Classification of Cash Flows

Cash receipts and cash payments must be classified as operating, investing, or financing activities on the basis of the nature of the cash flow.

Cash flows should be grouped into operating, investing or financing activities to enable investors and creditors to evaluate significant relationships within and between those activities.

Investing Activities

Investing activities include making and collecting loans and acquiring and disposing of debt or equity instruments and property, plant, and equipment and other productive assets, that is, assets held for or used in the production of goods or services by the entity (other than materials that are part of the entity’s inventory). Investing activities exclude acquiring and disposing of certain loans or other debt or equity instruments that are acquired specifically for resale.

Financing activities

Financing activities include obtaining resources from owners and providing them with a return on, and a return of, their investment; receiving restricted resources that by donor stipulation must be used for long-term purposes; borrowing money and repaying amounts borrowed, or otherwise settling the obligation; and obtaining and paying for other resources obtained from creditors on long-term credit.

Certain cash receipts and payments may have aspects of more than one class of cash flows. In such circumstances, entities must determine the appropriate classification by considering when to (1) separate cash receipts and cash payments and classify them into more than one class of cash flows and (2) classify the aggregate of those cash receipts and payments into one class of cash flows based on predominance.

Operating Activities

Operating activities include all transactions and other events that are not defined as investing or financing activities. Operating activities generally involve producing and delivering goods and providing services. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income.

Specific Considerations

  • Changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary should be accounted for as equity transactions (investments by owners and distributions to owners acting in their capacity as owners). Accordingly, payments to acquire noncontrolling interests in a subsidiary, or those associated with the sale of noncontrolling interests in a subsidiary, should be classified as financing activities in the statement of cash flows.
  • An entity that actively and frequently purchases, sells, or trades equity securities, intending to sell them in the near term (e.g., hours or days) to generate short-term profits, would generally present such cash flow activity as operating activities; otherwise, presentation within investing activities would generally be required.
  • When an entity pays for capital expenditures or operating expenses before the reimbursement of government grant monies, it should present the receipt of the government grant in the statement of cash flows in a manner consistent with the presentation of the related cash outflow. For example, a government grant that is intended to reimburse an entity for qualifying operating expenses would be presented in the statement of cash flows as an operating activity if the grant was received after the operating expenses were incurred.
  • When an entity receives the government grant before incurring the related capital or operating expenses, it should present the receipt of the government grant as a financing cash inflow in the statement of cash flows.
  • Lease payments made to repay a finance lease liability should be classified as follows: (1) the principal portion of the payments as cash outflows from financing activities and (2) the interest portion of the payments as cash outflows from operating activities.
  • Cash flows related to the purchases and sales of businesses; property, plant, and equipment; and other productive assets are presented as investing activities in the statement of cash flows. In a business combination, all cash paid to purchase the business is presented as a single line item in the statement of cash flows, net of any cash acquired.
  • Acquisition-related costs such as advisory, legal, accounting, valuation, and professional and consulting fees in a business combination should be reflected as operating cash outflows in the statement of cash flows.
  • The effects of exchange rate changes on cash should be shown as a separate line item in the statement of cash flows as part of the reconciliation of beginning and ending cash balances.

Treatment of share premium in the Financial Statements

The Companies Act 71 of 2008 no longer permits companies to have shares of par value, resulting in companies no longer recognizing share premiums. In this issue we look at what this means for existing share premium accounts.

One of the most fundamental changes that the new Companies Act No. 71 of 2008 brought about was that a pre-existing company may not authorize any new par value shares, authorize any shares having a nominal value, or do any subdivision thereof.

In light of this, questions have often been asked about the treatment of the existing share premium account already present in the financial statements and what the legalities surrounding this is. In order to answer this, it will be necessary to fully understand what the share premium account is and explore the alternative treatments which are allowed in respect of this.

Note: The requirements relating to the issuing of shares are relevant to all shares which have been issued since the implementation of the new Companies Act No. 71 of 2008.

