FRS 102 cashflow statements: Get the details right

A 2020 thematic review of cashflow statements by the Financial Reporting Council (FRC) noted some basic errors creeping into the statements. Conversely, the review also noted some areas of good practice and made suggestion on how companies can improve the cash flow statement.

While the thematic review focused on entities preparing their financial statements under IFRS, the feedback can be taken on board by UK GAAP preparers. Under UK GAAP, the cashflow statement, or “statement of cash flows” as they are described in the standard, are covered by section 7 of FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland. The UK requirements are broadly consistent with the standard, IAS 7 Statement of Cash Flows.

Discussions with file reviewers have also revealed a common stream of problems where the cashflow statement is concerned. This article will recap some of the main issues that preparers may face when it comes to preparing a cashflow statement under the principles of FRS 102.

Small entities are not required to prepare a cashflow statement. Non-small entities will be required to prepare a cashflow statement, unless they can claim exemption through the reduced disclosure framework (FRS 102, paras 1.8 to 1.13) if the entity is a qualifying entity. Within the UK standard, “qualifying entity” is defined as:

If the subsidiary (or ultimate parent) meets the definition of a qualifying entity, it can claim the exemption from preparing a cashflow statement in FRS 102, para 1.12(b) and para 3.17(d).

Structure of the cashflow statement

FRS 102, Section 7 presents the cashflow statement using three cashflow classifications:

• Operating activities
• Investing activities
• Financing activities

The cashflow statement refers to cash and cash equivalents. “Cash” is defined as:

“Cash equivalents” are defined as:

Operating activities are the day-to-day revenue-producing activities of the business. Effectively, the operating activities classification is the default classification. Examples of cashflows from operating activities include receipts from customers and payments to suppliers for goods and services; and payments to employees.

Payments or refunds of tax are also classed as operating activities unless they can be specifically identified with investing or financing cashflows.

Investing cashflows arise from the acquisition and disposal of long-term assets and other investments which are not cash equivalents.

Examples include cash payments to acquire fixed assets and the disposal proceeds from selling fixed assets. Investing activities can also include advances and loans made to third parties as well as the associated receipts from repayment of those advances and loans.

Where the entity acquires equity or debt in another entity, this will also be treated as an investing cashflow (as will the associated proceeds from disposal of equity or debt).

Financing activities are those activities which result in a change in the size and composition of the borrowing and equity structure of the entity. Examples include proceeds from a share issue, payments to owners to acquire or redeem the entity’s shares or cash payments of amounts borrowed.

Pitfalls to avoid

Incorrectly classifying cashflows in the cashflow statement is a common pitfall. For example, in one case the conditional provisions relating to the sale of a business were incorrectly treated as investing cashflows as opposed to operating cashflows. Similarly, acquisition costs were treated as investing rather than operating cashflows.

It is worth noting that an entity cannot treat a transaction as one thing in the profit and loss account/income statement and another in the cashflow statement; this is where a deficiency may be noted during any review of the financial statements.

Reporting cashflows from operating activities

FRS 102, para 7.7 allows two methods to report cashflows from operating activities: indirect or direct. The indirect method is more common and starts with a measure of profit or loss which is then adjusted for the non-cash effects of transactions reported in profit or loss and increases and decreases in working capital. This reconciliation arrives at net cashflow from operating activities and can either be shown on the face of the cashflow statement or within the notes.

FRS 102, para 7.7(a) refers to a “measure” of profit or loss disclosed in the statement of comprehensive income (or separate income statement, if presented). So any profit figure (including operating profit) can be used as a starting point for this reconciliation, provided that profit figure appears as a sub-total in the statement of comprehensive income/income statement. The reconciling items will vary depending on the measure of profit used.

Errors identified by the FRC during the thematic review

The table below shows the errors noted by the FRC reviewers in their sample of companies’ cashflow statements that were reviewed during the thematic review in November 2020, together with the impact that the correction would have on the relevant cashflow classification.

Disclosures

FRS 102, para 7.20 requires an entity to present the components of cash and cash equivalents. A reconciliation must be presented if they are different to the cash and cash equivalents per the balance sheet. In some cases this reconciliation has been missed and generally happens when one, or more, bank accounts are overdrawn, and other bank accounts are in hand.