How interest and dividends are classified in the statement of cash flows under IAS 7 and ASC 230

Interest and dividend cash flows are among the few items in the statement of cash flows where IFRS has long allowed a choice and US GAAP has not. Under IAS 7 Statement of Cash Flows, a company that is not a financial institution can show interest paid in operating or financing activities, interest and dividends received in operating or investing activities, and dividends paid in financing or operating activities. Under ASC 230 Statement of Cash Flows, interest paid, interest received and dividends received are operating cash flows and dividends paid are financing cash flows, with no election.

The difference is small in the total but large in the subtotals. Two companies with identical cash movements can report different cash flows from operating activities, which feeds directly into free cash flow, cash conversion ratios and some loan covenant definitions. The gap is also about to narrow from the IFRS side: IFRS 18 Presentation and Disclosure in Financial Statements, effective for annual reporting periods beginning on or after 1 January 2027, amends IAS 7 and removes the presentation alternatives for most entities.

The classification question arises every reporting period for any company with borrowings, cash deposits, equity investments or a dividend policy, and again whenever a group converts between frameworks, prepares for the first application of IFRS 18 or compares its cash flow metrics with peers reporting under the other framework.

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HOW IAS 7 CLASSIFIES INTEREST AND DIVIDENDS TODAY.

IAS 7 starts from a disclosure rule. Paragraph 31 requires cash flows from interest and dividends received and paid each to be disclosed separately, and each to be classified in a consistent manner from period to period as operating, investing or financing activities. The standard does not net interest paid against interest received, and it does not allow a company to move an item between categories from one year to the next without treating the move as a change in accounting policy.

Paragraph 33 then describes the practice. For a financial institution, interest paid and interest and dividends received are usually classified as operating cash flows, because they arise from its principal revenue-producing activities. For other entities, the standard acknowledges that there is no consensus. Interest paid and interest and dividends received may be classified as operating because they enter into the determination of profit or loss, or interest paid may be classified as financing and interest and dividends received as investing, because they are costs of obtaining financial resources or returns on investments.

Paragraph 34 applies the same logic to dividends paid. They may be classified as a financing cash flow because they are a cost of obtaining financial resources, or as an operating cash flow so that users can assess the entity's ability to pay dividends out of operating cash flows.

Paragraph 32 adds a rule for borrowing costs. The total amount of interest paid during a period is disclosed in the statement of cash flows whether it has been recognised as an expense in profit or loss or capitalised in accordance with IAS 23 Borrowing Costs. A company that capitalises interest into a construction project therefore still shows the full cash outflow for interest somewhere in its disclosures.

The definitions in paragraph 6 frame the choice. Operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing. Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Financing activities are those that change the size and composition of contributed equity and borrowings. Interest paid sits at the boundary between the cost of running the business and the cost of financing it, which is why IAS 7 tolerated both readings for so long.

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HOW IFRS 18 CHANGES THE IAS 7 OPTIONS FROM 2027.

IFRS 18 replaces IAS 1 and carries consequential amendments to IAS 7. According to the IASB's effects analysis of the new standard, the amendments make two changes relevant to interest and dividends: they require all companies to use the operating profit subtotal as the starting point for the indirect method, and they remove the presentation alternatives for cash flows related to interest and dividends paid and received.

For a company with no specified main business activity, the effects analysis sets out the new classification. Interest received and dividends received move to investing activities. Interest paid and dividends paid move to financing activities. The operating category no longer contains any of the four items.

Companies whose main business activity is investing in assets or providing financing to customers, such as banks, follow a different rule. They are required to classify interest received, interest paid and dividends received in a single category of the statement of cash flows. Dividends paid remain in financing activities.

IFRS 18 is applied retrospectively. A company reporting for the year beginning 1 January 2027 restates its comparative statement of cash flows for 2026 on the new basis, so any company that currently reports interest paid in operating activities will see its comparative operating cash flows increase on transition, with an equal decrease in financing cash flows.

The new starting point for the indirect method also changes the reconciliation. Starting from operating profit instead of profit or loss means that interest expense, interest income, dividend income and the share of profit of associates and joint ventures no longer appear as reconciling items, because they are already outside operating profit. The IASB's effects analysis reports that only 7% of the companies it sampled used operating profit as the starting point before the amendments, against 47% using profit or loss and 45% using profit before tax.

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INTEREST AND DIVIDEND CASH FLOWS UNDER ASC 230.

US GAAP fixes the classification in the Codification. ASC 230-10-45-16(b) lists cash receipts from returns on loans, other debt instruments of other entities and equity securities, meaning interest and dividends received, as operating inflows. ASC 230-10-45-17(d) lists cash payments to lenders and other creditors for interest as operating outflows. ASC 230-10-45-15(a) lists payments of dividends or other distributions to owners as financing outflows.

