Discuss the classification of cash flows according to accounting standard-3 (AS-3).

Classification of Cash Flow According to AS-3, cash flows for a period classified into three categories of cash inflows and cash outflows as given below:

  1. Cash flows from operating activities.
  2. Cash flows from investing activities.
  3. Cash flows from financing activities.

Cash flows from operating activities: 

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

The examples are :

  • Cash receipts from the sale of goods and rendering of services.
  • Cash receipts from royalties, fees, commission and other revenue.
  • Cash payments to suppliers of goods and services.
  • Cash payments to and on behalf of employees for wages, etc.
  • Cash receipts and payments of an insurance enterprise 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.
  • Cash receipts and payments relating to future contracts, forward contracts, option contracts, and swap contracts, when the contracts are held for dealing or trading purposes.

Some transactions, such as the sale of an item of plant, may give rise to a gain or loss which is included in the determination of net profit or loss. However, the cash flows relating to such transactions are cash flows from investing activities.

A financial institution may be dealing in securities. The cash inflow and cash outflow arising from the sale and purchase of securities are also treated as flows from Operating Activities, it being the principal revenue producing activity. However, if a non-financial institution ,buys and sells securities the cash flows will be treated as cash flows from investing activities. Similarly, cash advances and loans made by financial enterprises are usu¬ally classified as operating activities since they relate to the main revenue-producing activity of the enterprise.

The net effect of the operating activities on flow of cash is reported as cash flow from operating activities in the Cash Flow Statement. The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations of the enterprise have generated sufficient cash flows to maintain the operating capability of the enterprise, pay dividends, repay loans and make new investments without recourse to external source of financing.

Cash flows from investing activities:

Investing activities are the acquisition and disposal of long term assets and other investments, not included in cash equivalents. These activities include transactions involving purchase and sale of long term productive assets like machinery, land and buildings, etc., which are not held for resale.

The examples are :

Cash payments to acquire fixed assets and also payments for capitalized research and development costs and self constructed fixed assets.

Cash receipts from disposal of fixed assets.

Cash payments to purchase (acquire) shares, warrants, or debt instruments of other enterprises and interests in joint ventures (other than payments for those instruments considered to be cash equivalents and those held for trading or dealing purposes).

Cash receipts from sale (disposal) of shares, warrants, or debt instruments of other enterprises and interest in joint ventures (other than receipts from those instruments considered to be cash equivalents and those held for dealing or trading purposes).

Cash advances and loans made to third parties (other than advances and loans made by a financial enterprise).

Cash receipts from repayments of advances and loans made to third parties (other than advances and loans of a financial enterprise).

Cash receipts relating to future contracts, forward contracts, option contracts and swap contracts except when the contracts are held for trading purposes, or the receipts are classified as financing activities.

Cash payments relating to future contracts, forward contracts, option contracts and swap contracts except when the contracts are held for trading purposes, or the payments are classified as financing activities.

Cash flows from financing activities:

Financing activities are the activities which result in-changes in the size and composition of the owner’s capital (including preference share capital in case of a company) and borrowings of the enterprise from other sources. Cash flow from financing activities are:

  • Cash proceeds from issue of shares or other similar instruments.
  • Cash proceeds from issue of debenture, loan notes, bonds and other short term borrowings.
  • Cash repayments of the amounts borrowed.
  • Payments of dividend.(e) Cash payments to redeem preference shares.

The separate disclosure of cash flows arising from financing activities is important because it is useful in predicting claim on future cash flows by providers of funds.

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