Non-cash investing and financing activity transactions should be disclosed in a note to the financial statements, in order to provide all of the relevant information about these investing and financing transactions. Examples of non-cash transactions are the acquisition of assets, either by assuming directly related liabilities or entering into a lease, or the acquisition of an entity by issuing equity instruments.
Items recognized in other comprehensive income Question: How are items that are recognized in other comprehensive income reflected in the cash flow statement?
Answer: Items recognized in other comprehensive income that do not give rise to any cash flows should be excluded from the cash flow statement.
For example, all exchange differences arising on translation of foreign operations will have been recognized in other comprehensive income. Such exchange differences have no cash flow effect and they will not be included in the consolidated cash flow statement.
Disclosure of refinancing of existing borrowings Question: How and where should a refinancing of existing borrowings be disclosed in the cash flow statement?
Answer: The disclosure of a refinancing would depend on whether the renegotiation gives rise to any cash flows. A renegotiation undertaken with the same bank is unlikely to involve cash flows, and there would be no impact on the cash flow statement.
A refinancing carried out with a different bank, such that the new loan proceeds are used to settle all or part of the old short-term borrowing, will result in a cash inflow and outflow.
The new loan would be shown as a financing activity cash inflow, and the settlement of the short-term borrowing would be shown as a financing activity cash outflow.
It is possible that cash flows have occurred, even if the refinancing is carried out with the same bank. This might be the case if the old loans have been repaid and new loans have been drawn.
If actual cash flows have occurred, these are reflected in the cash flow statement, even where the refinancing is accounted for as a modification of an existing debt.
Entities should disclose the changes in liabilities that arise from financing activities, including both financing cash flows and non-cash changes. Liabilities that arise from financing activities are those for which cash flows were, or future cash flows will be, classified in the cash flow statement as cash flows from financing activities. Examples of non-cash changes include:
These disclosure requirements also apply to changes in financial assets if cash flows from those financial assets were, or will be, included in cash flows from financing activities.
Changes in liabilities arising from financing activities Question: What items are included in the disclosures for changes in liabilities arising from financing activities?
Answer: The requirements are for disclosure of the changes in liabilities that arise from financing activities. This is not limited to disclosures about changes in debt balances, but includes any balances for which cash flows are, or will be, classified as financing cash flows in the cash flow statement.
Examples of such balances would include:
- long-term debt;
- short-term debt;
- lease liabilities; and
- derivatives held to hedge long-term debt (including those in asset positions as at the balance sheet date).
Changes in other items are included where an entity considers that such disclosures would meet the disclosure objective.
For example, an entity might consider including changes in cash and cash equivalents, pension liabilities and interest payments that are classified as operating activities in the cash flow statement.
Any such disclosure should be clearly distinguished from the disclosure of changes in liabilities arising from financing activities.
Format for changes in liabilities arising from financing activities Question: Is a specific disclosure format required?
Answer: No. IAS 7 suggests that a reconciliation between the opening and closing balances in the balance sheet for liabilities arising from financing activities would meet the disclosure requirement, but a specific format is not mandated.
However, where a reconciliation is used, the disclosure should provide sufficient information to link items included in the reconciliation to the balance sheet and cash flow statement.
Meeting the disclosure objective Question: The disclosure objective in the standard requires that an entity provide disclosures that enables users of financial statements to evaluate changes in liabilities arising from financing activities.
How might users evaluate changes in liabilities that arise from financing activities?
Answer: The IFRS IC observed in an agenda decision in September 2019 that entities should report information that is sufficiently disaggregated to meet the disclosure objectives of the standard, For example, items that are of a different nature or individually material should not be aggregated together.
The IC also observed that an entity should explain movement in the gross amount of liabilities from financing activities, and not a measure of “net debt”.
In assessing whether sufficient information has been disclosed in respect of changes in liabilities that arise from financing activities, an entity should consider the users’ information needs.
The IC observed that investors and other users of financial statements may use information about cash and non-cash changes in financing activities to:
- check their understanding of the entity’s cash flows and use that understanding to improve their confidence in forecasting the entity’s future cash flows;
- provide information about the entity’s sources of finance and how those sources have been used over time; and
- help them understand the entity’s exposure to risks associated with financing.
These disclosures could be presented as a reconciliation between the opening and closing balances in the balance sheet for liabilities that arise from financing activities. Sufficient information should be provided in the reconciliation to enable users to link the items included in the reconciliation to the balance sheet and the cash flow statement.
Where significant amounts of cash and cash equivalent balances are not available for use by the group, disclosure is required of the relevant amounts, along with a commentary on their restriction. Sometimes, cash might be held by subsidiaries operating in countries where exchange control restrictions are in force, such that the cash is not freely transferable around the group.
