Overview of IAS 7 Amendments Under IFRS 18
IFRS 18 introduces consequential amendments to IAS 7 Statement of Cash Flows that eliminate classification options for interest and dividend cash flows and standardise the starting point for the indirect method. Under previous IAS 7, entities could choose between operating, investing, or financing classifications for these items, resulting in significantly different presentations for economically similar transactions.
The amendments establish mandatory classifications based on whether an entity has specified main business activities, creating a clear framework that aligns cash flow presentation with an entity's business model and income statement classification.
Key Change
IFRS 18 eliminates the accounting policy choice for classifying interest and dividends in the statement of cash flows for entities without specified main business activities, mandating financing classification for interest paid and dividends paid, and investing classification for interest received and dividends received.
Indirect Method Starting Point
IFRS 18 requires all entities presenting operating cash flows under the indirect method to use the operating profit or loss subtotal as the starting point. This replaces the previous flexibility under IAS 7, which permitted various profit measures.
Entities must adjust operating profit or loss for:
- non-cash items (depreciation, amortisation);
- changes in working capital (inventory, receivables, payables);
- items classified in investing or financing categories; and
- other items whose cash effects are investing or financing cash flows.
This requirement applies universally, creating uniformity across all entities when using the indirect method.
Entities Without Specified Main Business Activities
For entities that do not provide financing to customers or invest in assets as a main business activity, IFRS 18 establishes mandatory classifications that eliminate all previous accounting policy choices.
| Cash Flow Item | Previous IAS 7 | IFRS 18 Requirement |
|---|---|---|
| Interest paid | Operating or financing (choice) | Financing (mandatory) |
| Interest received | Operating or investing (choice) | Investing (mandatory) |
| Dividends received | Operating or investing (choice) | Investing (mandatory) |
| Dividends paid | Operating or financing (choice) | Financing (mandatory) |
Interest paid must be classified as financing, reflecting that for non-financial entities, interest represents the cost of obtaining finance rather than an operating expense.
Interest received must be classified as investing, aligning with the principle that interest typically arises from cash deposits, loans made to others, or debt securities held as investments.
Dividends received must be classified as investing, recognising that dividends represent returns on equity investments.
Dividends paid must be classified as financing, reflecting distributions to providers of equity capital.
These mandatory classifications apply to manufacturing companies, retailers, service providers, and other non-financial businesses.
Definition
Specified main business activities under IFRS 18 include providing financing to customers as a main business activity or investing in assets as a main business activity. These activities are typically characteristic of financial institutions, investment entities, and similar organisations.
Entities With Specified Main Business Activities
Entities that provide financing to customers or invest in assets as a main business activity follow different classification requirements that align cash flow presentation with income statement classification. These entities include banks, insurance companies, and investment funds.
Classification Principle
For interest paid, interest received, and dividends received, these entities classify each item in a single category corresponding to how the related income or expenses are classified in the income statement.
- If classified in one income statement category, classify cash flows in that same category
- If classified in multiple income statement categories, choose an accounting policy to classify cash flows in one of those categories (applied consistently)
Dividends Paid
Dividends paid on equity instruments must be classified as financing, regardless of income statement presentation. If dividends paid relate to instruments classified as financial liabilities, they are treated as interest paid and follow the classification principle above.
Example Application
A commercial bank that classifies all interest income in operating profit would classify all interest received as operating cash flows. An investment entity with dividend income partly in operating profit and partly in investing must choose to classify all dividend receipts in either operating or investing (not split between them).
Practical Examples
Example 1: Manufacturing Company
ABC Manufacturing Ltd does not have specified main business activities. During 2026:
- Interest paid on bank borrowings: £150,000
- Interest received on cash deposits: £8,000
- Dividends received from equity investments: £12,000
- Dividends paid to shareholders: £200,000
Classification under IFRS 18:
- Operating activities: £nil (relating to interest and dividends)
- Investing activities: £20,000 (£8,000 + £12,000)
- Financing activities: £350,000 outflow (£150,000 + £200,000)
Previous IAS 7 (if ABC classified all as operating):
- Operating activities: £370,000 net outflow
- Investing activities: £nil
- Financing activities: £nil
The IFRS 18 classification provides clearer visibility of financing costs and investment returns, separate from operating performance.
Example 2: Retail Bank
XYZ Bank plc provides financing to customers as a main business activity. All interest income and expense are classified in operating profit. During the year:
- Interest paid on customer deposits: £2,500,000
- Interest received on customer loans: £4,200,000
- Dividends received from equity securities (in operating profit): £150,000
- Dividends paid to shareholders: £800,000
Classification under IFRS 18:
- Operating activities: £1,850,000 net inflow (£4,200,000 + £150,000 - £2,500,000)
- Financing activities: £800,000 (dividends paid)
This reflects that interest and dividends from banking operations are integral to operating performance.
Example 3: Investment Entity
Investment Co Ltd invests in assets as a main business activity. Its dividend income is classified partly in operating profit (£400,000) and partly in the investing category (£600,000). Total dividends received: £1,000,000.
Classification under IFRS 18:
Investment Co must choose an accounting policy to classify all £1,000,000 dividends received in either:
- Option 1: All in operating activities, or
- Option 2: All in investing activities
The entity cannot split the £1,000,000 between categories.
Practical Consideration
Entities should review current cash flow classifications before IFRS 18's effective date to identify required changes, assess impacts on cash flow metrics and banking covenants, and update accounting policies, systems, and controls accordingly.
Transition and Implementation
IFRS 18 is effective for annual reporting periods beginning on or after 1 January 2027, with earlier application permitted. Retrospective application is required per IAS 8, meaning comparative information must be restated.
Key implementation steps:
Assessment: Determine whether the entity has specified main business activities. This requires judgement about the significance of financing or investing activities to the business model.
Gap Analysis: Compare current classifications with IFRS 18 requirements. Entities that classified interest paid as operating or dividends received as operating will experience the most significant changes.
System Updates: Modify cash flow reporting systems to reflect new classifications and update the indirect method reconciliation to start from operating profit or loss.
Policy Documentation: For entities with specified main business activities that have classification choices, document selected accounting policies and rationale.
Stakeholder Communication: Communicate changes to investors, lenders, and analysts, particularly if banking covenants reference specific cash flow measures that will be affected.
Conclusion
The IFRS 18 amendments to IAS 7 improve comparability by eliminating classification options for interest and dividend cash flows for most entities and standardising the starting point for the indirect method. Entities without specified main business activities must classify interest and dividends in prescribed categories reflecting their economic substance as financing and investing activities. Entities with specified main business activities retain limited flexibility governed by clear principles tied to income statement presentation.
Preparers should begin implementation planning early to ensure smooth transition, proper system updates, and effective stakeholder communication, as changes will affect financial statement presentation, performance metrics, and potentially debt covenant calculations.
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