Ind AS 7 requires cash flows to be classified into three categories — operating, investing and financing activities — and reported using either the direct method (showing major classes of gross cash receipts and payments) or the indirect method (starting from profit and adjusting for non-cash items and working capital movements), with the indirect method far more common in practice because it reconciles directly to the profit and loss statement. The classification itself is where most review attention actually belongs: several common items — interest paid, interest received, dividends — don't obviously belong in one category, and Ind AS 7 gives the entity some choice while still requiring consistency.
The three categories, and what belongs in each
| Category | Typical items |
|---|---|
| Operating | Cash receipts from sale of goods/services, payments to suppliers and employees, income tax paid (unless specifically attributable to financing or investing) |
| Investing | Purchase and sale of property, plant and equipment, acquisition and disposal of investments, loans made to other parties |
| Financing | Proceeds from issuing shares or debentures, repayment of borrowings, dividends paid |
Where classification actually gets contested
- 01Interest and dividends paidCan be classified as operating (consistent with their effect on profit) or financing (consistent with being a cost of obtaining finance) — the choice has to be disclosed and applied consistently period to period, not switched to flatter whichever classification looks better in a given year.
- 02Interest and dividends receivedCan be classified as operating or investing, with the same consistency requirement — typically investing, since they relate to returns on investments rather than core operations, though operating is also permitted.
- 03Bank overdrafts repayable on demandTreated as a component of cash and cash equivalents, not as financing activity, when they form an integral part of the entity's cash management.
- 04Taxes paidClassified as operating unless specifically identifiable with a financing or investing transaction — the default assumption is operating, with a specific reason required to classify otherwise.
A company switching interest paid from financing to operating classification in a year where that happens to make operating cash flow look stronger, with no stated policy change and no consistent rationale, is exactly the kind of inconsistency Ind AS 7's disclosure requirement is meant to make visible on comparison with the prior year.
Common practice, not a requirement
Non-cash transactions — a finance lease entered into, shares issued to settle a liability, an asset acquired by assuming a loan — are excluded from the cash flow statement entirely but must be separately disclosed, since they affect the entity's capital and asset structure without affecting current cash flows.
This is practical guidance written for audit teams, not an authoritative statement of any standard or statute. Standards, forms and timelines change. Check the current text issued by the ICAI and the relevant authority before relying on anything here in an audit file.
Related resources
- Audit documentationInd AS 1: presentation of financial statements, and what a complete set actually requiresFour statements plus notes isn't optional structure — Ind AS 1 defines exactly what counts as a complete set, and a financial statement missing one piece isn't compliant regardless of how good the other three look.
- Bank, cash & treasuryBank reconciliation audit procedure for statutory auditWhat a BRS must reconcile, the red flags that separate a timing difference from a cover-up, and how many months you actually need to review.
- Audit data & extractsExtracting a usable general ledger for audit testingDate, voucher type, narration, debit, credit, running balance: what a general ledger extract needs, and why a day-book export and a ledger-wise export are not interchangeable.
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