Description

IFRS - 18

Key Notes:

v  IAS 1 ‘Presentation of Financial Statements’ is replaced by new standard IFRS 18, while making no changes in many of the requirements

v  The new requirements under IFRS 18 are:

Ø  to present specified categories and defined subtotals in the statement of profit or loss

Ø  to provide disclosures on management-defined performance measures (MPMs) in the notes to the financial statements

Ø  improve aggregation and disaggregation

v  IAS 8 ‘Accounting Policies, Changes in Accounting Estimates and Errors’ and IFRS 7 ‘Financial Instruments: Disclosures’ will carry out some of the requirements in IAS 1 (IASB is changing the title of the IAS 8 to ‘Basis of Preparation of Financial Statements to reflect the extended content of IAS 8, once IFRS 18 is effective.)

v  IAS 7 ‘Statement of Cash Flows’ and IAS 33 ‘Earning per Share’ are also subjected to minor amendments by IASB

v  IFRS 18 requires retrospective application with specific transition provisions

v  IFRS 18 is required for annual reporting periods by an entity beginning on or after January 1st 2027 with earlier application submitted.

  

Background

To account for the investors’ concerns about the comparability and transparency of entities’ performance reporting, IASB initiated its primary financial statements project in 2016.

IASB published ED/2019/7 General Presentation and Disclosures in December 2019. IASB reconsidered the proposals taking into account the comments received from investors and entities. The proposals have been concluded in IFRS 18 with some changes.

Following proposal in the ED were not concluded by IASB:

·         The prohibition to analyze operating expenses by both nature and function i.e., a ‘mixed presentation’

·         The requirement to distinguish joint ventures from integral and non-integral associates

·         The requirements to disclose unusual items in a single note (unusual items means income and expenses with limited predictive value)

IAS 1 is replaced by IFRS 18 without making changes to many requirements, but complementing them with new requirements. Some paragraphs are moved from IAS 1 to IAS 8 and IFRS 7 and minor amendments are made to IAS 7 and IAS 33.

Major amendments

IFRS 18 has classified the following categories to classify income and expenses included in profit and loss. An entity requires to classify income and expenses into one of these categories:

·         operating

·         investing

·         financing

·         income taxes

·         discontinued operations

Each entity is required to follow the above classification module. However, some modifications are allowed for entities that invest in assets as a main business activity (example; investment entities, investment property entities and insurers) and entities that provide financing to customers as a main business activity (example; banks and financial institutions).

 

Explanation of categories:

Operating Category

The operating category includes all the items of income and expenses that are not included in any other categories. It also includes income and expenses from additional business activities and is not limited to income and expenses of the entity’s main business activity. To conclude, the operating category is a default category that includes income and expenses that do not meet the requirements to be classified into any other categories.

Investing Category

The investing category includes income and expenses from:

·         investments in joint ventures, associates and unconsolidated subsidiaries

·         cash and cash equivalents

·         other assets that generate a return individually and hugely independently of the entity’s other resources

‘Income and Expenses’ classified in the investing category comprises of following:

·         income generated by the assets

·         income and expenses that arise from the initial and subsequent measurement of the assets, including derecognition of the assets

·         incremental expenses directly attributable to the acquisition and disposal of the assets (costs incurred during the sale of assets)

 

Examples of income and expenses classified under investing category are as follows:

·         the share of profit of joint venture and associates accounted for using the equity method

·         interest revenue from debt investments

·         dividends from equity investments

·         rental income and fair value gains or losses from investment properties

 

Financing Category

The financing category includes income and expenses incurred during generation of finance for the entity, whether the transaction includes only generating finance or not.

