FRS 107:Indirect Format Of A Cash Flow Statement And Explanation Of Terms Used In The Cash Flow Statement

Indirect Method Cash Flow Statement

		2009
Cash flows from operating activities
Profit before taxation	3,350
Adjustments for:
Depreciation Foreign exchange loss Investment income Interest expense Increase in trade and other receivables Decrease in inventories Decrease in trade payables	450 40 (500) 400 3,740 (500) 1,050 (1,740)
Cash generated from operations	2,550
Interest paid	(270)
Income taxes paid	(900)
Net cash from operating activities		1,380
Cash flows from investing activities
Acquisition of subsidiary X net of cash acquired	(550)
Purchase of property, plant and equipment	(350)
Proceeds from sale of equipment	20
Interest received	200
Dividends received	200
Net cash used in investing activities		(480)
Cash flows from financing activities
Proceeds from issue of share capital	250
Proceeds from long-term borrowings	250
Payment of finance lease liabilities	(90)
Dividends paid	(1,200)
Net cash used in financing activities		(790)
Net increase in cash and cash equivalents		110
Cash and cash equivalents at beginning of period		120
Cash and cash equivalents at end of period		230

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Explanation of terms used in a Cash Flow Statement:

• Cash comprises cash on hand and demand deposits.

• Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.

• Cash flows are inflows and outflows of cash and cash equivalents.

Operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities.

More examples of cash flows from operating activities are as follows:

• cash receipts from the sale of goods and the rendering of services;

• cash receipts from royalties, fees, commissions and other revenue;

• cash payments to suppliers for goods and services;

• cash payments to and on behalf of the employees;

• cash receipts and cash payments of an insurance entity for premiums and claims, annuities and other policy benefits;

• cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities; and

• cash receipts and payments from contracts held for dealing or trading purposes.

Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.

More examples of cash flow from investing activities:

• cash payments to acquire property, plant and equipment, intangibles and other long-term assets. These payments include those relating to capitalised development costs and self-constructed property, plant and equipment;

• cash receipts from sales of property, plant and equipment, intangibles and other long-term assets;

• cash payments to acquire equity or debt instruments of other entities and interests in joint ventures (other than payments for those instruments considered to be cash equivalents or those held for dealing or trading purposes);

• cash receipts from sales of equity or debt instruments of other entities and interests in joint ventures (other than receipts for those instruments considered to be cash equivalents and those held for dealing or trading purposes);

• cash advances and loans made to other parties (other than advances and loans made by a financial institution);

• cash receipts from the repayment of advances and loans made to other parties (other than advances and loans of a financial institution);

• cash payments for futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the payments are classified as financing activities; and

• cash receipts from futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the receipts are classified as financing activities.

Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.

More examples of cash flow from financing actitivities are:

• cash proceeds from issuing shares or other equity instruments;

• cash payments to owners to acquire or redeem the entity’s shares;

• cash proceeds from issuing debentures, loans, notes, bonds, mortgages and other short or long-term borrowings;

• cash repayments of amounts borrowed; and

• cash payments by a lessee for the reduction of the outstanding liability relating to a finance lease.

What are the benefits of having a cash flow statement

The following are some of the benefits of having Cash flow information:

• The cash flow statement when used in conjunction with the rest of the financial statements provides information that enable users to evaluate (a) the changes in net assets of an enterprise; (b) its financial structure(including liquidity and solvency) and (c) its ability to affect the amounts and timing of cash flows in order to adapt to changing circumstances and opportunities
• The cash flow statement is useful in assessing the ability of the enterprise to generate cash and cash equivalents and enable users to develop models to assess and compare the present value of the future cash flows of different enterprises.
• The cash flow statement assists in enhancing the comparability of the reporting of operating performance by different enterprises because it eliminates the effect of using different accounting treatments for the same transactions and events.
• Historical cash flow information is often used as an indicator of the amount,timing and certainty of future cash flows.
• Useful in checking the accuracy of past assessments of future cash flows and in examing the relationship between profitability and net cash flows and the impact of changing prices

Sample Of LCCI Management Accounting Level Question And Answer Paper

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LCCI Management Accounting Level 3 Questions & Answers for Year 2004

True Or False Question (1) On Interpretation of Final Accounts/Financial Statements

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Attached herewith are 25 true or false accounting questions for the readers to practise on the topic on interpretation of final accounts/financial statements

Multiple Choice Question(1) on Interpretation Of Final Accounts/Financial Statements

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Append herewith a multiple choice question for readers to practise the topic on interpretation of final accounts/financial statement.

