IAS 7

Statement of Cash Flows

1Objective and scope

IAS 7 requires information about historical changes in an entity's cash and cash equivalents through a statement of cash flows, classifying cash flows during the period into operating, investing and financing activities. It applies to all entities, since cash flow information is relevant regardless of the nature of the entity's activities.

2Key definitions

Cash equivalents

Short-term, highly liquid investments readily convertible to known amounts of cash and subject to an insignificant risk of changes in value; ordinarily only investments with a maturity of three months or less from the date of acquisition qualify.

Operating activities

The principal revenue-producing activities of the entity and other activities that are not investing or financing.

Investing activities

The acquisition and disposal of long-term assets and other investments not included in cash equivalents.

Financing activities

Activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.

3Preparing the statement

Operating activities

Operating cash flows may be reported using the direct method (major classes of gross cash receipts and payments) or the indirect method (adjusting profit or loss for the effects of non-cash items such as depreciation, provisions, and deferred tax, and for changes in working capital). IAS 7 encourages the direct method but the indirect method is used almost universally in practice, and is the method examined most heavily.

Indirect method reconciliation, starting point
Profit before tax
+ Depreciation and amortisation (non-cash)
+/- Loss/(gain) on disposal of non-current assets
+/- Finance costs and investment income (reclassified below)
+/- Decrease/(increase) in inventories and receivables
+/- Increase/(decrease) in payables
= Cash generated from operations
- Interest paid, tax paid
= Net cash from operating activities

Classifying interest, dividends and tax

Interest and dividends paid may be classified as operating (because they enter the determination of profit or loss) or as financing (because they are the cost of obtaining finance) - the choice must be consistent from period to period. Interest and dividends received may be classified as operating or as investing. For financial institutions, interest paid and received and dividends received are usually classified as operating. Cash flows from taxes on income are usually classified as operating, unless specifically attributable to financing or investing activities.

4Presentation and disclosure

The components of cash and cash equivalents, and a reconciliation of the amounts in the statement to the equivalent items reported in the statement of financial position
Significant cash and cash equivalent balances held that are not available for use by the group, with commentary
Investing and financing transactions that do not require the use of cash (e.g. acquiring an asset by finance lease, converting debt to equity) are excluded from the statement of cash flows but disclosed elsewhere so as not to be lost

5Examinable focus

What KASNEB tests

Preparing a full statement of cash flows by the indirect method from two years of statements of financial position and one year's statement of profit or loss is one of the most consistently examined numerical questions across KASNEB's financial reporting papers. Watch for disposal proceeds and gains/losses on disposal (add back the loss, deduct the gain, then show the actual proceeds under investing), and for the treatment of a bank overdraft repayable on demand as part of cash and cash equivalents.