Accounting Standard 3 - Cash Flow Statements

 Accounting Standard 3 (AS 3) - Cash Flow Statements

Objective:

AS 3 prescribes the provision of information about the historical changes in cash and cash equivalents of an enterprise by means of a cash flow statement. This statement classifies cash flows during the period from operating, investing, and financing activities.

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Scope:

This standard applies to all enterprises except for:

• An enterprise whose turnover is less than ₹50 crore during the immediately preceding financial year.

Key Points:

1. Definitions:
• Cash: Comprises cash on hand and demand deposits with banks.
• Cash Equivalents: 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: Inflows and outflows of cash and cash equivalents.
• Operating Activities: Principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities.
• Investing Activities: Acquisition and disposal of long-term assets and other investments not included in cash equivalents.
• Financing Activities: Activities that result in changes in the size and composition of the owner's capital (including preference share capital in the case of a company) and borrowings of the enterprise.
2. Presentation of Cash Flow Statement:
• Cash flow statements should report cash flows during the period classified by operating, investing, and financing activities.
3. Operating Activities:
• Cash flows from operating activities primarily derive from the principal revenue-producing activities of the enterprise.
• Examples include cash receipts from the sale of goods and services, cash payments to suppliers and employees, and cash payments or refunds of income taxes.
4. Investing Activities:
• These activities include cash payments to acquire long-term assets, cash receipts from sales of long-term assets, and cash advances and loans made to other parties.
• Examples include cash payments to acquire property, plant, and equipment, cash receipts from the sale of investments, and cash advances made to third parties.
5. Financing Activities:
• These activities result in changes in the size and composition of the equity capital and borrowings of the enterprise.
• Examples include cash proceeds from issuing shares, cash payments to shareholders for dividends, and cash repayments of amounts borrowed.
6. Direct and Indirect Methods:
• The cash flow from operating activities can be reported using either the direct method or the indirect method.
• Direct Method: Shows major classes of gross cash receipts and payments.
• Indirect Method: Adjusts net profit or loss for the effects of transactions of a non-cash nature and deferrals or accruals of past or future operating cash receipts or payments.
7. Non-Cash Transactions:
• Investing and financing transactions that do not require the use of cash or cash equivalents should be excluded from the cash flow statement.
• These should be disclosed elsewhere in the financial statements.
8. Disclosure:
• Components of cash and cash equivalents.
• Reconciliation of the amounts in the cash flow statement with the equivalent items reported in the balance sheet.
• Cash flows from operating, investing, and financing activities, separately identified.

Questions and Answers from Previous CA Exams, Revision Test Papers, and Solved Case Studies

May 2018:

Question: Explain the difference between operating activities, investing activities, and financing activities as per AS 3.

Answer: Operating activities are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities. Investing activities relate to the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Financing activities are activities that result in changes in the size and composition of the owner's capital and borrowings of the enterprise.

November 2017:

Question: How is the cash flow from operating activities determined using the direct method as per AS 3?

Answer: Using the direct method, cash flow from operating activities is determined by showing major classes of gross cash receipts and payments. This includes cash receipts from customers, cash payments to suppliers and employees, and cash payments or refunds of income taxes.

May 2016:

Question: What are cash equivalents and what are their characteristics as per AS 3?

Answer: Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and are subject to an insignificant risk of changes in value. Their characteristics include short maturity periods (typically three months or less from the date of acquisition), high liquidity, and insignificantly low risk of changes in value.

Revision Test Paper (RTP) May 2019:

Question: Describe the indirect method of reporting cash flows from operating activities as per AS 3.

Answer: The indirect method of reporting cash flows from operating activities adjusts net profit or loss for the effects of:

1. Changes during the period in inventories and operating receivables and payables.
2. Non-cash items such as depreciation, provisions, deferred taxes, unrealized foreign currency gains and losses.
3. All other items for which the cash effects are investing or financing cash flows.

Solved Case Study:

Question: A company purchased machinery worth ₹10 lakh by issuing equity shares. How should this transaction be treated in the cash flow statement as per AS 3?

Answer: This transaction is a non-cash transaction and should be excluded from the cash flow statement. However, it should be disclosed elsewhere in the financial statements, such as in the notes, indicating that machinery was acquired by issuing equity shares.

November 2015:

Question: What are the disclosure requirements regarding cash and cash equivalents in a cash flow statement as per AS 3?

Answer: AS 3 requires the disclosure of:

1. Components of cash and cash equivalents.
2. Reconciliation of the amounts in the cash flow statement with the equivalent items reported in the balance sheet.
3. Separate identification of cash flows from operating, investing, and financing activities.

May 2014:

Question: How should a company report cash flows from investing activities? Provide examples as per AS 3.

Answer: A company should report cash flows from investing activities separately, including cash payments to acquire long-term assets, cash receipts from sales of long-term assets, and cash advances and loans made to other parties. Examples include:

• Cash payments to acquire property, plant, and equipment.
• Cash receipts from the sale of investments.
• Cash advances made to third parties.

November 2013:

Question: How are non-cash transactions treated in the cash flow statement as per AS 3?

Answer: Non-ccash transactions should be excluded from the cash flow statement as they do not require the use of cash or cash equivalents. These transactions should be disclosed elsewhere in the financial statements, usually in the notes, to provide a complete understanding of all financing and investing activities that do not affect cash flows.