8.2 IAS 7 Cash Flows — Investing and Financing Activities
Key Takeaways
- Investing cash flows represent capital expenditures on productive non-current assets intended to generate future cash flows, requiring ledger reconstruction to extract cash additions and disposal proceeds.
- Cash additions to Property, Plant and Equipment (PPE) are determined by reconciling opening carrying amounts with revaluation gains, depreciation charges, impairments, disposals, non-cash additions (ROU assets), and closing carrying amounts.
- Disposal proceeds in investing activities represent the full gross cash received (carrying amount plus gain or minus loss on disposal), rather than the accounting gain or loss reported in profit or loss.
- Financing activities encompass share capital issues (split between nominal capital and share premium), debt issues and repayments, the full lease payment including its finance charge, interest paid, and equity dividends paid.
- Bank overdrafts repayable on demand that fluctuate between positive and negative balances as part of cash management are included in cash and cash equivalents rather than financing activities.
8.2 IAS 7 Cash Flows — Investing and Financing Activities
Core Principle: While operating activities reveal the cash generated by an entity's core trading operations, Investing activities reflect capital expenditures made to sustain or expand productive infrastructure, and Financing activities reflect how that capital is funded through equity and debt. In the ACCA FR exam, mastering these sections requires rigorous T-account reconstructions of Property, Plant and Equipment (PPE), lease liabilities, and retained earnings to separate cash flows from non-cash accounting adjustments.
1. Scope and Definition of Investing Activities
Under IAS 7.6, investing activities are defined as the acquisition and disposal of long-term assets and other investments not included in cash equivalents.
Investing cash outflows represent capital expenditures (capex) that signal management's commitment to future productive capacity. Investing cash inflows represent divestments (asset sales) and returns on external investments.
Primary Line Items in Investing Activities
- Cash paid to acquire Property, Plant and Equipment (IAS 16)
- Cash paid to acquire Intangible Assets (IAS 38)
- Cash proceeds from the disposal of PPE and Intangible Assets
- Cash paid to acquire debt or equity instruments of other entities
- Cash proceeds from the sale of debt or equity instruments
- Dividends received (from equity investments or associates)
- Interest received (from loans or bonds held as investments)
2. Reconstructing Non-Current Asset Additions: The PPE T-Account
In ACCA FR examination questions, the cash paid to purchase property, plant and equipment is rarely stated directly on the balance sheet. Candidates must extract cash capex as the balancing figure in a PPE Carrying Amount ledger account.
PPE Carrying Amount Reconstruction Ledger
─────────────────────────────────────────────────────────────────────────────────────────
Debit: Opening Carrying Amount b/f [A] │ Credit: Depreciation Charge (P&L) [D]
Debit: Revaluation Surplus (OCI) [B] │ Credit: Impairment Losses (P&L/OCI) [E]
Debit: Cash Additions (Balancing Fig) [C] │ Credit: Disposal Carrying Amount [F]
│ Credit: Closing Carrying Amount c/f [G]
─────────────────────────────────────────────────────────────────────────────────────────
Total Debits │ Total Credits
Cash Additions = Closing PPE - Opening PPE - Revaluations + Depreciation + Impairments + Disposal Carrying Amount
Non-Cash Additions (IFRS 16 Leases & Government Grants)
A crucial trap in ACCA FR involves non-cash additions entering PPE:
- Right-of-Use (ROU) Assets: Under IFRS 16, when an entity enters into a new lease, it capitalizes an ROU asset with an equal lease liability. No cash was paid at inception. Under IAS 7.43, non-cash investing and financing transactions must be excluded from the Statement of Cash Flows and disclosed in the financial statement notes.
- Capitalized Decommissioning Provisions (IAS 37): Capitalizing future site restoration costs into PPE involves no current cash flow.
- Rule: Always subtract new ROU lease assets and non-cash provisions from the total additions before recording the cash outflow under investing activities.