The effect of this is that share premiums can no longer be recognised by the company.

1. What is a share premium?

A share premium is the amount received by a company over and above the par value of its shares. This amount typically forms a part of the non-distributable reserves of the firm.

2. What is the implication of the new Companies Act No. 71 of 2008 in relation to share premium?

The effect of The Companies Act No 71 of 2008 is that a share premium will no longer be applicable. The new Companies Act was signed into law on 8 April 2009 and became effective on 1 May 2011. Consequently, any company with an existing share premium account would not recognize increases in such an account for all future years.

3. A company has issued shares that have a par value and it has recognized share premium separately from share capital.

The issues are:

i. Whether IFRS permits reclassifications within equity, for example combining share capital and share premium into one line termed “stated capital / issued capital”?

The legal requirements relating to the different categories of equity capital affect the accounting classifications. Therefore, from an IFRS perspective, if there is no legal requirement to retain separate classifications for share capital and share premium within equity, these could be combined. Such a reclassification would be recognized within the statement of changes in equity. This would also be the case in the South African context.

ii. The accounting impact of a repayment of shares

If the share premium is paid out to shareholders (for example, where the Company’s Memorandum of Incorporation specifies that the shareholders are entitled to the share premium), this is accounted for as a distribution of shareholders equity for IFRS purposes.

4. Does the company HAVE to reclassify the share premium account back to equity, or can it maintain a separate share premium account?

As there is no legal requirement for the company to reclassify the share premium account, a separate share premium account may be maintained.

Where a company has maintained a separate share premium account, due consideration should be given to any movements on such accounts.

Governance and the role of Directors and Audit Committees

Corporate governance is essential to reduce risk within entities and to increase growth and long-term value for the business.

The role of Directors

The duty of a director to act in good faith requires that a director’s primary responsibility is to the organization; this responsibility must ordinarily take precedence over the personal interests of the director or the interests of a third party. It is important that when a director walks into the boardroom, that director is exercising their powers for the benefit of the organization. This means avoiding actual, potential and perceived conflicts of interest.

Where there may be a conflict, directors are obliged to disclose their conflict of interest or duty and take appropriate action to avoid any adverse consequences. Directors should tread cautiously when considering an actual, potential or perceived conflict of interest. An actual or potential conflict does not necessarily disqualify a person from serving on a board, but full disclosure is a legal and ethical imperative.

Focus of the Audit Committee

The following items are important to keep in mind as audit committees consider and carry out their 2019 agendas:

  • Take a fresh look at their agenda and workload.
  • Sharpen the company’s focus on culture, ethics, and compliance.
  • Understand how the finance team will reinvent itself and add greater value in this technology and data-driven environment.
  • Monitor management’s progress on implementing new accounting standards.
  • Reinforce audit quality by setting clear expectations for the auditor.
  • Give non-financial measures, other key operating metrics, and cybersecurity disclosures a prominent place on the audit committee agenda.
  • Focus internal audit on the company’s key risks beyond financial reporting and compliance, e.g. tone at the top, culture, cybersecurity, legal/regulatory compliance, global
    supply chain etc.
  • Board composition – confirm that the talent in the room is aligned with the company’s strategy and future needs.
  • Quality and content of the audit committee reports.
  • Focus on cyber risk and security.

Audit committees can expect their company’s financial reporting, compliance, risk and internal control environment to be put to the test in the year ahead. Among the top challenges and pressures are: long-term economic uncertainty (with concerns about global mounting trade tensions, resurging debt and market valuations), technology advances and business model disruption, cyber risk, regulatory scrutiny and investor demands for transparency; and political swings and policy changes locally and globally.

