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IAS 7 – STATEMENT OF
CASH FLOWS
BY SABI AKTHER 1
 What to focus on?

• Exam focus

• Classification of cash flows

• Proforma

• Cash and cash equivalents

• Preparation of a consolidated statement of cash flows

• Foreign exchange and cash flow statements

• Other issues
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 Exam Focus

• Question 1 in the SBR exam will always test consolidated financial statements. This might
include consolidated statements of cash flows.

• The exam will not ask for the production of a full consolidated statement. Instead, candidates
will be required to produce extracts from these statements and to explain the accounting
numbers that they have produced.

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 Classification of Cash Flows

Cash flows are classified under one of three headings:

• cash flows from operating activities, defined as the entity’s principal revenue earning activities
and other activities that do not fall under the next two headings

• cash flows from investing activities, defined as the acquisition and disposal of long-term assets
and other investments (excluding cash equivalents)

• cash flows from financing activities, defined as activities that change the size and composition
of the entity’s equity and borrowings.

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 Classification of Cash Flows

Cash flows from operating activities

The key figure within cash flows from operating activities is 'cash generated from operations'.
There are two methods of calculating cash generated from operations:

• The direct method shows operating cash receipts and payments, such as cash receipts from
customers, cash payments to suppliers and cash payments to and on behalf of employees.

• The indirect method starts with profit before tax and adjusts it for non-cash charges and credits,
deferrals or accruals of past or future operating cash receipts and payments, as well as for items
that relate to investing and financing activities.
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 Classification of Cash Flows

Cash flows from operating activities

• The indirect method the most frequently occurring adjustments required are:

• finance costs and investment incomes

• depreciation or amortisation charges in the year

• impairment charged to profit or loss in the year

• profit or loss on disposal of non-current assets

• change in inventories

• change in trade receivables

Cash flows from investing activities

• cash paid for property, plant and equipment and other non-current assets

• cash received on the sale of property, plant and equipment and other noncurrent assets

• cash paid for investments in, or loans to, other entities (excluding movements on loans from
financial institutions, which are shown under financing)

• cash received for the sale of investments or the repayment of loans to other entities (again
excluding loans from financial institutions).
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 Classification of Cash Flows
Cash flows from financing activities

Financing cash flows mainly comprise receipts or repayments of principal from or to external providers
of finance.

Financing cash inflows include:

• receipts from issuing shares or other equity instruments

• receipts from issuing debentures, loans, notes and bonds and from other long-term and short-term
borrowings (other than overdrafts, which are normally included in cash and cash equivalents).

IAS 7 says that financing cash outflows include:

• repayments of amounts borrowed (other than overdrafts)

• the capital element of lease payments 9

Interest and dividends

IAS 7 allows interest and dividends, whether received or paid, to be classified under any of the
three headings, provided the classification is consistent from period to period.

The practice adopted in this text is to classify:

• interest received as a cash flow from investing activities

• interest paid as a cash flow from operating activities

• dividends received as a cash flow from investing activities

• dividends paid as a cash flow from financing activities. 10

• The statement of cash flows reconciles cash and cash equivalents at the start of the reporting
period to the end of the reporting period.

• Cash equivalents are 'short-term, highly liquid investments that are readily convertible to
known amounts of cash and are subject to an insignificant risk of changes in value'

• IAS 7 does not define 'readily convertible' but notes that an investment would qualify as a cash
equivalent if it had a short maturity of 'three months or less from the date of acquisition'

• Equity investments are generally excluded from being included in cash equivalents because
there is a significant risk of a change in value. IAS 7 makes an exception for preference shares
with a short period to maturity and a specified redemption date. 14
Preparation of consolidated statement of
cash flows

• A consolidated statement of cash flows shows the cash flows between a group and third parties.
It is prepared using the consolidated statement of financial position and the consolidated
statement of profit or loss. This means that intragroup transactions have already been eliminated.