3. Reconstructing Disposal Proceeds
When an entity sells an item of property, plant, or equipment, the cash received is calculated by combining the asset's carrying amount at the date of sale with the resulting profit or loss:
Carrying Amount at Disposal = Original Historical Cost - Accumulated Depreciation at Disposal
Cash Disposal Proceeds = Carrying Amount at Disposal + Gain on Disposal (or - Loss on Disposal)
Treatment of Asset Disposals in IAS 7
┌──────────────────┐
│ Asset Disposed │
└────────┬─────────┘
│
┌──────────────────────────┴──────────────────────────┐
▼ ▼
Operating Activities (Indirect) Investing Activities
• Deduct Accounting Gain on Disposal • Record FULL Gross Cash Proceeds
• Add back Accounting Loss on Disposal (Carrying Amount +/- Gain/Loss)
• Strips non-operating accrual from profit • Reflects physical liquid inflow
4. Scope and Definition of Financing Activities
Under IAS 7.6, financing activities are defined as activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.
Financing cash flows show how an entity raises long-term funding from lenders and equity investors, and how it repays or rewards those capital providers.
Primary Line Items in Financing Activities
- Proceeds from issuing ordinary shares or preference shares
- Proceeds from issuing long-term loan notes, debentures, or bank borrowings
- Cash repayments of borrowings and redemption of debentures
- Capital repayment element of lease liabilities (IFRS 16)
- Dividends paid to equity shareholders — a financing activity in all cases under IAS 7 as amended alongside IFRS 18; the former policy choice to present them within operating activities has been withdrawn
- Interest paid, including the finance charge on lease liabilities — presented in financing activities for most entities unless an exam scenario directs otherwise
5. Equity Financing: Share Issues, Share Premium & Bonus Issues
When an entity issues ordinary shares for cash, the total cash received equals the increase in nominal share capital plus the increase in the share premium account:
Cash Proceeds from Share Issue = Increase in Share Capital + Increase in Share Premium
The Non-Cash Trap: Bonus Issues (Scrip Issues)
A bonus issue (capitalisation of reserves) involves issuing free additional shares to existing shareholders by converting reserves (such as share premium or retained earnings) into share capital:
Debit: Share Premium / Retained Earnings
Credit: Share Capital
- Crucial Rule: Zero cash is received in a bonus issue.
- When calculating cash proceeds from a share issue, the nominal value of bonus shares issued during the year must be deducted from the change in share capital.
- In contrast, a rights issue is an offer of new shares to existing shareholders for cash and is fully included in financing cash flows.
6. Accounting for Lease Liabilities Under IFRS 16 in IAS 7
Under IFRS 16, lease payments made during the year contain two distinct components that must be segregated in the Statement of Cash Flows:
- Finance Charge (Interest): Recognized in profit or loss and presented as an Operating cash outflow (under standard ACCA FR presentation).
- Capital Element (Principal Repayment): Reduces the lease liability on the Statement of Financial Position and is presented as a Financing cash outflow.
Reconstructing the Lease Liability Ledger
To determine the cash capital repayment, combine the current and non-current lease liabilities into a single ledger account:
Lease Liability Ledger
─────────────────────────────────────────────────────────────────────────────────────────
Debit: Capital Repayment (Balancing Fig) [X] │ Credit: Opening Balance b/f [A]
Debit: Closing Balance c/f [B] │ Credit: New Leases Entered (Non-Cash) [C]
─────────────────────────────────────────────────────────────────────────────────────────
Total Debits │ Total Credits
Capital Element Repaid = Opening Lease Liability + New Leases Entered - Closing Lease Liability
Total Cash Lease Outflow = Capital Element Repaid (Financing) + Lease Interest Paid (Financing)
7. Reconstructing Dividends Paid to Ordinary Shareholders
Cash dividends paid during the reporting period are calculated by analyzing the Retained Earnings reserve:
Opening Retained Earnings + Profit for the Year - Transfers to Reserves - Dividends Paid = Closing Retained Earnings
Dividends Paid = Opening Retained Earnings + Profit for the Year - Transfers - Closing Retained Earnings
Exam Trap — Proposed Dividends (IAS 10): Dividends declared or proposed after the end of the reporting period are non-adjusting events. They are not recognized as liabilities at the reporting date and involve zero cash outflow in the current period.
