Is Paying Interest an Operating Activity? GAAP, IFRS, IFRS 18

Yes, under U.S. GAAP paying interest is an operating activity, and it always has been. Under IFRS the answer is currently a choice between operating and financing, but that flexibility disappears in 2027 when IFRS 18 takes effect and pushes interest paid into the financing section for most companies. The classification question matters because it directly shifts reported operating cash flow, one of the numbers investors and lenders watch most closely.

The U.S. GAAP Rule

The Financial Accounting Standards Board requires every interest payment to sit in the operating activities section of the statement of cash flows. The reasoning tracks the income statement: interest expense reduces net income, and the operating section is built to capture the cash side of everything that flows through net income.

The purpose of the underlying debt doesn’t change the answer. A company that borrows $10 million to build a factory still reports the interest on that loan as an operating outflow. Only the principal repayment goes into financing, producing a clean split between the cost of borrowing and the return of borrowed funds.¹

Interest and dividends received also land in operating activities under U.S. GAAP, since they represent returns on investments that pass through net income. The one common exception involves distributions from equity-method investees: when a distribution is effectively a return of the original investment rather than a return on it, the cash flow shifts to investing.

The IFRS Rule Today

Companies reporting under International Financial Reporting Standards follow IAS 7, which currently lets management choose. Interest paid can be classified as either an operating activity or a financing activity, and whichever approach the company selects must be applied consistently from period to period.²

The case for putting interest in financing is that it’s the cost of obtaining financial resources, so it fits alongside debt repayments.³ The case for operating mirrors the U.S. GAAP logic: interest expense hits profit or loss, so the cash payment belongs with the other items that determine it.

The choice isn’t cosmetic. For a company paying $5 million a year in interest, classifying it as financing rather than operating makes operating cash flow appear $5 million higher, even though total cash out the door is identical. IAS 7 requires companies to disclose the policy they’ve adopted, and any change in approach has to be explained in the notes.

What Changes Under IFRS 18 in 2027

IFRS 18, issued in 2024, takes effect for annual reporting periods beginning on or after January 1, 2027, and removes the classification choice that IAS 7 currently provides.⁴ Most entities will have to present interest paid as a financing activity. Early adoption is permitted.

There is one carve-out. Entities whose main business is providing financing to customers or investing in assets — banks, insurers, and similar financial institutions — may still classify interest paid as operating, because for them interest is part of the day-to-day revenue cycle rather than a peripheral cost of capital.

For any IFRS reporter currently classifying interest paid as operating, adoption will lower reported operating cash flow. Debt covenants, analyst models, and internal performance measures tied to operating cash flow will all move with it, and comparative periods have to be restated on the new basis.

Capitalized Interest Is Treated Differently

When interest is capitalized into the cost of building or constructing a long-term asset — a new plant, for instance — the cash payment does not follow the ordinary rule. Under U.S. GAAP, capitalized interest is reported as an investing activity, because the outflow relates to acquiring a productive asset rather than running the business.¹

Under IFRS, the classification depends on what is being built. Interest capitalized into property, plant, and equipment generally goes to investing. Interest capitalized into inventory — goods that take a substantial period to get ready for sale — is treated as operating, consistent with other inventory-related outflows.

The supplemental disclosure of interest paid under U.S. GAAP shows the figure net of amounts capitalized, so a reader can see both the total interest burden and how much of it was routed to investing.

Cash Interest Paid Versus Interest Expense

The interest paid figure on the cash flow statement and the interest expense figure on the income statement often diverge, sometimes sharply. Interest expense includes non-cash pieces such as amortization of bond discounts or premiums and accrued interest that hasn’t been paid yet, none of which involved cash leaving the bank during the period.⁵

A company that issued bonds at a discount will report higher interest expense than the cash it actually sends to bondholders each period. Discount amortization pushes up the expense on paper but does not represent money leaving the account until the bonds mature. The cash flow statement strips those adjustments out and reports only the dollars that changed hands.

Creditors tend to focus on the cash figure, because it shows whether a company can actually meet its debt obligations in real time. A business might report modest interest expense thanks to favorable accounting treatment while facing heavy cash outlays to service its debt, or the reverse. That gap widens with complex debt structures involving zero-coupon bonds, payment-in-kind notes, or variable-rate instruments.

Where to Find the Number in the Statements

Most companies use the indirect method to present operating cash flows, starting with net income and adjusting for non-cash items. Interest paid gets absorbed into that reconciliation rather than appearing as its own line, so both frameworks require a separate disclosure of the total cash paid for interest during the period. Under U.S. GAAP the figure is reported net of any interest capitalized.¹

The disclosure usually sits at the bottom of the cash flow statement or in the footnotes. Under IFRS, IAS 7 requires the same separate disclosure regardless of whether the payment was classified as operating or financing, and the company must also disclose which classification policy it has adopted.³

Why the Classification Matters

Cash flow classification errors are consistently among the leading causes of financial statement restatements. The SEC’s Office of the Chief Accountant has stated that a classification error on the cash flow statement is not automatically immaterial just because total cash flow is unchanged; moving interest between sections changes how investors understand the nature of a company’s cash generation.⁶

Loan covenants often reference operating cash flow directly, so reclassifying interest can push a borrower into technical default even when nothing about the underlying business has changed. The SEC has emphasized that the cash flow statement deserves the same level of internal controls and audit attention as the income statement and balance sheet.⁶

For multinational companies that report under both frameworks, the mismatch is worth tracking closely. U.S. GAAP mandates operating, IFRS today allows a choice, and IFRS 18 will make financing the default for most non-financial IFRS reporters starting in 2027. The same interest payment can sit in different sections depending on which set of standards governs the filing.

1
Financial Accounting Standards Board (FASB). Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash Payments
2
IFRS Foundation. International Accounting Standard 7 Statement of Cash Flows
3
IFRS Foundation. IAS 7 Statement of Cash Flows
4
IFRS Foundation. Primary Financial Statements
5
BDO USA, P.C. Statement of Cash Flows Under ASC 230
6
U.S. Securities and Exchange Commission. The Statement of Cash Flows: Improving the Quality of Cash Flow Information Provided to Investors