Governance tips for SMEs

Compliance with the full range of corporate governance regulations applicable to larger companies is not always appropriate for SMEs. Depending on the company’s stage of development, here are a few governance tips for SMEs to consider:

  • Ensure the roles and responsibilities of the Board are clearly defined.
  • Put in place delegated authorities (e.g. authority to commit the company to expenditure, authority to sign contracts) – to whom and within what limits.
  • Ensure regular and properly run board meetings are held where the company strategy is discussed, budgets and finances are monitored, and progress on operations is reported.
  • Evaluate whether the composition of the board is appropriate for the next stage of the company’s development.
  • Implement a risk management process Where necessary, implement internal controls. This is especially important on the financial side (e.g. to monitor cash flow) but is also applicable to other areas of the business such as security of assets and company data.
  • Develop a disaster recovery and business continuity plan.

Implications of the effective dates of the IRBA Code on the auditor’s and assurance reports

As the effective date for Parts 1 and 3 of the IRBA Code differs from that of Parts 4A and 4B, it will have an impact on how the IRBA Code is described in the auditor’s and assurance reports.

Revised IRBA Code

The IRBA communicated the release of the IRBA Code of Professional Conduct for Registered Auditors (revised November 2018) (IRBA Code) which have different effective dates affecting the auditor’s and assurance reports.

The IRBA Code will have the following effective dates:

  • Parts 1 and 3 will be effective as of 15 June 2019
  • Part 4A relating to independence for audit and review engagements will be effective for audits and reviews of financial statements for periods beginning on or after 15 June 2019
  • Part 4B relating to independence for assurance engagements will be effective for periods beginning on or after 15 June 2019 (when covering periods), otherwise effective as of 15 June 2019.

As the effective dates for above is different, careful attention needs to be given to the implementation of the different parts of the IRBA Code and the impact thereof on the ‘BASIS FOR OPINION’ included in the auditor and assurance reports.

There will thus be 3 different types of audit reports that will need to be considered to address the above effectives dates:

  1. Current period – Auditor or assurance reports issued before 15 June 2019 (Extant IRBA Code – As normally reported)
  2. Transitional period – Auditor or assurance reports issued on or after 15 June 2019 in respect of financial periods beginning before or on 14 June 2019
  3. Period going forward – Auditor or assurance reports issued after 15 June 2019 in respect of financial periods beginning on or after 15 June 2019

See illustration below regarding above:

Examples

See below extracts for “Basis for Opinion” that will apply (except for Disclaimer opinion):

(Example based on audit of consolidated set of financial statements of a listed entity)

Current period

We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Consolidated and Separate Financial Statements section of our report. We are independent of the group in accordance with the Independent Regulatory Board for Auditors Code of Professional Conduct for Registered Auditors (IRBA Code) and other independence requirements applicable to performing audits of financial statements in South Africa. We have fulfilled our other ethical responsibilities in accordance with the IRBA Code and in accordance with other ethical requirements applicable to performing audits in South Africa. The IRBA Code is consistent with the International Ethics Standards Board for Accountants Code of Ethics for Professional Accountants (Parts A and B). We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Transitional period

We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the company in accordance with the sections 290 and 291 of the Independent Regulatory Board for Auditors’ Code of Professional Conduct for Registered Auditors (Revised January 2018) (IRBA Code (Revised January 2018)), parts 1 and 3 of the Independent Regulatory Board for Auditors’ Code of Professional Conduct for Registered Auditors (Revised November 2018) (IRBA Code (Revised November 2018)) and other independence requirements applicable to performing audits of financial statements in South Africa. We have fulfilled our other ethical responsibilities in accordance with the IRBA Code (Revised January 2018), the IRBA Code (Revised November 2018) and in accordance with other ethical requirements applicable to performing audits in South Africa. Sections 290 and 291 of the IRBA Code (Revised January 2018) are consistent with sections 290 and 291 of the International Ethics Standards Board for Accountants Code of Ethics for Professional Accountants. Parts 1 and 3 of the IRBA Code (Revised November 2018) are consistent with parts 1 and 3 of the International Ethics Standards Board for Accountants’ International Code of Ethics for Professional Accountants (including International Independence Standards). We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Period Going Forward

