Significant changes are on their way to the presentation and disclosures in financial statements following the International Accounting Standards Board (IASB) publication of IFRS 18: Presentation and Disclosure in Financial Statements (IFRS 18), with a particular focus on improving the reporting of financial performance.
Who will be affected by the changes?
IFRS 18 will impact all entities that prepare financial statements in accordance with IFRS Accounting Standards, which will replace IAS 1: Presentation of Financial Statements (IAS 1).
What is IFRS 18?
IFRS 18 aims to improve the effectiveness and consistency of financial communication to stakeholders. The new standard seeks to improve the structure and content of the financial statements, addressing challenges stakeholders face when comparing companies that may present their operating profit or loss differently.
Further to this, the issue is compounded by companies’ increasing use of non-GAAP measures, which lack standardisation and quality disclosures, to properly explain the financial performance of the company.
The introduction of IFRS 18 aims to address these challenges by enabling companies to present information in a way that is consistent and valuable to stakeholders, thereby improving transparency and comparability in financial reporting.
How will IFRS 18 impact the presentation of the profit or loss?
IFRS 18 will now require items of income and expense to be classified into five categories: operating, investing, finance, income taxes and discontinued operations. Whilst the first three categories mirror the classification of cash flows set out in IAS 7: Statement of cash flows (IAS 7), there is not an explicit alignment between these categories and the corresponding categories in the statement of cash flows.
In addition to the totals and sub-totals required by IAS 1, IFRS 18 introduces two new mandatory sub-totals, operating profit and profit before financing and income taxes.
A basic illustration of the requirements is presented below that conforms with the requirements of IFRS 18.
Operating expenses can continue be split by function, as shown in the illustration above, or by nature. However, unlike IAS 1, IFRS 18 allows for a mixed presentation, meaning that the illustration above could have included a separate line for depreciation or impairment charge above the operating profit line.
IFRS 18 also contains specific guidance on the presentation of gains and losses on foreign exchange and changes in fair value of derivatives.
Whilst IFRS 18 aims to improve the comparability between entities, the classification of income and expenses is dependent on the entity’s main business activity. For example, if an entity’s main business activity relates to providing finance to its customers, their interest income and interest expense may be assessed as being operating rather than financing.
How will IFRS 18 impact the presentation of the cashflow statement?
The changes being introduced by IFRS 18 also have a knock-on effect on other IFRS Accounting Standards, such as IAS 7, which prescribes the classification of interest and dividend cashflows to be presented, moving away from allowing the company to dictate it through its accounting policy.
The changes can be summarised in the below table:
Disclosures of non-GAAP performance measures
It is commonplace for an entity to disclose non-GAAP performance measures to aid management’s view of the entity’s financial performance to stakeholders. IFRS 18 introduces the concept of management-defined performance measures (MPMs), which capture most, but not all, commonly used non-GAAP performance measures.
Such MPMs can include earnings before interest, tax, depreciation and amortisation (EBITDA), operating profit excluding one-off costs incurred (such as IPO transaction costs) or an ‘adjusted’ profit to exclude the impact of certain costs (such as share-based payments).
IFRS 18 introduces the need for increased transparency in relation to MPM financial disclosures, should the MPM be used in public communications outside financial statements and used to communicate to users of financial statements, management’s view of an aspect of the financial performance of the entity as a whole. Private companies that do not make any public communications will not be subject to the new disclosure requirement.
For MPMs relating to the entity’s financial performance, the following disclosure will be required as part of the notes to the financial statements:
- How the MPM was calculated;
- A reconciliation to the most directly comparable total or subtotal specified by IFRS Accounting Standards
- A description of the aspect of financial performance that is being presented by the MPM, which should include an explanation as to why management believe the MPM provides an insight into the entity’s financial performance;
- The income tax effect and effect on non-controlling interest for each reconciling item disclosed as per above;
- A description of how the entity determines the income tax effect; and
- A statement explaining that the MPM disclosed may not be comparable to other companies disclosing similar MPMs, and reflects management’s views of this aspect of financial performance.
When does IFRS 18 come to effect?
IFRS 18 will be effective for annual reporting periods on or after 1 January 2027, with earlier application permitted. Restatement of the comparative period will be required in the year of adoption. Further to this, in the year of adoption, the financial statements must include a reconciliation of the comparatives presented under IAS 1 in the previous financial statements and the comparatives presented under IFRS 18 in the current financial statements.
For those that apply UK-adopted International Accounting Standards, the UK Endorsement Board (UKED), who are responsible for endorsing IFRS standards in the UK, are progressing the endorsement project for IFRS 18, and a decision on the adoption is expected to be made prior to the effective date of the standard.
If you would like to discuss any of the points discussed in this article, please get in touch with Jas Marwaha at jas.marwaha@oneadvisory.london.
Download Article
