Free Accounting Dissertations - When Comparing Just Cash Amounts, Ias 7 Format Company Will Show Higher
When comparing just cash amounts, IAS 7 format company will show higher number than the company using FRS 1.
Also the company using IAS 7 will report higher liquidity ratios such as cash to liability ratio or quick ratio. IAS 7 will also impact other ratios using cash like net debt to equity ratio. So two companies with exactly same components will show different financial statement analysis results.
Legal exemption.
FRS 1 gives certain companies exemption and they are not legally liable to include cash flow statements into their annual accounts. This exemption is available to small companies and certain open-ended investment funds among others.
All entities of a company using IAS 7 would also have to report cash flow statement. This will allow more in depth financial statement analysis of subsidiaries also.
Foreign exchange movements
Under FRS 1, cash flows of a foreign subsidiary should be translated at the same rate as the profit and loss account. FRS 1 also states that actual or approximation of actual rates should be used for intra group transactions. IAS 7 on the other hand states that cash flows of a foreign subsidiary should be translated at the exchange rates prevailing at the dates of the cash flows. In absence of actual exchange rate for each transaction, IAS 7 allows companies to use a weighted average exchange rate that approximates to the actual rate. This weighted average exchange rate will give same answer as obtained by using actual exchange rate for each transaction.
By using the exchange rates as on the date of actual cash flow transfer, cash flows generated under IAS 7 are more close to the real transfers. If there is a big movement between an actual transfer date and date of profit and loss preparation, cash flows under FRS 1 could be significantly different from actual cash flows. This means that we may encounter different financial statement analysis results under FRS 1 and IAS 7.
Net reporting
IAS 7 allows companies to report net of cash receipts and payments when such cash flows represent the activities of customers and not that of the reporting entity. This aspect is important for companies in the outsourcing services sector. Some companies collect and distribute huge amount of cash on behalf of their customers, many a times government authorities. Reporting a net figure obscures one additional layer of information from investors. It may happen that two companies reporting same net cash flows have very different magnitude of cash receipts and payments. If investors can see the exact magnitude of cash receipts and payments, they can judge which of the companies is better in cash flow management.
FRS 1 doesn’t permit netting of customer’s cash flows. Customers’ cash flow can be an important source of funding for many businesses and hence separate reporting of cash receipts and payments may show investors how the reporting company is utilising customers’ cash for its own benefit.
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