Cash Flow from Investing Activities

1. What are Investing Activities?

As per Accounting Standard-3 (AS-3), investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Think of this section as tracking the cash spent on or received from buying and selling items that are intended to generate future income and cash flows for the business.

To get a formal definition and see the typical items involved, please read the following short text.

The typical format for presenting these activities is quite straightforward. We list the cash inflows (positive amounts) and cash outflows (negative amounts, usually in parentheses).

The key components are:

• Cash Inflows (+):
  • Sale of Fixed Assets (e.g., machinery, land, building)
  • Sale of Intangible Assets (e.g., goodwill, patents)
  • Sale of Non-current Investments
  • Interest, Dividends, and Rent received on investments
• Cash Outflows (-):
  • Purchase of Fixed Assets
  • Purchase of Intangible Assets
  • Purchase of Non-current Investments

2. The Main Challenge: Calculating Purchase and Sale Amounts

In most exam problems, the amounts for 'Purchase of Asset' and 'Sale of Asset' are not given directly. Instead, you'll be provided with opening and closing balances of assets from a comparative balance sheet, along with some additional information (adjustments).

Your main task will be to use this information to calculate the missing figures. The primary tool for this is the Fixed Asset Account. The way you prepare this account depends on how the company maintains its books. Let's explore the two methods.

Method 1: Asset Account at Written Down Value (WDV)

This method is used when there is no separate 'Provision for Depreciation' or 'Accumulated Depreciation' account mentioned in the balance sheet. The value of the asset shown is its book value (Cost - Depreciation).

To find the purchase or sale figures, you prepare the Fixed Asset Account. The following video provides a clear, step-by-step walkthrough of this process.

Key Steps for Asset Account at WDV:

1. Debit Side: Start with the opening balance (To Balance b/d). Also, record any profit on the sale of the asset (To Statement of P&L). The balancing figure on this side will usually be the purchase made during the year (To Bank A/c).
2. Credit Side: Start with the depreciation for the year (By Depreciation A/c). Record the cash received from the sale (By Bank A/c) and any loss on sale (By Statement of P&L). End with the closing balance (By Balance c/d).

Method 2: Asset Account at Original Cost

This method is used when the balance sheet shows both the Fixed Asset (at Cost) and a separate 'Accumulated Depreciation' account. This means you need to prepare two accounts to find the required information.

This next video segment continues directly from the previous one, explaining this second, more detailed method.

Key Steps for Asset Account at Cost:

1. Fixed Asset Account (at Cost):
   • Debit the opening balance and profit on sale.
   • Credit the sale proceeds, loss on sale, and closing balance.
   • Crucially, also credit the total accumulated depreciation on the asset that was sold (By Accumulated Depreciation A/c).
   • The balancing figure on the debit side is the purchase (To Bank A/c).
2. Accumulated Depreciation Account:
   • Credit the opening balance.
   • Debit the accumulated depreciation on the asset sold (this amount is transferred to the Fixed Asset Account). Debit the closing balance.
   • The balancing figure on the credit side is the depreciation for the current year (By Depreciation A/c or By Statement of P&L).

This second method is very common in CBSE board exams, so make sure you are comfortable with preparing both accounts.

3. A Complete Example

Let's apply these concepts to a problem. The following example requires you to prepare ledger accounts to find the cash flows from investing activities.

Here's an image of the final solution from that illustration, showing how the calculated figures slot into the statement.

Conclusion

Well done! You've now covered the second major section of the Cash Flow Statement. While it can involve some detailed calculations, the underlying principles are quite consistent.

Key Takeaways:

• Investing activities involve transactions with non-current assets (fixed assets, intangible assets) and non-current investments.
• Cash inflows come from selling these assets and from income received on them (interest, dividends, rent).
• Cash outflows result from purchasing these assets.
• The most important skill is preparing the relevant ledger accounts (Fixed Asset A/c and Accumulated Depreciation A/c) to find the purchase and sale amounts when they are not given directly.

Preview of the Next Lesson:
We are now two-thirds of the way through the statement. In our next lesson, we will tackle the third and final section: Cash Flow from Financing Activities. This section deals with transactions that change the size and composition of the company's capital structure, such as issuing shares, taking loans, and paying dividends.