IAS 7 and IFRS 18: The Structure of the Cash Flow Statement Changes for the First Time in 30 Years
1. Background of the Birth of the Cash Flow Statement
The cash flow statement was not born from the discussions of accounting standards boards. It was born from practical necessity.
In 1863, the managers of the Dowlais Iron Company faced a contradiction. The business was profitable, but there was no cash to invest in new equipment. To explain this situation to stakeholders, they created a report different from the traditional income statement. It was a report that showed not only profit but also "where the cash actually is." Upon investigation, it was discovered that funds were tied up in excess inventory. This simple document is the prototype of today's cash flow statement.
About a century later, in October 1977, the IASC (International Accounting Standards Committee) published the first edition of IAS 7. The title was "Statement of Changes in Financial Position." However, in reality, it hardly functioned. The definition of "funds" was ambiguous, inter-company comparison was impossible, and the statement was treated as an afterthought.
The turning point came in the early 1980s. Corporate debt surged, and companies that were profitable went bankrupt one after another. The gap between net income based on accrual accounting and actual cash-generating ability was no longer just a theoretical problem. Financial statement users began to bypass the official statement and rely on EBITDA as a proxy for operating cash flow.
In response to this situation, the IASC published a significantly revised version of IAS 7 in December 1992 (effective January 1, 1994). "Funds" was replaced with the clear definition of "cash and cash equivalents," and cash flows were required to be classified into three categories: "operating activities," "investing activities," and "financing activities." This structure has governed global cash flow reporting for the past 30 years.
2. Structure of IAS 7: A Map of the Standard
The 1992 structure continued to function for a long time. Subsequent revisions to IAS 7 remained minor. The renaming to "Statement of Cash Flows" in 2007, the addition of disclosure requirements regarding changes in financial liabilities in 2016, and the amendments regarding supplier finance arrangements in 2023—none of these touched the basic structure.
This situation will change in 2027. IFRS 18, published in April 2024, brings structural reform to IAS 7 for the first time in about 30 years. It involves changes to the starting point of the indirect method and the classification of interest and dividend cash flows.
The following is a summary of the current structure of IAS 7 and the areas affected by IFRS 18.
① Basic Principles and Definitions (Paragraphs 1-9)
Scope, significance of cash flow information, definitions of cash, cash equivalents, and the three activity categories
Impact of IFRS 18: None
② Preparation of the Statement (Paragraphs 10-36)
Presentation requirements, direct method/indirect method, foreign currency, interest/dividends, corporate tax
Impact of IFRS 18: Significant
③ Consolidated/Group Cash Flows (Paragraphs 37-42)
Subsidiaries, associates, joint ventures, treatment of changes in equity
Impact of IFRS 18: None
(4) Disclosures (paragraphs 43-53)
Non-cash transactions, reconciliation of liabilities from financing activities, components of cash
Impact of IFRS 18: None
The impact of IFRS 18 is concentrated in (2). The structure of definitions, consolidation provisions, and disclosure requirements remains unchanged.
3. Details of each block
Block (1) Basic Principles and Definitions (paragraphs 1-9)
IAS 7 applies to all entities (regardless of industry or size). The definitions of cash, cash equivalents, and the three activity categories form the foundation for all subsequent provisions.
IFRS 18 does not change these definitions. However, attention must be paid to a significant inconsistency here.
IFRS 18 introduces a new structure for the statement of profit or loss, using the same three labels: "operating," "investing," and "financing." However, the boundaries do not align with IAS 7. The most clear example is the sale of property, plant, and equipment.
Gain or loss on sale (IFRS 18 statement of profit or loss) → Operating category
Cash received from sale (IAS 7 statement of cash flows) → Investing activities
The same transaction falls into different categories depending on which financial statement you are reading. This divergence is not limited to gains or losses on sales. Under the old IAS 7, it was possible to classify interest and dividends as operating activities, but under IFRS 18, the same items are classified as investing or financing activities on the statement of profit or loss.
IFRS 18 classifies by the "nature of profit or loss," while IAS 7 classifies by the "use of cash."
The IASB intentionally left this divergence in place. Practitioners preparing both statements must always be aware of these differences.
