How to approach it
- Answer every question the email asks, in the order asked, using short headed paragraphs.
- Methods: explain what each method starts from and shows, not just their names.
- List all four items with a choice (interest paid, interest received, dividends paid, dividends received) and the allowed headings for each.
- For the 'maximise operating cash flow' request, pick the heading for each item that keeps outflows out of and inflows in operating activities.
- Close by explaining that the choice is an accounting policy that must be applied consistently.
Key rules to apply
- Direct method shows major classes of gross cash receipts and payments; indirect method starts from profit and adjusts for non-cash items and working capital. IAS 7 encourages the direct method.
- Interest and dividends paid: operating or financing. Interest and dividends received: operating or investing. Classify consistently from period to period.
- Taxes on income are operating unless specifically identified with investing or financing.
- Changing the classification later is a change in accounting policy under IAS 8, allowed only if it gives reliable and more relevant information.
- Heads-up: IFRS 18's amendments to IAS 7 (periods from 1 January 2027) remove most of these choices for entities without a specified main business activity. Check which version your sitting examines.
Common mistakes
Drawn from the examiners' comments for this sitting (summarised in our words) and from typical errors on this topic.
- Listing only interest and dividends paid and forgetting the receipts (examiners' point).
- Not answering the CEO's 'maximise' and 'year-by-year flexibility' points.
- Saying there are two methods without explaining the difference.
Similar question with worked solution
Written by us with our own numbers; it tests the same skills as Q6 without copying it.
Original practice question
How classification changes operating cash flow
Profit before tax Rs 500m includes depreciation Rs 80m, interest expense Rs 60m, interest income Rs 20m and dividend income Rs 10m. Working capital increased by Rs 40m. Cash paid: interest Rs 55m, tax Rs 100m, dividends Rs 70m. Cash received: interest Rs 18m, dividends Rs 10m.
Required: Calculate net cash from operating activities under (A) the choices that maximise it and (B) the choices that minimise it.
Worked solution
| Line | A (Rs m) | B (Rs m) |
|---|---|---|
| Profit before tax | 500 | 500 |
| Depreciation | 80 | 80 |
| Interest expense | 60 | 60 |
| Interest and dividend income | (30) | (30) |
| Increase in working capital | (40) | (40) |
| Cash generated from operations | 570 | 570 |
| Tax paid | (100) | (100) |
| Interest received / dividends received | 28 | – |
| Interest paid | – | (55) |
| Dividends paid | – | (70) |
| Net cash from operating activities | 498 | 345 |
Answer: Operating cash flow is Rs 498m with receipts in operating and payments in financing, versus Rs 345m the other way round. The chosen policy must then be applied every year.