Your primary financial statements may look different in the future

The International Accounting Standards Board (IASB) is expected to issue a new IFRS Accounting Standard (expected to be IFRS 18) in the first half of 2024. IFRS 18 will significantly update the requirements for financial statement presentation and replace IAS 1 Presentation of Financial Statements.
While the final text of IFRS 18 was not available at the time of writing, IASB staff papers and decision summaries published by the IASB set out conclusions reached and therefore enable the fundamental requirements of IFRS 18 to be reasonably understood. This article summarises the main changes, which you can read more about in our recent publication.

Why the change?

The aim of IFRS 18 is to improve the comparability of financial performance between entities. For example, some entities present ‘operating profit’ in their statement of profit or loss, and others do not, while those that do may define it differently. In addition, some entities disclose management financial performance measures outside the financial statements, which may be defined differently to statutory profit measures.

Classification of income and expenses

We expect to see significant change in the way income and expenses are classified in profit or loss. Currently IAS 1 does not require income and expenses to be classified into particular ‘classes’ or ‘categories’.
To enhance consistency, IFRS 18 will require income and expenses to be classified into five categories:
  • Investing
  • Financing
  • Income tax
  • Discontinued operations
  • Operating (this is a residual category if income and expenses are not classified into any of the above categories).

It should be noted that there is not explicit alignment between the investing, financing and operating categories stated above for the statement of profit or loss, and the corresponding categories in the statement of cash flows as required by IAS 7 Statement of Cash Flows. However, they may be classified the same way for both statements in many cases.
The classification of income and expenses may also not be identical for all entities because IFRS 18 will require entities to assess their ‘main business activities’. For example, a manufacturer investing excess cash in publicly traded shares is not a main business activity, and it will likely classify any income received as investing. Contrast this with a bank actively trading a portfolio of publicly traded shares. This may be a main business activity for the bank, and it is likely to classify income as operating.

More line items and sub-totals in the statement of profit or loss

In addition to mandatory sub-totals required by IAS 1, IFRS 18 will introduce two new mandatory sub-totals:
  • Operating profit or loss – this is a sub-total of all income and all expenses classified as operating
  • Profit or loss before financing and income tax – this is the sub-total of operating profit or loss, and all income and expenses classified as investing.
     
These new sub-totals may differ from those quoted in non-IFRS information in the Directors’ or Chairperson’s Reports, or other information currently published by the entity such as market briefings, analyst presentations, etc.

Labelling, aggregation and disaggregation

IFRS 18 will introduce stricter requirements regarding aggregation and disaggregation. Items must be aggregated based on shared characteristics and disaggregated if the resulting disaggregation is material. The use of ‘other’ to describe a group of items will also be restricted in certain circumstances. It would help if you used the most informative label instead of ‘other’. If classifying expenses by function, additional information regarding expenses by nature, such as depreciation, amortisation, employee benefits, impairment, etc., must also be provided in a single note.

Amendments to IAS 7

We also expect IFRS 18 to result in consequential amendments being made to IAS 7, including:
  • When the indirect method is used, the starting point for operating cash flows in the statement of cash flows will be the newly introduced mandatory sub-total, operating profit or loss
  • In general, it will no longer be an accounting policy choice to classify interest and dividend cash inflows (to be shown as investing activities) and interest cash outflows (to be shown as financing activities). However, exceptions may exist if these form part of the entity’s main business activities
  • Dividend cash outflows will be classified as financing cash outflows.

Management performance measures

IFRS 18 will also contain new disclosure requirements for ‘management performance measures’ such as earnings before interest, taxes, depreciation and amortisation (EBITDA), ‘adjusted profit’, operating profit excluding recurring items, etc. These new disclosures will apply to ‘management performance measures' if they are used in public communications outside the financial statements, to communicate to users of financial statements, management’s view of an aspect of the entity’s financial performance.
These new disclosures will not apply:
  • To certain specific sub-totals in the statement of profit or loss such as gross profit
  • To social media posts and oral communications
  • If an entity makes no public communications (as may be the case for private companies)
  • To non-IFRS information based on financial measures that are not performance-related, such as measures based only on the financial position of the entity.
The new disclosures must be included in a single note to the financial statements, and include:
  • A description of why the management performance measure communicates management’s view of an aspect of the entity’s financial performance
  • A reconciliation to the most directly comparable total or subtotal specified by IFRS Accounting Standards (e.g., reconcile ‘adjusted operating profit’ to ‘operating profit’ as defined by IFRS 18 and explain the adjustments)
  • The income tax effect and effect on non-controlling interest for each reconciling item disclosed as per above.

Which requirements of IAS 1 are not expected to change?

The following topics are expected to be ‘brought forward’ into IFRS 18 without significant changes:
  • The four primary financial statements to be included in financial statements
  • Frequency of reporting
  • Comparative information
  • Offsetting
  • Most statement of financial position requirements
  • Classification of assets and liabilities as current versus non-current
  • Most statement of cash flows requirements
  • Statement of comprehensive income requirements
  • Statement of changes in equity requirements
  • Capital disclosures.

What do these changes mean in practice?

Entities may need to adjust accounting systems to appropriately ‘tag’ and categorise income and expenses into the new IFRS 18 categories. This process may be complex for groups with diverse operations (various main business activities) and multiple reporting systems.
Investor relations teams will also need to be aware of these changes, as any new management performance measures used in public communications must be disclosed and reconciled within the financial statements.

Effective date

The effective date of IFRS 18 is expected to be for annual periods beginning on or after 1 January 2027. Comparatives must also be restated. As the main impact is on the statement of profit or loss, entities need to have adjusted or upgraded systems ready by 1 January 2026 (for December reporting entities) or 1 July 2026 (for June reporting entities).

For more on the above, please contact your local BDO representative.

This article has been based on an article that originally appeared on BDO Australia: Read the original article here.