This series of blogs describes how SAP Financial Consolidation, Starter Kit for IFRS has been configured to meet International Financial Reporting Standards (IFRS).
Summary of IAS 7 Requirements
According to IAS 7, the statement of cash flows should report cash flows during the period classified by operating, investing and financing activities.
Cash comprises cash on hand and demand deposits. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value (IAS 7.6). Bank overdrafts are included as a component of cash and cash equivalents if they form an integral part of an entity’s cash management.
The components of cash and cash equivalents must be disclosed as well as a reconciliation of the amounts in the statement of cash flows with the equivalent items in the statement of financial position.
Cash flows from operating activities are derived from the principal revenue-producing activities of the entity. They include, for example, cash receipts from the sale of goods or cash payments to employees.
An entity should report cash flows from operating activities using either:
- The direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed
- The indirect method, whereby profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows.
The Board encourages entities to use the direct method (IAS 1.19) but without characterizing it as a preferred solution.
Cash flows from investing activities are those that arise from the acquisition and disposal of long-term assets and other investments not included in cash equivalents.
Financing activities are defined as activities that result in changes in the size and composition of the contributed equity and borrowings of the entity. Cash flows from financing activities comprise, for example, cash proceeds from issuing shares or cash repayments of amounts borrowed.
The cash flows of a foreign subsidiary should be translated at the exchange rates between the functional currency and the foreign currency at the dates of the cash flows. In accordance with IAS 21 it is possible to use a rate that approximates the actual rate (such as an average rate for the period). However, the use of the exchange rate at the end of the period is prohibited.
IAS 7 does not provide the minimum line items that should be included in the statement of cash flows. However, it specifies that the following amounts should be disclosed separately:
- Interests received (to be classified in a consistent manner from period to period as either operating, investing or financing activities)
- Interests paid (operating, investing or financing)
- Dividends received (operating, investing or financing)
- Dividends paid (operating or financing)
- Income taxes paid (to be classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities)
- Cash flows arising from obtaining control of subsidiaries or other businesses (investing activities)
- Cash flows arising from losing control of subsidiaries or other businesses (investing activities)
Cash flows arising from changes in ownership interests in a subsidiary that do not result in a loss of control should be classified as cash flows from financing activities.
Non cash transactions – such as the acquisition of an asset by means of a finance lease or the conversion of debt to equity – should be excluded from the statement of cash flows.
In the starter kit
Even if IAS 7 encourages companies to use the direct method, operating cash flows are presented using indirect method in the starter kit for the following reasons:
- It is the most commonly used presentation by groups that currently apply IFRS;
- Only the indirect method enables automatic calculations of operating cash flows from balance sheet movements in a (relative) simple way.
The statement of cash flows delivered in the starter kit complies with the minimum line items prescribed by IAS 7.
Regarding classification of interests paid and received and dividends paid and received, the options taken in the starter kit are based on an analysis of illustrative financial statements published by audit firms (PricewaterhouseCoopers, Deloitte, Ernst & Young and KPMG):
- Interests paid in operating activities,
- Interests and dividends received in investing activities,
- Dividends paid in financing activities.
The different line items displayed in the statement of cash flows are automatically calculated by consolidation rules using the same principles as with the statement of changes in equity and the statement of other comprehensive income.
Dedicated reports can be used to drill down from consolidated data displayed in the statement of cash flows to the breakdown by original accounts / flows, as illustrated below:
In the next blog, we will focus on the effect of changes in foreign exchange rates (IAS 21).