Classification of cash flows

Classification of cash flows – IAS 7 10 requires an entity to analyse its cash inflows and outflows into three categories:

Operating activities

It is often assumed that this category includes only those cash flows that arise from an entity’s principal revenue producing activities.

However, because cash flows arising from operating activities represents a residual category, which includes any cash flows that do not qualify to be recorded within either investing or financing activities, these can include cash flows that may initially not appear to be ‘operating’ in nature (e.g. cash inflows from other revenue sources that are not from the sale of goods or rendering of services, such as proceeds from an insurance claim).Classification of cash flows

Investing activities

An entity’s investing activities typically include the purchase and disposal of its intangible assets, property, plant and equipment, and interests in other entities that are not held for trading purposes. However, cash flows from investing activities do not include those arising from changes in ownership interest of subsidiaries that do not result in a change in control, which are classified as arising from financing activities.

It should be noted that cash flows related to the sale of leased assets (when the entity is the lessor) are classified in operating activities in accordance with IAS 7.14.

Investing activities also include cash inflows and outflows associated with the draw down and repayment of inter-company and other loans (provided the entity’s principal activities do not include the lending of funds). One common example in practice is funds that are advanced to, and related repayments from, related parties.

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Financing activities

An entity’s financing activities typically include the following:

  • The issue and repurchase by an entity of its own share capital
  • Distributions (dividends) paid to equity shareholders (note that IAS 7 contains an option for the classification of these distributions – see below)
  • The drawdown and repayment of borrowings from third parties Classification of cash flows
  • Any other cash flows related to items classified in equity. Classification of cash flows

Classification of interest and dividends

IAS 7 31 requires cash flows from interest and dividends received and paid to be disclosed separately, and permits each of them to be classified within either operating, financing, or investing activities. The classification chosen must be applied consistently from period to period. Classification of cash flows

However, it is also necessary to consider other requirements of IAS 7. In particular, if borrowing costs are capitalised to ‘qualifying assets’ in accordance with IAS 23 Borrowing Costs, the related cash flows will be classified within investing activities. Classification of cash flows

In practice, some regulators require consistent classification between interest paid and interest received, particularly when an entity classifies interest received as an operating activity (i.e. financial institutions). Similar regulatory requirements have also been seen in some jurisdictions in respect of the presentation of cash flows relating to dividends paid and received.

IAS 7 33 Interest paid and interest and dividends received are usually classified as operating cash flows for a financial institution. However, there is no consensus on the classification of these cash flows for other entities. Interest paid and interest and dividends received may be classified as operating cash flows because they enter into the determination of profit or loss. Alternatively, interest paid and interest and dividends received may be classified as financing cash flows and investing cash flows respectively, because they are costs of obtaining financial resources or returns on investments. Classification of cash flows

IAS 7 34 Dividends paid may be classified as a financing cash flow because they are a cost of obtaining financial resources. Alternatively, dividends paid may be classified as a component of cash flows from operating activities in order to assist users to determine the ability of an entity to pay dividends out of operating cash flows.

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Classification of cash flows

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