We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the company in accordance with the Independent Regulatory Board for Auditors’ Code of Professional Conduct for Registered Auditors (IRBA Code) and other independence requirements applicable to performing audits of financial statements in South Africa. We have fulfilled our other ethical responsibilities in accordance with the IRBA Code and in accordance with other ethical requirements applicable to performing audits in South Africa. The IRBA Code is consistent with the International Ethics Standards Board for Accountants’ International Code of Ethics for Professional Accountants (including International Independence Standards) (Parts 1, 3, 4A and 4B). We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Note: To ensure that the appropriate report is issued, all audit reports issued between June and September 2019 must be submitted to the Technical Department at technical@nexia-sabt.co.za for review before signing the audit report

Disclosure of Directors’ Remuneration in Group Companies

The Companies Act requires full disclosure of the remuneration of directors and prescribed officers (whether executive, non-executive or alternate directors) in the financial statements of companies that require an audit in terms of the Act. This requirement may become quite cumbersome where a Group of Companies consists of multiple companies.

Note: The Act requires that each company that is required to have its annual financial statements audited, must provide the directors disclosure as required by Section 30 of the Companies Act.

In terms of section 30(5), the disclosure must show the amount of any remuneration or benefits paid to or receivable by persons in respect of:

  • services rendered as directors or prescribed officers of the company; or
  • services rendered while being directors or prescribed officers of the company-
    – as directors or prescribed officers of any other company within the same group of companies; or
    – otherwise in connection with the carrying on of the affairs of the company or any other company within the same group of companies.
  1. The act defines a “group of companies” as a holding company and all of its subsidiaries.
  2. If a person serves as director and/or prescribed officer of more than one company in a group of companies, that person’s total remuneration would be disclosed in the annual financial statements of all the companies in the group that are required to disclose remuneration, i.e. all companies where that person is a director/prescribed officer or employee carrying out affairs of company (see below).
  3. If a person is a director of a company in a group of companies and the same person is also an employee of another company in the group, the company where the person is a director will have to disclose in its AFS the person’s remuneration received as director of the company AND the salary earned as an employee of the other company within the same group of companies (i.e. for the carrying on of the affairs of the company)
  4. The Act requires the company to disclose all amounts payable to or received by its directors/prescribed officers in respect of services rendered as directors/prescribed officers of the “company”. Therefore, any amounts paid to directors/prescribed officers in respect of services rendered to a trust or a foreign company within the group would not be disclosed, since trusts and foreign companies are not “companies” as defined by the Act.

Accounting for non-cash consideration in terms of IFRS 15

Consideration for the sale of goods can be received in cash as well in a form other than cash. IFRS 15 provides specific guidance when it comes to determining the transaction price for contracts in  which a customer promises consideration in a form other than cash.

Note: The requirements for accounting for non-cash consideration are prescribed by IFRS 15. The determination of the fair value of the non-cash consideration to be accounted for must be done in accordance with IFRS 13.

If a customer provides goods and/or services to assist an entity in fulfilling its contract, the entity should assess whether it obtains control of such goods or services. In the event that the entity does obtain control of such goods and services, the goods and services will be considered to be non-cash consideration and should be accounted for as such.

This document will provide a brief snapshot regarding the treatment which IFRS 15 prescribes when accounting for non-cash consideration.

  1. What is non-cash consideration?
    Non-cash consideration can typically be defined as consideration which is received or receivable by the customer which is in a form other than cash.Examples of non-cash consideration typically include:
    ➢ Shares
    ➢ Material, equipment and labor
    ➢ Contribution of assets from the customer for the purposes of the contract being met where the entity gains control of these assets.
  2. How should non-cash consideration be measured?
    IFRS 15 prescribes that an entity shall measure the non-cash consideration (or promise of non-cash consideration) at fair value as defined in IFRS 13. Therefore, the fair value of such the non-cash consideration (or promise of non-cash consideration) should be as at the measurement date of the transaction, which would typically be the transaction date. It is therefore extremely important to ensure that your client has accounted for the fair value of any non-cash consideration receivable at the correct date.Note that if an entity cannot reasonably estimate the fair value of the non-cash consideration, the entity shall measure the consideration indirectly by reference to the stand-alone selling
    price of the goods or services promised to the customer (or class of customer) in exchange for the consideration.
  3. How should subsequent changes in fair value of the non-cash consideration receivable be accounted for?
    If the fair value of the non-cash consideration promised by a customer varies for reasons other than only the form of the consideration (for example, the fair value could vary because of
    the entity performance), an entity shall apply the requirements in paragraphs 56 – 58 of IFRS 15.