Interest paid is disclosed net of amounts capitalized. Companies that use the indirect method disclose the amounts of interest paid (net of amounts capitalized) and income taxes paid in related disclosures, so the cash outflow for capitalized interest is not part of the operating figure for interest paid.

ASU 2016-15 Classification of Certain Cash Receipts and Cash Payments addressed several fact patterns that touch interest and returns on investments:

- On settlement of a zero-coupon or insignificant-coupon debt instrument, the portion of the cash payment attributable to accreted interest is an operating outflow and the portion attributable to principal is a financing outflow.

- Cash payments for debt prepayment or debt extinguishment costs are financing outflows.

- Distributions from equity method investees are classified under an accounting policy election, applied consistently: the cumulative earnings approach treats distributions as operating returns on investment until they exceed cumulative equity in earnings, with the excess in investing activities; the nature of the distribution approach classifies each distribution according to the activity of the investee that generated it.

- When a cash flow has aspects of more than one class and cannot be separated, it is classified according to the activity that is likely to be the predominant source or use of cash.

IAS 7 contains no comparable list of specific fact patterns. An IFRS reporter applies the general definitions and its chosen policy, which is one reason the same transaction can appear in different categories across frameworks even after IFRS 18.

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IAS 7 VS ASC 230: CLASSIFICATION COMPARED.

The table summarises the classification for a company that is not a financial institution and has no specified main business activity.

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Cash flow	IAS 7 before IFRS 18	IAS 7 after IFRS 18	ASC 230
Interest paid	Operating or financing	Financing	Operating
Interest received	Operating or investing	Investing	Operating
Dividends received	Operating or investing	Investing	Operating
Dividends paid	Financing or operating	Financing	Financing
Interest capitalized	Total interest paid disclosed	Total interest paid disclosed	Interest paid shown net of amounts capitalized
Indirect method start	Profit or loss in practice, various	Operating profit	Net income

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Two consequences follow. From 2027, an IFRS reporter with no specified main business activity and a US GAAP reporter will show interest paid in different categories with no option to align them, because IFRS 18 moves it to financing and ASC 230 keeps it in operating. Whenever interest paid exceeds interest and dividends received, a US GAAP company will therefore show lower operating cash flows than an otherwise identical IFRS reporter, for as long as the frameworks stay as they are.

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WORKED EXAMPLE: INTEREST AND DIVIDEND CASH FLOWS WITH JOURNAL ENTRIES.

The figures below are illustrative. A company reports interest expense of 480 for the year. Interest payable was 60 at the start of the year and 90 at the end, so cash interest paid is 450. It reports interest income of 130, with interest receivable rising from 20 to 30, so cash interest received is 120. It receives dividends of 80 in cash from equity investments, and it declares and pays dividends of 600 to its shareholders. Other operating cash flows, from customers, suppliers, employees and taxes, are a net inflow of 5,000. It spends 2,000 on property, plant and equipment and repays 1,000 of loan principal.

The journal entries for the interest and dividend items are as follows.

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Entry	Account	Debit	Credit
1. Accrue interest	Interest expense	480
	Interest payable		480
2. Pay interest	Interest payable	450
	Cash		450
3. Accrue interest income	Interest receivable	130
	Interest income		130
4. Collect interest	Cash	120
	Interest receivable		120
5. Receive dividends	Cash	80
	Dividend income		80
6. Declare dividends	Retained earnings	600
	Dividends payable		600
7. Pay dividends	Dividends payable	600
	Cash		600
Total		2,460	2,460

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The statement of cash flows reports the cash entries (2, 4, 5 and 7), never the accruals. Under the indirect method, the increase of 30 in interest payable is added back and the increase of 10 in interest receivable is deducted, which converts the income statement amounts of 480 and 130 into the cash amounts of 450 and 120.

The same cash movements produce the following subtotals under the classification approaches.

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Subtotal	ASC 230, or IAS 7 operating policy	IAS 7 after IFRS 18	IAS 7 with dividends paid in operating
Operating activities	4,750	5,000	4,150
Investing activities	-2,000	-1,800	-2,000
Financing activities	-1,600	-2,050	-1,000
Net increase in cash	1,150	1,150	1,150
Free cash flow (operating less capex)	2,750	3,000	2,150

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Under ASC 230, operating cash flows of 4,750 are the other operating inflow of 5,000 plus interest received of 120 and dividends received of 80, less interest paid of 450. Financing outflows of 1,600 are the loan repayment of 1,000 and dividends paid of 600. Under IAS 7 as amended by IFRS 18, operating cash flows stay at 5,000, investing outflows fall to 1,800 because the 200 of interest and dividends received are investing inflows, and financing outflows rise to 2,050 because interest paid of 450 joins the loan repayment and dividends.

