First things first, a loan can be repaid in number of ways for example in cash, by handing over certain asset or converting debt to shares etc. But if the repayment does not involve cash outflow then such transaction will not be disclosed in the statement of cash flows.
A loan installment mostly has two components or elements in it:
- Interest which is basically debt servicing cost
- Principal or capital which is simply the actual amount paid back towards borrowings
Therefore, if the payment involves the above two elements then we first have to split the total amounts into its components i.e. interest component and principal component. The reason is that IAS 7 requires the disclosure of two components separately.
Principal or capital amount repaid is disclosed under financing activity where as interest actually paid, NOT interest expense, can be disclosed as an outflow either under operating activity or financing activity.
Remember that principal amount repaid is classified under financing activity. It is just the interest paid on such borrowings for which entity has the option to either disclose under operating activity head of statement of cash flows or financing activity heading. To read more about the choices entity has for interest paid and received and the reasons for such choices please check out our detailed answer: How interest and dividends are disclosed in statement of cash flows?
Example:
ABC Ltd has taken a loan of 30,000 at the start of current year which is payable by the end of the year. Interest charged is 10% per annum. Company is preparing its financial statements for the current year ended.
Solution:
Total amount borrowed (principal amount) = 30,000
Total interest payable = 30,000 x 10% = 3,000
Total amount payable (principal + interest) = 33,000
Although the company would make a lump sum payment of 33,000, it will be divided into principal amount and interest paid i.e. 30,000 cash outflow will be reported under financing activities and 3,000 can be reported either under operating activities or financing activities.
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Thanks for making things clear on this post with regards to a disclosed statement cash flows. I was thinking of this issue lately because I don’t know some of the flows in loan repayments and some other things with regards to loaning.