Question

Dear Auditor: Hi-Tech Fashion Inc. (“Fashion”) is a retailer of women’s clothes and clothing accessories. Fashion’s operations are based in Seattle, WA, with retail stores located in the nearby suburbs and throughout northwestern United States. Fashion is actively developing opportunities to expand its operations in the surrounding region, including construction of several new retail stores in California. Fashion intends to complete construction and open new stores over the next four years. Fashion anticipates incurring significant expenses and making short-term cash outlays during the construction phase of the expansion. As a result of this growing need to obtain new, readily available capital, Fashion entered into a three-year revolving line of credit (the “Facility”) with its bank on January 1, 2010. The line of credit has a maximum borrowing capacity of $100 million. Since Fashion has not previously used a revolving line of credit, it does not have knowledge of the relevant accounting literature and guidance on how to present the related cash flows in its financial statements. Accordingly, as Fashion’s external auditor, management has asked for your assistance in determining the appropriate presentation of the borrowing and payment activity within its statement of cash flows for the year ended December 31, 2010.

1) Should Fashion present the borrowing and payment activity related to its revolving line of credit as cash flows from operating, investing, or financing activities?

2) For each of the following scenarios, on the basis of the specific facts and circumstances, determine whether Fashion should present its borrowing and payment activity under the Facility on a net or gross basis within the financing activities section of its statement of cash flows.

Scenario A:

• The line of credit has a maximum borrowing capacity of $100 million, and under the terms of the agreement, all draws are considered to be due on demand.

• On July 15, 2010, Fashion drew $60 million on the Facility.

• On August 30, 2010, Fashion drew an additional $40 million on the Facility.

• On September 30, 2010, Fashion paid down the draws by $50 million. • Assume the turnover of transactions is considered to be quick.

Scenario B:

• The line of credit has a maximum borrowing capacity of $100 million, and under the terms of the agreement, specific maturity terms will be negotiated by Fashion and the bank after each draw on the Facility.

• On June 15, 2010, Fashion drew $60 million, and signed a note to repay the full amount borrowed by December 15, 2010.

• On September 30, 2010, Fashion drew an additional $40 million, and signed a note to repay the full amount borrowed by December 1, 2010.

• On December 1, 2010, Fashion paid $40 million to the bank related to the second draw.

• On December 15, 2010, Fashion paid $60 million to the bank related to the first draw.

• Assume the turnover of the transactions is considered to be quick

Answer 1

Answer 1)

• operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities.
• investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. The aggregate cash flows arising from obtaining and losing control of subsidiaries or other businesses are presented as investing activities.
• financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.

Since the borrowing and payment of activity related to its revolving line of credit result in changes in size and composition of the contributed equity and borrowing of the entity it is a financing activity.

Answer 2

U.S GAAP, IFRS generally requires entities to present information about an entity's cash receipts and cash payments during a period on a gross basis. However, in certain circumstances, IFRs permit certain cash flow activities to be presented on a net basis.

Paragraph of 22(b) of IAS states that cash flow may be reported on a net basis when cash receipts and payments for items in which turnover is quick, amounts are large, and the maturities are short.

Scenario A

Facts and circumstances

a) In this case the amount due on demand, generally they are considered to have maturities of 3 months or less

b) volume of the transaction are large and the maturities are short

c) The turnover is quick

based on the above fact and circumstances it is advisable to present the cash flow on net basis financing activity.

Scenario B

Facts and circumstances

a) line of credit due is short i.e less than a year

b) volume of the transaction are large

c) The turnover is quick

based on the facts and circumstances it is advisable to present the cash flow on a net basis under financing activity.