Share this content
FRS 102 cash flow statement
iStock_Cash flow statement_Gordan D

FRS 102 cashflow statements: Get the details right

by

An FRC review of recent cashflow statements produced under FRS 102 revealed a worrying level of mistakes. Steve Collings digs into the documentation to steer preparers away from trouble.

28th Jun 2022
Share this content

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:

A member of a group where the parent of that group prepares publicly available consolidated financial statements which are intended to give a true and fair view (of the assets, liabilities, financial position and profit or loss) and that member is included in the consolidation.

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 on hand and demand deposits.

“Cash equivalents” are defined as:

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

Operating activities

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 activities

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

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.

Error

Correction would impact:

Operating

Investing

Financing

Deferred purchase consideration for subsidiary undertakings incorrectly classified as an investing rather than operating cashflow

Decrease

Increase

 

Payment for the acquisition of a business incorrectly classified as an operating cashflow rather than an investing cashflow

Increase

Decrease

 

Cash outflows on an investment in legal cases and the purchase of a property for resale relating to the cash were presented within investing activities. The cash inflow upon settlement of the cases was presented in operating activities. Both types of cash outflow should have been presented in operating activities on the grounds they arose in the normal activities of the entity

Decrease

Increase

 

Post-acquisition restructuring costs treated as investing activities rather than operating activities

Decrease

Increase

 

Cashflows in respect of a joint venture funding treated as financing activities rather than investing activities

 

Decrease

Increase

Advances to joint ventures treated as operating activities rather than investing activities

Increase

Decrease

 

Expenses in respect of an acquisition recognised in profit or loss treated as investing activities rather than operating activities

Decrease

Increase

 

Promissory notes treated as debt, but movements in the balance sheet were treated as operating cashflows rather than financing cashflows

Increase

 

Decrease

Cash outflow for restructuring treated as investing activities rather than operating activities

Decrease

Increase

 

Incorrect classification of certain restricted cash balances which were included in financing activities rather than in investing activities

 

Decrease

Increase

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.

Cash and cash equivalents: Illustration

The amounts disclosed on the cashflow statement in respect of cash and cash equivalents are in respect of these balance sheet amounts:

     

31.12.21

01.01.21

     

£

£

Cash and cash equivalents

X

X

Bank overdrafts

 

(X)

(X)

     

(X)

(X)

         
     

31.12.20

01.01.20

     

£

£

Cash and cash equivalents

X

X

Bank overdrafts

 

(X)

(X)

     

(X)

(X)

FRS 102, para 7.22 also requires the entity to disclose an analysis of changes in net debt from the beginning to the end of the reporting period. The term “net debt” is defined as follows:

Net debt consists of the borrowings of an entity, together with any related derivatives and obligations under finance leases, less any cash and cash equivalents.

Net debt: illustration

     

At 1.1.21

Cashflow

At 31.12.21

     

£

£

£

Net cash

         

Cash at bank

 

X

X

X

Bank overdrafts

 

(X)

X

(X)

     

(X)

X

(X)

           

Debt

         

Debts falling due within one year

(X)

(X)

(X)

Debts falling due after one year

(X)

X

(X)

     

(X)

X

(X)

           

Total

   

(X)

X

(X)

Conclusion

Most automated accounts production software systems can produce the cashflow statement up to a certain point before user input is needed. Preparers need a sound understanding of the definitions of operating activities, investing activities and financing activities to ensure that cashflows are correctly classified in the statement.

Auditors should also devise audit procedures to ensure that the cashflow statement is accurately presented and that the disclosures presented follow the requirements of FRS 102, Section 7.  

Replies (0)

Please login or register to join the discussion.

There are currently no replies, be the first to post a reply.