Statement of Cash Flows (IAS 7 Advanced)

IAS 7 requires a statement of cash flows classified into three activities:

1. Operating activities: Principal revenue-producing activities and other activities that are not investing or financing. Two methods:

• Direct method: Presents major classes of gross cash receipts and payments (preferred but rarely used in practice)
• Indirect method: Starts with profit before tax and adjusts for non-cash items (depreciation, impairment, share of associate profit, etc.), working capital movements, and investing/financing items incorrectly in P/L (e.g., gains on disposal). Most commonly used.

2. Investing activities: Acquisition and disposal of long-term assets and other investments. Includes: purchases/sales of PPE and intangibles, purchases/sales of subsidiaries and investments (NET of cash acquired/disposed), dividends and interest received (classification choice), loans to other parties.

3. Financing activities: Changes in the size and composition of contributed equity and borrowings. Includes: share issues, share buybacks, proceeds/repayment of borrowings, dividends paid (classification choice), payments for lease liabilities.

Presentation choices for interest and dividends:

The key is consistency across periods. Most UK entities present interest paid as financing, dividends paid as financing, interest received as investing, and dividends received as investing.

The indirect method starts with profit before tax (or sometimes operating profit) and reconciles to cash generated from operations. Typical adjustments:

Working capital changes in group FS: When calculating movements in inventory, receivables, and payables, exclude the opening and closing balances of any subsidiary acquired or disposed of during the year. Otherwise the "change" would not reflect underlying trading — it would be contaminated by the acquisition/disposal effect.

Tax paid: Calculated from the tax reconciliation:

Opening tax liability + Tax charge − Tax paid = Closing tax liability
Tax paid = Opening tax liability + Tax charge − Closing tax liability (+/− deferred tax, which is non-cash)

When a subsidiary is acquired during the year, the consolidated SoFP at year-end includes the subsidiary's balances (assets, liabilities, and cash) — but these were not built up through group trading during the year. The cash flow statement must reflect this carefully.

Presentation on the face of the SoCF — Investing activities:

Show a single line: "Acquisition of subsidiary, net of cash acquired" = Cash consideration paid − Cash and cash equivalents in the acquired subsidiary

Example: P pays £500,000 to acquire S. S had £80,000 of cash at acquisition. The net cash outflow shown in investing activities = £500,000 − £80,000 = £420,000 outflow.

Non-cash consideration is NOT shown here — if P also issued shares worth £300,000 or took on S's debt, these are disclosed separately as non-cash transactions (typically in a note) but do NOT appear in the cash flow statement. Only actual cash movements are shown.

Effect on working capital line items:

When calculating working capital movements (for operating activities), adjust for the balances of the subsidiary at acquisition. For example:

• P's opening inventory: £200k
  S's inventory at acquisition: £50k (this came in with the acquisition — not a working capital INCREASE in trading terms)
  Consolidated closing inventory: £280k
  Working capital change (inventory) = £280k − £200k − £50k = £30k increase (deducted from operations)
• Similarly for receivables, payables, provisions.

Disclosures required (IAS 7):

• Total consideration paid (aggregated for all acquisitions in the period)
• Portion paid in cash and cash equivalents
• Cash and cash equivalents of the acquired subsidiaries
• Amount of assets and liabilities other than cash recognised

Similar concept to acquisitions — but in reverse. When a subsidiary is sold during the year:

Presentation on the face of the SoCF — Investing activities:

Show a single line: "Disposal of subsidiary, net of cash disposed" = Cash consideration received − Cash and cash equivalents in the disposed subsidiary

Example: P sells S for £700,000. At the date of disposal, S had £50,000 of cash. The net cash inflow shown in investing activities = £700,000 − £50,000 = £650,000 inflow.

Gain or loss on disposal: The gain/loss on disposal recognised in P/L (calculated using the rules from the "Changes in group structures" topic) is DEDUCTED from profit in the operating activities reconciliation — it is not an operating cash flow.

Adjustments to working capital movements: When the subsidiary is disposed of, its inventory, receivables, payables, etc. leave the consolidated balance sheet. Exclude these outgoing balances when calculating the "trading" working capital movements of the group.

• Example: Opening receivables £500k. S had receivables of £100k at disposal. Closing receivables £420k.
  "Trading" receivables movement = £420k − £500k + £100k = £20k increase (if we consider S's receivables left the group with the disposal, the remaining balance movement is £20k up).

