Advanced Accounting · AS 3 Cash Flow Statement

AS 3 Objective, Scope and Key Definitions Explained

Updated 4 October 2026 · Fact-checked

AS 3 requires a cash flow statement showing how an enterprise generated and used cash and cash equivalents during a period, split into operating, investing and financing activities. Cash means cash in hand and demand deposits. Cash equivalents are short-term, highly liquid investments with insignificant risk of value change.

Understand AS 3 Objective, Scope and Key Definitions

A profit and loss account shows profit on the accrual basis. It does not show whether the business actually had cash to pay its bills. AS 3 Cash Flow Statement fills this gap. It tells users where cash came from and where it went during the period.

The objective of AS 3 is to require information about historical changes in cash and cash equivalents through a statement that classifies cash flows into operating, investing and financing activities. The statement helps users judge the enterprise's ability to generate cash and its need to use it.

On scope, an enterprise prepares a cash flow statement and presents it for each period for which financial statements are prepared. Under the Companies Act, 2013, a cash flow statement is part of the financial statements, with exemptions for certain classes such as One Person Companies, small companies and dormant companies. For accounting standards applicability, the level of the enterprise (Level I, II or III) decides whether AS 3 applies. Check the exemptions for Level II and III entities in the related pages.

Now the key definitions. Cash comprises cash in hand and demand deposits with banks. Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash and are subject to an insignificant risk of change in value. They are held to meet short-term cash commitments, not for investment. An investment normally qualifies only when it has a short maturity, say three months or less from the date of acquisition. Cash flows are inflows and outflows of cash and cash equivalents. Movements between cash and cash equivalents are not cash flows, because they are components of the same pool.

The three activities are: Operating activities are the principal revenue-producing activities and other activities that are not investing or financing. Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Financing activities change the size and composition of owners' capital and borrowings of the enterprise.

Key rules to remember

Cash: Cash = Cash in hand + Demand deposits with banks; Demand deposits are those withdrawable without notice or penalty, such as current and savings accounts.
Cash equivalents test: Short-term + Highly liquid + Convertible into known cash + Insignificant risk of value change + Held for short-term commitments; All conditions must be met. A maturity of three months or less from acquisition is the usual cut-off.
Cash and cash equivalents: Cash and cash equivalents = Cash + Cash equivalents; The cash flow statement explains the change in this total, not only cash.
Net change: Net increase or decrease = Operating + Investing + Financing cash flows; Add this to opening cash and cash equivalents to get closing balance.
Activity classification: Operating = principal revenue-producing; Investing = long-term assets and investments; Financing = owners' capital and borrowings; Operating is the residual category for activities not investing or financing.

How to solve AS 3 Objective, Scope and Key Definitions questions

For a definition or classification question on AS 3, use this sequence so every item lands in the right place.

1Read the item and note whether cash moved at all. Non-cash items such as depreciation or bonus issue are not cash flows.
2Check whether the item is a movement between cash and cash equivalents. If yes, it is not a cash flow.
3For investments, apply the cash equivalent test: short maturity from acquisition date, highly liquid, known amount, insignificant risk, held for short-term commitment.
4Ask what the item does. Is it part of day-to-day revenue activity? Then operating.
5If it buys or sells long-term assets or non-equivalent investments, classify as investing.
6If it changes owners' capital or borrowings, classify as financing.
7State the category with a one-line reason and cite AS 3 wording.
8Check the direction: inflow or outflow.

Quickest way: Three-question filter for MCQs and short answers

When to use it: Use for MCQs on classification and for short theory answers where time is tight.

Question 1: Did cash or cash equivalents actually move in or out of the enterprise? If no, eliminate.
Question 2: Is it long-term assets or investments? Choose investing.
Question 3: Is it share capital or borrowings, including repayment? Choose financing. Everything else is operating.
For cash equivalents MCQs, test the maturity from the date of acquisition, not from the balance sheet date.
In written answers, write definition, then classification, then reason. Each part earns step marks.

Common mistakes in AS 3 Objective, Scope and Key Definitions

Treating all bank deposits as cash.
Students see the word bank and assume it is cash.
Fix: Only demand deposits are cash. A fixed deposit is a cash equivalent only if it has a short original maturity, about three months or less, and is held for short-term needs.
Measuring the three-month limit from the balance sheet date.
Students look at the remaining period instead of the original one.
Fix: Measure maturity from the date of acquisition. An investment bought with a one-year maturity does not become a cash equivalent later.
Showing transfer from bank to fixed deposit (qualifying as equivalent) as a cash flow.
Money leaves the bank account, so it looks like an outflow.
Fix: Movements within cash and cash equivalents are not cash flows. Both are part of the same pool.
Classifying interest paid or dividend received by memory without reading the enterprise type.
Students apply one rule to all enterprises.
Fix: Classification of interest and dividends depends on the type of enterprise, such as financial or non-financial. Read the question and the later special items page before classifying.
Including non-cash items such as depreciation as cash flows.
They appear in the profit and loss account.
Fix: Cash flows are only actual inflows and outflows of cash and cash equivalents. Non-cash items are adjusted out while computing operating cash flow.

