How a liability paid in kind or by issuing shares is disclosed in statement of cash flows?

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Most of the time entities pay out their liabilities, whether short term or long term, in cash. And by cash it means either in hard cash or by issuing cheque or using cash equivalents.

Sometime company does not have a ready cash in which case it will sell an asset, get the cash and pay its liabilities. But this payment should not be confused with the payment in kind. As this transaction involves the use of cash and cash equivalents and asset was first converted to cash and then liability was paid. Such transactions shall be disclosed in the statement of cash flows under investing and financing activities.

But sometimes obligations are also settled through other means completely skipping the use of cash and cash equivalents. Transactions which are of such nature are called non-cash transactions.

Some of the examples are as follows:

  • In kind or by giving out an asset not liquid in nature. For example a debtor hand over his vehicle to the creditor in respect of the money the debtor owed.
  • By issuing shares to the creditor. For example  a debtor owed 10,000 to a supplier and this liability was settled by issuing shares worth 10,000.
  • By accepting the liability of the creditor. This is not so common practice but liabilities are settled using this method as well. For example, Person ‘A’ owes 4,000 to person ‘B’ whereas ‘B’ owes 4,000 to ‘C’. Person A’s liability towards B can be settled if A accepts to pay B’s debt towards person C. Remember the liability taken up may or may not be equal to amount actually payable.
  • Convertible loan stock in which case the instrument holder has the option to convert the instrument into ordinary shares after a specified date and if such option is exercised then the issuer stands clear and the liability will be settled. As loan will be converted to equity.

All the examples mentioned above do not involve cash and cash equivalents. Even though such transactions are investing and/or financing activities still all such non-cash transactions shall not be included in statement of cash flows or cash flow statement.

But exclusion of non-cash transactions from statement of cash flows does not mean that such transactions will not be reported in financial statements altogether rather such transactions shall be reported in other financial statements in a way that makes financial statements more understandable for the users. Because even though such transactions are non-cash in nature, they do affect the residual interest in the entity by affecting the assets and liabilities of the entity.

For example, loan is converted to shares. Although this is a non-cash transactions and thus cannot be disclosed in statement of cash flows but it has affected the assets, liabilities and share capital of the entity and thus require disclosure. Therefore, the effect this transaction shall be disclosed in statement of financial position and statement of changes in equity.

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