Block (2) Preparation of the Statement (paragraphs 10-36)
This is the core of IAS 7 in practice and the block most strongly affected by IFRS 18.
IAS 7 permits two methods for presenting operating cash flows. The direct method lists actual cash receipts and payments. The indirect method starts with the profit figure and adjusts for non-cash items and changes in working capital. Both produce the same result, but the indirect method is the mainstream in practice.
The issue of the starting point, and the solution by IFRS 18
In practice, many companies have used profit before tax or net profit as the starting point. Since IAS 7 did not specify a particular subtotal, the situation where starting points varied among companies continued.
IFRS 18 eliminates this diversity. All companies using the indirect method will be required to use the subtotal of 'operating profit or loss' as defined by IFRS 18 as the starting point.
Interest and dividends: From choice to obligation
Under IAS 7 before IFRS 18, the classification of interest and dividend cash flows was left to the choice of accounting policy. Interest paid could be classified as either operating or financing activities, and the same applied to interest received. This diversity made comparisons between companies difficult.
IFRS 18 eliminates these options for most non-financial companies. For financial institutions, specific classification requirements that reflect the nature of their business will continue to apply.
Mandatory classification for non-financial companies (after IFRS 18 application)
Interest received → Investing activities
Interest paid → Financing activities
Dividends received → Investing activities
Dividends paid → Financing activities
Block 3: Consolidated and group cash flows (paragraphs 37-42)
This block deals with cash flows related to subsidiaries, associates, and joint ventures (including the treatment of changes in equity). The preparation of a consolidated statement of cash flows involves unique complexities related to foreign currency translation and the elimination of intercompany transactions. We plan to cover this in another article in this series.
Block 4: Disclosure (paragraphs 43-53)
The main disclosure requirements are as follows:
Non-cash transactions (such as the conversion of debt to equity) note disclosures
Reconciliation of changes in financial liabilities (added in the 2016 amendment)
Components of cash and cash equivalents and reconciliation with the balance sheet
4. Comparison before and after IFRS 18: Changes in the indirect method
The following shows how the classification of operating activities changes when a non-financial company uses the indirect method.
[Before IFRS 18 Adoption]
税引前当期純利益 X
調整：
減価償却費及び償却費 X
支払利息の戻し入れ X ← 出発点から除くために加算
有形固定資産売却益 (X)
運転資本の変動 ±X
-------
営業活動から生じた現金 X
支払利息（実際の現金支出） (X) ← 実際の支払として再び控除
支払法人税等 (X)
-------
営業活動によるキャッシュ・フロー（純額） XInterest appears twice. It is added back to the starting profit and then deducted as an actual cash outflow. This double-entry is one of the most misunderstood aspects of the indirect method.
[After IFRS 18 Adoption (From 2027 onwards)]
営業利益（IFRS 18の定義による） X
調整：
減価償却費及び償却費 X
有形固定資産売却益 (X)
運転資本の変動 ±X
-------
営業活動から生じた現金 X
支払法人税等 (X)
-------
営業活動によるキャッシュ・フロー（純額） X
財務活動：
支払利息 (X) ← 1回だけ、正しい区分に
支払配当 (X)By definition, operating profit is a figure that does not include interest paid. Therefore, the add-back is no longer necessary. Interest paid moves cleanly into financing activities and appears only once. The structure of the statement becomes simpler, and the logic becomes clearer.
5. What this change really means
This reform looks like a technical adjustment. However, it is more than that.
The process of 'adding back and then deducting' interest was not an intentional design. It was merely a roundabout way to make the numbers reconcile. Because the starting point already included interest paid, it had to be added back before reclassification. As a result, it created a statement that confused even experienced practitioners and a preparation process that introduced unnecessary complexity into accounting systems and mapping settings. (Even the AI made mistakes multiple times while writing this article)
IFRS 18 makes this detour unnecessary. By fixing the starting point of the indirect method to 'operating profit,' which by definition excludes interest, the statement returns to what it should be: a report that clearly and traceably shows how cash moved through the business.
More importantly, this reform aligns the starting point of the cash flow statement with the new 'operating profit' subtotal in the income statement. For the first time, users will be able to track the bridge between 'operating performance' and 'operating cash generation' consistently when comparing companies.
