Question

1.An entity may report significant profits over a number of successive years and still experience negative net cash flows overall. Provide two reasons and explain how this is possible.

2. A company’s workforce went on strike for an indefinite period commencing on 28 June 2022. The strike was expected to cause severe financial conditions for the company. The financial statements for the year ended 30 June 2022 were expected to be finalised by 3 August 2022.

Required: Analyse the above event and classify the event as either an adjusting or a non-adjusting event.

Apply relevant accounting standards to justify your classification.

Answer 1

1) A company may report significant profit and experience negative cash flows at the same time under the following circumstances:

a) When the company makes huge investments in the capital assets which will create negative cash flows under the investing activities while the cash flows from the operative activities may be positive, the huge cash outflows from the investing activities lead to the negative overall cash flows.

b) when the company repays the borrowings, it leads to negative cash flows. The positive cash flows from the operating activities will not be sufficient to cover the cash outflows arising from the repayment of borrowings which leads to negative overall cash flows.

2) As per IAS 10, an adjusting event is an event that provides evidence of the conditions that existed on the balance sheet date.

Event after reporting periods are the events occurring between the date of financial statements and the date the financial statements are authorized for issue.

In the given case, the date of financial statements is 30th June and the date the financial statements are authorized for the issue is 3rd August.

Since the employee strike was started on 28th June which is before the date of financial statements i.e., 30th June .

it will be an adjusting event.

Hence the adverse financial conditions resulting from the strike are adjusting events and the effect of those events has to be reported in the financial statements.