Effect on other cash flow sections:

• Depreciation add-back (in operating activities reconciliation): use total depreciation charged in the consolidated P/L during the year — which already excludes the disposed subsidiary for the post-disposal period. No further adjustment usually needed.
• Tax paid: usually calculated from group's tax accounts. If the disposed subsidiary had tax balances, consider carefully.
• Dividends paid to NCI: include dividends paid by the disposed subsidiary to its NCI shareholders DURING the year (pre-disposal).

Disposal involving retained interest (e.g., subsidiary becomes associate): only the CASH element is shown on the SoCF. Any retained interest at FV is a non-cash element.

Associates are NOT consolidated line-by-line — they appear as a single-line equity method investment. Therefore the group's cash flow statement should NOT include the associate's individual cash flows.

Cash flows involving associates:

Important working capital consideration: If there are intra-group balances with the associate (trade receivables/payables between the group and its associate), these are NOT eliminated in the consolidated SoFP (associates are not consolidated — their individual balances are not in the group FS). So no adjustment is needed for these in working capital movements — they are part of "normal" trading balances.

Illustrative reconciliation adjustment for the associate:

• Profit before tax includes "share of profit of associate" (say £50,000)
• In the operating activities reconciliation, DEDUCT £50,000 (non-cash)
• Separately show "Dividends received from associate" under investing activities (say £20,000) as a cash inflow

When a group has foreign operations, cash flow preparation must address two issues:

Issue 1 — Translating foreign subsidiaries' cash flows:

• Translate at the rate on the date of each cash flow (or an average rate if rates do not fluctuate significantly — usually acceptable for practical reasons)
• Do NOT use the closing rate (which is used for translating the SoFP under IAS 21)
• This is the consistent treatment with P/L items (translated at average/transaction date rate for the P/L under IAS 21)

Issue 2 — Effect of exchange rate changes on cash and cash equivalents held:

• When a foreign subsidiary holds cash, the value of that cash in the presentation currency changes as exchange rates move — without any cash flow occurring
• This "translation adjustment on cash" must be presented SEPARATELY as a reconciling item between opening and closing cash balances
• Typically shown as: "Effect of exchange rate changes on cash and cash equivalents"
• This preserves the integrity of the SoCF total (the three activities) as reflecting actual operating, investing, and financing cash flows

Example layout:

Why this matters: Without this reconciling item, the sum of operating, investing, and financing cash flows would not reconcile opening to closing cash — because some of the change is due to FX translation, not actual cash movements.

From 1 January 2017 (IAS 7 amendment), entities must provide disclosures that enable users to evaluate changes in liabilities arising from financing activities, including both cash flow changes and non-cash changes.

A typical disclosure takes the form of a reconciliation of opening to closing carrying amount of liabilities arising from financing activities (e.g., borrowings, lease liabilities, dividends payable):

Purpose:

• Users can distinguish between actual financing cash flows and non-cash changes (e.g., new leases capitalised under IFRS 16, acquired liabilities on business combinations, foreign exchange retranslation, fair value movements on swap-hedged debt)
• Required disclosure — typically presented as a note to the SoCF
• May cover other items associated with financing activities (e.g., financial assets held for hedging purposes of financing liabilities)

Non-cash investing and financing transactions are excluded from the SoCF (they are not cash flows) but must be disclosed separately in the notes to provide users with a full picture.

Common examples:

• Acquisition of a subsidiary funded by share issue: If P acquires S by issuing 100,000 shares (worth £1m) plus £200k cash, only the £200k cash outflow appears on the SoCF. The share issue is disclosed separately.
• New lease liabilities (IFRS 16): When a lease commences, the lessee recognises both a ROU asset and a lease liability — but no cash moves. The addition is a non-cash transaction. Cash only flows as lease payments are made.
• Conversion of debt to equity: If a convertible bond is converted into shares, the liability reduces and equity increases — no cash flow.
• Revaluation of assets: Gains in OCI — no cash involved.
• Disposal of subsidiary for share consideration: If P sells S and receives shares in the purchaser, the only "cash" element is any cash portion received.
• Deemed acquisitions/disposals where control changes due to share issues/buybacks by the subsidiary — no direct cash flow for the parent.

IAS 7 requirement: Disclose these transactions in a way that provides all the relevant information about the investing/financing activities — typically in a note describing the transaction and its effects.