Income and expenses that involve generating finance only are:

·         debt instruments settled in cash

·         bonds that are settled against the entity’s own shares

Income and expenses that do not involve generating finance only are:

·         payables for goods or services

·         lease liabilities

·         defined benefit pension liabilities

The financing category includes following income and expenses:

·         income and expenses that arise from the initial and subsequent measurement of the liabilities, including derecognition of the liabilities

·         incremental expenses directly attributable to the issue and extinguishment of the liabilities i.e, transaction costs

 

Income Taxes Category

The income taxes category includes the following income and expenses:

·         tax expense or income included in profit or loss under under IAS 12 Income Taxes

·         any related foreign exchange differences

 

Discontinued Operations Category

The discontinued operations category includes income and expenses from discontinued operations under IFRS 5 ‘Non-current Assets Held for Sale and Discontinued Operations’.

 

Illustration of Profit and Loss Statement

IFRS 18 gives an example of Statement of profit and loss which is extracted below for reference. The illustration indicates that the entities are required to present two new defined subtotals viz. ‘operating profit’ and ‘profit before financing and income taxes’ in addition to the total profit and loss.

Statement of Profit or Loss

Particulars	Year 1	Year 2	Category
Total Revenue	xx	xx	Operating Category
Less: Cost of Sales	(xx)	(xx)
Gross Profit	xx	xx
Other Operating Income	xx	xx
Selling Expenses	(xx)	(xx)
Research and Development Expenses	xx	xx
General and Administrative Expenses	(xx)	(xx)
Goodwill Impairment Loss	-	(xx)
Other Operating Expenses	(xx)	(xx)
Operating Profit	xx	xx
Share of profit and gains on disposal of associates and joint ventures	xx	xx	Investing Category
Profit before financing and income taxes	xx	xx
Interest expenses on borrowing and lease liabilities	(xx)	(xx)	Financing Category
Interest expenses on pension liabilities and provisions	(xx)	(xx)
Profit before income taxes	xx	xx
Income tax expenses	(xx)	(xx)	Income Tax Category
Profit from continuing operations	xx	xx
Loss from discontinued operations	(xx)	(xx)	Discontinued Operations Category
Profit	xx	xx

 

 

Requirements for entities with specified main business activities

As per IFRS 18, there are two types of ‘specified main business activities’ viz. investing in assets and providing financing to customers as main business activities. Entities involved in such specified main business activities are required to classify some income and expenses in the operating category that would be classified in investing or financing category in other cases.

 IFRS 18 provides detailed guidance on factors to be considered for the assessment in the cases where an entity may invest in assets or provides financing to customers. There are some entities like investment entities and retail banks which may invest in assets as well as provide financing to customers as its main business activities.

 

Classification of Specific Income and Expenses

·         Fair value gains and losses on derivatives: The use of derivatives to manage exposure to identified risks or use as hedging instruments determines the classification of fair value gains and losses on derivatives.

·         Foreign exchange differences: Foreign exchange differences belong to the same category of income and expenses that induced the differences. For example, foreign exchange difference is induced due to the payable for purchase of goods. In this case, purchase of goods is classified under operating category and the foreign exchange difference is also classified under the same category. The classification to the same category is allowed if the income and expenses that induces the differences would involve undue cost or effort.

·         Income and expenses from hybrid contracts: The separation of embedded derivative from host liability and the nature of the hybrid contract determines the classification of income and expenses from hybrid contracts comprising host liabilities and embedded derivatives.

 

Management-defined performance measures (MPMs)

The subtotals of income and expenses that meet all of the following criteria are MPMs:

·         Used for public communications outside financial statements like management commentary, press releases and investor presentations. However, oral communications, written transcripts of oral communication or social media posts are not recognized as MPMs

·         Used for communicating the investors management’s view of an aspect of the financial performance of the entity as a whole. A subtotal of income and expenses that an entity uses in public communications outside its financial statement is presumed to communicate management’s view of an aspect of the financial performance of the entity as a whole, unless the entity rebuts the presumption

·         Are not listed in IFRS 18 or specifically required by IFRS Accounting Standards.

