While IFRS 18 Presentation and Disclosure in Financial Statements primarily replaces IAS 1 to reshape the statement of profit or loss, it also introduces mandatory consequential amendments to IAS 7 Statement of Cash Flows (see IFRS 18 Appendix D – Section IAS 7 Statement of Cash Flows).
Extract from IFRS 18 – Appendix D – Paragraph 10
The statement of cash flows must report cash flows for the period classified as operating, investing and financing activities. In preparing the statement of cash flows, an entity shall apply IAS 7 together with the general requirements for financial statements in paragraphs 9-43 and 113-114 of IFRS 18.
What is the new starting point for the indirect method, and why did the IASB change it?
Before IFRS 18, IAS 7 allowed entities to begin the indirect method with profit before or after tax. Under IFRS 18’s consequential amendments (IAS 7 paragraph 18), the indirect method now requires entities to start with operating profit or loss, adjusted for:
(i) Non‑cash items (e.g., depreciation);
(ii) Deferrals or accruals of past or future operating cash receipts or payments.
Accruals example: BXCo recognises A$50,000 of wage expense in December, reducing operating profit, but pays employees in January. The A$50,000 increase in accrued liabilities is added back to operating profit.
Deferrals example: A customer pays A$10,000 in advance. Cash increases, but revenue is deferred. The A$10,000 increase in unearned revenue is added to operating profit.
(iii) Income or expenses classified as operating in profit or loss where the related cash flows are investing or financing.
Scenario: BXCo’s factory is destroyed and receives an A$250,000 insurance payout. The gain is recognised in operating profit, but the cash inflow is an investing cash flow. The non‑cash gain is removed from operating profit, and the A$250,000 is shown in investing activities.
(iv) Operating cash flows where the related income or expenses are not classified as operating in profit or loss.
Scenario 1: Income taxes: Current tax expense is excluded from operating profit, but tax paid is an operating cash flow. Tax movements cannot be embedded in working capital and net tax paid must be shown directly in operating activities.
Scenario 2: Rental income: A retail entity earns rent from an investment property. Under IFRS 18, rental income is classified in the investing category of profit or loss, but rental cash received remains an operating cash flow. The entity must add the rental cash received to operating cash flows because operating profit excludes it.
How does IFRS 18 eliminate classification choices for interest and dividends?
Before IFRS 18, entities could previously choose to
classify interest and dividends as operating, investing, or financing as an
accounting policy choice (IAS 7.33 prior to amendments).
After IFRS 18, for entities without specified
main business activities, this policy choice is strictly eliminated Interest
and dividends paid are universally Financing, while those received are
universally investing (IAS 7.34A).
Entities that previously classified capitalised interest under IAS 23 as investing cash flows must now classify capitalised interest paid as operating or financing, depending on their financing activities and accounting policy choices.
How do entities with specified main business activities classify these cash flows?
An entity whose main business activities include investing in assets or providing financing to customers must classify dividends received, interest received and interest paid in the statement of cash flows based on how it presents the related income and expenses in the statement of profit or loss. Each type of cash flow must be placed entirely within one category operating, investing or financing in the statement of cash flows.
If an entity presents all dividend income, interest income or interest expenses within a single category of the statement of profit or loss, it must classify the related cash flows dividends received, interest received and interest paid in the same activity category in the statement of cash flows. For example, if all interest expenses are shown within financing in the profit or loss statement, then all interest paid must be shown as financing cash flows.
When applying IFRS 18, an entity may need to present dividend income, interest income and interest expenses across more than one profit or loss category. In that situation, paragraph 34B requires the entity to choose an accounting policy that places the related cash flows dividends received, interest received and interest paid into one of the associated activity categories in the statement of cash flows. For example, if interest expenses appear partly in operating and partly in financing in profit or loss, the entity must classify all interest paid consistently as either operating or financing cash flows. Cash flows from a single item cannot be split across multiple activities in the statement of cash flows.
Dividend paid shall remain under the financing category irrespective of the specified main business activity. Prior to the update, there was an option to classify it as operating or financing depending on the circumstances.
How is the presentation of income tax cash flows affected?
Income tax cash flows must be presented separately and classified as operating cash flows unless they can be clearly linked to investing or financing activities. If tax payments relate to more than one activity, the total amount paid must be disclosed. Entities can no longer embed tax movements within working capital movements because current tax expense is excluded from operating profit. The net income taxes paid must be explicitly presented directly in the operating section.
amr.
Researched and written by Aamir Sheikh
FCCA, CAANZ, MCOM, BSc in Applied Accounting