Funds Flow Statement, Funds from Operations - Adjustments

These are incorporated into accounting by making mathematical adjustments to the figures in the trading account, profit and loss account and balance sheet at the time of making up final accounts.

To know what adjustments are to be made in relation to a transaction, we need to know the journal entry that we use to record that transaction.

However, they are transactions which have already been journalised.

They represent transactions relating to the business which might have brought about a change in (influenced) working capital (Fund).

To know the influence of a transaction, we need to know the journal entry that we use to record that transaction.

The opening figure after going through none or more changes during the period for which funds flow is being measured, would end up as the closing figure.

Analysing funds flow is analysing the reasons for the change in balances of non-current accounts. Therefore, to analyse funds flow we need the information relating to the accounting transactions that have brought about a change in the balances.

For this we prepare a working notes by building the non-current ledger accounts (on a memorandum basis) and posting each transaction to enable us to explain the difference between the opening and closing balance.

If the difference still remains unexplained, we make proper assumptions to explain the remaining difference.

While making up the journal entries, considering Profit and Loss a/c for nominal accounts in case of cross transactions and Profit and Loss Appropriation a/c for nominal accounts in case of non-cross transactions which are not cross transactions would be helpful.

At any point of time, the written down value of the asset is ascertained by setting off the asset account and the relevant depreciation reserve account.

At the end of every accounting period, value equal to the depreciation to be charged is transferred from the asset account to the depreciation account treating it as a loss.

There are two transactions involved in the sale of such asset. The transaction of sale of asset and the transaction of recording profit/loss on the sale of asset. They are two distinct transactions. Where there is neither profit/loss on sale, the second transaction would be irrelevant.

In financial accounting we generally combine both the transactions which should be avoided here to get a clear understanding.

When sale is recorded using Asset Disposal a/c

At the end of every accounting period, value equal to the depreciation to be charged on the asset is credited to the depreciation reserve account by charging the profit and loss account.

The reserve account is carried forward over the accounting periods and is shown on the liabilities side of the balance sheet or is adjusted from the value of the relevant asset on the assets side of the balance sheet. At the time of sale or disposal of the asset, the depreciation reserve account is closed by transfer to the relevant asset account thereby bringing down the asset to its real value.

Even in the sale of this asset, there are two transactions involved. The transaction of sale of asset and the transaction of recording profit/loss on the sale of asset. They are two distinct transactions. Where there is neither profit/loss on sale, the second transaction would be irrelevant.

When sale is recorded using Asset Disposal a/c

Where the other account involved is a non-current account, the transaction would not be a cross transaction and as such would not result in a change in working capital (fund).

Giving away an Asset for clearing a long term liability, giving an asset in exchange of another asset would be examples of such transactions.

A transaction resulting in a debit to the profit and loss can be claimed to be an appropriation if the account to which the profits are being transferred is a part non-current liabilities in the balance sheet.

Therefore, creation of reserve for bad and doubtful debts can be treated as an appropriation if the Reserve for Bad and Doubtful Debts account is a non-current liability in the balance sheet.

Where is Bad Debt Reserve positioned in the balance sheet?

Since the debit is made to the profit and loss account, it represents a transaction that results in a charge to the profit and loss account. The affect of all such transactions on the working capital is considered in a consolidated manner under the head funds from operations.

Moreover, because these accounts are current accounts, they would not be considered for the purpose of analysing funds flow They will be taken into consideration only for the purpose of preparing the statement of changes in working capital.

When there is no indication we may choose either of the options. However, it is a convention that if we find the accounts grouped together with current accounts we treat them as current natured and if they are grouped together with non-current natured accounts we treat them as non-current accounts.

Where it is not possible to decide based on their presence in the Balance Sheet (in cases where the balance sheet items are not arranged in an order or where the Balance Sheet is not known/given), then we can make our own assumptions, in the absence of any other indication regarding the same. In such cases, because these are capable of being treated either ways, it would always be appropriate to indicate our assumption.

All need not be of the same kind

Such a transaction, since it is not related to any non-current account would be irrelevant for the purpose of analysing funds flow.

It represents

• An existing liability, when the account is assumed to be a current liability
• A provision for a future liability (one which has not been determined), when the account is assumed to be a non-current liability.

  In this case, the liability would become an existing liability as and when the tax/dividend due is determined.

  In the absence of information to the contrary, we make the following assumptions,

  • By the end of the current period the liability has been determined and is equal to opening balance in these accounts.

• The liability which has been pre determined or has been determined in the current period is paid out in the current period.

• The total closing balance in the reserve for Taxation/Dividend accounts is on account of the provision created during the current period.

Where only the information relating to the opening and closing balances is known, we assume that the opening balance becomes a determined liability by the end of the accounting period and is therefore paid out by the end of the accounting period.

Assumptions

1. The opening balance of 1,24,000 is paid out during the current period.
2. The balancing represents the provision made by charging profits during the current period or by appropriating profits at the end of the accounting period.

Reserve for Taxation

Provision for Dividends

Since we need to consider only the accounts present in the balance sheet for the purpose of preparation of the statement of changes in working capital, and the interim dividend account would not be present in the balance sheet, we need not consider the transactions relating to interim dividends for the purpose of analysing funds flow when it is a current account.