• When producing a consolidated statement of cash flows, there are three extra elements that need
to be considered:

• Acquisitions and disposals of subsidiaries

• Cash paid to non-controlling interests

• Associates
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Preparation of consolidated statement of
cash flows

Acquisitions of subsidiaries

• In the statement of cash flows we must record the actual cash flow for the purchase of the
subsidiary net of any cash held by the subsidiary that is now controlled by the group.

• The assets and liabilities of the acquired subsidiary must be dealt with in your workings when
calculating the cash movement for an item during the year

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Preparation of consolidated statement of
cash flows

Disposals of subsidiaries

• The statement of cash flows will show the cash received from the sale of the subsidiary, net of
any cash held by the subsidiary that the group has lost control over.

• The assets and liabilities of the disposed subsidiary must be dealt with in your workings when
calculating the cash movement for an item during the year.

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Preparation of consolidated statement of
cash flows

Cash paid to non-controlling interests

• When a subsidiary that is not wholly owned pays a dividend, some of that dividend is paid
outside of the group to the non-controlling interest. Dividends paid to non-controlling interests
should be disclosed separately in the statement of cash flows.

• To calculate the dividend paid, reconcile the non-controlling interest in the statement of financial
position from the opening to the closing balance. You can use a T-account or a schedule to do
this.
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Preparation of consolidated statement of
cash flows
Associates

• An associate is a company over which an investor has significant influence. Associates are not part of the
group and therefore cash flows between the group and the associate must be reported in the statement of
cash flows.

• Cash flows relating to associates that need to be separately reported within the statement of cash flows
are as follows:

• dividends received from an associate

• loans made to associates

• cash payments to acquire associates

• cash receipts from the sale of associates. 19

• These cash flows should be presented as cash flows from investing activities.
Preparation of consolidated statement of
cash flows

Associates

• Remember, associates are accounted for using the equity method. This means that, in the
consolidated statement of profit or loss, the group records its share of the associate's profit for
the year. This is a non-cash income and so must be deducted in the reconciliation between profit
before tax and cash generated from operations.

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Foreign exchange & cash flow statements

Exchange gains and losses

• The values of assets and liabilities denominated in an overseas currency will increase or
decrease partly due to movements in exchange rates. These movements must be factored into
your workings in order to determine the actual cash payments and receipts during the year.

Overseas cash balances

• If cash balances are partly denominated in a foreign currency, the effect of exchange rate
movements must be reported in the statement of cash flows in order to reconcile the cash
balances at the beginning and end of the period
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 Other issues

Direct and indirect method

• Allowing entities to choose between using the direct or indirect method of presenting cash
generated from operations limits comparability.

• Many users of the financial statements will not understand the adjustments made to profit when
cash generated from operations is presented using the indirect method.

Disclosures

• Current cash flow disclosures are deemed to be inadequate. In particular, there is a lack of
disclosure about restrictions on an entity’s ability to use its cash and cash equivalents
(particularly if located overseas) and whether other sources of finance would be more
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economical
 Other issues
Lack of guidance and disagreements

• IAS 7 allows dividends and interest paid to be presented as cash flows from either operating or
financing activities. This limits comparability between companies.

• Entities may classify cash flows related to the same transaction in different ways (a loan
repayment might be split between interest paid within operating activities and the repayment of
the principal in financing activities). This could hinder user understanding.

• There are disagreements about the presentation of payments related to leases. Some argue that
they should be classified as a financing activity, whereas others argue that they are a form of
investment activity.

• Expenditure on research is classified as an operating activity. Some argue that this should be
included within investing activities, because it relates to items that are intended to generate
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future income and cash flows.

1) Objective of statement of cash flows

• To provide information on changes in cash & cash equivalents

• To enable users to assess the liquidity, solvency & financial adaptability of a business

2) Classification of cash flows

• Operating activities

• Investing activities

• Financing activities

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 Summary
3) Preparation of group statement of cash flows

• Cash paid to NCI

• Associates

• Acquisition & disposal of subsidiaries/associates

4) Foreign currency transactions

• Exchange gains must be taken into account

5) Evaluation of statements of cash flows

• Provides information not available in the statement of financial position & the statement of
profit or loss
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• Shows relationship between profitability & cash generating ability
Thank You for Watching!!

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