | | | $000 | | $000 | | 31.3.10 Balance b/d | 180 | Disposals | 45 | | Additions in year | | 31.3.11 Balance c/d | 166 | | [balancing figure] | 31 | | | | | 211 | | 211 |
Total property, plant and equipment additions in year: $171,000 + $230,000 + $31,000 = $432,000.
| Working 2: development expenditure | | | $000 | | $000 | | 31.3.10 Balance b/f | 65 | Amortisation | 15 | | Additions in year | 10 | 31.3.11 Balance c/f | 60 | | | 75 | | 75 |
| Working 3: brand name | | | $000 | | $000 | | 31.3.10 Balance b/f | 40 | Impairment | 10 | | | | 31.3.11 Balance c/f | 30 | | | 40 | | 40 |
| Working 4: income taxes paid | | | $000 | | $000 | | Income taxes | | 31.3.10 Balance | 260 | | 31.3.11 Balance | | 31.3.10 Balance | | | c/f current | 250 | b/f deferred | 120 | | 31.3.11 Balance | | Tax charge per | | | c/f deferred | 130 | income statement | 280 | | | 660 | | 660 |
| Working 5: interest paid | | | $000 | | $000 | | Interest paid | 25 | 31.3.10 Balance b/f | 20 | | 31.3.10 Balance b/f | 10 | Finance cost per | | | | | income statement | 15 | | | 35 | | 35 |
| Working 6: retained earnings | | | $000 | | $000 | | Dividends paid | | 31.3.10 Balance b/f | 423 | | [balancing figure] | 580 | | | | 31.3.11 Balance c/d | 652 | Profit for year | 809 | | | 652 | | 809 |
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