By MIA Financial Statements Review Department
In the current uncertain and volatile economic environment, some entities face a downturn in their business, and this hence impacts their profit and liquidity position. The increasing attention on entities’ liquidity position and the ability of the entities to turnaround has led to greater focus on the Statement of Cash Flows by investors, regulators, and other users of financial statements.
Entities that prepare financial statements in conformity with the Malaysian Financial Reporting Standards (MFRS) are required to present a Statement of Cash Flows in accordance with the requirements of MFRS 107 Statement of Cash Flows (MFRS 107). The objective of a Statement of Cash Flows is to enable users of financial statements to assess the ability of the entity to generate cash and cash equivalents and the needs of the entity to utilise those cash flows.
The Statement of Cash Flows analyses changes in cash and cash equivalents during a reporting period. Cash flows must be analysed between operating, investing and financing activities.
SCOPE
This article intends to share the review findings of the Financial Statements Review Committee (FSRC) relating to disclosures made in the Statement of Cash Flows and related notes to the financial statements. The comments discussed herein are intended to be applied to the specific facts and circumstances surrounding the identified observations. Hence, it is not intended to be exhaustive and does not address all issues that may be raised relating to the Statement of Cash Flows.
Additionally, careful consideration and judgment should be applied accordingly for individual facts and circumstances as MFRSs is principles-based. Circumstances may appear similar but be different in substance.
OBSERVATIONS
Below are the observations noted by the FSRC relating to the Statement of Cash Flows based on the review of financial statements of public listed companies/entities (PLCs).
The review findings are related to PLCs whose business activities typically involve the supply of goods and services to customers.
Cash flow movements arising from the amount due from/ to subsidiary companies, the amount due from an associate and the amount due to directors, which are non-trade in nature, were classified as cash flows from operating activities as part of changes in working capital.
The Committee further noted that there are no related party transactions disclosed in respect of purchases or sales of goods and services from/ to associates, subsidiaries or directors during the financial period.
Response from PLC
The PLC explained that the cash flow movements for the amount due from/to subsidiaries and the amount due from an associate are related to revenue producing activities and other activities that are not investing or financing activities of the PLC.
The PLC further explained that the amount due to directors is because the directors were indirectly contributing their efforts that are related to revenue-producing activities of the PLC.
However, the above explanation provided by PLC is inconsistent with the disclosures in the financial statements as there were no related party transactions disclosed.
FSRC’s comments
Paragraph 6 of MFRS 107 defined the following:
- Operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities.
- Investing activities are 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 contributed equity and borrowings of the entity.
Paragraph 14 of MFRS 107 states thatcash flows from operating activities are primarily derived from the principal revenue-producing activities of the entity and generally result from the transactions and other events that enter into the determination of profit or loss.
As such, in Observation 1, the cash flow movements arising from the amount due from/ to subsidiary companies, the amount due from an associate and the amount due to directors, which are non-trade in nature and not directly related to revenue-generating activities, should not be classified as cash flows from operating activities.
Entities will need to assess the nature of transactions to determine the classification of cash flows. MFRS 107 defines cash flows from operating activities as the principal revenue producing activities and other activities that are not investing or financing.
Hence, for other activities which are not revenue producing activities, the entity will need to assess whether these cash flows are financing or investing activities in nature, to determine the correct classification in the statement of cash flows based on the definition in Paragraph 6 of MFRS 107. For example, for the observation above, the entity should assess whether the cash advanced to associates that is non-trade in nature, meets the definition of investing activities or financing activities. If it meets the definition, the entity should classify the related cash flows under investing activities or financing activities accordingly rather than operating activities.
The PLC has presented interest paid under both the operating and financing activities.
Response from PLC
The PLC explained that the interest paid relates to banking facilities and stated that the said interest paid should have been presented as financing activities.
FSRC’s comments
Paragraph 33 of MFRS 107 states that interest paid, and interest and dividends received are usually classified as operating cash flows for a financial institution. However, there is no consensus on the classification of these cash flows for other entities. Interest paid and interest and dividends received may be classified as operating cash flows because they enter into the determination of profit or loss. Alternatively, interest paid, and interest and dividends received may be classified as financing cash flows and investing cash flows respectively, because they are costs of obtaining financial resources or returns on investments.
Paragraph 11 of MFRS 107 requires an entity to present its cash flows from operating, investing and financing activities which is most appropriate to its business.
MFRS 107 does not specify the classification of cash flows from interest paid and interest and dividends received, hence an entity may choose to present these cash flows in the most appropriate manner to its business.
In Observation 2, based on the PLC’s response, the policy adopted is for interest paid relating to banking facilities to be classified as financing activities. Hence, in accordance with Paragraph 31 of MFRS 107, all interest paid relating to banking facilities shall be classified in a consistent manner from period to period, based on the policy adopted, as cash flows from financing activities.
Government grants received have been classified as cash flows from financing activities.
It was noted that the PLC is involved in the businesses of providing express bus and city bus services, sale of express and used buses as well as repair and maintenance services.
