Application of IAS 7 - Statement of Cash Flows
Introduction
IAS 7, "Statement of Cash Flows," is an accounting standard that requires entities to
provide information about their cash flow movements during a financial period. The
purpose is to assist users of financial statements in assessing the entity's ability to
generate cash and cash equivalents, its liquidity, and its financial flexibility. This
report provides an overview of IAS 7's requirements, practical applications, and
examples to illustrate its use in financial reporting.
Objective of IAS 7
The primary objective of IAS 7 is to ensure that financial statements include
relevant information about the cash flows of an entity over a period, enabling users
to evaluate the company’s liquidity, solvency, and financial adaptability. Cash flows
are classified into three main activities: operating, investing, and financing
activities.
Key Definitions
Cash: Cash on hand and demand deposits.
Cash Equivalents: Short-term, highly liquid investments that are readily
convertible to cash and subject to an insignificant risk of changes in value.
Cash Flow Classifications under IAS 7
IAS 7 classifies cash flows into three categories:
1. Operating Activities: The principal revenue-generating activities of the
entity.
2. Investing Activities: The acquisition and disposal of long-term assets and
other investments not included in cash equivalents.
3. Financing Activities: Activities that result in changes in the size and
composition of the equity and borrowings of the entity.
Breakdown of Cash Flow Activities
1. Operating Activities
Operating activities refer to the core business activities that generate revenue.
Examples include:
Cash receipts from sales of goods or services.
Cash payments to suppliers for goods and services.
Cash payments to employees.
IAS 7 allows two methods to present cash flows from operating activities:
Direct Method: Shows major classes of gross cash receipts and payments.
Indirect Method: Adjusts profit or loss for non-cash transactions, deferrals,
or accruals of past or future operating cash receipts and payments.
Example of Operating Activities (Indirect Method):
A company reports a net profit of $200,000. Adjustments for non-cash items include
depreciation ($50,000) and an increase in accounts receivable ($10,000). Cash flow
from operating activities would be calculated as:
Net profit: $200,000
Add: Depreciation: $50,000
Less: Increase in Accounts Receivable: -$10,000
Cash Flow from Operating Activities: $240,000
2. Investing Activities
Investing activities include transactions related to the acquisition and disposal of
long-term assets. These activities typically involve:
Purchase or sale of property, plant, and equipment.
Purchase or sale of equity or debt instruments.
Loans made to other entities.
3. Financing Activities
Financing activities relate to transactions that affect the equity and debt structure
of the entity. Examples include:
Issuing shares.
Borrowing funds.
Repaying loans.
Payment of dividends.