The net increase in cash is 1,150 in every column. The free cash flow figure, defined here as operating cash flows less capital expenditure, ranges from 2,150 to 3,000 for the same company in the same year, a spread of 850 created entirely by presentation.

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PRESENTATION AND DISCLOSURE OF INTEREST AND DIVIDEND CASH FLOWS.

Under IAS 7, each of the four items is presented separately and the chosen classification is applied consistently. A company that changes its classification before IFRS 18 applies is changing an accounting policy and applies the change retrospectively under IAS 8, with comparatives restated and the change disclosed. On the first application of IFRS 18, the reclassification is part of the retrospective transition to the new standard, and a company can explain the resulting movement between operating, investing and financing cash flows alongside its transition disclosures.

Income taxes follow a separate rule in both frameworks. IAS 7 paragraph 35 requires cash flows arising from taxes on income to be separately disclosed and classified as operating cash flows unless they can be specifically identified with financing and investing activities. Taxes paid on interest income or on dividends received are therefore usually not reclassified alongside the interest or dividend itself.

Under US GAAP, the supplemental disclosure of interest paid net of amounts capitalized and income taxes paid applies when the indirect method is used. Companies that elected the cumulative earnings or nature of the distribution approach for equity method distributions apply that election consistently, and a forced move from one approach to the other for an investee is accounted for as a change in accounting principle.

For readers working through the full mechanics of a cash flow statement, the Data Studios guide on how to prepare the statement of cash flows under IFRS and US GAAP walks through each section, and the comparison of direct and indirect methods and the three activity categories covers the structure in which these classification choices sit.

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COMMON ERRORS IN CLASSIFYING INTEREST AND DIVIDEND CASH FLOWS.

The most frequent error is presenting the income statement amount instead of the cash amount. Interest expense includes accruals, the unwinding of discounts on provisions, and the amortisation of transaction costs under the effective interest method, none of which is a cash payment in the period. The cash figure comes from the movement in the related payable and from the actual coupons settled.

A second error is netting. IAS 7 requires interest and dividends received and paid to be disclosed separately, so a single net finance cost line in the statement of cash flows does not meet the requirement.

A third area is capitalised interest. Under IAS 7 the total interest paid is disclosed whether expensed or capitalised, while US GAAP reports interest paid net of amounts capitalized. A group reporting under both frameworks, or reconciling a US subsidiary into an IFRS consolidation, needs a bridge between the two figures.

A fourth area is the scope of the specified main business activity rule in IFRS 18. Treasury centres, captive finance subsidiaries and holding companies that invest in subsidiaries need to assess whether they have such an activity, because the answer decides whether interest and dividends follow the general rule or the single-category rule. Restricted balances add a further layer, discussed in the Data Studios article on classification and measurement of restricted cash.

A fifth area is metric definitions. Loan agreements, management incentive plans and investor presentations often define free cash flow or cash conversion by reference to operating cash flows. When IFRS 18 moves interest paid out of operating activities, a covenant drafted on the old basis may give a different result even though nothing in the business has changed, and those definitions need to be checked before the 2027 comparatives are restated.

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INTEREST AND DIVIDEND CLASSIFICATION UNDER IAS 7 AND ASC 230: PRACTICAL CHECKLIST.

The classification of these four cash flows is settled under US GAAP and will be largely settled under IFRS from 2027, but the two frameworks will land in different places for interest paid and for interest and dividends received. Preparers and analysts can work through the following points:

- Identify the current IAS 7 policy for each of the four items and confirm it has been applied consistently in every period presented.

- Compute interest paid and received from cash movements, separating accruals, discount unwinding and effective interest amortisation.

- Under IFRS, disclose total interest paid including capitalised amounts; under US GAAP, disclose interest paid net of amounts capitalized.

- Assess whether the entity has a specified main business activity under IFRS 18 before mapping interest and dividends to the new categories.

- Restate the 2026 comparative statement of cash flows for IFRS 18 and quantify the movement between operating, investing and financing activities.

- Under US GAAP, document the election for equity method distributions and the treatment of zero-coupon settlements and debt extinguishment costs.

- Review covenants, incentive targets and published free cash flow definitions that rely on operating cash flows, and update them or disclose the bridge.

For a reader comparing two companies, the safest approach is to rebuild operating cash flows on a common basis, moving interest and dividends to the same categories for both, before comparing free cash flow or cash conversion. The illustrative company above carries a spread of 850 on identical cash movements, and a gap of that kind will persist between IFRS and US GAAP reporters after 2027 unless the FASB changes ASC 230.

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