Next time
In future articles, I will provide a basic explanation of the cash flow statement while examining how this structural change will impact practice.
I will explain why cash flow preparation has historically been considered difficult, why it tends to become a black box, and what a simpler, more modern approach looks like.
The content of this article is for informational purposes only and does not constitute professional accounting advice. Please consult a qualified professional regarding individual transactions or reporting requirements.
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Practice questions
Question 1: Profit or Loss vs. Cash Flow Definitions
Q: Under IFRS 18, are the boundaries between operating, investing, and financing activities identical in both the income statement (P&L) and the cash flow statement (IAS 7)?
A) Yes, they are completely identical across both statements.
B) No, they use the same labels but have different boundaries.
C) Yes, because IAS 7 was fully replaced by IFRS 18.
D) No, because the cash flow statement no longer uses these categories.
Correct Answer: B
Explanation: As highlighted in the provided article, the IASB deliberately chose not to fully align the two standards. For example, the gain or loss on the disposal of property, plant, and equipment (PP&E) is classified as "operating" in the income statement under IFRS 18, but the actual cash received from the disposal remains under "investing activities" in the cash flow statement (IAS 7).
Question 1: Definitions of the Income Statement and Cash Flow Statement
Q: Under IFRS 18, are the boundaries of "operating activities," "investing activities," and "financing activities" identical in the income statement (P&L) and the cash flow statement (IAS 7)?
A) Yes, they are completely identical in both statements.
B) No, they use the same labels but have different boundaries.
C) Yes, because IAS 7 was fully replaced by IFRS 18.
D) No, because the cash flow statement no longer uses these categories.
Correct Answer: B
The IASB deliberately chose not to fully align the two standards. For example, the gain or loss on the disposal of property, plant, and equipment (PP&E) is classified under the "operating" category in the income statement under IFRS 18, but the cash received from the disposal continues to be classified under "investing activities" in the cash flow statement under IAS 7.
Question 2: Starting Point for the Indirect Method
Q: Following the implementation of IFRS 18, what is the mandatory starting point for calculating net cash flows from operating activities using the indirect method for non-financial entities?
A) Profit before taxation
B) Net income / Profit or loss for the period
C) Operating profit or loss as defined by IFRS 18
D) EBITDA
Correct Answer: C
Explanation: To eliminate corporate diversity and improve comparability, IFRS 18 mandates that all entities using the indirect method must start their calculation specifically with the newly defined "operating profit or loss" subtotal.
Question 2: The Starting Point for the Indirect Method
Q: After the implementation of IFRS 18, when a non-financial entity uses the indirect method, what is the mandatory starting point for calculating cash flows from operating activities (net amount)?
A) Profit before tax
B) Profit or loss for the period
C) 'Operating profit or loss' as defined by IFRS 18
D) EBITDA
Correct Answer: C
To eliminate diversity among companies and enhance comparability, IFRS 18 mandates that all companies using the indirect method must use the newly defined 'operating profit or loss' subtotal as the starting point.
Question 3: Classification of Interest Paid
Q: Under IFRS 18, where must interest paid (actual cash outflow) be classified in the cash flow statement for a standard non-financial entity?
A) Operating activities
B) Investing activities
C) Financing activities
D) Either operating or financing activities, depending on the accounting policy choice
Correct Answer: C
Explanation: IFRS 18 removes the accounting policy choices previously available under IAS 7. For non-financial entities, interest paid must now be cleanly classified as a financing activity. This single-entry presentation eliminates the traditional, confusing practice of adding back interest expense at the start of the operating section only to deduct the cash payment later.
Question 3: Classification of Interest Paid
Q: Under IFRS 18, where must interest paid (actual cash outflow) by a standard non-financial entity be classified in the cash flow statement?
A) Operating activities
B) Investing activities
C) Financing activities
D) Either operating or financing activities, depending on the accounting policy choice
Correct Answer: C
IFRS 18 eliminates the accounting policy choices that were permitted under IAS 7. For non-financial entities, interest paid must be clearly classified as a financing activity. This resolves the traditional, confusing practice of adding back interest expense at the beginning of the operating section and then deducting it again as a cash payment.