IFRS 18 Presentation and Disclosure in Financial Statements: Be ready for a major shake-up in presentation of financial statements

IFRS 18 Presentation and Disclosure in Financial Statements: Be ready for a major shake-up in presentation of financial statements

In April 2024, the International Accounting Standards Boards (IASB) published a new IFRS Accounting Standard, viz., IFRS 18 Presentation and Disclosure in Financial Statements. IFRS 18 marks the culmination of the IASB’s Primary Financial Statements (PFS) project, running since 2014, whose objective was to improve communication in financial statements.

Once effective, IFRS 18 will replace IAS 1 and some requirements currently included within IAS 1 are moved to IAS 8 (which was also renamed as ‘Basis of Preparation of Financial Statements’) and to a much lesser, extent IFRS 7 Financial Instruments: Disclosures. There are also narrow scope consequential amendments made to other IFRS Accounting Standards including:

• IAS 7 statement of cash flows
• IAS 33 earnings per share
• IAS 34 interim financial reporting

IFRS 18 and the consequential amendments to other IFRS Accounting Standards are effective for periods beginning on or after 1 January 2027, with earlier application permitted.

While IFRS 18 represents a major overhaul of the requirements relating to presentation and disclosure of information in financial statements, many of the existing requirements in IAS 1 are carried forward. This is because the IASB has chosen to focus on targeted improvements designed to address the three key concerns expressed by users of financial statements (hereafter users), being:

• Financial statements, particularly the statement of profit or loss, are not sufficiently comparable across reporting entities
• The transparency and understandability of non-GAAP measures needs to be improved, and
• The level of disaggregation in financial statements does not always provide the information users need and material information can be obscured

New requirements in IFRS 18 are primarily intended to address these concerns. This Article deals with the key new requirements in IFRS 18 and key consequential amendments in other IFRS Accounting Standards that could impact the financial statements for most reporting entities.

What are the major changes?

The application of IFRS 18 will not impact recognition and measurement of items in the financial statements but it is expected to change how entities present and disclose their financial statements particularly the statement of profit and loss (also known as the ‘income statement’) IFRS 18 will affect the complete set of financial statements and the areas that are likely to be significantly affected include:

Key changes are explained further below:

Presentation of new categorization and subtotals in the statement of profit and loss

Under the IAS 1, there is no requirement to classify income and expenses into different ‘categories’ and it allows but does not require sub-totals. Operating profit, one of the most frequently used measures of performance, has until now not been defined in IFRS Accounting Standards, which has resulted in entities applying different definitions to the same subtotal. This has resulted in significant diversity, which makes it difficult for users of the financial statements to understand the information presented in the statement of profit and loss and compare information between entities.

To address these challenges and enhance comparability, IFRS 18 requires an entity to classify all items of income and expenses into three new and defined categories, viz., operating, investing and financing. These three categories are complemented by the requirement to present subtotals and totals for ‘operating profit or loss,’ and ‘profit or loss before financing and income taxes’.’ The first subtotal is intended to give a relevant representation of an entity’s operations, while the second is intended to allow users to analyze the performance of an entity before the effect of its financing decisions. These categories and subtotals ought to result in a more standardized statement of profit or loss.

Main business activities

For the purposes of classifying its income and expenses into the three new categories required by IFRS 18, an entity will need to assess whether it has a ‘specified main business activity’ of investing in assets or providing finance to customers, as specific classification requirements apply to such entities. Determining whether an entity has such a specified main business activity is a matter of fact and circumstances which requires judgement. An entity may have more than one main business activity.

An entity will be required to assess whether it has a ‘specified main business activity’ of investing in assets or providing finance to customers, as there are specific requirements for such entities.

The investing category

The investing category will generally include income and expenses from investments in associates, joint ventures and unconsolidated subsidiaries, cash and cash equivalents and other assets, if they generate a return individually and largely independent of the entity’s other resources (IFRS 18 includes examples of such assets). To illustrate, for entities that do not have a specified main business activity of investing in assets or providing finance to customers, income and expenses in the investing category could include:

• Income generated by the assets mentioned above (for example, interest. dividends and rental income)
• Income and expenses that arise from the initial and subsequent measurement of those assets, including on derecognition of the assets (for example, impairment losses and reversals of impairment losses)
• Incremental expenses directly attributable to acquiring and disposing of those assets (for example, transaction costs and costs to sell)

The financing category

In order to determine what income and expenses to classify in the financing category, IFRS 18 requires an entity to differentiate between two types of liabilities (which we have termed as ‘Type 1’ and ‘Type 2’ for brevity in this publication):

• Type 1: liabilities that arise from transactions that involve only the raising of finance (i.e., entity receives finance in the form of cash, own equity or the discharge of a liability and will return cash or its own equity in exchange at a later date)
• Type 2: other liabilities (i.e., liabilities other than Type 1 liabilities)

The following diagram summarizes the requirements for Type 1 and Type 2 liabilities:

For entities that do not provide financing to customers as a main business activity, the financing category includes income and expenses that arise from the initial and subsequent measurement of all Type 1 liabilities, as well as incremental expenses attributable to the issue and extinguishment of such liabilities. For example, interest expense on a debt instrument issued. There are separate requirements for entities that provide financing to customers as a main business activity, which is discussed in the ‘Operating’ section below.

