IAS 7 and IFRS 18: The Biggest Cash Flow Statement Reform in 30 Years

1. A Brief History: Why the Cash Flow Statement Exists

The cash flow statement was not born in an accounting standards committee. It was born out of necessity.

In 1863, the managers of the Dowlais Iron Company faced a paradox: the business was profitable, yet there was no money to invest in new equipment. To explain the situation to stakeholders, they created a new kind of report — one that showed not just profit, but where the cash actually was. It turned out to be tied up in excess inventory. That simple document was the ancestor of today's statement of cash flows.

Nearly a century later, in October 1977, the IASC issued the first version of IAS 7, titled Statement of Changes in Financial Position. In practice, it was largely ineffective. The standard failed to define "funds" with precision, making comparisons between entities almost meaningless. The statement was treated as an afterthought.

Then came the crisis that changed everything. In the early 1980s, corporate debt loads increased dramatically, and high-profile bankruptcies began to surface — many involving companies that had been reporting healthy profits. The disconnect between accrual-based net income and actual cash generation was no longer a theoretical concern. Users bypassed the official statement altogether, turning to EBITDA as a proxy for operating cash flow.

In response, the IASC issued a thoroughly revised IAS 7 in December 1992, effective from 1 January 1994. "Funds" was replaced with a precise definition — cash and cash equivalents — and cash flows were required to be classified into exactly three categories: operating, investing, and financing activities. This is the structure that has governed cash flow reporting globally for the past three decades.

2. The Structure of IAS 7: A Map of the Standard

The 1992 structure proved durable. For three decades, IAS 7 required only minor adjustments: a retitling to Statement of Cash Flows in 2007, a 2016 amendment on disclosure of financing liability movements, and a 2023 amendment on supplier finance arrangements. None of these touched the fundamental architecture of the statement.

That changes in 2027. IFRS 18, issued in April 2024, introduces the first structural reform to IAS 7 in approximately 30 years — altering both the starting point of the indirect method and the classification of interest and dividend cash flows.

Here is a map of IAS 7 as it stands, and where IFRS 18 leaves its mark.

IFRS 18's impact is concentrated entirely in Block ②. The definitions, consolidation rules, and disclosure requirements remain structurally unchanged.

3. Inside Each Block

Block ① — Foundations & Definitions (Par. 1–9)

IAS 7 applies to all entities, regardless of industry or size. The definitions— cash, cash equivalents, and the three activity categories — form the foundation of everything that follows.

IFRS 18 does not change these definitions. However, this is where an important misalignment deserves attention.

IFRS 18 introduces a new income statement structure using the same three labels — operating, investing, and financing — but the boundaries are not identical to IAS 7. The clearest example is the sale of property, plant and equipment:

The same transaction lands in different buckets depending on which statement you are reading. The divergence is not limited to gains and losses on asset disposals. Under the old IAS 7, interest and dividends could be classified as operating activities in the cash flow statement — yet under IFRS 18, the same items fall into the investing or financing categories in the income statement.

IFRS 18 classifies items based on the nature of profit or loss, whereas IAS 7 classifies them based on the use of cash.

This is intentional — the IASB deliberately chose not to fully align the two standards. Practitioners will need to be alert to these divergences when preparing both statements.

Block ② — Preparation of the Statement (Par. 10–36)

This is the operational core of IAS 7 — and the block most significantly affected by IFRS 18.

IAS 7 permits two approaches for presenting operating cash flows. The direct method lists actual cash receipts and payments. The indirect method starts with a profit figure and adjusts for non-cash items and working capital changes. Both produce the same result; the indirect method dominates in practice.

The starting point — and how IFRS 18 resolves it

In practice, most entities used profit before tax or net income as the starting point, although IAS 7 did not prescribe a specific subtotal. Operating profit was used by a small minority. The result was that starting points varied widely across entities, with no consistent standard.

IFRS 18 eliminates this diversity. All entities using the indirect method are now required to use the operating profit or loss subtotal as defined by IFRS 18 as their starting point.