Worked Example On Cost Volume Profit Analysis (2)

Question A

ABC Limited sells a product at $4 per unit and the variable cost of the product is $2 per unit. The current fixed cost is $30,000. What is the break-even point, the firm must produce?

Suggested Solution To Question A

Applying the following formula:

=Fixed costs/Selling price/unit –Variable cost per unit

= Break-even
= $30,000/$4-$2
=15,000unit



Question B
Multiproducts Ltd expects a total sales of $200,00 for this year. Its variable costs totaled $120,000 and fixed costs $40,000. What is its sales volume in order to break-even

Suggestion solution to Question B

Formula = Fixed costs /(Sales-Variable costs/Sales)
=$40,000/($200,000-$120,000)/$200,000
=$40,000/$80,000/$200,000
=$40,000 x $200,000/$80,000
=$100,000

Worked Example On Cost Volume Profit Analysis (1)

Question:

The data for Company XYZ is as follow:-Volume of sales 20,000 units
Sales price per unit $10
Total fixed costs $50,000
Variable cost per unit $5

Compute the new break-even point with the following effect of:

(a) a 20% increase in selling price
(b) a 20% increase in fixed costs
(c) a 20% decrease in variable costs
(d) a 10% increase in volume of sales




Suggested Solution:

(a) Effect of a 20% increase in selling price
New Break-even point
=Fixed cost/(Sales price per unit-Variable cost per unit)
=$50,000/($12-$5)
=7,144 units

(b) Effect of a 20% increase in fixed costs
New Break-even point
=Fixed cost/(Sales price per unit-Variable cost per unit)
=$50,000 x 1.2/($10-$5)
=$60,000/$5
=12,000 unit



© Effect of a 20% decrease in variable costs
New Break-even point
=$50,000/($10-$5x(1-0.2))
=$50,000/$6
=8,333 units

(d ) Effect of a 10% increase in volume of sales
Original sales =20,000 unit x $10 per unit =$200,000
New sales =$200,000 x 1.1 =$220,000
Be=$100,000 or 10,000 units

How to construct or prepare a break-even chart.

In break-even chart, the unit of production are measured on the horizontal axis and costs and revenues on the vertical axis. Fixed costs are shown as a constant in a line parallel to the horizontal axis.

The following steps are used to construct a break-even chart:-

• Prepare a graph with the horizontal axis representing activity and vertical axis representing costs and revenues
• Draw the fixed cost line at the appropriate point on the chart
• Draw the total cost line starting from the point where the fixed cost line cut the vertical axis.
• Draw the sales revenue line starting at zero and finishing at point of maximum sales.
• Write on the completed break-even chart suitable description e.g. break-even point, profit,etc
  
  

Understand The Assumptions And Limitation Underlying Break-Even Analysis

Like all other financial/costing model, break-even analysis using break-even chart to understand the business’s break-even point has also certain assumptions and limitations underlying it.

Some Of the Assumptions & Limitation are as follows:

1.0 It assumes that fixed costs remain the same at different level of activity

2.0 It assumes that the total cost line is shown as a straight line when in actual fact, costs do not usually vary in direct proportion to volume. Each unit produced and sold may not necessarily incur the same variable cost as attempts to sell more units may increase the variable cost at a faster rate than activity

3.0 It assumes that revenue is perfectly variable with activity, showing a straight line on the break-even chart which is unrealistic as very often in order to increase sales volume, it may be necessary to give extra discount or reduce the selling price. The sale revenue line will therefore no longer be linear but curved.

4.0 Break-even charts are only true within the minimum and maximum ranges of activity. Any attempt to determine figures outside this range of activity is not valid

5.0 Break-even analysis assumes that all units produced are sold

6.0 Break-even chart has a life span as the nature of variable and fixed cost change with time. It would then be necessary to construct new charts based on different circumstances

7.0 In a multi-product firm, each possible product mix will tend to incur different costs so that with any change in the product mix, a new break-even chart is required. Thus in a break-even chart of such firm, the sales mix is assumed to remain constant throughout its level of activity

8.0 It assumes as in conventional accounting that monetary values are stable. In order to establish the break-even point in real terms it may be necessary to adjust revenues and costs to current purchasing powers.

Understanding the Importance of the business’s break-even point

Break-even point is important for business decisions as it marks the very lowest level to which activity can drop without putting the life of the company in jeopardy. By understanding break-even analysis, a firm can decide on which following strategies to use in order to increase profit or decrease loss like:

• Increase sale volume
• Increase selling price per unit
• Decrease fixed costs
• Decrease variable cost per unit
  

What is A Break-Even Chart?