Remember to take note of the following important points when accounting for non-cash consideration:

  • The general rule to follow is that if the consideration in the contract is received or is to be received in a form other than cash, the entity will measure such non-cash consideration at
    fair value, as defined in IFRS 13.
  • The requirements of IFRS 13 with regards to the measurement therefore need to be applied when accounting for non-cash consideration.
  • It is also crucial to note that, in accordance with IFRS 13, fair value is market-based measure of an exit price that is receivable and NOT an entity-specific value.
  • Therefore, an entity’s intention with regards to any non-cash consideration received (for example, an asset) is not relevant for the purposes of determining its fair value.

Tips on how to successfully manage the transition to the new Lease Accounting Standard

Note: The requirements for lessors remain basically unchanged since IFRS 16 substantially carries forward the requirements of IAS 17 based on the distinction between operating leases and finance leases.

To become – and remain – compliant, companies need to address five key challenges in the life cycle of a lease as far as lessees are concerned:

  1. Engage with your auditors and advisors
    a. IFRS 16 requires a significant amount of judgement and estimations.
    b. Engaging with your auditors and IFRS advisors ensures you begin with the end in mind, and will make good choices that will withstand the test of time, and help you sleep better at night.
  2. Determine if the contract contains a lease?
    a. Is there an identified asset?
    b. Does the person renting the asset obtain substantially all of the economic benefits?
    c. Does the person renting the asset have the right to direct the asset’s use?
    d. Does the person renting the asset have the right to operate the asset?
  3. Determining the lease term
    a. Non-cancellable period of the lease PLUS
    b. Period covered by an option to extend (if option is likely to be exercised) PLUS
    c. Period covered by an option to terminate (if option not exercised) contract (non-lease component).
  4. How to determine the appropriate discount rate.
    a. If there is an interest rate implicit in the lease then you should use this to discount the minimum lease payments.
    b. However, if this cannot be readily determined, you should use your company’s incremental borrowing rate (which is the rate of interest that you would have to pay to borrow a similar amount of money to fund a similar asset for a similar length of time with similar securities.)
  5. Presentation and disclosure requirements.
    a. As IFRS 16 requires much of the information that was previously disclosed in the notes to financial statements to appear on the balance sheet, investors may expect that lease liabilities on the balance sheet under IFRS 16 will reflect the discounted amount of lease commitments disclosed in the notes section under the previous Standard.
    b. Making sure that the disclosures are as complete as possible in the period between now and the application of the new Standard, will help avoid unnecessary complications.

Remember to make use of the practical expedients during the transition:

  • Application of a single discount rate to a portfolio of leases with reasonably similar characteristics.
  • Use of the exemption to apply lease accounting to leases for which the lease term ends within 12 months of the date of initial application.
  • Use of the exemption to apply lease accounting to leases of low-value items.
  • Exclusion of the initial direct costs from the measurement of the right-of-use asset at the date of initial application.
  • Using the “grandfather” approach on the previous assessment of contracts – this means the definition of a lease in terms of IFRS 16 is only applied for contracts entered into after the date of initial application.

The ‘date of initial application’ is the beginning of the annual reporting period in which a company first applies the standard. If a company prepares financial statements for annual periods ending on 31 December, presents one year of comparative financial information and adopts IFRS 16 in 2019, then its date of initial application is 1 January 2019.