 

Disclosure Requirements

Information about an entity’s MPMs is required to be disclosed in a single note to the financial statements. The note should state that the MPMs provide management’s view of an aspect of the financial performance as a whole and are not necessarily comparable with measures having similar descriptions or labels provided by other entities.

An entity is required to disclose the following information for each MPM:

·         an explanation of the aspect of financial performance that it communicates including the reason for the management to believe that MPM provides useful information about the financial performance of the entity

·         an explanation showing calculation of MPM

·         a reconciliation between the MPM and the most directly comparable subtotal listed in IFRS 18 or total or subtotal required by IFRS Accounting Standards. Each item disclosed in the reconciliation requires:

Ø  income tax effect

Ø  effect on non-controlling interests

·         an explanation on how the income tax effect is determined by the entity

Following information must be disclosed, if the entity ceases to use a previously disclosed MPM or introduces a new MPM or changes the method of calculation of an MPM:

·         an explanation of the cessation, addition or change and its effects

·         the reasons for cessation, addition or change

·         reflect the cessation, addition or change through a comparative statement, unless it is impracticable to do so

IFRS 18 specifies that the subtotals of operating profit or loss before depreciation, amortization and impairments within the scope of IAS 36 ‘Impairment of Assets’ (OPDAI) are not MPMs and are not subject to the above mentioned requirements.

Note:

Earnings before interest, tax, depreciation and amortization (EBITDA) is not included in the list of subtotals. EBITDA is one of the commonly used measures for users of financial statements but it is not used by entities in some industries like banking and insurance. Although EBITDA is a starting point for various analyses, no conclusion could be derived on what it represents.

The definitions of MPM might be met by EBITDA but OPDAI provides information similar to many of the EBITDA measures currently provided. The IASB included OPDAI only in the list of subtotals in IFRS 18.

 

Roles of primary financial statements and notes

The financial information about the entity’s recognized assets, liabilities, equity, income and expenses is provided by the financial statements. Such information is useful to investors in assessing the prospects for future net cash inflows to the entity and management’s administration of the entity’s economic resources.

The primary financial statements and notes have the following roles in providing financial information:

·         primary financial statements  provide structured summaries of an entity’s recognized assets, liabilities, equity, income, expenses and cash flows which are useful for:

Ø  obtaining an overview of the entity’s recognized assets, liabilities, equity, income, expenses and cash flows

Ø  drawing comparisons between entities and between reporting periods for same entity

Ø  recognizing items for which the users of financial statements may look for additional information in the notes

·         the notes provide material information required for:

Ø  enabling the investors to understand the items in the primary financial statements

Ø  complementing the primary financial statements with additional information to achieve the objective of the financial statements

 

Aggregation and Disaggregation of Information

Principles for aggregation and disaggregation of information

Aggregation or disaggregation of information about individual transactions and other events into the information presented in the primary financial statements and disclosed in the notes is required by IFRS 18 for entities.

As per IFRS 18, following principles are required to be ensured by the entities:

·         items of similar characteristics are aggregated and dissimilar characteristics are disaggregated

·         items are aggregated or disaggregated based on primary financial statements fulfilling their roles

·         material information is not concealed due to aggregation or disaggregation

IFRS 18 provides application guidance on aggregating and disaggregating items and labelling aggregated items and consideration to be made for assessing the information for similarities and dissimilarities of characteristics. Disaggregation of information is essential when the resulting information is material.

 

Presentation of operating expenses

As per IFRS 18, classification and presentation of operating expenses should provide the most structured summary of expenses of the entities, using one or both of the following characteristics:

·         function of the expenses (example; cost of sales)

·         nature of the expenses (example; employee benefit expenses, raw material expenses)

The line items that provide the most useful information about the main components or drivers of the entity’s profitability and industry practice is one of the factors to be considered for presentation of operating expenses. Such other factors should be recognized and considered for deciding on how to present operating expenses.

Disclosure of amounts for specified expenses by nature in a single note to the financial statements is required by an entity that presents one or more line items for operating expenses classified by function.