Decoding Accounting Standard 3 (AS3)

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Introduction

Accounting Standard 3 (AS 3) deals with the preparation and presentation of cash flow statements, ensuring that businesses provide clear insights into their cash movements. A cash flow statement helps stakeholders understand how a company generates and utilizes cash, aiding in liquidity analysis, solvency assessment, and decision-making.

Applicability

AS 3 applies to all entities whose financial statements are required to be presented as per the accounting standards, other than one-person company, small company and dormant company. While it is mandatory for companies falling under the Companies Act, it is also recommended for other entities to provide better transparency.

Major Provisions of AS 3

AS 3 classifies cash flows into three main activities:

Operating Activities
- Cash flows related to the principal revenue-generating activities of the enterprise.
- Examples include cash received from customers, cash paid to suppliers, salaries, rent, and taxes.
- Operating cash flows can be presented using two methods:
  - Direct Method: Shows major classes of cash receipts and payments.
  - Indirect Method: Adjusts net profit by non-cash expenses and changes in working capital.
Investing Activities
- Cash flows from the acquisition and disposal of long-term assets and investments.
- Examples include purchases or sales of property, plant, and equipment, investments in shares, and lending money.
Financing Activities
- Cash flows related to changes in the size and composition of capital and borrowings.
- Examples include issuing shares, taking or repaying loans, and paying dividends.

Disclosure Requirements

Entities must disclose the following in their cash flow statements:

Classification of Cash Flows under operating, investing, and financing activities.
Non-Cash Transactions, such as conversion of debt into equity, which do not involve cash flows.
Reconciliation of Cash and Cash Equivalents at the beginning and end of the period.

Illustrative Formats

Direct Method

Cash Flow Statement for a Financial Enterprise

Cash flows from operating activities		(Rs. ‘000)
1996
Interest and commission receipts	28,447
Interest payments	(23,463)
Recoveries on loans previously written off	237
Cash payments to employees and suppliers	(997)
Operating profit before changes in operating assets	4,224
(Increase) decrease in operating assets:
Short-term funds	(650)
Deposits held for regulatory or monetary control purposes	234
Funds advanced to customers	(288)
Net increase in credit card receivables	(360)
Other short-term securities	(120)
Increase (decrease) in operating liabilities:
Deposits from customers	600
Certificates of deposit	(200)
Net cash from operating activities before income tax	3,440
Income taxes paid	(100)
Net cash from operating activities		3,340
Cash flows from investing activities
Dividends received	250
Interest received	300
Proceeds from sales of permanent investments	1,200
Purchase of permanent investments	(600)
Purchase of fixed assets	(500)
Net cash from investing activities		650
Cash flows from financing activities
Issue of shares	1,800
Repayment of long-term borrowings	(200)
Net decrease in other borrowings	(1,000)
Dividends paid	(400)
Net cash from financing activities		200
Net increase in cash and cash equivalents		4,190
Cash and cash equivalents at beginning of period		4,650
Cash and cash equivalents at end of period		8,840

Indirect Method

Indirect Method Cash Flow Statement

		(Rs. ’000)
		1996
Cash flows from operating activities
Net profit before taxation, and extraordinary item	3,350
Adjustments for:
Depreciation	450
Foreign exchange loss	40
Interest income	(300)
Dividend income	(200)
Interest expense	400
Operating profit before working capital changes	3,740
Increase in sundry debtors	(500)
Decrease in inventories	1,050
Decrease in sundry creditors	(1,740)
Cash generated from operations	2,550
Income taxes paid	(860)
Cash flow before extraordinary item	1,690
Proceeds from earthquake disaster settlement	180
Net cash from operating activities .		1,870
Cash flows from investing activities
Purchase of fixed assets	(350)
Proceeds from sale of equipment	20
Interest received	200
Dividends received	160
Net cash from investing activities		30
Cash flows from financing activities
Proceeds from issuance of share capital	250
Proceeds from long-term borrowings	250
Repayment of long-term borrowings	(180)
Interest paid	(270)
Dividends paid	(1,200)
Net cash used in financing activities		(1,150)
Net increase in cash and cash equivalents		750
Cash and cash equivalents at beginning of period (see Note 1)		160
Cash and cash equivalents at end of period (see Note 1)		910

Content Source: ICAI Resources

Importance of AS 3

Helps in understanding the liquidity and financial stability of an enterprise.
Assists investors and creditors in decision-making.
Provides insights into a company’s ability to generate cash for future expansion.

🔗Also See: Accounting Standard 1

🔗Also See: Accounting Standard 2