Interest income and expenses, as well as the effect of interest rate changes that arise while applying another IFRS accounting standard to ·other liabilities’ (i.e., Type 2 liabilities above), are recognized in the financing category. For example, the interest expenses recognized under IFRS 16 Leases on the accounting for lease liabilities.

The latter part of this requirement is important, as not all lFRS Accounting Standards require an entity to disaggregate income and expenses arising from changes in the carrying amount into separate amounts for interest income and expenses and other types of income and expenses - IFRS 2 Share-based Payments is an example of such a standard.

An entity would therefore recognize in the financing category the interest expenses on:

• Payables recognized under IFRS 9
• Contracts with a significant financing component, recognized under IFRS 15
• Revenue from Contracts with Customers
• Lease liabilities recognized under IFRS 16
• Net interest expense on a net defined benefit liability (or asset)
• Unwinding of a discount on a provision

Taking a long-term provision as an example, an entity could recognize three types of changes to the provisions:

1. Periodic unwinding of the discount

2. Effects of changes in the discount rate

3. Effects of changes in the best estimate of the expenditure required to settle the liability

Only the first two would be classified in the financing category, because they are financing in nature.

How we see it

Under IAS 1, practice is somewhat mixed with respect to the presentation of the different types of changes in provisions. Thus, the prescriptiveness of IFRS 18 will assist in comparability between entities.

For the avoidance of doubt, the standard outlines income and expenses that are not interest income or expenses arising as a result of applying IFRS Accounting Standards and that will therefore be classified in the operating category, for example:

• Expenses recognized for the consumption of purchased goods or services
• Current and past service costs from a defined benefit plan and
• Fair value remeasurements of a contingent consideration liability recognized by applying IFRS 3 Business Combinations

The operating category

The operating category is intended to capture income and expenses from the entity’s main business activities. However, IFRS 18 describes it as a residual category, so the operating category will comprise all income and expenses not included within the other categories, even if such income and expenses are volatile and/or unusual.

This approach was intended to work for different business models, while still providing a complete picture of the entity’s operations. By applying the residual approach, the operating category will include all income and expenses from an entity’s main business activities and will also include other items that are not classified within any other category. However, any income or loss from investments accounted for using the equity method is to be included in the investing category, regardless of the specified main business activities of the entity.

If an entity has a specified main business activity of investing in assets, the income and expenses from those assets will be included in the operating category, e.g., real estate companies will need to present rental income in the operating category.

Entities with a specified main business activity of providing financing to customers will classify income and expenses from cash and cash equivalents that relate to providing financing to customers (for example, cash and cash equivalents held for related regulatory requirements) within the operating category. These entities will also need to determine which of their Type 1 liabilities (mentioned above) relate to providing financing to customers, since income and expenses arising from these liabilities must be included in the operating category. For income and expenses from Type 1 liabilities that do not relate to providing financing to customers, a policy choice is available to the entity to include these in either the operating or the financing categories. If an entity is unable to distinguish between these Type 1 liabilities, the income and expenses on all Type 1 liabilities will need to be included in the operating category.

Operating profit or loss subtotal

IFRS 18 specifies that an entity shall present a subtotal representing operating profit or loss, which comprises all income and expenses classified in the operating category. This has been introduced to provide useful information to users, to reduce diversity in reporting and to enhance comparability.

How we see it

Although many entities already present an operating profit or loss subtotal, it cannot be presumed that the classification of income and expenses to the operating category will not change. For example, many entities currently present ‘share of the profit or loss of associates and joint ventures accounted for using the equity method’ in the operating category, which is not permissible under IFRS 18.

Income taxes

An entity is required to classify in the income taxes category tax expense or tax income that are included in the statement of profit and loss applying IAS 12 Income Taxes and any related foreign exchange differences. The IASB has clarified that the presentation of income and expenses related to income tax in that category complies with the presentation requirements of IAS 12.

Discontinued operations

An entity is required to classify in the discontinued operations category income and expenses from discontinued operations as required by IFRS 5. The IASB has clarified that the presentation of income and expenses related to discontinued operations in that category complies with the presentation requirements of IFRS 5.

