Accounting Business Reporting for Decision Making

CHAPTER 7 Statement of cash flows 291

Let’s consider these items in turn.
The profit or loss would contain an adjustment for depreciation. Depreciation is a non-cash item and
therefore does not form part of the statement of cash flows. It therefore needs to be added back to the
profit.
An increase in a current asset such as inventory, accounts receivable or prepayments means a reduc-
tion in cash; that is, we would have had to spend more on them than we received over the year for there
to be an increase. Coconut Plantations Pty Ltd had an increase in inventory for the year. This means
that it bought more inventory than it sold. The increase in prepayments means it used up cash. The
accounts receivable balance also increased, which means that fewer debts were collected from cus-
tomers, reducing cash.

Increase in current assets means a reduction in cash

Decrease in current assets means an increase in cash

An increase in current liabilities such as accounts payable and accruals means that we have not paid
as much over the period as we have expensed, thus increasing cash. Conversely, a decrease in cur-
rent liabilities means that we have paid out more over the year than we have expensed, and therefore
a decrease in cash results. Coconut Plantations Pty Ltd had an increase in accounts payable, which
means it conserved cash and increased its debt. The accruals increased, thus saving cash. The direc-
tion of changes in current assets and liabilities is consistent with a growing business.

Increase in current liabilities means an increase in cash

Decrease in current liabilities means a decrease in cash

Step 6: Complete notes to the statement of cash flows

The IFRS requires other explanatory notes to the statement of cash flows. These notes would generally
cover items such as non-cash financing and investing activities, the disaggregated cash flows con-
cerning acquisitions and disposals of entities, and a reconciliation of cash amounts shown in the bal-
ance sheet and those shown in the statement of cash flows. These items are included as notes to the
statement to ensure users have adequate information concerning the cash flows of the entity. They have
not been prepared for our example, but as a potential user of financial statements, you should be aware
that some notes are required to help in the evaluation of an entity.
Let’s summarise the discussion above relating to the preparation of the statement of cash flows:
• The preparation of the statement of cash flows requires the conversion of accrual accounts
(statement of profit or loss and balance sheet) to a cash basis.
• The statement of cash flows can be prepared using the direct method or the indirect method
(reconciliation).
• A review of processes needed to convert the accrual basis to the cash basis under the direct
method is:
Cash from customers = Opening accounts receivable +
Sales − Closing accounts receivable
Cash paid to suppliers = Opening accounts payable +
Purchases − Closing accounts payable
Cash paid to other suppliers = Other expenses +/− Increase (decrease)
in prepayments +/− Decrease (increase) in accruals

• A review of processes needed to convert the accrual basis to the cash basis under the indirect
method (reconciliation) is:

Increase in current assets means a reduction in cash

Decrease in current assets means an increase in cash

Increase in current liabilities means an increase in cash

Decrease in current liabilities means a decrease in cash