After understanding operating, investing, and financing cash flows, Accounting Standard 3 (AS-3) deals with certain special situations that do not arise regularly but are extremely important from both exam and practical perspectives. These include:
- Cash flows arising from purchase or disposal of business units
- Cash flows in foreign currency
- Non-cash investing and financing transactions
Incorrect treatment of these items can seriously distort a Cash Flow Statement. AS-3 therefore provides specific guidance to ensure clarity and consistency.
Cash Flows Arising from Purchase or Disposal of Business
Meaning of Business Purchase / Disposal
Purchase or disposal of a business refers to acquisition or sale of:
- A subsidiary
- A business unit
- An undertaking capable of operating independently
Such transactions usually involve large cash flows and are therefore treated separately under AS-3.
Classification of Cash Flows from Business Purchase or Disposal
AS-3 requires that aggregate cash flows arising from purchase or disposal of a business should be classified as investing activities.
This is because:
- These transactions involve long-term investments
- They affect the future earning capacity of the enterprise
How Cash Flows Are Shown in the Cash Flow Statement
When a business is purchased or disposed of, the Cash Flow Statement should show:
- Total purchase consideration paid (or received)
- Less: Cash and cash equivalents acquired (or disposed of)
Only the net cash flow is shown as an investing activity.
Illustration: Purchase of a Business
Suppose:
- Purchase consideration paid = ₹20,00,000
- Cash and bank balance of acquired business = ₹5,00,000
Then:
- Net cash outflow = ₹15,00,000
- Classified as investing cash outflow
This ensures that only actual cash movement is reflected.
Separate Disclosure Requirement
AS-3 requires that:
- Cash flows from purchase or disposal of business should be disclosed separately
- Such disclosure improves transparency
This helps users distinguish routine investing activities from major structural changes.
Foreign Currency Cash Flows under AS-3
Enterprises often deal in foreign currencies through:
- Export and import transactions
- Foreign bank balances
- Overseas operations
AS-3 provides clear guidance on how such cash flows should be reported.
Reporting of Foreign Currency Cash Flows
Cash flows arising from transactions in foreign currency should be:
- Recorded in reporting currency
- Converted using the exchange rate on the date of cash flow
This ensures consistency and accuracy.
Illustration: Foreign Currency Receipt
An enterprise receives USD 10,000 when:
- Exchange rate on receipt date = ₹75 per USD
Cash inflow recorded:
- ₹7,50,000
This amount is shown in the Cash Flow Statement.
Treatment of Exchange Differences
AS-3 makes an important clarification:
“Exchange differences arising from translation of foreign currency cash balances are NOT cash flows.”
These differences:
- Do not involve actual cash movement
- Arise only due to change in exchange rates
How Exchange Differences Are Shown
AS-3 requires that:
- Effect of exchange rate changes on cash and cash equivalents should be shown separately
- This is done to reconcile opening and closing cash balances
Illustration: Exchange Difference on Foreign Bank Balance
Suppose:
- Opening foreign bank balance = USD 5,000
- Exchange rate at beginning = ₹70
- Exchange rate at end = ₹72
Increase in rupee value:
- ₹10,000
This increase is not a cash inflow and is shown separately for reconciliation.
Why Exchange Differences Are Excluded from Cash Flows
Because:
- No receipt or payment of cash occurs
- It is only a valuation adjustment
Including such differences would misrepresent actual cash movements.
Non-Cash Investing and Financing Transactions
Meaning of Non-Cash Transactions
Non-cash transactions are those transactions that:
- Do not involve inflow or outflow of cash
- Affect assets, liabilities, or equity
Although important, such transactions are excluded from the Cash Flow Statement.
Examples of Non-Cash Investing Transactions
- Acquisition of machinery by issue of shares
- Purchase of assets through conversion of liabilities
- Exchange of assets without cash payment
Examples of Non-Cash Financing Transactions
- Conversion of debentures into equity shares
- Issue of shares to settle liabilities
Why Non-Cash Transactions Are Excluded
AS-3 focuses only on actual cash movements. Since non-cash transactions do not affect cash and cash equivalents, they are not included in the Cash Flow Statement.
However, ignoring them completely would reduce usefulness.
Disclosure of Non-Cash Transactions
AS-3 requires that:
- Significant non-cash investing and financing transactions should be disclosed separately
- Disclosure may be made in: (a) Notes to accounts, or (b) A separate statement
This ensures complete financial information without distorting cash flows.
Illustration: Machinery Acquired by Issue of Shares
If machinery worth ₹10,00,000 is acquired by issuing equity shares:
- No cash outflow occurs
- Transaction is not shown in Cash Flow Statement
- It must be disclosed separately
Combined Understanding of These Special Situations
| Situation | Treatment under AS-3 |
| Business purchase/disposal | Investing activity (net cash) |
| Foreign currency cash flows | Converted at date of cash flow |
| Exchange differences | Not cash flows |
| Non-cash transactions | Excluded but disclosed |
This summary is exam-critical.
Common Exam Mistakes to Avoid
Students often:
- Show total purchase consideration instead of net cash
- Treat exchange differences as operating cash flows
- Include non-cash transactions in Cash Flow Statement
- Forget disclosure requirements
Avoiding these mistakes can significantly improve marks.
Importance from Practical Perspective
Correct treatment ensures:
- Accurate liquidity analysis
- Clear distinction between cash and non-cash events
- Better comparability between enterprises
Analysts rely heavily on these disclosures.
AS-3 from Examination Perspective
This topic is frequently tested through:
- Short notes
- MCQs
- Conceptual questions
- Adjustments in practical problems
Clear understanding is essential for scoring well.
Conclusion
Accounting Standard 3 provides clear guidance for handling special situations such as business purchase or disposal, foreign currency cash flows, and non-cash transactions. These items may not occur regularly, but when they do, their impact on cash reporting is significant.
By following AS-3 rules carefully and making appropriate disclosures, enterprises can ensure that their Cash Flow Statements present a true and meaningful picture of cash movements. For students, mastering this topic completes a major portion of AS-3 preparation.
“To see how all AS-3 concepts are applied together, continue with our Accounting Standard 3 (AS-3): Cash Flow Statement – Complete Guide.”
FAQs
1: How are cash flows from business purchase treated under AS 3?
Answer: Cash flows arising from purchase or disposal of a business are classified as investing activities and shown net of cash and cash equivalents acquired or disposed of.
2: How are foreign currency cash flows reported under AS 3?
Answer: Foreign currency cash flows are recorded in the reporting currency using the exchange rate on the date of the cash flow.
3: Are exchange differences treated as cash flows under AS 3?
Answer: No, exchange differences arising from translation of foreign currency cash balances are not considered cash flows under AS 3.
4: How are exchange differences disclosed in Cash Flow Statement?
Answer: Exchange differences are shown separately to reconcile opening and closing cash and cash equivalents.
5: What are non-cash investing and financing transactions?
Answer: These are transactions that do not involve cash, such as acquisition of assets by issue of shares or conversion of debentures into equity.
6: Are non-cash transactions included in Cash Flow Statement?
Answer: No, non-cash investing and financing transactions are excluded from the Cash Flow Statement but must be disclosed separately.
7: Why is disclosure of non-cash transactions important?
Answer: Disclosure ensures complete financial information and helps users understand significant investing and financing activities that do not involve cash.
