The Cash Flow Statement Under IFRS 18: The Indirect Method Starts at Operating Profit, and Interest Paid Moves to Financing for Most Companies

The cash flow essay in SOCPA's September 2025 mock Financial Accounting paper has the company show dividends paid in operating activities, and its model answer starts the indirect method from net profit. Both were right for 2025; neither is allowed for a year beginning on or after 1 January 2027. IFRS 18 (not the old IAS 18 Revenue) amended IAS 7 to start the indirect method at operating profit, put dividends paid in financing and remove the free choices for interest and dividends.

For most companies the visible effect is one number: interest paid moves to financing and interest and dividends received to investing, so the same cash gives a different operating cash flow. It lands on a weak spot, too: SOCPA's 2025 report on low-performance topics lists cash and the statement of cash flows second of sixteen in Financial Accounting.

What changed in IAS 7, and what did not

The amendments apply when IFRS 18 does (IAS 7 paragraph 64) and set no transition method of their own, so, like IFRS 18 itself (paragraph C2), they apply retrospectively (IAS 8 paragraph 19(b)) and 2026 comparatives are restated. SOCPA endorsed them with IFRS 18 on 25/06/1446H (26 December 2024).

Paragraph 18(b) makes operating profit or loss the starting point, and paragraph 20 adjusts it for working capital, non-cash operating items such as depreciation, operating-category items whose cash is investing or financing, and operating cash flows, such as income tax, whose income or expense is outside that category. The choices in old paragraphs 33 and 34 are deleted. Paragraph 33A puts dividends paid in financing; paragraph 34A puts interest paid, capitalised interest included, in financing and interest and dividends received in investing for every entity without a specified main business activity.

What did not change: the direct method, explained in Cash Flow Statement: Direct vs Indirect Method, is still encouraged (paragraph 19), taxes on income stay operating unless specifically identified with investing or financing (paragraph 35), and the activity definitions were not aligned with IFRS 18's categories, so an item can be investing in the income statement and operating in the cash flow statement. The IASB's tentative cash flow decisions of 28 October 2026 leave interest and dividends alone.

One SOCPA-style essay, solved both ways

An illustrative company with no specified main business activity, in SAR thousands: depreciation of property, plant and equipment and right-of-use assets of 2,100 sits in operating expenses; receivables rose by 900, inventories fell by 400, payables rose by 300; rent and interest were received and paid as recognised; the associate paid no dividend.

Income statement, SAR thousands	Amount
Revenue	50,000
Cost of sales	(32,000)
Selling and administrative expenses	(9,000)
Goodwill impairment	(1,200)
Operating profit	7,800
Rent from investment property	600
Depreciation of investment property	(150)
Share of profit of associate	900
Interest income on bank deposits	200
Profit or loss before financing and Zakat and income taxes	9,350
Interest on bank loans	(1,100)
Interest on lease liabilities	(300)
Profit or loss before Zakat and income taxes	7,950

The labels are SOCPA's; IFRS as issued says "before financing and income taxes". Items between the first two subtotals are investing (IFRS 18 paragraph 53 and B46), those after them financing; a full restatement is in IFRS 18 vs IAS 1: One Saudi Income Statement Restated Line by Line. Required: the indirect-method operating section for 2026 and 2027.

Operating section, SAR thousands	2026: old IAS 7	2027: amended IAS 7
Starting point	Profit before zakat and income tax 7,950	Operating profit 7,800
Depreciation, PP&E and right-of-use assets	2,100	2,100
Goodwill impairment	1,200	1,200
Depreciation of investment property	150	Disappears
Share of profit of associate	(900)	Disappears
Interest income	(200)	Disappears
Finance costs	1,400	Disappears
Increase in receivables	(900)	(900)
Decrease in inventories	400	400
Increase in payables	300	300
Operating-category items	No such subtotal	10,900
Rent received, paragraph 20(d)	Inside profit already	600
Cash generated before interest, zakat and income tax	11,500	11,500

Four adjustments disappear because their items are no longer inside the starting figure. One appears: IAS 7's definition of investing activities (paragraph 6) does not include rent, so the 600 received is an operating cash flow whose income is investing, added under paragraph 20(d). Stopping at 10,900 misses the rent; adding finance costs back to operating profit reverses an expense never deducted.

Below that line, a 2026 policy that kept interest in operating activities deducted interest paid of 1,400 and added interest received of 200: 10,300 before zakat and income tax. In 2027 those go to financing and investing, and the same cash reports 11,500.

Interest and dividends: an ordinary company against a bank or an investor

Cash flow	Until 2026	From 2027: ordinary company	From 2027: bank or investor	US GAAP
Interest paid, capitalised included	Operating or financing	Financing (34A)	Follows profit or loss (34B to 34D)	Operating; capitalised: investing
Interest received	Operating or investing	Investing (34A)	Follows profit or loss (34B to 34D)	Operating
Dividends received	Operating or investing	Investing (34A)	Follows profit or loss (34B to 34D)	Operating
Dividends paid	Financing or operating	Financing (33A)	Financing (33A)	Financing

A bank or investor provides financing to customers or invests in assets as a main business activity (IFRS 18 paragraphs B30 to B41). Its interest and dividend cash flows follow the related income or expense, one category each (IAS 7 paragraphs 34B and 34C). A bank's deposit interest is operating (IFRS 18 paragraph 65(a)(i)) but its lease interest is financing (paragraph 65(b)(i)), so paragraph 34D makes it pick one activity for all interest paid. An investment company's interest and dividend income is operating (paragraphs 56(a) and 58), and so is the cash (see Operating, Investing or Financing Under IFRS 18: 40 Income Statement Lines Classified).

