Common errors in cash flow statements

Common errors in cash flow statements - Part 2

Following on from our recent articles explaining what is cash and cash equivalents and disclosures required when cash is subject to restrictions, we embark on a journey to highlight common errors preparers make when preparing the cash flow statement.

The cash flow statement is one of the four primary financial statements and provides extremely valuable (material) information to users, particularly in respect of an entity’s liquidity, going concern and general financial health. Together with the basis of preparation note and the auditor’s report, the cash flow statement is the key statement users should read when trying to analyse the risk of an entity failing.

In Part 1 of our series, we considered common errors that could result in the cash flow statement being materially misstated, including overstating operating cash flows, incorrect grossing up of non-cash settlements, and incorrect netting off of cash settlements. This month we look at:

Errors with foreign currency
Changes in ownership interests in subsidiaries and other businesses
Non-cash transactions
Supplier finance arrangements
Disclosures about changes in liabilities from financing activities.

Errors with foreign currency

The preparation of a cash flow statement becomes complicated when the group has subsidiaries with a different functional currency to that of the group’s presentation currency. Errors can occur, leading to the overstatement of operating cash flows. These errors include:

Incorrectly accounting for foreign exchange (FX) movements in cash held in the subsidiary’s functional currency that is different from the group’s presentation currency
Incorrectly accounting for FX gains and losses on foreign currency loans as cash flows
Incorrectly translating cash receipts from financing activities.

Example 1 - FX movements in cash held in the subsidiary’s functional currency that is different from the presentation currency

Parent A has a subsidiary, Subsidiary B. The Parent A group has an Australian dollar (AUD) presentation currency and Subsidiary B has a US dollar (USD) functional currency.
The following exchange rates are relevant:

AUD to USD as at 30 June 2023 was 1: 1
AUD to USD as at 30 June 2024 was 1: 0.7.

At both 30 June 2023 and 30 June 2024, Subsidiary B had cash on hand of $10,000 USD. This amount translates to $10,000 AUD as at 30 June 2023 and $14,286 as at 30 June 2024. Recognising that there is no profit impact on this translation, there is an amount of $4,286 when reconciling the opening and closing cash positions in the cash flow statement. This amount should not be included in operating cash inflows, but is shown as a separate line in the cash flow statement.

Example 2 - FX gains and losses on foreign currency loans

Parent A has a subsidiary, Subsidiary B. The Parent A group has an Australian dollar (AUD) presentation currency and Subsidiary B has a US dollar (USD) functional currency. Subsidiary B has long-term borrowings of $10,000 AUD.

The following exchange rates are relevant:

AUD to USD as at 30 June 2023 was 1: 1
AUD to USD as at 30 June 2024 was 1: 0.7.

Subsidiary B’s long-term borrowing translates to $10,000 USD as at 30 June 2023 and $7,000 USD as at 30 June 2024. This retranslation represents an FX gain in Subsidiary B’s income statement, but it does not represent an operating inflow . Rather it is a non-cash transaction.

Example 3 - Incorrectly translating cash receipts from financing

The following exchange rates are relevant:

AUD to USD as at 30 June 2023 was 1: 1
AUD to USD as at 30 June 2024 was 1: 0.7
AUD to USD as at 31 May 2024 was 1: 0.75
Average AUD to USD exchange rate for the year was 1: 0.90.

Parent A group incorrectly translates the cash receipt at the average annual exchange rate, rather than the exchange rate as at 31 May 2024 (the date the cash was received).

Assume the group had no cash as at 1 July 2023. The table below compares the incorrect and correct presentation of this fact pattern.

	Incorrect presentation	Correct presentation
Cash flow statement
Cash flows from operating activities	$3,175	Nil
Financing cash flows
Cash from financing activities	$11,111 ($10,000/0.90)	$13,333 ($10,000/0.75)
Net cash inflows	$14,286	$13,333

Cash as at 1 July 2023	Nil	Nil
Impact of FX on foreign cash balances	Nil	$953
Cash as at 30 June 2024	$14,286	$14,286

Changes in ownership interests in subsidiaries and other businesses

Another common error occurs when there has been a change in ownership interest in subsidiaries and other businesses during the period. For example, entities sometimes incorrectly classify the gross cash outflow to acquire a subsidiary or business as cash outflows from investing activities, with the acquiree’s existing cash balances shown as an increase in cash for the period. IAS 7 Statement of Cash Flows, paragraphs 39 and 42, require the net cash flows arising from gaining or losing control of a business, to be classified as arising from investing activities.

