In Schweser exam 1 afternoon question 90, the contributions were 5000 and total periodic pension costs 4250. This means the firm reduces its overall pension obligation by 750. The question is what adjustments should be made to the cashflow, going from IFRS to GAAP. In GAAP all pension costs are reported under operating, while in IFRS principal payments in financing. So we need to adjust the financing and operating cash flow to convert from IFRS to GAAP.
The correct answer is increase operating cashflow by 750 and decrease financing cashflow by 750.
My question is, why is it not the other way around, i.e. reducing operating cash flow by 750, and increasing financing cash flow by 750?
I would think of it as paying more than what required so u repay your loan ie a financing activity my cash flow from financing decreases but my net cash flow should not be impacted therefore add back to cash flow from operations.
It is increase to CFO and a decrease CFF, because it was incorrectly logged as an outflow from CFO. It should have been an outflow from CFF, since you are overpaying, ie a principal payment which is CFF outflow.
Yes I agree. But the exercise is to adjust the cash flow statements, from IFRS to how if would be with US GAAP. With US GAAP all pension costs is operating cashflow. So why would we not increase the financing cash flow by 750 (to net out the outflow) and decrease the operating cash flow by 750, so that all 5000 would be deducted in the operating cash flow when using GAAP?
There is a major distinction in the CFO and CFF when addressing interest.
IFRS makes a split between financial institutions and everything else, i.e. if you are a financial institution then interest income/expense is part of your operating activities. For a farming company interest income/expense is a financing activity. Makes it more complicated but in the meantime also makes more sense.
In CF statement upon IFRS, interest cash flow may be operating CFO or CFF. No matter of kind of company, financial or not.
In P/L at IFRS entities net interest income/expenses are core for banks and financial institutions so in its P/L net interest income is core operating activity unlikely for companies from real sector (eg. production) where interest expenses and revenues are always financial activities.