Response from PLC
The PLC clarified that the government grant was granted to a subsidiary company for the maintenance of city buses, managing the bus hub and payroll support.
FSRC’s comments
There is no specific guidance in MFRS 107 on how to present cash flows from the receipt of a government grant.
Paragraph 11 of MFRS 107 states that an entity presents its cash flows from operating, investing and financing activities in a manner which is most appropriate to its business.
Paragraph 6 of MFRS 107 has defined the following:
- Operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities.
- Investing activities are 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 contributed equity and borrowings of the entity.
Accordingly, in determining the appropriate classification of cash flows, an entity would need to consider the nature of its business and the nature of the government grant received. This would require judgement and classification to be made based on the entity’s circumstances and transaction’s substance. In addition, there should be consistency of treatment between the cash flow statement and the other primary statements, and consistency of classification from period to period.
In this case, the receipt of a government grant should be classified according to its substance. Grants given as a contribution towards expenditures used to generate period revenues should be classified as cash flows from operating activities, to match their treatment in the statement of comprehensive income.
As such, in Observation 3, the grant received represents compensation for operating expenses incurred. Therefore, the cash inflows from the grant received shall be classified as cash flows from operating activities, to match the treatment in the PLC’s income statement.
In January 2016, MFRS 107 was amended by Disclosure Initiative (Amendments to MFRS 107). These amendments require entities to provide disclosures about changes in liabilities arising from financing activities.
It was noted that there are entities which did not disclose the above required disclosure on the changes in liabilities arising from financing activities as required by MFRS 107.
Response from PLCs
Upon request, PLC 1 has furnished the required disclosure of the changes in liabilities arising from financing activities to the Committee. The items disclosed include the following:
- Payment of lease liabilities
- Drawdown of hire purchase payables
- Repayment of hire purchase payables
- Drawdown of term loans
- Repayment of term loans
PLC 2 has lease liabilities through an acquisition of a new subsidiary. PLC 2 replied that the required disclosure has been made in the note of “cash flows arising from the acquisition of a subsidiary”. PLC 2 further explained that the required disclosure was disclosed as a note in the Cash Flow Statement of the Company’s subsidiary’s financial statements. Further, PLC 2 provides the reconciliation for which movement during the year relating to lease payables balance from acquisition of the subsidiary was wrongly described as the opening balance of the Group.
FSRC’s comments
Paragraph 44A of MFRS 107 states that an entity shall provide disclosures that enable users of financial statements to evaluate changes in liabilities arising from financing activities, including both changes arising from cash flows and non-cash changes.
Paragraph 44B further states that to satisfy the requirement in paragraph 44A, an entity shall disclose the following changes in liabilities arising from financing activities:
- changes from financing cash flows;
- changes arising from obtaining or losing control of subsidiaries or other businesses;
- the effect of changes in foreign exchange rates;
- changes in fair values; and
- other changes.
Paragraph 44D of MFRS 107 states that one way to fulfil the disclosure requirement in Paragraph 44A is by providing a reconciliation between the opening and closing balances in the statement of financial position for liabilities arising from financing activities, including the changes identified in Paragraph 44B. Where an entity discloses such a reconciliation, it shall provide sufficient information to enable users of the financial statements to link items included in the reconciliation to the statement of financial position and the statement of cash flows.
The requirements mentioned above clearly state how the disclosure relating to changes in liabilities arising from financing activities shall be made.
For PLC 2, it was noted that PLC 2 has lease liabilities as one of the items in its statement of financial position. As such, the reconciliation should consist of a reconciliation between the opening and closing balances in the statement of financial position (for the Group and the Company) for liabilities arising from financing activities. In addition, apart from the Company’s subsidiary’s financial statements, the reconciliation should also be disclosed in the Consolidated Financial Statements.
Further, as the interest expense and interest payments are part of changes of the liabilities arising from financing activities, the interest expense and interest payments respectively (if any) should be disclosed separately in the reconciliation [Paragraph 44B(e) of MFRS 107] and the amount should be able to be linked to the statement of cash flows.
CONCLUSION
A Statement of Cash Flows provides information about the changes in cash and cash equivalents of an entity by classifying cash flows into operating, investing and financing activities. Hence, it is important that cash flows are appropriately categorised into the said categories (i.e. operating, investing or financing) based on the nature and substance of the underlying transactions to ensure that usefulness of the Statement of Cash Flows can be achieved accordingly. When used in conjunction with the rest of the financial statements, it provides information that enables users of financial statements to evaluate the changes in net assets of an entity, its financial structure (including its liquidity and solvency) and its ability to affect the amounts and timing of cash flows in order to adapt to changing circumstances and opportunities.
Analysing changes in cash flow from one reporting period to the next also gives users a better idea of how an entity is managing its cash and cash equivalents. Some may use it to assess liquidity and going concern, whilst management may make informed decisions for regulating business operations.
A Statement of Cash Flows is an important tool used to manage finances by tracking the cash flow of an entity. In addition, the usefulness of cash flow information is greatly enhanced if it can be related to information reported elsewhere in the financial statements.