This results in different amounts being presented in the statement of cash flows (i.e. the net cash outflow) and the notes to the financial statements (the total purchase consideration). Therefore, the cash flow statement must not include the gross cash flows arising from the acquisition, and instead show a single net amount. IAS 7, paragraph 40 then requires the gross amounts to be disclosed in the notes.

‘An entity shall disclose, in aggregate, in respect of both obtaining and losing control of subsidiaries or other businesses during the period each of the following:

the total consideration paid or received;
the portion of the consideration consisting of cash and cash equivalents;
the amount of cash and cash equivalents in the subsidiaries or other businesses over which control is obtained or lost; and
the amount of the assets and liabilities other than cash or cash equivalents in the subsidiaries or other businesses over which control is obtained or lost, summarised by each major category.’

IAS 7, paragraph 40

Non-cash transactions

The cash flow statement should only reflect transactions that have a cash flow impact. IAS 7, paragraph 43, requires investing and financing transactions that do not have a cash flow impact (i.e. they do not flow through the entity’s bank accounts) to be excluded from the cash flow statement. Instead, such transactions must be disclosed elsewhere in the financial statements.

Examples of non-cash transactions are:

Acquiring assets either by assuming directly related liabilities or by means of a lease
Acquiring an entity by issuing equity instruments rather than paying cash
Converting debt to equity.

Typical errors include the following when in fact there has been no cash impact:

A lessee including the cost of a right-of-use asset as an investing cash outflow and the related lease liability as a financing cash inflow
An acquirer showing the acquisition cost of a new business as an investing cash outflow and a related financing cash inflow for the new equity instruments issued
An entity presenting a financing cash inflow and an equivalent financing cash inflow when converting debt to equity.

Supplier finance arrangements

The IFRS Interpretations Committee published an agenda decision in December 2020, explaining how reverse factoring (supply chain financing) arrangements should be presented in the balance sheet and cash flow statement. Supplier finance arrangements can be complicated and varied. Entities need to apply judgement to determine whether to present liabilities as trade payables or borrowings, and also whether and how cash flow effects are presented in the cash flow statement. Common errors can easily occur.

Entities should also note the new disclosures required for 31 December 2024 regarding supplier finance arrangements (including for Tier 2 Simplified Disclosures). The new disclosures are contained in IAS 7 and IFRS 7 Financial Instruments: Disclosures. The purpose of these disclosures is to enable users to:

Assess how supplier finance arrangements affect an entity’s liabilities and cash flows, and
Understand the effect of supplier finance arrangements on an entity’s exposure to liquidity risk, and how the entity could be affected if the arrangements were no longer available to the entity.

What is a ‘supplier finance arrangement’?

The amendments to IAS 7 do not define a ‘supplier finance arrangement’ but rather describe the characteristics of a ‘supplier finance arrangement’ in paragraph 44G to IAS 7 as follows:

One or more finance providers offer to pay amounts an entity owes its suppliers
The entity agrees to pay the finance provider(s) according to the terms and conditions of the arrangement at the same date, or a later date, than suppliers are paid
Entity gets extended payment terms, or supplier gets early repayment terms, compared to the invoice payment due date
Often referred to as ‘supply chain finance’, ‘payables finance’ or ‘reverse factoring arrangements’
Do not include arrangements that are solely credit enhancements for the entity (for example, financial guarantees including letters of credit used as guarantees)
Do not include instruments used by the entity to settle amounts owed directly with a supplier (for example, credit cards).

Disclosures about changes in liabilities from financing activities

Our last common error relates to inadequate disclosure about changes (movements) in liabilities shown as financing activities in the cash flow statement. Due to non-cash movements that often affect liability balances, it is not always easy for a user to reconcile financing cash movements relating to liabilities with balance sheet movements. IAS 7, paragraphs 44A-44E were introduced to require entities to disclose the changes in liabilities arising from financing activities (usually represented in tabular format and supplemented with narrative disclosures if necessary). An example of this is shown below:

	1 January 2024	Cash flows	Non-cash changes			31 December 2024
			Acquisition	Foreign exchange movements	Fair value changes
	$	$	$	$	$	$
Long-term borrowings	22,000	(1,000)	-	-	-	21,000
Short-term borrowings	10,000	(500)	-	200	-	9,700
Lease liabilities	4,000	(800)	300	-	-	3,500
Assets held to hedge long-term borrowings	(675)	150	-	-	25	(500)
Total	35,325	(2,150)	300	200	25	33,700

More information

Our publication contains more information about the appropriate presentation of cash flows.

We are here to help

Given the importance of the cash flow statement to investors, it is vital that entities present operating, investing and financing cash flows accurately. This is not as simple as one might think. Please contact our IFRS & Corporate Reporting team for help.