1. Introduction
The Statement of Cash Flows is one of the most significant financial statements because it explains how an entity generates and utilises cash during a financial year. While the basic structure of the cash flow statement classifies cash flows into operating, investing, and financing activities, certain transactions require special treatment and disclosures under Ind AS 7. These transactions often involve complexities relating to foreign currency movements, financing arrangements, investment activities, and tax payments. Proper classification and disclosure of such items is essential because it improves transparency and enables users of financial statements to understand the entity’s liquidity position and financial flexibility more effectively.
Among the important areas requiring special consideration are foreign currency cash flows, interest and dividend transactions, taxes on income, and transactions involving investments in subsidiaries, associates, and joint ventures. Let us understand each of these considerations in a detailed manner.
2. Foreign Currency Cash Flows
Foreign currency cash flows are accounted for in accordance with Ind AS 21, read together with Ind AS 7. In modern business environments, entities frequently engage in international transactions involving foreign currencies such as US Dollars, Euros, Pound Sterling, or Japanese Yen. Since financial statements are prepared in the functional currency of the reporting entity, cash flows denominated in foreign currencies must be translated into that currency.
2.1 Translation of Foreign Currency Cash Flows
Ind AS requires that cash flows arising in a foreign currency should be translated using the exchange rate prevailing on the date of the cash flow transaction. In the case of consolidated financial statements, cash flows of foreign subsidiaries are translated using the exchange rates applicable on the respective dates on which such cash flows arise.
The standard also permits the use of an average exchange rate for a period if the average reasonably approximates the actual rates prevailing on the transaction dates. However, the closing exchange rate at the reporting date cannot be used for translating cash flows because the cash flow statement reflects actual movement of cash during the year and not year-end valuations.
2.2 Unrealised Exchange Differences
An important issue arises in relation to exchange differences caused by fluctuations in foreign exchange rates. Exchange gains or losses that arise merely because of changes in exchange rates without any actual movement of cash are considered unrealised exchange differences. Since no cash inflow or outflow occurs in such situations, these unrealised differences are generally not treated as cash flows.
However, where exchange differences arise on cash and cash equivalents held in foreign currency, they are disclosed separately in the Statement of Cash Flows in order to reconcile the opening and closing balances of cash and cash equivalents.
2.3 Example – Export Receipt in Foreign Currency
Suppose an Indian company exports goods to a customer in the United States for USD 50,000. On the date of export, the exchange rate is ₹82 per USD. Accordingly, the export sale is recorded at ₹41 lakh.
Later, when the amount is actually received, the exchange rate increases to ₹84 per USD and the company receives ₹42 lakh. In the Statement of Cash Flows, the actual operating cash inflow reported will be ₹42 lakh because this represents the real cash received by the entity.
2.4 Example – Unrealised Exchange Difference on Foreign Currency Bank Balance
Assume a company maintains a USD bank account containing USD 20,000. If the exchange rate at the beginning of the year is ₹81 per USD and at year-end becomes ₹85 per USD, the rupee value of the bank balance increases without any actual receipt of cash.
In such a case, the increase arising due to exchange fluctuation is not classified as operating, investing, or financing cash flow. Instead, it is separately disclosed as the effect of exchange rate changes on cash and cash equivalents.
3. Interest and Dividend
Interest and dividend cash flows require careful classification because they may relate to financing arrangements, investment returns, or operational activities depending upon the nature of the entity and the transaction.
Under Ind AS 7, interest paid and dividend paid are generally classified as cash flows from financing activities because they represent costs incurred for obtaining financial resources. On the other hand, interest received and dividend received are generally classified as cash flows from investing activities because they represent returns earned on investments made by the entity.
The logic behind this classification is based on the economic substance of the transaction. Borrowings are a source of finance for the entity, and therefore the cost incurred in relation to such borrowings is regarded as financing cash flow. Likewise, investments are made for earning returns, and therefore interest or dividends received from such investments are regarded as investing cash flows.
3.1 Interest Paid
Interest paid on loans, debentures, lease liabilities, or other borrowings is generally classified as financing activity because such payments arise due to financing arrangements undertaken by the entity.
3.2 Interest Received
Interest received on fixed deposits, loans granted, bonds, or other investments is generally classified as investing activity because it represents income generated from investments.
3.3 Dividend Received
Dividend received from shares, mutual funds, subsidiaries, associates, or joint ventures is generally treated as investing activity because it represents return on investment.
3.4 Dividend Paid
Dividend paid to shareholders is generally classified as financing activity because it represents distribution of profits to owners of the entity.
3.5 Treatment in Case of Financial Institutions
The treatment differs in the case of banks, non-banking financial companies, and other financial institutions. For such entities, lending and borrowing activities form part of their principal business operations. Therefore, interest received and interest paid are generally classified as operating activities instead of investing or financing activities.
3.6 Capitalised Borrowing Costs
A practical issue often arises where borrowing costs are capitalised under Ind AS 23. Under Ind AS 23, borrowing costs incurred for construction of qualifying assets may be capitalised instead of being charged to the Statement of Profit and Loss.
Nevertheless, even where the borrowing cost is capitalised, the actual payment of interest still represents a cash outflow. Accordingly, the related cash flow must still be disclosed in the Statement of Cash Flows. Where the borrowing directly relates to construction of a qualifying asset, the related cash flow is often presented as investing activity because it forms part of the cost of creating the asset.
3.7 Example – Classification of Interest and Dividend
Suppose a manufacturing company pays interest of ₹12 lakh on a term loan obtained from a bank. During the same year, the company earns interest income of ₹3 lakh on fixed deposits and receives dividend income of ₹2 lakh from investments in mutual funds. Further, the company pays dividend of ₹8 lakh to its shareholders.
In such a case, the interest paid and dividend paid will generally be classified as financing activities, whereas interest received and dividend received will be classified as investing activities.
3.8 Example – Capitalised Borrowing Cost
Assume a company borrows funds specifically for construction of a factory building. The company pays total interest of ₹25 lakh during the year, out of which ₹18 lakh is capitalised under Ind AS 23.
Although the interest is capitalised and included in the cost of the factory building, the payment still involves actual cash outflow. Therefore, the cash flow relating to such capitalised interest is disclosed in the Statement of Cash Flows and is generally treated as investing activity because it directly relates to creation of a long-term asset.
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