Common cash flow classification errors in practice in 1 way

Common cash flow classification errors in practice – Although the definitions of operating activities, financing activities and investing activities may appear straightforward, in practice a number of classification errors are frequently made. These include: Common cash flow classification errors in practice

1. Cash outflows related to the acquisition of intangible assets and items of property, plant and equipment incorrectly included within operating activities.

Some items of property, plant and equipment are purchased from suppliers on standard credit terms that are similar to those for Milestone methodinventory and for amounts payable to other creditors. Because of this, the transactions for property, plant and equipment may incorrectly be included within changes in accounts payable for operating items. Consequently, unless payments for property, plant and equipment are separated from other payments related to operating activities, they may be allocated to the incorrectly to operating activities.

2. Cash inflows and outflows related to deposits held by financial institutions, or the purchase of short term investments, included within operating activities

Surplus funds are sometimes used to purchase investments with short-to-medium term maturities that do not meet the definition of cash and cash equivalents (e.g. a deposit with a fixed term maturity that is greater than 3 months (IAS 7.7)). Entities sometimes argue that, because these funds are included in their working capital balances (because the funds will be used in the short-to-medium term for operating activities), the cash flows related to these investments should be classified within operating activities.

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This is incorrect.

Common cash flow classification errors in practiceThe entity is acquiring debt instruments of another entity that neither meet the definition of cash and cash equivalents, nor are held for dealing and trading purposes. Consequently, these cash outflows and inflows should be classified as investing (IAS 7.16(c)). Upon maturity of the investment the subsequent use of the funds for operating activities will result in cash flows being included in that category.

In contrast, if an entity holds financial assets that are classified as held for dealing or trading activities (such as cash held by most financial institutions), then cash flows associated with those assets are classified within operating activities. This is because financial assets classified as held for dealing or trading purposes are typically held by an entity in the short-term (a matter of days) for the purposes of short term profits or losses. Consequently, they fall within the entity’s operating activities.

3. Failure to classify cash flows arising from an entity’s principal operating activities as operating

An entity in the financial services sector typically derives operating income from advancing loans to customers in return for future payments of principal and interest. Although IAS 7.31 permits an entity to classify interest cash flows as operating, investing or financing, the requirements of IAS 7.6 (which includes the definition of operating activities) override this option.

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Consequently, cash flows relating to loans advanced to customers by a financial institution are required to be classified as operating activities.

4. Including cash flows in investing activities when they do not result in the recognition of an assetCosts

Some cash outflows relate to items which do not qualify to be recorded as assets (for example, research costs and certain development costs do not qualify to be capitalised as intangible assets in accordance with IAS 38 Intangible Assets). Some argue that such cash outflows should be included within investing activities, because they relate to items which are intended to generate future income and cash flows. Common cash flow classification errors in practice

Prior to 2010, IAS 7 was not specific about this point. However, effective for annual periods commencing on or after 1 January 2010, the 2009 Annual Improvements to IFRSs introduced an amendment to IAS 7 16 which makes it clear that, to be classified as an investing cash outflow, the expenditure must result in an asset being recognised in the statement of financial position (IAS 7.BC7). Common cash flow classification errors in practice

This is particularly relevant for entities operating in the extractives industry which apply IFRS 6 Exploration for and Evaluation of Mineral Resources, as these entities have a (temporary) exemption from applying the requirements of paragraphs 11 and 12 of IAS 8 Accounting policies, Changes in Estimates and Errors when developing an accounting policy in respect of the recognition of exploration and evaluation assets.

If the accounting policy adopted by the entity in accordance with IFRS 6 does not result in the recognition of an asset, then those cash flows do not qualify to be included within investing activities.

5. Cash receipts relating to the leased assets of lessors CLease car IFRS 16 Leasesommon cash flow classification errors in practice

When an entity is the lessor of assets, cash receipts relating to rental income as well as any subsequent sale of the leased assets are classified within operating activities.

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This may seem to contradict the requirement of IAS 7 16(b) which lists cash receipts from sale of assets as investing activities. However IAS 7.15 makes it clear that for lessors, cash flows received from lessees in respect of leased assets are classified in operating activities.

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