IAS 7 Statement of Cash Flows provides guidelines to financial accountants and auditors regarding reporting of cash and cash equivalent items that effects business entity`s cash flow position.
Entity following IFRSs in its reporting should be preparing statement of cash flow along with the other component of financial statements as described by IASB. IAS 7 requires presentation of historical changes in cash and cash equivalent items over a period of time through preparing statement of cash flow in a way all cash and cash equivalent items are classified in to three separate categories: operational, financial and investing activities’ cash flows. There are two methods specified by IAS 7 for preparing statement of cash flows i-e Direct method and Indirect method.
Component of cash and cash equivalent items are: All items including liquid cash or cash in hand, short term deposits and all short term investments which are readily convertible in to cash. An investment is categorized as short term when it is made for three or less months, it can be converted into readily available cash and there is less chance of risk of change in value of the cash convertible. In other way, it can be converted into some certain amount of cash. Bank overdraft and equity instruments if having specific redemption date are also included in cash and cash equivalents as they are integral part of entity`s cash flow management.
Activities which are principal source of revenue of entity are operating activities. These are activities that are considered when reaching at the figure of profit or loss and these are principal activities whose end result will show the cash flow position of entity to manage investing and financing activities.
Investing activities are associated with acquisition and disposal of long term assets of the business. Investments other than cash equivalent investments are also dealt under investing activities. Separate presentation of investing activities shows fixed term investments of entity to generate long term inflows that will impact on revenue generation capacity of business.
These activities comprises of finance generating activities which are resulted through changes in contributed equity and loan arrangements.
Direct method of calculating result of operating activities takes gross receipts and payments. Whereas indirect method takes items as per accrual basis and adjust profit or loss figure by taking into account non-cash items, changes in receivables and inventories, foreign exchange gain and losses etc.