Determinants of cash flow classification under IAS 7: an analysis from a weak equity country

Accounting standards generally require the separate reporting in financial statements of flows and obligations arising from the provision of finance to the firm from those arising from other activities, called operating. However, this distinction in financial reporting has been a source of interpretative doubts and different practices. International Financial Reporting Standards (IFRS) too concede that the definitional issues are not clear; IAS 7 - Cash flow statements allows firms to re-port cash flows from interest paid, interest received, dividends paid, and dividends received in the operating, investing, or financing section of the cash flow statement. The flexibility offered by IAS 7 allows man-agers, for instance, to improve the reported operating cash flow, by classifying interest paid as cash flow from financing operations. We analyze the cash flow statements of all the non-financial companies listed on the Italian stock market and reporting under IFRS. We expect that, for companies based in a country where the role of debt financing is relevant, classification choices can affect the cash flow presentation considerably. We find that 19.8% of the companies in our sample chose to classify interest paid as cash flows from financing activities. The average effect on the reported cash flow from operations is an in-crease of 37.19%. In order to assess the determinants of this manage-rial discretional choice, we check whether variables such as financial leverage, interest expenses, company size, and profitability, can ex-plain the classification choices made by the firms.