8. Net Change in Cash and Cash Equivalents & The Overdraft Rule
Definition of Cash and Cash Equivalents (IAS 7.6–7.7)
- Cash: Comprises cash on hand and demand deposits.
- Cash Equivalents: Short-term, highly liquid investments that are readily convertible to known amounts of cash and subject to an insignificant risk of changes in value. An investment normally qualifies as a cash equivalent only when it has a short maturity of three months or less from the acquisition date.
Bank Overdrafts (IAS 7.8)
Bank overdrafts present a unique classification rule in ACCA FR:
- Where bank overdrafts are repayable on demand and form an integral part of an entity's cash management (i.e. the bank balance regularly fluctuates between being positive and overdrawn), they are included as a negative component of cash and cash equivalents.
- Where an overdraft or revolving credit facility represents a formal long-term borrowing arrangement, it is classified within Financing activities.
Cash and Cash Equivalents Reconciliation
─────────────────────────────────────────────────────────────────────────────────────────
Net increase / (decrease) in cash and cash equivalents (Operating + Investing + Financing)
Add: Cash and cash equivalents at beginning of period (Net of opening overdraft)
─────────────────────────────────────────────────────────────────────────────────────────
Equals: Cash and cash equivalents at end of period (Net of closing overdraft)
─────────────────────────────────────────────────────────────────────────────────────────
9. Comprehensive Worked Example: Investing and Financing Flows
Scenario
Triton Global plc presents the following balances and extracts for the year ended 31 December 20X1:
- PPE Carrying Amount: 1 Jan 20X1: $1,200,000; 31 Dec 20X1: $1,480,000.
- Revaluation Reserve: Increased by $80,000 during the year following an upward revaluation of commercial land.
- Depreciation Expense: Charged in the P&L for the year: $130,000.
- Disposal of Machinery: A machine with an original cost of $120,000 and accumulated depreciation of $70,000 was sold for cash at an accounting loss of $8,000.
- New Leases: On 1 April 20X1, Triton acquired a specialized production crane under a new 5-year lease, recognizing an ROU asset and lease liability of $90,000.
- Share Capital ($1 Ordinary Shares): 1 Jan 20X1: $500,000; 31 Dec 20X1: $700,000.
- Share Premium: 1 Jan 20X1: $100,000; 31 Dec 20X1: $220,000.
- Bonus Issue: On 1 June 20X1, Triton made a 1-for-10 bonus issue of ordinary shares, funded entirely from the share premium account.
- Bank Loan Notes: 1 Jan 20X1: $300,000; 31 Dec 20X1: $200,000.
- Total Lease Liabilities (Current + Non-Current): 1 Jan 20X1: $140,000; 31 Dec 20X1: $185,000.
- Retained Earnings: 1 Jan 20X1: $410,000; 31 Dec 20X1: $525,000. Profit for the year was $185,000.
- Bank Balance (Cash Management Overdraft): 1 Jan 20X1: $35,000 overdrawn; 31 Dec 20X1: $48,000 in credit.
Step-by-Step Solution
Step 1: Calculate Cash Paid for PPE Additions
- Carrying amount of disposed machine = Cost $120,000 - Acc Dep $70,000 = $50,000.
- Cash proceeds from disposal = Carrying amount $50,000 - Loss $8,000 = $42,000.
- Set up PPE Carrying Amount ledger:
- Opening carrying amount: $1,200,000
- Add: Revaluation surplus: +$80,000
- Add: Non-cash ROU asset addition: +$90,000
- Less: Depreciation charge: -$130,000
- Less: Disposal carrying amount: -$50,000
- Subtotal before cash additions: $1,190,000
- Closing carrying amount: $1,480,000
- Cash Additions to PPE = $1,480,000 - $1,190,000 = $290,000.