Interest and dividends — from choice to mandate

Under the pre-IFRS 18 version of IAS 7, the classification of interest and dividend cash flows was a matter of accounting policy choice. Each entity could classify interest paid as either operating or financing, interest received as either operating or investing, and so on. The diversity this created made cross-entity comparison difficult.

IFRS 18 removes these options for most non-financial entities. Financial institutions continue to apply specific classification requirements reflecting the nature of their business activities.

Block ③ — Consolidated & Group Cash Flows (Par. 37–42)

This block addresses cash flows related to subsidiaries, associates, and joint ventures — including the treatment of ownership changes. The consolidation of cash flow statements introduces its own layer of complexity, particularly around foreign currency translation and intercompany eliminations. This will be addressed in a separate article in this series.

Block ④ — Disclosures (Par. 43–53)

Key disclosure requirements include: non-cash transactions (such as debt-for-equity conversions) disclosed in the notes; a reconciliation of financing liability movements introduced in the 2016 amendment; and disclosure of the components of cash and cash equivalents with reconciliation to the balance sheet.

4. Before and After IFRS 18: The Indirect Method Compared

The following comparison illustrates how the structure of the operating activities section changes under IFRS 18 for a non-financial entity using the indirect method.

Before IFRS 18

Profit before taxation                            X
Adjustments:
  Depreciation and amortisation                   X
  Interest expense (reversal)                     X   ← added back to remove from starting figure
  Gain on disposal of PP&E                       (X)
  Changes in working capital                     ±X
                                              -------
Cash generated from operations                    X
  Interest paid (actual cash outflow)            (X)  ← deducted again as actual payment
  Income taxes paid                              (X)
                                              -------
Net cash from operating activities                X

Interest appears twice: once added back to strip it out of the starting profit figure, and once deducted as the actual cash payment. This double-entry logic is one of the most commonly misunderstood aspects of the indirect method.

After IFRS 18 (from 2027)

Operating profit (as defined by IFRS 18)          X
Adjustments:
  Depreciation and amortisation                   X
  Gain on disposal of PP&E                       (X)
  Changes in working capital                     ±X
                                              -------
Cash from operating activities                    X
  Income taxes paid                              (X)
                                              -------
Net cash from operating activities                X

Financing activities:
  Interest paid                                  (X)  ← appears once, in the right place
  Dividends paid                                 (X)

Because operating profit is calculated before interest expense, there is no need to add it back. Interest paid moves cleanly to financing activities and appears once. The statement becomes structurally simpler and the logic becomes transparent.

5. What This Change Really Means

The reform looks like a technical adjustment. It is more than that.

The "add back, then deduct" treatment of interest was not a deliberate design choice — it was a workaround. It existed because the starting point already included interest expense, forcing preparers to reverse it before reclassifying it. The result was a statement that confused even experienced practitioners, and a preparation process that created unnecessary complexity in accounting systems and mapping configurations.

IFRS 18 removes the need for the workaround. By anchoring the indirect method to operating profit — a figure that excludes interest by definition — the statement becomes what it was always meant to be: a clear, traceable record of how cash moved through the business.

The implications for how cash flow statements are prepared — and for the systems that support that preparation — are significant. In practice, many preparers rely on complex mapping rules, manual adjustments, and reconciliation processes that are difficult for users — and sometimes even preparers — to follow. More importantly, the reform aligns the starting point of the cash flow statement with the newly defined operating profit subtotal in the statement of profit or loss. For the first time, users can trace a consistent bridge between operating performance and operating cash generation across entities.

In the next article, we will examine what this structural change means in practice: why cash flow preparation has historically been so difficult, what makes the process prone to becoming a black box, and what a simpler approach looks like.

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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 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 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.

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The content of this article is intended for informational purposes only and does not constitute professional accounting advice. Readers should consult qualified professionals for guidance on specific transactions or reporting requirements.