Presentation of specific items

The requirement to classify all income and expense into one of the five categories above can be difficult for items that might fit into more than one of these categories. Thus, IFRS 18 provides guidance for classifying some specific types of income and expense.

Foreign exchange differences

Foreign exchange differences are classified in the same category as the income and expenses from the items that gave rise to those differences. For example, foreign exchange differences on a trade receivable denominated in a foreign currency will be classified in the operating category, whereas foreign exchange differences arising from a debt instrument liability (that will be settled in cash) denominated in a foreign currency will be classified in the financing category. However, an entity is permitted to classify foreign exchange differences in the operating category if classifying them in the same category as the income and expenses from the items that gave rise to them would involve undue cost or effort.

How we see it

The undue cost and effort exemption, resulting in the classification of particular foreign exchange differences in the operating category, is a pragmatic solution which could involve significant judgement.

Fair value gain or loss derivatives

The classification of fair value gains and losses on derivatives depends on whether the derivatives are used to manage exposure to identified risks and whether they are designated as hedging instruments. The following diagram, based on Figure 5 in the illustrative examples to IFRS 18, summarizes these requirements:

The requirements for derivatives only specify the appropriate category for gains and losses arising on them; they do not override the requirements in other IFRS , nor do they specify the line item.

How we see it

Many entities already present the gains and losses on designated hedging instruments and on those instruments used to manage risk in the manner required by IFRS 18. However, the new prescriptive requirements will require entities who are not currently presenting this information in line with IFRS 18 to change the current practice.

Example of presentation of the statement of profit of loss

A simple illustration of IFRS 18 requirements is prescribed below for an entity without specified main business activities (i.e., the entity does not invest in assets or provide financing to customer as main business activity):

Statement of profit or loss*

*Applicable to an entity that does not have a main business activity of investing in assets and/or providing financing to customers.

The following figure, based on Figure 6 in the Illustrative Examples to IFRS 18, provides an overview of how an entity identifies an MPM:

IFRS 18 intentionally limits the definition of MPMs to subtotals of income and expenses. This intentionally narrow definition results in MPMs being a subset of other performance measures (e.g., alternative performance measures), as illustrated in the following diagram based on a presentation by the IASB Staff:

To improve transparency around these measures, IFRS 18 requires an entity to disclose information about all of its MPMs in a single note to the financial statements. The standard also lists several disclosures to be made, including:

• How the measure is calculated
• How it provides useful information, and
• A reconciliation to the most comparable subtotal specified by IFRS 18 or another IFRS Accounting Standard

IFRS 18 does not prohibit presentation of MPM in the Statement of Profit and Loss. However, the IASB noted that an entity presenting an MPM in the statement of profit and loss will need to comply with the requirements set out in IFRS 18.24 for additional subtotals presented in the statement. An entity that presents an MPM in the statement of profit and loss would also need to disclose all the information required for MPMs in a single note, even if this results in duplication.

An entity presents additional subtotals and line items if they are necessary to provide a useful structured summary in the primary financial statements.

Location of information, aggregation, and disaggregation

The standard differentiates between ‘presenting’ information in the PFS and ‘disclosing’ it in the notes and introduces a principle for determining the location of information based on the identified ‘roles’ of the PFS and the notes. An entity is required to ‘present’ information in the PFS to provide structured summaries of the entity’s income, expenses, assets, liabilities, equity and cash flows that are useful to users. The entity will also need to ‘disclose’ other material financial information in the notes to supplement the PFS.

IFRS 18 requires aggregation and disaggregation of information to be performed with reference to similar and dissimilar characteristics while keeping the identified roles of the PFS and the notes in mind. Since the purpose of the PFS is to provide a useful structured summary, an entity will, by design, aggregate material items on the face of the PFS, and then need to disaggregate them in the notes.

IFRS 18 also includes guidance on determining meaningful descriptions, or labels, for items that are aggregated in the financial statements and it requires disclosure of further information regarding items labeled as ‘other’.

Consequential amendment to IAS 7

The amended IAS 7, once effective, will require all entities to use the ‘operating profit’ subtotal as the starting point for determining cash flows from operating activities under the indirect method. It is expected that the use of the operating profit subtotal as a consistent starting point will make the statement of cash flows more consistent and help investors analyze and compare companies’ operating cash flows. The change in the starting point is also simplifies the presentation of cash flows from operating activities as it will eliminate some reconciling items that are used at present.