Step 2: Calculate Cash Proceeds from Share Issue
- Opening shares = 500,000 shares. A 1-for-10 bonus issue created 50,000 new $1 shares ($50,000).
- Journal for bonus issue: Dr Share Premium $50,000; Cr Share Capital $50,000.
- Total increase in Share Capital = $700,000 - $500,000 = $200,000.
- Cash increase in Share Capital = Total increase $200,000 - Bonus issue $50,000 = $150,000.
- Share premium after bonus issue deduction = $100,000 - $50,000 = $50,000.
- Cash increase in Share Premium = Closing $220,000 - Adjusted opening $50,000 = $170,000.
- Total Cash Proceeds from Share Issue = $150,000 + $170,000 = $320,000.
Step 3: Calculate Lease Liability Capital Repayments
- Opening lease liability: $140,000
- Add: New lease entered during the year: +$90,000
- Subtotal liability before payments: $230,000
- Closing lease liability: $185,000
- Capital Element Repaid (Financing Outflow) = $230,000 - $185,000 = $45,000.
Step 4: Calculate Dividends Paid
- Opening retained earnings: $410,000
- Add: Profit for the year: +$185,000
- Subtotal: $595,000
- Less: Closing retained earnings: -$525,000
- Dividends Paid in Cash = $70,000.
Step 5: Investing and Financing Statements
| Line Item | Amount ($) |
|---|---|
| Cash flows from investing activities: | |
| Purchase of property, plant and equipment | (290,000) |
| Proceeds from disposal of machinery | 42,000 |
| Net cash used in investing activities | (248,000) |
| Cash flows from financing activities: | |
| Proceeds from issue of ordinary shares | 320,000 |
| Repayment of bank loan notes ($300,000 - $200,000) | (100,000) |
| Principal repayment of lease liabilities | (45,000) |
| Dividends paid to ordinary shareholders | (70,000) |
| Net cash generated from financing activities | 105,000 |
Step 6: Reconciliation to Cash and Cash Equivalents
- Assuming Net Cash from Operating Activities was $226,000:
- Net increase in cash and cash equivalents = $226,000 - $248,000 + $105,000 = $83,000.
- Cash and cash equivalents at 1 January 20X1 = ($35,000) (Overdraft).
- Cash and cash equivalents at 31 December 20X1 = -$35,000 + $83,000 = $48,000 (Positive bank balance).
10. Exam Traps & Examiner Guidance
ACCA Examiner Tip:
- Bonus Issues vs. Cash Issues: Never mistake a bonus issue for a cash flow. Bonus issues capitalize existing equity reserves; no cash enters the business.
- Right-of-Use Asset Additions: Always verify whether PPE additions include leased assets under IFRS 16. Leased additions are non-cash investing/financing transactions.
- Proceeds vs. Gains: When an asset is sold at a loss, remember that cash was still received. The cash proceeds equal carrying amount minus loss on disposal.
At 1 January 20X1, the carrying amount of an entity's property, plant and equipment was $820,000. During 20X1, an item of equipment with an original cost of $140,000 and accumulated depreciation of $65,000 was sold for a loss of $12,000. Depreciation charged in the statement of profit or loss for the year was $95,000. A property was revalued upwards by $60,000 during the year, with the revaluation surplus recognized in other comprehensive income. The closing carrying amount of property, plant and equipment at 31 December 20X1 was $980,000. No new right-of-use assets were acquired. What was the cash paid to purchase property, plant and equipment during the year?
During the year ended 31 December 20X1, an entity had the following equity and debt transactions:
An entity's bank balance was $45,000 overdrawn at 1 January 20X1. At 31 December 20X1, the bank balance was $25,000 in credit. The overdraft facility is repayable on demand and fluctuates regularly between debit and credit balances as an integral part of the entity's daily cash management. How should the overdraft and net movement be presented in the statement of cash flows under IAS 7?
Under IAS 7.43, how must non-cash investing and financing transactions (such as acquiring plant via a new lease under IFRS 16 or acquiring a building through the direct issue of ordinary shares) be reported?