Question

explain the rationale for the classification of interest receipts and interest payments in the statement of cash flows. Further, identify where interest receipts and interest payments should theoretically be classified.

Answer 1

The interest receipts and interest payments are classified in cash flow statement as operating activities. In indirect method of cash flow adjustment is only made for interest receivable and interest payable. In direct method of cash flow cash interest receipts is shown as cash inflow and cash interest payment is shown as cash outflows. The rationale beyond this classification is interest income is received out of investments made from cash flow received from operating activities and hence they are part of operating activities. Similarly interest payments pertain to operations during the year since the capital is deployed for operational requirements of the firm.

Theoretically interest received should be classified as investment income since interest is received for investments made by firm. Interest payments should be classified as financing income since interest is paid on debt which is part of financing activities of the firm.