The amendments will also remove the optionality around the classification of cash flows from dividends and interest in the statement of cash flows currently available under IAS 7. That removal aims to increase comparability between entities and provide more meaningful information as, currently, the different classifications of these cash flows do not necessarily convey information about the role of interest and dividends in an entity’s business activities. The table below, based on Table 4 in the IASB’s Effects Analysis of IFRS 18, presents the comparison of the IAS 7 requirements before and after the amendments:

* Classification of these types of cash flows for entities with a specified main business will be impacted by how the related income and expenses are classified in the statement of profit or loss.

Transition and effective date

IFRS 18 will be effective for annual reporting periods beginning on or after 1 January 2027. Earlier application is permitted and must be disclosed in the notes. An entity is required to apply the consequential amendments to other IFRS Accounting Standards when it applies IFRS 18.

The standard applies retrospectively. However, an entity is not required to present the quantitative information specified in IAS 8.28(f) (i.e., the adjustment for each financial statement line item affected and the related effect on basic and diluted EPS, for the current period and each prior period presented).

In its annual financial statements, an entity must disclose, for the comparative period immediately preceding the period in which IFRS 18 is first applied, a reconciliation between each item in the statement of profit or loss between:

• The restated amounts presented in accordance with IFRS 18, and
• The amounts previously presented by applying IAS1

An entity is permitted, but not required, to provide the reconciliation for:

• The reporting period in which IFRS 18 is first applied, and/ or
• Earlier comparative periods

Applicability in India

The Institute of Chartered Accountants of India (ICAI) has still not issued an exposure draft corresponding to IFRS 18. However, since Indian accounting standards (Ind AS) are largely converged with IFRS, considering India’s overall commitment to converge with IFRS and its past experience, we expect that Ind AS corresponding to IFRS 18 to be notified and adopted in due course. We also expect that to ensure consistency and apply IFRS 18 equivalent Ind AS in entirety, consequential amendments to Schedule Ill to the Companies Act 2013 (as amended), which prescribes format of financial statements for companies in India, and consequential amendment to other Ind AS will also be made.

In addition, Indian entities, which are preparing IFRS financial statements (either for some specific requirements or voluntarily), and entities which are required to do group reporting under IFRS, will also be required to comply with these requirements. If there are significant differences in adoption of IFRS 18 equivalent under Ind AS, such entities may need to maintain dual books or make other system changes.

Practical implication of new requirement

While there appears to be time before IFRS 18 become effective, we believe effective implementation requires advanced preparation, including system changes and user awareness of potential implications in advance. Hence, entities are strongly encouraged to proactively begin preparing for transition. For this, they may consider the following steps:

Readiness assessment:

• Conduct a detailed analysis of IFRS 18, particularly focusing on new categorization requirements. Understanding changes and training team is important for successful implementation.
• For groups of entities with diverse main business activities, evaluate how the categorization of income and expenses will impact group financial reporting and consolidation processes.
• For entities reporting under multiple GAAPs, decide the approach for reporting such as the need for dual books of accounts, templatization, etc.
• Evaluate judgement areas and policy choices available.
• Conduct readiness assessment for availability of relevant data and information.

Evaluate systems, process and controls impacts:

• Entity may need to adjust system and process to capture relevant information to satisfy new requirements, e.g., impact on chart of accounts, groupings, and classifications at the time of transaction accounting.
• Evaluate how to change the classification of income and expenses retrospectively to meet the requirement for comparative periods.
• In India, there is a requirement to maintain audit trail under the Companies Act (as modified). Evaluate potential implications of the system changes or manual data processing on the requirement to maintain audit trail.
• Updating standard operating procedure (SOPs) and controls, if any.

Revisit performance measures:

• Identify MPMs and determine which are within the scope of IFRS 18 requirements.
• Revisit/ reevaluate the presentation of MPMs.
• Develop mechanism for regular tracking of MPMs used in various public communications to comply with IFRS 18 disclosure requirements.
• Entities may need to design new systems/ processes and controls around MPMs due to their inclusion in financial statement.

Effect on contracts or compensation policies:

• Assess impact on contracts or compensation policies: Entities with management remuneration policies based on a particular measure in the statement of profit and loss may need to consider whether IFRS 18 impact determination of such measure. For example, operating profit measurement before and after IFRS 18 application may potentially differ and entities paying remuneration based on such measure may need to consider whether there is also a need for a corresponding change measure the remuneration policy.
• Similar to management remuneration, the application of IFRS 18 may also change the determination of performance measures used in loan agreement and thereby compliance with debt covenants. Entities will also need to evaluate whether there is a need for changes in the loan agreement to avoid potential non-compliance.

Communication strategy:

• Develop a strategy for communicating potential impacts of IFRS 18 adoption to the shareholders and other stakeholders, ensuring transparency and preparedness.
• Monitor changes in local reporting landscape.