Zakat paid, income taxes and the sale of property, plant and equipment

SOCPA's endorsed IAS 7 (item 4 of its endorsement document) adds zakat to paragraphs 14(f) and 35: cash flows from taxes on income and zakat are shown separately and are operating unless specifically identified with investing or financing, because "Saudi companies are required to pay Zakat". The expense sits in the Zakat and income taxes category (IFRS 18 paragraph 67 as endorsed), outside operating profit, so zakat and income tax paid are deducted under paragraph 20(d).

Outside the Kingdom the IASB text is silent on zakat and the expense's category is still open (see Accounting for Zakat in Saudi Financial Statements), but zakat paid is neither investing nor financing, so it is operating by default (paragraph 6).

Now sell a machine carried at 700 for 1,000. The 300 gain is operating, because plant earns its return only with other resources (IFRS 18 paragraphs B48 and B49), while the 1,000 is investing (IAS 7 paragraph 16(b)). So the 2027 reconciliation still deducts the 300 under paragraph 20(c): the gain is inside the starting figure. A gain on the investment property sits in investing, so nothing comes off operating profit.

Three operating cash flow figures for one set of cash movements

Company B, a Saudi subsidiary of a US group (SAR millions), pays interest of 46 (6 on leases), receives 12 of deposit income and an 18 associate dividend, repays 22 of lease principal and spends 150 on capital expenditure. With interest paid and interest and dividends received all in operating, its old figure was 300. Amended IAS 7 gives 316: 300 plus the 46 paid, less the 12 and 18 received. On the lease difference alone, the parent's US GAAP package shows 278: an ASC 842 operating lease keeps the whole payment in operating activities, including the 22 that IFRS 16 treats as principal (ASC 842-20-45-5(c)). Company B's other GAAP differences are left aside.

Company B (SAR m)	US GAAP	Old IAS 7 policy	Amended IAS 7
Net cash from operating activities	278	300	316
Capital expenditure	(150)	(150)	(150)
Operating cash flow less capital expenditure	128	150	166
Interest paid reported elsewhere	None	None	(46)
Lease principal reported elsewhere	None	(22)	(22)
Interest and dividends received reported elsewhere	None	None	30
Free cash flow, one definition	128	128	128

Free cash flow as operating cash flow less capital expenditure gives 128, 150 or 166; the IFRS 18 figure flatters because interest paid has left the line. Build it from lines instead, subtracting interest paid and lease principal and adding interest and dividends received wherever each is reported, and all three return 128. The same goes for cash conversion ratios and for covenants on operating cash flow (Loan Covenants and Bonus Plans After IFRS 18).

The US GAAP column: ASC 230

ASC 230 never had the options: taxes and interest paid are operating outflows (230-10-45-17(c) and (d)), interest and dividends received operating inflows (230-10-45-16(b)), dividends paid financing (230-10-45-15(a)), and the indirect method reconciles from net income (230-10-45-28). From 2027 a non-financial IFRS reporter and a US GAAP company disagree on every interest and dividend row except dividends paid, and on the starting line. FAR tests only the US map (IFRS Has Not Been Tested on the CPA Exam Since July 2021); 278 against 316 is the size of the trap.

Where to practise this

On the exams: SOCPA Financial Accounting, main topic 2 (45 to 65%), subtopic 2/1, cash and the statement of cash flows, with five tasks in the February 2026 guidance framework up to analysis; SOCPA has not announced which cycle first examines IFRS 18, so answer to the year in the stem. IMA's CMA: Part 1, Section A (15%), LOS A.1.g, indirect-method preparation, with IFRS limited to six differences in LOS A.2.ff, none on cash flows. CPA: FAR Area I, Group A, Topic 5, ASC 230, up to Analysis.

Prepito's SOCPA Financial Accounting course and FAR course carry practice questions with full explanations; start with the SOCPA course's free sample questions. The CMA Part 1 and CMA Part 2 courses open soon (CMA programme). The paper is mapped in the SOCPA Financial Accounting study guide.

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Sources: IAS 7 as amended by IFRS 18 and IASB Update, October 2026; IFRS 18 as reproduced in AASB 18; SOCPA, IFRS endorsement document, low-performance topics, 2025, mock Financial Accounting questions and guidance framework; FASB, ASU 2016-15 and ASU 2016-02; AICPA Blueprints; IMA, CMA Learning Outcome Statements. Figures are illustrative; as at 3 November 2026 the IASB's cash flow project and SOCPA's exam timing are open, so check both before a 2027 sitting.