The analysis of revenues and costs in relation to the volume of production is known as break-even analysis. This relationship can be best shown in a break-even chart where the point at which total revenue equals total costs is the break-even point. This break-even point is where a company is neither making a profit or loss.

Standard Costing-The Sources of Variances

In standard costing, the idea is establish the attainable standards and then work out the variance between the standard and the actual. By reviewing the variances,managers can immediately take the necessary corrective actions. Therefore it is necessary for them to understand the various type of variances that they are facing and their sources.


Append below is a snapshot or summary of type of variances and its sources:


Variance:Sales PRICE
Source:Actual selling price

Variance:Sales VOLUME
Source:Actual units sold

Variance: Direct materials PRICE
Source:Actual cost of materials

Variance: Direct materials USAGE
Source:Actual usage of materials

Variance: Direct materials MIX
Source:Material Mix

Variance:Direct materials YIELD
Source:Actual output

Variance:Direct labor RATE
Source:Actual labor rate

Variance:Direct labor EFFICIENCY
Source:Actual productivity

Variance:Variable production overhead EFFICIENCY
Source:Actual consumption per unit of output

Variance:Variable production overhead EXPENDITURE
Source:Actual variable production overhead

Variance:Fixed production overhead EXPENDTIURE
Source:Actual fixed production overhead

What are the required Qualitative characteristic of the financial statement

One of the examination question asked about on financial statement is on the qualitative aspect of the financial statement.

Normally, candidates are asked to quote some qualitative characteristic of the financial statement or to elaborate on any of the following qualitative characteristic:


1.0 UNDERSTANDABLE & USEFUL

• Accounting information should be readily understandable to the intended users of the information.
• This is a function of both the intended users and the intended uses of the information. Accounting systems that define either the users or uses narrowly may justify more complex information requirements and standards. Accounting systems that envision a broad body of users and/or uses would tend towards less complexity in published information and standards.
• Typically the belief that, for information to be understandable, information contained in the various financial disclosures and reporting must be transparent (i.e., clearly disclosed and readily discernable).

2.0 RELEVANT

The information should be relevant to the decision-making users of the information. It should make a difference in their decisions. Typically, this means the information must
be:
• Timely
• Have predictive value
• Provide useful feedback on past decisions

3.0 RELIABLE

The information should be reliable and dependable. This usually includes the concepts of:

• Representational faithfulness - the information represents what it claims to represent. For example, if the reported value of a common stock holding purports to be the current market value, that value should be approximately what the stock could be sold for by the company holding it.

• Verifiability - another person or entity should be able to recreate the reported value using the same information that the reporting entity had.

• Completeness - the reported information should not be missing a material fact or consideration that would make the reported information misleading.

• The concept of neutrality is sometimes incorporated into the concept of reliability.

4.0 COMPARABLE AND CONSISTENT

• For accounting information to be usable, it must allow for comparisons across time and across competing interests (such as competing companies or industries).

• This leads to a need for some consistency, wherever such comparisons are to be expected. For example, comparisons of two companies would be very difficult and potentially misleading if one discounts all its liabilities while the other discounts none of its liabilities.

5.0 UNBIASED

• Information that is biased can be misleading.
• Biased information is not useful unless the users understand the bias, any bias is consistently applied across years/firms/industries, and the users can adjust the reported results to reflect their own desired bias.
• When faced with uncertainty, there is a need to either require reporting of unbiased values accompanied with sufficient disclosure, or require the reporting of biased (prudent or œconservative) values with the bias determined in a predictable, consistent fashion.

6.0 COST-BENEFIT EFFECTIVE

• General understanding that the development of accounting information consumes resources.

• As such, the cost of producing such information should be reasonable in relation to the expected benefit.

• Use the materiality accounting rule - may not have to be fully followed for immaterial items if full compliance would result in unwarranted higher costs.

Worked Example On Correction Of Errors

Typical examination questions from LCCI Accounting and other asked for identification of the type of errors, its general journal entries to correct the errors and would like to see the Suspense Account being corrected and to see the original difference of the suspense account re: which is a balancing figure.

Above represents a worked question and answer to such typical questions from examiners.
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Worked Example No 1 On Balance Sheet Classifications

Question No 1:
List the amount of Total current assets from below listing:

Patents,trademark =$100,000
Accounts Receivable=$30,000
Inventory=$100,000
Investment in subsidiaries=$200,000
Property, plant and equipment=$600,000
Cash & Bank=$40,000
Total Current Assets= ?