Classification of restricted funds Question: Should restricted funds be classified in the cash flow statement as part of cash and cash equivalents?
Answer: Management should consider whether the restricted funds meet the definition of ‘cash and cash equivalents’ or whether the funds are restricted in a manner such that the definition is not met. This is to ensure that only those items that are available to meet short-term cash commitments are classified as cash or cash equivalents.
The economic substance of the restrictions should be assessed in each case. Deposits that are available for use in the short term, albeit with some restrictions over their use, might still be classified as cash and cash equivalents. This will depend on the specific facts of the restrictions.
Funds that do not meet the criteria to be classified as cash and cash equivalents should not be presented as part of cash or cash equivalents.
Management should assess whether these funds should be presented in a separate line item in the balance sheet, based on IAS 1’s requirements, and should clearly distinguish restricted funds from cash and cash equivalents.
If the funds meet the criteria to be classified as cash and cash equivalents but the use of the funds is subject to restrictions, disclosure is required of the relevant amounts, along with a commentary on their restrictions.
Example of restricted funds: account requiring a third-party signature A deposit is held in an escrow account that requires two signatures to access it, one of which is from a third party. This restriction is so severe that the deposit is unlikely to meet the definition of cash and cash equivalents. It is excluded from cash and cash equivalents in the balance sheet, and it is not shown as cash and cash equivalents within the cash flow statement.
Example of restricted funds: cash restricted for use within subsidiary’s business A property group has secured finance from its bankers for use within a subsidiary entity that is undertaking a construction project. The funds are available, on demand, for use by the subsidiary and used to meet its ongoing expenditure.
The funds cannot be transferred to other parts of the group. The restriction applies to use of the cash within the wider group, but the cash is available on demand and freely available for use within the subsidiary.
The balance can be included within cash and cash equivalents in the consolidated cash flow statement, with the restriction disclosed.
Example of restricted funds: government power to restrict remittance of cash A subsidiary holds deposits with domestic banks. It operates in a country where the government restricts the remittance of cash abroad to fellow subsidiaries and to the parent.
This restriction is unlikely to preclude the classification of the subsidiary’s deposits as cash and cash equivalents in the consolidated financial statements, but disclosure of the restriction would be required.
Example of restricted funds: blocked accounts A property entity secured development finance of C10 million from its bankers during the year ended 31 December 20X6. The funds are held in a special blocked account, to be used only for capital payments on the specific development.
Development on the property commenced during the year and, by the end of its financial year, the entity had expended C2 million. At 31 December 20X6, there was a balance of C8 million in the blocked account.
The classification of the C8 million would depend on the restrictions.
For example, it might be appropriate to classify the balance as cash and cash equivalents, with a clear explanation of the restriction, if the property entity only needs to provide evidence of relevant expenditure to withdraw the funds and the approval process is perfunctory.
But it might not be appropriate to present the balance as cash and cash equivalents if the approval is not perfunctory or there are other requirements including, for example, budgets or maximum expenditure within a specified period.
Classification of restricted funds that are not cash and cash equivalents Question: How should restricted funds that do not meet the definition of ‘cash and cash equivalents’ be classified in the cash flow statement?
Answer: Changes to funds that do not meet the definition of ‘cash and cash equivalents’ (such as restricted cash accounts) generally meet the definition of an investing activity, because they relate to the acquisition or disposal of assets other than cash equivalents or financial instruments held for trading.
However, there might be circumstances where classification within investing activities does not reflect the nature of the transaction, and classification within operating or financing might be more appropriate.
For example, consider an entity that receives an advance payment from a customer for goods and services to be delivered in the future. The customer specifies that the funds should be segregated into a restricted account until the goods and services have been delivered.
The restricted cash is released to the entity’s general cash funds when the goods and services have been delivered. The restricted funds are associated with pre-paid or deferred revenue, and they directly affect the entity’s operations.
Once the entity performs its services or delivers the goods to the customer, the funds are no longer restricted, and it might be appropriate to classify the cash inflow as an operating activity in the cash flow statement.
Another example is an entity that obtains financing of C10 million for a property development from a bank. The proceeds are deposited in a restricted account at the bank.
The funds have been classified as restricted cash, and not cash and cash equivalents, because the bank should approve withdrawals and that approval is not perfunctory. There is no cash inflow or outflow.
If material, the non-cash transaction is disclosed. If the bank were to release the restrictions on the account, the entity would have an increase in cash and cash equivalents and a financing cash inflow.
If the funds in the restricted account were classified as cash and cash equivalents, a financing cash inflow of C10 million and a corresponding change to the closing balance of cash and cash equivalents are recorded when the proceeds are deposited.
