IAS 7 Key Components and Disclosure

IAS 7 is a crucial standard for financial reporting, and understanding its key components and disclosure requirements is essential for financial statement preparers and users alike.

The standard requires companies to disclose their cash flows from operating, investing, and financing activities.

Cash flows from operating activities include cash received from customers, cash paid to suppliers, and cash generated from operating assets.

IAS 7 also requires companies to disclose their cash and cash equivalents, as well as their non-cash transactions.

Companies must present their cash flows in a manner that is consistent with their financial statements.

The standard emphasizes the importance of presenting cash flows in a way that is easily understood by users of financial statements.

Cash flows from investing activities include cash spent on property, plant, and equipment, as well as cash received from the sale of investments.

Companies must disclose their cash flows from financing activities, including cash received from borrowing and cash paid to repay debt.

The main objective of IAS 7 is to provide information about the historical changes in cash and cash equivalents of an entity.

IAS 7 classifies cash flows into three main activities: operating, investing, and financing.

Operating Activities are cash flows directly related to the company's principal revenue-generating activities, and they include adjustments for non-cash items such as depreciation and changes in working capital.

Investing Activities include cash flows from purchasing and selling long-term assets, such as property, plant, equipment, and investments.

Financing Activities are cash flows related to changes in the entity's capital structure, such as issuing shares, obtaining loans, repaying debt, and paying dividends.

When preparing a cash flow statement, you have two main options to choose from. Both methods can provide valuable insights into a company's financial health, but they approach it from different angles.

The Direct Method shows actual cash receipts and payments, making it easy to see where the money is coming from and going to.

This method can be especially useful for companies that have a simple financial structure and few non-cash transactions.

The Indirect Method, on the other hand, adjusts net profit or loss for the effects of non-cash transactions, such as depreciation, changes in working capital, and non-operating items.

This method can be more suitable for companies with complex financial structures or many non-cash transactions, as it helps to identify areas where cash flow may be impacted.

Both methods have their own strengths and weaknesses, and the choice ultimately depends on the company's specific needs and circumstances.

Here are the two methods summarized:

Cash Flow Components are the building blocks of a company's cash flow statement.

Cash flows from operating activities include net income, depreciation, and changes in working capital, such as the increase in Accounts Receivable of $5,000 and the decrease in Inventory of $8,000.

The indirect method is used to calculate cash flows from operating activities, starting with net income and adjusting for non-cash items like depreciation and changes in working capital.

Cash flows from investing activities are primarily related to purchasing and selling long-term assets, such as the purchase of equipment worth $20,000.

The company's financing activities involve issuing shares, obtaining or repaying loans, and paying dividends, such as the issuance of new shares worth $50,000 and the loan repayment of $15,000.

Here's a breakdown of the cash flow components:

IAS 7 explains that intragroup transactions are excluded from cash flow statements. This is because they do not affect the company's ability to generate cash.

Companies disclose information about intragroup transactions in the notes to the financial statements. This includes the nature and amount of such transactions.

Intragroup financing is a type of transaction that is also excluded from cash flow statements.

Financing activities can result in changes to an entity's liabilities, and it's essential to understand how to account for these changes.

According to IAS 7.44A-E, a reconciliation is required between the opening and closing balances in the statement of financial position for liabilities arising from financing activities. This reconciliation should include both cash and non-cash changes, such as accrued interest and fluctuations in foreign exchange rates.

Reconciliations can be complex, but they provide valuable insight into an entity's financial position. A comprehensive reconciliation should distinctly outline changes in liabilities resulting from financing activities.

Entities should also consider disclosing the reconciliation of the opening and closing balance of net debt if they choose to disclose it. This can help stakeholders understand the entity's overall financial position and the impact of financing activities on its liabilities.

Here are some key points to remember when reconciling changes in financing liabilities:

Intragroup pooling arrangements can be complex, but they're a common practice among groups. Some groups use central pooling for all cash and cash equivalents, essentially making subsidiaries deposit cash with a parent company or another group entity.

This arrangement must be assessed against IAS 7 criteria, which can be a challenge. Considerations include the terms and conditions of the intragroup arrangement, the group's credit rating, liquidity, and access to external financial resources.

Orange's Polish subsidiary provides an example of how such funds can be classified as cash equivalents. The company's experience shows that it's plausible to treat these balances as cash equivalents under the right circumstances.

Ownership changes in subsidiaries can be complex, but understanding the basics is key to accurate financial reporting.

Transaction costs associated with business combinations should be shown as operating activities, not capitalised and therefore not incorporated in investing activities.

These costs are a normal part of doing business, and shouldn't be treated as a separate investment.

Contingent consideration, recognised at the acquisition date at fair value, is a different story. This is recorded as a debit entry attributed to acquired assets or goodwill.

The value of contingent consideration may fluctuate due to post-acquisition events, such as achieving a specified revenue target.

When paid, contingent consideration should be apportioned between operating and investing activities.

The amount recognised at the acquisition date is reported under investing activities, while the remaining balance is allocated to operating activities.