IAS 7, or International Accounting Standard 7, is a standard that deals with the presentation of cash flow statements. The main objective of IAS 7 is to require companies to provide information about their cash flows during a given period.
Under IAS 7, companies are required to prepare a statement of cash flows that reports the cash inflows and outflows during the period. The statement of cash flows is divided into three sections:
- Operating Activities: This section reports the cash flows from the company’s primary operations. This includes cash receipts from customers and cash payments to suppliers and employees.
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The operating activities section of the statement of cash flows can be prepared using either the direct method or the indirect method. Here are the steps involved in preparing the operating activities section using the indirect method:
- Start with Net Profit or Loss: Begin with the company’s net profit or loss for the period, as reported in the income statement.
- Adjustments for Non-Cash Items: Make adjustments to the net profit or loss for non-cash items that have been included in the income statement. Examples of non-cash items include depreciation and amortization expenses, deferred taxes, and gains or losses on the disposal of assets.
- Adjustments for Changes in Working Capital: Make adjustments for changes in working capital accounts, including accounts receivable, accounts payable, inventory, and prepaid expenses. For example, if accounts receivable increased during the period, this represents a decrease in cash inflows, and should be subtracted from net profit or loss.
- Adjustments for Other Items: Make adjustments for any other items that affected cash flows from operating activities during the period, such as changes in accrued expenses, deferred revenue, or other non-operating items.
- Calculate Cash Flows from Operating Activities: Sum up the adjustments to net profit or loss to arrive at the cash flows from operating activities for the period.
The indirect method of preparing the operating activities section of the statement of cash flows is more commonly used than the direct method, as it is generally easier to prepare and provides a more detailed explanation of the sources and uses of cash during the period.
- Investing Activities: This section reports the cash flows from the company’s investments. This includes cash inflows from the sale of assets and cash outflows for the purchase of new assets.
- Financing Activities: This section reports the cash flows from the company’s financing activities. This includes cash inflows from the sale of stock or issuance of debt and cash outflows for the payment of dividends or the repayment of debt.
In addition to the statement of cash flows, companies are also required to provide a reconciliation of their net profit or loss to their cash flows from operating activities. This helps investors and stakeholders understand the relationship between the company’s net profit or loss and its cash flows.
Overall, IAS 7 helps to provide investors and stakeholders with important information about a company’s cash flows, which is critical to understanding a company’s financial health and future prospects.