Management should apply this judgement consistently and ensure clear disclosure of material items.
Entities are encouraged to disclose the amount of any undrawn borrowing facilities to users (For example, undrawn loan facility agreed with the bank). Disclosure of any restrictions on the use of these facilities by the entity is also encouraged.
The standard encourages but does not require, entities to give separate disclosures of those cash flows that represent maintaining the entity’s operating capacity and those that represent an increase in the entity’s operating capacity.
Disclosure of maintenance expenditures Question: What are cash flows that represent maintaining operating capacity and those that represent an increase in the entity’s operating capacity?
Answer: IAS 7 does not define these concepts. Routine replacement of plant and machinery for normal wear and tear might be considered to be the maintenance of operating capacity, whereas investing in new products and services could be viewed as increasing operating capacity.
In practice, there is no clear distinction between these two types of capital expenditure, and the criteria used might also differ from entity to entity. This disclosure is often given, in practice, as part of a management commentary.
IAS 7 suggests that cash flows should also be reported on a segment basis, with operating, financing and investing activities disclosed for each reportable segment. This enables users to understand the relationship between the cash flows of the business as a whole and those of its parts.
Disclosures of segmental cash flows Question: What components of segmental cash flows should be disclosed?
Answer: IAS 7 does not specifically identify the type of segmental cash flow information to be reported, but an entity should consider including the most important elements of operating cash flows between the major reportable segments.
There might be questions regarding allocations, such as for common costs and interest, but they could be allocated between segments in the same way as other segmental information.
Disclosure of inter-segment cash flows Question: How should inter-company and inter-segment cash flows be presented when disclosing segmental cash flows?
Answer: Entities or groups might operate using a cash-pooling system or intercompany accounts to manage cash flows within the business. Consideration should be given to the appropriate classification and treatment of these items for each segment.
An appropriate approach would be to present the information for each segment as though that segment had prepared a full cash flow statement in compliance with IAS 7.
This would involve considering whether cash in the cash pool met the definition of ‘cash and cash equivalents’, from the perspective of each segment on a stand-alone basis. It might be necessary to present a column for inter-company eliminations and other adjustments, to reconcile the segmentalized information to the primary statements.
In addition to the specific disclosures identified above, the standard encourages reporting entities to provide any additional information that will aid users in understanding the entity’s financial position and liquidity.
Supplementary disclosures: additional information Question: What additional cash flow information might an entity consider providing to enhance the understanding of its financial position and liquidity?
Answer: Entities commonly provide a reconciliation of cash and cash equivalents to net debt, to provide useful information about changes in liquidity on a broader basis than that provided solely by the movement in cash and cash equivalent balances.
A net debt reconciliation shows the changes in cash and cash equivalents for the period and reconciles this through to the change in net debt.
This shows whether an entity with a significant increase in cash achieved this only by taking on a corresponding increase in debt. It can also highlight debt acquired or disposed of in business combinations, as well as foreign exchange movements arising on debt.
However, IFRS does not define ‘net debt’; entities presenting a net debt measure should define what they consider to be ‘net debt’ or ‘net funds.
For annual periods beginning on or after 1 January 2017, entities are required to disclose changes in liabilities arising from financing activities and might conclude that a separate measure of net debt is no longer relevant to an understanding of the entity’s financial performance.
If an entity determines it is appropriate to continue to show a net debt measure in addition to changes in liabilities arising from financing activities, they should continue to define what they consider to be ‘net debt’ or ‘net funds.
Other useful information might include changes in net working capital or ‘free cash flow’, as defined and disclosed by management. Many entities might choose to give this information, along with other encouraged disclosures, as part of a management commentary outside the financial statements.
Some entities also disclose ‘cash flow per share’, as defined and disclosed by management, as part of a management commentary.
Some might argue that cash flow per share disclosure should not be given, on the basis that it could be regarded as comparable to (or as a substitute for) earnings per share.
However, there is no such prohibition in IAS 7. Cash flow per share information presented over time would reveal trends in cash flows and, when compared to earnings per share, would demonstrate the quality of profits earned.
Supplementary disclosures: net debt reconciliation Question: If an entity provides a net debt reconciliation or similar disclosure in the financial statements, where could it be disclosed?
Answer: A net debt reconciliation could be given either on the face of the cash flow statement (but clearly labelled and kept separate, to reflect the fact that it is not part of the cash flow statement) or in the notes to the financial statements.
There is nothing in IAS 7 to suggest that information cannot be shown on the face of the cash flow statement. The views of local regulators should be taken into account when presenting a net debt reconciliation in the financial statements.