IFRS 18 will usher in essentially the most significant change to profit and loss accounting because the introduction of IFRS accounting standards greater than 20 years ago to bring consistency and transparency to the financial statements of listed corporations.
The latest standard responds to investor concerns in regards to the challenges of comparing corporations’ financial performance. Today, corporations’ profit and loss statements vary significantly in content and structure. IFRS 18 provides investors with more transparent and comparable details about corporations’ financial performance and may support higher investment decisions.
IFRS 18 won’t come into effect until January 1, 2027, but corporations can apply the usual early. Regardless, several steps must be taken to organize. For example, corporations can assess mandatory changes to internal systems and processes. And they will consider the right way to communicate changes to reported information to investors. It is feasible that early adopters of IFRS 18 will share a few of this information with the market next yr.
IFRS 18 responds to market demand for greater comparability and transparency and focuses on financial performance information within the income statement. And all corporations applying IFRS worldwide are expected to adopt the brand new standard from 2027.
IFRS 18 introduces three latest requirements, including:
- two latest subtotals within the profit and loss account;
- disclosures about management-defined key performance indicators (MPMs); And
- expanded guidance on grouping information in financial statements.
Subtotals within the profit and loss statement
IFRS 18 improves the comparability of data within the income statement by introducing:
- three newly defined categories – operations, investment and financing; And
- two latest required subtotals to enable evaluation – operating profit and profit before financing and income taxes.
Among the challenges investors face when comparing the financial performance of corporations is the inconsistency in reporting operating profit. Operating profit is one of the vital commonly used subtotals. However, corporations use different definitions for this subtotal because operating profit was not previously defined in IFRS. For example, in a sample of 100 corporations, 61 represented operating profit using no less than nine different definitions.
The profit and loss statement structure laid out in IFRS 18 requires corporations to consistently classify their income and expenses as operating, investing or financing. These requirements are illustrated in Figure 1 for a corporation that presents its operating expenses primarily by function. The dark gray highlighted subtotals are required under IFRS 18 and the sunshine gray subtotals are additional subtotals presented to offer a meaningful structured summary of the corporate’s income and expenses.
Figure 1. Companies reporting operating expenses primarily by function.
The Operating categoryalong with the Operating profit or loss Subtotal:
- consists of all income and expenses not classified in the opposite categories;
- provides a whole picture of an organization’s operations; And
- serves as the place to begin for the money flow statement.
The Investment category:
- includes income and expenses from money and money equivalents in addition to individual investments, i.e. rents from an investment property or dividends from shares in other corporations;
- also includes shares in profits or losses of associates and joint ventures accounted for using the equity method; And
- allows investors to investigate the returns of those investments independently of an organization’s operations.
The Financing categoryalong with the Profit before financing and income taxes Subtotal:
- includes income and expenses from financing liabilities corresponding to bank loans and bonds;
- also includes interest expenses for all other liabilities, e.g. B. Leasing and pension liabilities; And
- allows investors to investigate an organization’s performance before the impact of its financing.
IFRS 18 also accommodates specific requirements to be certain that the operating profit of all corporations includes the income and expenses from an organization’s essential business activities. These requirements mean that some corporations, corresponding to banks and insurance firms, would otherwise assign certain income and expenses to the “operating” category moderately than the “investment” or “financing” categories.
Performance metrics defined by management
Companies often offer company-specific measures, commonly known as alternative performance measures or non-GAAP measures. IFRS 18 requires corporations to reveal company-specific metrics related to the income statement within the notes to their audited financial statements, along with accompanying explanatory notes and reconciliations.
Not all company-specific measures must be disclosed within the annual financial statements. Only those metrics that meet the definition of management-defined key performance indicators (MPMs) are disclosed. MPMs are subtotals of income and expenses, corresponding to: B. Adjusted operating profit, that are included in an organization’s public communications outside of the financial statements and supply management’s view of the corporate’s performance.
Companies must disclose details about MPMs in a single communication. A critical aspect of the disclosures is that every MPM should be reconciled to essentially the most directly comparable subtotal or grand total defined within the IFRS accounting standards. Figure 2 shows the reconciliation of adjusted operating profit (MPM) to operating profit under IFRS 18 and adjusted benefit from continuing operations (MPM) reconciled to benefit from continuing operations under IFRS 18.
Figure 2. MPM disclosure.
These reconciliations will provide investors with a greater understanding of how MPMs compare to subtotals under IFRS accounting standards. The MPMs disclosure package will bring transparency and discipline to those measures. Companies are also required to offer:
- Explanations of why each MPM is reported and the way it’s calculated;
- for every adjusting item, the quantity included in each item of the income statement along with the tax impact and the impact on non-controlling interests; And
- Explanations of any changes to reported MPMs.
Companies welcome disclosure requirements for MPMs because they will present their view of performance in financial statements, and investors like them because they expect more transparency about management’s view.
Grouping information
IFRS 18 introduces expanded guidance on grouping information in financial statements, also often known as aggregation and disaggregation. Companies have to rethink how they summarize information in financial statements. You must consider the next:
- whether information must be presented in the first financial statements (to offer useful structured summaries of income, expenses, assets, liabilities, equity and money flows) or disclosed within the notes (if material);
- the right way to meaningfully label items and disclose details about items marked “other”; And
- How business expenses are presented or disclosed by type or function.
These requirements address investor concerns that the way in which corporations group information in financial statements doesn’t all the time provide investors with the data they need for his or her evaluation. An example of investor frustration is that some information will not be presented in enough detail, while other information is obscured by an excessive amount of detail.
For more information on how IFRS 18 will provide investors with more transparent and comparable details about corporations’ financial performance, see https://www.ifrs.org/news-and-events/news/2024/04/new-ifrs-accounting-standard-will-aid-investor-analysis-of-companies-financial-performance/
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