Answer:
Total Current Assets=Accounts Receivable+Inventory+Cash & Bank=$170,000



Question No 2:

Insert the following to classify the Balance Sheet items:

Current Asset; Non Current Asset; Intangible asset
Current Liability; Non Current Liability, Equity

a ________ Trademarks
b ________ Retained earnings
c ________ Salaries payable
d ________ Income Tax payable
e ________ Accruals
f ________ Prepayments
g ________ 15 year mortage owned by the company
h ________ Accounts Payable
i ________ Petty Cash
j ________ Land
k ________ Sundry deposits like rent
l ________ Fixed Deposit with bank

Answer:
a Intangible asset
b Equity
c Current liability
d Current liability
e Current liability
f Current asset
g Non Current liability
h Current liability
i Current asset
j Non Current asset
k Current asset
l Current asset

Format Of Balance Sheet: The Horizontal And Vertical Presentation

A Balance Sheet is also called the Statement of Financial Position. It is a snapshot of a company's financial position at a particular point in time. The Accounting equation which is Assets=Liabilities+Stockholder's Equity is closely link to the Balance Sheet. Because of this accounting equation and the double entry system, the Balance sheet must always tally.

Append below are two format namely the Horizontal and Vertical Presentation to display the Balance sheet of a company.

(a)Format of A Balance Sheet: Horizontal Presentation

The horizontal presentation uses a format that present assets on the left and liabilities and equity on the right

XYZ Company

Balance Sheet As at December 31st 2008

Assets		Liabilities & Stockholders’ Equity
	$		$
Current Assets		Current Liabilities
Cash	10,000	Accounts payable	15,000
Accounts Receivable	20,000	Salaries Payable	9,000
Inventories	30,000	Total Current Liabilities	24,000
Deposits, prepayments	5,000	Bonds payable	20,000
Total Current Assets	65,000	Mortgages	35,000
		Total Liabilities	79,000
		Stockholders’ equity
Property, plant and equipment, net	55,000	Common stock	50,000
Intangible assets	10,000	Retained earnings	1,000
Total Assets	130,000	Total Liabilities and Stockholders’ equity	130,000

(b) The Vertical Presentation of The Format Of A Balance Sheet

The vertical presentation show the assets followed by liabilities and equity directly below the assets.

XYZ Company

Balance Sheet As At 31 st December 2008

Assets
Current Assets
Cash	10,000
Accounts Receivable	20,000
Inventories	30,000
Deposits, prepayments	5,000
Total Current Assets	65,000
Non Current Assets
Property, plant and equipment, net	55,000
Intangible assets	10,000
Total Non Current Assets	65,000
Total Assets	130,000
Liabilities & Stockholders’ Equity
	$
Current Liabilities
Accounts payable	15,000
Salaries Payable	9,000
Total Current Liabilities	24,000
Non Current Liabilities
Long Term Bonds payable	20,000
Mortgages	35,000
Total Non Current Liabilities	55,000
Total Liabilities	79,000
Stockholders’ equity
Common stock	50,000
Retained earnings	1,000
Total Liabilities and Stockholders’ equity	130,000

Income Statement Format –Single Step Format

Earlier article describe the fundamental accounting concepts underlying the Income Statement.

Here, we look at the type of format, Income Statement can be displayed namely the Single Step Format and Multiple-Step Income Statement. Also the advantages and disadvantages of using the different method will be discussed.

Format of A Single Step Income Statement

	$
Revenues
Net Sales	180,000
Gains	10,000
Total revenues	190,000
Expenses
Cost of goods sold	55,000
Selling and administrative expenses	24,000
Interest expenses	10,000
Losses	8,000
Income tax expenses	15,000
Total expenses	112,000
Net Income	78,000

Format of A Multiple Step Income Statement

	$
Net Sales	180,000
Cost of goods sold	55,000
Gross Profit	125,000
Selling and administrative expenses	24,000
Operating Profit	101,000
Other revenues and gains	10,000
Other expense and losses	18,000
Pretax income from continuing operations	93,000
Income tax expenses	15,000
Net Income	78,000

Whether you use the Single Format Income Statement or Multiple Step Income Statement, you will still get the end result/bottom line re: same net income.

The advantages of using the multiple step income statement format are:

• It clearly display important financial and managerial information
• The four measures of profitability are revealed at four critical areas of a company’s operation namely gross profit, operating profit/operating income, pretax income and after tax net income

As for the single step format of Income Statement, the advantage is that is relatively simple to prepared and understand however, the gross and operating income figures are not stated which need to be computed.