Worked examples

Example 1

Classify each as cash, cash equivalent or neither under AS 3: (a) Balance in current account ₹2,00,000; (b) Treasury bills acquired with an original maturity of 2 months from the date of acquisition, held to meet short-term needs ₹5,00,000; (c) Equity shares of another company bought for trading, ₹3,00,000; (d) Fixed deposit acquired 18 months before maturity ₹4,00,000. Find total cash and cash equivalents.

Show the solution

(a) A current account is a demand deposit with a bank, so it is cash: ₹2,00,000.
(b) Treasury bills with an original maturity of 2 months from acquisition are highly liquid, convertible into known amounts and carry insignificant risk. Held for short-term commitments, so a cash equivalent: ₹5,00,000.
(c) Equity shares are subject to market price risk, so the risk of value change is not insignificant. Not a cash equivalent. It is an investment.
(d) Maturity of 18 months from acquisition is not short-term. Not a cash equivalent.
Total cash and cash equivalents = ₹2,00,000 + ₹5,00,000 = ₹7,00,000.

Answer: Cash and cash equivalents total ₹7,00,000; items (c) and (d) are excluded.

Example 2

State with reasons whether each is an operating, investing or financing activity, and whether it is an inflow or outflow: (a) Cash received from customers ₹8,00,000; (b) Purchase of machinery for cash ₹3,00,000; (c) Proceeds from issue of equity shares ₹10,00,000; (d) Repayment of a bank term loan ₹2,00,000; (e) Cash sale of a long-term investment ₹1,50,000.

Show the solution

(a) Cash from customers arises from the principal revenue-producing activity. Operating inflow of ₹8,00,000.
(b) Machinery is a long-term asset. Investing outflow of ₹3,00,000.
(c) Issue of equity shares changes owners' capital. Financing inflow of ₹10,00,000.
(d) Repaying a term loan changes borrowings. Financing outflow of ₹2,00,000.
(e) Disposal of a long-term investment is investing. Investing inflow of ₹1,50,000.
Net investing = ₹1,50,000 − ₹3,00,000 = outflow of ₹1,50,000. Net financing = ₹10,00,000 − ₹2,00,000 = inflow of ₹8,00,000.

Answer: (a) Operating inflow; (b) Investing outflow; (c) Financing inflow; (d) Financing outflow; (e) Investing inflow. Net investing is an outflow of ₹1,50,000 and net financing is an inflow of ₹8,00,000.

Exam tips

Learn the cash equivalent definition word by word. Most theory questions ask for it and for the reason an item qualifies or fails.
In MCQs, the usual traps are original maturity, equity shares as equivalents, and transfers within cash and cash equivalents.
Always give a reason after classification in written answers. A bare label often earns only part marks.
Note the scope point in short answers: the statement is presented for each period for which financial statements are prepared, and applicability depends on the enterprise level and the Companies Act exemptions.
Practise a quick table of items with columns for category and direction. The same logic carries into full cash flow problems.

Practice questions from AS 3 Cash Flow Statement

AS 3 Objective, Scope and Key Definitions in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

AS 3 Objective, Scope and Key Definitions: frequently asked questions

What are cash equivalents as per AS 3?

They are short-term, highly liquid investments that can be readily converted into known amounts of cash and carry an insignificant risk of change in value. They are held to meet short-term cash commitments rather than for investment. A maturity of three months or less from acquisition is the usual test.

What is the difference between cash and cash equivalents under AS 3?

Cash means cash in hand and demand deposits with banks. Cash equivalents are short-term liquid investments such as short-dated treasury bills or short-term deposits. The cash flow statement explains changes in both together.

Is a fixed deposit always a cash equivalent?

No. It qualifies only if its original maturity is short, about three months or less, and it is held for short-term commitments. A longer-term fixed deposit is an investment.

What are the three categories of activities in a cash flow statement?

Operating activities are the principal revenue-producing activities. Investing activities relate to long-term assets and investments not in cash equivalents. Financing activities change owners' capital and borrowings.